This week saw continued volatility in the US and global equities markets, with the DOW claiming the second highest single point gain in history on Tuesday of 889 points. Most expected the markets to post substantial losses Wednesday as sellers might have stepped in to take short-term profits; but instead of high volume and steep declines, we saw a modest day-over-day point swing on light volume, as the Federal Reserve offered a widely anticipated .5% cut in the Fed Funds rate. Trading on Thursday showed meaningful gains in spite of the release of two obviously negative economic reports: 3rd Quarter 2008 GDP decline of .3%, and weekly jobless claims of 479,000.
So why is it that the market can get so excited about a .5% rate cut when rates are already so low as to be nominal, and how can the markets not react to reports of declining GDP and jobless claims representing continued unemployment of almost half a million workers? The answer has everything to do with expectations and confidence.
Though a .5% fed funds rate cut will obviously decrease the overall cost of short-term borrowing, the relative benefit is minimal with rates already deeply discounted; but it was an important move in terms of the Federal Reserve showing its ongoing commitment to support the credit markets through an extraordinarily difficult period. Equally as important was the Fed’s indication that inflation appears to be a non-issue when compared to overall financial concerns. This helped to calm the fears of those concerned over the possibility of a period of stagflation, a time period in which the economy might shrink while the costs of goods, services, and borrowing might increase.
The announcement of a decline in GDP for the 3rd quarter was actually better than expected, and may be an indicator of a milder, shorter recessionary period than the markets are currently bracing for. Economic consensus expected a .5% decline in GDP for the 3rd quarter to be followed by 4th Quarter 2008 and 1st Quarter 2009 declines of 2% and .7% respectively, before seeing a return to economic growth of 1% , 2% and 2.3% in the 2nd, 3rd and 4th Quarters of 2009. These appear to be very small numbers, but they have significant impact on employment. If we are to endure a more mild recession than has been feared, then fewer jobs will be lost, more debt payments will be made on a timely basis, more goods and services may be purchased, and the economy could have a less difficult time of regaining solid footing. Most important is the potential for a swifter return to a stable real estate market.
Even with jobless claims remaining steady and the unemployment rate unchanged for the past two months, we can expect that unemployment will increase from the current level of 6.1% to as much as 7.3% before the end of 2009, with a reduction back towards 5% in 2010. These are low unemployment rates for a recessionary period, as unemployment during sustained recessions often exceed 10-12%. So far in 2008, the economy has lost 760,000 jobs with non-farm payrolls standing at 137.3 million jobs.
The last few weeks have also represented the heart of the corporate earnings reporting season, and we’ve seen more surprises of higher than expected earnings than we have those that are lower than expected. Most of this has been ignored by the markets as confidence has remained low and uncertainty has remained high. Interesting to note: the three major hurricanes and natural disasters experienced during the 3rd Quarter reduced GDP by 1%. Without these events, our economy might have posted gains rather than the lower than expected decrease reported Thursday morning.
Oil and Energy Costs
In last week’s Signature Update, we discussed the economic and political benefit to reduced energy costs and how the timing of reduced fuel prices as we enter the holiday buying season couldn’t be better. With consumer confidence figures released for October reflecting a substantial decrease from September, 38 versus 64.1, it is critical that oil costs remain below $70 per barrel through the end of the year. OPEC met within the last week and announced their decision to cut production by 2 million barrels per day and the oil markets barely reacted, signaling that the global demand destruction is further entrenched than OPEC might have supposed.
This bodes well for a sustained move towards fuel efficiency that must transcend the price of oil. If we are to stave off future runs on the price of oil, we must continue our reduction in energy demands, otherwise $147 per barrel oil might seem like a bargain in the future. We must avoid the temptation to eschew ‘greening’ policies simply because the cost of energy declines. To not do so will simply continue to unnecessarily export billions of US dollars to foreign governments and to expand our nation’s dependency across the globe.
‘Wackonomics’
Walter E. Williams, a popular economic and political columnist published in numerous major US news publications and a Professor of Economics at George Mason University, wrote an article that appeared this week in the Deseret News (October 29, 2008 A13) in an attempt to explain what he refers to as ‘Wackonomics’. Williams’ comments address the irrational attitudes expressed by the news media, many politicians, and the population at large, over executive compensation and corporate greed. He rightly contrasts the outcry over executive compensation versus the silent acceptance of celebrity compensation, which most often dwarfs that received by CEO’s of publically held corporations. Though Williams stops short of describing how these highly paid CEO’s strive to increase their shareholder value in contrast to the personal motivation of most celebrities, he does state his interest to ‘talk to these people and learn their strategies’. The article is worth reading and can be viewed at http://www.gmu.edu/departments/economics/wew/articles/08/Wackonomics.htm.
Friday, October 31, 2008
Monday, October 27, 2008
Petro-Politics, Releif for the US Economy, and General Motors 10-24-2008
Relief for the US Consumer and Petro-Politics
Oil dipped below $70 per barrel in trading late Thursday for the first time in over 12 months. Aided by a stronger US dollar and weaker global demand, the price of light sweet crude has been in steady decline. Much to the delight of US consumers and the chagrin of OPEC and other oil rich dictatorships around the globe, an enormous tax on the US marketplace is finally being trimmed, and it couldn’t have come at more critical time.
The US consumer faces tough challenges as we head into the all-important holiday buying season. Recession fears have brought real economic slow down; and though the US consumer has always led us out of such difficulties, it hasn’t appeared likely that retail purchases would lead us towards economic strength again. Fortunately, declining fuel prices may leave $20-$25 more per week in consumer pockets than only a few short months ago; and this, coupled with renewed talks of another economic stimulus package, just may save the retail season, while at the same time provide much deserved economic pressure to unfriendly oil producing nations rarely sympathetic to US concerns.
This is a good news, good news story, with a bad news chaser. The decrease in demand that has driven some of oil’s price decline represents a domestic and global economic slowdown that won’t retreat for at least two or three calendar quarters. It is also indicative of a shift in our country from being net spenders to net savers as many have realized that their lifestyle demands simply grew beyond their resources. This shift will be uncomfortable as families adjust spending patterns, but will ultimately yield benefits as savings levels ultimately support capital investment and a more secure financial foothold for consumers.
With the dramatic retreat in the oil markets, the likes of Venezuela, Russia, Iran, and Saudi Arabia, currently awash in US dollars due to oil prices well over $100 per barrel, exporters of tremendous pressure on the US’s political and military establishments, will now have to face their own problems at home, without the aide of hundreds of billions of excess US dollars. As their corrupt leadership attempts to deal with the domestic unrest already being felt as a result of sharp declines in oil revenues, their citizenry may finally call for action and accountability where there has simply been rhetoric and excuses for years.
Over the past several years, these nations have exported fear, terrorism, and excessive anti-American sentiment alongside the enormous quantities of high-priced oil. Today, not only are oil prices down, but the volumes are in decline as well, making it more difficult for these countries as the value of their currency is declining against the US dollar. The convergence of these three important financial events equates to a tremendous loss of political, social, and economic strength for some of the US’s least cooperative foreign leaders.
General Motors and the three ‘C’s: Corvette, Cadillac, and Camaro
The upheaval in the American automotive industry took a sharp turn for the worse with the dramatic increase fuel prices this last year. As oil made its historic run to eventually top out at over $147 per barrel, the US transportation market was left bleeding in its wake. Airline, railroad, transports, and SUV manufacturers were devastated. The loneliest road in America, formerly the section of US Highway 50 running through central Nevada, all of a sudden became the approach road to any Hummer dealership in the country. Just as oil prices turned back towards $90, $80 and then $70 per barrel and fuel prices began a sharp decline, the credit crisis surged to strike yet another blow to automobile sales. For some, the blow may have been fatal.
US auto sales have fallen sharply in recent months. Overshadowed by the decline in housing prices, the credit crisis, and the turmoil on Wall Street, the US automotive industry has been fighting for its life, or at least its asset value. Successful auto dealers reported having difficulties making payrolls a few weeks ago and stock values plummeted. Ford Motor Corporation bottomed out today at $2 per share, down from a 52 week high of $8.75. And General Motors looks like a multi-car wreck taking place before our eyes.
Over the past few years we’ve commented several times that some form of reorganization must be part of General Motor’s (GM) long term business plan. The enormous legacy costs they carry from millions of former employees, many of whom are current retirees, is crippling, especially in light of continued upward revisions in their underfunded pension and medical benefit costs. When GM ruled the domestic market and proudly supported a major national labor force, they were better able to compete with other US auto manufacturers and appease the ever-hungry labor unions. But today, with only a fraction of the weakening US auto market, a labor force that bears little resemblance to the army of technicians formerly on GM’s payroll, and extraordinary pressure from foreign automobile brands, many with US manufacturing operations, GM is in serious trouble.
Two weeks ago GM’s corporate credit rating was downgraded by Standard and Poors, and the stock went into a tail spin to close at $4.00 per share, down from a 52 week high of $39.45. Without the appropriate credit rating, GM may barely be able to hang on through the end of the year without some sort of intervention, whether from a bankruptcy filing, takeover bid, or sale to a private equity firm.
