Recovery and Recession Personalities 5-22-2009

May 22, 2009 Edition, Volume III

Inside Signature Update

• Recovery and Recession Personalities
• The VIX (volatility index) Wanes
• A Troubling Calm?
• FOMC vs The Fed Staff
• Baltic Dry Shipping Index



Recovery and Recession Personalities

Among the favorite games of economists, market analysts, commentators and media representatives is to compare historic recoveries and recessions to the current climate as a means of forecasting what may come next or when various events may unfold. We all do it, noting that there is some basis for historical patterns as accurate indicators of future activity. What we often forget, and of which we are now receiving an excellent lesson, is that no two recoveries or recessions are alike. Though some may share fundamental similarities, the complexity of our markets and society are such that yesterday’s activity becomes anecdotal to tomorrow’s reality.

The recession from which we are beginning to emerge is as complex as it has been difficult, and bears little detailed resemblance to any other we’ve experienced in our country’s history. Likewise, our current recovery, though in its earliest stages, will have its own hallmarks and create opportunities different from any other.

We’ve discussed this period of economic unrest as a reset and there is mounting evidence for this. The nature of governmental involvement, executive compensation, shareholder action, and market reliance are all evolving. Certainly, we will emerge from this period with economic strength and vitality, but the pillars representing these attributes will be different. Opportunities in energy output and utility, technology, health care, education, and business development will be greater than ever as we seek new solutions to current and future problems.

New industry leaders will emerge and our collective vision for the future will evolve. We will seek out efficiencies in areas we’ve previously taken for granted and will no longer depend on old models for future development. Our global society will face challenges only theorized over ten and twenty years ago. Population centers have already begun to shift in ideology and ancestry. Both Europe and North America’s traditional populations are in decline while immigrant populations are expanding, bringing cultural and attitudinal changes with them. At the same time, Asian, South American and African economies are taking on an importance like never before.

Each of these elements promises a future that has little dependence on, or resemblance to the past. Our challenge becomes being willing to embrace the change while holding onto the strengths and values that have made us great.


The CBOE Volatility Index Wanes – that’s the good news!

One of the many indicators of market volatility is commonly referred to as the VIX – the Chicago Board Options Exchange (CBOE) Volatility Index. This index, in existence since March of 2004, is an indicator of how volatile trading is in the options markets, and directly correlates with the volatility of the US stock market. When the VIX is high, the markets are considered to be volatile - unpredictable. When the VIX is lower, the markets are calmer and traders are less likely to make irratic moves.

In the five years during which the VIX has been used as a volatility index it has had an average daily level of less than 20; the first time the VIX rose above 20 was on 12/31/2007. In contrast, while the markets were making mad, unpredictable swings in both price and trading volume last fall, the VIX reached a peak of 80.86 (November 20, 2008). It has now steadily declined from that level; having posted a decrease to 28.8 on May 19th.

The import here is one of stability and predictability. The VIX is not an indicator of upward or downward movements in the market or economy; rather, it simply helps us better understand how volatile the marketplace is at any point in time.


A Troubling Calm?

Investors have become much calmer in recent months, having certainly been pleased at the gains the markets have posted since the DOW bottomed out near 6,500 in March. Improved economic reports have also helped ease investor concerns, but an interesting phenomenon has developed; we’ve become so used to troubling political and economic news that we simply aren’t reacting to it as we did in years past. Why is this? Have we become used to economic difficulty and troublesome news? Are we no longer paying attention? Or have too many been lulled into a false sense of security by populist pandering from elected officials?

The Obama administration reported today that it expects to place GM into bankruptcy in less than two weeks. Heretofore, had elected officials suggested they would intervene in the fate of a publically held company, the stock’s value would have plummeted and the markets would have reflected outrage. But not today, maybe that’s already taken place in today’s less-than-free market system. We’ve very quickly become accustomed to this sort of political/governmental intervention, consistently accompanied by the administration’s assurance that we will be taken care of. This is troubling to say the least.

Bankruptcy eliminates shareholder value and in all likelihood GM stock will become worthless, but GM shares, though trading modestly lower today, continue to trade almost 50% above the low of $1.09 per share on above average volume. It’s remarkable that GM is trading at all, well enough near the $1.50 per share mark. Trading patterns and volumes suggest more individual investor activity than anything else, perhaps due to too many investors’ expectations that a White Knight will save the day and GM shares will rise again. In truth, GM will rise again, but in all likelihood the current shareholders will be left behind.

Though there is reason to be optimistic about our economic future, it doesn’t mean we should give in to political promises; no matter how appealing. Our economy will heal and the markets will prosper, not by our business leaders and investors being lulled into a false sense of security or calm, but by innovation, sacrifice and sharp attention paid to the details.


Economic Growth on the Horizon: FOMC vs. The Staff

Recent Statements released by the Federal Reserve Board of Governors acting as the FOMC (Fed Open Market Committee) earlier this week sent markets lower as projections for economic growth and improved employment figures were pushed out by 3-9 months. At the same time, the Fed’s professional economic staff reasserted their position that GDP would post positive gains in the 3rd and 4th Quarters of 2009 and unemployment would bottom out and post marked improvements early next year.

