Search results matching tag 'Credit Crisis'

We (Still) Don't Know What We Don't Know

VinnyCatalano — Thu, 19 Nov 2009 02:08:00 GMT

So, here we are. More than two years into what started out as a credit crisis, one plus year after the Lehman collapse and a question that pertains to the one of the central workings of the equities market cannot be answered.

At last evening's Market Technicians Association Educational Foundation seminar, the question your trusty moderator (that's me) posed to the esteemed panel with its decades of experience was in regards to volume. Specifically, the equity markets' volume as recorded each day for every stock traded. That is, the volume that accompanies the price action that results in the market capitalization of the stock market that results in the market value of every investor's portfolio.

Many market analysts have noted the low volume that has accompanied this bull rally. Some have used this fact as a reason to be more cautious, even bearish. Others have cited that low volume bull rallies have occurred in the past and this one is no different. However, in the past, the volume recorded for equity trades completed were quite accurate and reliable, being recorded on exchanges and reported accordingly. Today, the picture is not quite so clear.

With so much trading occurring in the off the exchanges hidden recesses of dark pools and structured products, I asked my very knowledgeable panel, can any investor rely on the volume figures being generated in this current market to measure the strength of the price action of a stock? The answer received was, "We don't know". Well, if this well connected, highly informed group of individuals doesn't know, you can easily assume that just about no one knows. Do you?

The importance of understanding this issue goes beyond its impact on basic market analysis tools (such as technical analysis) and cuts to the heart of a financial system that is still shrouded in opaqueness.

Transparency remains elusive. Yet, transparency (knowing what investors need to know) is vital to the restoration of a sustained confidence in a system that can be measured. When trades occur in the dark corners of dark pools and other off-exchange structured products, clarity as to what exactly is transpiring becomes the victim and investors seeking to measure the market become the equivalent of a bystander to a drive-by financial shooting.

Investment Strategy Implications

Nothing increases the risk factor of any investment more than the dangers posed by ignorance. Yet, here we are. More than two years into what started out as a credit crisis, one plus year after the Lehman collapse and we still don't have a clear idea of what exactly is transpiring in a central part of the capital markets - equities.

For those who might be tempted to dismiss such concerns I simply point to the two key impacts of changing equity prices: the wealth effect and the cost of capital. Both directly impact the real economy, in the current case in a positive way. Were it not for rising market values, the current government policies designed to rescue the US (and global) economy would be brought into doubt. And doubt, a close cousin of uncertainty, is a bad thing for a fragile economic environment.

Price without volume is an incomplete measure of the strength (or weakness) of a market move. Yet, in the current environment, price is the only metric that can be tracked with clarity. Volume, its indicator of power, cannot.

Two years and running and we still don't know what we don't know.

To further the exploration of what we don't know tomorrow I will describe how hedge fund replication products pose a potential threat to the equity markets.

Vinny Catalano, CFA, Global Investment Strategist with Blue Marble Research publishes the "Sectors and Styles Strategy Report" newsletter, which contains the market beating Model Growth Portfolio. To learn about subscribing as well as other benefits, click here.

The Best of Times

JohnMauldin — Sat, 24 Oct 2009 02:52:00 GMT

It's The Best of Times
The Elements of Deflation
It's More Than Half Full
Argentina, Brazil, and Uruguay

What's a Fed to do? We get talk about tightening and taking away the easy credit, but we got the fourth largest monetization on record last week. This week we examine the elements of deflation, look at some banking statistics that are not optimistic, and then I write a reply to my great friend Bill Bonner about why it's the best of times to be young. I think you will get a few thought-provoking ideas here and there.

But before we get to the main letter, I want to recommend a book to you. I am on a 17-day, 12-city speaking tour. It is rather brutal, but I did it to myself. However, one of the upsides of traveling is that I get quiet time on airplanes to read books. I am working my way through a very large stack of books on my desk. One that caught my eye - and I'm glad it did - is a book by Tom Hayes called Jump Point: How Network Culture is Revolutionizing Business. Hayes writes about how we are getting ready to experience a cultural change every bit as profound as the Industrial Revolution. He argues that as the 3 billionth person gets online sometime in 2011, it will shift the dynamic of how we interact as businesses and consumers. We get to 5 billion by 2015. The mind boggles.

Clearly, it is already changing things, and I am not sure if I buy Hayes' thesis that 3 billion is a magical number, though it is great marketing. That being said, I found something on almost every page that I underlined or highlighted. This book made me think about the future in ways that my kids already get but Dad doesn't.

I like to read books about "important stuff" by people who have done a lot of thinking about their subjects, and who can write easily and fluidly and communicate their thoughts without weighing me down with unnecessary verbiage. Hayes has done that. (I am sure some of you, my patient readers, wish I could be better at that!)

No long review here. Go to Amazon and read the reviews. One writer wrote: "I gave the book 5 stars not because it was perfect -- I think Hayes's enthusiasm sometimes makes him jump to conclusions - but because there are so many ideas and observations here that it would take ages to put something like this together from other sources."

I agree. If you are in business, any business, you need to read this. As an aside, I will insist that all my partners worldwide get this book and read it. You can go to Amazon.com and buy the book. And Tom, if you get this (and I bet one of your friends will forward it to you), call me.

The Elements of Deflation

One of the advantages of travel is that it gives you time away from the tyranny of the computer to think. (Am I the only one who feels like I am drinking information through a fire hose?) But getting the information is important too, as it gives you something to think about. And I have been thinking a lot lately about deflation.

I get asked at almost every venue where I stop, whether I think we will see inflation, or deflation. And I answer, "Yes." And I am not trying to be funny. I think the primary forces in the developed world now are deflationary. When asked if I don't think that the Fed monetizing debt of all kinds won't eventually be inflationary, I answer, "We better hope so!"

Let's quickly summarize some of the ideas from the last few months of this letter. Just as water is made up of two parts hydrogen to one part oxygen, so deflation has its own elemental structure.

The first element is Rising Unemployment. There has never been a sustained inflationary period without wage inflation. Wages are basically flat and falling. With 9.8% unemployment, 7% underemployed (temporary), and another 3-4% off the radar screen because they are so discouraged they are not even looking for jobs, and thus are not counted as unemployed (who made up these rules?), it is hard to see how wage inflation is in our near future.

Think about this. Only a few years ago, less than 1 in 16 Americans was unemployed or underemployed. Today it is 1 in 5. That is a staggering, overwhelming statistic. Mind-numbing.

Keynes said that you should stimulate the economy in recessions in order to bring back consumer spending. That is not going to happen this time. As my friends at GaveKal point out, this time we will have to have an Austrian (economic) recovery, or a business-spending recovery. My argument will be, when I am with them in Dallas in December at their conference, "Where are we going to get business-investment spending when banks aren't lending and capacity utilization is at an all-time low?" This, of course, leads the Keynesians to jump in and say, "The government has to step up and jump-start consumption!" Which means more debt. Wash. Rinse. Repeat.

The next element of deflation is massive Wealth Destruction. Two bear markets and a housing market collapse have put the American consumer on the ropes. And the next bear market will bring him to the canvas.

Then we have Reduced Borrowing and Lending, as consumers are paying down debt and banks are reducing their lending. Both are necessary in a credit crisis-caused recession. Bank lending is basically back to where it was two years ago, and shows no sign off rebounding. Banks, as I have written, are buying US government debt in an effort to shore up their balance sheets. Lending to small business, the real engine of job creation, is sadly decreasing each month. (See graph below.)

Next up in our elemental list we have Decreased Final Demand and its counterpart Increased Savings. Although the savings rate has come back down to 3% from 6% a few months ago, almost every expectation is that it will rise over the next 3-5 years back up to the 9% level where it was only 20 years ago. The psyche of the American consumer has been permanently seared. Consumption and savings habits are being changed as I write.

And of course we must address the element of Low Capacity Utilization. While capacity utilization is rebounding, it is still lower than at any time since the data has been collected, other than the last few months. It is hard to see where businesses are going to get pricing power, when not only US but world capacity utilization is still extremely low. The chart below is not the stuff that inflation is made of.

And let's just quickly throw in Massive Deleveraging and $2 trillion in Bank Losses and a Very Weak Housing Market. Which brings us to a Slowing Velocity of Money.

As I have written on several occasions, prices are a function of the amount of money times the velocity of money. If the velocity of money is slowing, the amount of money can rise without bringing about inflation. It is a delicate balance, but nonetheless the hyperventilation in some circles about the coming hyperinflation is, well, overinflated. Simplistic. Economically naive.

The Fed is going to do what it takes to bring about inflation (in my opinion). But they will not monetize US government debt beyond what they have already agreed to. If they need to "print money" to fight deflation, they can buy mortgage or credit-card or other forms of private debt, which have the convenience of being self-liquidating. Read the speeches of the Fed presidents and governors. I can't imagine these people will recklessly monetize US debt. You don't get to their level without having a stiff backbone. (Yes, I know the gold bugs will call me terminally naive. We will have to wait to see who is right. Peter Schiff, care to make a bet on this one?)

