Wednesday, December 26, 2012

More Good News About Housing

The economy continues to struggle in many respects, but housing has been one bright spot in recent months. The S&P/Case-Shiller numbers for October were announced today and they provided more evidence that demand for existing homes is strengthening. The 20-City Composite Index showed only a slight rise in prices from September to October, but prices were up a robust 4.3% on a year-over-year basis. They are up 5.4% from the low set in January 2012.

Of course, much of the demand is coming from investors who see an opportunity to buy homes at rock-bottom prices. However, a good portion of the demand is coming from genuine would-be residents. After all, there is a lot of pent-up demand. Furthermore, housing is closely tied to employment. People don't rush out and buy homes if they think they might get laid off in the near future. Keep in mind that the numbers released today are lagged by two months so we don't really know how good (or bad) the housing market was in November and December. Yet I can't help but get a bit enthusiastic about the employment market and the overall economy based on these latest results. Now if we could just get our fiscal house in order, 2013 could turn out to be a pretty good year.

Monday, December 24, 2012

Political Dysfunction Remains Primary Risk

With 2012 drawing to a close, it is really difficult to believe that American politicians have yet to resolve the fiscal cliff. Just a few years ago my good friend Ian Bremmer of the Eurasia Group identified political risk as his greatest concern. Unfortunately, that's even truer today.

Washington has become completely dysfunctional. In addition to the fiscal cliff, the country is once again coming close to the debt ceiling. A failure to resolve both issues could result in another round of credit rating downgrades. As bad as that sounds, it's not clear what the consequences will be. The last time our credit rating was reduced, Treasury interest rates went even lower.

No doubt the dysfunction in Washington will cause increased volatility in stocks. To a large extent, retail investors have reduced their holdings of equities. The financial crisis of 2008 was so traumatic that many of them got out and stayed out. However, another round of heavy selling, if it occurs, should be viewed as an opportunity for long term investors to get back into the market.

Finally, as the year draws to a close, I'd like to wish all my blog subscribers a happy holiday season and a prosperous 2013. And keep your eyes open for some changes to this blog. I am planning a revamp that should be ready to roll out in another month or so.

Friday, December 21, 2012

Nice mention in MarketWatch article on changing demographics and companies that could thrive and falter as the population ages. Click here to read.

Saturday, December 15, 2012

Fox Interview Overshadowed by Tragedy

I went to the Fox studios in New York City yesterday to do an interview about how lower trading costs have driven small investors out of the market. On the way, I received a news alert on my phone about a shooting at a school in Connecticut. When my interview with Lauren Simonetti was about to begin, there were still no reports of any deaths.

After the interview, I had to rush off to a two-hour meeting. Then I jumped on the subway for another meeting at the Forbes building on lower Fifth Avenue. That's when I learned about the full scope of the tragedy. There are many heinous crimes, but I can't imagine anything worse than this. I hope there is a special place reserved in Hell for those who intentionally harm children.

Compared to what happened in Sandy Hook, our discussion was all but meaningless. Nonetheless, anyone interested in watching can click here.

Tuesday, December 11, 2012

Workers' Rights

The "right-to-work" debate going on in Michigan struck a nerve with me. If you haven't been following the story, Republican Governor Rick Snyder plans to sign legislation that would prevent workers from having to join a union or pay dues to a union even if they do not join. In other words, he is in favor of giving workers choice. The unions, however, oppose choice.

I have never been a union member, but I was twice asked to join. The first time was when I was in college (a long, long time ago). I financed my senior year in part by driving a school bus on a part-time basis. I woke up at 5:30 in the morning, rode my bike to the school bus parking lot, and clocked in by 6:30. I drove kids from kindergarten to high school until 9 am. I then rode home, ate something, got in the car, and drove to Villanova University where I had arranged my classes so I could return to work by 3 pm for the afternoon shift. I drove the school bus a total of five hours a day and I earned just over $4 per hour (almost twice the minimum wage at the time).

I was eventually approached by a union representative. I was told (not asked) that I had to join the union. I was told that the union would negotiate for better wages and benefits on my behalf, and in return, I had to pay dues, which would eat up a good portion of my part-time wages. I quickly realized that my arm was being figuratively, yet vigorously, twisted. I managed to avoid joining the union by explaining that I was going to quit the job in a few months as soon as I finished college.

The second "invitation" to join a union came seven years later when I became a university professor. Once again, I was approached by a union representative, but this time the pressure was much more subtle. I again refused to join. I reasoned that if ever I was unhappy with my compensation, I could ask for a raise. If that didn't work, I could seek employment elsewhere. And if I could not find a better paying job, well then I must have overestimated my worth.

It's not that I am so opposed to unions. I actually think they played a critical role in the development of workers' rights, and even today, they sometimes provide a useful service. I am opposed, however, to the concept of forced membership. If someone wants to join a union then by all means let them; but if they don't want to join, leave them alone. No one should be denied employment or harassed on the job because they refused to join a union. This is what the debate in Michigan is all about. Unions want to be able to force membership, or at the very least, to force even non-members to pay union dues. This is akin to extortion and it simply does not pass the smell test.

Thursday, December 06, 2012

Another Reason Why Small Investors Are Staying Away From Stocks

I am in Pittsburgh on business but I saw an interesting article in today's WSJ by Jason Zweig and Tom McGinty about fund managers manipulating stock prices at the end of each quarter by putting in orders to buy stocks they already own. It's an extreme form of window dressing that is illegal. Investor confidence in the integrity of the markets is already low. This doesn't help.

Monday, December 03, 2012

Introducing MM Indicators



Today's Manufacturing ISM report was extremely disappointing, falling below the critical level of 50. Any number below 50 signals contraction in the manufacturing sector of the economy. Today's number (which measures November activity) came in at 49.5, its lowest level since July 2009.

Some time ago, I began tracking a number of economic indicators, including the ISM Index, that I believe provide a good signal of future economic activity. These indicators focus on employment, housing, manufacturing, services, and the stock market. I have been aggregating and quantifying the numbers on a short-term (i.e., month-over-month) basis and long-term (i.e., year-over-year) basis as shown in the table above. Dubbed the MM Indicators, a positive figure indicates improvement in the economy while a negative number indicates deterioration. As the table above shows, in the aggregate, economic indicators are much healthier today than they were a year ago, yet slightly worse than they were in the recent past. The danger, of course, is that prolonged short-term deterioration can turn into a serious long-term problem.

Thursday, November 29, 2012

Gallup Poll Highlights Divergence Between Republicans and Democrats

I know a number of people who have immigrated to the U.S. from former Soviet republics. They lived under socialism and communism in authoritarian countries. They say they came here for freedom, democracy, and capitalism. They often complain that there was little or no incentive to work hard in their home countries because everyone got paid the same. Recall that it was Karl Marx, a proponent of socialism and author of "The Communist Manifesto," who came up with the slogan, "From each according to his ability, to each according to his need."

This morning I heard an interview on National Public Radio (yes, I do listen to NPR) with Frank Newport, Editor in Chief at Gallup. The interview was about a poll Gallup conducted to see how Americans react to certain words. Gallup went a step further. They segmented the results based on political affiliation. The good news is that both Republicans and Democrats had overwhelmingly positive reactions to the terms, "small business," "free enterprise," and "entrepreneurs" with Republicans having a slightly more positive reaction to each.

Here is the worrying part. Republicans had a much stronger positive reaction than Democrats did to the words "capitalism" and "big business," but Democrats had a much stronger positive reaction to the words "federal government" and "socialism." Indeed, three-fourths of Democrats had a positive reaction to "federal government" and more than half had a positive reaction to "socialism." No doubt this comes as a shock to all those immigrants who came to the U.S. to escape the Soviet Union's version of socialism. Click here to see the full Gallup report.

Wednesday, November 28, 2012

The Rush for Special Dividends

With fiscal cliff negotiations still going on, one thing is certain. Tax rates on dividends and capital gains will be going up. The only question is by how much. The highest tax rate on qualified dividends is currently 15%, but in 2013, it could jump to as high as 43.4% for the highest income individuals. As a result, even the most anti-tax advocates are willing to settle for a smaller increase. A 20% tax rate on dividends is starting to look pretty good right now.

Yet 20% is still a third higher than the current rate. This is why, in anticipation of higher rates, many companies are announcing special dividends. Special dividends are dividends in addition to regular dividends. However, unlike regular dividends, special dividends are not recurring. The most recently announced special dividend comes from Costco, which said today that it would dole out $7 per share by year-end to stockholders of record December 10. That's in addition to the regular quarterly dividend of 27.5 cents per share. This is a huge payout for a company that is expected to earn about $4.50 per share this fiscal year. There is no doubt that Costco is doing what it can to help its shareholders avoid higher expected taxes in the future.  

Costco is not the only company to announce a special dividend. Others include Brown-Forman, Las Vegas Sands, Carnival, Tyson Foods, and Movado. Of course, the elephants in the room are Apple and Microsoft. Both companies sit on vast cash hoards and a lot of people are betting that they, too, will announce a special dividend before long. Higher taxes can be avoided as long as these dividends are paid before year-end. Even though they will taxed at just 15%, the payouts will produce windfall revenues for the government this year. 