The disconnect between the Fed’s appointed leadership and professional economists brought to light a study published by Christina Romer (Chair of the President’s Counsel of Economic Advisors) and Dr. David Romer in 2008 while at the University of California Berkley. The study found that the Fed Staff is a more reliable source of accurate economic data (American Economic Review: Papers & Proceedings 2008, 98:2, 230-235 The FOMC versus the Staff) and suggested that the FOMC would better serve the nation’s business leaders and policy makers by sticking to the factually supported data rather than bending to politically expedient theorizing.


Baltic Dry Shipping Index

Among the numerous indicators of improved economic activity is the Baltic Dry Shipping Index (BDSI), which accurately depicts the level of transport of raw materials to manufacturing ports to fill customer ordering and inventory needs. The BDSI had declined by almost 90% in the six month period ending March 31st, but has now staged a substantial turnaround reflecting a nearly 300% increase in the last few months.

As manufacturing and retail inventory levels have declined unemployment has risen sharply. While consumer spending has been lower than in recent years, the level of consumption has exceeded factory orders to the point that factory output must now improve simply to resupply inventory levels necessary to support current needs. The BDSI’s gains support the increased expectations for factory output and are an accurate leading indicator of improved employment markets and economic growth.

Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC

Bulls Make Money, Bears Make Money, and Hogs Get Slaughtered 5-13-2009

May 13, 2009 Edition, Volume III

Inside Signature Update

• Beware of Extremes
• Stress Tests May Have Revealed, But Offer A Lesson In Finance
• It’s not that easy – this is still a risky market

Beware of Extremes

In the midst of any meaningful crisis, certain ideas come to the forefront to be aired once again for a public looking for some measure of reason. Tuesday morning’s Deseret News, one of Salt Lake City’s major daily news outlets, featured an article detailing how various white supremacist groups have used the election of President Obama to stir up angry citizens and enact violence on minority populations throughout the region. It wasn’t two months ago that several otherwise knowledgeable colleagues forwarded articles to me regarding the ‘Amero’ - a novelty coin purported to be a newly minted currency for the Americas. And just this morning I was offered the newest and most certain income opportunity of a lifetime, ‘not really a multi-level company’, but replete with structure, compensation model, and marketing hype of popular network marketing and network marketers. I could go on.

For some reason, in our society many of us choose to gravitate to extremes when what once worked doesn’t appear to be working now. We love to have someone else to blame or to associate ourselves with some ideology or business concept that will change our world, if not everyone elses. Too many of us want what we want or choose to see things through deeply colored glasses without regard for reality, common sense, or reason.

In economics we look for outcomes that create efficiency or provide optimization. Blame is irrelevant, an outcome that only advantages one party is considered a market failure, and the idiom ‘there ain’t no such thing as a free lunch’ has its own acronym – TANSTAAFL; okay… economists can’t make anything simple. My paternal grandfather, after whom I’m named, offered one piece of advice that I’ll carry for the rest of my life; I can still hear him say, ‘Don’t believe anything you read, and only half of what you see’, often to be followed by ‘Think son, think’. He was right. The volume and import of decisions made based on assumption, void of objective observation, or without taking into account potentially difficult outcomes would astound us if we stopped to really consider.

Once every twenty years or so, respected social or political leaders will herald the end of capitalism or decry the evils of a free-market economy. But in the end, there is no end; and our economy responds to thrive once again. From my perspective, the only real value in extremes is to help test operating principals. What appears to make sense often falls apart when taken to extremes; oh … and the thrill that comes just below redline of an aggressively tuned small block – that’s an extreme worth pursuing!

Stress Tests May Have Revealed, But Offer a Lesson in Finance

The recent buzz over stress testing of the nation’s nineteen largest banks has done more to stress the public and the markets than anything else. It brought no revelations regarding the strength of the banking system, but may have created a good opportunity to teach the public a lesson concerning capitalization in the corporate world.

The stress tests sought to determine how well these banks might fare in the event of further economic declines - something along the magnitude of the declines we’ve already experienced. Even though Ben Bernanke, while testifying before the US House and Senate, recently explained that further declines were highly unlikely and that the US banking establishment is stronger today than it was six and nine months ago, with most firms posting meaningful profits. Many consumers have expected that any bank found needing additional equity capital as a result of the stress test must be a bank at the brink of insolvency. This is not the case; there is a substantial difference between the potential need for further equity capital in the event of market declines and the need for liquidity to meet business demands today or tomorrow.

Most suppose that capital equates to resources available for spending and investment; and in many cases it means just that. But with regards to the type of capital being measured in the bank stress testing by the US Treasury, capital equates to equity. Specifically, shareholder equity, Tier 1 Capital, and that’s a different thing altogether. Capital, as represented by shareholder equity, refers to the net value of a company that may be attributed to shareholders and against which there is no corresponding liability. It is reported in a very particular manner on a corporation’s balance sheet and is often referred to as Tier 1 Capital or Tier 1 Equity.

