Wednesday, January 29, 2014 - Benny Jets

Benny Jets

by Sinclair Noe

DOW – 189 = 15,738
SPX – 18 = 1774
NAS – 46 = 4051
10 YR YLD - .07 = 2.67%
OIL – 01 = 97.40
GOLD + 12.00 = 1268.70
SILV + .15 = 19.81

You’ve heard the old post office creed; “neither snow nor rain nor heat nor gloom of night stays these couriers from the swift completion of their appointed rounds.”

Generally true, however I bet some letter carriers are having a tough time delivering mail in Atlanta today. The Federal Reserve apparently has a creed. Who knew? Neither a disappointing December jobs report nor turmoil in emerging markets nor gloom of the US economy shall stay these central bankers from the incremental completion of their taper.

Don’t worry; nothing to look at here; keep moving, keep moving. No sonny, that’s not a train wreck on Wall Street, that’s just the debris and detritus stirred up by the whirlybird which will now carry Helicopter Ben into the sunset, or more accurately to the boardroom of some investment bank. Yes, this is the last FOMC meeting for Ben Bernanke. He promised he would set a course for exiting QE, and he has; the problem is that the set course is fraught with perils.

The Federal Reserve’s policy making Federal Open Market Committee wrapped up a two day meeting today by announcing they would cut back their bond buying program by $10 billion, to a mere $65 billion per month.  The FOMC added that it was “likely” to continue the pullback, suggesting a similar cut is probable at its next meeting, in March. The stock market fell for the fifth session out of the past six, wiping out yesterday’s gains, but stocks were already moving lower before the Fed announcement.

While noting recent weakness in the housing sector recovery the FOMC statement says the overall economic picture continues to improve. And then the statement included a little slap on the wrist for Congress: “Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.

The Fed reiterated their view that "risks to the outlook for the economy and the labor market as having become more balanced," language they added to the statement for the first time in December. They reconfirmed that they will likely keep interest rates in the near zero range even if the unemployment rate drops below the target of 6.5%. And just remember your mantra: tapering is not tightening, tapering is not tightening.

And if taper leads to a little turmoil in emerging markets, well what’s it to you? The Fed pullback is contributing to a global shift in investments. That is causing problems for countries like Turkey, which would the example du jour.  The central bank in Turkey tried to bolster that nation’s currency yesterday by sharply raising its benchmark interest rate. The Turkish central bank increased the rate for one-week loans to banks to 10% from the previous level of 4.5%. The idea was to lure investors with a better yield, instead it may be causing collateral damage to the rest of its economy.

And today, the Turks learned the meaning of the old axiom, “don’t fight the Fed”, as the Turkish lira slumped, along with other emerging market currencies. The Russian ruble took another hit, the Argentine peso continued to plunge, and the South African rand could not be shored up. The South Africans raised rates a more subtle half-percent from 5% to 5.5%.

We used to identify the fast growing emerging markets as BRICS – Brazil, Russia, India, China, and South Africa. Now the new catch phrase is the “fragile five” and it refers to the emerging economies of Turkey, Brazil, India, South Africa and Indonesia as economies that have become too dependent on skittish foreign investment to finance their growth ambitions. The term has caught on in large degree because it highlights the strains that occur when countries place too much emphasis on stoking fast rates of economic growth.

Actually, the emerging market turmoil may be working in the Fed’s favor. Investors concerned about emerging market risk are seeking out the safe haven of Treasury bonds, bidding up prices and pushing down yields even as the Fed pulls back from bond purchases. But there are limits to how low the Fed can push emerging market currencies. The declines could come back to bite the developed economies of the US, Europe and Japan. Developing countries have served as engines of global growth, but now they find their purchasing power diminished and that equates to buying fewer exports. The direct effects of the recent emerging market foreign exchange turbulence, if contained, are not likely to prove substantial, but that’s based on the idea that things don’t deteriorate from here.

It makes for challenging times for the central bankers of emerging economies. The flight of foreign capital, which is a primary reason for the currency declines, is a result of investors’ putting money back into developed countries as their economies improve. To counteract the outflow of capital, the policymakers lure investors with higher interest rates but higher rates put the brakes on economic growth. And currency investors know this and bet that the central banks won’t be able to keep rates high for long. Sure enough, in today’s case of the Turkish central bank, the currency sharks smelled blood and they killed off the policymakers last vestiges off credibility.

All the blame for the problems in Turkey can’t be laid at the feet of the Fed; the Turks had a big mess before the taper. There has been an extensive corruption probe against the government and Prime Minister Erdogan responded by purging the judiciary and the police force.

The world can be chaotic at times, but we usually muddle through, except when it gets too crazy. Whenever we talk about emerging market turmoil, we’re reminded of 1997, when the Fed raised rates just a little and a few months later, the hot money went flying out of the developing Asian markets, then Russia defaulted, Long Term Capital Management missed that bet, and wham, bam, it was a meltdown man.

Of course, back then we didn't have hundreds of trillions of dollars in derivatives to contain the risk. Nowadays we have more than a quadrillion in derivatives to protect us. What could go wrong?

And that brings us to our next question of the day: what the heck is a MyRA?

Did you catch that last night during the State of the Union speech? A quick and stumbling reference to My-aye-aye-aye-RA. Obama promised to use executive action to create a new middle class savings vehicle, although he didn’t explain what it was. So, the White House issued a briefing sheet to explain that the MyRA, or My Retirement Account, is a new simple, safe and affordable “starter” retirement savings account that will be available through employers and help millions of Americans save for retirement. This savings account would be offered through a familiar Roth IRA Account and, like savings bonds, would be backed by the US government.

