Friday, April 30, 2010

First Quarter GDP: A Look Inside the Numbers

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The advance report for first quarter GDP was out today and it indicated that the U.S. economy expanded by 3.2%. Approximately half of that was due to increases in business inventories. Business equipment and software investment supposedly went up over 13% and was the biggest sub-category gainer. Consumer expenditures somehow went up 3.6% even though real disposable income was flat. Increases in federal government spending helped raise the numbers.

While the biggest contribution to the report was in the inventory category, this represented a lower percent than in the fourth quarter of 2009. Inventories added 3.8% of the 5.6% increase in GDP last quarter, or two-thirds of the total. Inventories didn't actually increase in the fourth quarter either; they dropped by $19.7 billion. Thanks to the peculiarities of GDP math, the slower rate of decline led to a big increase in GDP.  Mainstream media then reported this turn of events as the U.S. economy being on fire (if they meant it was burning down, they may have been correct). In Q1, inventories actually increased though by $31.1 billion. This is certainly more positive, but inventory restocking by itself doesn't indicate a recovering economy. It does however lead to a recovery in the GDP number.

The increase in business equipment and software of 13.4% in Q1 was less than the also very high 19.0% last quarter. Overall this led to nonresidential fixed investment increasing 4.1% in the current quarter even though investments in nonresidential structures (commercial buildings) declined 14.0%. Still, that was better than the 18.0% drop in Q4 of last year. Real residential fixed investment  (housing) decreased 10.9% this quarter, in contrast to a supposed increase of 3.8% in the fourth quarter of 2009. Real estate, which was the epicenter of the Credit Crisis and the damage to the economy, is obviously still troubled. How can there be recovery under such circumstances?

When reporting on first quarter GDP, big media highlighted the consumer spending numbers. The 3.6% current number was much higher than the 1.6% number at the end of last year. Durable goods sales supposedly increased 11.3% in Q1 compared to just 0.4% in Q4 2009. Motor vehicles created a 0.52% growth in GDP by themselves. Nondurable goods were up 3.9% compared to 4.0% last quarter, so almost all of the big change took place in durable goods. U.S. consumers managed to increase their spending on these high-ticket items even though real disposable income didn't go up. Consumer credit was also declining in the first quarter. Revolving credit (credit cards) fell at a 13% annual rate in February. So somehow consumers are now spending more money even though they don't have the funds available from their income or credit. That certainly is interesting.
 
Finally, government spending, which has been the mainstay of the economy for the last two years, increased by 1.4% in the first quarter compared to no change in the last quarter of 2009. Nondefense spending increased 1.7 percent in the beginning of 2010 and this compares to a jump of 8.3% at the end of last year. State and local spending were down in both quarters. At this point it will be hard for the federal government to increase its spending from current levels, so decreases are likely in the future and this will be a drag on GDP going forward. What part of the economy will pick up the slack? Well, I guess that depends on what numbers the statisticians find easiest to manipulate.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Thursday, April 29, 2010

Fed Will Leave Rates at Zero Until Inflation Shows Up

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The Federal Reserve left the fed funds rate in the zero to 0.25% range at its April meeting. This is the 16th month that the Fed has maintained rates at an all-time low. While the Fed was a bit more upbeat about the economy than it has been at recent meetings, it still pledged to keep rates near zero "for an extended period of time".

When it comes to the Fed and other government representatives, investors would be best off by paying attention to what they do and not to what they say. The Fed was certainly more upbeat in its statement from the April meeting than it was in previous meetings. It noted that "economic activity has continued to strengthen and that the labor market is beginning to improve","growth in household spending has picked up recently" and  "business spending on equipment and software has risen significantly". You would think happy days were here again and short-term rates will be 5% before you know it. Well maybe not, it turns out.

While strong economic growth leads to inflation, apparantly there is no risk of that (inflation that is) as far as the Fed is concerned. The Fed went on to say that "with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time". So the Fed seems to be talking out of both sides of its mouth. Either growth is not sustainable in the long-run and it thinks this will keep inflation subdued or the Fed has pumped so much money into the financial system that this is creating economic expansion (at least for the moment) and inflation will follow.

The first scenario was seen in Japan during the last two decades, especially after its two-year recession in the early 1990s. The economy was supposedly recovering nicely without inflation for a few years. Instead, it gradually fell into the abyss and a deflationary spiral. In the second case, uncontrollable inflation is possible - and this can take place with a great deal of resource slack. Rapidly declining and eventual collapse of resource utilization is the marker of hyperinflation. Fed chair Bernanke should tell Zimbabwe that it couldn't have possibly had the second highest inflation rate in world history, sextillion percent, because it had an unemployment rate of 94%. Weimar Germany, with a mere 100 trillion percent inflation rate, had unemployment that reached almost 25%.

The Fed statement also had two telling comments that provide significant insight in the Fed's thinking. These were, "financial market conditions remain supportive of economic growth" and "bank lending continues to contract". Taken together these indicate that the financial conditions that are supportive are the Fed's low interest rates and the high prices of stocks - the paper economy. While the paper economy is going great, as indeed it was before the Credit Crisis and during every other bubble in history, the real economy is struggling. It can't function well without adequate credit from banks. In other words, the Fed's positive view of the economy is based on economic make believe.

If the Fed really believed the economy was improving, it would be raising rates or at least getting ready to do so and not say it was maintaining its ZIRP (zero interest rate policy) for a long time. As I have documented in previous articles, there is usually a two to three year lag from the end of a recession until the Fed starts raising rates. If we assume optimistically that the recession ended in July 2009, that would take us until at least July 2011 before rates went up. Any rate rise before that date would indicate significant inflation risk and a rate rise after July 2012 would indicate a serious deflation problem.  In either case, the Fed's response will be too little, too late.

Disclosure: None Relevant

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Wednesday, April 28, 2010

It's De Facto Default for Greece

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The debt crisis in Greece looks like it is finally going to be resolved now that an S&P downgrade of the country's debt to junk status on April 27th has brought the crisis to a head. The eurozone leadership will finally have to stop its denial and provide Greece with funding to roll over its debts. Calm will be then be restored to the markets - at least for a while.

The inept handling of the situation in Greece seems reminiscent of the U.S. government's refusal to bail out Lehman Brothers. That act of political obliviousness led to a crash of the entire world financial system. Greece will have some sort of bailout however, so the more apt analogy would perhaps be the collapse of Bear Stearns. The markets were calmed when the U.S. Fed and Treasury arranged for JP Morgan to buy Bear Stearns at a fire sale price. If they were handling the Greek debt crisis, they probably would have solved it by having Goldman Sachs purchase the country at a 90% discount. Because of the brokered deal by the feds, Bear Stearns never officially went under, although in reality it did because it was no longer capable of independently functioning. If some bailout program is necessary to roll over Greece's government debt or allow it to make interest payments on it, Greece has for all intensive purposes defaulted.