Common stock is equity – it represents the value of the company in respect to shareholders. Though both common and preferred shares are offered for the purpose of raising capital for a company and signal ownership in that company, preferred shares are more likely to be stated as liabilities in that preferred stock holders are not only entitled to a specified dividend, which must be paid, but they stand in line before common shareholders in the event of a bankruptcy. Preferred shareholders are owed something by the company; common stock holders own the company and are owed nothing. Though bonds issued by a corporation will create capital with which a corporation may choose to purchase assets or fund operations, they also represent a debt that must be repaid to the bondholder; they are the opposite of equity.

So how does a corporation create capital that can be expressed as equity? By issuing common stock and creating profits; sometimes by selling assets and realizing gains.

Let’s take a look at Bank of America and how they are responding to the need to come up with $33.9 billion in equity capital in order to meet the Treasury and Federal Reserve’s newly imposed guidelines.

Bank of America will issue $14 - $16 billion in new shares of common stock, which stock offering has already received a warm reception by the markets. They will also convert $10 - $12 billion of TARP funds into common stock; while this doesn’t raise new capital, per se, it does transfer $10 - $12 billion in debt to equity as the federal government becomes a meaningful equity shareholder in the bank. Finally, the bank is selling China Construction Bank for another $8 billion. These actions will raise between $32 - $36 billion and the Treasury’s equity capital requirement will have been met. Bank of America CEO, Ken Lewis, further notes that the company generated $2.8 billion in profit during the 1^st Quarter 2009 and expects to generate billions more in the coming calendar quarters, and he has made it clear that he intends to use those excess profits to repay TARP loans, thereby reducing the company’s debt load and improving the capitalization ratio.

Lewis isn’t alone in using the stress test as an opportunity to transition debt into equity and to then reduce his company’s dependence on the government. As a number of banks have faced the need to raise equity capital to meet stress test requirements and have stated their plans to get rid of TARP debt in the process, others have chosen to take advantage of the same opportunity.

It was only a few months ago that loud voices could be heard clamoring for the nationalization of the banking industry, and many in the current federal executive and legislative branches wanted President Obama to use the financial crisis to bring banks under federal control. Thankfully, reason prevailed and the domestic banking industry is beginning to thrive once again.

It’s not that easy – this is still a risky market

Federal Reserve Chairman Ben Bernanke was cited Tuesday morning as saying that the risk of deflation is decreasing and commented on the building strength of the US economy. Few would argue that the economy is booming, but we have clearly turned some important corners. Consumer spending, though posting decreases for both March and April, has shown marked improvement from the dangerously low levels of 2008 – absent consumer’s drawing on home equity. Real Estate sales in most markets have increased by more than the seasonally adjusted rates often seen in the late spring or early summer. Granted, home prices have yet to improve in most markets, but buyers are in the market and stretching their muscles. Unemployment has edged towards the 9% level, but the rate of increase in job losses has slowed and we appear to be very near the point at which unemployment will begin to decrease soon - in some markets this has already begun. Inventory levels are now so low that increased consumer spending has an almost immediate effect on the labor markets, and some analysts expect an employment boom on the horizon for the US and China; hard to believe, but a welcome thought nonetheless.

Much of this appears to signal a quick and certain economic recovery, but it’s not that easy. There are still areas of significant risk in these markets. Residential real estate foreclosures are once again on the rise, commercial real estate is showing signs of weakness, the auto manufacturers are far from out of danger, and the enormous budget deficits we’ve created will offer significant inflation pressure if not moderated. The Federal Reserve and Treasury have assured us all that they are prepared to deal with these pressures, just as they assured us that the sub-prime credit debacle of 2006-2007 would have little impact on the overall markets.

The US dollar has weakened sufficiently that oil is now nearing the $60 per barrel range. Traders expect economic improvements in the US and China will stimulate demand, and prices at the pump have begun their climb to well over $2 per gallon. Natural gas is also on the rise and will likely climb well past $5. We learned very recently that these increases in necessary fuel sources ripple through the economy and pressure households and businesses alike.

Gold has rallied to over $900 an ounce, but this appears to strictly be the byproduct of the weakened dollar. Copper, one of the more dependable commodity indicators of economic activity has increased in recent trading from a 52-week low of $1.30 to $2.09 per ounce.

The domestic equities market has enjoyed eight weeks of solid gains and speculation abounds as to whether or not this is a Bull Market, a Bear Market Rally, a secular Bull in a cyclical Bear, etc. CNBC’s Larry Kudlow and Mark Haines, in daily interviews with various market insiders, hear virtually every argument to be made on the issue; but when offering their own opinion, admit that it just doesn’t matter at this point and remind us that Bulls make money, Bears make money, and Hogs get slaughtered – there’s a lesson in there for all of us.

Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC