Wednesday, February 27, 2013

Is the Great Rotation a Myth?  
The Great Rotation is the rotation of investor dollars from bonds back into stocks.  

The article is in italics.  The bold is my emphasis.  From

As investors begin to dip back into the stock market, chatter about a so-called Great Rotation has been growing louder.  But so far it's proving to be more of a myth.

The Great Rotation came into the spotlight at the end of 2012, when Bank of America Merrill Lynch investment strategist Michael Hartnett predicted that investors who had fled the stock market for the safety of bonds would start to rotate back into stocks.

In fact, investors have added more money to bonds than stocks almost every week this year. In total, U.S. stock mutual funds have raked in nearly $20 billion in 2013, while bond funds have attracted more than $40 billion, according to data from the Investment Company Institute.

Rather than trimming their bond exposure, investors have been adding to stocks at the expense of their cash holdings, said Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock.

"In the panic following the 2008 collapse, investors initially flocked to cash," said Rosenberg, noting that assets in money market funds jumped by nearly 40% to about $3.5 trillion and peaked at $4 trillion in 2009.

Cash levels declined steadily from there until the end of last year when fiscal cliff fears sent investors back to cash. And once a deal to avoid the cliff was struck, assets in money market funds and bank deposits began to fall - that's the money that has been flowing into stocks, said Rosenberg.

While the Great Rotation out of bonds and into stocks may still be coming, it won't be anytime soon, according to Tobias Levkovich, chief U.S. equity strategist at Citigroup.

"Unfortunately losing money in bonds may not cause a huge outflow from bond funds which would then pour into stock funds," he wrote in a recent note. Investors didn't start consistently pulling money out of stocks until two years after the tech bubble and stock market peaked in 2000, he noted, adding, "Believing in a rotation now seems fairly premature."

Still, even shifting from cash toward stocks signals a change in sentiment, according to Bill Stone, chief investment strategist at PNC Wealth Management.

"Perhaps some of the residual fear from the financial crisis that caused investors to shun stocks is starting to dissipate," he said.

Monday, February 25, 2013

The Millennials are Borrowing Less
People I talk to are always wondering when things are going to get back to normal.  The point is they are not ever going to be like they were prior to the Financial Crisis of 2007 - 2008.  One of the major issues is that Millenials (those born between 1982 and 2004) are borrowing less.  They are similar to the generation of Americans brought up during the Great Depression.  Not sure, but my guess is this is permanent behavior change in this group.
The article is in italics and the bold is my emphasis.  From CNNMoney:
Since the Great Recession, countless Americans have shunned the idea of taking on more debt. Homeowners discovered that stretching to buy bigger houses would result in years of financial turmoil. Jobless college grads unable to pay down their student loans now wonder if their degrees are really worth it. And as Europe grapples with its own debt problems, Washington lawmakers struggle to find a way to reduce the US deficit.
Indeed, many have learned a few harsh lessons. But debt isn't always a bad thing. More of it can reflect a healthy economy -- one where consumers, as well as lenders feel comfortable taking on more risks.
Young adults, however, haven't taken on nearly as much debt as their parents. It's uncertain if the trend will continue as the economy improves, but for now, those under 35 years old have shed debt faster than older ones, according to a report by Pew Research Center released last week. The study doesn't say if this is a good or bad development, but many signs suggest the drop means Millenials are more anxious than responsible about their finances.
It's a negative sign. The Federal Reserve's policies to keep interest rates super-low has spurred more home and car sales by getting consumers to borrow more, but it appears young adults have benefitted less from the central bank's bond-buying program.
Across households headed by people under 35 years old, median debt fell by 29% to $15,473 in 2010, compared with $22,000 in 2007, according to the report. That compares with a much smaller 8% drop at households headed by those 35 and older during the same period.
To be sure, the decline partly reflects a fall in home loans and purchases by young adults. This doesn't necessarily signal that younger people aren't able to afford a house, since many have been delaying marriage (which is typically followed by homeownership) for various reasons. However, the share of first-time homebuyers typically comprised of young adults has fallen. And young people are less willing to take on credit card debt and auto loans, suggesting they aren't in financial positions to commit to monthly payments. Compared with 50% in 2001, only 39% of young households in 2010 had credit card debt. When it comes to vehicles, 73% of households headed by an adult younger than 25 years old in 2001 owned or leased at least one vehicle. By 2011, that share fell to 66%.
What's maybe most perplexing is that student debt has increased while all other consumer loans fell. Still, roughly three-quarters of household debt for young adults comes from home loans; student debt makes up only 15%.
The study's results are similar to other research looking at the finances of young adults. In a 2012 Rutgers University survey of college graduates, 40% said student debt was making them delay large-scale purchases, such as a house or a car. Faced with big monthly payments, recent college graduates aren't earning as much as graduates before them. The median salary for those graduating between 2009 and 2011 was $27,000 -- $3,000 less than 2007. The difference is significant. It could mean having enough to help with a down payment on a home or spending money for everything from clothes and furniture.
For now, the no-debt Millenials have spawned a generation that rents most everything.