Bernanke warned Congress again last week about rising deficits. Watch the deficit rhetoric coming from the Fed after the next two governors are appointed next year, side by side with Bernanke's reappointment. There will be a line drawn in the sand. Some in Congress will not be happy, but my bet is that the Fed will maintain its independence. If they do not, then my recent letters will prove far too optimistic (and many of you protest my rather less-than-positive suggestion of a double-dip recession). But I must admit I cannot imagine that happening. And there are not enough votes in Congress to change that independent status. There is a day of reckoning coming with the US debt. And thank God for that.

Bottom line: The Fed will do what it takes to keep us from deflation. They will deal with the problems of the ensuing inflation. I wrote six years ago that the best outcome from all the easy monetary policy and budget deficits would be stagflation. I see no need to change that assessment. I am not happy with stagflation, but as I came into my young adult life in the '70s (see below), I know that we can deal with that. The far more worrisome prospect is continued trillion-dollar deficits.

It Is the Best of Times

Now let's change the topic. My friend Bill Bonner, of Daily Reckoning and Agora Publishing fame, recently wrote about his mother. Bill also turned 60 recently. I wrote to him about the similarities between our mothers. Both were born in hard circumstances, on farms that had no indoor plumbing. They joined the WACs and met their husbands. They struggled raising families. Bill and I both grew up in rather humble circumstances (to put a mild spin on it).

That exchange caused Bill to write about the future our kids face. He has six kids and I have seven. He has graciously allowed all my kids to invade his chateau in rural France (where they mingle with his kids), and has invited us back next summer. I think Bill is the best writer, the best "turner of a phrase," in the business. I often feel like a house painter standing in front of a Rembrandt when I read his work.

But Bill is a tad pessimistic. He makes me look like Larry Kudlow. He wrote (among other books) Financial Reckoning Day, which has just been updated and is now titled Financial Reckoning Day Fallout: Surviving Today's Global Depression. It makes for some interesting reading. Get it with Jump Point.

Now to the point. As I said, Bill wrote about the future our kids face. I will repeat what he said and then respond. Bill's thoughts:

"We sat in a cab yesterday, stuck in traffic in central London. We watched people walk by and wondered. What are they thinking about? What do they want out of life? What do they think of themselves?

"There were hundreds of them...different shapes...different sizes. A businessman in a pin-striped suit, briefcase in hand, concentrating on his sales report; he almost stepped in front of a motorcycle. A salesgirl, grotesquely overweight...yellow hair streaked with brown...wishing she hadn't had so much to drink the night before. A lawyer daydreaming about his secretary. A man who would have rather been fishing...still in his waxed coat. A woman annoyed about something. A heavy construction worker, his legs splayed outward as he walked. A tense young woman who dared not look up. A woman worrying about her son. A man thinking about buying a new car. One man trying to remember a line from a song he learned 30 years ago. Another talking to herself. One looked like a doctor taking an afternoon stroll. Another was stark raving mad.

"All of them walking along...from one place to another...shuffling along...the living towards the dead.

"We were thinking of our children. What a different world they grow up in. And yet, it is still the same too. A man might have been stuck on a London street 50 years ago...and hundreds of years ago he might have watched the same shopkeepers and carpenters walk by, each caught in his own thoughts like a fly in a spider's web.

"Our old friend John Mauldin wrote to say that his mother's experience was not much different than ours. She joined the WACs during the war...met John's father...and then nature took her course.

"But both John and your editor had a big advantage in life. We both caught the upswing.

"Not so with our children. They inherit a different world. America was the world's leading nation in the '50s and '60s. And it was growing in power and wealth - rapidly. We grew up with it. Things were getting better and better...we were sure we'd live much grander, richer, and more exciting lives than our parents. The sky was always the limit!

"Now, America is in decline. China's economy grows while hers declines. The Far East has savings, while she has none. The Asia nations are net exporters, making huge profits...while American industries are judged too old, too expensive, and too highly regulated to compete. Americans have debt up the kazoo, while their competitors have little. A young person in America has to look forward to supporting 70 million retired baby boomers...and paying for their drugs, their food, their wars, and their bailouts.

"For our children - ours and John's - the situation on a personal level is different too. Coming from poor families, we could look forward to much more wealth and material success than our parents ever knew.

"We came back to Ireland this week for a reason that our parents would never have dreamed of. Your editor has set up a family office. It is a very modest affair by family office standards. The typical family office manages a fortune of $100 million, according to The New York Times. We may not even be on the same planet with these rich families; but we are in the same universe. That is, we try to think about...and manage...our wealth as rich people do...as a family legacy or an endowment, not as a retirement fund.

"What wealth we have accumulated - even if it is paltry - will be held by a family-owned corporation. Then, the corporation, run largely by the adult children, manages the assets - from our base in Ireland.

"Your editor, freed from the responsibility of managing his own money, will be free to wander and think...like a vagabond, a gypsy, a refugee, an itinerant mendicant...forced to sup on whatever is at hand and take lodging wherever he can find it - but favoring the Four Seasons and Chateau Margot when they are available.

"Whatever else this does, it puts the children in a very different situation from their parents. Instead of starting out with nothing, they're starting out with something. While this would seem to be a big advantage to them, it has huge hidden disadvantages. Like America itself, they are in danger of finding themselves slipping downhill. Instead of expecting things to get better, they may find it hard even to hold onto what they've got. Instead of the "Morning in America" that Ronald Reagan promised, they may find that it seems more like evening, both in their personal as well as their national lives.

"'From shirtsleeves to shirtsleeves in three generations,' say the French. The grandfather begins without a coat. His grandson ends that way.

"But what to do? Spend it all now...so the children begin with the same clean slate we had? Move to Brazil or India - countries with more obvious upside?

"In the deep, cosmic end, it probably doesn't matter. The advantage to starting out on an upper rung of the ladder may be about equal to the disadvantage of having to worry about falling off. Who can know?

"Every man has to play the cards he's been dealt. What else can he do? He may have a humpback or a beautiful voice. He may have had a hard upbringing or a soft head. He may have a fortune worth of poetry in his soul but not a dime in his pocket. As far as we can tell, every young man starts out even. Each one begins life in the same place - where he is. And every generation takes what it is given, and makes the best of it.

"The real advantage in life is having the gumption to get on with it; no one knows where that comes from."

It's More Than Half Full

Ok, Bill, let's review those wonderful days from whence we sprang, so fraught with the advantages of having nothing. So potent with opportunity. It was the middle of the '70s when we started our careers. Inflation was high and rising. The Soviets were seen as a major threat. Japan was beating our brains out and buying everything, even if nailed down (like Pebble Beach and New York skyscrapers). I had to borrow money at 15% (or more) to buy paper in order to meet customer demands for printing. And guess what? The banks got into trouble and called loans willy-nilly. (My bank even called my mother and threatened her to pay off my loan - against written agreements - and she did. Evil sons of bitches. The more things change... And that bank did fail, I report delightedly! Not that I hold a grudge.)

There were multiple successive and ever-deeper recessions. Gold was rising and the dollar was seen as a joke. Howard Ruff (a good friend to both of us when we were starting out!) and almost every newsletter writer were telling people to buy gold and freeze-dried food to protect themselves against a near-certain economic, if not apocalyptic, catastrophe. Unemployment was high and rising for a decade.

The correct answer to the question, "Where will the jobs come from?" back then was, "I don't know, but they will." And that is the correct answer today.

In 20 years, no one will want to come back to the halcyon days of 2005. Our kids (all 13 of them) are getting ready to live through what will be the most exciting period in human history. There will be a century's worth of change, measured by the standard of the 20^th century, just in the next ten years, and then we will double that pace in the next ten after that. Medical miracles will mean our kids and grandkids will live a lot longer than their dads, although I intend to be writing well into my 80s, like our mutual hero Richard Russell.

There will be whole new industries developed in the US. How do I know that? Follow the money. The rest of the world spends a fraction of what we do on research and development. Where do you go if you are looking for venture capital?

Do I care if the Chinese and the "developing" world are far better off, relatively speaking, than the US in 20 years? Not a whit. Good on them. I hope they make discoveries and inventions and grow new businesses that benefit us all. But we are not going into some long dark night. We, and our kids, get to choose how we respond to what is the reality of the day.

Our nation had to almost hit the wall in 1980 before a Volker could come along and force us to take the pain of recession to beat back inflation. And we will have to come perilously close to the wall this time before we take action as a nation. Way too close for comfort. Maybe you are right, and we have a soft depression. I hope not; but even so, the world will be better, far better, in 20 years, with far more opportunities than today.

It was not fun starting new businesses in the '70s and early '80s. But we did. I remember coming to Baltimore and being (literally) afraid to get out of the car to visit your offices in the slums. But that was what you could afford. A far cry from the chateau in Ouzilly.