The administration noted that many private-sector providers don’t allow “smaller balance savers” to open accounts; providers who do allow such accounts often charge fees that can eat up a proportionately high percentage of their balances. In his address, Obama described the myRA as “a new savings bond” that “guarantees a decent return with no risk of losing what you put in.”

Today, Mr. Obama signed a presidential memorandum to create the "myRA" program, which he told employees would go toward "making sure that after a lifetime of hard work you can retire with some dignity." The retirement accounts can be opened with as little as $25, and monthly contributions can be as little as $5, automatically deducted from paychecks. The program will operate like a Roth IRA, so contributions would be made with after-tax dollars. That means account-holders could withdraw the funds at any time without paying additional taxes.

The funds would be backed by US government debt, similar to a savings option available to federal employees, and earn the same variable interest rate return as the Thrift Savings Plan Government Securities Investment Fund accounts that federal employees enroll in. Investors could keep the accounts if they switch jobs or convert them into private accounts, and once the account reaches $15,000 funds must be withdrawn or it can be rolled over into a private sector Roth IRA. Treasury Secretary Jack Lew will be in charge of setting up the program and it should be available through some employers by the end of the year. Workers can invest if they make less than $191,000 a year. Businesses will not administer or run the accounts. They will simply offer them to their employees if they decide to participate.

There are still some details of the plan that are not quite clear. The Federal Thrift Savings Plan caps contributions to 10%, and there are rules on what investments are made. Already we are hearing the loons come out with conspiracy theories. This is not – repeat NOT – an effort to confiscate existing IRAs. It is a little like the old Savings bonds that you used to buy, which were actually a decent deal; not a big wealth builder but a decent savings vehicle.

There was plenty more to the State of the Union speech, but you probably slept through that part, so I’ll give you a quick recap: The state of the union is absolutely fantastic for the top 1%, and for about 25% it’s decent, and for the rest of the country things are pretty lousy. Fifty years after the declaration we can now announce that the War on Poverty has been won. The poor and the middle class have been defeated. 

Tuesday, January 28, 2014 - If I Had a Hammer

If I Had a Hammer

by Sinclair Noe

DOW + 90 = 15,928
SPX + 10 = 1792
NAS + 14 = 4097
10 YR YLD - .02 = 2.75%
OIL + 1.50 = 97.22
GOLD - .80 = 1256.70
SILV - .13 = 19.66

The State of the Union is… tonight.

President Obama will describe how he will use his pen and phone to overcome the Do-Nothing Congress, and the Republicans have ironically lined up not one, but three responses to refute the idea they are nothing more than obstreperous obstructionists.

Everybody from the Pope to the big wigs in Davos have been talking about inequality and it will likely be a major theme in tonight’s speech. Job and wage growth has been broken since the 1990s. Median family incomes grew very slowly from 1979 to 1999, peaked that year, and have fallen 13% since. The economy has recovered since the near financial meltdown of 2008, but it has been the weakest recovery since the Great Depression, and one of the reasons it has been such a slow recovery is that the spoils of recovery have been unevenly distributed.

Even though we have seen job growth in the past 54 months, 6 of the 10 fastest growing job categories are in low paying service sector positions, such as retail clerk and home health care aids. Middle class income is sinking; the ranks of the poor are rising; and the economic gains only go to the top, or 95% of all economic gains in the “recovery” have gone to the top 1%. For the fourth year in a row, the real median weekly earnings for full-time workers fell slightly. Profits, on the other hand, have been putting on a show. As a share of national income, corporate profits were 14.6% in the third quarter of 2013, the most recent quarter for which we have data. In the history of these data going back to 1947, there was only one quarter higher than that, the last quarter of 2011.

These trends are moving in opposite directions but they are related. Profit is simply revenue minus expenses, and so there are two ways to grow profits: increase revenue or cuts expenses. Profits have been propelled by squeezing costs rather than growing demand. The strength of profits is directly related to the weakness in hourly wages. In a normal business cycle, you would expect profits to increase before wages. During the good times, we tend to get fat and lazy. During a downturn, businesses get lean and mean and they start running at high productivity again. But that hasn’t happened. Real compensation has grown more slowly than productivity.

One way to look at this is to compare labor costs against the unit profit costs, and even after accounting for increases in productivity, profits have outpaced workers earnings. Compensation net productivity growth is up about 10% since 2000, while profits net productivity growth has doubled in the same time.

In the US, there is no job security. The share of working age Americans holding jobs is now lower than at any time in the last 30 years, and three-quarters of those working people are living hand to mouth. Advances in technology are just going to make job prospects even more challenging. A recent McKinsey Global Institute survey found that 230 million service jobs representing some $9 trillion in salary globally could be transformed by computers by 2025. Forget about outsourcing manufacturing jobs overseas, the robots are coming.

So, there is really nothing to drive wages higher because demand for jobs outweighs supply of jobs. It is hard to demand higher wages when your replacement is filling out an application in the lobby, or when your replacement is a robot.

So, in addition to a pen and a phone, the President has a bully pulpit, and he will use it tonight. It remains to be seen if he will use it to put important ideas in people’s minds by shaping public discourse. We know he's going to talk about economic inequality, as he should. He will probably mention worker salaries, which haven't risen in 30 years.

One of the ideas we will hear tonight is the President will to use an executive order to raise the minimum wage in new federal contracts.  The order about the minimum wage and federal contracts will raise the pay from the national minimum of $7.25 an hour to $10.10 an hour. The change applies only to new federal contracts, and not to renewals of existing agreements. So, he’s using a pen and a phone to raise the minimum wage, but nobody will see an increase in their next paycheck.