Analysts project that GM’s current cash position will only support operations through 2009, after which the unthinkable could possibly occur. But GM has tremendous value if it can be stripped of its legacy costs. Several of GM’s domestic brands still rate extraordinary loyalty from enthusiasts: Corvette, Cadillac, Camaro, the three ‘C’s of the automotive world are alive and racing, literally. GMAC, though tainted through association with the sub-prime mortgage disaster, remains a powerful, and profitable, financing arm. GM’s dealer portfolio is impressive and includes some of the wealthiest and most successful auto dealers in the country. And GM’s manufacturing operations control vast pools of real estate, technology, and skilled labor world-wide.
Some of GM’s future strength may rest in emerging markets and green technology, but other manufacturers are developing those same markets and technologies in what may ultimately be a fast-paced, high-stakes game of musical chairs. The likes of Toyota, Nissan, Honda, Ford, Chrysler and others have invested billions towards the same end, and it’s likely that only one or two companies will be able to capture the right technologies, in the right markets, at the right time to win big. Though most of the others will be able to ride some of the same wave, some brands won’t survive, and the others will spend years playing catch-up.
The GM brand will almost certainly survive, but without some of the baggage that currently holds it down. If a corporate reorganization was part of GM’s long-term business plan before, it’s likely to be part of its short-term strategy today. A bankruptcy would rid GM of its excess pension and medical liabilities, give it room to breathe as it restructures debt, and allow it to remake itself as a leaner, greener domestic and international manufacturing powerhouse once more.
Unthinkable only a few short months ago, GM is now inexpensive enough for a private equity firm to make a credible run at the company. Cerberus Capital Management, LP, the private equity firm that owns Chrysler, Air Canada, and the half of GMAC that GM no longer owns, is reportedly in talks with GM executive leadership to acquire the auto manufacturer. Cerberus has made no secret of its interest in owning the entirety of GMAC, and if it has to purchase the auto manufacturer to gain control of its lucrative financing arm, then so be it. This was Cerberus’s strategy in acquiring Chrysler, but it quickly realized that the manufacturing concern took more of the luster off of Chrysler Credit than it had bargained for. An acquisition of GM would allow Cerberus to merge the two automobile manufacturers, gain enormous economies of scale, perhaps shed some the legacy cost liabilities in the process and reintroduce GM/Chrysler to the public markets. Cerberus could possibly be left with the financing arms they’ve long sought after, and end up saving two automotive legends at the same time. The logistics of such a transition would be enormous, and the painful red ink that might be written at the dealer level could take years to erase, but the Corvette would still be an American icon, Cadillac could continue to reign as an American luxury brand, and Camaro could once again steal the hearts of teen-agers (young and old) throughout the heartland.
Oil dipped below $70 per barrel in trading late Thursday for the first time in over 12 months. Aided by a stronger US dollar and weaker global demand, the price of light sweet crude has been in steady decline. Much to the delight of US consumers and the chagrin of OPEC and other oil rich dictatorships around the globe, an enormous tax on the US marketplace is finally being trimmed, and it couldn’t have come at more critical time.
The US consumer faces tough challenges as we head into the all-important holiday buying season. Recession fears have brought real economic slow down; and though the US consumer has always led us out of such difficulties, it hasn’t appeared likely that retail purchases would lead us towards economic strength again. Fortunately, declining fuel prices may leave $20-$25 more per week in consumer pockets than only a few short months ago; and this, coupled with renewed talks of another economic stimulus package, just may save the retail season, while at the same time provide much deserved economic pressure to unfriendly oil producing nations rarely sympathetic to US concerns.
This is a good news, good news story, with a bad news chaser. The decrease in demand that has driven some of oil’s price decline represents a domestic and global economic slowdown that won’t retreat for at least two or three calendar quarters. It is also indicative of a shift in our country from being net spenders to net savers as many have realized that their lifestyle demands simply grew beyond their resources. This shift will be uncomfortable as families adjust spending patterns, but will ultimately yield benefits as savings levels ultimately support capital investment and a more secure financial foothold for consumers.
With the dramatic retreat in the oil markets, the likes of Venezuela, Russia, Iran, and Saudi Arabia, currently awash in US dollars due to oil prices well over $100 per barrel, exporters of tremendous pressure on the US’s political and military establishments, will now have to face their own problems at home, without the aide of hundreds of billions of excess US dollars. As their corrupt leadership attempts to deal with the domestic unrest already being felt as a result of sharp declines in oil revenues, their citizenry may finally call for action and accountability where there has simply been rhetoric and excuses for years.
Over the past several years, these nations have exported fear, terrorism, and excessive anti-American sentiment alongside the enormous quantities of high-priced oil. Today, not only are oil prices down, but the volumes are in decline as well, making it more difficult for these countries as the value of their currency is declining against the US dollar. The convergence of these three important financial events equates to a tremendous loss of political, social, and economic strength for some of the US’s least cooperative foreign leaders.
General Motors and the three ‘C’s: Corvette, Cadillac, and Camaro
The upheaval in the American automotive industry took a sharp turn for the worse with the dramatic increase fuel prices this last year. As oil made its historic run to eventually top out at over $147 per barrel, the US transportation market was left bleeding in its wake. Airline, railroad, transports, and SUV manufacturers were devastated. The loneliest road in America, formerly the section of US Highway 50 running through central Nevada, all of a sudden became the approach road to any Hummer dealership in the country. Just as oil prices turned back towards $90, $80 and then $70 per barrel and fuel prices began a sharp decline, the credit crisis surged to strike yet another blow to automobile sales. For some, the blow may have been fatal.
US auto sales have fallen sharply in recent months. Overshadowed by the decline in housing prices, the credit crisis, and the turmoil on Wall Street, the US automotive industry has been fighting for its life, or at least its asset value. Successful auto dealers reported having difficulties making payrolls a few weeks ago and stock values plummeted. Ford Motor Corporation bottomed out today at $2 per share, down from a 52 week high of $8.75. And General Motors looks like a multi-car wreck taking place before our eyes.
Over the past few years we’ve commented several times that some form of reorganization must be part of General Motor’s (GM) long term business plan. The enormous legacy costs they carry from millions of former employees, many of whom are current retirees, is crippling, especially in light of continued upward revisions in their underfunded pension and medical benefit costs. When GM ruled the domestic market and proudly supported a major national labor force, they were better able to compete with other US auto manufacturers and appease the ever-hungry labor unions. But today, with only a fraction of the weakening US auto market, a labor force that bears little resemblance to the army of technicians formerly on GM’s payroll, and extraordinary pressure from foreign automobile brands, many with US manufacturing operations, GM is in serious trouble.
Two weeks ago GM’s corporate credit rating was downgraded by Standard and Poors, and the stock went into a tail spin to close at $4.00 per share, down from a 52 week high of $39.45. Without the appropriate credit rating, GM may barely be able to hang on through the end of the year without some sort of intervention, whether from a bankruptcy filing, takeover bid, or sale to a private equity firm.
Analysts project that GM’s current cash position will only support operations through 2009, after which the unthinkable could possibly occur. But GM has tremendous value if it can be stripped of its legacy costs. Several of GM’s domestic brands still rate extraordinary loyalty from enthusiasts: Corvette, Cadillac, Camaro, the three ‘C’s of the automotive world are alive and racing, literally. GMAC, though tainted through association with the sub-prime mortgage disaster, remains a powerful, and profitable, financing arm. GM’s dealer portfolio is impressive and includes some of the wealthiest and most successful auto dealers in the country. And GM’s manufacturing operations control vast pools of real estate, technology, and skilled labor world-wide.
Some of GM’s future strength may rest in emerging markets and green technology, but other manufacturers are developing those same markets and technologies in what may ultimately be a fast-paced, high-stakes game of musical chairs. The likes of Toyota, Nissan, Honda, Ford, Chrysler and others have invested billions towards the same end, and it’s likely that only one or two companies will be able to capture the right technologies, in the right markets, at the right time to win big. Though most of the others will be able to ride some of the same wave, some brands won’t survive, and the others will spend years playing catch-up.
The GM brand will almost certainly survive, but without some of the baggage that currently holds it down. If a corporate reorganization was part of GM’s long-term business plan before, it’s likely to be part of its short-term strategy today. A bankruptcy would rid GM of its excess pension and medical liabilities, give it room to breathe as it restructures debt, and allow it to remake itself as a leaner, greener domestic and international manufacturing powerhouse once more.