I lived in a small mobile home. Tiffani was born there, and we converted part of the kitchen to be her bedroom. (Yes, I was white "trailer trash.") But I got up every morning just like you did and killed as many alligators as I could. The rest had to wait 'til the next day.

And that is the legacy our kids have. They know what it is to wade into the swamp every morning. Never quitting. In thinking about this, you may be the father I respect the most. You have raised your kids to be multilingual children of the world. What a work ethic. How did you get them to scrape window shutters at your chateaus? (I actually saw this, and my kids marveled. Thereafter I threatened to make them go live with you when they didn't behave!)

You have given your kids the opportunity to follow their dreams, even demanded that they do so. And such dreams they (and mine) have. Will they succeed? Who knows? But they will go at it with gusto, in a world with more opportunities than you and I ever imagined 40 years ago. And, oh boy, were we optimists back then. How else could we have done what we did? If we believed the rhetoric that the world was coming to an end, would we have dared to venture out?

You cannot have raised your kids to be such bold adventurers without instilling in them a certain high level of optimism. I am going to out you, Mr. Bonner. You present yourself to your readers as a bona fide end-of-the-world pessimist. But you are a really and truly a closet optimist. Your whole business empire (and what an empire it has become!) is based on finding people who are optimists, in the sense that they think they can actually get people to send them money for what they write. Which they do! Even if it is to read why the world will come to an end, which thankfully it never does.

You are right in this: it is personal gumption that makes or breaks us. There are those who started out with less than we did (hard to imagine but true) and made a lot more. And there are those who started out with far more and made less. But there are very few who are happier than either of us. Or luckier.

Our kids? It is not the times that dictate the man (or daughter!), but the response of the man which dictates his own time. Today promises a brighter future for someone young than any other time in history, whether they are in the US or Brazil or China. They just have to seize it.

And as our kids do just that, and as the millions of kids of those who read us do so, and the billions of kids who are just now getting ready to bust loose all work to achieve their dreams, the world is going to be a far more fantastic place. Smooth ride? Not a chance. We didn't get one; and in thinking through history, there have not been many smooth rides. Why should we think that will get any better? Our kids will just have to live with our generational (and individual) iniquities, government debt and all, and figure out how to master their own fates. But if I had a choice to take the '70s or today? In less than a heartbeat I would choose today. And I bet you would too!

(Side note: You can subscribe to the Daily Reckoning and read more of Bill's great prose. Warning: it is bearish, but lively and fun.)

Argentina, Brazil, and Uruguay

Tonight I am in Orlando, where I spoke at the Commonwealth national conference. I have been to a few conferences here and there, but I must admit to being impressed. A conference for brokers and advisors who are affiliated with them, it was exceptionally well done. And a very smart crowd. These guys have attracted some exceptional talent.

Tomorrow morning I fly back to Dallas, where I get to see my new grandson, Hayden, for the first time. Born this week a little early while I am on the road, I get a call at 3 am on Monday telling me the news and sending me a picture. Wow. The heck with deficits and deflation. How can you not be an optimist?

Then later in the afternoon I am off for Argentina, Brazil, and Uruguay, speaking in four cities and meeting with clients (and future clients) of my Latin American partner, Enrique Flynn. And then back to Philadelphia, again in Orlando, Scottsdale, and one trip to New York in early December. Then not much else is scheduled - but past performance says that will change.

There is a steak and a bottle of wine waiting for me down the hall, so it is time to hit the send button. Have a great week. I know I am. I love South America, and look forward to coming back to you with my impressions.

Your wondering who made up this schedule analyst,

John Mauldin

A Country for Old Men and a Bit of Samba

JohnMauldin — Mon, 05 Oct 2009 20:05:00 GMT

We all know that a large wave of Baby Boomers in the US are approaching retirement. But what about the rest of the world? And what happens when those retirees need to spend out of savings? There is more than just a credit crisis and a government deficit crisis in our future. A rising level of retirrees to workers is happening even as I write. And the US is not, for once, the center of the problem. As this week's writer of your Outside the Box Niels Jensen explains, we cannot all export our way out of the problem. There is a global adjustment that must happen and when it does, it will have serious consequences for all. This week's letter is guaranteed to make you think. Set aside a few minutes to do so.

Niels Jensen is the Senior Partner of Absolute Return Partners based in London. I have worked closely with Niels for years and have found him to be one of the more savvy observers of the markets I know. You can see more of his work at www.arpllp.com and contact them at info@arpllp.com.

John Mauldin, Editor
Outside the Box

A Country for Old Men and a Bit of Samba

The Absolute Return Letter October 2009

The Man Card

"Excuse me Sir, can I see your Man Card?" The stone-faced look of the security guard at Dallas Fort Worth Airport gave nothing away and, after two days of celebrating John Mauldin's 60th, my brain was probably operating somewhat below full capacity. "I need to see your Man Card Sir". Couldn't he just go away, I thought to myself, not really sure how to deal with the situation. Suddenly his face cracked wide open and in the broadest possible Texas drawl he said: "With those pink socks on Sir, I need to make sure you are a man". Welcome to Dallas!

The highlight of the weekend was a two hour roundtable discussion on Saturday afternoon where John had asked 15 of his friends and business associates to share with the group what their fears and hopes were for the next 15-20 years. I duly noted that the issues on the minds of our American friends are not at all dissimilar to what we worry about in Europe – our children's welfare, unemployment, immigration, racism, the impact of technology and the aging of our society to mention but a few.

This month's letter is about demographics and is the second in our series about major trends defining the future of the world we live in. Last month I wrote about the energy outlook, and I had an unusually high number of emails commenting on the letter. Many of them made the point that the world is in better shape than I seem to think, even if oil supplies are dwindling, as natural gas reserves are ample. We just need to switch source. Whilst I don't disagree that natural gas seems the way forward, one should not underestimate the task ahead of us. About 2/3 of all oil is used for transportation purposes and it is an enormous task to reduce our oil dependency. It will take many, many years and cost gigantic sums of money.

It is the banks, Stupid!

Back to this month's topic - in the financial press, there has been no shortage of attempts to apportion blame for the credit crisis. Disregarding the more obvious finger-pointing (it is the banks, stupid!), there seems to be a growing acknowledgement that large imbalances in the global economy are to blame for the current mess.

Put differently, a large number of countries - mainly Anglo-Saxon in origin but also the majority of our Eastern European friends - became credit junkies and spent beyond their means, year-in year-out. Conversely countries with large current account surpluses (e.g. China, Japan and Germany) were only too happy to deliver the drug to the intoxicated.

It is therefore too simplistic to suggest that only the deficit countries are to blame. The suppliers of credit must accept that they carry no small part of the responsibility, just like the drug dealers do when supplying junkies. In the past, I have been critical of Ms. Merkel of Germany when she stated publicly that Germany should continue to do what Germany does best, and that is to export goods of high quality. The obvious point here is that if Germany pursues such a strategy, the world will be no more balanced ten years from now than it is today, and a crisis similar to the one we have just been through could happen again.

It should therefore be obvious that not only should the deficit nations become more disciplined (i.e. save more and spend less), but the large surplus nations should actually put measures in place to ensure that their citizens save less and spend more. In practice, however, that is easier said than done. Demographic forces have a much bigger say on spending and savings patterns than generally acknowledged.

The Life Cycle Hypothesis

My story begins with Franco Modigliani. In 1985 he was awarded the Nobel Memorial Prize in Economic Sciences for his life cycle hypothesis which (somewhat simplified) states that spending and savings patterns are predictable and largely a function of demographics. When you are in your 20s and 30s, savings are low as much of your income is spent on establishing a family, buying and furnishing your home, putting the children through education, etc. Then comes a phase, from your early to mid 40s until just before you reach retirement age, where your savings grow significantly. The outgoings are smaller during this phase of your life as the kids have left home, and you focus on accumulating wealth to pay for your retirement. Eventually, when you retire, your savings rate turns negative as you begin to live on your life savings¹.

Empirical evidence has since shown that this is generally true both for the individual and for society at large. Obviously, you don't win the Nobel Prize for pointing out something that can hardly be classified as original thinking, but Modigliani's claim to fame was to demonstrate the effect this pattern has on the general economy as the population ages. Let me introduce you to a chart constructed by fellow Dane Claus Vistesen who is an economist and active blogger. He has made a solid attempt to graphically illustrate the consequences of Modigliani's work (chart 1).

The blue line represents the current account – it is in surplus when above the red line and in deficit when below. As you can see, when a country's population is relatively young, the country should (all other things being equal) run a current account deficit. As the population grows older, and the savings rate rises for the reasons described above, the deficit turns into a surplus until such time that the elderly begin to dominate the young at which point the surplus turns into a deficit yet again.

Our export dependency

Why is all this important? Well, take another look at chart 1, but focus on the purple line instead, which represents the country's export dependency. Translated into plain English, Modigliani's work implies that a country with an ageing population must grow its exports aggressively in order not to build up an unsustainably large current account deficit. Unfortunately, as you can see from the shape of the curve, it is not a linear function. The problem gets progressively worse as the population ages.