Tuesday, February 19, 2013

Is Inflation the Problem? Part #2

This is actually part 1 of the previous post on inflation.  The article gives a good sense argument why the US and other countries are not headed for high inflation.

The article is in italics and the bold emphasis is mine.  From Economic Matters:

Cocoa Prices and Inflation

Everyone is currently worried about inflation with the central banks printing like there is no tomorrow. But the actual inflation numbers are much less than people think inflation is in their everyday lives. 

For example, Let`s look at Cocoa prices, literally at the bottom of their five year range at 2,227 per ton, well below the 3,800 per ton level established in March of 2011.

Rough Rice Prices and Inflation

If we take Rough Rice which closed at $16.34 per cwt. it is well below the highs of $22.65 and $19.02 per cwt. established in April 2008 and September 2011 respectively. Sure there is a general trend higher in Rough Rice if we go back to 2003, but how actively traded was the instrument back then from an overall investment standpoint? However, the bigger picture of the last five years shows no real signs of inflation for a major food staple in the world`s diet. 

Wheat Prices and Inflation

If we look at Wheat prices which closed at 756 cents per bushel or $7.56 per bushel these prices are also well below the highs of $13.00 per bushel and $9.65 per bushel established in February 2008 and April 2011 respectively. Again Wheat prices are much higher than 2003, but markets were so much smaller back then from a global and fund perspective. 

There are just a lot of investment dynamics that modern markets with ETFs opening up additional investment options, and electronic markets allowing for greater participation levels, plus the natural progression of inflation of assets over time that play a large role in these elevated prices during a 10-year time span. 

However, it should be noted that despite the price spikes, and inflation fears in the media and the investment community, wheat prices for the most part have been pretty stable the last five years. Not exactly runaway inflation for a mass consumed food staple! 

Emerging Markets and Inflation

There is no doubt that there is food inflation in emerging markets with some of the cause due to central banks exporting some inflation pressures, but most of the food inflation these countries experience is due to inefficient food supply chain issues, and poor governmental policies regarding currencies and financial market structural issues.

Of course population factors in many of the emerging economies add their own set of price pressures as well. But these issues are nothing new and not a direct result of central bank monetary policies in the developed world for the most part. 

Higher Spending Levels and Inflation

In conclusion, for there to be runaway inflation in the developed economies that everyone fears right now it is going to take much more spending pressures by consumers along the entire supply chain of goods and services needed for everyday living. Not just a couple of areas like Healthcare or Education which exhibit definite higher inflation trends, and are actually mainly the result of government, corporate and insurance related subsidy issues. 

Fed Injected Liquidity Chases Stocks and Bonds Not New Clothes

There just isn`t the demand needed to push up spending levels to the point necessary for more capital chasing fewer and fewer goods and services. It is still skewed in the opposite direction, despite all the increase in monetary capital, but this capital isn`t chasing essential goods and services in the economy. 

The loose monetary capital is meant to fill the void and help offset the lack of actual consumer spending in the economy, and the nasty effects of the deflationary, deleveraging process. The one area where we experience inflation due to the central banks is in more capital chasing fewer investment opportunities, and thus prices rise in stocks and bonds as a result during this loose monetary policy period. 

But consumers are not so well off, or flush with cash, that they are massively consuming at the levels needed to cause major inflation pressures in the goods and services area of the economy. 

The Wealth Effect and Spending

The wealth effect will even be less than policy makers would like because not everyone is invested in 401k`s in the stock market, and investors don`t feel comfortable enough with their retirement levels to start cashing out major amounts, and putting this new found wealth back into the economy. Shoot investors are just now back to the level they were five and ten years ago. 

In addition, the problem is not all assets can be reflated as many companies have gone out of business with the tech and financial market collapses, that investment capital is forever lost, and completely deflationary in nature. You can`t get back to even if you were completely wiped out in an invested company, or you were wiped out so bad, that you pulled your money from the market. 

Other examples are small businesses that went bankrupt and lost all their built up equity in the business, or homeowners who lost their homes and all the money they invested over the years of home ownership. If you bought at the top of the housing market you are also caught in the deflationary trap. 

That is what makes re-pricing in assets such a nasty process, and very deflationary in nature. There is so much personal wealth that is forever lost, and nothing central banks do from a monetary perspective can ever bring this wealth back into circulation chasing goods and services in the economy.   

Banks have recapitalized their balance sheets; Consumers still have a long way to go!

Banks and financial institutions have enjoyed the fruits of the asset recapitalization in markets far greater than actual retail investors participating in financial markets over the last 10 years. Maybe if the Dow goes to 25,000 new investors will all be rich and pull this money and put it to use buying goods and services in the economy. 

But there just aren`t enough actual consumers of overall goods and services who are doing so well in their personal finances given that wages have been stagnant for seven years to increase the spending part of the curve so that there is more capital chasing fewer goods. 

The Underemployed and Unemployed Not Flush with Cash to Spend=Deflationary Pressures

As I said earlier, it is still a buyer`s market, i.e., please buy the goods and services that we bring to the market.  With the high number of the total unemployed or underemployed still putting substantial deflationary pressures on the demand for goods and services in the economy because they lack the financial resources we have a while to go before runaway inflation rears its unmanageable head in the developed economies of the world. 