The reaction of the euro zone leadership to Greece's problems seem inexplicable to anyone from the outside. It is definitely a shoot yourself in the foot to punish the other guy approach. A potential bailout for Greece is very unpopular among the electorate in Germany and there will be regional elections there on May 9th. It's the Germans that have been holding up the aid package. German banks have an estimated $45 billion in exposure to Greek debt (France is even higher, holding $75 billion in Greek loans), so an official Greek default would potentially cost Germany more than a bailout. Almost all of Greece's debt is held outside the country and the rest of the eurozone is heavily exposed. It's enough to make you wonder if big banks anywhere in the world ever apply any credit standards to their loans.

The market disaster yesterday seems to have woken the EU from its comatose state of deep denial and fast-tracked handling of a Greek aid package. The euro (FXE) hit a new yearly low of 131.63 and looks like its may have taken out a possible triple bottom. Stocks got hammered on bourses across the continent. Greece itself was down 6.7% and it reacted by instituting a two-month ban on short selling (the U.S. did the same for financial stocks after Lehman collapsed).  Portugal, which had its credit downgraded two notches by S&P, dropped 5.4% and is getting hit hard again today. Italian stocks suffered similar damage. The CAC-40 in France, the Dax in Germany and the FTSE in the UK fell 3.8%, 2.7% and 2.6% respectively. Five-year credit default swaps (CDSs) reached 840 basis points for Greek debt, 430 basis points for Portuguese debt, 270 basis points for Irish debt and 225 points on Spanish debt. The spread between German 10-year governments and equivalent Greek debt rose to 9.63%. Interest rates on two-year Greek governments rose to 18%.

When the EU created the euro currency union, it didn't plan on how to handle debt crises in member states. This was the case even though it allowed some countries with checkered fiscal pasts to become part of the eurozone.  EU leadership (or more appropriately lack thereof) has continued to avoid this issue throughout the entire Greek debt crisis so far. The obvious solution of using dollarization - letting a country continue to use the euro, but not be a part of the credit union - has seemingly not occurred to them. Instead, the tried and true bailout solution will once again by utilized. As became evident in the U.S. during the Credit Crisis, one bailout is never enough. There is already talk about raising the Greek loan guarantees from the EU and IMF from 45 billion euros to 100 to 120 billion euros and extending them over a three-year period. This bailout for Greece will likely just be just one of many and Greece itself will just be the first country to be bailed out.

EFTs that are useful for trading the current crisis in Europe include: EZU (euro monetary union), GUR (emerging Europe), VGK (European stocks), EWI (Italy) and EWP (Spain).

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
 http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Tuesday, April 27, 2010

Ford Still Financially Troubled Despite Q1 Earnings

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Debt ridden Ford Motor earned $2.1 billion in the first quarter or 50 cents a share. Mainstream media reported this as "another sign the economy is improving as people spend more on big-ticket items like cars". Unstated was which economy was improving or that those people were in China. Nor did any report mention that Ford stock has a negative book value of minus $2.32 per share.

What struck me immediately about Ford's 2010 Q1 earnings report was a major inconsistency with the Q1 earnings report for 2009. Ford lost $1.4 billion, or 60 cents per share in the same period last year. This implies that there were 2.3 billion shares outstanding twelve months ago. Based on today's earnings numbers there appear to be 4.2 billion shares outstanding. Ford did issue an additional 300 million plus shares of stock last May and exchanged $4.3 billion in convertible debt for 468 million shares of common stock in the first half of 2009. News reports in May 2009 indicated it had 2.9 billion shares outstanding before the new stock was sold. Today, Ford supposedly has 3.4 billion shares of stock. Off hand, I would say these numbers don't appear to match up.

It is quite amazing that Ford did not sink into bankruptcy, as did General Motors and Chrysler. From 2006 to the first quarter of 2009, the company lost $31.4 billion. Actions taken by Ford in 2009 though are helping the bottom line today. The new shares it issued at the time were used to fund VEBA, the UAW run health car trust, and this saved the company from using real money for this purpose. Ford also worked out an agreement with the UAW that allowed it to lower its labor costs by $500 million annually. At the same time, Ford managed to lower its interest payments on its substantial debt by $500 million a year with its debt to stock conversion. Fortunately for the company, Ford is making a good share of its profits from its credit unit (not from selling cars), which earned a net profit of $528 million in the first quarter of 2010. Ford has the Fed's zero interest rate policy to thank for that.

As for sales, there was a huge increase - in China. Ford reported an 84 percent improvement there. As for North America, U.S. sales did climb 37 percent over last years exceptionally low levels. Part of this is due to Ford's market share rising nearly three percentage points thanks to problems at Toyota. Total U.S. auto sales in 2009 came in at 10.4 million, down from over 16 million before the recession began. Ford still sees sales in the 11.5 to 12.5 million range for 2010. This is still substantially below pre-recession levels. Investors should also ask themselves how much of those extra sales are due to federal government policy. If this is a recovery, it's not much of one. 

Ford (F) stock was down more that 9% on its earnings announcement in morning trade. It fell as low as $13.15. That's still a pretty high stock price for a company with a negative book value.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
 http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Monday, April 26, 2010

Greek Debt Crisis: Why Not Try Dollarization?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Like a thousand page novel that never gets to the climax, the Greek debt crisis is still dragging on. Terms have yet to be worked out for the aid package from the EU and IMF and the Germans seem hesitant about providing it. The market reacted by pushing yields on two-year Greek bonds above 13% today. Even with the proposed aid, Greece's debt problem will merely be put on hold until next year and not solved.

Greece is only 2% of the EU economy, yet its debt crisis has had outsized impact on global markets. Funds have flowed out of Europe into North America and Asia because of it. This has particularly benefited the U.S. and Canadian dollars and weakened the euro. Constant talk about the potential collapse of the euro currency union has accompanied these moves. This has happened not just because of Greece, but also because of looming problems in Portugal, Ireland, Spain and Italy.

There have been suggestions that Greece leave the euro currency union, at least temporarily, and start reusing the drachma. This would be more than disruptive to say the least. I have seen no one recommend the obvious solution of dollarization. This doesn't mean Greece would use U.S. dollars; it would still use the euro, but not as a member of  the currency union. Dollarization is the generic term for when one country uses another country's currency. Panama and Ecuador for instance use American dollars as their official currency, although neither is part of a currency union with the United States. In early 2009, Zimbabwe dealt with its hyperinflation problem by allowing foreign currencies to be used in the country. One of those currencies was the euro.