Unthinkable only a few short months ago, GM is now inexpensive enough for a private equity firm to make a credible run at the company. Cerberus Capital Management, LP, the private equity firm that owns Chrysler, Air Canada, and the half of GMAC that GM no longer owns, is reportedly in talks with GM executive leadership to acquire the auto manufacturer. Cerberus has made no secret of its interest in owning the entirety of GMAC, and if it has to purchase the auto manufacturer to gain control of its lucrative financing arm, then so be it. This was Cerberus’s strategy in acquiring Chrysler, but it quickly realized that the manufacturing concern took more of the luster off of Chrysler Credit than it had bargained for. An acquisition of GM would allow Cerberus to merge the two automobile manufacturers, gain enormous economies of scale, perhaps shed some the legacy cost liabilities in the process and reintroduce GM/Chrysler to the public markets. Cerberus could possibly be left with the financing arms they’ve long sought after, and end up saving two automotive legends at the same time. The logistics of such a transition would be enormous, and the painful red ink that might be written at the dealer level could take years to erase, but the Corvette would still be an American icon, Cadillac could continue to reign as an American luxury brand, and Camaro could once again steal the hearts of teen-agers (young and old) throughout the heartland.
Feel Good Products: A Consumer Necessity During a Difficult Economy
The US consumer is a complex and resourceful animal; we appear to have a need to be satisfied that transcends even the most difficult times. Consider how we reacted to the Great Depression: at a time of extraordinary financial turmoil, most in the nation turned inwards towards family and culture, making the era one of the most memorable for American arts and crafts. The entire ‘craftsman’ style and ‘arts and crafts’ movement came out of the depression, and though few were able to afford luxury purchases or finely crafted products for their homes, we saw a surge in artistry and craftsmanship that would come from the home. American households, under extraordinary fiscal pressure, continued to crave warmth, values, family, and entertainment.
As our society surfaced from World War I and then came through the prosperous 1920’s, personal values declined steadily and styles trended towards the complex, though relatively cool lines of the ‘art deco’ movement. However, as the nation plunged headlong into financial turmoil of the 1930’s, and finally another world war in the 1940’s, hearts and minds turned towards home, family, and warmth. Many of us remember the 1940’s and 1950’s as a simpler, more wholesome time for home and family, but few stop to realize that it became that way after an entire movement swung the pendulum back to a place of personal satisfaction, a time in which the home became the center of our lives again, while we created memories around the fireplace, the radio, and the kitchen table.
This same sort of transition took place after the conflict in Vietnam. The 1960’s and 1970’s were punctuated by societal, financial, and political unrest. But by the late 1970’s and early 1980’s we were once again seeking hearth and home. We eschewed the establishment, and welcomed national leadership in the warmth and genuine tones of Jimmy Carter and the values oriented confidence offered by Ronald Reagan. Home designs once again trended towards warmth and away from sleek and modern. Toll painting, quilting, wood working, gardening and scrap booking became national pastimes once more. But in the years since, we’ve morphed back to a point where high tech has replaced high touch, and an economy that has rewarded complex promises more readily than sound advice. The societal pendulum swings with amazing consistency, you just need to look at thirty and fifty year time frames to see it with any clarity.
While our nation adjusts to the current challenges facing our economy, consumers will once again put more of themselves into gift giving, home decor, and creative efforts. We tend to want to get as much out of our purchases as before, but with fewer dollars to put towards them, we begin to invest more of our own effort in an attempt to create a higher level of quality or a greater affect. At the end of the day, it’s all about feeling good, and the US consumer will transition towards ways to drive personal and family pleasure without having to spend as much as they have might have before.
I recently visited in the home of an affluent client whom I knew to be in the process of remodeling their kitchen and family room. Their original plans included interior decorators, expensive wall treatments, commercial appliances, and high end furnishings, so I wasn’t at all surprised to find rooms that had been transformed into warm, comfortable, and attractive spaces. As we talked about the decorating process and I looked more closely at the level of finish, I was interested to note that the artwork was all about older family photographs instead of the prints and oil paintings I had expected to find. The planned for, costly wall treatments and window fabrics had given way to warm colors accented by home made draperies and personally applied, vinyl wall lettering, quotes and sayings that reinforced the values of home and family. The finished rooms were as tasteful, attractive, and inviting as anyone might have wished for, but instead of simply being the product of an expensive group of technicians, the space was a reflection of a family that had economized, sacrificed, and made it their own.
This is the stuff of which the American consumer is made. We continued to demand quality and comfort, and when need be, we’re willing to exert the time and effort to offer it to ourselves for ourselves, rather than go without. As we create and innovate, we find more satisfaction in our own efforts than we might otherwise have found by having spent more and benefited less. When we haven’t as much money to spend we invest more of ourselves to achieve a similar affect.
As our society transforms itself from a nation of net spenders back towards an economy reflective of meaningful personal investment, consumers will face choices that will motivate them to do more with less. Less glamour and more comfort, fewer excesses and greater warmth; personal, emotional and heart felt will replace expensive and cutting edge. In recent years we’ve seen personal savings levels fall to negative numbers in the minus 2% to 3% range. Almost overnight that trend is reversing and will likely settle in at a personal savings rate somewhere between 4% and 8%. The contraction of household incomes as unemployment rises above the 6% level is likely to make the transition more painful, and as consumers feel the pain they’ll look for simple pleasures.
Once the transition has been made it will take several years before a noticeable shift begins back towards excesses and less personal trends. In the mean time, cottage businesses reflective of our evolving national ethos are most likely to prosper. As they do so, we’ll see that the innovation and resourcefulness of the consumer will have found a way to bring the economy back to the robust growth trends of the 1950’s and 1990’s.
As our society surfaced from World War I and then came through the prosperous 1920’s, personal values declined steadily and styles trended towards the complex, though relatively cool lines of the ‘art deco’ movement. However, as the nation plunged headlong into financial turmoil of the 1930’s, and finally another world war in the 1940’s, hearts and minds turned towards home, family, and warmth. Many of us remember the 1940’s and 1950’s as a simpler, more wholesome time for home and family, but few stop to realize that it became that way after an entire movement swung the pendulum back to a place of personal satisfaction, a time in which the home became the center of our lives again, while we created memories around the fireplace, the radio, and the kitchen table.
This same sort of transition took place after the conflict in Vietnam. The 1960’s and 1970’s were punctuated by societal, financial, and political unrest. But by the late 1970’s and early 1980’s we were once again seeking hearth and home. We eschewed the establishment, and welcomed national leadership in the warmth and genuine tones of Jimmy Carter and the values oriented confidence offered by Ronald Reagan. Home designs once again trended towards warmth and away from sleek and modern. Toll painting, quilting, wood working, gardening and scrap booking became national pastimes once more. But in the years since, we’ve morphed back to a point where high tech has replaced high touch, and an economy that has rewarded complex promises more readily than sound advice. The societal pendulum swings with amazing consistency, you just need to look at thirty and fifty year time frames to see it with any clarity.
While our nation adjusts to the current challenges facing our economy, consumers will once again put more of themselves into gift giving, home decor, and creative efforts. We tend to want to get as much out of our purchases as before, but with fewer dollars to put towards them, we begin to invest more of our own effort in an attempt to create a higher level of quality or a greater affect. At the end of the day, it’s all about feeling good, and the US consumer will transition towards ways to drive personal and family pleasure without having to spend as much as they have might have before.
I recently visited in the home of an affluent client whom I knew to be in the process of remodeling their kitchen and family room. Their original plans included interior decorators, expensive wall treatments, commercial appliances, and high end furnishings, so I wasn’t at all surprised to find rooms that had been transformed into warm, comfortable, and attractive spaces. As we talked about the decorating process and I looked more closely at the level of finish, I was interested to note that the artwork was all about older family photographs instead of the prints and oil paintings I had expected to find. The planned for, costly wall treatments and window fabrics had given way to warm colors accented by home made draperies and personally applied, vinyl wall lettering, quotes and sayings that reinforced the values of home and family. The finished rooms were as tasteful, attractive, and inviting as anyone might have wished for, but instead of simply being the product of an expensive group of technicians, the space was a reflection of a family that had economized, sacrificed, and made it their own.
This is the stuff of which the American consumer is made. We continued to demand quality and comfort, and when need be, we’re willing to exert the time and effort to offer it to ourselves for ourselves, rather than go without. As we create and innovate, we find more satisfaction in our own efforts than we might otherwise have found by having spent more and benefited less. When we haven’t as much money to spend we invest more of ourselves to achieve a similar affect.
As our society transforms itself from a nation of net spenders back towards an economy reflective of meaningful personal investment, consumers will face choices that will motivate them to do more with less. Less glamour and more comfort, fewer excesses and greater warmth; personal, emotional and heart felt will replace expensive and cutting edge. In recent years we’ve seen personal savings levels fall to negative numbers in the minus 2% to 3% range. Almost overnight that trend is reversing and will likely settle in at a personal savings rate somewhere between 4% and 8%. The contraction of household incomes as unemployment rises above the 6% level is likely to make the transition more painful, and as consumers feel the pain they’ll look for simple pleasures.
Once the transition has been made it will take several years before a noticeable shift begins back towards excesses and less personal trends. In the mean time, cottage businesses reflective of our evolving national ethos are most likely to prosper. As they do so, we’ll see that the innovation and resourcefulness of the consumer will have found a way to bring the economy back to the robust growth trends of the 1950’s and 1990’s.