Sunday, February 17, 2013

Is Inflation a Problem?

Everyone worries about inflation, but we are seeing deflationary pressure in a number of areas in the economy.  The article points out a few that are worth noting.

For some interesting insight into the economy and the markets.  Give Economic Matters a try.  Some of their material is pretty interesting.

The article is in italics and the bold is my emphasis.  From Economic Matters:

Consumers only focus on Inflation, they ignore deflation areas.

It seems that to exclusively focus on one side of the equation can be human nature at times, and with regard to inflation concerns humans never see the other side of the equation, i.e., areas where they are actually experiencing deflation in their lives.

The Housing Market

Let`s start with housing, the Case-Shiller 20-City Home Price Index shows quite clearly that after years of inflation, consumers are getting a large break on prices due to the deflationary effects in the housing industry over the last five years.

Mortgage & Interest Rates

How about interest rates, rates for getting financing either to finance a first purchase or refinance an existing loan have been a real boon to consumers, and rates generally have been coming down for twenty years. I am sure your parents or grandparents can tell stories of 18% mortgages; we are definitely experiencing deflation in financing costs around borrowing money.

Copper Prices

Next let us look at Copper prices for the last five years down over 2%, and that is after a price spike for the first quarter, wait for the first major selloff in markets and copper will be much cheaper, i.e., Copper prices can easily sell off 30 cents or more per pound when assets sell off over the annual summer selloff. 

The first quarter the last three years has been good for asset prices, but it is important to take the yearly average in prices to smooth out the fund inflow noise that look to make a quick buck on the first quarter ramp up in investment flows. 

But again Copper is a major component used for industrial & commercial economic projects and an inflation hedge, and it is exhibiting deflationary effects the last five years, especially when you factor in ‘real terms’ it is even more deflationary. 
Natural Gas Prices

Let us next take Natural Gas prices down over 40%  for the last ten years, but consumers don`t want to factor the areas where they are doing much better in regards to the “pernicious effects” of inflation.

Yes Natural Gas prices are another major economic input cost for many manufactured products from plastics to chemicals, and this major economic input commodity is in a major deflationary cycle.
Gasoline Prices

Now let us take everyone`s poster child for inflation gasoline prices; over the last five year`s they are up 20%, but this is misleading as we are at the highest point ever for this time of year, and gasoline like oil prices are quite volatile. 

For example, they were down 10% over a five year period in June of 2012, so again it is important to take the yearly average in gasoline and oil products. 

But even one of the worst categories for inflation, at the height of a recent influx of capital, is only averaging 4% annual inflation. 

Plus there are other factors at work here including the newly minted exporting of gasoline and petroleum products that has occurred as a trend the last three years in these markets that are making these numbers worse than they otherwise would be.

Just be patient folks gasoline prices will come down as high prices are actually deflationary for the product, and the old adage applies, there is no better cure for high prices than high prices for economic sensitive goods. 

Expect a pullback in gasoline prices for the second half of the year, and when we revisit these numbers I can envision a negative print for gasoline prices over the last five years.
Electronics have built in Deflationary Cycles

But we haven`t even gotten into electronics, televisions, computers, cell phones etc. there are many other areas which continually have deflationary product cycles that help cancel out the areas where we do have inflation effects, and even some areas that are indeed “pernicious”! 

I am not saying there is no inflation, clearly even the government numbers show over a 2% annual inflation rate.  But the exercise is meant to show that there are major deflationary pressures still at work in our economy, and they are worth taking notice of to balance some of the inflation rhetoric that seems built into our psyches. 

Wholesalers Probably Take Advantage of Inflation Fears

I think a lot of wholesalers, middlemen, retailers, etc. actually fatten margins because consumers believe inherently in the “pervasiveness” and “perniciousness” of inflation; why not tap into this and confirm their worst fears, and gain some pricing power along the way.

The input costs that I have presented over these two articles are actually quite deflationary, and I can keep going as there are so many examples of deflationary price pressures in many commodities.  The second article will be posted on Monday (Feb 18)

The fact that I can easily find so many examples should in itself say something regarding the inflationary environment in the economy. I literally just started pulling up charts and indexes, and was not cherry picking for results. 

Sure I can find many areas that are inflationary, but if inflation was really as “Pernicious” and “Pervasive” as everyone seems to believe these days, I shouldn`t be able to find so many counterexamples to their argument so effortlessly.  

Thursday, February 14, 2013

The Minimum Wage - Actual and Corrected for Inflation



The grey line shows the minimum wage, unadjusted for inflation, whereas the blue line shows you what it would be worth in 2012.
When President Franklin D. Roosevelt first created the minimum wage in 1938, it was 25 cents. Adjusted for inflation, that would be worth $4.07 today.
The minimum wage had its lowest buying power in 1948, when it was worth about $3.81 in today's dollars. It had its highest buying power in 1968, when it was worth about $10.56.
At $7.25 in 2012, our current minimum wage is in the middle of those two extremes.
President Obama's proposal to raise the minimum wage to $9 would put it back to a value last seen in the early 1980s.