Tuesday, November 27, 2012

The Norquist Pledge

Contrary to popular belief, the much ballyhooed anti-tax pledge signed by almost all Republicans in Congress, does not begin with the line, "I pledge allegiance to Grover Norquist." Instead, the pledge is a simple document that states that the signer will oppose efforts to increase marginal tax rates and efforts to eliminate deductions or credits that are not matched by decreases in tax rates. Simple enough; yet Norquist and his pledge are being blamed for a failure (so far) to reach agreement on the fiscal cliff. At one time it was thought impossible for a Republican to get elected (or reelected) if he or she refused to sign the pledge or violated the pledge.

It now appears that the tide has turned. Opinion polls strongly suggest Republicans will get the blame if a resolution to the fiscal cliff is not reached. The recent presidential election proved that Republicans were not very good at interpreting polls. They are trying to get better. Several have already said they will not be bound by the pledge. Norquist's stock is falling fast, but only time will tell if these Republicans can get reelected.

By the way, here is a link to my Fox Business interview on the fiscal cliff: The Fiscal Cliff and Your Portfolio

Friday, November 16, 2012

Some Observations

Everyone is holding their breath, hoping Democrats and Republicans reach an agreement on the fiscal cliff. Today we saw an unusual sight: The majority and minority leaders of both Houses speaking to reporters in a conciliatory manner. It looks like we are getting close to an agreement. Get ready for a big rally when a credible deal is announced.

That's the good news. Here's the bad:

Hurricane Sandy has had a huge negative impact on the economy. It caused a large spike in initial jobless claims and a sharp drop in industrial production. Sandy raises the risk of another recession.

Twinkies are no more. Some of you would say that's good news. After all, there is no nutritional value to those delicious cupcake-like treats. No doubt, Twinkies are the last thing an obese country needs. Hostess, the company that makes Twinkies and other bad-for-you treats, is going out of business. Before you cheer, keep in mind that Hostess runs 33 plants around the country that employ almost 20,000 Americans. Goodbye Twinkies. Goodbye jobs.

Shares of Apple keep plummeting. The company has lost about a quarter of its market capitalization since its September peak. Is this a buying opportunity? It's hard to say no.

America's military leadership is in turmoil; but not because of battles gone wrong. The culprit is sex. Imagine that.

The Middle East is in turmoil. While many in the West celebrated the so-called Arab Spring, Israel's leaders worried more about the instability that it could produce. Indeed, Islamists have gained power and they are proving their credentials by attacking Israel. The bombs are flying and things will likely get worse. How will the Obama administration react? It's still trying to figure out exactly what happened in Benghazi.

Wednesday, November 14, 2012

Stop Posturing and Cut a Deal Now!

It is difficult to point this out without sounding partisan, but U.S. stocks have been sinking ever since Election Day. The selling has been across the board. The Dow Jones Industrial Average and the S&P 500 Index are both down 5.1%. The NASDAQ Composite Index is down 5.5%. The Russell 2000, a small-cap index, is down 6.4%. Apple Inc., which had already suffered a large sell-off prior to the election, has given up another 7.9% since President Obama was reelected. Only the most die-hard Democrats (and left-leaning journalists) can fail to notice how poorly investors have greeted Obama's second term.

The selling today was particularly disappointing. After all, stocks began the day on the upside. The futures markets were pointing strongly higher as investors cheered Cisco's earnings, which came out after yesterday's close. They also applauded Staples' report, which was released before the open today. Both companies reported better-than-expected results and their stocks rallied strongly in pre-market trading. Unfortunately, things began to sour soon after the markets opened. The thinking is that investors are beginning to fear the prospect of higher tax rates next year. In order to minimize the tax burden, they are trying to realize gains before 2012 comes to an end.

Minutes before the president was to speak at a press conference at 1:30 pm today, stocks put in a bit of a rally. Investors were hoping to hear some conciliatory words about cutting a deal with Republicans and avoiding the dreaded fiscal cliff; but it was not to be. The selling took on steam soon after the president approached the podium and began his address. It quickly became clear that Obama views his reelection as a mandate to raise taxes on the rich. Investors sensed that this was not a man who seemed willing to compromise. By the end of the day, the Dow was almost 200 points lower.

How much lower can the markets go? That truly depends on the politicians. Each day brings us one step closer to disaster, yet I am holding my breath. I find it inconceivable that our elected officials would not cut a deal. It would be incredibly irresponsible of them not to. A failure to compromise will take both the economy and the stock market over the edge. My expectation is that a deal will be struck. However, for stocks to rally, it has to be a genuine deal. Increases in tax revenues must be met with spending cuts, and there has to be meaningful reform to the tax code. There is no question that the election results strengthen President Obama's hand, but he won't like what will happen to the markets if investors become convinced that he is simply riding roughshod over the Republicans.

Saturday, November 10, 2012

Immigration, One Reason Why Romney Lost


The election is over and the analysts are trying to explain the results. Of course, there are many reasons why Barack Obama won and Mitt Romney lost. Yet one thing is clear. The Democrats did an excellent job of defining the candidates. They defined Mitt Romney as Old America and Barack Obama as New America. They defined Romney as a successful, wealthy, white businessman, as if these are attributes to be ashamed of. Of course, Obama is successful, too, yet he is less wealthy and less white. Best of all from their perspective, Obama never ran a business. Instead, Obama made his money by telling his story in books. We have somehow reached a point in America where becoming rich by writing books is okay, but making money through business is not. Furthermore, you might think that as a Mormon, Romney was the quintessential outsider in this race. Yet Democrats managed to convince voters that Romney was the ultimate insider. You could almost imagine a President Romney cutting secret deals in smoked-filled rooms that enriched his friends. Ironically, Obama is the one who smokes.

In a recent article, Steve Forbes lists Five Reasons Why Romney Lost. He specifically names Romney's failure to define his own message. Nothing illustrates this better than the issue of immigration.

Other than Native Americans, every citizen of this country is either an immigrant or the descendant of an immigrant. I am an immigrant myself and, of course, I strongly favor immigration. I also know a lot of Republicans, yet for the life of me, I can't name one who is opposed to immigration. Republicans favor immigration because they know that immigration is the lifeblood of the economy. So how is it that they got labeled as the anti-immigrant party? It is because they allowed Democrats to define their message. While Republicans favor legal immigration, they are strongly opposed to illegal immigration. You might think this is common sense. Yet, Democrats managed to turn the issue around. You may have noticed that Democrats never  use the word "illegal" when describing people who came here or stayed here in violation of the law. Instead, they call these people "undocumented." That makes it sound like it is not their fault. It makes it sound like some government official simply forgot to give these poor people the right papers.

Republicans oppose illegal immigration for a number of reasons. National security is the most obvious one. Ever since 9/11, national security has become more important than ever. For national security reasons, we must be able to screen and track immigrants. We must make sure we are not allowing terrorists to get in. Yet, there is another critical reason as well. Illegal immigration is simply unfair to the millions of people around the world who are trying to come to this country through the proper channels. People from Africa, Asia, and Europe can't simply cross a border in the middle of the night. These people often travel long distances just to get to the nearest American embassy in order to properly apply for the right to immigrate to this country. These people sometimes wait years before that right is granted, if it is ever granted. Granting asylum to the millions of illegal immigrants who are already here is a slap in the face to the millions of aspiring Americans all over the world. What's worse, it sends the wrong message: "If you really want to come to America, figure out some way to sneak across the border."

Immigration is a critical issue and it must be resolved. The election results demonstrate that Americans won't tolerate a solution as simple as deporting everyone who is here illegally. There has to be another way. This will be one of the greatest challenges in President Obama's second term. He must find a way to work with Republicans to find an acceptable solution.

Friday, November 09, 2012

The Fallacy of Gasoline Rationing

If you haven't heard, the lines at the gas stations in New York City and other areas affected by Hurricane Sandy have been very long. In response, New York City is following New Jersey's lead and introducing a rationing system based on license plate numbers. Referred to as odd-even, you can buy gasoline only every other day. If your license plate ends in an odd number, you must buy on odd numbered days. If it ends in an even number, you must buy on even numbered days.

This morning I heard a commentator on the radio claim that this will reduce demand. In fact, he said it would reduce demand by half every day. This is nonsense. Rationing does not reduce demand. Think of it this way. Suppose you drive your car 100 miles per day and get 20 miles per gallon. If you fill up your car every day, you will buy five gallons per day. Under the rationing system, you will buy 10 gallons every other day. In other words, demand hasn't changed. What has changed is how frequently you visit a gas station.

So, yes, odd-even rationing can help alleviate the long lines at the gas stations. It won't, however, reduce demand. In the short run, the only thing that will reduce demand is if people drive less. Unless rationing causes more people to rely on public transportation or prompts them to car pool, it will have no effect on demand.

Thursday, November 08, 2012

Fiscal Cliff Fears Founder the Market

The post-election sell-off is becoming a serious concern. The S&P 500 is down 3.6% in just the two days following the election. This is a clear indication that investors are not happy with the election results. President Obama remains in the White House, the Senate continues to be dominated by Democrats, and Republicans control the House. In other words, nothing has changed. This recipe did not do the economy much good during the past four years. Right now, there is no reason to believe that the next four years will be any better. There is a real fear among investors that politicians will fail to reach a resolution on the fiscal cliff. The sell-off in the market is not the vote of confidence President Obama and his team in the White House were hoping for.