Monday, October 20, 2008
A SELF-FULFILLING PROPHECY and PRESIDENTIAL IMPACT
A SELF-FULFILLING PROPHECY 10-17-2008
If someone had come to me two years ago asking how often the DOW would swing more than 500 points in any one day - from opening, to low, to high, to close - I might have responded, rarely… not very often. If the question had come only a year ago, I’d have likely suggested that it happens, but only a few times a year - seldom enough to be an event when it does. Were I to be asked that same question today, I’d have to stop, look at the DOW for that very day, and then suggest it could happen on any given day and today is one of those days. At this writing, the low to high differential on the DOW, forget including the open to close, is over 560 points. This is the stuff of amusement park rides and nightmares - not of rational markets.
In recent days, there’s been much made of whether or not the Treasury and Federal Reserve acted swiftly enough to avoid aggravating an already weakening economy; and once again, the Washington ‘blame game’ is being played out in the national press. In truth, the actions of the Federal Reserve and Treasury have likely come late enough as to not stem the flow of red ink in the domestic and global credit, debt, and equities markets, but how could they have come any time sooner? Had Paulson and Bernanke brought enough liquidity to the economy a year ago to stem the tide of what we’re now suffering, the public outcry and political confrontation would have been enormous. Forget that they’d have needed prophetic vision to have seen just how deeply this would run, and how widespread an effect the credit crisis would have.
The reality is that the volatile markets we’re enduring are a byproduct of credit market forces emanating from years of loose credit and possibly unsustainable economic growth, fueled by credit. Today, it’s all too clear to see the trail and where it has led us; that’s the beauty of hindsight. Where this will take our economy tomorrow is far less certain.
What is most concerning to many of us today is what may be labeled as a self-fulfilling prophecy. The emotion and fear exhibited by some over the last several months regarding a much heralded recession has unreasonably constrained capital investment, job creation, corporate and personal borrowing, and consumer spending. So much so, that we are now likely experiencing the very recession that most already supposed us to be in, though we were not! Their very suppositions and reactions have now almost certainly caused what they feared was already upon them.
GDP figures for all but the 4th Quarter of 2007 have not only been positive, but in most cases higher than expected. Early indications of 3rd Quarter 2008 GDP growth follow the same trend. But 4th Quarter 2008 and 1st Quarter 2009 will almost certainly reflect negative GDP growth, and that makes a recession. We haven’t seen a recession stemming from fear or a lack of confidence since 1907, and those that had been experienced previous to that time were relatively brief in duration, but admittedly occurred in economic times that bear little resemblance to the complex, fast moving, and globally connected economy we have today.
PRESIDENTIAL IMPACT
With little more than two weeks to go before the US Presidential election, it appears increasing likely that Senator Obama will be the next POTUS. Many are elated, others are frustrated, and some just don’t care. Regardless, it’s important to understand some of the impact that may come from an Obama presidency, and in contrast (allowing for equal time and opportunity), what a McCain administration might otherwise offer.
Under an Obama presidency, in all likelihood, there will be an immediate sense of increasing confidence in the electorate. Persuasive and confidence-inspiring rhetoric, an attractive Obama trait, may help calm fears and heal some open wounds. The import of which is not to be taken lightly.
The federal deficit may decrease, not as a byproduct of decreased spending, but due to an increase in personal and corporate tax rates of varying types, not just the obvious federal income tax. There will likely be continued pressure to keep interest rates low, possibly at the risk of a weaker dollar and even greater risk of inflationary pressures. Job creation at the low end of the wage scale may improve as employers are pressured to keep jobs in the US, and increases in federal minimum wage levels are almost certain. The term ‘pro business’ may become as caustic as ‘lucrative executive compensation’ is today, and while many successful US corporations may seek asylum offshore, there may be a pain-inducing effort towards protectionism, both in keeping corporations in the US and trade tariffs. The role of government in business is likely to increase, and government intervention in health care will continue at a fevered pace, though likely still missing the point as in prior democratic administrations.
The replacement of two or more Supreme Court justices is near certain, but given the age and makeup of the court today, it is most likely that those who may leave the bench will be those that have a more liberal bent to begin with, notwithstanding unexpected health conditions. The makeup of the various lower courts will likely be very different as more liberally-minded judges are likely to replace many of their retiring conservative peers.
Conservative commentators will likely gain the same type of traction that their liberal counterparts have seen in recent years, but only after what might be an attractive ‘honeymoon’ period. Conservationist efforts may overtake more productive ‘green business’ activities, resulting a more ‘tree hugging’ environmental movement than a more effective business led campaign.
In the event that McCain becomes the next US president, it is most likely that liberal commentators will immediately surge and the negative rhetoric that has surrounded the Bush administration will continue. Unless McCain is a more eloquent and convincing orator than his two republican predecessors, it is likely that only the conservative faithful will gain much additional confidence and trust in the economy and government.
Taxes on those that contribute the greatest portion of federal revenues may decrease at the cost of fewer federal services and higher federal deficits. Trade barriers are likely to remain low, and the globalization of our economy will continue to increase at a rapid pace, though trade imbalances may ebb and flow. In the short term, the US may continue to be seen less than favorably around the globe as many nations will continue to see a McCain administration as a continuation of those that came before, but in time, assuming deft foreign policy actions, the US’s global esteem should improve even as the US economy regains lost strength.
Free market influences may constrain jobs at first, but will likely give way to more higher paying jobs as entrepreneurs and innovators are encouraged to build, grow, and develop ideas into profitable business enterprises. ‘Green’ business practices are likely to escalate rapidly as it becomes more obvious that businesses can profit from them while improving public relations.
The makeup of the US Supreme Court could shift farther to the right as aging liberal justices are replaced, and liberal columnists and activists are likely to gain enough additional momentum to make a second McCain term as hard fought as the first. US forces abroad will almost certainly maintain a high level of activity.
The overall effect of either of the candidates on the US economy during the next two presidential terms is uncertain. There are as many respected decision makers who favor one candidate as there are those that favor the other. Some predictably conservative voices in our society sound like they favor a change in parties for the coming administration, and at the same time, many more liberally minded business executives appear to be leaning towards a house, senate, and presidency that represent the same party.
ON THE LIGHTER, BUT STILL ENLIGHTENING, SIDE
The following came to me this week by way of email. I thought you might enjoy it and maybe even learn something from it.
BAR STOOL ECONOMICS:
Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that's what they decided to do. The ten men drank in the bar everyday and seemed quite happy with the arrangement, until one day, the owner threw them a curve. 'Since you are all such good customers’, he said,’ I'm going to reduce the cost of your daily beer by $20’. Drinks for the ten now cost just $80.
The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?'
They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay!
And so:
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
'
I only got a dollar out of the $20, 'declared the sixth man. He pointed to the tenth man, 'but he got $10!'
'Yeah, that's right,' exclaimed the fifth man. 'I only saved a dollar, too. It's unfair that he got ten times more than I!
''That's true!!' shouted the seventh man.
'Why should he get $10 back when I got only two? The wealthy get all the breaks!
''Wait a minute,' yelled the first four men in unison. 'We didn't getanything at all. The system exploits the poor!'
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!
And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
For those who understand, no explanation is needed.
For those who do not understand, no explanation is possible
If someone had come to me two years ago asking how often the DOW would swing more than 500 points in any one day - from opening, to low, to high, to close - I might have responded, rarely… not very often. If the question had come only a year ago, I’d have likely suggested that it happens, but only a few times a year - seldom enough to be an event when it does. Were I to be asked that same question today, I’d have to stop, look at the DOW for that very day, and then suggest it could happen on any given day and today is one of those days. At this writing, the low to high differential on the DOW, forget including the open to close, is over 560 points. This is the stuff of amusement park rides and nightmares - not of rational markets.
In recent days, there’s been much made of whether or not the Treasury and Federal Reserve acted swiftly enough to avoid aggravating an already weakening economy; and once again, the Washington ‘blame game’ is being played out in the national press. In truth, the actions of the Federal Reserve and Treasury have likely come late enough as to not stem the flow of red ink in the domestic and global credit, debt, and equities markets, but how could they have come any time sooner? Had Paulson and Bernanke brought enough liquidity to the economy a year ago to stem the tide of what we’re now suffering, the public outcry and political confrontation would have been enormous. Forget that they’d have needed prophetic vision to have seen just how deeply this would run, and how widespread an effect the credit crisis would have.
The reality is that the volatile markets we’re enduring are a byproduct of credit market forces emanating from years of loose credit and possibly unsustainable economic growth, fueled by credit. Today, it’s all too clear to see the trail and where it has led us; that’s the beauty of hindsight. Where this will take our economy tomorrow is far less certain.
What is most concerning to many of us today is what may be labeled as a self-fulfilling prophecy. The emotion and fear exhibited by some over the last several months regarding a much heralded recession has unreasonably constrained capital investment, job creation, corporate and personal borrowing, and consumer spending. So much so, that we are now likely experiencing the very recession that most already supposed us to be in, though we were not! Their very suppositions and reactions have now almost certainly caused what they feared was already upon them.
