Class A Sleuth

A dozen years ago, when I was on the faculty at Boston College, I was teaching in the Master of Science in Finance program. One of my students was a quantitative analyst at a hedge fund. This guy was an excellent student who instinctively understood derivatives and their pricing models. He was an active member of the Boston Security Analysts Society and provided great encouragement as I toiled with the CFA exams.

I joined Forbes in 1997. Every now and then I spoke with this former student of mine. Eventually, he quit his job. He told me he had become disillusioned with the whole Wall Street game and was convinced there was a lot of fraud going on in the industry. He said he was going into business for himself investigating fraud in the securities industry. Without being specific, he said he was on to one of the biggest Ponzi schemes ever. He also told me about his frustrations dealing with the SEC.

Sounds kind of paranoid, doesn't it? I knew this guy wasn't crazy, but I had to wonder if he wasn't exaggerating a bit. Well, imagine my surprise when I read about him on the front page of the Wall Street Journal on Thursday morning. His name is Harry Markopolos and he has been mentioned on my blog before. It turns out the Ponzi scheme Harry was looking into was the one run by Bernie Madoff.

Thanks Harry for doing such a great service to your country. I wish the powers that be had paid more attention to what you had to say long ago.

Facebook Friend

One of the best things about Facebook is that it allows you to track down long lost friends. That's how I found Mark Stivers, the kid who lived three houses down from me when we were growing up. Mark is a multi-talented individual. It turns out he is also an excellent cartoonist. I suggested he draw this cartoon of Ron Gettelfinger, which fits in nicely with my Dec. 12 post. I hope to feature Mark's work from time to time in the Forbes Growth Investor.

The UAW has Priced Itself Out of the Auto Market

When the $14 billion bailout for the auto industry fell through last night, Senate Majority leader Harry Reid said, "I dread looking at Wall Street tomorrow. It's not going to be a pleasant sight."

Stocks opened lower as Reid predicted, but not nearly as much as his words suggested. And soon after the open, stocks began to rally. Some will say investors grew hopeful that the White House and Treasury Secretary Henry Paulson would step in and use TARP money to save the auto industry. However, I believe investors are simply pleased that Congress is taking a hard stand against bailout seekers. Bad companies should be allowed to fail. At least some of our politicians have finally gotten that message.

Ron Gettelfinger, president of the United Automobile Workers, gave a press conference this morning blaming Republicans for the failure of the bailout, but the conference only proved how defensive Gettelfinger has become. The U.S. auto industry is dying, yet the UAW refused to allow any wage concessions in 2009. The UAW doesn't seem to understand that it has priced its membership out of the market. While this union tries to "protect" its members, foreign manufacturers are grabbing market share and putting Americans to work throughout the South. It won't be long before out-of-work union members begin migrating south seeking employment at these non-union shops.

Initial Jobless Claims Get Worse

The Department of Labor reported today that initial jobless claims for the week ending December 6 hit 573,000 on a seasonally-adjusted basis. The news is certainly unsettling. Nonetheless, even though the number exceeded the consensus estimate by almost 50,000, the stock market gave the report a rather ho-hum reception.

Because the week-to-week initial claims figures can be volatile, economists prefer to focus on the four-week moving average. This average climbed to 540,500. It has risen six weeks in a row. During the previous recession (March to November 2001), the 4-week average climbed five weeks in a row before peaking at 489,250. I suspect, however, that this time we haven't yet hit the peak. The graph above plots the 4-week moving average ever since the 2001 recession began. As you can see, it has been rising sharply since late 2007, and so far shows no sign of leveling off. I really don't think it is alarmist to suggest that the unemployment rate could hit 8-9% by mid-2009.

Dismal Employment Numbers May Mark Bottom in Stocks

Today the Bureau of Labor Statistics released the employment figures for November. They weren't pretty. Nonfarm payrolls fell by a much bigger-than-expected 533,000. Even worse, the September and October figures were revised. October's job losses went from 240,000 to 320,000. September's went from 284,000 to 403,000.

The service sector alone lost 370,000 jobs in November. Losses were widespread from retail to automobile dealerships to leisure and hospitality. Health care was the only bright spot, gaining 34,000 jobs.

Surprisingly, the unemployment rate ticked up to just 6.7%. No doubt, this measure will rise considerably in coming months. I was criticized for suggesting it could surpass 8% by mid 2009. I sincerely hope I am wrong about that.

So far in 2008, the economy has lost an astounding 1.9 million jobs. It won't be easy to put all these people back to work on short notice. But that is exactly what President-elect Barack Obama hopes to do. Part of his economic stimulus plan is to increase infrastructure spending by $60 billion over 10 years. He estimates this will create about two million jobs--about the same number of jobs lost so far this year.

The American Society of Civil Engineers estimates that $1.6 trillion is needed just to bring all U.S. public works to good condition, so increasing spending on infrastructure is certainly a good idea. It is also inevitable. But $60 billion over 10 years is just a drop in the bucket. Despite so many other priorities right now, such as bailing out the the finance and auto industries, this figure is likely to rise.

The market initially responded to the employment figures just as one might expect. It sold off. Yet by the end of the day, stocks were up. The Dow finished higher by 259 points. I don't think investors are wrong to bid up stocks right now. The recession, which started a year ago, is already growing long in the tooth; and when employment numbers get this bad, it often marks a bottom in stocks. I continue to expect a strong rally in 2009.