And for college age students, who you might expect would raise a ruckus about all the inequality, well they don’t have jobs; they do have mountains of student debt and so they don’t dare take to the streets. Besides, nobody really thinks you can change government anymore. Pete Seeger is dead and nobody can find a hammer, much less figure out how to use a hammer. Cynicism is stifling, not motivating. It’s hard to get people worked up to change something that seems irreparably dysfunctional. Maybe we’ll just have to wait until the whole mess to topple under its own weight. And things right now are pretty lopsided. Even the high rollers at Davos acknowledged that just 85 people now hold as much wealth as 3.5 billion people.

Whatever the economic costs of inequality, the social costs are even greater. Research shows that unequal economies are more fragile and prone to financial crisis and that they have higher levels of social unrest, poor health, anxiety and a host of other problems. Inequality also reduces social mobility—the very foundations of the American Dream—and it’s a voting issue. A new Gallup Poll shows that two-thirds of adults are dissatisfied with wealth distribution in the US. It’s also a global problem and it is certainly at the core of the volatility we’ve seen in emerging market economies in the past couple of weeks.

The problems in emerging markets are not just related to the monetary policy of central bankers, although that is a big part of the equation; the problems are related to economic inequality and subsequent political problems which tend to crop up when there is economic inequality. After 5 down days on Wall Street, you might think the markets were waking up to the problems; then we have a modest gain and we are lulled into a sense of complacency. The financial markets in 2012 and a much of 2013 were moving in lockstep, in a “risk on-risk off” pattern, with high yielding emerging markets as the preferred “risk on” trade. Investors were chasing yield and finding it in emerging markets, where the yield was much higher than here, where the Fed has engineered negative real yields.

And in our complacency, we might have overlooked the similarity in emerging markets today with the similarities of 1997.  In the 1990s Asian crisis, the rapid withdrawal of hot money triggered combined liquidity and exchange rate-regime crises. Then and now, capital flight merely served to exacerbate homegrown problems. The initial flight of capital needn’t be prompted by a crisis anywhere at all. It might simply be a ‘rotation’ of short-term capital from one set of opportunities to others elsewhere: game over, move on. That means that as emerging countries tried to enter into the global economy, they set up to allow capital to flow in with ease, which also meant capital could flow out with ease. Emerging market economies that had nurtured reasonably liquid domestic capital markets were among the worst hit.

Even though the Fed’s taper talk sent a shudder through emerging markets last year, at least as big a culprit has been slowing growth in China, since lower demand for commodities hits many smaller economies hard. China is trying to engineer a transition from an export/investment driven economy to a consumer oriented one, and no country has managed that transition smoothly. Even worse, China’s consumption share of GDP has generally been declining in recent years.

Remember that Lehman, which had a large emerging markets desk, nearly went bust in the 1997 Asian markets crisis. Our big banks now look better diversified, but if a large bank bet wrong on enough trades, it could take a meaningful hit to its balance sheet. And more weakly capitalized Eurobanks are less able to sustain this sort of blow well. So while the emerging markets wobbles may not evolve into a full-blown crisis, it’s likely we’ll have a sustained period of roller coaster volatility before conditions stabilize.

There have been 14 Federal Reserve Chairmen; Janet Yellen is about to become the fifteenth. The transition of the Chair is cause for some trepidation. Market makers rightly wonder about the direction of monetary policy and the markets may act in a skittish manner. The first year of a new Fed Chair is not necessarily bad for the markets. By a 9 to 4 ratio, the first year of a new Fed chair leads to positive gains in the Dow Jones Industrial Average. The most recent and notable exception being the first year under Alan Greenspan (1987), where the Dow tanked more than 30% and finished the year down about 20%. Under Paul Volker, the Dow was volatile, with significant moves from negative to positive territory, but after one year of trading under the guidance of Volker saw the Dow in positive territory. Bernanke took the reins in 2006, which you may recall was a very good year for the Dow. Yellen? Well, time will tell.  Tune in tomorrow. 

Monday, January 27, 2014 - Sniffing Out Weakness

Sniffing Out Weakness

by Sinclair Noe

DOW – 41 = 15,837
SPX – 8 = 1781
NAS – 44 = 4083
10 YR YLD + .04 = 2.76%
OIL - .94 = 95.70
GOLD – 12.50 = 1257.50
SILV - .22 = 19.79

Last week was rough for the Dow Industrial, and today started with the blue chips in the red but not by much; it even looked like we might finish in positive territory. Nahh. The markets have been trending downward over the last week due to a mix of concerns. Emerging market strains, anxiety over tapering by the Federal Reserve, and weak manufacturing data from China likely contributed to a pullback. Also, new home sales were weak in December.

The international problems started with a report that Chinese manufacturing may contract for the first time in 6 months. Then Argentina’s central bank limited dollar sales to preserve international reserves that had fallen to a seven-year low. Then there were concerns about a default in the shadow banking system in China. Then there concerns about a corruption scandal for Prime Minister Erdogan’s cabinet in Turkey. Protesters occupied municipal buildings in the Ukraine. Then the South African rand dropped big. Then the whole thing spread. I don’t know what happened in Mexico but the peso took a hit. Bank of America analysts recommended buying the Mexican peso on Nov. 24 as one of their top two Japan-related trades for this year, predicting a rally that would have boosted the currency’s value to 8.4 yen. Instead, the peso slumped 3.5% last week. More than a third of the most-traded emerging-market currencies have already fallen below forecasts.

Neither China, Turkey, Argentina, nor any other country has anything to do with consumer stocks, or most other equities, badly underperforming following an excellent year for the US stock market which was supposed to help consumers through the wealth effect. If you haven’t received your trickle down just yet, don’t hold your breath.