Wednesday, February 13, 2013

US Fiscal Policy - A Problem

Below is an article from the New Yorker that articulates fairly well the issues in Congress when it comes to the budget deficit.  The article is in italics.

Reading through the new budget outlook from the Congressional Budget Office, which was released on Tuesday, three figures made the biggest impression on me: 1.4 per cent, 2.4 per cent, and 76 per cent. Taken together, these three numbers explain a good deal about what’s wrong with Washington, and how we are focussing on precisely the wrong things. Rather than tackling the projected rise in entitlement spending, which does present a long-term threat to the country’s prosperity, policy makers, particularly congressional Republicans, are intent on making short-term spending cuts across the board, which would threaten the current economic recovery. In short, they’ve got things upside down.

The 1.4 per cent figure is the C.B.O.’s forecast for how much the economy will grow this year. If you think this sounds like a low figure, you’re right. Last year, which was hardly a rip-roaring one, the inflation-adjusted gross domestic product rose by 2.4 per cent. In an economy recovering from a deep recession that has kept the unemployment rate close to or above eight per cent for four years now, we need annual growth of three per cent or higher to make a real dent in the jobless figures.

You might think, therefore, that both parties would be doing all they can to get the economy humming, and avoiding anything that risks plunging the country back into a recession. But you would be wrong. Ever since the November election, practically the entire debate in Washington has been about cutting spending and raising taxes, both of which reduce the level of demand for goods and services. The fiscal-cliff deal raised the taxes that most working Americans pay by two per cent, and high-income taxpayers had a bigger hike. Now we are faced with the so-called sequester, which, if enacted on March 1st, will cut defense spending by forty-eight billion dollars (about eight per cent of the total) and non-defense spending by twenty-nine billion dollars (about five per cent of the total).

The C.B.O. estimates that, taken together, the fiscal-cliff deal and the sequester will reduce G.D.P. growth by about 1.5 per cent. Another way of putting it is that if neither of these policies had been introduced, growth this year would have been close to three per cent, which is what we badly need. In the interest of reducing the budget deficit and stabilizing the debt-to-G.D.P. ratio, policy makers have effectively hacked growth in half—that’s assuming the sequester goes through, which most people in Washington now think will happen. Consequently, the C.B.O. says, the unemployment rate is likely to stay close to eight per cent for at least another couple of years.

True, the C.B.O.’s forecasts could be wrong. (Like all economic predictions, they often are.) Despite the fact that the G.D.P. fell slightly in the fourth quarter of 2012, according to last week’s advance estimate from the Commerce Department, I think the economy has enough forward momentum to withstand the fiscal hit and still grow at a reasonable pace in 2013—say, 2.5 per cent, or even a bit higher. But I could well be being overly optimistic. When other countries with big deficits shifted from stimulus to austerity, the results were disappointing. In Britain, for example, the outcome was a double-dip recession, which is currently threatening to turn into a triple dip.

The U.S. is taking a big risk, to say the least, by turning to austerity policies, and for what end? Contrary to popular belief, the country is not facing an immediate fiscal crisis. Since peaking in 2009, at 10.1 per cent of the G.D.P., the budget deficit has been steadily declining. This year, according to the C.B.O., it will be 5.3 per cent of the G.D.P., and next year it will be 3.7 per cent. By 2015, it will be just 2.4 per cent of the G.D.P., which is below what it averaged in the three decades prior to 2007.

These figures are based on the assumption that all of the sequester will go into effect, and that Medicare payments to doctors will be cut by a quarter at the start of next year. If neither of these things happen—Congress regularly suspends the Medicare cuts—the deficit would be a bit higher than the C.B.O. projections, but not dramatically so. Under any likely policy scenario, assuming the economy doesn’t go into another slump, the deficit will be back down to manageable levels within a couple of years. Alarmists who say we have to slash now or meet the same fate as Greece are just that: alarmists.

That’s the good news. The worrying thing is that, even according to the C.B.O. projections, the deficit starts to rise again after 2015—not dramatically, but enough to be of concern. By 2021, it will be up to 3.8 per cent of the G.D.P., and thereafter, according to the Budget Office’s latest long-term projections, which it released last summer, things start to get pretty dire. By 2037, according to the C.B.O.’s “extended alternative fiscal scenario,” which assumes that most current policies continue, the debt-to-G.D.P. ratio would be close to two hundred per cent. (At the moment, it is about seventy-five per cent.)

While some countries with very high savings rates, such as Japan, have managed to live with and finance such a high debt burden, the United States, which has a low savings rate—we love to shop—might well have trouble finding enough foreigners willing to buy Treasury bonds. In extremis, the result could be a U.S. default. More likely, a sharp rise in Treasury yields, and quite possibly a generalized financial crisis, would force the government to tackle the problem at some point before then.

It’s no mystery what underpins this worrying scenario: a big rise in entitlement spending—on Medicare, Medicaid, Obamacare, and Social Security, mainly—and interest payments on the rising debt. Forty years ago, mandatory spending, which largely consists of entitlements, made up about a third of the federal budget. Today, it makes up about three-fifths of the budget, and the share is rising. Add in interest payments, which can’t be avoided, and the situation is even more stark. By 2023, according to the C.B.O. projections, three-quarters of the budget will be going to entitlements and interest payments.