The EU should consider handling the problem with Greece by temporarily suspending it from the currency union with the understanding it would still be using the euro. Greece could rejoin when its debt problems were finally resolved. This of course might not be soon. At some point a country accumulates so much debt that default becomes inevitable. That point differs for every country. Greece looks like its already gotten to that state with its debt to GDP ratio over 100%. The debt to GDP ratio for Japan is going to be over 200% though this year and it is still functioning better than Greece. Japan has its own currency though and can therefore print any amount of extra money if need be. It has funded its spending internally by borrowing the massive savings of its people. That game is over however and the situation there could eventually turn ugly almost overnight as occurred in Greece.

While Greek bond interest rates and spreads are hitting new highs, the euro itself is trying to stabilize. A look at its chart shows that it has so far made a triple bottom in late March, early April and mid-April trading. Traders are obviously getting bored with selling the euro down and the currency will be due for a rebound soon. How long that lasts depends on how the EU handles its member countries ongoing debt problems. So far, it's been only an unending number of promises with no results out of Brussels.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Friday, April 23, 2010

Greek Tragedy Moves Closer to Final Act

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Greece has finally requested an activation of a proposed EU-IMF $60 billion aid package. Negotiations on the terms will be taking place over the next several days. Currently it looks like Greece will be loaned the money at a five percent interest rate. This is more likely to delay default rather than prevent it.

Events on April 22nd finally forced Greece's hand. Moody's downgraded its sovereign debt to A3 from A2 and placed it on credit watch for a possible further downgrade. At almost the same time, the EU Statistical Agency revised Greece's 2009 budget deficit as a percentage of GDP to 13.6% from a previous estimate of 12.7%. The markets reacted negatively with yields on 10-year Greek government bonds rising to 8.7%. Spreads between Greek and German debt rose to 5.6%. Credit default swaps, which are bond insurance, rose to a very high 650 basis points. The euro (FXE) hit a fresh 11-month low of 132.55 against the U.S. dollar.

How much will loan support from the EU and IMF really help Greece though?  The aid package provides enough money to tide Greece over into some time in 2011. Greece has not been having trouble borrowing money, but the trouble is paying high interest rates on the money its borrows. Would 5% be low enough to not seriously threaten Greece's attempt to reduce its budget deficit?  The answer is probably not. Greece, like many countries before it, has entered a downward spiral where debt default becomes inevitable without massive ongoing bailouts. Attempts to balance its budget will severely damage its economy, which is heavily dependent on government spending (as is the case for many other countries including the United States). As it cuts spending and raises taxes to reduce its budget deficit, its GDP will also decrease. A lower nominal budget deficit with lower GDP, means the percentage of the budget deficit to GDP may not decline that much despite extensive efforts to make it happen.

While it looks like Greece's problems happened overnight, they did not. Greece made efforts to hide its fiscal problems for at least a decade. Its most recent endeavors included simply lying about its budget numbers. The fibs it told were so outrageous that if Greece had been Pinocchio, its nose would have stretched across the Mediterranean. Nevertheless, the EU Statistical Agency accepted them without question. It was Greece itself that revealed the scam as it was falling apart. Pervasive lying with statistics is a common last phase before a fiscal collapse. Americans may want to take a close look at the GDP, inflation, and employment numbers produced by the U.S. government as they ponder this thought.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Thursday, April 22, 2010

Why Popular Market Indicators May be Giving False Signals

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Market indicators based on percent of stocks above their 50-day moving average and the number of advancing versus declining stocks are flashing bullish buy signals. While these have supposedly worked well in the past, the underlying conditions that led to their success may not exist in today's market. If so, these indicators could be dangerously misleading.

Ned Davis from Ned Davis Research has recently declared the market is experiencing a 'breadth thrust'. This takes place when more than 90% of stocks are trading over their 50-day moving average. This indicates extreme bullishness in the market. This indicator could be a valuable buy signal to investors if it takes place after a significant market low. The indicator did indeed give a buy signal on May 4, 2009 and again on September 16, 2009. The returns have been considerable from these buys. Another buy signal was given on April 5, 2010. After more than a year of rallying and the Dow Jones Industrial Average up around 70% from low to high, this signal is now more likely to indicate a seriously overbought market with few investors left to buy. This indicator has only flashed 12 buy signals since 1967, three of which took place within the past year. The good returns from the two signals in 2009 have in all likelihood made the overall profit potential of following this indicator look a lot better than it was previously and this should be taken into account when examining claims as to this indicators past performance.

Dan Sullivan from The Chartist is also bullish. He bases his outlook on advances versus declines in the market being greater than two to one. His indicator gave three buy signals in 2009. There have only been 18 such buy signals in the last 60 years. The only other years with multiple buy signals were 1962, 1975 and 1982. The Dow was down 11% in 1962. As for 1975, it followed a major two-year bear market in 1973 and 1974 that almost cut the Dow in half. The Dow rose 32% in 1975 and closed at 852. Six years later in 1981, it ended the year at 875 or an additional 3% higher. In 1982, an 18-year secular bull market began, so this was a good call. However, what made it a good call was the market finally broke out after going sideways and down for 16 years. The most analogous situation to today's rally was 1975. The Dow should have rallied in 2009 from its deeply oversold condition and it has, but that rally can't be infinite.

Investors should not blindly follow market indicators, especially when media reports usually give information that is limited to only what is taking place right now. To accurately decide the value of a current buy or sell signal, it is necessary to know how and why it worked in the past. Close examination may indicate the indicator didn't work as well as claimed or that it works only under certain conditions like the Fed lowering interest rates or immediately after a major sell off. As is always the case, investors who want to make money in the markets need to think for themselves.

Disclosure: Not relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Wednesday, April 21, 2010

Debt Crisis Back in Greece, U.S.Has Borrowing Problems Too

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The markets are telling us that the Greek debt crisis, which has supposedly been solved numerous times, is still with us and getting worse. Interest rates on Credit Default Swaps on Greek bonds hit a record 495 basis points on April 21st. While Greece is at the end stage of a sovereign debt problem, the U.S. is at the beginning. Some U.S. corporate bonds have recently had lower interest rates than equivalent treasuries indicating that the market believes those companies are in a better financial position than the U.S. government.

The problems that have arisen in Greece are those that occur when a government borrows too much money relative to its GDP. Eventually the interest payments on the debt become overwhelming and default becomes inevitable. Default can take place in two ways however. It can be a simple failure to make interest payments on bonds or it can result from a major inflation of a currency. With inflation borrowers get the nominal amount of money due them, but that money doesn't have the same purchasing power. Since Greece is part of a currency union and can't print its own money, it can only default by not paying off its bonds. The U.S. on the other hand, can print all the money it wants to so it can only default through inflation.

Up to now Greece has had no problem borrowing money. The problem is that the interest rate it has had to pay in the last several months is so high that it undoes the effect of budget cutting measures taken to get its fiscal house in order. The recent EU and IMF proposed 45 billion euro aid package makes funds available for Greece, but didn't do so in a manner that would lower Greece's interest payments. Unless Greece gets access to large amounts of credit at well below market rates, there is no possibility of it avoiding default. Even if it does, sovereign default in all likelihood will simply be delayed.