Tech stocks, which by extension are a type of consumer stock, have started to look weak, after being so strong last year. After the close today, Apple whiffed on earnings because they really whiffed on iPhone sales. The company reported that it sold 51 million units, a 6.7% jump in sales, year-over-year, which is lower than sell-side expectations of 54.7 million. The good news is that Apple beat expectations on the top and bottom line, despite weak iPhone sales. Revenue was $57 billion, up 5.6% on a year-over-year basis. EPS was $14.08, up 2% year-over-year. If the market is going to catch a second wind, don’t look for tech, at least not tomorrow.

Has the correction begun? Check back in a few months and we’ll know for sure. If you don’t want to wait that long I understand; waiting for clarity is risky, and we all know you can’t go broke taking a profit. So, some folks are looking at this as a chance to get out while the getting is good. At the very least, make sure you have a prevent defense in your portfolio playbook. And then there’s the whole January Barometer, which posits that as January goes, so goes the rest of the year. We know that January has been ugly, and if you need further confirmation, the financial press has been clinging to thin straws in their never-flinching belief that any decline is a buying opportunity.

A core principle of both fundamental and technical analysis is "a rising tide lifts all boats." If the economy is strong and growing, the vast majority of companies should benefit. We should expect to see this show up in both quarterly earnings reports and higher stock prices. And when prices don’t move higher, that might be an indicator that the financial markets are sniffing out economic weakness in advance. When it comes to the possible end of a bull market though, we need to remember the real driver behind the move in the first place – the Fed. And the Fed is meeting this week to determine policy.

There’s growing evidence that things aren’t as good as the Fed anticipated, but I don’t think we’re at the point where the Fed is going to pull back and stop their tapering, and they certainly won’t reverse the taper. The Fed will probably cut its purchases in $10 billion increments over the next six gatherings before announcing an end to the program no later than December. Treasuries fell today, pushing the 10-year yield up from almost a two-month low.

The state of emerging markets has very little impact on the Fed’s decision to continue taper. Charles Plosser, president of the Philadelphia Fed, said in a January 14 speech: "When we started QE ... there were many economies and emerging markets and other places that were very critical of our policy. Now that we're trying to stop it, they've been very critical of our policy."

Minneapolis Fed President Narayana Kocherlakota, a voting Federal Open Market Committee told the New York Times there are other ways to offer accommodative monetary policy, other than buying bonds. He talked about the Fed providing forward guidance, which is a far cry from cranking up the printing press. And just for the record, Kocherlakota is one of the Fed guys who thinks the Fed needs to do more to expand its efforts to reduce unemployment.

Now that the tapering has begun, the idea of less Federal Reserve stimulus combined with slower Chinese growth and specific concerns in some countries led last week to a full-scale flight from emerging-market assets that could continue this week. Emerging markets have been inflated in recent years by huge amounts of cheap cash created by the Federal Reserve, much of which found its way into developing economies in the hunt for better returns. If it all seems vaguely familiar, it’s because it looks a lot like the wildfire that spread through the developing world and resulted in currency runs that hit the Asian Tiger economies, or Russia,  or Latin America.

There are a few reasons for concern about this latest conflagration. The scale of money that has moved to developing markets over the past decade and now dwarfs the sums which fled in panic 15 years ago. Lending into emerging markets has increasingly been through bond markets, rather than in the direct bank loans that dominated previously and which involved longer-term relationships between banks and the firms and countries. And the growth of index tracking exchange traded funds over the past decade has increased the liquidity and also the volatility, meaning money that flowed in can flow out very, very, fast. Emerging markets have attracted about $7 trillion since 2005 through a mix of direct investment in manufacturing and services, mergers and acquisitions, and investment in stocks and bonds. That was considered hot money, stoked by the Fed’s QE.

The State of the Union is…tomorrow. The State of the Union speech will likely be light on legislative agenda and long on optimism. We have a budget, there probably won’t be another government shutdown, at least until October; there is a chance for immigration reform, maybe. And that’s about it. Don’t look for big legislative vision because it won’t happen. There is an election later in the year and so lawmakers will be yelling at each other for most of the year and trying to highlight their differences rather than creating consensus. That means tomorrow’s speech will likely be long on optimism and framing the national conversation.

These annual updates have become more and more predictable, and less and less inspiring. There will be a new piece of technology; the President’s communications team is urging us to watch what they call the “Enhanced State of the Union” online with a live stream of the address and a split screen format with graphics and charts to highlight key points and statistics. Well, that should be fun. The site is whitehouse.gov/sotu

One chart you won’t see comes today from the Green Party in the European Parliament; it estimates the cost of the implicit guarantee that governments will back large financial institutions, known as “too big to fail”; the price tag in 2012 was 234 billion euros. That is the corporate welfare dished out to big banks in the form of free benefits. The estimates were based on eight academic and institutional studies focused on implicit subsidies. Most of the studies arrive at a figure by quantifying the lower lending costs that large financial institutions enjoy from the market because of governments’ willingness to prop up failing national financial institutions, called the funding advantage approach. Others use a more complex option-pricing theory model.

There may actually be more costs than the studies have calculated. Government backing also creates moral hazard, or the willingness of banks to take outsize risk, knowing there is a lender of last resort. At the World Economic Forum meeting in Davos, Switzerland, last week, Mario Draghi, president of the European Central Bank, said he did not know whether any banks would need to be closed as a result of the central bank’s examination but that the system was prepared to deal with the consequences if any significant problems materialized. Draghi said, “The banks that should go, should go.”

Yea, you won’t hear that in the State of the Union speech, or in the response.