The exact figure is seventy-six per cent—the third number I mentioned at the start of the post—which would leave just a quarter of the budget to cover everything else: defense, homeland security, income-support programs for the poor, education, scientific and medical research, national parks, and so on. It doesn’t take a genius to figure out that there wouldn’t be enough money to go around, meaning that the only options would be higher taxes to boost revenues or big cuts in spending on popular programs.

With neither party willing to tell Americans that they need to pay more in taxes, the only sensible alternative would appear to be obvious. Go easy on immediate spending cuts—we need to let the economy recover—but start work now on trimming entitlement programs, essential as they are, so they don’t eventually swallow the rest of the budget. Unfortunately, that order of proceeding runs into party politics. Many anti-government Republicans want to slash federal spending as a matter of principle. Many Democrats are dragging their heels about making cuts to Social Security and Medicare.

On Tuesday, President Obama called on Congressional Republicans to replace the sequester with smaller spending cuts and the elimination of some corporate-tax loopholes. He was right. In recent months, however, he has backed away from earlier suggestions that he would be willing to make tough choices in tackling entitlement reform. The country needs both things: immediate action on the sequester and a sound long-term fiscal strategy. But with the two sides digging in, the most likely outcome is more upside-down policies.

Read more:

Tuesday, February 12, 2013

The Great Housing Mania - Insight from Martin Conrad

This is hands-down the best article I have ever read on the housing crisis.  It is short, succinct, and very insightful.  There is no finger pointing, no emotions, no politics, it is just what happened.  Economics is all about choice.  If we choose this, this will be the consequences both intended and non-intended.  Be careful how you choose.

The article written by Martin Conrad of CIG is in italics and the bold is my emphasis.  From Barron's:

The full story about housing and the economy has been ignored too long. Like all manias, it was a long time building.

The boom of the 1950s and 1960s, featuring rising incomes and wealth, occurred in a well-balanced economy. The benefits of economic growth were fairly evenly distributed. That was an economy where the U.S. manufacturing sector was competitive and flourishing, its infrastructure was adequate and being improved, and housing valuations were at least fair, if not cheap. The value of housing averaged 80% to 90% of gross domestic product in this era -- about half of the peak value set in the mania that ended so badly in 2008.

During the 1970s and 1980s, as the large baby-boom generation grew to adulthood and formed households, housing markets were distorted. The result: about a 50% rise in the aggregate value of housing, to 120% of GDP. At the end of this period, there was a solvency crisis in the thrifts and banks that had financed the housing sector. A few thousand of them had to be liquidated by the federal government.

During the 1990s, the U.S. enjoyed renewed prosperity, with a booming stock market and the creation of 20 million jobs. Housing valuations moderated, and the aggregate value of housing declined to a bit over 100% of GDP, not much higher than the average during the postwar boom.

More ominously, the few thousand thrifts and banks that had been lost during the savings-and-loans crisis were mostly being replaced by a mortgage-securitization process, not by new banks and thrifts using traditional credit standards. The new home-loan system soon came to be dominated by Wall Street investment banks.
In the late 1990s, there was a major banking reform. The Glass-Steagall Act, a reform of the Depression era that had separated investment banking from commercial banking and had given only the latter government-supported deposit insurance, was repealed. This began an era of mass securitization of mortgages, which enabled large-scale lending to subprime borrowers. Other features of the period included making loans with little or no documentation of borrowers' ability to pay, and loans with low or no down payments. The easy money for homeowners stimulated widespread speculation in everything related to housing, including precarious financing.

This culminated in a final manic race to the top, when the aggregate value of housing exceeded 170% of GDP.
THE INEVITABLE BUT UNEXPECTED RESULT was a wave of mortgage defaults and a catastrophic decline in housing values. The market for securitized mortgages declined and then collapsed in 2008. In that year, houses with mortgages had about $11 trillion in aggregate mortgage debt that was collateralized by a net equity of zero.

At its peak in 2006, 2007, and 2008, this mania had overallocated as much as $10 trillion to the housing sector, based on the long-term average of housing value to GDP. This misallocation came at the expense of more productive and more sustainable economic opportunities in manufacturing, infrastructure, and technological innovation. The catastrophic losses also were a major factor in the extremely unequal distribution of national wealth, as the middle class lost approximately 40% of its net worth, most of it on overpriced and overleveraged housing.

Knowledgeable insiders who were aware of the distortions and the dangers headed for the exits early, leaving the masses with gigantic losses and unmanageable debt. There was an enormous rise of insider selling in 2005 by senior management of the major home builders, and in 2008 there was an epidemic use of derivatives to speculate against overleveraged Wall Street securitizers.

Eventually, the huge unknown risk associated with these complex derivatives led to a crisis of confidence: Could the counterparties pay on their losing bets? Would they pay, even if they could? This lingering destructive counterparty risk is still huge and its many connections mostly unknown, and hence it continues to paralyze investment confidence.
Manias occur for many reasons, but great manias are made possible and sustained by errant government policies that may seem to have good reasons, none of them with any long-term economic value. Housing, despite high leverage, high transaction costs, and poor liquidity, was promoted as a dream investment for everyone. Massive intervention in this market by populist government policies and agencies fostering affordability exacerbated these normal defects and disastrously distorted the market. It was a "dream," in the sense of confused, wishful thinking. But to think and act this way with many trillions of dollars, most of it borrowed, was irresponsible on an historic scale.