Now, with most OECD countries fast approaching the danger zone where an uncomfortably large part of the population consists of old-age pensioners, how do we get out of this pickle? We can't all export our way out of the problem. Somebody needs to buy our products. I will get back to answering this question later, but let's take a quick look at the so-called dependency ratio first. If the ratio is, say, 30, it means that there are 30 people at the age of 65 or older for every 100 people between the age of 15 and 64 (which defines the working population).

Obviously, the higher the dependency ratio, the fewer working people there are to pay for the elderly. At some point the cost of supporting the elderly will reach a level which spells economic disaster, and some of the more exposed countries may quite simply be forced to abandon their welfare standards to cope. More about this later -let's get some data points on the table. In chart 2 below, I have tried to keep things relatively simple. I have assumed, for example, that the fertility rate will remain unchanged going forward. This may or may not be a reasonable assumption. Only time can tell.

A walk in the park

The first thing that struck me when I produced this chart was how relatively benign the US outlook is. I read an awful lot of US centric macro economic research (my wife thinks too much!) and, more often than not, there is a reference to the bleak future for America given the fact that baby boomers in large numbers will be retiring over the next two decades. However, when you compare the US numbers (a dependency ratio of 19 today growing to 34 by 2050) to most other developed nations, the US demographic challenge suddenly looks like a walk in the park.

No other country is aging as quickly as Japan. Saddled with a large number of old age pensioners already (the dependency ratio is currently 35), the ratio will grow to an astonishing 76 over the next four decades. The Japanese economy has struggled to drag itself out of a slow growth environment for the past twenty years (give or take). The problems in Japan are well publicised and are often blamed on failed policy measures. I just wonder how big a role demographics have actually played in all of this and whether the Japanese mire is a sign of things to come for the rest of us?

Europe is toasted

The outlook for Europe doesn't make for pretty reading either. In fact, you can argue that we are worse off than Japan given our lower savings, and it raises some serious questions about the sustainability of our entire welfare model. The IMF has calculated that the cost of age-related spending in the average advanced G20 country will cause public debt-to-GDP to grow to over 400%, with Spain and Greece reaching over 600% unless the existing welfare model is cut back. For comparison, Japan has the highest public debt-to-GDP ratio today at about 225%.

As our business partner, John Mauldin, always reminds us, what cannot happen, will not. We may have to prohibit the use of condoms (not advisable for other reasons), import more labour from countries with higher birth rates (immensely unpopular) or simply reduce old-age benefits. The latter carries its own set of challenges as the political influence of the elderly is on the rise, and it won't exactly become any easier over the next 20 years to pass draconian legislation to reduce old-age benefits. Frankly, I have no idea how we will find a way out of this pickle. But find a way we will.

BRICs versus PIGS

As far as emerging economies are concerned, the outlook is considerably brighter (note the big difference between the BRICs and the PIGS in chart 2) but perhaps not as straightforward as you may think. Most investors seem to buy into the idea that, over the next few decades, emerging markets will offer better investment opportunities than more mature markets, as their economies are likely to grow much faster, and you don't yet pay for the faster growth through higher P/E ratios. Whilst we wrestle with depressing issues such as how to pay for the credit crisis and how not to bankrupt ourselves as we age, emerging economies should benefit from a growing labour force. In fact, as you can see from chart 3, in the next few years less developed countries, which tend to have very young populations, will actually outgrow more developed countries in terms of the size of the working population relative to the total population (which is good for economic growth).

The growing number of workers should, according to Modigliani, be followed by stronger economic growth and rising savings. If these savings can be invested into new productivity enhancing investments, emerging economies should enjoy much higher living standards in the years to come. You may raise a hand here and say "STOP – didn't you just argue that countries with young populations should run current account deficits and hence low savings rates?" It is indeed correct that 'young' countries should, according to Modigliani's hypothesis, not be able to generate savings rates at the magnitude we have seen coming out of South East Asia in recent years.

Cheating is omnipresent

But Modigliani didn't take cheating into account. Virtually every country in Asia has artificially depressed its currency in recent years in order to export itself to prosperity. This cannot, and will not, go on forever. As living standards rise in these countries, and domestic demand fuels economic growth, expect their currencies to appreciate against the old world currencies.

At the same time, one should not ignore the fact that not all emerging economies have young populations. I have included the four BRIC countries in chart 2 in order to make this point clear. As you can see, by the middle of the century, China and Russia will actually both have a higher dependency ratio than the United Kingdom, whereas Brazil and in particular India should continue to benefit from relatively young populations.

In a recent research paper², BCA Research analysed a number of emerging economies and found that, broadly speaking, they can be divided into 3 categories – those where the working population is peaking just about now, those that will peak in the next 7-10 years and finally those where the peak is still 15-20 years away (chart 4).

It is clear from BCA Research's work that some countries are in much better shape demographically than others. Most interestingly, China, which everybody (well, almost everybody) raves and rants about, does not look particularly attractive. Obviously you cannot judge the investment appeal based only on demographics, but if you add to that China's fragile banking system and a construction boom which has left most new buildings half empty and led the Chinese authorities to block local access to hedge fund manager Hugh Hendry's website, because he had the audacity to point out the insanity of many of the construction projects in China, then the Chinese investment story loses some of its glamour.

Too much of a good thing

A great growth story like China will always attract plenty of capital but, in the case of China, you can actually argue that too much capital has been attracted. As I was taught at university, economic growth loses its momentum if capital spending outgrows labour because of the diminishing return on capital. BCA has illustrated this graphically (chart 5), and it is obvious that China is attracting too much capital for its own good. You want to invest where capital is scarce, not plentiful.

You are therefore likely to earn a higher return on investment by investing elsewhere in the universe of emerging economies. One such country is Brazil which does not attract nearly the amount of capital that China does. I have been keeping an eye on Brazil for some time now as I am intrigued about their fledgling oil industry, and the more I learn about this country, the more excited I get. The story has not gotten any worse in recent days after the International Olympic Committee's decision to award the 2016 summer games to Rio de Janeiro. But that is an entirely different story which I may write more about another day.

Going back to the question I raised earlier, how do we get out of this pickle? As already stated, we cannot all become exporters as we grow older and domestic demand begins to fade. The only way out, if we want to maintain economic growth, is for the younger and more dynamic emerging economies to become net importers. This will require a sea change in policy, and attitude, in those countries. Most importantly, it will require the exchange rate cheating to stop once and for all. There is no alternative, unless you are prepared to accept negative GDP growth year-in year-out. And that is no fun.

Niels C. Jensen

Footnotes:
1 See http://www.princeton.edu/~deaton/downloads/romelecture.pdf for more information on Modigliani's work.
2 'Demographics, Investments and Growth: Where are the opportunities?', BCA Research, August 2009.

Beyond the Sound Bite: An Interview with Susanne Trimbath, Ph. D.

VinnyCatalano — Wed, 09 Sep 2009 15:26:00 GMT

My interview with the CEO and Chief Economist of STP Advisory Services includes her libertarian perspectives on the virtuous circle, the risks in the Fed's exit strategy, key consequences of financial innovation, and the next global financial crisis: public debt. Dr. Trimbath is also the author of "Beyond Junk Bonds: Expanding High Yield Markets".

The length of the interview is 18 minutes 28 seconds.

(Please visit the site to view this media)

On the Economy & Obama's Trillions

GaryHalbert — Tue, 08 Sep 2009 20:33:00 GMT

IN THIS ISSUE:

The Economy - More Signs of Recovery
Is the Recession & Credit Crisis Over?
Obama Adds $2 Trillion to Debt Forecast
Economic Assumptions Still Too Optimistic
What in the World Are They Thinking?
Do They Want Control Even If It Ruins The Economy?

Introduction

In my June 16 E-Letter, I reprinted the non-partisan Congressional Budget Office's (CBO) projections of annual federal budget deficits over the period from fiscal 2009 to fiscal 2019, which estimated that the national debt will more than double over that 11-year period - not including over $1 trillion for nationalized health care (if it passes) and several trillion more that will be required to rescue Social Security, Medicare and Medicaid over the next decade.

The White House Office of Management & Budget (OMB), which is partisan, runs budget deficit projections similar to those of the CBO. The OMB's deficit projections over the same period, 2009-2019, showed the national debt increasing over $2 trillion less than the CBO's forecast of $11.11 trillion. However, on Friday, August 21, the White House quietly announced that the OMB had revised upward its deficit projections to fall in line with the CBO's. So, it's official.

The only good news on the deficit front is that both the CBO and the OMB recently revised downward the fiscal 2009 budget deficit, which closes out at the end of September, from the earlier reported $1.8+ trillion to around "only" $1.6 trillion. Time to break out the bubbly, right? Wrong! We will look at the latest deficit projections as we go along, but the problem is still the same; Obama seems intent on spending this country into financial ruin.