Wednesday, February 13, 2013 - Everything You Need to Know - Fast and Furious Edition

Everything You Need to Know - Fast and Furious Edition

by Sinclair Noe

DOW – 35 = 13,982
SPX + 0.90 = 1520
NAS + 10 = 3196
10 YR YLD +.04 = 2.02%
OIL - .37 = 97.14
GOLD – 8.70 = 1643.60
SILV - .34 = 30.88

I realize that you are a very important person; your time is valuable; time is money. I could spend hours bloviating on the minutiae of the State of the Union Address. Instead, I respect your busy schedule by condensing the one hour Address down to less than 3 minutes. Seriously, you take out the applause and the pomp and circumstance and a few adjectives, and the hour long speech fits neatly in just under 3 minutes. Here you go:

I know you also like lists, so here's the top ten policy area's covered in the speech:

#10 – an emotional appeal to vote on gun control,

#9 – raise the minimum wage to $9 an hour,

#8 – on the energy front, tap the oil and gas royalties for revenue to find alternatives to oil,

#7 – the president pledged action on climate change and if Congress won't do it he would use executive authority,

#6 – Education starting with universal pre-school for 4-year olds,

#5 – let people vote, (turns out this is controversial. Who knew?)

#4 – immigration reform,

#3 – on foreign policy, cut the forces in Afghanistan by half,

#2 – beef up American manufacturing (starting with a visit today to a Canadian auto parts plant in North Carolina, and

#1 – try to get Congress to avoid imploding on national debt. (yea, that's not gonna happen)

So, there is fast and furious version of the State of the Union.

There were a few little things that didn't make the condensed version. For example: the T-TIP, the Transatlantic Trade and Investment Partnership with the European Union, which was worth one single sentence saying we will launch talks; which wasn't accurate; talks have already been going on behind the scenes. Between them, the United States and Europe account for about half of global economic output and one-third of world trade. Trade in goods between the Union and America totaled $646 billion last year.

The Union is the best customer for U.S. exports, buying $459 billion in goods and services and supporting 2.4 million American jobs. So, it might be the biggest trade agreement in the history of the planet. Tariffs on goods traveling between the US and the Eurozone are only about 3% but the volume is enormous. One big sticking point would be agricultural products. We send them genetically modified corn; they send us horsemeat lasagna and pony burgers.

There was also something about fighting back against cyberattacks. I made a note last night but I can't seem to find it on my computer today.

One issue that did not make the State of the Union Address was financial reform. During Tuesday’s speech, the president made one direct reference to the financial crisis, saying during the first few minutes of his address, “Together, we have cleared away the rubble of crisis, and can say with renewed confidence that the state of our union is stronger.” No mention of regulatory reform. No mention of the very significant work that still needs to be done under Dodd-Frank. No reference to the necessary things we need to do beyond Dodd-Frank to really fix the financial system. You may remember last year's State of the Union included an  initiative within the Department of Justice -- a special investigative unit that Obama said would "hold accountable those who broke the law" in the lead up to the financial crisis.

A new report says the top 1% has captured all of the income gains since 2009, and then they took some more; wracking up 129% of the income gains. How did that happen? Incomes to the bottom 99% fell by 0.4%.And the new Emmanuel Saez paper also describes how it came about. In short form, income to the top 1% is significantly influenced by capital gains. Remember, the tax reporting is not clean here: rising equity and bond markets help all those private equity and hedge fund professionals, who are able to get capital gains treatment for what ought to be labor income. But the paper also stresses that the lower orders were hit hard in the aftermath of the global financial crisis than in the dot-bomb era, which also saw a big drop in capital gains. That isn’t as hard to understand. The collapse of the dot-com mania didn’t impair the real economy overmuch because it was not fueled in a meaningful way by borrowings. 

It’s important to recall that at least in America, the relentless pursuit of wealth for its own sake dates from the Gilded Era, or at least so argues Richard White in the Boston Review:

After his death, Lincoln’s personal trajectory from log cabin to White House emerged as the ideal American symbol. Anything was possible for those who strived. But the goal of this striving was not great wealth. Perhaps the most revealing memorial to Lincoln and his world is found in one of the most mundane of American documents: the census. There he is in the Springfield, Illinois, listing of 1860: Abraham Lincoln, 51 years old, lawyer, owner of a home worth $5,000, with $12,000 in personal property. His neighbor Lotus Niles, a 40-year-old secretary—equivalent to a manager today—had accumulated $7,000 in real estate and $2,500 in personal property. Nearby was Edward Brigg, a 48-year-old teamster from England, with $4,000 in real estate and $300 in personal property. Down the block lived Richard Ives, a bricklayer with $4,000 in real estate and $4,500 in personal property. The highest net worth in the neighborhood belonged to a 50-year-old livery stable owner, Henry Corrigan, with $30,000 in real estate but only $300 in personal property. This was a town and a country where bricklayers, lawyers, stable owners, and managers lived in the same areas and were not much separated by wealth. Lincoln was one of the richer men in Springfield, but he was not very rich.

Not only was great wealth an aberration in Lincoln’s time, but even the idea that the accumulation of great riches was the point of a working life seemed foreign. Whereas today the most well-off frequently argue that riches are the reward of hard work, in the Civil War era, the reward was a “competency,” what the late historian Alan Dawley described as the ability to support a family and have enough in reserve to sustain it through hard times at an accustomed level of prosperity. When, through effort or luck, a person amassed not only a competency but enough to support himself and his family for his lifetime, he very often retired. Philip Scranton, an industrial historian, writes of one representative case: Charles Schofield, a successful textile manufacturer in Philadelphia who, in 1863, sold his interest in his firm for $40,000 and “retired with a competency.” Schofield, who was all of 29 years old, considered himself “opulent enough.” The idea of having enough frequently trumped the ambition for endless accumulation.