Today, the S&P 500 closed below its 200-day moving average. Those who follow such technical factors would consider this is an extremely bearish signal. Another bearish signal is the sell-off in Apple, the largest company by market capitalization in the S&P 500 and one of the hottest stocks in recent years. Apple is the bellwether stock of today's economy. Unfortunately, Apple is down 23% since hitting its closing high on September 19!

I explained on this blog back in March why I wasn't buying Apple. At the time, the stock was already above $600 per share. However, I said sentiment could take it even higher. It did. Yet the recent sell-off in Apple demonstrates how a simple turn in sentiment can devastate a stock. There is no change in the fundamentals. Apple still makes great products and it is still expected to generate tremendous sales growth. Some investors are actually justifying the sell-off by saying that since Steve Jobs passed away, Apple is just not the same company it once was. But Jobs died over a year ago. I can't believe investors suddenly woke up to this news.

Thanks to the sell-off, Apple is becoming very attractive. By most measures, it is not an expensive stock. On the contrary, it offers great value. Based on my conservative discounted cash flow analysis, I would value Apple at about $600 per share. On a more realistic basis, it is worth closer to $700 per share. Even so, negative sentiment could drive both Apple and the market lower.

At this point, however, I think there is a good chance for an upside surprise in the markets. Politicians on both sides of the aisle seem to have discovered a new sense of urgency to resolve the fiscal cliff. I am even sensing that the Republicans will relent on some tax increases in exchange for tax simplification. I once told Steve Forbes I would be willing to pay a little more in taxes if I could fill out and file my own return in half an hour. The market will rally even if there is no concrete agreement signed before January 1. All it will take is for investors to believe that a real resolution is in the works.

Wednesday, November 07, 2012

Obama Wins, Stock Futures Turn Red

The elections are over. President Obama gets another four years in the White House. This means Ben Bernanke remains at the Fed. Tim Geithner will remain at Treasury if Obama insists, but Geithner has made clear his preference to step down. Analysts are speculating about who might replace him. Chances are, however, that Geithner will remain at least until some compromise is reached on the fiscal cliff, the most important immediate issue facing the government.

As for stocks, the Obama victory means that the Fed's easy money policy will continue indefinitely. The effect is already wearing thin, but this policy could fuel the rally in stocks and commodities a little longer. Over the long term, however, it runs the risk of fueling inflation. The Obama victory is bad news for medical device manufacturers who are facing a 2.3% excise tax on the price of their products. This is a tax that will come right off the top line. It's also bad news for for-profit education companies and financial companies, both of which will face more regulatory hurdles. Obama's victory is good news for alternative fuel companies, especially those working in the solar and wind industries. It's bad, however, for traditional carbon-based energy companies. It means less drilling for oil and gas than we would have seen under a Mitt Romney presidency. Obama's victory also means that Obama Care will not be tweaked. As a result, healthcare insurance companies should see more customers even though profit margins could decline.

The stock market rallied strongly on Tuesday. Perhaps investors, who tend to favor Republican policies on the economy, thought Mitt Romney might actually pull off a victory. Or perhaps they were just happy that the uncertainty was about to end. Whatever the case, investors seem to be suffering from a morning-after hangover. As of early Wednesday morning, stock futures are decidedly in the red.

Sunday, November 04, 2012

Markets Weaken as Election and Fiscal Cliff Loom Ahead

I'm happy to report that our power is back. Electricity was restored to my neighborhood on Saturday afternoon. We were in the dark for a full five days. I don't want to sound too gleeful because there are still many people less than a mile from us who remain without power. And one of my cousins in Long Island was told that it could be two weeks or longer before the power is restored in her area. The past week has given me a new found appreciation for the flashlight. When you don't have electricity, you begin to think that the flashlight is man's greatest technological innovation.

Now that the crisis is over for my family, I can focus once again on economic issues. For the most part, the economic data that came out last week was better than expected. The gain in nonfarm payrolls for the month of October was 171,000, well above the 125,000 expectation. More importantly, the August and July estimates were revised upward. In addition, initial jobless claims of 363,000 beat the consensus estimate. Another encouraging sign was the ISM Index of 51.7, which points to expansion in the manufacturing sector (albeit at very weak levels).

While the latest economic figures bode well for President Obama's reelection efforts, the stock market shrugged it all off. Gold also sold off, dipping well below $1,700 per ounce. The election, of course, is on everyone's mind. It's not yet clear how the aftermath of Hurricane Sandy will affect the voting. Real Clear Politics, which aggregates results from the major polls, is currently showing Obama and Romney in a statistical dead heat. Obama looks much stronger on electoral votes.

The winner will have to contend with a looming crisis: the fiscal cliff. It remains to be seen if politicians can put aside their differences before the January 1 deadline. Economic indicators may be improving on the margin, yet the markets don't seem to be going along. Another positive economic number I should mention is China's better-than-expected purchasing managers' index. With a crisis in Europe and a looming crisis in the United States, investors are hoping China can pull the world out of its doldrums. Because China is so important, I thought I'd give a shout out to Lynn Harrison. Lynn was a guest on this MoneyMasters video shot in 2007! His comments about China are just as relevant today. Lynn and his wife were kind enough to give my family shelter on Friday night when we were still without power or heat.

Wednesday, October 31, 2012

Hurricane Sandy

My condolences to everyone who sustained damage or injury from Hurricane Sandy; and especially to those who lost loved ones. We were relatively lucky. We weren't in the hurricane's direct path, yet we still have no electricity, phone, or internet at home. Our office in Greenwich has the electricity  back, but no phone or internet. 

Despite the hardships, some businesses are benefiting. Home Depot, for example, is expected to do well from all the rebuilding and repairs that have to go on. Restaurants are booming since so many people can't cook at home. 

My neighborhood sustained serious damage from a great number of large trees that toppled over and tore down overhead wires. We are hoping to get back to normal in a few more days. Until then, good luck to everybody. 

Saturday, October 27, 2012

Military Spending Boosts Third Quarter GDP

The advance estimate for third quarter GDP growth came in at a better-than-expected 2.0%. This was up from 1.3% growth in the second quarter and, on the surface, it looks like good news. With the election just days away, the headline number is extremely important to the Obama administration. A 2-handle on GDP growth this far along in an economic recovery is weak, yet it helps make the case that things are getting better.

The market, however, took it as a non-event. Perhaps investors noticed that a good chunk of the increase was due to government spending. Indeed, real (as opposed to nominal) national defense spending surged 13%. Conspiracy theorists might say that the government accelerated military spending in order to boost the GDP report and help make President Obama's case for reelection. I think it is more likely that the accelerated spending was due to the pending sequestration. Unless Congress acts soon, the military budget will be slashed. The increased spending at this time could simply be the Pentagon's way of preparing for the expected cuts.

Whatever the reason, it is extremely disheartening to realize that even with this huge surge in defense spending, third quarter GDP climbed just 2.0%. In fact, growth would have been just 1.4% had defense spending remained flat. No doubt this is information many Obama supporters would prefer the electorate not to know.

Wednesday, October 24, 2012

Investors Get Nervous About Election

Initial jobless claims come out Thursday morning as they do every Thursday morning. Economists are expecting a figure of about 375,000. Any number significantly better helps President Obama make his case that the employment picture is improving. Any number significantly worse bodes well for Mitt Romney.

I delved into this matter in my July 19 posting. In that posting I showed that initial jobless claims have been improving significantly ever since they peaked in early 2009. I also pointed out, however, that the employment participation rate has been deteriorating. In fact, it is at a 30-year low. Some observers have said this is because of the baby boomers retiring. There is some truth to that. Unfortunately, that explains only part of the story. The bulk of the decline in the participation rate is due to large numbers of people simply dropping out of the workforce due to an inability to find jobs.

I have also discussed in the past why the stock market has been rallying even as the economy has been struggling. The bottom line is the Fed. The Federal Reserve has been pushing an easy monetary policy. Each time the Fed announces another round of quantitative easing, stocks rally. In a bit of twisted logic, however, stocks sold off on Tuesday in part because more investors are starting to believe that Mitt Romney may actually win the presidential election. Investors seem to believe that Romney will be better than Obama for the economy in the long run; but in the short run a Romney victory might mean an end to the Fed's easy monetary policy. Romney has already said he would not reappoint Ben Bernanke as Fed Chairman. He will likely replace Bernanke with someone who is more hawkish. That could be bad for stocks as interest rates rise back to what are considered normal levels.

The election is still a toss up. What is clear, however, is that stock market volatility is rising. It still makes sense to invest for the long run. You should, however, be prepared for some severe gyrations.

Thursday, October 11, 2012

Investor's Business Daily on Apple

Back in March, I had a posting asking if Apple was a BUY? My conclusion was that momentum would probably take the stock higher, but Apple wasn't a stock I would buy at the time. Of course, the stock did go higher and eventually topped $700 per share. But Apple has fallen back quite a bit in the last few weeks. Since Apple is the largest stock by market cap in the S&P 500 and NASDAQ, it has a huge influence on those indices. I love Apple's products, but I as I explain in today's Investor's Business Daily, there has simply been too much enthusiasm over the iPhone, the iPad, and Apple TV.

Tuesday, October 09, 2012

Book Interview

Click on Equities.com to read my interview with Henry Truc about The Forbes/CFA Institute Investment Course.

Friday, October 05, 2012

Low Interest Rates Are Punishing Savers

Stephen Horan of the CFA Institute interviewed me last week about the challenges of trying to generate income in a low-interest rate era. Click here to watch the interview.