But first, there is more good news on the economic front. More and more forecasters now believe that GDP has moved into positive territory in the 3Q, and perhaps it has. Unfortunately, we don't get our first 3Q GDP estimate until the end of October. The latest GDP estimate for the 2Q was unchanged at -1.0%, which was better than expected. I will cover the latest encouraging (and not so encouraging) economic news just below.

The Economy - More Signs of Recovery

We have seen considerably more positive signs than negative over the last month. Let's begin with the ISM manufacturing index which rose sharply to 52.9 in August, up from 43.4 in July. It is the highest reading since June 2007. A reading above 50 in the ISM index indicates that the economy is recovering. The ISM "new orders" index jumped 9.6% in August to 64.9, which confirms that inventory rebuilding is intensifying, albeit from very depressed levels.

Durable goods orders jumped 4.9% in July (latest data available) following -1.3% in June. Industrial production increased 0.5% in the same period. The factory operating rate also increased modestly in July. Construction spending, however, was still down slightly in July.

The Index of Leading Economic Indicators rose for the fourth consecutive month in July (latest data available) with a rise of 0.6% following a gain of 0.8% in June. Four consecutive up months in the LEI is quite encouraging, indicating that the worst of the recession is likely behind us, and the economy may move into positive territory before year-end.

The Consumer Confidence Index bounced back in August to 54.1 versus 47.4 in July. After rising sharply in the spring, the Index drifted lower in June and July so the latest recovery was welcomed. The University of Michigan Consumer Sentiment Index also closed out higher at the end of August.

Unfortunately, the rise in consumer confidence that began in the spring has not translated into significantly higher consumer spending. Retail sales in July fell 0.1%. Personal consumption expenditures, another measure of consumer spending, were up only 0.2% in July. Most Americans are still very concerned about the economy, and many are choosing to save rather than spend. The Commerce Department reports that the personal savings rate rose to 5% of disposable income in the 2Q, the highest rate in over a decade.

On the housing front, there was some good news in the last month. Pending home sales rose 3.2% in July following a gain of 3.6% in June. Actual sales of existing homes rose 7.2% in July to an annual rate of 5.24 million units. Sales of new homes rose 9.6% in July, the largest monthly gain since February 2005. Much of the increase in home sales in recent months is attributed to the up to $8,000 in tax incentives for first-time home buyers; yet no one knows what will happen when this stimulus program ends later this year.

The Labor Department announced last Friday that the US unemployment rate jumped to 9.7% in August, up from 9.4% in July, and above pre-report expectations. In August, the official number of unemployed persons increased by 216,000. The Labor Dept. also reported that there are now 14.9 million unemployed Americans, and this number is likely headed even higher in the months ahead.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Is the Recession & Credit Crisis Over?

In the 30 years that I have been writing about the markets and the economy, a "recession" has consistently been defined as two or more consecutive quarters of negative growth in GDP (or GNP back in the old days). Likewise, two consecutive positive quarters meant that the recession was over. Be that as it may, if the initial GDP report for the 3Q is even mildly positive (which we won't get until the end of October), you're going to hear virtually everyone declare that the recession is over - whether or not that proves to be the case.

While I remain a bit skeptical, most of my trusted sources believe at this point that 3Q GDP will be at least mildly positive, and that the 4Q will be as well, in large part due to inventory rebuilding. But most of these same sources are not predicting a strong recovery in the economy. Some believe that there is still a real chance that we will slip back into recession in late 2010 or 2011, especially if consumers continue to save rather than spend.

As for the credit crisis, I think it is fair to say that it is no longer a crisis. But as anyone who is trying to get credit for a business knows, the banks are still not lending remotely as they were before the subprime blowup occurred. New lines of credit are few and far between. Many banks still have too many bad loans on their books, so they're not looking for new ones.

According to the FDIC, 84 US banks have failed so far in 2009, a record pace. So while it may be safe to say that the credit "crisis" is over, we are still far from being out of the woods. There are now 416 banks on the FDIC's "problem list" (up from 305 in March), so there will continue to be multiple bank failures every month for some time to come.

Then there's the 800-pound gorilla in the room - the Fed. At some point, the Fed will have to unload the $2+ trillion in questionable securities and toxic assets on its balance sheet. The Fed can't continue to print money ("quantitative easing") indefinitely; likewise, it will have to shrink the money supply at some point; and finally, short and medium-term interest rates will have to be allowed to rise somewhere down the road, especially if the economy rebounds.

Obviously, no one short of Ben Bernanke knows when this will happen. My best sources believe that because of the deflationary forces created by deleveraging, the Fed has at least a year to maintain its current stimulative policies without risking higher inflation. Similarly, they believe the Fed can wait a year or so before having to begin unloading assets and trim its balance sheet.

Virtually, everyone I read in the financial/investment world agrees that the Fed faces a daunting challenge when the time comes to unload these assets. This problem, above all, will continue to hold the threat of a double-dip recession over the economy and the markets. We all need to keep this in mind even if the economy goes positive for a few quarters.

Obama Adds $2 Trillion to Debt Forecast

2009	$1.845	trillion	2015	$785	billion
2010	$1.379	trillion	2016	$895	billion
2011	$970	billion	2017	$945	billion
2012	$658	billion	2018	$1.023	trillion
2013	$672	billion	2019	$1.189	trillion
2014	$749	billion

TOTAL $11.11 Trillion

As noted in the Introduction, both the CBO and the White House Office of Management & Budget (OMB) recently reduced the budget deficit forecast for fiscal 2009 from the $1.845 trillion noted in the table above to apprx. $1.6 trillion. So, the $11.11 trillion shown above would now be reduced to apprx. $10.87 trillion (if the latest projections prove to be correct).

Note that this astronomical amount does not include over $1 trillion for nationalized health care (if it passes) and several trillion more that will be required to rescue Social Security, Medicare and Medicaid over next decade as the Baby Boomers retire. Nor does it include the existing national debt of $11.7 trillion. The $10.87 trillion is merely the sum of annual budget deficits over the 11 years from 2009 to 2019.

Given that September is the end of fiscal 2009, the talk is now focused on record budget deficits for the 10 years from 2010 to 2019. Never mind that the 2009 deficit will be apprx. $1.6 trillion, almost four times larger than our previous worst deficit in history, which was $438 billion in fiscal 2008 under President Bush.

If you take out the $1.845 trillion 2009 deficit from the table above, the CBO deficit estimate for 2010-2019 is $9.02 trillion. This is $9 trillion that we will add to the national debt over the next 10 years, based on Obama's budget projections. Yet for months now, the Obama administration has taken flack because its own OMB has maintained that the 2010-2019 deficits would only total apprx. $7 trillion. But that has recently changed.

Now if you're the President of the United States, and you have some news that is not flattering to release to the public (especially in a recession), you might decide to quietly release that news at the end of the day on a Friday, and hope that it doesn't get much play on the weekend news shows. That is exactly what happened on Friday, August 21.

At the end of the day on Friday, August 21, a senior White House official announced that the Office of Management & Budget had revised its deficit forecasts for 2010-2019 from $7 trillion to apprx. $9 trillion. At long last, that puts Obama's forecast in line with the CBO's forecast.

Obama Administration officials acknowledged that they relied on overly optimistic assumptions about the economy when they forecast in March that President Barack Obama's budget plans would generate deficits of $7.1 trillion over the next 10 years. After factoring in the severity of the recession and the prospect of a more sluggish recovery, the White House concluded that the budget outlook is significantly worse and revised the 10-year tally of deficits to $9.05 trillion.

Some in the media welcomed the presumably more accurate deficit forecast; some even went so far as to note that such huge spending will be just fine, such as liberal commentator Paul Krugman of the New York Times. Others, however, were quite critical and seriously questioned how the Obama Administration could have been off by $2 trillion in its forecast.

The conservative Weekly Standard published a scathing article on August 31. Here are some excerpts:

"What's $2 Trillion Among Friends?

$2,000,000,000,000. That's the amount by which the Obama administration raised its ten-year estimate of the nation's budget deficit from the one it made only a few months ago. Now, $2 trillion is a lot of money. But even more significant is the fact that this revision represents almost a 30 percent increase -- no tiny percentage of the earlier $7 trillion figure. It seems that expenses are higher -- up 24 percent this year, the largest increase since the height of the Korean War -- than originally estimated, and revenues are lower. The resulting deficit, says Peter Orszag, Obama's budget director, is ‘higher than desirable'. He might have added that the administration's critics had it right when they claimed that the earlier estimate represented a turn around the dance floor with that old seductress, Rosy Scenario.

There's worse: the new estimate assumes that Medicare and Medicaid spending will be cut by $622 billion, even though Congress has made it known that it is reluctant to make any such cut. Then there is the $600 billion in revenue included for the sale of [carbon] emission permits, despite the fact that the House has given away so many permits in order to buy support for the cap-and-trade emission-reduction that the program will produce at most $450 billion. Those two items alone come to almost another trillion dollars in red ink. Throw in another trillion-plus for Obamacare, and it is no surprise that senior economist Bill Gale, at the liberal Brookings Institute, says that the deficit will hit over $10 trillion over the next decade, a figure he finds ‘deeply alarming'.