There is now much media commentary that no sustained and robust recovery is possible until the housing sector recovers (that is, until house prices rise again). This desire to simply reinflate the collapsed bubble would likely yield the same disastrous result again. Another course would likely be more effective: restructuring away from so much dependence on leveraged, expensive, and speculative housing values. We should no more regret the demise of expensive housing than we should the decline of expensive oil, both of which are poorly correlated with productive, sustainable economic growth, but strongly correlated with damaging inflation.

Disciplined buyers -- too long unfairly disadvantaged by government policies -- are now sitting on trillions in savings that are earning, doing, and financing nothing. This money could clear the housing market, but only at lower, fairer prices. That would finally be "affordable housing."

Manias begin in obscurity and pessimism, rise with confidence and imitation, reach a state of euphoria and finally end in tragedy. They often change history in ways that are not foreseeable.

Sunday, February 10, 2013

DO YOURSELF A FAVOR AND STOP BEING SCARED - Philip Pilkington on the Fear Industry - Austrian Economics and the Gold

This is an interesting article about selling fear.  What a friend of mine calls "cliff-aggedon".  According to the news we the US and the world lurch from one crisis to another with the next one possibly causing the end of the world as we know it.  I don't buy any of it.  Are there risks out there - you betcha!  Are any of these going to cause us to assume the status of a refugee or to be put into camps - probability pretty close to 0%.  It is just fear mongering so someone can pick your pocket.  If you have enough time to be scared, you have enough time to go down to the local univertsity or community college and take some history or economics classes and find out how things work from people that do it for a living.

Do yourself a favor and stop being scared.

The article is in italics.  From Naked Capitalism

When you survey the websites and the pundits of Austrian economics on the internet you tend to get a niggling feeling that they’re trying to sell you something. Of course, every writer is ultimately trying to earn a living but with many Austrians it seems to be a little different. It feels more like many are just churning certain content out in order to flog a certain line which, while certainly not quite mainstream, nevertheless seems geared toward generating if not income then at least traffic. To say that some of this comes across as spam-like would be slightly unfair, but not too unfair. After all, there is a high degree of repetition and the ultimate aim does seem to be to get the punter into the gold market or something similar.

But the sheer scale by which the fear industry has taken off is, to be frank, quite surprising. We have all seen the likes of Peter Schiff as a regular guest on the American business news spouting vague talking points about the impending dollar collapse and gold reaching $5000 an ounce. Is he trying to flog something? Probably, he does run an investment fund after all that seems to take strong and uncompromising positions in gold that have a history of losing investors boatloads of money. But beyond that one gets the impression that he just likes the attention.

The thing that really drove home to me the nature of the fear industry is an advertisement that I recently came across on Craigslist (hat tip Nathan Tankus, click to enlarge).

The advertisement is for a website entitled Economic Collapse News. The site itself is everything we’ve come to expect from such reputable news outlets. At the time of writing this article one of what appeared to be top feature was entitled ‘FEMA Coffins Revealed’. Presumably this was in reference to some sort of conspiracy where the Federal Government is going to set up FEMA camps where they will slaughter large sections of the population. However, when I clicked on the link to find out more about the dreaded FEMA coffins I came to realise that this was just an advertisement for food items that were going to fly off the shelves in the coming economic collapse – food items which I should, it seemed, buy from this website.
The website also contained advertisements for gold and links to Schiff, the Von Mises Institute, Lew Rockwell and Robert Murphy. Basically, this is an “apocalypse-is-coming” site that encourages the reader to stock up on guns, gold and cat food and read out-of-date economics ideas purely for the shock value and to reinforce the reader’s existing belief that collapse is nigh.

But back to our advertisement, for it is this that illustrates just how cynical the industry has become. The reader can peruse the advertisement themselves but I would highlight three dog whistle notes for the would-be writer to be sure to hit.
1. Libertarian political orientation, “aligned” with the Austrian School.
2. Invocation of certain sources (Schiff, Von Mises Institute etc.).
3. Recommendation of only the Austrian “solution” to the current crisis.
Okay, so the first requirement has two components. One of these is to have a certain political orientation. This doesn’t bother me so much. Certainly, Yves Smith didn’t ask me my political orientation when I started writing for this site – indeed, the issue has never come up – but I think if I had started writing articles championing Big Finance and bashing the unemployed our professional relationship would soon come to an end. This is the case for most media outlets. So, while it is unusual for a certain political orientation to be a requirement in an advertisement, I think we can look beyond this to some extent.

It is the second component of the first requirement that is particularly suspicious: namely, that the potential writer must be “aligned” with the Austrian School. This, it seems to me, indicates that the potential writer should think in a very specific way. This is not something that should ever be asked of a writer. Again, if a writer’s general thinking strays too far from a certain editorial line one can be sympathetic if an editor decided that enough was enough. But to require in an advertisement that the writer have a certain way of thinking appears to me something out of Soviet Russia; a sort of online Pravda.