Thursday, October 04, 2012

Is the Rally Going Beyond the Fundamentals?


The following commentary was previously sent to subscribers of the Forbes Special Situation Survey investment newsletter. 

We are growing increasingly concerned that the fundamentals do not justify the recent rise in stock prices. The U.S. economy continues to struggle. At the end of September, the Bureau of Economic Analysis revised its estimate for second quarter GDP growth from 1.7% (on an annual basis) to just 1.3%. Because growth is so anemic, the unemployment rate remains stuck at more than 8%. The official figure for August was 8.1%. (The September estimate will be released this Friday.) While it is true that the unemployment rate is down significantly from its peak of 10.0% in October 2009, we find the dismal participation rate more alarming. This little noticed, but extremely important metric has plunged to 63.5%, its lowest level since September 1981! In part, the decline is explained by demographics. After all, baby boomers are retiring in large numbers. Unfortunately, a greater portion of the decline in the participation rate is explained by people dropping out of the workforce simply because they are too discouraged to keep looking for work.

Even the few bits of good economic news have to be taken with a grain of salt. The latest ISM Index came in at 51.5. Any reading above 50 signals expansion in the manufacturing sector. However, this metric is barely above the critical level, meaning that any expansion is weak at best. The ISM Index was signaling contraction during the prior three months and it could easily fall below 50 again. In addition, the Chicago PMI, which came out just a few days earlier, dipped below 50, hitting its lowest level in three years. The housing market is giving some investors comfort with both new and existing home sales and prices picking up; yet the numbers remain at incredibly depressed levels. 

What explains the run up in stocks? We attribute it to a number of factors. First, Federal Reserve Chairman Ben Bernanke keeps delivering more stimuli and promises to keep interest rates low indefinitely. In a few more years, we may be talking about QE 15. The rise in stock prices shows how painful it is for investors to fight the Fed. Second, as bad as things are in Europe, investors go “risk on” every time a European politician or banker indicates that the abyss may be a little further away than they initially thought. Third, investors are hoping that no matter who wins the presidential election in the United States, no politician would be stupid enough to let the country go over the fiscal cliff. Unfortunately, we don’t know many investors who have grown rich by overestimating the intelligence of politicians.

We are about to enter what is known on Wall Street as “earnings season.” While stock prices may rise or fall on any particular day for any number of reasons, over the long run, nothing matters more than sales and earnings. We are concerned with the large number of companies that are issuing warnings. Companies frequently lower expectations in order to beat the reduced estimates; but this time around there appear to be a greater number doing so than usual. Furthermore, sales growth is slowing. The markets have been unusually tranquil in recent months. We suspect things are about to get much more volatile. Cautious investors might want to reduce exposure to equities at this time.

Monday, September 17, 2012

Fed Throws Granny Off The Cliff


At last week's press conference, Fed Chairman Ben Bernanke defended his low-interest rate policy even though it is punishing savers. Specifically, he said, "My colleagues and I are very much aware that holders of interest-bearing assets, such as certificates of deposit, are receiving very low returns. But low interest rates also support the value of many other assets that Americans own, such as homes and businesses large and small. Indeed, in general, healthy investment returns cannot be sustained in a weak economy, and of course it is difficult to save for retirement or other goals without the income from a job. Thus, while low interest rates do impose some costs, Americans will ultimately benefit most from the healthy and growing economy that low interest rates help promote."

A liberal group that supports the Democrats recently ran an ad that shows a Paul Ryan stand-in throwing an old woman in a wheel chair off a cliff. The message was that Ryan doesn't care about elderly Americans.

But isn't the Fed's low interest rate policy sending the same message? Elderly Americans are the ones that depend most on income from interest. They are the ones that keep their savings in relatively safe assets, such as savings accounts and the certificates of deposit that Chairman Bernanke talked about. Bernanke believes that his low interest rate policy is good for America in the long run. So far, the evidence on that is debatable. What is clearly true, however, is that for elderly Americans, the long run is not very long. They have already saved for retirement. Now they must depend on the income their savings generate, which thanks to Mr. Bernanke, is virtually zero. Does the Fed Chairman really want people in their 80s and 90s taking money out of the bank and putting it into the stock market?

Karen Dynan of the Brookings Institution has a paper out titled, "What's Been Weighing on Consumption?" Here's an interesting line from her paper: "Although interest income typically falls along with interest rates in cyclical downturns, the decline in such income in the current cycle has been materially larger than in the past (just as the sustained low level of interest rates is unusual by past experience)."

And here's an interesting paper from William McBride of the Tax Foundation titled, "The Great Recession and Volatility in the Sources of Personal Income." He includes an interesting table that breaks down income from source. The data is from the IRS and unfortunately it only goes up to 2009, yet is shows interest income falling precipitously after 2007. No doubt, an updated table would show an even sharper drop.

Is the Fed's low-interest rate policy really helping the economy? Perhaps a little. Since high interest rates are not what ails the economy, it isn't clear why the Fed keeps trying to drive them lower. What is perfectly clear, however, is that low interest rates are punishing savers, especially elderly savers. Now who's really the one "throwing Granny off the cliff?"

Monday, September 10, 2012

A Preview to the Fed's Announcement

President Obama's recent speech at the Democratic National Conference seemed to focus a bit too much on the tough road ahead. Perhaps astute traders took that to mean that the next day's jobs report would be disappointing. It sure was. Nonfarm payrolls increased by an incredibly anemic 96,000. What's worse, the gains for June and July were revised down from 64,000 and 163,000 to 45,000 and 141,000, respectively.

Furthermore, the one piece of good news turned out to be an anomaly. The unemployment rate fell from 8.3% to 8.1%, but only because more people dropped out of the labor force. I have been beating the drum for some time about the deteriorating employment participation rate. It just keeps on falling. It is now down to 63.5%, the lowest it has been since September 1981!

So why didn't the stock market sell off on the news? Because, in their twisted logic, investors seem to believe that the worse the jobs numbers get, the greater the odds for more monetary stimulus from the Federal Reserve. In fact, if the jobs numbers had been strong, stocks probably would have sold off.

The Fed's Open Market Committee will meet this Wednesday and Thursday. The Fed will then provide its economic projections and Chairman Bernanke will hold a press conference. Investors will be listening carefully and hoping for more stimulus. Chances are good that something (perhaps QE3) is on the way. It remains doubtful, however, if it will do much good. After all, high interest rates are not what ails this economy. The Fed's announcement might boost stocks, but only temporarily. With Europe facing recession, growth slowing in China, and the U.S. economy stuck at less than 2% growth, the returns from more monetary stimulus could be meager at best.

Thursday, September 06, 2012

Stocks Rally on ECB, Jobs, and ISM

Another day, another rally fueled by a central bank. Just a few weeks ago, Mario Draghi, president of the ECB, promised to do whatever it takes to defend the euro. Today, he announced a new "unlimited" bond-buying program dubbed outright monetary transactions (OMTs). Draghi said the ECB would focus on buying bonds that mature in one to three years. There are some hurdles that must be cleared before the ECB executes these so-called OMTs so it isn't entirely clear just how much money the ECB will throw into troubled economies. Other than giving us a new acronym, however, it is unlikely that the ECB will be able to prevent a recession in the European Union.

Stocks got a further boost from better-than-expected numbers about the U.S. jobs market. The ADP report showed a gain of 201,000 jobs in August; and the July estimate was revised up by 10,000 to 173,000. In addition, initial jobless claims fell to 365,000 for the week ended September 1. Both the ADP jobs report and initial jobless claims are on an improving trend.

There was more good news. The ISM services index came in at 53.7 for August, which was better than expected, better than the July estimate, and more importantly, better than the critical level of 50. This means that the services sector is expanding. This is especially critical since the manufacturing sector has been contracting for three months in a row.

As welcome as today's rally is, investors should remain cautious. After all, in the long run, how well the stock market does depends on corporate profits and the health of the overall economy. There is good reason to worry about both. For example, FedEx Corporation recently reduced earnings guidance for its fiscal first quarter, which just ended on August 31. Management blamed the weak global economy. Because FedEx's customers include most of the world's corporations, it is a bellwether of how the business sector is doing. As for the economy, it remains stuck at below 2% annual growth. What's worse, things are even deteriorating in the world's strongest major economy. A key manufacturing index in China fell to a nine-month low.

Despite the need for caution, stocks could still move higher. Tomorrow we get the all-important nonfarm payroll figures. The market is expecting to hear that 130,000 new jobs were created in August. Given today's ADP number, that expectation appears easy to beat. As for the unemployment rate, the expectation is that it will remain steady at 8.3%.

President Barack Obama addresses the Democratic National Convention tonight. When he takes the podium, he will already know what tomorrow's payroll announcement will be. No doubt he will play it close to the vest, but you can bet that a lot of investors will be looking for hints of what to expect in the morning.

Friday, August 31, 2012

Markets Rally on Expectations of QE3

Fed Chairman Ben Bernanke delivered his much anticipated speech in Jackson Hole, Wyoming this morning. I have criticized Bernanke for his reluctance to make clear that the economy's problems must be addressed through fiscal reforms. Well, today he spoke up strongly about that. Bernanke said, "Uncertainties about fiscal policy, notably about the resolution of the so-called fiscal cliff and the lifting of the debt ceiling, are probably also restraining activity, although the magnitudes of these effects are hard to judge. It is critical that fiscal policymakers put in place a credible plan that sets the federal budget on a sustainable trajectory in the medium and longer runs."