This year, the deficit will come to 11.2 percent of GDP, and by 2019 the [national] debt will be equal to 76 percent of the [projected] value of the nation's output of goods and services, almost double the 41 percent when Obama took control of the nation's finances. No problem, say White House economists. Unsustainable, says Warren Buffett, among others."

Economic Assumptions Still Too Optimistic

Warren Buffet is absolutely correct. Whether it's $7 trillion or $9 trillion, it's way too much and unsustainable. Over the next five years alone, 2010-2014, the debt swells by $4.5 trillion. In fact, these projections could actually be too low based on the economic forecasts used in the projections. I should point out that this is not just an Obama phenomenon. White House budgets, whoever was president, have been laced with optimism, and no president has forecast a recession in these 10-year projections.

(By the way, all presidential administrations produce these 10-year forecasts on spending, revenues and the budget deficits/surpluses, even though they won't be in office 10 years from now.)

Consider the latest OMB projections for growth in GDP in the next several years in real terms, exclusive of inflation. The White House projects that GDP will grow by 3.8% in 2011 and climb above 4% a year for the next three years, followed by two years above 3%. This is far higher than historical norms; the economy has not seen such a period of growth since the 1960s.

And we can almost be assured of at least one more recession, if not two, over the next 10 years, what with the government running massive deficits every single year. Remember, the Fed will have to unload some $2 trillion in troubled assets at some point in the next few years. And, most forecasters agree that at some point, foreigners are going to curtail US dollar purchases, which will likely drive interest rates higher, at the least, or a currency crisis at the worst.

Excessive Obama optimism is not limited to economic growth. Despite the enormous monetary stimulus pumped out by the Federal Reserve in 2008-2009, bank credit that is widely regarded as potentially inflationary, the Obama administration assumes that inflation will actually decline from 2.1% in 2008 to 1.5% in 2009 and then to 1.3% in 2010 and 2011, and not rise above 1.8% through 2019. While it is true that inflation is declining now, thanks largely to the big drop in energy prices over the last year, we are almost certain to see higher inflation down the road.

What in the World Are They Thinking?

Most Americans that keep up with the economy and rising government spending, even remotely, are very alarmed about the exploding debt that President Obama has proposed for the next decade. Many of us wonder, what in the world could they be thinking? Do they want to purposely wreck the US economy? Frankly, I'm beginning to think so, as I will discuss later on.

Here is a snapshot of how many liberals on the left think about the perpetual rise in government spending and exploding deficits over the next decade. What follows is an August 23 editorial in the New York Times by liberal commentator Paul Krugman. He boldly attempts to explain why Obama's massive spending and deficits won't be a problem. He is wrong, of course, and I have inserted many bracketed words to help his column be more readable. I will elaborate afterward:

"How big is $9 trillion?

There's been some hysteria [no kidding] about the [Obama] administration's new estimate that the cumulative deficit will be $9 trillion over the next decade. Don't get me wrong: this is bad. But it's being treated as an inconceivable sum, far beyond anything that could possibly be handled. And it isn't. [really?]

What you have to bear in mind is that the economy — and hence the federal tax base — is enormous, too. Right now GDP is around $14 trillion [annually]. If economic growth averages 2.5% a year, which has been the norm, and inflation is 2% a year, which is the target (and which the bond market seems to believe), GDP will be around $22 trillion a decade from now. So we're talking about adding debt that's equal to around 40% of GDP [this figure is bogus - see comments below].

Right now, even if we do run these [trillion dollar annual] deficits, federal debt as a share of GDP will be substantially less than it was at the end of World War II. It will also be substantially less than, say, debt in several European countries in the mid to late 1990s. (There are some technical issues in comparing these various numbers — gross debt versus net (mainly about Social Security) and overall government debt versus federal, but they don't change the basic picture.)

Again, the debt outlook is bad. But we're not looking at something inconceivable, impossible to deal with; we're looking at debt levels that a number of advanced countries, the US included, have had in the past, and dealt with."

Wow! So record trillion dollar deficits don't matter, Mr. Krugman? There are so many ways to debunk this article, I almost don't know where to start. Let's first look at Krugman's most egregious misrepresentation. In the second paragraph, he states that the $9 trillion in new debt will be only 40% of GDP by 2019. What he fails to note is that we already have $11.7 trillion in national debt today. If we add another $9 trillion, the debt will be $20.7 trillion - or 94% of GDP - by 2019!! Nice try, Mr. Krugman.

Second, it's a lame attempt to compare the economy today with the period just after World War II. We had the most robust economic growth in history just after WWII when we were rebuilding Europe, veterans were buying homes, durable goods, cars, etc. as never before and our manufactured goods faced very little foreign competition. May I remind you, Mr. Krugman, that we are not in that position today!

Third, why should we all just assume that the US economy will average 2.5% annual growth over the next 10 years, despite doubling the national debt, just because it is some historical average? As discussed earlier, we will almost certainly see another recession in the next decade, as foreign buyers of our massive debt may require higher interest rates or dump the US dollar.

Do you honestly believe the US economy will grow by 2.5% annually for the next 10 years when consumer spending is stagnant and Americans are increasing savings at the highest rate in over a decade? We've just been through the worst financial crisis since the Great Depression, and we are very likely looking at several years of below-trend economic growth. On top of that, if we spend the $9 trillion, taxes will have to go up on almost all Americans at some point, which is also bad for the economy.

Like your liberal cronies, you make these assumptions and leave out certain facts to justify your belief that bigger government and higher taxes are the answer to all of our problems. Mr. Krugman, take a look at Social Security, Medicare and Medicaid - and more recently President Bush's prescription drug program. Give me one example of how these government-run programs have been anything but a fiscal disaster. You can't.

Finally, Mr. Krugman (in case you happen to read this), let me say that I enjoy reading your columns and watching you on the TV talk shows. You give me insight and understanding as to the thinking of those on the far left.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Do They Want Control Even If It Ruins The Economy?

As noted earlier, I have thought about this question for many years. Why do the liberals want the government to control most everything in the economy and our lives? While members of Congress have the best healthcare in the world, they will have dozens of family members and friends and countless colleagues that will be subject to the House healthcare bill, if it is passed. So why are they so hell-bent on passing it?

The answer can only come down to two questions. Question #1: Do they really believe that their proposed national heathcare program is the very best we can offer the American people? And if so, why doesn't Congress adopt it for themselves? Or Question #2: Is this really just a massive power grab that puts the government in control of our healthcare and our lives?

President Obama would like us to believe that nothing will change if healthcare reform is passed - that if you like your current insurance plan, you can keep it. But that is patently false and abundantly clear if you read the onerous House healthcare bill, or even just the highlights that are readily available on the Internet. If they ram this down our throats, I firmly believe that the quality of our healthcare will suffer and the costs will far exceed any estimates being put forth by President Obama and the Democrats.

At the end of the day, I have to conclude that nationalizing healthcare (one-sixth of the US economy) is nothing more than a giant power grab by the liberals. In addition, if our government racks up $10+ trillion in cumulative deficits over the next 10 years, as Obama proposes, we are on our way to financial ruin.

Bill Clinton never scared me; he was too much of a political animal to swerve too far from the center. Unfortunately, the same could be said of George W. Bush, who routinely strayed from his supposedly conservative principles. Not so with President Obama. Sadly, many of those who voted for him did not do their homework or they would have known that he is a left-wing ideologue, as I warned in these pages last year.

Sorry to end on such a negative note, but it is what it is.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Federal deficits to bankrupt America
http://washingtontimes.com/news/2009/sep/04/looking-behind-the-curtain/

ObamaCare's Crippling Deficits
http://online.wsj.com/article/SB10001424052970203585004574393110640864526.html

Massachusetts & the ObamaCare Mistake
http://www.realclearpolitics.com/articles/2009/09/05/obamacare_increases_costs_wait_times_98176.html

Obama Cannot Escape Hard Choices in September
http://www.realclearpolitics.com/articles/2009/09/07/obama_cannot_escape_hard_choices_in_september_98192.html

When Does the Spending Charade End?
http://www.ibdeditorial.com/IBDArticles.aspx?id=336955542241664

The 3 Phases of this Bull Market

VinnyCatalano — Tue, 25 Aug 2009 13:41:00 GMT

The stock market rally since early March appears to have three distinct phases to it.

The first phase was the backing off from the economic abyss. The second phase was a bounce to fair value normalcy. The third phase (the one we are in now) is what I would call the return to business as usual phase (or “Recession. What recession?).

From where I sit, the first two phases were justified on many levels. Both phases featured massive amounts of government intervention combined with strong technicals to produce a rally to fair value. The elimination of the tail risk of the Great Depression II was followed by the above consensus macro economic readings (my MERI indicator), which was reinforced by the above consensus earnings results of 2Q09. Stocks rose to a reasonable fair value. So far, so good.