So what are the implications for the U.S.? The U.S. is not much more fiscally responsible than Greece is, but is does have the reserve currency of the world and a very big printing press. The U.S. can get away will a lot more than Greece does before an irreversible credit disaster begins. In the last few years, the national debt in the U.S. has been skyrocketing because of the Credit Crisis and the recession that followed. It was  estimated in the proposed 2010 federal budget that that the U.S. will owe slightly more than  $14 trillion by the end of the fiscal year. Debt service was listed as $164 billion.

Based on the budget figures, the U.S. is paying approximately a 1.2% interest rate on its national debt. Could interest rates get any lower than that? Not likely, especially considering that Federal Reserve has kept short term rates around zero. If interest rates return to a more normal, but still relatively low four or five percent, debt service would rise to around $600 billion, without any further increases in borrowing. U.S. federal debt is continually increasing by large amounts however. If 1970s interest rates return, debt service would eventually rise to around $2.4 trillion for the current debt, which is approximately the total estimated revenue for the federal government in 2010. Long before that happened, money printing would be a major source of revenue needed to run government operations on a day to day basis - and hyperinflation would become unavoidable.

The market has been sending hints lately that it is not happy with the U.S. fiscal situation. Interest rates on corporate bonds from Berkshire Hathaway (BRKB), Proctor and Gamble (PG), Johnson and Johnson (JNJ), Lowe's (L) and Abbot Laboratories (ABT) have been lower than equivalent U.S. treasuries at some point in the last few months. Corporate interest rates should never be lower than government rates, at least in theory, because corporations are supposed to be riskier than a government. The market is telling us that it sees things the other way around. Investors should consider this a long-term warning.

The euro (FXE) of course sold off on the latest developments in Greece, but did not make a new low. The market may therefore have already priced in the full impact, at least for the moment, of debt problems in the eurozone. There are more potential problems there in Portugal, Ireland, Spain and Italy however. Whether the market will continue to see those as more significant than the debt problems in the U.S. is still an unanswered question.

Disclosure: Not relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Tuesday, April 20, 2010

How Accounting Changes Created Wall Street's Good Earnings

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


If you can't win under the existing rules of the game, simply change the rules. Wall Street firms were losing big money during the Credit Crisis, but not only did the federal government come to their rescue with truckloads of taxpayer money, but accounting rule changes were also instituted to make their financial position look much stronger. The much improved earnings for the banks and investment houses showing up today are the result of both and not an improved economy.

After a record earnings year in 2007, built on a highly leveraged sub-prime mortgage pyramid, things started to go terribly wrong on Wall Street in 2008. Mark to market accounting was forcing firms to value their sub-prime paper at fire sale prices. This was causing massive losses. Wall Street's friends in the federal government launched a massive counteroffensive, including TARP - the welfare for Wall Street banker's bill, approximately half a dozen new Fed policies that supported the market for Wall Street's junk paper, legislation to hold up the housing market to give underlying value to that paper, and a change in accounting rules that would allow the big banks to look like they were making money even if they weren't.

Citigroup's first quarter 2010 earnings report provides a good example of the better earnings through accounting chemistry approach. Many market observers maintained that Citi was insolvent during the Credit Crisis. The U.S. Treasury wound up buying 27% of Citigroup's shares to help keep the company afloat. In reaction to the Credit Crisis debacle, Citi set up a company, Citi Holdings, to isolate its questionable assets. That entity had losses of $5.49 billion in the first quarter of 2009. It only lost $876 million in the first quarter of this year. The difference improved Citigroup's earnings in Q1 2010 by $4.61 billion. Total earnings reported for Citi in the quarter were $4.43 billion, so it would have lost money without the boost from Citi Holdings. Nevertheless, mainstream media reports were aglow with Citi's great earning's recovery.

The change in accounting rules took place between September 2008 and April 2009. On September 30, 2008 the SEC and FASB, the Financial Accounting Standards Board, issued a joint announcement that stated that forced liquidations of securities, meaning subprime junk debt, were not indicative of fair value. The Emergency Economic Stabilization Act of 2008, which was passed a few days later on October 3rd, codified this into law by allowing the SEC to suspend existing accounting rules if doing so was thought to be in the best interests of the public. In actuality, the 'best interests' being protected were the Wall Street's. Goldman Sachs and Morgan Stanley stock price's hit bottom and began rallying the next month. On March 16, 2009, FASB proposed allowing companies to use more leeway in valuing their assets under "mark-to-market" accounting and this eased balance-sheet pressures on the big banks by letting them cross out the old bad numbers and start replacing them with much better looking new numbers. The overall stock market bottomed right around this date.

The accounting changes came too late to save Bear Stearns and Lehman Brothers of course. Bear went under in March 2008 and the events surrounding its demise indicate that existing Wall Street accounting numbers already had a large fantasy component before the gutting of mark-to-market for subprime junk. Bear Stearns was trying to expedite a good first quarter earnings report before it collapsed. When the feds arranged for it to be bought by JP Morgan, they valued it at $2 a share. The book value for Bear Stearns was around $90. If people at the Federal Reserve and Treasury Department think that $90 really means $2 for a Wall Street company, the individual investor might want to take the hint. These people have a lot more information about what is really going on than you do. If they don't believe the numbers, why should you?

Disclosure: None applicable.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Monday, April 19, 2010

Market Sell Off on Goldman News Has Deeper Roots

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The SEC's announcement on Friday (April 17th) that it was investigating Goldman Sachs on fraud charges seems to have been the cause of a serious market sell off, but other factors were at work as well. While major financial stocks took a hit, so did gold, gold miners, and oil. The tech heavy Nasdaq also had a sharp decline. The market was overbought and options expiration added an extra impetus to the volatility.  In such circumstances, any bad news can cause contagious selling.

While selling was broad based, large cap financials were indeed the epicenter of the damage. Goldman (GS) itself closed down 13% on the day. JP Morgan (JPM) was down 5% and Morgan Stanley (MS) down 6%. XLF, the financial ETF, was down 4.5%. Inexplicably, the gold mining index HUI was down 4.4% and gold and oil were each down over 2%. Gold should have seen safe haven investing flows, but did not.

As for the major market indices, the financial heavy S&P 500 had the biggest drop, falling 1.6%. The Dow Jones Industrial Average was down only 1.1% and the small cap Russell 2000 ended 1.3% lower. Nasdaq lost 1.4%. On the daily charts, the S&P 500 and Russell 2000 reached overbought territory in the middle of last week. Nasdaq became extremely overbought at the same time. If selling hadn't started on Friday, it would have done so probably at the beginning of this week.