Thanks, Ben, for making that clear. The market rallied in response to Bernanke's remarks, but not because he called for fiscal reforms. It rallied because, once again, the Chairman implied that more monetary stimulus could come. To critics (like me) who believe the economy's problems are not due to high interest rates, Bernanke said, "Early in my tenure as a member of the Board of Governors, I gave a speech that considered options for monetary policy when the short-term policy interest rate is close to its effective lower bound. I was reacting to common assertions at the time that monetary policymakers would be 'out of ammunition' as the federal funds rate came closer to zero. I argued that, to the contrary, policy could still be effective near the lower bound. Now, with several years of experience with nontraditional policies both in the United States and in other advanced economies, we know more about how such policies work. It seems clear, based on this experience, that such policies can be effective."

I would say such policies were not nearly as effective as changes to fiscal policies would have been, but that's beside the point. The point is that Bernanke is saying that despite near zero interest rates, he believes that even more quantitative easing will help. Does this mean he will actually do more? These two sentences from the speech answer that question. "Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."

Bernanke is giving Congress cover. He says fiscal reforms are a must, but he also says more quantitative easing will help. Let there be no doubt. QE3 is on the way.

Two Interesting Papers From NBER

I noticed a couple of interesting working papers on the National Bureau of Economic Research (NBER) website. The first (NBER Working Paper No. 18075) has to do with how changes in housing wealth affect college choice. You might expect that as the value of a family's home grows, the more likely that family is to send their child to a better (and more expensive) school. Indeed, Michael Lovenheim of Cornell University and Lockwood Reynolds of Kent State University document that for every $10,000 increase in housing wealth, the probability of attending an elite public university increases by two percent. Furthermore, they found that the effect is strongest for the lowest income homeowners. However, their study was limited to the 1993-2003 time period, which is well before the housing bust began. It would be interesting to see what has happened to college choice now that so many homeowners are under water on their mortgages. It would also be interesting to see what is going on at the very expensive elite private universities. I suspect only the very poor and very rich are able to attend these kinds of schools. The very rich, of course, don't really care how high tuition goes. They are more than happy to write a big check to send Johnny to a top school. As for the poor, they are eligible for all kinds of grants. (Harvard, for example, waives tuition for students coming from families that make less than $60,000 per year). As is usually the case, it is the middle class that gets squeezed. They are considered too well off to qualify for grants, yet they are not well off enough to be immune to the pain of writing a large tuition check.

The second paper (NBER Working Paper No. 18035has to do with how recent recessions have affected the income of the wealthy. Conventional wisdom says that the wealthy are immune to recessions. No matter what happens, they continue to roll in the big bucks. Indeed, the authors, Fatih Guvenen, Serdar Ozkan, and Jae Song argue that in past recessions, lower income individuals suffered larger drops in income than did the very rich. They find, however, that just the opposite occurred during the most recent two recessions. I suspect the authors' findings may be related to sources of income. For example, the very rich are more likely than the poor to generate a substantial amount of income from interest, dividends, and capital gains. The most recent recessions, of course, have decimated investment income. With interest rates so low, interest income has all but disappeared; and income from dividends have not made up for large capital losses. Some people might applaud the low interest rate environment and the toll it is taking on wealthy savers. They should not rejoice. Low interest rates punish every saver (rich or poor) who is trying to plan for the future.

Tuesday, August 28, 2012

Housing Market Improves Marginally



There has been a lot of talk in recent weeks about the improving housing market. One of the most closely followed indicators, the S&P/Case-Shiller Index, came out today. The results were consistent with the thesis that the housing market is improving. The 20-City Composite index showed marginal improvement on both a month-over-month and a year-over-year basis. Indeed, the numbers have been improving for five months in a row. (See the tail end of the chart above.) Because Case-Shiller is delayed by almost two months, the most recent figures reflect sales in June. As a result, it is entirely possible that the housing market is actually stronger than what the latest numbers indicate.

Keep in mind that Case-Shiller does not examine new home sales. It examines repeat sales of existing homes only. Since the existing home market is much larger than the new home market, the improving figures are all the more encouraging. Despite the improvement, however, the gains are minuscule and the index remains depressed. In fact, the year-over-year gain was less than one-half of one percent. The Case-Shiller index remains 32% below the all-time high set in April 2006. According to the index, on average, homes purchased after June 2003 are now worth less than they were then.

Despite the most recent improvements, housing prices are not about to escalate. The most we can say for now is that the declines might be over. We would need to see much stronger job creation before any meaningful housing appreciation occurs.

Sunday, August 26, 2012

A (Tall) Tale of Two Armstrongs

This has been a tough week for folks named Armstrong. First, Lance announced that he was giving up his fight to prove that he didn't take performance-enhancing drugs. He was immediately stripped of his seven Tour de France titles. Those victories will be awarded to the "clean" runners up, no matter how deep they have to go to find them.

After the news about Lance, we learned that Neil passed away. Of course, Neil is famous for being the first man to walk on the moon. But soon after Neil's death, it was revealed that he, too, had dabbled with performance-enhancing drugs. Some experts believe this gave him an edge, allowing him to beat Buzz Aldrin out of the escape hatch of their spacecraft. It seems that Neil will be stripped of his title. From now on Buzz will be known as the First Man to Walk on the Moon, assuming of course that he was clean.

Speak the Truth Ben

On August 1, Darrell Issa, Chairman of the Congressional Committee on Oversight and Reform, wrote a 10-page letter to Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System. In this letter, Issa asked 22 specific questions about the economy and what it takes to bring it out of its current malaise. Issa extensively cited the opinions of Allan Meltzer (an economics professor at Carnegie Mellon University), David Stockman (former Director of the Office of Management and Budget), and Andy Kessler (a noted investor). All three individuals have been critical of Federal Reserve policy.

Bernanke's answers to Issa's questions are revealing, often more for what they don't say than for what they do say. For example, in his first question, Issa asks if forcing interest rates even lower than they already are will do much good to promote growth and reduce unemployment. Without actually saying so, Bernanke implies that the answer is no. Issa's next three questions are about bank reserves. He wants to know if these reserves are excessively high and if they are helping the U.S. economy. Bernanke dances around those questions and instead focuses on how reserves got so high. Reading between the lines, however, it seems that he thinks that, yes, reserves are too high and, no, high reserves are not doing much good to help the economy. 

Another point that seems to come through loud and clear is that the Fed's so-called dual mandate (maximum employment and stable prices) is making the Fed's job extremely difficult. Of course, Bernanke does not say this directly. Nonetheless, he seems keenly aware that pressure to maximize employment today is increasing the risk of significant inflation tomorrow.

The Fed Chairman is clearly caught in the middle of an ideological debate taking place in Congress. Democrats want him to continue doing whatever it takes to reduce interest rates and maximize employment. Republicans want him to admit that current monetary policy risks significant inflation and that it is no longer doing any good anyway. Republicans want Bernanke to say loud and clear that the economy's problems must be addressed through fiscal policy.

Indeed, it should be crystal clear to every observer that the Fed has done enough already. It has ballooned its balance sheet and it has driven interest rates to historic lows. It is impossible to believe that the economy is suffering from excessively high interest rates. It also impossible to believe that reducing rates even further will do any good. On the contrary, low rates are punishing savers (especially older Americans who tend to keep their capital in bank accounts) and increasing the risk of future inflation. Perhaps Bernanke finds a need to be "political" when responding to inquiries from politicians. It would be refreshing, however, if he'd simply say what he really believes.

Friday, August 24, 2012

Hanke's Prescription for Tight Money

In a forthcoming article in Globe Asia, Steve Hanke argues that, contrary to popular belief, the money supply in the U.S. is tight and that this is keeping the economy from growing. He reaches this conclusion in his article, Money: West vs. East, by looking at the combined liabilities of the central bank and the banking system. He says many economists make the mistake of focusing on the former and ignoring the latter. What's key is that the state money supply is dwarfed by the bank money supply.

Sure enough, state money has almost tripled since the collapse of Lehman Brothers in 2008. This is because the Federal Reserve has flooded the economy with dollars. At the same time, however, bank money has contracted thanks largely to new regulations and increased capital requirements. Indeed, Hanke shows that the bank money supply, which makes up more than 90% of the total supply, has shrunk almost 10% since the Lehman crisis.

Hanke's best solution is to relieve the banking sector of some of the onerous regulations imposed since 2008. He recognizes, however, that this can't happen quickly enough. Therefore, he prescribes a more immediate remedy. He says the government should borrow short-term money from the commercial banks and use the proceeds to purchase long-dated government bonds from the public. In effect, the government's net debt obligations remain the same, but the average duration of its debt decreases. When the government buys debt from the public, that money gets deposited into banks. As a result, this action increases the money supply without increasing net government debt.

This all sounds a bit like quantitative easing, but Hanke argues it is very different. With QE, the purchased bonds land on the Fed's balance sheet. They don't disappear. With his recommendation, the bonds are purchased directly by the government and are simply canceled out.

With interest rates so low, perhaps it would be better for the government to borrow long term from the banks and use the proceeds to buy back short-term bonds. Duration will rise, which does not seem like a good thing at first--unless, of course, you expect interest rates to rise in future periods. An outcome that appears quite likely.