Unfortunately, at this point the seeds of questionable earlier decisions began to bear fruit. (Now, this going to sound very libertarian, so here goes.) Instead of pursuing the necessary cleansing process that all excesses produce, the Obama administration (which includes the US Treasury and the “independent” Federal Reserve) opted for a massive debt transference from the private to the public sector with the hope that time will heal all wounds. Along with this decision to socialize the bad behavior of the private sector most responsible for the crisis, the financial services industry, the Obama administration supported its core structure built on the laissez-faire era of the past two decades, accepting the largely unsubstantiated argument that financial innovation is a vital and necessary good for the economy.

With the government’s tacit support of the status quo, the investment mood shifted from fear and concern to hope and then enthusiasm.

The evidence of this mood shift back to the animal spirits days of yore came from a logical source – the financial services industry, the very sector of the global economy that provided the financial innovation grease to the out of control freight train of credit. And what better symbolic locomotive than Goldman Sachs, whose earnings report of July 14th whistled the bad old days were back in action. At this point, the Obama administration swung into action – with silence.

With its absence of outrage, the increasingly politically tone deaf Obama administration sent the public policy signal that its okay to bring the world economy to its knees, its okay to get bailed out with taxpayer money, its okay to shrink the competitive landscape (via Bear and Lehman’s demise), and its okay to return to the way things were – big profits and in your face fat bonuses.

The product of this wink and nod to Wall Street was the backlash at town hall meetings, which were as much about fairness as they were about healthcare reform concerns, a paranoid view of government, and a reactionary view of what constitutes being an American. It also produced an enthusiasm for stocks and an implied return to the bad old days.

Investment Strategy Implications

When you combine all these factors with the massive amount of investment capital ($3.5 trillion) still sitting in the near zero interest rate money market sidelines, the rising belief among many institutional investors that P/Es above their historical average are justified in the current low inflation environment, and the fledgling confidence that the global economy is on the mend* (along with the blind faith that the economic data from China is real), it is understandable how valuation levels could get to where they are today – stretched.

The investment question then becomes, “Is this a solid enough foundation upon which sustainable bull markets are built?” I have my doubts.

*I suggest reading Nouriel Roubini's comments in yesterday's FT.

Beyond the Sound Bite: An Interview with Gillian Tett

VinnyCatalano — Wed, 05 Aug 2009 19:33:00 GMT

My interview with the assistant editor of the Financial Times and author of "Fool's Gold" includes key aspects of financial innovation, the consequences of a reluctance to lend by financial institutions, the utility qualities of the financial services industry, and the transitional nature of both the financial services industry and the global economy.

The length of the interview is 16 minutes 24 seconds.

(Please visit the site to view this media)

Credit Crisis Watch

JohnMauldin — Tue, 26 May 2009 16:49:31 GMT

This week we look at a number of charts of various parts of the credit markets to see what kind of progress is being made on getting back to "normal" or to a "new normal." And my friend Prieur du Plessis shows us there is reason to believe that we have seen the worst.

"This too shall pass" are words we should all take to heart. Things will neither stay on permanently high or low plateaus. Those doom and gloomers who expect the world to keep devolving back to some pastoral age of scarcity where we will all need those guns and freeze dried food will be disappointed. We are simply hitting the re-set button on many of our institutions and businesses, and while the adjustment is painful, we will eventually get through it. Today's Outside the Box is a kind of map that tells us where we are in the process.

Dr Prieur du Plessis is chairman of Plexus Asset Management and writes the Investment Postcards from Cape Town blog (www.investmentpostcards.com). Click here to subscribe to e-mail updates to the blog.

John Mauldin, Editor
Outside the Box

Credit Crisis Watch: Thawing – noteworthy progress

Are the various central bank liquidity facilities and capital injections having the desired effect of unclogging credit markets and restoring confidence in the world's financial system? This is precisely what the "Credit Crisis Watch" is all about – a review of a number of measures in order to ascertain to what extent the thawing of credit markets is taking place.

First up is the LIBOR rate. This is the interest rate banks charge each other for one-month, three-month, six-month and one-year loans. LIBOR is an acronym for "London InterBank Offered Rate" and is the rate charged by London banks. This rate is then published and used as the benchmark for bank rates around the world. The higher the LIBOR rate, the greater the stress on credit markets.

Interbank lending rates – the three-month dollar, euro and sterling LIBOR rates – declined to record lows last week, indicating the easing of strain in the financial system. After having peaked at 4.82% on October 10, the three-month dollar LIBOR rate declined to 0.66% on Friday. LIBOR is therefore trading at 41 basis points above the upper band of the Fed's target range – a substantial improvement, but still high compared to an average of 12 basis points in the year before the start of the credit crisis in August 2007.

Importantly, US three-month Treasury Bills have edged up after momentarily trading in negative territory in December as nervous investors "warehoused" their money while receiving no return. The fact that some safe-haven money has started coming out of the Treasury market is a good sign.

The TED spread (i.e. three-month dollar LIBOR less three-month Treasury Bills) is a measure of perceived credit risk in the economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. On the other hand, when the risk of bank defaults is considered to be decreasing, the TED spread narrows.

Since the peak of the TED spread at 4.65% on October 10, the measure has eased to an 11-month low of 0.48%. This is a vast improvement, although still somewhat above the 38-point spread it averaged in the 12 months prior to the start of the crisis.

The difference between the LIBOR rate and the overnight index swap (OIS) rate is another measure of credit market stress.

When the LIBOR-OIS spread increases, it indicates that banks believe the other banks they are lending to have a higher risk of defaulting on the loans, so they charge a higher interest rate to offset that risk. The opposite applies to a narrowing LIBOR-OIS spread.

Similar to the TED spread, the narrowing in the LIBOR-OIS spread since October is also a move in the right direction.

Further evidence that the convalescence process is on track comes in the form of data showing a sharp decline in borrowing by primary institutions at the discount window – down by almost 65% since the "panic peak" recorded during the week of October 29, 2008.

The Fed's Senior Loan Officer Opinion Survey of early May serves as an important barometer of confidence levels in credit markets. Asha Bangalore (Northern Trust) said: "The number of loan officers reporting a tightening of underwriting standards for commercial and industrial loans in the April survey was significantly smaller for large firms (39.6% versus peak of 83.6% in the fourth quarter) and small firms (42.3% versus peak of 74.5% in the fourth quarter) compared with the February survey and the peak readings of the fourth quarter of 2008."

"In the household sector, the demand for prime mortgage loans posted a jump, while that of non-traditional mortgages was less weak in the latest survey compared with the February survey. At the same time, mortgage underwriting standards were tighter for both prime and non-traditional mortgages in the April survey compared with the February survey," said Bangalore. In other words, more needs to be done by the lending institutions to revive mortgage lending.

The spreads between 10-year Fannie Mae and other Government-sponsored Enterprise (GSE) bonds and 10-year US Treasury Notes have compressed significantly since the highs in November. In the case of Fannie Mae, the spread plunged from 175 to 26 basis points at the beginning of May, but have since kicked up to 37 basis points on the back of the rise in Treasury yields.

After hitting a peak of 6.51% in July last year, there was a marked decline in the average rate for a US 30-year mortgage. However, the rise in the yields of longer-dated government bonds over the past nine weeks – 92 basis points in the case of US 10-year Treasury Notes – resulted in mortgage rates creeping higher since the April lows. Also, the lower interest rates are not being passed on to consumers, as seen from the 434 basis-point spread of the 30-year mortgage rate compared with the three-month dollar LIBOR rate. According to Bloomberg, this spread averaged 97 basis points during the 12 months preceding the crisis.

Fed Chairman Ben Bernanke said earlier in May that "mortgage credit is still relatively tight", as reported by Bloomberg. This raises the possibility that the Fed will boost its purchases of Treasuries to keep the cost of consumer borrowing from rising further. [The Fed has so far bought $95.7 billion of Treasury securities from $300 billion earmarked for this purpose. Similarly, purchases of agency debt of $71.5 (out of $200 billion) and mortgage-backed securities of $365.8 billion (out of $1.25 trillion) have taken place.]

As far as commercial paper is concerned, the A2/P2 spread measures the difference between A2/P2 (low-quality) and AA (high-quality) 30-day non-financial commercial paper. The spread has plunged to 48 basis points from almost 5% at the end of December.

Similarly, junk bond yields have also declined, as shown by the Merrill Lynch US High Yield Index. The Index dropped by 44.4% to 1,213 from its record high of 2,182 on December 15. This means the spread between high-yield debt and comparable US Treasuries was 1,213 basis points by the close of business on Friday. With the US 10-year Treasury Note yield at 3.45%, high-yield borrowers have to pay 15.58% per year to borrow money for a 10-year period. At these rates it remains practically impossible for companies with a less-than-perfect credit status to conduct business profitably.

Another indicator worth monitoring is the Barron's Confidence Index. This Index is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds. The discrepancy between the yields is indicative of investor confidence. There has been a solid improvement in the ratio since its all-time low in December, showing that bond investors are growing more confident and have started opting for more speculative bonds over high-grade bonds.