GDP figures for all but the 4th Quarter of 2007 have not only been positive, but in most cases higher than expected. Early indications of 3rd Quarter 2008 GDP growth follow the same trend. But 4th Quarter 2008 and 1st Quarter 2009 will almost certainly reflect negative GDP growth, and that makes a recession. We haven’t seen a recession stemming from fear or a lack of confidence since 1907, and those that had been experienced previous to that time were relatively brief in duration, but admittedly occurred in economic times that bear little resemblance to the complex, fast moving, and globally connected economy we have today.
PRESIDENTIAL IMPACT
With little more than two weeks to go before the US Presidential election, it appears increasing likely that Senator Obama will be the next POTUS. Many are elated, others are frustrated, and some just don’t care. Regardless, it’s important to understand some of the impact that may come from an Obama presidency, and in contrast (allowing for equal time and opportunity), what a McCain administration might otherwise offer.
Under an Obama presidency, in all likelihood, there will be an immediate sense of increasing confidence in the electorate. Persuasive and confidence-inspiring rhetoric, an attractive Obama trait, may help calm fears and heal some open wounds. The import of which is not to be taken lightly.
The federal deficit may decrease, not as a byproduct of decreased spending, but due to an increase in personal and corporate tax rates of varying types, not just the obvious federal income tax. There will likely be continued pressure to keep interest rates low, possibly at the risk of a weaker dollar and even greater risk of inflationary pressures. Job creation at the low end of the wage scale may improve as employers are pressured to keep jobs in the US, and increases in federal minimum wage levels are almost certain. The term ‘pro business’ may become as caustic as ‘lucrative executive compensation’ is today, and while many successful US corporations may seek asylum offshore, there may be a pain-inducing effort towards protectionism, both in keeping corporations in the US and trade tariffs. The role of government in business is likely to increase, and government intervention in health care will continue at a fevered pace, though likely still missing the point as in prior democratic administrations.
The replacement of two or more Supreme Court justices is near certain, but given the age and makeup of the court today, it is most likely that those who may leave the bench will be those that have a more liberal bent to begin with, notwithstanding unexpected health conditions. The makeup of the various lower courts will likely be very different as more liberally-minded judges are likely to replace many of their retiring conservative peers.
Conservative commentators will likely gain the same type of traction that their liberal counterparts have seen in recent years, but only after what might be an attractive ‘honeymoon’ period. Conservationist efforts may overtake more productive ‘green business’ activities, resulting a more ‘tree hugging’ environmental movement than a more effective business led campaign.
In the event that McCain becomes the next US president, it is most likely that liberal commentators will immediately surge and the negative rhetoric that has surrounded the Bush administration will continue. Unless McCain is a more eloquent and convincing orator than his two republican predecessors, it is likely that only the conservative faithful will gain much additional confidence and trust in the economy and government.
Taxes on those that contribute the greatest portion of federal revenues may decrease at the cost of fewer federal services and higher federal deficits. Trade barriers are likely to remain low, and the globalization of our economy will continue to increase at a rapid pace, though trade imbalances may ebb and flow. In the short term, the US may continue to be seen less than favorably around the globe as many nations will continue to see a McCain administration as a continuation of those that came before, but in time, assuming deft foreign policy actions, the US’s global esteem should improve even as the US economy regains lost strength.
Free market influences may constrain jobs at first, but will likely give way to more higher paying jobs as entrepreneurs and innovators are encouraged to build, grow, and develop ideas into profitable business enterprises. ‘Green’ business practices are likely to escalate rapidly as it becomes more obvious that businesses can profit from them while improving public relations.
The makeup of the US Supreme Court could shift farther to the right as aging liberal justices are replaced, and liberal columnists and activists are likely to gain enough additional momentum to make a second McCain term as hard fought as the first. US forces abroad will almost certainly maintain a high level of activity.
The overall effect of either of the candidates on the US economy during the next two presidential terms is uncertain. There are as many respected decision makers who favor one candidate as there are those that favor the other. Some predictably conservative voices in our society sound like they favor a change in parties for the coming administration, and at the same time, many more liberally minded business executives appear to be leaning towards a house, senate, and presidency that represent the same party.
ON THE LIGHTER, BUT STILL ENLIGHTENING, SIDE
The following came to me this week by way of email. I thought you might enjoy it and maybe even learn something from it.
BAR STOOL ECONOMICS:
Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that's what they decided to do. The ten men drank in the bar everyday and seemed quite happy with the arrangement, until one day, the owner threw them a curve. 'Since you are all such good customers’, he said,’ I'm going to reduce the cost of your daily beer by $20’. Drinks for the ten now cost just $80.
The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?'
They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay!
And so:
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
'
I only got a dollar out of the $20, 'declared the sixth man. He pointed to the tenth man, 'but he got $10!'
'Yeah, that's right,' exclaimed the fifth man. 'I only saved a dollar, too. It's unfair that he got ten times more than I!
''That's true!!' shouted the seventh man.
'Why should he get $10 back when I got only two? The wealthy get all the breaks!
''Wait a minute,' yelled the first four men in unison. 'We didn't getanything at all. The system exploits the poor!'
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!
And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
For those who understand, no explanation is needed.
For those who do not understand, no explanation is possible
Friday, October 10, 2008
Shock and Awe
I’m sure that you, like many, are sickened by the recent slate of financial news, and the daily reports of further declines in the equity and debt markets. You might be among those that simply want to ignore your investment statements, or you might even feel numb to the constant battering the markets have received. Believe me, I understand.
I’m going to ask that you not ignore the news, your statements, or the difficulties around us. Rather, this is precisely the time you need to stay informed, and understand as much as possible about our markets, your money, and our collective futures. Believe it or not, right now, you are among the single most important group of decision makers in the country. You are a voter and a consumer, and two of the most important events in recent years are about to unfold: the US Presidential Election, and crucial holiday buying season.
This week’s issue of Signature Update will present numerous topics, far more than usual, because there has been such unusual activity in the domestic and global financial markets. Hopefully, as you learn more about the markets and economy, you’ll better understand the impact your decisions, and those of others, have on all of us.
The Three C’s: Confidence, Clarity, and Credit
The value of stocks can be expressed in many different ways, and one of those is the ratio between the price of the stock and the earnings per share of the company they represent. This is referred to as the P/E Ratio and can range widely depending on the industry the company is in. It is an indication of whether or not the stock is overpriced, oversold, or priced in line with their peers in the market. As of Wednesday afternoon, the average P/E ratio of the stocks that make up the S&P 500 was less than 11, an astoundingly low figure, perhaps half of what it should be, and an indication that the US stock market is dramatically oversold, or undervalued.
Likewise, credit markets have their own indicators of value. One of these is the LIBOR, or the London Inter Bank Offering Rate, and this figure typically is slightly higher than the US Fed Funds rate and short term treasury rates. When the LIBOR is high against benchmark rates, it suggests that there is a lack of confidence in the credit markets, and a concern that those banks involved may not be able to make good on their promises to repay. As of 6:47 am EDT this morning, the LIBOR was at 4.82%, one week ago it was at 4.33% and one month ago it was at 2.82%. By contrast, the Fed Funds rate is at 1.5% today, was at 2% one week ago, and was at 2% one month ago. The LIBOR spread has widened dramatically.
The question is, 'Why is the LIBOR so high, and why is the average P/E ratio of the S&P so low’? The answer has everything to do with Confidence, Clarity, and Credit.
Consumers and businesses around the world have been shocked by the constant negativity and stories of doom and gloom reported through the press. In a day when we have near constant access to financial news, 24/7 reporting of even the most minor economic, political or social event, coupled with inexpensive trading of stocks, bonds, and mutual funds, it creates a scenario ripe for volatility. Reactions run high, common sense goes out the window, and the volume of selling transactions goes through the roof. This puts immense downward pressure on the price of stocks unless there are ready buyers; and with the credit markets being as constrained as they are, money becomes tight and few buyers are present. Likewise, with such negativity reported in the press, coupled with lower stock prices, investors often demand redemptions in mutual funds, private equity funds, and hedge funds and the selling pressure expands. The result: stock prices tumble.
The issue in the credit markets includes that of clarity. The complex credit instruments used in today’s markets can be difficult for even the most experienced investor to understand. Often the complexity impedes the ability to know exactly what the value of the instrument is and what assets, or collateral, stand behind the instrument. When the value of these assets start to fall, as is the case when the value of real estate declines, it becomes very difficult to clearly assess the value of the instrument; and whatever clarity was present when the instrument was created becomes clouded. Without clarity, there is no confidence, and the credit markets slow down, or can seize up altogether.
This is exactly the scenario we’ve faced for the past several weeks in the markets. The DOW is down some 3,000 points in the face of all of this; all due to emotion, fear, and a lack of confidence, not due to any meaningful economic shifts.
Recognize that the fundamentals of our economy haven’t changed in this time frame. Oil prices continue to fall, now well below $90 per barrel. Unemployment, though higher than we’d like at 6.1%, is still low by historical standards. Interest rates, with the Fed Funds rate at 1.5%, are low. Businesses continue to grow, and the buying and selling of goods and services continues throughout our economy, though at a slower rate than in previous years.