Although the Dow has not gotten to overbought territory, it has other technical issues, namely volume or lack thereof. The Dow finally had a high volume trading day on Friday ... on heavy selling, which added even more weight to the technically negative picture. Overall volume on the Dow has been dropping since the bottom was put in last March, something that should not be taking place during a rally. Even worse, selling has been occurring on above average volume recently. This is known as distribution and indicates big money is getting out of the market. The only above average volume day so far in April was last Friday. The only high volume day in March also saw selling. February was more mixed, but the four highest volume days in January, all well above average, saw selling. 

Where the buying has been taken place in the market is also not encouraging. Only six stocks frequently account for up to 30% of the buying on the NYSE - Citigroup (C), AIG (AIG), Ambac (ABK), Bank of America (BAK), Popular (BPOP) and Fannie Mae (FNM). Considering that AIG and Fannie Mae are nationalized enterprises owned by the U.S. government and Ambac, Citigroup and Popular were penny stocks selling for 1.00 or less during the Credit Crisis, this is not exactly a sterling list of solid growth companies leading the market.

Liquidity is what makes markets go up (good earnings are the result of liquidity, although in the current rally, liberalized accounting standards may be even more important). The fed and other central banks throughout the world have pumped an almost unlimited amount of it into the world financial system since the Credit Crisis began. Too much liquidity over too long a period of time though pumps up stocks to unsustainable levels as happened in 1929, 1987 and 2000. Under such circumstances withdrawing even small amounts of liquidity can have the effect of sticking a pin in a very over inflated balloon.

Disclosure: Long oil.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Friday, April 16, 2010

A GDP Canary in the Inflation Coal Mine

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Singapore recently reported that its 2010 first quarter GDP increased by a whopping 32.1%. While a huge growth rate like this would be OK for an emerging market in its earliest stage of growth, Singapore is already an advanced economy. China, which is behind Singapore on the development curve, saw a GDP expansion of 11.9% in the beginning of this year and inflation is already starting to show up there.

While countries are always trying to increase their GDP growth rates, this is one of those areas where the proverbial 'too much of a good thing' can lead to trouble. There is a desirable band of GDP growth for every economy. Too little is not enough to keep the population employed and happy, too much creates more demand for resources than available supply and this causes inflation. The desirable level of economic growth for the U.S. is generally believed to be around 3% a year. It can be much higher for an emerging market.

Singapore is a trading economy and its current huge growth is an indication of how much Asian trade is picking up. It's first quarter GDP was a record increase. The central bank just began raising interest rates to tighten credit. Singapore also boosted its inflation forecast to the 2.5% to 3.5% level as a result of its GDP numbers. It will indeed be lucky if it can keep its inflation rate that low.

China's consumer prices were up 2.5% in March. China's economy grew by 8.7% in 2009, while the U.S. and EU economies stagnated. China is now arguably the second largest economy in the world and if it hasn't already moved ahead of Japan, it will do so very soon.  Almost half a trillion dollars in stimulus in a $4.9 trillion economy can be credited for maintaining China's spectacular growth rate. Stimulus creates inflation as well as growth though. The growth numbers were all very high for the first quarter. Retail sales were up 19.6%. Fixed asset investment was up 25.6%. Exports were up 29%. China, like most Asian economies has based its economic expansion model on export growth.

Not everyone in the world can be a net exporter however. Someone has to be buying those exported goods and that someone is the United States. The U.S. trade deficit widened by 7.4% in February (this subtracts from U.S. GDP and requires borrowing from foreign sources in order to fund it) and the deficit with China widened. The U.S. trade deficit is going up again because imports are rising faster than exports. The media reported that Wall Street economists were surprised. Apparently having a PhD in economics doesn't mean you can grasp the concept that increased exports from one country lead to increased imports in another. Many of these same economists also say there will be no inflation in the U.S. even though the government is engaged in substantial money printing.

Disclosure: Not relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Thursday, April 15, 2010

An April 15th Look at Taxes and the Stock Market

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Tax policy can impact not just how much money you pay in taxes, but how much money you are likely to make in the first place if you are an investor. U.S. capital gains taxes have risen and fallen over the last one hundred years and the stock market usually follows the direction of rates. A significant rate increase will be taking place on January 1, 2011.

The reason capital gains are taxed at different rates than ordinary income is that investing involves risk and capital will not flow unless risk is adequately rewarded. Lower capital gains tax rates encourage more business formation and expansion and bring more capital into the stock market. This is the source of real economic growth. Taking on risk to obtain gain of course means the possibility of loss as well. Uncle Sam is more than willing to demand his share of your profits if you make money, but is no longer your full partner when you experience losses. If you make a million dollars investing, you pay taxes on that million dollars. If you don't have trader status with the IRS and lose a million dollars, you get a $3000 deduction per year and will certainly be dead long before you use it up.

Originally, capital gains were taxed at the rate of ordinary income between 1913 and 1922. Top marginal rates were only 7% at first, but rose to as high as 77% in 1918 to pay for World War I.  An alternative capital gains rate of 12.5% for assets held at least two years was introduced in 1922. The top marginal tax rate on earned income was lowered to 25% in 1925. It was an era of low inflation and even deflation starting in the late 1920s. The stock market and economy did quite well; at least for seven years after the lower capital gains rate was introduced.

In 1932, when Herbert Hoover was still president, the top marginal tax rate on earned income was raised to 63%. In 1934, capital gains tax rates were changed and based on how long an investment was kept. For assets held 1,2, 5 and 10 years, the exclusions were 20, 40, 60, and 70 percent respectively. In 1942, top marginal tax rates were increased to 88%, but maximum capital gains rates were capped at 25% for assets held for six months or longer. Top marginal rates went as high as 94% in 1944 and 1945. They remained at 91% or 92% until 1963. The huge differential between marginal rates on earned income and capital gains rates along with low inflation created an economic and stock market boom that lasted from 1942 until the late 1960s.

The top marginal rate was lowered to 77% in 1964 and then 70% in 1965. Capital gain rates were raised in 1969. Inflation began picking up at around the same time and the combination was a negative for the economy and stock market for over a decade. The government made the problem worse by raising capital gains rates significantly in 1976 and added insult to injury by taxing gains that only existed because of inflation. Maximum capital gains rates peaked at just under 40% in 1977 and 1978.

In 1978, congress voted to reduce maximum capital gains to 28%. In 1981, capital gains were lowered to 20% and the top marginal tax rate to 50% starting in the 1982 tax year. The high rates of inflation from the 1970s were beginning to decline significantly. An almost 20-year boom period followed. There were bumps along the way however. The 1986 Tax Reform Act increased capital gains rates to 28% and lowered the top marginal rate on earned income to 38.5% starting in 1987. The marginal rate was lowered further to 28% in 1988. Ironically, equalization of earned income tax rates and capital gains, a long sought goal of certain liberal economists, took place during the Reagan administration.  The U.S. stock market zoomed for the first eight months. Unfortunately, it then fell almost 40% in a few days in October.