According to Markit, the cost of buying credit insurance for American, European, Japanese and other Asian companies has improved strongly since the peaks in November. This is illustrated by a significant narrowing of the spreads for the five-year credit derivative indices. By way of example, the graphs of the North American investment-grade and high-yield CDX Indices are shown below (the red line indicates the spread).

In summary, the past few months have seen impressive progress on the credit front, with a number of spreads having declined substantially since their "panic peaks". The TED spread (down to 0.48% from 4.65% on October 10), LIBOR-OIS spread (down to 0.45%% from 3.64% on October 10) and GSE mortgage spreads have all narrowed considerably since the record highs.

In addition, corporate bonds have seen a strong improvement, although high-yield spreads remain at elevated levels. Credit derivative indices for companies in all the major geographical regions have also shown a marked tightening since the November highs.

Most indications are that the credit market tide has turned on the back of the massive reflation efforts orchestrated by central banks worldwide and that the credit system has started thawing. However, although the convalescence process seems to be well on track, it still has a way to go before confidence in the world's financial system returns to more "normal" levels, liquidity starts to flow freely again, and the economic recovery can commence.

* Dr Prieur du Plessis is chairman of Plexus Asset Management and writes the Investment Postcards from Cape Town blog (www.investmentpostcards.com). Click here to subscribe to e-mail updates to the blog.

China Watch: Chinamerica Holdings

BeauJohnson — Tue, 26 May 2009 14:11:00 GMT

Beau Johnson, chairman and CEO of Chinamerica Holdings, discusses his fund and why China is bound to emerge from the current crisis stronger.

CLICK HERE TO WATCH THE INTERVIEW

Association of Investor Awareness - Week of 04/30/2009

AIAAdvocate — Thu, 30 Apr 2009 14:20:00 GMT

In This Issue:

Signs Of A Better Economy? (Or At Least Not As Bad?)
Stocks For A Weak Recovery
The Bottom Line This Week

Last month investors received another booster shot from Wall Street as the Dow and the Nasdaq rose an additional 1.2% and 5.5% respectively. The gains left stocks up 26% from the rally's jumping off point. With any luck, and a few encouraging numbers from the economy, the rally could continue for another few weeks.

Lest anyone think the bear is finished, however, we must remind you that the market never moves in a straight line very long. Even if this is the start of a new bull market, we must expect to get some nasty shocks along the way. After such a strong rally, the first correction may be close at hand.

Signs Of A Better Economy? (Or At Least Not As Bad?)

Analysts are all over the map when it comes to predicting the future of the economy. Some see improvements, others think the most we have is a slower decline. A few super bears believe the worst hits are still to come, and they are fastening their safety belts.

Because the economic outlook is the most important issue that investors must deal with right now, we will review the three main arguments for each outlook. Of course, we will finish up by giving you our own sterling opinion.

1) The Economy Is Improving:

The strongest indication that economic relief is on the way is the rising stock market. Although many investors are not particularly well informed about economic matters, it's just the opposite with big spenders – and they are buying stocks. Since the market tends to look ahead from six to nine months, economic relief is probably about that far away.

Consumers are also showing greater confidence in the future by traipsing off to the mall a little more often than they did a few months ago. Since consumers are two thirds of the economy, their improving outlook can be a self-fulfilling prophesy. Spending is still very low, but at least the trend appears to be changing.

Business spending is also on the floor, and it will probably remain there for several months. But with consumers beginning to buy goods again, businesses will need to replace them. Inventories are already low for many products. As with consumers, however, a business turnaround is likely to be modest.

Housing remains weak in most markets, but there are signs of life in others. That's not surprising since home affordability, an established measure of housing trends, is higher than it has been in over five years. Many hopeful homebuyers know that prices could go lower, but they also know they might start to go back up again. As a result, many people who can afford to buy at today's prices are deciding to take the plunge. Lower interest rates are another incentive to buy.

Credit for every type of loan is still tight but the situation isn't as bad as the news stories might have you believe. Throughout America, hundreds of regional banks that didn't follow the subprime path to ruin have money for worthy clients. Lending standards are higher than they were during the boom, but that's a good thing. Only an idiot would want to go back to the loosey goosey standards that brought ruin to our country. The bottom line is, people with good credit histories and a respectable down payment can get mortgages. The same is true for business loans, new car financing, and so on.

Oil prices are remaining low, which is probably doing more for the economy than Washington's bailout program. The drop from almost $150 a barrel to under $50 had the same impact as a huge tax cut. Natural gas prices are also on the floor.

Lastly, the bailouts are helping to stimulate several industries, not just banking. Although we are very concerned about the colossal size of the federal debt, the money is a plus right now.

2) No It Isn't:

Naysayers believe the economy is not improving at all, it is just not dropping as quickly. Although the slowdown may be a technical victory, the bears say there is no way to make "less bad" look like "good."

Pessimists also say that the downward trend could continue and take the economy to the same low place it would have reached at the faster pace. This is known as the "we're dead either way" argument.

Other analysts say that even if the economy stops dropping, that doesn't mean a rebound is anywhere in sight. They point to the Great Depression when growth remained at very low levels for several years. During that time the unemployment rate hit 24% and businesses continued to fail.

3) A Disaster Is On The Way:

The toughest crowd are analysts who are certain that a full-blown depression is coming. They call the new calamity the "Greater Depression" to distinguish it from the not-so-bad Great Depression. Arsenic anyone?

The Armageddon crowd believes that the bailout program won't save the banks because they have been too badly damaged to recover. Instead, the depressionists say, the stimulus money will just put off the inevitable for a few months, and make the collapse all the worse.

The super bears also say the huge federal giveaways are putting so much money into the economy that a period of high inflation –and perhaps hyperinflation- is unavoidable. Therefore, the argument goes, even if the economy starts to pick itself up off the floor, inflation will slam it back down again. The result would be super stagflation, a situation where unemployment remains high at the same time prices soar. It's not a pleasant prospect.

As long-time readers know, we place much more faith on what we actually see happening in the world than what statistics and ivory tower number crunchers say. It's a practice that has kept us in the chips on many occasions when most investors were selling.

For example, we remained bullish on energy efficient industries when oil prices were soaring and most analysts thought modern life was ending. We were of the opinion that railroads, inland shipping companies and other fuel misers would actually benefit from more expensive energy because it would hurt the competition. It turned out that we were right, and our recommendations did well.

Of course, past performance does not guarantee future results, and all that. But for what it is worth, we think the first economic outlook is correct, and the economy is more likely to continue to claw its way out of the hole than it is to begin sinking again. Although a typical recovery seems unlikely, growth should be above the zero mark by the end of the year or by early 2010. If we are correct, many top-quality stocks remain oversold.

Stocks For A Weak Recovery

We hate to repeat ourselves in this newsletter, but on the other hand we never get tired of making money. As a result, we are continuing to recommend the boring multinational stocks that have been doing so well of late. We think their biggest moves are yet to come.

If you only want to make a single blue chip investment, an excellent choice would be the iShares Dow Jones Select Dividend Index (DVY), one of our favorite EFTs. http://finance.yahoo.com/q/bc?s=DVY The index has been performing very well of late. On March 9, DVY closed at $25.91. By April 28, the fund was up to $34.98, a 35% gain. We take back what we said about boring stocks.

We think investors who prefer to buy individual issues should look at three growth companies that should be headed higher.

The first of the three is Alcoa (AA), the giant aluminum producer. http://finance.yahoo.com/q/bc?s=AA Demand for the lightweight metal dropped sharply when the economy fell out of bed and industrial production hit the floor. But even with a small increase in the economy, demand for aluminum should jump smartly.

Deere Company (DE) is another probable winner in an improving economy. http://finance.yahoo.com/q/bc?s=DE The biggest potential for Deere isn't its farm machinery, although sales should improve this year. Instead, demand for the company's construction equipment should begin to rebound as President Obama's infrastructure programs ramp up.

General Electric (GE) http://finance.yahoo.com/q?s=ge should do well as the company continues to get its troubled financial unit back on track. GE's worldwide sales of everything from locomotives to jet engines should also increase. We think this global powerhouse will be a very big long-term winner. A few years from now many investors will wonder how they could have ever thought that GE might not make it through the recession.

Last month we wrote that Ford http://finance.yahoo.com/q?s=F has an excellent "chance for a profitable recovery" and "a small position appears to make sense at today's low price."

That proved to be something of an understatement. When that issue was sent out on March 26, Ford was $2.94. Today Ford closed at $5.45, an 85.4% gain. The worse things get for GM and Chrysler, the better the outlook will be for Ford, the only one of the formerly "big three" automakers that didn't need a bailout. Henry would be pleased.

The Bottom Line This Week

The outlook is improving by inches, but we are a long way from being out of danger. It would not take a very big shock to send the economy and the stock market down again. As a result, we think the best strategy for investors is to use the positive trend we have now and buy blue chip stocks with good outlooks – but protect all your positions with stop-loss orders.