Real Estate
August existing home sales figure were reported earlier this week and represented an increase of 7.4%. That’s great news for the real estate markets and a meaningful figure for all of us to understand. While it doesn’t necessarily mean that the housing market is now in a sustained upward correction, it does mean that there are buyers willing to step in at today’s prices, many of whom are now finding home ownership affordable for the first time in years. With the recent tightening in the availability of credit, many of these buyers are being forced to wait on the sidelines, but the signs that they are there and interested are unmistakable. As credit availability eases, especially at the low interest rates being seen today, these buyers may be able to present a strong front in the battle to stabilize the residential real estate market.
Warren Buffett
Warren Buffett is a name virtually every financially-aware American is aware of, and a shrew investor. Among the many things for which Buffett is famous is the saying ‘When everyone around you is frightened, it’s time to be brave’. This holds especially true for the financial markets today, and Buffett has once again shown why he is one of the nation’s premier investors. Last week alone, Buffett invested more than $8 billion of his company’s surplus cash into the stock market as he purchased interests in both Goldman Sachs and General Electric. This week the shares of each of those companies declined with the rest of the markets. Buffett, though, only sees profitability in his purchases. At more than eighty years of age, Buffett continues to focus his vision to the long term - one of the traits that has made him one of the wealthiest individuals in the world.
Federal Reserve and Treasury Actions
A large portion of the decline in investor confidence has been due to the House and Senate’s delay in passing the Troubled Asset Relief Program bill, or TARP. Not only did our legislators delay the passing of this important piece of legislation, they amended it to the point that frustrations among investors reached a fever pitch, and they’re yet to subside. TARP will be effective once the Treasury begins to purchase the targeted assets, but this will take another 3-4 weeks to begin, and likely several more weeks for the effects to be felt. Had confidence remained as high as it was the day this legislation was introduced, there would have been an immediate and positive effect on the markets, once passed. Now we’ll have to wait for it to actually impact the economy before we can enjoy any positive impact in the markets.
The passage of TARP may not be the ideal solution to the problem at hand, but it appears to have been the best solution available in the time frames dictated by the credit and equities markets.
The most recent actions of the Treasury and Federal Reserve, including a historic coordinated rate cut with other central banks, and greatly expanded credit facilities to assist money center, commercial and investment banks, as well as American businesses, will have a positive impact on the flow of funds throughout the domestic and international economy. But it will take time, perhaps four to eight weeks before the impact can be measured or felt by investors and consumers.
Short Sales Resume
Short sales on all publically traded companies were once again allowed as of 12:00 am midnight on October 9th. Little wonder then that companies like General Motors became the target of such aggressive selling pressure after Standard and Poors announced a down grade in GM’s credit worthiness. S&P’s announcement wasn’t news to anyone paying attention to GM’s balance sheet in recent months or years, but short sellers in the market hammered the stock, just as they resumed attacks on various financial services stocks and sent the markets into a veritable freefall.
The SEC simply must bring back the ‘up tick’ rule that only allows for short selling of a stock when the last transaction has been to the positive, otherwise, short sellers can create their own profits by pressuring the stock price downwards.
The Penalty for Missing the Market
Over the past 20 years, the US stock market has been much like a tide, experiencing ebbs and flows. These ups and downs remind us of the unpredictability of market movements. When stock prices are declining, many investors run the risk of making emotion-based decisions and pulling out of the market. We believe that by remaining fully invested through volatile weeks or months, however, investors can potential avoid sitting on the sidelines at the wrong time.
Unless there is a specific guarantee program active on a client account that strategically takes money out of the market when faced with volatility and then moves back into the market when appropriate, staying the course of a diversified and considered investment strategy works.
Remember: It’s time in the market that matters, not market timing. How significant is the potential penalty for missing the market? In the time period shown below, being out of the market on the 70 days when the market advanced most would have significantly reduced an investor’s average annual total return.
During the period of 1987 to 2007, those who were invested in the S&P 500 all 5,296 day posted an annualized return of 11.5%; those that missed the best 10 days only received 7.96%; those that missed the best 40 days saw an 1.3%; and those that missed the best 70 days actually lost 3.63%.
While market fluctuations can be disconcerting, timing can be costly. A strategic, personalized investment plan, combined with the ongoing counsel of your Investment Professional, can help you to remain focused and keep market downturns in perspective.
Source: Goldman Sachs Asset Management. Calculation is based on 5,296 days, excluding weekends and holidays The returns are based on the S&P 500 Index, a market-weighted index of 500 of the largest U.S. stocks in a variety of industry sectors. It is not possible to invest directly in an unmanaged index.
Jim Cramer – the Mad Man of Wall Street
On Monday morning of this week, Jim Cramer was a guest on The Today Show and declared that anyone needing access to their money within the next five years should take it out of the market now, and then proffered that the US stock markets would see another 20% decline before regaining stability. Cramer’s a well respected guy and The Today Show is seen by millions – his pronouncement helped move the market over 800 points lower before sanity prevailed and the DOW closed off some 369 points. Many have suggested his remarks, and The Today Show’s release of them, was nothing short of irresponsible, some citing no observable evidence that Cramer has reduced his own long or short positions in the current market.
By Monday afternoon, many had asked what I thought of Cramer’s comments. Though I had my own opinions, fortunately I had already asked the same question while on a conference call with a portfolio manager from the UK, and again later in the day of a fellow economist I pay attention to. They both gave a similar answer, consistent with my own thoughts:
Cramer is an entertainer and a trader, not an investor – there’s a big difference. He often treats 3-6 months as long term, and has been much better at calling the direction of a particular stock than he has the market, economy or a given industry. That said - he's also a really entertaining guy, has a wealth of experience, and I've learned a lot from listening to him over the years. If you believe that TARP and the other Federal Reserve and Treasury actions don’t have enough horsepower to be effective, then Cramer's right and we're in for a tough time that will likely take 3-5 years to overcome. However, if you think the package will do what it is intended to do, then Cramer's over-reaction, like many of his media peers, is patently incorrect. By the way, Cramer is famous for his over reactions and on-air rants.
To be candid, the 20% decline figure may not be far off, but the five year time frame is excessive, to be sure.
I’m going to ask that you not ignore the news, your statements, or the difficulties around us. Rather, this is precisely the time you need to stay informed, and understand as much as possible about our markets, your money, and our collective futures. Believe it or not, right now, you are among the single most important group of decision makers in the country. You are a voter and a consumer, and two of the most important events in recent years are about to unfold: the US Presidential Election, and crucial holiday buying season.
This week’s issue of Signature Update will present numerous topics, far more than usual, because there has been such unusual activity in the domestic and global financial markets. Hopefully, as you learn more about the markets and economy, you’ll better understand the impact your decisions, and those of others, have on all of us.
The Three C’s: Confidence, Clarity, and Credit
The value of stocks can be expressed in many different ways, and one of those is the ratio between the price of the stock and the earnings per share of the company they represent. This is referred to as the P/E Ratio and can range widely depending on the industry the company is in. It is an indication of whether or not the stock is overpriced, oversold, or priced in line with their peers in the market. As of Wednesday afternoon, the average P/E ratio of the stocks that make up the S&P 500 was less than 11, an astoundingly low figure, perhaps half of what it should be, and an indication that the US stock market is dramatically oversold, or undervalued.
Likewise, credit markets have their own indicators of value. One of these is the LIBOR, or the London Inter Bank Offering Rate, and this figure typically is slightly higher than the US Fed Funds rate and short term treasury rates. When the LIBOR is high against benchmark rates, it suggests that there is a lack of confidence in the credit markets, and a concern that those banks involved may not be able to make good on their promises to repay. As of 6:47 am EDT this morning, the LIBOR was at 4.82%, one week ago it was at 4.33% and one month ago it was at 2.82%. By contrast, the Fed Funds rate is at 1.5% today, was at 2% one week ago, and was at 2% one month ago. The LIBOR spread has widened dramatically.
The question is, 'Why is the LIBOR so high, and why is the average P/E ratio of the S&P so low’? The answer has everything to do with Confidence, Clarity, and Credit.
Consumers and businesses around the world have been shocked by the constant negativity and stories of doom and gloom reported through the press. In a day when we have near constant access to financial news, 24/7 reporting of even the most minor economic, political or social event, coupled with inexpensive trading of stocks, bonds, and mutual funds, it creates a scenario ripe for volatility. Reactions run high, common sense goes out the window, and the volume of selling transactions goes through the roof. This puts immense downward pressure on the price of stocks unless there are ready buyers; and with the credit markets being as constrained as they are, money becomes tight and few buyers are present. Likewise, with such negativity reported in the press, coupled with lower stock prices, investors often demand redemptions in mutual funds, private equity funds, and hedge funds and the selling pressure expands. The result: stock prices tumble.
The issue in the credit markets includes that of clarity. The complex credit instruments used in today’s markets can be difficult for even the most experienced investor to understand. Often the complexity impedes the ability to know exactly what the value of the instrument is and what assets, or collateral, stand behind the instrument. When the value of these assets start to fall, as is the case when the value of real estate declines, it becomes very difficult to clearly assess the value of the instrument; and whatever clarity was present when the instrument was created becomes clouded. Without clarity, there is no confidence, and the credit markets slow down, or can seize up altogether.
This is exactly the scenario we’ve faced for the past several weeks in the markets. The DOW is down some 3,000 points in the face of all of this; all due to emotion, fear, and a lack of confidence, not due to any meaningful economic shifts.
Recognize that the fundamentals of our economy haven’t changed in this time frame. Oil prices continue to fall, now well below $90 per barrel. Unemployment, though higher than we’d like at 6.1%, is still low by historical standards. Interest rates, with the Fed Funds rate at 1.5%, are low. Businesses continue to grow, and the buying and selling of goods and services continues throughout our economy, though at a slower rate than in previous years.
Real Estate
August existing home sales figure were reported earlier this week and represented an increase of 7.4%. That’s great news for the real estate markets and a meaningful figure for all of us to understand. While it doesn’t necessarily mean that the housing market is now in a sustained upward correction, it does mean that there are buyers willing to step in at today’s prices, many of whom are now finding home ownership affordable for the first time in years. With the recent tightening in the availability of credit, many of these buyers are being forced to wait on the sidelines, but the signs that they are there and interested are unmistakable. As credit availability eases, especially at the low interest rates being seen today, these buyers may be able to present a strong front in the battle to stabilize the residential real estate market.
Warren Buffett
Warren Buffett is a name virtually every financially-aware American is aware of, and a shrew investor. Among the many things for which Buffett is famous is the saying ‘When everyone around you is frightened, it’s time to be brave’. This holds especially true for the financial markets today, and Buffett has once again shown why he is one of the nation’s premier investors. Last week alone, Buffett invested more than $8 billion of his company’s surplus cash into the stock market as he purchased interests in both Goldman Sachs and General Electric. This week the shares of each of those companies declined with the rest of the markets. Buffett, though, only sees profitability in his purchases. At more than eighty years of age, Buffett continues to focus his vision to the long term - one of the traits that has made him one of the wealthiest individuals in the world.
Federal Reserve and Treasury Actions
A large portion of the decline in investor confidence has been due to the House and Senate’s delay in passing the Troubled Asset Relief Program bill, or TARP. Not only did our legislators delay the passing of this important piece of legislation, they amended it to the point that frustrations among investors reached a fever pitch, and they’re yet to subside. TARP will be effective once the Treasury begins to purchase the targeted assets, but this will take another 3-4 weeks to begin, and likely several more weeks for the effects to be felt. Had confidence remained as high as it was the day this legislation was introduced, there would have been an immediate and positive effect on the markets, once passed. Now we’ll have to wait for it to actually impact the economy before we can enjoy any positive impact in the markets.
The passage of TARP may not be the ideal solution to the problem at hand, but it appears to have been the best solution available in the time frames dictated by the credit and equities markets.
The most recent actions of the Treasury and Federal Reserve, including a historic coordinated rate cut with other central banks, and greatly expanded credit facilities to assist money center, commercial and investment banks, as well as American businesses, will have a positive impact on the flow of funds throughout the domestic and international economy. But it will take time, perhaps four to eight weeks before the impact can be measured or felt by investors and consumers.
Short Sales Resume
Short sales on all publically traded companies were once again allowed as of 12:00 am midnight on October 9th. Little wonder then that companies like General Motors became the target of such aggressive selling pressure after Standard and Poors announced a down grade in GM’s credit worthiness. S&P’s announcement wasn’t news to anyone paying attention to GM’s balance sheet in recent months or years, but short sellers in the market hammered the stock, just as they resumed attacks on various financial services stocks and sent the markets into a veritable freefall.
The SEC simply must bring back the ‘up tick’ rule that only allows for short selling of a stock when the last transaction has been to the positive, otherwise, short sellers can create their own profits by pressuring the stock price downwards.
The Penalty for Missing the Market
Over the past 20 years, the US stock market has been much like a tide, experiencing ebbs and flows. These ups and downs remind us of the unpredictability of market movements. When stock prices are declining, many investors run the risk of making emotion-based decisions and pulling out of the market. We believe that by remaining fully invested through volatile weeks or months, however, investors can potential avoid sitting on the sidelines at the wrong time.
Unless there is a specific guarantee program active on a client account that strategically takes money out of the market when faced with volatility and then moves back into the market when appropriate, staying the course of a diversified and considered investment strategy works.
Remember: It’s time in the market that matters, not market timing. How significant is the potential penalty for missing the market? In the time period shown below, being out of the market on the 70 days when the market advanced most would have significantly reduced an investor’s average annual total return.
During the period of 1987 to 2007, those who were invested in the S&P 500 all 5,296 day posted an annualized return of 11.5%; those that missed the best 10 days only received 7.96%; those that missed the best 40 days saw an 1.3%; and those that missed the best 70 days actually lost 3.63%.
While market fluctuations can be disconcerting, timing can be costly. A strategic, personalized investment plan, combined with the ongoing counsel of your Investment Professional, can help you to remain focused and keep market downturns in perspective.
Source: Goldman Sachs Asset Management. Calculation is based on 5,296 days, excluding weekends and holidays The returns are based on the S&P 500 Index, a market-weighted index of 500 of the largest U.S. stocks in a variety of industry sectors. It is not possible to invest directly in an unmanaged index.
Jim Cramer – the Mad Man of Wall Street
On Monday morning of this week, Jim Cramer was a guest on The Today Show and declared that anyone needing access to their money within the next five years should take it out of the market now, and then proffered that the US stock markets would see another 20% decline before regaining stability. Cramer’s a well respected guy and The Today Show is seen by millions – his pronouncement helped move the market over 800 points lower before sanity prevailed and the DOW closed off some 369 points. Many have suggested his remarks, and The Today Show’s release of them, was nothing short of irresponsible, some citing no observable evidence that Cramer has reduced his own long or short positions in the current market.
By Monday afternoon, many had asked what I thought of Cramer’s comments. Though I had my own opinions, fortunately I had already asked the same question while on a conference call with a portfolio manager from the UK, and again later in the day of a fellow economist I pay attention to. They both gave a similar answer, consistent with my own thoughts:
Cramer is an entertainer and a trader, not an investor – there’s a big difference. He often treats 3-6 months as long term, and has been much better at calling the direction of a particular stock than he has the market, economy or a given industry. That said - he's also a really entertaining guy, has a wealth of experience, and I've learned a lot from listening to him over the years. If you believe that TARP and the other Federal Reserve and Treasury actions don’t have enough horsepower to be effective, then Cramer's right and we're in for a tough time that will likely take 3-5 years to overcome. However, if you think the package will do what it is intended to do, then Cramer's over-reaction, like many of his media peers, is patently incorrect. By the way, Cramer is famous for his over reactions and on-air rants.
To be candid, the 20% decline figure may not be far off, but the five year time frame is excessive, to be sure.
Friday, October 3, 2008
UNCERTAINTY AND OPPORTUNITY 10-3-2008
Uncertainty and Opportunity
This week’s market volatility was all about confidence and emotion, or the lack of confidence and too much emotion. While it is clear that we are in a protracted economic slow down, and may very well be in a recession, it is also clear that the economy is much stronger than the media would represent and recent market volatility would indicate.
With unemployment holding steady at 6.1%, energy prices decreasing rapidly (oil is now less that $95 per barrel), the federal funds rate at 2% and likely decreasing when the Fed meets on October 29th, the dollar increasing against foreign currencies, and the trade deficit coming into line, there is more than enough to be optimistic about. At the same time, we can’t ignore the possibility that unemployment may increase, consumer spending during the critical holiday season is likely to decrease, recent durable goods orders are off, and there is continued pain in the housing sector. This reflects a mixed bag for the economy. Add to this the uncertainty of the upcoming presidential election and real concerns over the credit crisis, and we have a setting that breeds fear for some and spells opportunity for others.
It is precisely this sort of unsettling financial environment that gives consummate investors, such as Warren Buffett, the confidence to invest $5 billion in Goldman Sachs and another $3 billion in GE in the course of one week. Financial fortunes are made in this type of market by those who are willing to stay the course, continue to work their plan, and hold firm to their long-term objectives.
Wall Street versus Main Street
Much of the debate over whether the Financial Rescue package would be good for the country has centered on the concepts of Wall Street versus Main Street, as though there is a difference. In a day when over 50% of the population owns stocks, either through various investment funds or directly, when some 79% of adults use various credit instruments to help manage their lives, and when the vast majority of Americans over the age of 16 have a bank account, Main Street and Wall Street are the same street, and we all live and work on them.
Certainly, there are many corporate executives with earnings well in excess of the national average, and many more who enjoy substantial investment holdings. This is evidence of a free market economy. When we begin to limit opportunities for these individuals, we limit the leadership strength of our society. Corporations become feeble, workers become disenfranchised, and leaders become corrupt. We have too many tremendous examples of such limits throughout the former Soviet block countries and in economically ravaged dictatorships and communist holdout nations where oil is not a major export.