The second requirement indicates something similar. The potential writer is expected to follow certain leaders in the field. Again there is a strong element of controlling what the potential writer is and is not allowed to say. Sure, in the mainstream media and even to some extent on the internet (Naked Capitalism, in my experience, being one of only a few exceptions) it is expected that a not-so-well-known writer don’t stray too far from the dominant discourse. But again, this advertisement indicates something altogether different. Like a trooper in the army, the writer is told exactly who their generals are to be.

The third requirement is perhaps the most extreme. It can be translated simply as: you must tow the Party Line. The would-be writer is told that there is only one solution to the current crisis and that is the Austrian solution (i.e. to deflate the economy). One suspects that what they mean here is not just that the writer must adhere to this solution but must also advocate singular personal solutions to readers that fit in with the website’s advertisers: that is, that the reader of the site should hoard items that they buy from the online store.

What is so interesting is that the fear industry grows larger and larger at a time when the make-up of their key market – the gold market – has fundamentally altered its composition. Last year the always excellent FT Alphaville ran a piece by the equally excellent Izabella Kaminska about central bank intervention in the gold market. Kaminska showed that in 2011 the central banks (represented in the chart below as the ‘Official Sector’) had increasingly come to prop up the gold market.
Kaminska wrote that were it not for the central banks the gold market would be largely dead because Exchange Traded Funds (ETFs) had begun piling out in 2010 – probably moving toward equities at that time. I would tend to agree with this analysis to some extent, but I’d also point to the growth in the ‘Bar & Coin Investment’ component in those years. This is the precisely the component of the industry that is supported by the Austrian School and the fear industry. As we can see it began to grow substantially in 2011, although again (and rather ironically given the ideology of these people) it would not have been sufficient to hold up the price without central bank intervention.
Here are the latest figures from the World Gold Council together with some of my own projections that show gold demand in 2012 as compared to 2011.

As we can see the bar and coin investment component actually shrank while the ETFs and the central banks picked up some of the slack. This indicates that the fear industry’s most successful year was actually in 2011 and this in turn is reflected in the fact that the gold price reached its record high in the summer of that year as is seen in the graph below.
It would seem that the fear industry is getting a tad overstretched in its propaganda. In addition to the sort of crude advertisements we studied above, which almost certainly indicate that the industry has become hollow to the point of irrelevance, we can also see this in what can only be described as the corruption of commercial radio stations in the United States. This can be heard in the second half of this discussion of the commercial radio scene in the US in which one host refers to the gold aspect of the contemporary scene as “the gold scam situation” (relevant conversation starts around 1.50):

Yes, it would seem that the fear industry has probably stretched itself too thin and it is likely that we saw its peak last year. From here on in it will probably be diminishing returns and we’ll likely hear of more and more scams as people within the industry compete for ever scarcer resources. Meanwhile the likes of Peter Schiff, Alex Jones and the Von Mises crowd will assure their followers that the end game is just around the corner while ever more money accumulates into their own hoards which, need we say, probably do not simply consist of tinned food and semi-automatic assault rifles.

Perhaps Naked Capitalism should get in on the action while we still can. If readers are interested in water filters, maps laying out the FEMA regions across the US and high-calibre ammunition please show your support by emailing us and we might, with Yves’ permission of course, look into setting up an online store. In the meantime, onward to $5000 an ounce for gold!

Saturday, February 9, 2013

3 Big Shockers in the Stock Market in 2012 and What It Says About 2013

The 3 big shockers in the markets for 2012 were:  Europe was up, gold was weak and dividend stocks were weak.  What so does that mean for 2013?  

The article is in italics and the bold is mine.  Allan Roth, the author, is always interesting to read.  From CBS News:

Last year will go down as one replete with political and government dysfunction both in the U.S. and abroad -- and an impressively strong stock market. U.S. stocks in 2012 rose 16.45 percent as measured by the Vanguard Total Stock ETF (VTI), and international stocks rose 18.62 percent, as measured by the Vanguard Total International ETF (VXUS).

To that end, here are three additional facts about the stock market's performance in 2012 that might take some people by surprise.

1.  Europe was the star. While international stocks bested U.S. stocks, regions around the world were not equal when it came to investments. Pacific rim stocks gained 15.86 percent, emerging markets were up 19.22 percent and Europe came in at No. 1 with a 21.55 percent gain (All of these are measured by the corresponding Vanguard index funds.)

How could Europe -- the part of the world with the slowest growth and that remains beset by an economically calamitous sovereign debt crisis -- end up being the star? Simple -- there is a slight correlation showing that countries with slower growing economies make for faster growing stock markets. Europe is the equivalent of a collection of "value" countries, which is similar to the data showing that value companies usually outperform "growth" companies in stock appreciation.

Still not convinced? Consider that Europe was also the strongest performing region outside of the U.S. in 2011. And what was the strongest performing country in 2012? Greece -- the ultimate value country, where stocks were up a whopping 36.48 percent on the year.