Friday, August 10, 2012

Rudisha is the Greatest

Perhaps it's true that nothing is certain, but picking David Rudisha to win a gold medal is about as certain as anything gets. He broke the world record, too. I can't wait to see a sub 1:40 800 meters.

Tuesday, July 31, 2012

Track Starts Friday, But Don't Forget the Jobs Report

The world's attention (and mine) has turned to the Olympics. The most outstanding performance so far was Mr. Bean's during the opening ceremonies. However, I'm really looking forward to the track & field events, which begin on Friday, the same day that July's jobs report is released. Economists are expecting an increase of about 100,000 in nonfarm payrolls. They also expect the unemployment rate to remain steady at 8.2%. However, last week's GDP figure portends weaker results. Real GDP increased at an annual rate of just 1.5% during the second quarter. This beat the expectations of some economists, but fell well short of the revised 2.0% growth figure for the first quarter, indicating a general slowdown in economic activity from Q1 to Q2. Particularly worrisome was the anemic 1.5% growth in personal consumption expenditures. That was down from 2.4% in Q1. Expenditures on durable goods actually fell 1.0%.

We'll get a better idea of what the jobs report might look when the ADP Employment Report comes out tomorrow. Although the ADP report is based on actual payroll figures, it does not always accurately predict what the nonfarm payrolls might look like. Over time, however, there is a strong correlation between the two. 

Initial jobless claims come out Thursday and the ISM Indexes will be released on Wednesday and Friday. These also have the potential to move the markets. The former gives us an indication of layoffs. While many companies are still reluctant to hire workers, layoffs appear to have slowed. As a result, initial jobless claims could be better than the expected 365,000. As for ISM, the manufacturing index is expected to come in around 50 while the services index is expected to be a bit stronger. Yet these are extremely weak expectations since any number below 50 suggests contraction. 

The S&P 500 rallied 3.6% from last Wednesday to Friday. That's a nice move, but the gain had nothing to do with outstanding economic results or corporate profits. On the contrary, the economy is still struggling and corporations are reducing guidance. But stocks are rallying on hopes that European leaders will finally get serious about addressing their problems and that the Federal Reserve is about to initiate a new round of quantitative easing. Rallies based on these kinds of expectations are likely to fizzle out. 

As for the Olympics, nothing is for certain. Yet if I had to put my money on just one athlete, it would be David Rudisha of Kenya in the 800 meters. He is the current world record holder. One of these days he may become the first man to break 1:40. 

Thursday, July 19, 2012

Improving Jobless Claims Hide Real Story

A number of pundits argue that President Obama's reelection prospects rest largely on the employment market. Some predict that unless the unemployment rate falls to below 7.0% by November, an unlikely outcome, he won't get reelected. Today we learned that initial jobless claims jumped up 34,000 to 386,000 for the week ended July 14. Despite the increase, the Obama camp can at least make a case that initial jobless claims have improved significantly since they took control of the White House in January 2009. The number peaked at 667,000 for the week ended March 28, 2009, but as shown in the graph below, things have certainly been moving in the right direction ever since.

Unfortunately, the situation looks much worse when you examine the employment participation rate. This figure has dropped from 65.7% in January 2009 to just 63.8% in June 2012.

To put this decline in context, the civilian noninstitutional population over the age of 16 totaled 234,739,000 in January 2009, of which 154,236,000 million were in the labor force. Since then, the population has grown by 3.6% to 243,155,000, but the labor force has grown by just 0.6% to 155,163,000. In other words, had the labor participation rate remained constant, there would be approximately 4.6 million more individuals in the labor force.

Where did all these people go? They simply dropped out. Because the employment market is so bad, some gave up looking for work. Others "chose" to retire early. Still others decided to stay in school, hoping things would improve by the time they got yet another degree. The official unemployment rate of 8.2% is bad enough, but if we were to account for the missing 4.6 million, the unemployment rate would be a much higher 10.9%. It is not the improving trend in initial jobless claims, but the deteriorating labor participation rate that tells the real story about the dismal state of the U.S. employment market.

Tuesday, July 17, 2012

The Fed is Willing But Unable; Congress is Able But Unwilling

Ben Bernanke answered questions from the Senate Banking Committee today. A few items really stuck out. The first is how obvious it should be to everyone, even the politicians, that economic problems in the U.S. cannot be solved by tweaking monetary policy. They can only be addressed by fiscal policy. The second was how hard some of the committee members tried to change the subject. Instead of focusing on important economic problems here in the U.S. and how to solve them, members with their heads stuck in the sand chose to attack banks for manipulating LIBOR. They wanted to know what the Fed was doing about this; as if it could do anything.

Economic problems in the U.S. have nothing to do with interest rates being too high. They have everything to do with the so-called fiscal cliff, something only Congress can fix. Perhaps the most enlightening moment was provided by Senator Charles Schumer of New York. Addressing Chairman Bernanke as if he were a bad schoolboy who had not done his homework, Schumer first forced Bernanke to admit that the Fed was not out of tools then he told Bernanke to go back and do his job. Why? Because Congress refuses to do its fiscal job.

Monday, July 16, 2012

The Increasingly Elusive Level Playing Field

According to finance theory, a stock's price at any moment in time represents the present value of future expected cash flows. Prices fluctuate because investors disagree on what those cash flows will be or at what rate they should be discounted. When new information hits the market, stock prices can exhibit tremendous volatility.

As most investors know, it is extremely difficult to earn excess returns by relying solely on publicly available information, yet it is very easy to make a lot of money by relying on material and non-public information; what is often referred to as inside information. The problem, of course, is that using inside information is illegal. As a result, some investors looking for an edge try to access material information that is not necessarily coming from "inside" the corporation. Today's New York Times provides an excellent example of hedge funds operating in this gray area.

In Surveys Give Big Investors Early View From Analysts, Gretchen Morgenson explains how some of the biggest hedge funds are getting an early peek at what analysts think about the companies they cover. Morgenson claims that certain documents actually "state that the goal is to receive nonpublic information." What's worse, she says that documents state that surveys filled out by analysts for hedge fund clients "allow for front-running analyst recommendations."

While it is not clear if this practice of surveying analysts constitutes a violation of law, it certainly adds to the suspicion and unease that many ordinary investors share that the stock market is not operating on a level playing field. Hedge funds, in particular, are using more and more sophisticated technologies that allow them to buy or sell large amounts of stock in milliseconds, before other investors can access or process information. This explains in part why so many retail investors are either out of the market entirely or investing solely through mutual funds or exchange-traded funds. Morgenson's article will no doubt prompt regulators to ask a whole lot of questions.

Friday, June 29, 2012

A Buyout is RIMM's Best Hope for Survival

Research in Motion is the worst stock recommendation I have ever made. The company introduced one of the greatest technological devices ever invented, yet it squandered its market-leading position and it is now in danger of going out of business. Its demise is due almost entirely to mismanagement. RIMM was previously run by co-CEOs, a management structure that was doomed for failure. And while Apple and Samsung came out with generation after generation of new devices that wowed consumers, RIMM kept promising that it was working on something big. That promise is now ringing hollow.

Yesterday's (lack of) earnings announcement was extremely disconcerting. Revenues for the first quarter of fiscal 2013 plunged to $2.81 billion from $4.19 billion in the previous quarter. The company reported a net loss of $518 million or 99 cents per share. However, believe it or not, the subscriber base actually increased marginally and cash, cash equivalents, short-term, and long-term investments increased by more than $100 million during the quarter to $2.25 billion. That comes out to almost $4.30 per share.

RIMM is banking its future on the BlackBerry 10. Management said yesterday that this new platform will be available during the first calendar quarter of 2013. This announcement is being interrupted as a delay. After all, the company previously said that the BlackBerry 10 would be launched during the second half of fiscal 2013. The more important concern is whether the BlackBerry 10 will live up to expectations and, even if it does, will that make a difference. RIMM has demonstrated the device to developers, many of which were duly impressed; however, even if the BlackBerry 10 blows the iPhone out of the water, it may be too late to save the company.

It is becoming increasingly clear that RIMM's best chance for survival depends on it being acquired. In the past, the company turned down a number of offers. This time, it is actively seeking strategic alternatives. I would think that there are a number of companies that would be interested in getting access to RIMM's patents, international distribution channel, and its secure network. As always, it's just a matter of price. Given the company's cash horde and lack of debt, a 35% premium to the current market price would cost a potential acquirer only about $6 per share out of pocket.

Tuesday, June 26, 2012

More Evidence of Slowdown as Advisers Fear Obama Reelection

Last week we learned from the Philly Fed Index that manufacturing activity had slowed in the Third District, which includes most of Pennsylvania, southern New Jersey, and all of Delaware. Today, we got similarly disappointing news from the Federal Reserve Bank of Richmond. This report covers the Fifth District, which includes Maryland, Washington D.C., the Carolinas, Virginia, and most of West Virginia.

Once again, the evidence shows a slowdown in business activity. The composite index fell from +4 in May to -3 in June. It was +14 in April. There was significant deterioration in key individual components of the index as well. Shipments were down and backlog fell. The volume of new orders plummeted, as did capacity utilization and the average workweek. There was an increase in inventories. Input prices and prices for finished goods increased, but at lower rates than in May and April. Perhaps because conditions worsened,manufacturers expect (or hope) that future conditions will improve.