Now there were robber barons who dated before that era, such as John Jacob Astor. And the railroad boom (and related stock market speculation) may have been a catalyst for the shift in American values. But if you buy this thesis, then there’s a reason for the expression “conspicuous consumption”. It really was describing a novel phenomenon.

We now know the problem that sank the London Whale, courtesy of Baselinescenario.com, referring of course to the London based trading unit of JPMorgan Chase which lost $6 billion. Turns out a quantitative analyst for the trading unit had figured out the value at risk model for the derivatives trades by using a series of Excel spreadsheets. The numbers were entered on the spreadsheets manually by a process of copy and paste from one spreadsheet to the other. Here's what went wrong: “After subtracting the old rate from the new rate, the spreadsheet divided by their sum instead of their average, as the modeler had intended. This error likely had the effect of muting volatility by a factor of two and of lowering the VaR . . .” Essentially, it was a $6 billion typo.

Tuesday, February 12, 2013 - The Battles to Come

The Battles to Come

by Sinclair Noe

DOW + 47 = 14,018
SPX + 2 = 1519
NAS- 5 = 3186
10 YR YLD + .01 = 1.97%
OIL + .48 = 97.51
GOLD + 3.00 = 1652.30
SILV + .17 = 31.22

The all-time high in the S&P 500 index is 1565. The all-time intraday high in the Dow Industrials is 14, 198.10, reached in October 2007. We are close.

After years of acting like deer in the headlights, investors are now throwing cash at the stock markets. Meanwhile, insiders are selling. Google's CEO is selling more than 40% of his stock. He didn't sell hardly anything from 2008 through now. There is a thought that insiders are selling now and mom and pop investors are buying, and once we work through this exchange, the markets will tank. This theory is being called the grand rotation.

Ahead of tonight’s State of the Union Address, the White House has followed custom by leaking tidbits from the speech. It is expected the president will talk about North Korea testing a nuclear bomb; this, for the third time, and bigger than ever. Apparently Mr. Obama will also announce that 34,000 out of 66,000 troops will come home from Afghanistan by this time next year, which sounds better than it is. That means the Pentagon is roughly on pace to hand over security to the Afghans by the end of 2014, as Mr. Obama has long promised. It also means there will still be more than 30,000 troops in Afghanistan, and I'm not sure what will be accomplished. 

The most recent Medal of Honor recipient, Clint Romesha was invited to attend the State of the Union speech as a guest of the first lady. Apparently he will spend the evening with his wife and buddies from his former unit, Black Knight Troop, 3-61 CAV. Romesha and his wife are celebrating their wedding anniversary. I don't know whether they will watch the address or not. Viewership is down to 38 million or so, less than back in the 70's. Romesha's story is inspiring. He was wounded on the battlefield during what has been described as one of the fiercest fights in the Afghan war, but he fought on, rescued his comrades and managed to hold onto an outpost that was technically indefensible. The young Sergeant is amazing; he can spend his evening however he wants.

President Obama will have a fight on his hands as he proposes a second-term agenda that includes new government investments, limits on guns, a revamped immigration system and new initiatives to kick-start the economy for middle-class Americans. The president will propose government action in education, manufacturing, infrastructure and clean energy. The president is also expected to announce his intention to begin negotiations on a free trade agreement with the 27-member European Union.

Mr. Obama already faces stiff opposition from Republicans who control the House and have repeatedly blocked some of his top priorities. On Tuesday, Republicans began using the Twitter hashtag #notserious to describe Mr. Obama’s expected speech; and that's the gentler of the hashtags; the not-so-gentle tag is #youlie.

House Speaker John Boehner this morning gave his own preview of the State of the Union as he  repeatedly challenged the president's willingness to go against his own party on issues that include reforms to social programs and spending.

Speaking with a small group of reporters this morning, Boehner said: "I think he'd like to deal with it [fiscal problems], but to do the kind of heavy lifting that needs to be done, I don't think he's got the guts to do it. He understands there is a spending problem. He understands that we need changes and reforms, and we need to solve these problems." When pressed about the severity of that statement, he modified, saying the president does not have the "courage."

Washington is in the midst of yet another self-inflicted, artificial fiscal crisis, facing a political showdown over "sequestration," the self-imposed round of across-the-board spending cuts to domestic programs and the Pentagon. The sequester was supported by both the White House and Congress as a way to encourage lawmakers to find common ground. Instead, they have been mired in a stalemate, unable to find an equitable solution for both sides. The deadline is March 1^st. It doesn't look good.

The State of the Union wasn't the only big speech of the week but it certainly has been overshadowing a speech by Janet Yellen, vice-chair of the San Francisco Federal Reserve; she talked about how slow this recovery has been and why. One of the culprits for the slower recovery? Fiscal policy. Specifically? We're not spending enough. Government spending, which usually provides a boost to the economy in the quarters following the recession, has been a net drag this time because the government is spending less than it normally does.

After passage of the 2009 economic stimulus package, which helped save or create millions of jobs, Congress all but gave up providing support to the labor market. Instead, in the last two years, the nation’s deficits have been reduced by $2.5 trillion, with the overwhelming majority coming from spending cuts. Yellen described fiscal policy as a headwind for the recovery: “Discretionary fiscal policy hasn’t been much of a tailwind during this recovery. In the year following the end of the recession, discretionary fiscal policy at the federal, state, and local levels boosted growth at roughly the same pace as in past recoveries. But instead of contributing to growth thereafter, discretionary fiscal policy this time has actually acted to restrain the recovery.”