2.  Gold closed way below its 2011 high. Though gold had a pretty decent year in 2012, rising 8.7 percent, that's only about half the gain of stocks. Further, the $1,664 an ounce closing price represented a 13.3 percent decline from the high set on Sept. 6, 2011. How can this be given that 2012 was a year of record deficits, and even a growing belief that currencies like the U.S. dollar and the euro were doomed?

The answer again is as simple and unavoidable as the laws of gravity: What goes up must come down. No financial asset rises in value forever. The expected collapse of these currencies also represented the conventional wisdom, which is nearly always a fools game when it comes to investing.

3.  Dividend stocks were dogs. The Dow Jones U.S. Dividend 100 index gained only 11.61 percent in 2012 (This return includes the dividends being reinvested.) While that's a respectable number, it's nearly five percentage points less than the overall U.S. stock market's gain for the year. 

This also shouldn't be a surprise considering that it's not exactly a secret that total return is more important than just the return from dividends. Sometimes, dividend stocks outperform the stock market as a whole, but investors that count on this year after year are sure to be disappointed. 

Sadly, many investors remain in denial, as I have learned when pointing the fact out to clients that their high dividend-paying stocks have underperformed. The response I often hear is, "I don't care -- I'm collecting a great dividend." Such fantasies are tough to kill.

These are only three example of market "shockers" that, in fact, aren't in the least bit shocking when one is ready to look at the underlying data and recognize that the market doesn't run on conventional wisdom.

When you invest for 2013 and beyond, ask yourself if your logic on selecting where to invest is already known to most investors. If the answer is yes, you may want to pick a new strategy.

Thursday, February 7, 2013

U.S. judge orders Flagstar to pay Assured Guaranty $90.1 million

This is not to sexy a topic, but it has very far reaching ramifications.  Basically, a lawsuit was filed against a bank by a bond insurer concerning the contractual agreement the bank had with the bond insurer regarding the quality of the mortgages the bank included in a securitized bond offering.  The bank lost.  
The article is in italics and the bold is mine.  From Reuters:
Flagstar Bancorp Inc was ordered on Tuesday to pay $90.1 million to bond insurer Assured Guaranty Ltd in a contract dispute over loans underlying $900 million in mortgage-backed securities.

U.S. District Judge Jed Rakoff in Manhattan ruled that Flagstar had materially breached contracts specifying the quality and characteristics of loans to be packaged into the securities.

The closely watched lawsuit has been seen as a test of the ability of bond insurers to hold banks accountable for losses incurred insuring securities at the heart of the financial crisis.

A number of other suits have been filed against banks by Assured and fellow insurers, but have yet to reach trial.

"This ruling is a significant milestone in forcing the banks to honor the contractual commitments they made and have long sought to avoid," Jacob Buchdahl, a lawyer for Assured at Susman Godfrey, said in a statement.

The ruling followed a bench trial last year. Assured had at the close of trial sought $116 million.

In a statement late on Tuesday, Flagstar Bancorp said it "strongly disagrees with the court's ruling and intends to vigorously contest the outcome on appeal."

The lawsuit, filed in April 2011, accused Troy, Michigan-based Flagstar of misrepresenting the quality and traits of loans packaged into two mortgage securitizations issued in 2005 and 2006, valued at more than $900 million.

Assured had guaranteed the Flagstar securities. When the housing meltdown hit, it was forced to pay millions in claims.

Rakoff said the loans in the securitizations "pervasively breached Flagstar's contractual representations and warranties."

The decision was another reminder of the continued litigation fallout from the subprime meltdown of 2007 and the financial crisis that followed.

The ruling came a day after the U.S. Department of Justice launched a civil fraud lawsuit against credit ratings agency Standard & Poor's, a unit of The McGraw-Hill Companies Inc , over its mortgage bond ratings.

The Flagstar case mirrors other lawsuits by insurers such as MBIA Inc and Ambac Financial Group Inc. Defendants have included JPMorgan Chase & Co, Credit Suisse Group AG and Bank of America Corp's Countrywide Financial unit.

Assured's lawsuit against Flagstar was the first by the insurers to reach trial. Assured CEO Dominic Frederico, whose company is pursuing other lawsuits, in a statement said the ruling "sets a strong precedent in support of the rights of Assured Guaranty in these cases."

Flagstar, which had net income of $223.7 million for 2012, said Jan. 23 that it had reserved $82.7 million for pending and threatened litigation, including Assured's lawsuit.

The litigation reserves also cover another bondholder lawsuit launched earlier this month by MBIA, which sued after paying out $165 million on claims related to two mortgage-backed transactions it insured.

Flagstar had separately agreed in February 2012 to pay $132.8 million to settle claims by the U.S. Department of Justice that it improperly approved mortgages for government insurance.

The Assured case amounted to what Rakoff called a "war of experts." Expert witnesses for Assured used a statistical sample of 800 of the 15,000 loans at issue. Of the 800, 606 were defective, an expert for Assured testified.

Flagstar challenged the experts' methodologies and the insurer's ability to prove liability on a sample. But Rakoff said sampling was a "widely accepted method of proof" and largely accepted the experts' testimony.

The case is Assured Guaranty Municipal Corp v Flagstar Bank, FSB in U.S. District Court, Southern District of New York, 11-2375.