Marginal rates started rising in 1991 and reached 39.6% by 1993. The Taxpayer Relief Act of 1997 reduced maximum capital gains rates to 20%, once again creating a significant differential between earned income rates and capital gains. Inflation was falling and low during this time and this kept the real capital gains rate close to the official one. The stock market and economy did extremely well for the next three years until the tech bubble burst. To pick up the flagging economy and stock market, the Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced maximum capitals gains rates to 15% and made this the rate for qualified dividends as well. Inflation was very low during this period. The market and economy did well for the next four years.

Now the maximum capitals gain rate is scheduled to increase from 15% to 20% after the end of the year. Additional taxes will be imposed later on because of the recently passed health care legislation. It looks like we are entering a period of rising inflation and this will make the actual capital gains rate continually go up. I will leave it to the reader to decide what impact this will have on the U.S. economy and the stock market going forward.

Disclosure: Long oil.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Wednesday, April 14, 2010

Intel's Earnings: Not Much Has Changed in 10 Years

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The French saying, 'the more things change, the more they remain the same' tells the story of the last decade of semiconductor giant Intel's earnings. While media commentary was gushing with enthusiasm about Intel's first quarter earnings of 43 cents this morning, it went unmentioned that Intel had also reported earnings of 43 cents per share ten years ago in the first quarter of 2000.  Intel's stock price reached the $75 level in 2000; it is under $24 today.

While Intel's earnings have finally recovered to what they were at the top of the tech bubble, gross revenues have increased by more than 25% in the last decade. In the first quarter of 2000, Intel sold almost $8.0 billion in products, but last quarter it sold $10.3 billion. This improved Intel's operating income from $2.5 billion ten years ago to $3.4 billion today. Quarterly Income Before Taxes was $3.2 billion in 2000, but $3.5 billion last quarter. Whatever Intel earns today has a more significant impact on its per share earnings though. There were 6.7 billion shares of common stock outstanding at the end of the first quarter in 2000, while there are only 5.5 billion today. Stock buybacks during the lean times have paid off for the company.

Some things that haven't changed are the importance of Asia for the computer market and Intel's microprocessor sales. North America ceased to be Intel's largest market long ago. The CFO's commentary today on first quarter earnings noted that Asia Pacific, Japan and Europe performed better than seasonal patterns would have predicted. The Americas experienced a larger than seasonal revenue decline from the fourth quarter. So if Intel's first quarter results indicate economic recovery, as many in the media suggested, that recovery is taking place in Asia, not in North America.

Semiconductors have always been a cyclical business. Stock prices for semi companies tend to decline before peak earnings in the cycle. Intel's stock is up nicely today on its earnings news, so it is quite possible business is still heading up. The longer-term picture on the other hand seems to have changed dramatically. Intel was leading a rapidly growing industry in the 1980s and 1990s. The last ten years have been fairly stagnant, although characterized by significant ups and downs. Based on stock price, the market isn't nearly as happy today with 43-cent quarterly earnings from Intel as it was ten years ago.

Disclosure: No position in Intel

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Tuesday, April 13, 2010

Why the Stock Market May Be Topping

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Markets hit tops or bottoms when almost everyone shares the same opinion. Current conditions in the U.S. stock market are reaching an excess of bullishness and this indicates a top could be forming. Investors should proceed with caution.

When it comes to market opinion, the majority is usually right and investors should generally move with predominant view in the short term. However, when majority opinion starts to become overwhelming - say less than 20% of investors are bullish or bearish - then herd behavior has taken over and its time to think about stepping aside. At extremes there is no one left to buy or sell, so there is no more fuel left to propel the market in the direction that it has been going. The U.S. stock market has probably already reached that state.

News media coverage is one of the best gauges of whether or not a market has overreached. When it starts to become too positive or negative, the end of the trend is usually near. News coverage for the recent market rally has indeed become extremely positive. When the Dow Jones Industrial Average closed above 11,000 yesterday (April 12th), it got a lot of glowing press reports. This new high for the rally was hit on volume that was below average - an indication of a lack of enthusiasm from market participants. Declining volume has been a serious problem for the rally for a long time now and will eventually do it in.

The dollar has had a significant sell off from around 82 to 80 in the last few days because of the Greek bailout. Money has flowed out of Europe during the crisis and into North America, helping to drive up the U.S. stock market as well as the dollar. A resolution to the crisis will reverse this flow and be bearish for U.S. assets. In reality, the problems in Greece are not over. While a bond auction held yesterday was quite successful in terms of selling the bonds, the interest rates Greece paid were very high - more than double the rates from the January 12th auction for similar debt. Greece's problem wasn't selling its bonds, but the high rate of interest it had to pay on those bonds. So far, the bailout doesn't seem to have fixed the actual problem. While money may no longer be flowing out of Europe, it may not be quite ready to return there just yet. When it does, the U.S. stock market will drop.

Yale professor Robert Shiller has just released an updated version of his historical PE chart for the S&P500. The current level, just below 22, is around the long-term market peak in 1966 and is higher than the PE before the 1987 crash. It is well below the 30 level reached in 1929 and the 44 level reached in 2000 though. Investors should assume that the current 22 number understates the actual PE ratio. Changes in accounting rules during the Credit Crisis have made corporate earnings much higher than they would have been, especially for the financials. The New York State Comptroller's office reported that Wall Street's earnings were three times larger in 2009 than they were in 2007, which itself was an all time record year for earnings. Investors should wonder how earnings could triple from historical highs during the worse economic downturn since the Great Depression. Disneyland accounting along with the federal government transferring money from the U.S. treasury into the coffers of bailout recipients is the answer.

As always, investors should pay close attention to the VIX, the S&P volatility index. A low number indicates investors have become too complacent and the market is likely to start selling off. The VIX fell to 15.23 yesterday and is testing levels last seen in May 2008 and October 2007. The 2003 to 2007 bull market peaked in October 2007 and stocks fell off a cliff in the fall of 2008. Investors were extremely optimistic during the 2007 VIX low, as they always are during a market top.

Disclosure: Long oil.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Monday, April 12, 2010

Do Conditions Exist for a Fall Stock Market Crash?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Market crashes don't take place overnight. They result from excesses that build up because the market has failed to neutralize them with intermittent bouts of selling. Stock prices always correct and if they don't do so by smaller amounts every now and then, they will correct by bigger amounts later on. While crashes almost always take place in the fall, the possibility that one might occur at that time can usually be ascertained by the condition of the market in the preceding spring.

When there is going to be trouble in the fall, the market should already be showing frothiness around March and April. This condition is currently being met. U.S. stocks have been in rally mode for over a year now without any significant correction. Sentiment indicators are starting to indicate too much bullishness and too much complacency. The most recent Investor's Intelligence poll found less than 20% of investors are bearish. This is a low number. Market Harmonics put/call volume ratio for equities has fallen to multi-year lows and is well into extreme bulllish territory. The VIX (the volatility index for the S&P 500) made a new yearly low of 15.32 today, April 12th, and this is also quite low. All of the aforementioned are contrary indicators and the lower the numbers, the more bearish it is for stock prices going forward.