Everybody that’s tried austerity in a time of no growth has wound up cutting revenues even more than they cut spending because it results in a downward spiral and it drags the country back into recession. The experience of Europe should be showing US policymakers that cutting spending in a weak economy backfires, squashing economic growth, which causes debt to expand. But it doesn’t seem like that lesson is taking hold.

Today, the Treasury Department reported the federal government had a rare surplus for January and is on track to run its smallest annual budget deficit since  2008. The government took in a surplus of $2.9 billion in January. That's the first monthly surplus since April, a month that benefited from income tax payments. January's budget benefited from an estimated $9 billion in extra revenue from higher Social Security taxes. That helped lowered the deficit through the first four months of the budget year to $290.4 billion — nearly $60 billion lower than the same period a year ago. The budget year began on Oct. 1.

For the entire year the Congressional Budget Office is forecasting the deficit will total $845 billion. If correct, that would be first time government hasn't run an annual deficit in excess of $1 trillion since 2008.

The deficit is the amount the government must borrow when its expenses exceed its revenue. Each month's deficit is volatile and can be affected by calendar quirks that shift government spending or revenue from one month to another. The annual deficit is projected to be smaller this year because the government is collecting more revenue this year, mainly because of faster job growth and higher taxes. At the same time, the government is spending less on some programs. That's in part because of spending cuts that were enacted under a 2011 agreement to raise the federal borrowing limit. Also, the improved economy has reduced demand for unemployment benefits and some other government programs, or some people have just used up their benefits and fallen from the rolls.

The Congressional Budget Office is projecting even smaller annual deficits of $616 billion in 2014 and $459 billion in 2015.

This weekend the G-20 will meet in Moscow. Today, the G-7 broke into the European trading morning with its first statement on exchange rates since September 2011, in which it pledged to keep economic policies directed at domestic needs and disavowed targeting currencies. The G-7 acknowledged Japan isn’t driving a devaluation and that its monetary policy is aimed at ending 15 years of deflation.

But after the G7 statement, an unnamed official of the G7 told reporters in the United States that markets had misinterpreted the statement and that it was in fact aimed at Japan, that it's okay for Tokyo if a weaker yen is the result of policies aimed at driving the economy, but it's not kosher if policies are aimed specifically at devaluing the currency.

What the G7 appeared to be saying - before the unnamed official signalled it was a warning to Tokyo - is that currency devaluation can be a byproduct, rather than a goal, on the long, hard road back to a sustained recovery. The Federal Reserve's quantitative easing, for example, an asset-buying program, is negative for the US dollar, but is aimed at juicing the economy, not driving down the greenback; theoretically anyway.

So, the G-7 issued another statement that said: "We, the G7 ministers and governors, reaffirm our longstanding commitment to market determined exchange rates and... that we will not target exchange rates."

And now the thinking is that this means Japan won't be buying US Treasury bonds as part of its stimulus plan because that would further weaken the yen. This also means there is a global race to devalue currencies.

China has become the world's biggest trading nation in goods. China's customs administration said the combined total for imports and exports in Chinese goods reached $3.87 trillion last year, edging past the $3.82 trillion trade in goods registered by the US commerce department. The US economy is still twice the size of the Chinese economy, but apparently we are more self contained.

A new report from the Project on Government Oversight says that regulators at the SEC derailed last year's efforts to reform the $2.6 trillion money market fund industry, and that many of those regulators are now working in the private sector, and the “revolving door” policy may have impacted policy and enforcement decisions. Yea, we're all shocked.

Friday, February 08, 2013 - The State of the Union is Contradictory

The State of the Union is Contradictory

by Sinclair Noe

DOW + 48 = 13,992
SPX + 8 = 1517
NAS + 28 = 3193
10 YR YLD un = 1.95%
OIL -.06 = 95.77
GOLD – 3.80 = 1668.20
SILV - .03 = 31.53

The State of the Union is...

Tuesday.

Do we have a solid economic recovery underway? The evidence will leave you whipsawed. Everywhere you turn, it seems, there is an economic contradiction.

Housing is up, but gross domestic product was sharply down in December, almost to recessionary territory. The economy has lost 3.2m jobs since 2007, but 5.2m have been created since 2009. Even so, the number of unemployed far outpaces the number of jobs. The Center on Budget and Policy Priorities says: "In November 2012, 12 million workers were unemployed but there were only 3.7m job openings. That is about 10 unemployed workers for every three available positions – in other words, even if every available job were filled by an unemployed individual, about seven of every 10 unemployed workers would still be unemployed."

The jobless rate keeps dropping, but the ratio of employed-to-unemployed people is about the same as last year. The economy gained 181,000 jobs a month last year, but the percentage of people who have been unemployed for more than 27 weeks has stayed relatively steady. People are working more hours, but productivity is falling. And economic output has almost ground to a halt, growing by 0.1% in December.

Households are becoming less indebted, which is a welcome development, but that's mostly because they are people are defaulting on debt. A side effect of the defaults is that disposable personal income is rising; when you default on debt you have more cash in pocket. Still, income inequality continues to climb and the middle class continues to shrink.

And whatever progress we've seen on the economy could grind to a halt at the end of the month with the possible implementation of the sequester. It is certainly a possibility, although it was not intended. The idea behind the sequester was that it was so draconian, it would be so lousy for the economy, that neither side would allow it to happen; the cuts would be so deep that no reasonable politician would permit them to pass. Of course, Diogenes could light his lantern and wander through the streets of Washington DC for years without locating a reasonable politician.

What happens if the sequester hits? The Congressional Budget Office estimates the economy would slow to a sluggish 1.4% this year. Job growth and job quality will lag, the housing market will languish. Everyone agrees that the sequester is terrible policy.