Financial Rescue Package
Jeff Thredgold’s article in TEA Leaves this week, titled The Blame Game, is excellent. Thredgold discusses the $700 billion financial rescue package, the FDIC, congressional leadership, and the national media in an insightful and concise manner. It’s worth taking the time to go to Thredgold Economic Advisors website: http://www.thredgold.com/html/leaf080930.html
What Thredgold doesn’t discuss is whether or not our economy can live without the house and senate’s passage of this bill. The answer of course, is yes we can. We can also live without electricity, running water, cell phones, and sushi, but why would we want to? There are some that suggest the passage of this bill takes us one step closer to a socialist society; others decry the intrusion of government in our lives and in what is intended to be a free market. Okay, I understand each of these things. I also understand that when I left my home this morning to come to my office, I was one step closer to getting into an accident. When I put my foot on the gas pedal and unleashed 370 horse power worth of engine, I was closer still. When I then chose to obey the speed limit, stop at the red light, and respect the other drivers around me, I effectively steered clear of any avoidable accidents.
My point is this: there are certain obligations that must be met, roles that must be fulfilled, and risks that are unavoidable. In the case of our government, one of the roles is to help facilitate an orderly market and to maintain the value of our currency. At the end of the day, we need to have some confidence in our lawmakers and their willingness to maintain the tenants of the free market system we enjoy. We saw on Monday of this week what can take place if our legislative representatives don’t step up to do their jobs, and we don’t ever want to see that again. Seeing to it that the economy and the markets have sufficient liquidity to operate efficiently is critical to our national interest.
Signal Value
The house, senate, and executive branch leadership brought out their biggest guns this week in order to assure the passage of the Financial Rescue Package. In an attempt to turn up the heat on those legislators that had yet to ‘see the light’, the administration focused on the fears of the nation, and in so doing resorted to a level of fear mongering that will exacerbate some of the problems at hand. We heard from corporate executives concerned about making payrolls, investment guru’s wringing their hands over recent losses, fathers and mothers afraid of losing their homes, and economists assuring us that a recession is now a certainty. None of this is news, of course, but putting it in front of the American people in such a flagrant manner only heightens concerns and all by itself creates some of the problems being addressed. It also helped the house and senate to gather the courage to pass the legislation.
This is referred to as Signal Value, the lasting effect that comes from a signal sent to a group and the resulting impact that it creates. In this case, the hope has been that the passage of the Financial Rescue Package would provide enough of a counter measure to the exaggerated fears presented that any harm would be undone. While this may be the case, and it may have been warranted in this situation, it certainly heightens concerns in the meantime. Automobile showrooms have been virtually empty all week, mortgage applications have dried up altogether, and investor confidence has been tested.
Now that the package has passed both the house and the senate, the administration and the media must now come out and reassure the public that the measure will work and the investment of $700 billion will pay off.
Federal Reserve Rate Cut
The US markets appear to have priced in a 50 basis point, or one half of one percent, rate cut in the fed funds rate. The Federal Reserve meets on October 29th, and given their accommodative stance towards strengthening the economy it would appear that such a cut will be made. However, what is less certain is what it will actually mean. The fed funds rate is already at 2%, but consumers and business aren’t seeing much benefit from a low cost of borrowing. Low rates become irrelevant when credit is difficult to get and offer little benefit to our economy. While the Fed is likely to offer the rate cut, we can be sure that they’ll continue to work overtime to see to it that the credit supply loosens up considerably over the coming weeks.
This week’s market volatility was all about confidence and emotion, or the lack of confidence and too much emotion. While it is clear that we are in a protracted economic slow down, and may very well be in a recession, it is also clear that the economy is much stronger than the media would represent and recent market volatility would indicate.
With unemployment holding steady at 6.1%, energy prices decreasing rapidly (oil is now less that $95 per barrel), the federal funds rate at 2% and likely decreasing when the Fed meets on October 29th, the dollar increasing against foreign currencies, and the trade deficit coming into line, there is more than enough to be optimistic about. At the same time, we can’t ignore the possibility that unemployment may increase, consumer spending during the critical holiday season is likely to decrease, recent durable goods orders are off, and there is continued pain in the housing sector. This reflects a mixed bag for the economy. Add to this the uncertainty of the upcoming presidential election and real concerns over the credit crisis, and we have a setting that breeds fear for some and spells opportunity for others.
It is precisely this sort of unsettling financial environment that gives consummate investors, such as Warren Buffett, the confidence to invest $5 billion in Goldman Sachs and another $3 billion in GE in the course of one week. Financial fortunes are made in this type of market by those who are willing to stay the course, continue to work their plan, and hold firm to their long-term objectives.
Wall Street versus Main Street
Much of the debate over whether the Financial Rescue package would be good for the country has centered on the concepts of Wall Street versus Main Street, as though there is a difference. In a day when over 50% of the population owns stocks, either through various investment funds or directly, when some 79% of adults use various credit instruments to help manage their lives, and when the vast majority of Americans over the age of 16 have a bank account, Main Street and Wall Street are the same street, and we all live and work on them.
Certainly, there are many corporate executives with earnings well in excess of the national average, and many more who enjoy substantial investment holdings. This is evidence of a free market economy. When we begin to limit opportunities for these individuals, we limit the leadership strength of our society. Corporations become feeble, workers become disenfranchised, and leaders become corrupt. We have too many tremendous examples of such limits throughout the former Soviet block countries and in economically ravaged dictatorships and communist holdout nations where oil is not a major export.
Financial Rescue Package
Jeff Thredgold’s article in TEA Leaves this week, titled The Blame Game, is excellent. Thredgold discusses the $700 billion financial rescue package, the FDIC, congressional leadership, and the national media in an insightful and concise manner. It’s worth taking the time to go to Thredgold Economic Advisors website: http://www.thredgold.com/html/leaf080930.html
What Thredgold doesn’t discuss is whether or not our economy can live without the house and senate’s passage of this bill. The answer of course, is yes we can. We can also live without electricity, running water, cell phones, and sushi, but why would we want to? There are some that suggest the passage of this bill takes us one step closer to a socialist society; others decry the intrusion of government in our lives and in what is intended to be a free market. Okay, I understand each of these things. I also understand that when I left my home this morning to come to my office, I was one step closer to getting into an accident. When I put my foot on the gas pedal and unleashed 370 horse power worth of engine, I was closer still. When I then chose to obey the speed limit, stop at the red light, and respect the other drivers around me, I effectively steered clear of any avoidable accidents.
My point is this: there are certain obligations that must be met, roles that must be fulfilled, and risks that are unavoidable. In the case of our government, one of the roles is to help facilitate an orderly market and to maintain the value of our currency. At the end of the day, we need to have some confidence in our lawmakers and their willingness to maintain the tenants of the free market system we enjoy. We saw on Monday of this week what can take place if our legislative representatives don’t step up to do their jobs, and we don’t ever want to see that again. Seeing to it that the economy and the markets have sufficient liquidity to operate efficiently is critical to our national interest.
Signal Value
The house, senate, and executive branch leadership brought out their biggest guns this week in order to assure the passage of the Financial Rescue Package. In an attempt to turn up the heat on those legislators that had yet to ‘see the light’, the administration focused on the fears of the nation, and in so doing resorted to a level of fear mongering that will exacerbate some of the problems at hand. We heard from corporate executives concerned about making payrolls, investment guru’s wringing their hands over recent losses, fathers and mothers afraid of losing their homes, and economists assuring us that a recession is now a certainty. None of this is news, of course, but putting it in front of the American people in such a flagrant manner only heightens concerns and all by itself creates some of the problems being addressed. It also helped the house and senate to gather the courage to pass the legislation.
This is referred to as Signal Value, the lasting effect that comes from a signal sent to a group and the resulting impact that it creates. In this case, the hope has been that the passage of the Financial Rescue Package would provide enough of a counter measure to the exaggerated fears presented that any harm would be undone. While this may be the case, and it may have been warranted in this situation, it certainly heightens concerns in the meantime. Automobile showrooms have been virtually empty all week, mortgage applications have dried up altogether, and investor confidence has been tested.
Now that the package has passed both the house and the senate, the administration and the media must now come out and reassure the public that the measure will work and the investment of $700 billion will pay off.
Federal Reserve Rate Cut
The US markets appear to have priced in a 50 basis point, or one half of one percent, rate cut in the fed funds rate. The Federal Reserve meets on October 29th, and given their accommodative stance towards strengthening the economy it would appear that such a cut will be made. However, what is less certain is what it will actually mean. The fed funds rate is already at 2%, but consumers and business aren’t seeing much benefit from a low cost of borrowing. Low rates become irrelevant when credit is difficult to get and offer little benefit to our economy. While the Fed is likely to offer the rate cut, we can be sure that they’ll continue to work overtime to see to it that the credit supply loosens up considerably over the coming weeks.
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