While the market could certainly be characterized as overbought, the technical indicators I use don't indicate that it is severely overbought just yet, especially on the intermediate-term charts. The stock market indices got to incredibly oversold levels in the fall of 2008 and spring of 2009 and they are still working off this condition. One of the most amazing aspects of the current rally is the lack of volume support for the Dow Jones Industrial Average. Volume peaked at the bottom in March 2009 and has been in a long, slow decline since then. Declining volume on a rally indicates buyers are losing interest. For a rally to hold up for more than a year given this condition is truly amazing.

Some selling in stocks could start any time in the next few weeks, but this would probably not indicate the end of the rally. A break in a market that is already frothy can be patched up and the market can then go even higher. When that happens there is risk of much greater selling a few months down the road. Abundant liquidity is always necessary for this to occur. That exists today just as it did in 1929 and 1987. Other underlying conditions are different however. While the 1987 market was supported by falling interest rates and lower commodity prices, current conditions are just the opposite. Now longer-term interest rates are changing trend and are going to higher levels. Commodity prices,with the notable exception of a number of food commodities, are also going higher. These are negatives in the long run for stock prices. There is also political risk to the markets later this year because U.S. capital gains rates will be raised in 2011. Ironically, the higher the market goes now, the bigger investors' profits will be and the more likely they will sell before the end of the year.

The easiest way for investors to check up on the rally is to watch the VIX. While anything at the 15 level is pretty low, the VIX fell slightly below 10 in late 2006 and early 2007. Macro economic and market conditions are not as supportive now as they were at that time though, so it should not be assumed that these same ultra-low levels will be reached again. The VIX tends to bottom several months before a major stock market sell off as well. It bottomed in May in 2008 for instance and the S&P 500 low for the year was in November. Investors who think the VIX has bottomed can buy the ETNs, VXX or VXZ. This is the same as shorting the market, but is a simpler way of doing it.

Disclosure: Long oil

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This article is not intended to endorse the purchase or sale of any security.

Friday, April 9, 2010

Currencies React to Ongoing Greek Debt Crisis

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup (http://investing.meetup.com/21).


The spread between Greek government bonds and their German equivalent hit a new record high yesterday (April 8th) as new worries of a possible Greek debt default emerged. EU central bank president, Jean-Claude Trichet, promptly moved to calm the markets by stating that Greece is in no danger of default and it does not require a bailout. While we have heard it all before, Trichet's remarks kept the euro from hitting a new low against the U.S. dollar and this may indicate the a temporary bottom is in place.

The latest phase of the seemingly never-ending financial crisis in Greece took place as the ECB (European Central Bank) and BOE (Bank of England) had their rate-setting meetings. Both left interest rates unchanged. The ECB kept its rate at 1.0% for the eleventh month in a row and the BOE kept its rate at a historically low 0.5%. The BOE also kept its quantitative easing target at $200 billion pounds (the figure has been raised a few times) and stated it was optimistic about low inflation going forward. The market seemed somewhat less hopeful with the pound falling below 1.54 per U.S. dollar.

Despite choppy trading in the pound, it did not test its March lows, which had last been seen ten months previously. The Euro fell as low as 132.80 against the dollar, slightly above its low in late March of 132.67. The euro's inability to hit a new low on the latest flare up of problems in Greece is bullish for the currency and indicates a bottom may have been put in. Along with the euro and the British pound, the Swiss franc also did not take out its March low. The Greek crisis has caused money to flow out of the Europe in general, not just the eurozone and this may have come to an end - at least for the moment.

The money that flowed out of Europe went to North America first and this has been bullish for both the U.S. and Canadian dollar. The Canadian has not only risen against major European currencies, but has almost hit parity with the U.S. dollar.  The Australian dollar has also held up well and has been rallying since early February. Market attention is now turning to China with reports that it might revalue its currency upward 3%.

While it looks like we have seen the crisis low in the euro, we have yet to see the final resolution of problems in Greece. The market seems confident that that will occur soon. Resolving the problems with Greek debt is in and of itself not that difficult. Greece represents only 2% of the eurozone economy. What happens with Greece will set a precedent with how debt problems in other eurozone countries will be handled however. Sooner or later the EU will have to do something about Portugal, Ireland, Spain and Italy, the other potential trouble spots in the eurozone.  How the market reacts to this remains to be seen.

ETFs/ETNs for the currencies mentioned in this article are FXA, FXB, FXC, FXF, DXY, and CYB and CNY representing the Australian dollar, the British pound, the Canadian dollar, the Swiss franc, the U.S. dollar and the Chinese renimbi respectively.

Disclosure: None

NEXT:

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Thursday, April 8, 2010

Why China is About to Change Its Currency Policy

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Reports are out today, April 8th, that China is about to abandon its fixed rate currency policy instituted in July 2008. It is likely to let the renminbi revalue upward a small amount immediately and then trade in a narrow trading band on any give day after that. China took such an approach in 2005. The U.S. has been pressuring China for this change.

The Obama administration had a report that was supposed to be delivered to congress on April 15th on whether or not China was a currency manipulator. This has become an increasingly sore point in U.S. China relations. It was abruptly announced a few days ago that the report would be delayed. Treasury Secretary Geithner has since gone to China and met with officials to get them to be more flexible with the renimbi's exchange rate. The Chinese have remained adamant that their currency isn't undervalued. If that was indeed the case, they should simply let it float freely and everyone would be happy. There is of course zero chance that that is going to happen at this point in time.

Keeping the value of a currency artificially low is a boon for a country's exporters because it makes their goods cheaper. Business and labor interests in the country with the artificially high currency necessarily lose out. This is a good description of Japanese U.S. trade situation in the 1970s and early 1980s. Now China has a huge trade surplus with the United States and has accumulated approximately a trillion dollars in reserves of U.S. currency.  The U.S. gains from China's undervalued currency policy because China recycles the hoard of dollars its gets from its trade surplus by buying U.S. treasuries (Japan did the same thing). This allows the U.S. in turn to run massive budget deficits because it can borrow a lot of money from China. That game may be up however. China was a net seller of treasuries for three months in a row up to this January (the latest month for which figures are available).

Keeping a currency undervalued is not without its risks. One of those major risks is inflation. China has compounded that risk even further by engaging in a massive stimulus program while its currency was frozen. Inflation does seem to be bubbling up internally within the country and even beyond its borders in higher prices for commodities. Chinese buying is the key driver of commodity prices.  China is in fact the epicenter for potential global inflation and this will impact the U.S. despite any moves the Federal Reserve takes to try to dampen rising prices.