In fact, it was designed to be terrible policy. The sequester is a nondescript name for a poison pill, devised as a deterrent so unpalatable that Capitol Hill’s warring factions would be forced to make peace. That was back in the summer of 2011, when the artificial threat of a debt default loomed. So the White House and Congressional Republicans crafted the Budget Control Act, which appointed a bipartisan “super committee” to find $1.2 trillion in deficit reduction over 10 years. The super committee’s failure would trigger sequestration, a package of about $1 trillion in automatic cuts to domestic and security programs which would send the fragile economy into a tailspin. Self-inflicted austerity right now would be a really bad idea. The Federal Reserve in the past has been able to cut rates to cushion the effect of spending cuts. It can’t do anything like this now, because the Fed funds rate has already been cut more or less to zero in an attempt to fight the effects of financial crisis; the adverse effects on demand can’t be offset by cutting interest rates. And so, monetary policy just can't come to the rescue of fiscal policy.

Right now the central challenge is to reignite the economy; getting jobs back, improving wages, and restoring growth. Deficit reduction moves us in the opposite direction. That’s because most consumers (whose spending is 70 percent of economic activity) are still losing ground, and businesses won’t expand and hire without more consumers. 

The impasse has members of both parties warning, once again, that an unthinkable policy is becoming a very real possibility. House Speaker John Boehner has started using the phrase “the President’s sequester”. Back in 2011, Obama warned he would veto any attempt to sidestep the sequester; now he is trying to offer alternatives. For its part, the White House will blame Republicans for refusing to reduce tax breaks that benefit the wealthy. Democrats, who are seeking some $600 billion in new revenues, want to dump sweetheart provisions that protect owners of corporate jets or financiers who benefit from low carried-interest rates.

Obama also offered to revive dormant talks to reach a sweeping deal to slash the federal deficit and overhaul the U.S. tax code and entitlement systems. But it would be very tough to iron out a grand bargain in a couple of weeks.

If Republicans won’t give way on new revenues, it would become impossible. And there is no sense the GOP is prepared to cave, particularly because many of its members have sought the deep cuts the sequester would produce. What we’re left with yet another stalemate, and yet another countdown to a self-inflicted crisis.

The National Small Business Association, this week released its year-end survey of economic conditions. The outlook, as their press release stated, is “not so good”. The report says: “there are very few incentives to start or grow a small company” under prevailing conditions. Indeed, the survey shows that pessimism is rampant. Fifty-one percent of respondents say they anticipate a flat economy next year. Thirty-five percent foresee a recession, while just 14 percent anticipate that the economy will grow next year. By a 47-23 margin, surveyed small-business owners think the national economy is worse than it was one year ago. Particularly troubling to small business owners is “economic uncertainty,” which 69 percent of business owners cite as a significant challenge to the future growth and survival of their business.

So are we doomed? Not really. The history of NSBA reports paints a picture of small-business owners as a remarkably grumpy and pessimistic lot. The number of respondents foreseeing a recession next year is the highest since July 2009. It turns out that July ’09 was basically the low point of the recession, and output from July '09 to July 2010 expanded by $357 billion. In other words, small-business owners predicted a recession just as the recovery was starting. The 47-to-23 ratio of respondents saying the economy is worse off today than it was a year ago is alarming. But six months ago the ratio was an equally alarming 48-to-21. 

Perhaps the most interesting indicator in the survey is that small-business owners take a considerably rosier view of their own business prospects than those of the economy as a whole. A healthy 47 percent of respondents anticipate their own gross sales rising, while just 23 percent say they’ll decline. If growing businesses outnumber shrinking ones 2-to-1, then it’s hard to see how the economy is going to shrink.

And today, the major stock market indices climbed to multi-year highs. One headline I read credits optimism about the economy. Go figure.

Apple is sitting on a big pile of cash. David Einhorn, the hedge fund manager of Greenlight Capital wants Apple to issue preferred shares as a way to unlock shareholder value. His other ideas include increasing dividends and buying back its own shares. This is how a hedge fund manager thinks. For a man who's only tool is a hammer, the world looks like a nail. Apple became one of the biggest companies in the world because it invested in cutting edge technology; it spent time and money on design. Now, they can't figure out how to spend their money; they can't find new things to create. The inventors have become gentrified and cautious. They listen to hedge fund managers instead of inventors.

I don't mean to pick on Apple. It's happening to lots of corporations. Boeing started paying more attention to the bean counters than the engineers. The result was melting batteries and Dreamliners full of smoke. Stock buybacks are a sign of innovative constipation and scared management. I'm not advocating reckless behavior. I just don't like business cowardice.

We used to talk about Yankee ingenuity. Now companies are content to sit on cash. And they are sitting on a big bundle. And we know the story of the faithful servant who buried the talents in the yard to make sure they were secure. Nobody should be a shareholder in a company that buries its talents.

So, we have corporations sitting on cash, too stupid to use it; a middle class, or what's left of it, too weak to support the consumer spending that has historically driven economic growth; a middle class racked by debt and unable to invest in their future, too weak to educate themselves, too uncertain to take the quantum leap to entrepreneurship, and too weak to broaden out the tax base; and that in turn means we have a country too poor to invest in infrastructure (which might improve productivity and global competitiveness, education and research ( which might result in innovation), and are crucial for restoring long-term economic strength.

The Inaugural Address a couple of weeks ago was part one of a two part presentation; it focus on vision and philosophy. On Tuesday, February 12th, when the president gives his State of the Union address, he'll have an opportunity to make specific proposals, and build support to fix America's most challenging problem. That will be the nuts and bolts speech.

The state of the Union is...?