Today's report from the Richmond Fed adds to the evidence that the economy is worsening. Whether the slowdown has anything to do with the crisis in Europe is not entirely clear. Whatever the reason, it is apparent that there is a lack of confidence in how governments worldwide are addressing today's serious economic problems. Furthermore, InvestmentNews reports that 70% of the 450 financial advisers surveyed by Brinker Capital claim that their single biggest fear is another four-year term for the Obama administration. Financial advisers tend to cater to the affluent so this finding may not be surprising. Nonetheless, it does not bode well for an administration that needs the affluent to help finance its reelection campaign.

Thursday, June 21, 2012

Philly Fed Fuels Fears of Slowdown

The Business Outlook Survey, better known as the Philly Fed Index, came out this morning and the results were not good. The data comes from a survey of approximately 160 manufacturing companies in the Third Federal Reserve District, which includes most of Pennsylvania, the southern half of New Jersey, and all of Delaware. About half the surveyed firms respond.

The diffusion index plummeted to -16.6 in June from -5.8 in May, the second negative monthly reading in a row. A negative number indicates contraction in the manufacturing sector. A more negative number indicates an increase in the rate of contraction. In other words, business conditions were not good in May and they got worse in June.

The results also indicate that new orders and shipments fell from May to June as did unfilled orders, delivery times, and inventories. While the last three items might appear encouraging, they are not. They indicate a lack of business that could eventually result in layoffs. Ironically, the survey indicated that the number of workers actually increased from May to June; however, the average number of hours worked fell. Unless business activity picks up soon, many firms will conclude they are overstaffed.

The survey also has implications for inflation, or more correctly, the lack thereof. Both input prices and prices received for finished goods fell, which should give the Federal Open Market Committee more confidence in its accommodative monetary policy.

Keep in mind that business executives tend to be optimistic by nature. Indeed, the respondents said they expect business conditions to improve over the next six months. More importantly, however, they were less optimistic than they were earlier this year.

Although these results cover only a small part of country on a geographic basis, the Third District is densely populated and includes a large number of businesses. In other words, the implications for the entire economy are not good. The results are consistent with other data that indicate a general slowdown in economic activity. GDP forecasts of 1.0% to 2.0% growth are beginning to look too optimistic.

Monday, June 18, 2012

The Fed is Like a Drug Dealer

Investors worldwide were holding their collective breath over the weekend worried about the elections in Greece, Egypt, and France. Greece, of course, was the primary focus. Many investors feared that the left-wing Syriza party would win the election and hasten the country's exit from the euro. However, Syriza lost to New Democracy, a more conservative party that has vowed to stick with the nation's previously made bailout agreements. However, New Democracy's victory was not decisive. As a result, it is trying to form a coalition with the third-place finisher.

Initially, markets were relieved. U.S. futures surged, indicating a strong open. But the gains fizzled out as investors began to realize that the election solves nothing. Greece is still in trouble. There is still a good chance it will abandon the euro, only later rather than sooner. Furthermore, Spain and Italy present even more serious problems.

The big mystery is not why the markets opened flat, but why they are holding up so well. The explanation has to do with the Federal Reserve. Investors seem to think that bad news is really good news, and that really bad news is even better. They reason that the worse things get in Europe, the more likely the Fed will come to the rescue by dishing up more stimulus. One concern I've had for a long time is that stock market rallies are being fueled not by improvements in the economy, but by Federal Reserve stimulus. The Fed, however, is like a drug dealer delivering a temporary fix. The Fed cannot address the real problems in the economy. That will require Congressional action. For example, a complete overhaul of the tax code would help matters tremendously. Congress could start by simplifying the tax code. It should eliminate deductions and reduce tax rates. But with an election just months away, it's a sure bet that Congress won't do anything.

We'll hear more from the Fed on Wednesday. Some investors are betting that Ben Bernanke will extend "Operation Twist," the Fed's attempt to bring down long-term interest rates. Unfortunately, the economy's troubles have nothing to do with high interest rates. Nonetheless, the markets may rally in reaction to whatever action the Fed announces. Stock market rallies are nice, but they won't solve the real systemic problems in the economy.

Wednesday, March 21, 2012

Is Apple a Buy?

Apple Inc. (AAPL) is the most talked about stock in the market today. It recently broke above $600 per share and it is setting new highs almost on a daily basis. In response, analysts are outdoing one another by raising their price targets. They argue that at just 17 times trailing earnings, and 14 times expected 2012 earnings, AAPL is still a cheap stock. Indeed, AAPL does offer more value than many other highfliers. For example, Lululemon Athletica (LULU), an apparel maker, generates just a fraction of the sales that AAPL produces, yet LULU is selling for 65 times trailing earnings and 60 times expected earnings. So what gives?

One reason why AAPL looks comparatively cheap is because it is so huge. With a market cap of $565 billion, it is the largest stock in the S&P 500 Index by far. In fact, it is 35% larger than the second-largest stock (Exxon Mobil). Investors simply cannot get their minds around a company this big being able to generate the kind of growth typically seem only in small-cap companies. APPL's revenues were up 14% in 2009 then they surged 52% in 2010 and 66% in 2011. Over the past four quarters, sales are up 68%. In other words, despite the company's already gigantic size, revenue growth is still accelerating. One could reasonably argue that there is still plenty of room for growth, especially in international markets. Imagine, for example, how much larger AAPL could get once it establishes a real foothold in China.

Another problem has to with skepticism about the company's ability to continue coming out with revolutionary must-have products--especially now that its co-founder and inspiration, Steve Jobs, has passed away. The stereotypical AAPL customer is young and extremely passionate about the company's products. I personally know a few who live in my house. They refuse to consider buying any competing products. These kinds of customers don't really care if iPhones drop calls or iPads overheat. If APPL builds something, these consumers will run, not walk, to the nearest store. But how long can AAPL count on this lemming-like behavior? How long will customers leap every time the company announces a new product? AAPL depends heavily on exactly the kinds of customers who are also the most fickle. Do something that really upsets them and they will abandon you in a second. And you can bet that the competition is not sitting still. They haven't had much success so far, but competitors are doing their best to try to beat AAPL at its game. Indeed, the next hot gadget may come from a company we haven't even heard of yet.

So is AAPL a buy? I have been around long enough to know that momentum can take any stock much higher--or much lower--than you could possibly imagine. Right now, upside momentum is clearly on AAPL's side. Take a look at the price chart and you will see that for three straight years, AAPL shares increased at a fairly steady rate. However, starting about three months ago, the gains suddenly accelerated. It's a bit like watching Usain Bolt running at full speed unexpectedly shifting into a faster gear. Therefore, I would not be surprised to see this stock go higher, but that's not a bet I'm willing to make. I simply find it impossible to believe that the world's largest company can maintain annual revenue growth rates of 65% for much longer.

Friday, March 16, 2012

Apple Stands Falsely Accused

"In the theater, our job is to create fictions that reveal truth—that's what a storyteller does, that's what a dramatist does." You can be excused if you mistake this for a quote from George Orwell's 1984. Unfortunately, it is a real statement released by the Public Theater in New York City to defend the lies behind Mike Daisey's accusations against Apple Inc.'s working conditions in China.

Daisey is a performer who put together a fictional piece about Steve Jobs. However, he somehow convinced a prominent member of the media that his story was really true. Ira Glass, a highly respected journalist who hosts the radio show This American Life, devoted an entire episode to Daisey and his lies against Apple. This American Life is distributed by Public Radio International and airs on National Public Radio affiliate stations.

Daisey made up lies about the Foxconn factory in Shenzhen, China. For example, he said he met workers who were just 12-years old, and he said he met workers who were exposed to chemicals that were so toxic, it left their hands shaking "uncontrollably." Apple took a lot of heat for what was supposedly going on at this factory. Now we know they were lies.

The unfortunate truth is that Foxconn has a history of treating workers badly. Indeed, a number of Foxconn employees have committed suicide. As a result, it is not difficult to understand how someone (even a respected journalist) could be duped into believing the worst. Furthermore, because NPR has long been accused of having a liberal, anti-business bias, it is easy to imagine the folks putting together the show champing at the bit. They no doubt knew this story would be big. It turned out to be one of the most popular episodes in the program's history.

But journalists are supposed to be skeptical, and they are supposed to check out the facts. Thanks to Rob Schmitz who works for another show that airs on NPR, Marketplace, we now know the truth. To Mr. Glass's credit, he and Public Radio International have retracted the story. That's more than what some others may have done. Better late than never, yet the damage is already done.

As for Mr. Daisey, he remains defiant. He thinks his only sin was not making it clear to Mr. Glass that he was putting on an act. But he has been selling his fiction as truth to other media outlets as well. Unfortunately, Daisey has victimized the very workers he claims to be protecting. Employee abuse is a real problem in China, but due to Daisey's lies, the next person who comes along with a real story about worker abuse will get a much less receptive hearing.

Wednesday, March 14, 2012

Goldman's Muppet Clients




Goldman Sachs is in the news again, this time because a now former executive by the name of Greg Smith wrote a scathing resignation letter published in the New York Times titled Why I Am Leaving Goldman Sachs. In his article, Mr. Smith (who no doubt will be going to Washington when Congress calls for another investigation), accuses his former employer of putting its own interests ahead of its clients'. That may come as a shock to some people, but I would bet that most clients suspected as much anyway.