In the long-term, China will have to let the renminbi peg to the U.S. dollar, China will still need to maintain stringent capital controls to prevent big moves in its currency if the renminbi is inappropriately valued (many experts claims it would rise 40% if it floated freely).  Economic forces always win in the end and the Chinese leadership will eventually find this out.

ETNs that can be used to take a position in the renminbi are CYB and CNY.

Disclosure: None

NEXT: Currencies React to Ongoing Greek Debt Crisis

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Wednesday, April 7, 2010

An Analysis of Retail Sales Media Coverage

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Retail sales look like they increased 8% to 10% in March 2010 according to the International Council of Shopping Centers. Assuming the numbers are correct, and this is perhaps a very big assumption, a number of mitigating factors led to the unusual rise, including an Easter holiday that fell right in the beginning of April and very mild weather in March after a February filled with snowstorms. Nevertheless, mainstream media reports heralded that "consumers are finally coming out of hiding" and that happy days are here again.

Today's New York Times had some of the most positive reporting stating that the U.S. consumers' mood has gone from panicked to cautious to "almost a bit giddy" - a quote from Mark Zandi, chief economist for Moody's Economy.com. In coverage elsewhere, Jackson Bros., Boesel & Co. noted that this is season when chain store sales increase and that they saw interesting possibilities in Woolworth, Grand Union, and J.C. Penney.

Today's coverage in the Times noted that "import cargo volume in March also suggested a strong month for retailers", having risen for four months in a row and being up an estimated 6% in March according to the National Retail Federation.  Other publications reported that rail freight loadings in the week that ended March 21st gained more than they usually do in March and had hit a new high for the year. The implications are of course that this indicates that retail sales will be getting better in the future.

The Times upbeat coverage also included "sales are simply much stronger than companies had expected,” and the improvement extends to some of the most costly items including autos with Ford, Toyota and General Motors having robust sales increases in March. The Times did concede that incentives such as no-interest loans may have been responsible. Other sources reported that one major automaker had its third straight monthly gain of around 50% and its highest sales since last June. Dodges, De Sotos, Plymouths, and Fargos were apparently flying off the lot in March... March 1931 that is.

While the New York Times article was published on April 7, 2010, the other articles cited were published 79 years ago in early April 1931 - two years before the economy hit bottom during the Great Depression and many more years before the U.S. managed to crawl out of the economic devastation that the downturn had caused. Rosy media reports in 1931 did not mean that the economy was getting better and it is quite possible that don't indicate that in 2010 as well. Mainstream media wants to tell the 'everything is getting better' story and managed to do so in 1931 when the U.S. economy was actually falling off a cliff. Investors should assume little has changed with media reporting since that time.

What has changed since the 1930s is that the Federal Reserve is pumping huge amounts of liquidity into the financial system and the government is spending huge amounts of money it doesn't have to keep the economy functioning. Retail ETFs, such as RTH, XRT and PMR, are trading at two-year highs. While a realistic analysis of the macro picture may not justify such high stock prices for retailers, liquidity is responsible for the ongoing rally. The party should continue as long as the Fed continues to supply free booze. One it stops doing so, expect one big hangover.

Disclosure: None

NEXT: Why China is About to Change Its Currency Policy

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Tuesday, April 6, 2010

Inflation Denial Won't Keep Prices Low

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Denial is one of the most destructive forms of behavior for investors. While the markets can operate on false scenarios for a significant period of time, reality always wins in the end. When it does, the situation can get quite ugly and all the profits gained from a belief in an unsupportable viewpoint can evaporate over night. At the moment, there is a lot of denial about inflation and investors should be paying attention to this.

The case for inflation is based on common sense and the laws of simple arithmetic. A country cannot create money at a faster rate than its economy is growing. If this occurs, the currency is devalued and it then takes more units of currency to purchase any given item (which is the same as saying prices go up).  There is a time lag between these two events however, sometimes many years, so people frequently don't connect them. Indeed, governments who engage in this behavior frequently go to great lengths to insure the public doesn't make the connection and realize that inflation is caused by government actions. Invariably throughout history, speculators and foreigners are blamed for rising prices. Think about whether or not you've heard any talk about speculators lately. There will be a lot more of that in the future.

When it comes to inflation, governments not only try to act like magicians and dazzle you with one hand while picking your pocket with the other, but they also engage in strong and persistent denial of its existence. Any number of fanciful, but easily debunked, arguments will be produced to show inflation doesn't and even can't exist. In Weimar Germany in the early 1920s, the economic establishment engaged in an across the board denial that inflation existed and there were even 'proofs' created to show that there was really deflation. Inflation eventually reached the hundred trillion percent level there.

So what is happening in the U.S. today? At the March 16th FOMC meeting, the Fed stated "With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.” The implication is of course inflation can't exist if there is substantial resource slack. By the rules of logic, if we can find a single example that contradicts this, we cannot rely on this statement. There are of course many, many such examples. The most recent and perhaps extreme is what just took place in Zimbabwe. The unemployment rate there reached 94% (yes that's unemployment) and the economy essentially experienced a total collapse. According to U.S. Fed, there should have been massive deflation in Zimbabwe, instead of the second worse case of hyperinflation in world history. How could this have happened? Zimbabwe printed a lot of money. The U.S. has also been engaged in significant excess money printing during the last two years.

The evidence of inflation is also not likely to show up first in U.S. government reports. The government has a vested interest in making sure that it doesn't. This is part of managing inflation expectations, which the Fed also mentioned in its statement. The last thing the government wants is for people to be aware of coming inflation and they will manipulate the official numbers and the news as much as necessary to keep this from happening. Investors who want to know what is really going on with inflation need to look elsewhere for the facts. The most recent ISM (Institute of Supply Management) reports indicated very strong inflation pressures in the system, particularly in the manufacturing sector. This story got buried in the media though and was covered up with glowing claims for economic recovery.

Investors should also watch the markets for what they are saying about inflation. There are three important indicators - interest rates, oil and gold. U.S. treasury interest rates have been bubbling up for awhile now. The market is having trouble absorbing the huge supply of bonds that the U.S. has to sell in order to fund the budget deficit. Long-term interest rates have broken a 30-year downtrend line and look like they will be heading higher for many years to come. Oil just broke above a nine-month trading range and is now heading higher as well. Nothing has more of an impact in leading to higher consumer inflation than does rising oil prices (which are set internationally and are out of the Fed's control). Gold has risen from a low just above $250 in 2001 to its recent high in December above 1200. It is in a seasonally weak period at the moment, but should be hitting new all-time highs in the fall.

Inflation provides an object lesson of how investors need to approach the markets. The media is filled with information on financial topics, and much of that information is misinformation. It is necessary to cut out or ignore the irrelevant to make good investing decisions. The best way to do this is think for yourself, believe your own experience, and watch what the markets are actually doing.

Disclosure: Long oil.

NEXT: An Analysis of Retail Sales Media Coverage

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.