Mr. Smith says that Goldman's stock in trade for 143 years has been trust. However, he says that today a new culture has taken over, one which stresses "ripping eyeballs out" and "getting paid." Perhaps most interesting was Mr. Smith's claim that during the past 12 months he heard five different directors refer to their clients as "muppets."

Anyone familiar with the real Muppets would know that Misters Statler and Waldorf (pictured above) are the only ones who are wealthy enough to be Goldman clients. Interestingly (and this is no joke), Goldman Sachs has actually arranged financing deals for movie studios trying to raise money from hedge funds and private equity firms. I could find no evidence, however, that Goldman was involved in any of the Muppet movie deals.

In all seriousness, this is just another incident that tarnishes the reputation of Warren Buffett's favorite investment bank. Buffett, who has long been critical of investment bankers, has praised Goldman Sachs on a number of occasions. Berkshire Hathaway still holds a sizable financial interest in Goldman in the form of warrants, an investment that came about during the financial crisis when Buffett was approached by a former Goldman banker named Byron Trott.

One has to wonder what purpose Mr. Smith's public letter of resignation serves. He must have been very angry or fed up to do what he did. It certainly was one of the greatest displays of publicly burning ones bridges. His actions make it all but certain that no other bank will hire him. Yet Mr. Smith is probably wealthy enough to live comfortably for the rest of his life without having to work. I have no doubt, however, that a number of investment firms would be happy to have him on their staff. Yet criticizing Goldman so publicly for unethical behavior will also bring a certain degree of scrutiny on how exactly Mr. Smith has been earning his living over the past 12 years. Because he must know this, he must also be quite confident that he can withstand the scrutiny.

Tuesday, March 06, 2012

Earnings Guidance Revisted

Earnings guidance is one of the more controversial management practices. It is something I feel strongly about. I even devoted a whole chapter to defending this practice in my 2008 book, "Even Buffett Isn't Perfect." Those who would like to see an end to guidance are basically arguing that investors are better off having less information. In a day and age when regulators are trying to increase transparency, this makes no sense.

It was wonderful to see the recent Wall Street Journal article written by Professor Baruch Lev of New York University defending guidance. It reminded me of the excellent interview I had with Professor Lev several years ago when he was a guest on the MoneyMasters video program I used to host at Forbes. Click here to watch Professor Lev's excellent defense of earnings guidance.

Saturday, March 03, 2012

Stocks Ignore Economic Woes as Apple Drives the Indexes

The following commentary is derived from a Special Report distributed to subscribers of the Forbes Special Situation Survey on March 2.

So far, 2012 is turning out to be a great year for stocks. Through Friday, March 2, the NASDAQ Composite Index was up 14.2% year-to-date and the S&P 500 was up 8.9%. Of course, both indexes benefit greatly from their inclusion of Apple Inc., which is up 34.6% year-to-date. Apple, which has a market capitalization of more than $500 billion, is about one-fourth larger than Exxon Mobil, the second largest stock in the S&P 500. Because both the NASDAQ Composite and the S&P 500 are cap-weighted, they got a big boost from Apple's outstanding performance. On the other hand, the Dow Jones Industrial Average, which does not include Apple, is up just 6.2% year-to-date. This demonstrates just how influential Apple has been to the other two indexes.

For the most part, the corporate sector of the economy is doing well. Companies have benefited greatly from low interest rates and years of cost-cutting. Profits and balance sheets are strong. Many companies are using cash to increase dividends, repurchase shares, and pay down debt (or at least refinance existing debt with cheaper debt). Yet three critical legs of the economy remain troubled.

Employment – On the surface, there appear to be significant improvements in the employment market. The unemployment rate, which peaked at 10% in October 2009, has gradually declined to 8.3%. Weekly initial jobless claims improved from 659,000 in March 2009 to 351,000 for the week ending February 25, 2012. Nonfarm payrolls increased by 243,000 in January, marking the 16th consecutive month that the economy added jobs. There is no question that these trends are good. They certainly indicate that the jobs market is moving in the right direction. However, the improvement in the unemployment rate is largely an aberration because discouraged workers, who are many, are not counted. Furthermore, initial jobless claims are still higher than they should be in a recovery, and job creation is still much too anemic. Take a look at the employment participation rate to see just how troubled the jobs market remains. This figure is calculated by dividing the civilian labor force by the civilian non-institutional population. This critical measure, which hovered above 66% before the financial crisis of 2008, is now down to just 63.7%. In other words, a smaller proportion of the population is taking part in the labor force. If you think there isn't much difference between 66% and 63.7%, you will probably be shocked to learn that had the participation rate remained at 66%, the unemployment rate today would actually be 11.8% instead of 8.3%. As bad as it is, the unemployment rate looks better simply because fewer people are participating in the jobs market. Also, don't forget that if the jobs market truly strengthens, the unemployment rate should initially rise as more people begin to look for work.

Housing – Warren Buffett argues that the housing market is near bottom. He says that over the long term, the number of housing units must rise in line with the number of households. Today, household formation is outpacing the increase in housing units. That doesn't help the housing market in the short term because there is an oversupply of homes. In the long term, however, more houses will have to be built. Furthermore, because interest rates are low and housing prices are so depressed, the cost of buying a home looks extremely attractive compared to the cost of renting. Buffett is right that the housing market will eventually improve. Of course, the critical question is when? Unfortunately, the latest S&P/Case-Shiller numbers show that we aren't there yet. Housing prices are still falling. In fact, they are almost 35% below the 2006 peak. On average, homes today are worth what they were back in early 2003. Many people who purchased a house after that date are underwater.

Energy – According to the AAA Daily Fuel Gauge Report, the national average price of regular gasoline has reached $3.74 per gallon. In some parts of the country, it is well above $4.00 per gallon. Just one month ago, the national average price was $3.45 per gallon. This 8.4% increase in a month is largely due to the rise in crude oil prices. The oil market has been particularly sensitive to rumors. For example, any talk that Israel is about to attack Iran in order to destroy that nation’s nuclear capabilities causes prices to rally. A recent rumor that a pipeline in Saudi Arabia exploded caused another spike in oil prices. Interestingly, that rumor, which turned out to be false, appears to have originated in Iran. That may not be surprising, yet the reaction showed just how nervous oil traders are. Demand for gasoline, which has been depressed since the start of the financial crisis, was starting to pick up. Higher gasoline prices, however, are likely to reduce demand again, which is not a good development for the economy. Higher gasoline prices could also fuel inflation. One energy bright spot is natural gas, which is plentiful, cheap, and not imported. Maybe it's time to start thinking more seriously about alternative sources of energy, such as T. Boone Pickens' idea of converting long-haul trucks to natural gas.

Sunday, February 19, 2012

A Commercial for Singapore


I am still a little jet-lagged after a two-week stint in Singapore teaching an intensive executive class in equity investment management. This was part of the M.S. in Finance program run by the Zicklin School of Business at Baruch College. The students were all business executives. Some were working for large international companies, including Credit Suisse and Barclays. Others were working with local companies. All of them were experienced, smart, hard-working, and motivated.

This was my first visit to Singapore and I was extremely favorably impressed, so please excuse the somewhat promotional nature of this post. I had heard a lot about this small pro-business city-state before going, but nothing beats seeing it with your own eyes. Singapore is very modern, clean, and safe. There is very little crime and you can walk where ever you want without worrying about your safety. Because the country is near the equator, you should be prepared to sweat if you plan to do a lot of walking. Unlike in most American cities, I spotted no litter or graffiti. Of course, the authorities are famous for cracking down hard on violators, but it simply is not in the nature of the population to deface property or throw trash into the streets. People seem to be extremely conscious of how their actions affect others.

I found that most prices were quite similar to those in the U.S., but a few things were clearly much more expensive. For example, a small (or should I say tall) plain cup of coffee from Starbucks costs more than $3.00 U.S. And don't even think about buying a car. A small Toyota would set you back about $80,000 U.S. This is the government's way of controlling traffic. Nonetheless, there were still plenty of nice cars on the streets. However, a car isn't even necessary since public transportation is readily available and taxis are reasonably priced.

Of course, Singapore's biggest draw is its pro-business climate, which includes low taxes. I met with Will Adamopoulos, who heads the Forbes office in Singapore. Will and his family have been living in Singapore for many years. He stressed the rising number of billionaires in Asia. I also met with Mykolas Rambus, CEO of Wealth-X, a company he founded in New York City in 2009. Wealth-X now has eight offices around the world. Mykolas moved his family to Singapore about six months ago. Other well-known residents include Eduardo Saverin, co-founder of Facebook, and billionaire investor Jim Rogers.

Singapore often shows up at the top of the world rankings of best places to conduct business. The International Finance Corporation and the World Bank rank Singapore #1 in their Doing Business 2012 report. Anyone interested in getting started can refer to the website, Guide Me Singapore.

Unfortunately, I missed the famous Singapore Airshow. It got underway the day after I left to return home. I probably would not have been able to get a ticket anyway. They sold out quickly. Fortunately, the Airshow was extremely profitable for Boeing, which scored a $22.4 billion contract with Indonesia's Lion Air for 230 new jet planes. This deal certainly highlights the growing importance of Asia in the global economy. And with the rest of the world in an economic slump, American companies that want to grow must increasingly turn their focus to Asia.