New home sales continue to plummet. According to the joint release issued this morning from the Census Bureau and the Dept. of Housing and Urban Development, only 51,000 new single-family homes were sold in March in the entire country. Seasonally-adjusted and annualized, that comes out to about 526,000 new home sales, down 8.5% from February and down 36.6% from March 2007. Because the 90% confidence level is ±11.1%, it is possible that the decline was much worse. We'll find out for sure over the next two months as this figure is revised.
If that's not bad enough, it turns out that inventory is still growing. If sales stopped falling and homebuilders stopped working, there would still be enough new homes available for sale to satisfy demand for 11 months. Furthermore, the median price of a new home is down 6.8% over the past month and down 13.3% over the past year.
Despite this seemingly dismal news, almost all homebuilding stocks are up today. Although most homebuilding stocks are down by huge amounts over the past year, they are also some of the best-performing stocks year to date. At least three of them, Hovnanian Enterprises, Standard Pacific, and M/I Homes, are up more than 50% so far this year.
Many investors are obviously betting that the worst is over for the homebuilders. I doubt this is the case. Most of these companies will report huge operating losses this year. Indeed, they may report losses next year as well, assuming they survive that long. While some may consolidate, others will go out of business. At current prices, it's still too early to buy the homebuilders.
Thursday, April 24, 2008
Wednesday, April 16, 2008
More Questions About JPMorgan/Bear Stearns Deal
A recent SEC filing from JPMorgan Chase raises more questions about the government's role in JPMorgan's pending acquisition of Bear Stearns. Steven Davidoff does an excellent job of pointing all this out in a New York Times DealBook piece. For example, he asks why the New York Fed agreed to give Bear Stearns a secured lending facility on Friday, March 14, then suddenly changed it's mind and backed out of the agreement by the end of the day. The SEC filing also notes that JPMorgan indicated a willingness to pay $8-$12 per share for Bear Stearns, but eventually offered only $2 per share following discussions with government officials. Take a look at Anatomy of a Merger for more questions prompted by the SEC filing. I thank Gary Lutin for bringing Davidoff's piece to my attention.
Monday, April 14, 2008
Buffett Loses Another General Re CEO
After a week of rumors, Joseph Brandon finally stepped down as CEO of General Re, a Berkshire Hathaway subsidiary and one of the country's largest reinsurance companies.
Brandon's resignation is big news because he was frequently praised in Buffett's annual letters to shareholders. Berkshire followers considered Brandon a leading candidate to replace the great man when he eventually retires. But Brandon is now the second General Re CEO to step down under a cloud. Ron Ferguson was the first.
Warren Buffett does not like to use stock to consummate acquisitions. He made an exception, however, when he bought General Re on Berkshire's behalf in 1998 for $22 billion using a combination of cash and stock. Things soured almost from the start.
When writing about General Re in his 1999 letter to shareholders, Buffett said, "we had a huge--and, I believe aberrational--underwriting loss." He said General Re was underpricing policies, yet he also praised CEO Ferguson. However, just a couple of years later, Ferguson was out and Brandon was in.
It turns out General Re was also plagued with other problems. It had accounting irregularities that resulted in $800 million of costs being charged against 2001 earnings. It had derivatives-related losses that amounted to about $400 million. In fact, these losses prompted Buffett to make his now famous statement calling derivatives "financial weapons of mass destruction."
Just two months ago, Ferguson and three other General Re executives were convicted of helping American International Group, formerly run by Maurice Greenberg, deceive investors by manipulating earnings with fraudulent reinsurance contracts. Although Brandon was not convicted of any crime, prosecutors considered him a co-conspirator and Buffett came under intense pressure to let him go. Today, he relented to that pressure.
Losing Brandon can not be easy for Buffett. Each year, Buffett heaps praise on several of his managers in his annual letter to shareholders. Brandon's name frequently showed up in these letters. Now that Brandon is gone, Ajit Jain is the leading candidate to become Berkshire's next CEO. If interested, you can read more about Berkshire's investment in General Re in my forthcoming book, Even Buffett Isn't Perfect.
Brandon's resignation is big news because he was frequently praised in Buffett's annual letters to shareholders. Berkshire followers considered Brandon a leading candidate to replace the great man when he eventually retires. But Brandon is now the second General Re CEO to step down under a cloud. Ron Ferguson was the first.
Warren Buffett does not like to use stock to consummate acquisitions. He made an exception, however, when he bought General Re on Berkshire's behalf in 1998 for $22 billion using a combination of cash and stock. Things soured almost from the start.
When writing about General Re in his 1999 letter to shareholders, Buffett said, "we had a huge--and, I believe aberrational--underwriting loss." He said General Re was underpricing policies, yet he also praised CEO Ferguson. However, just a couple of years later, Ferguson was out and Brandon was in.
It turns out General Re was also plagued with other problems. It had accounting irregularities that resulted in $800 million of costs being charged against 2001 earnings. It had derivatives-related losses that amounted to about $400 million. In fact, these losses prompted Buffett to make his now famous statement calling derivatives "financial weapons of mass destruction."
Just two months ago, Ferguson and three other General Re executives were convicted of helping American International Group, formerly run by Maurice Greenberg, deceive investors by manipulating earnings with fraudulent reinsurance contracts. Although Brandon was not convicted of any crime, prosecutors considered him a co-conspirator and Buffett came under intense pressure to let him go. Today, he relented to that pressure.
Losing Brandon can not be easy for Buffett. Each year, Buffett heaps praise on several of his managers in his annual letter to shareholders. Brandon's name frequently showed up in these letters. Now that Brandon is gone, Ajit Jain is the leading candidate to become Berkshire's next CEO. If interested, you can read more about Berkshire's investment in General Re in my forthcoming book, Even Buffett Isn't Perfect.
Friday, April 11, 2008
Shiller at the BSAS
I want to thank one of my former students from Boston College, Harry Markopolos, for sending me his notes from a talk delivered last month by Robert Shiller to members of the Boston Security Analyts Society. Shiller, who is a member of the faculty at Yale University, is also the man who closely tracks housing prices. He was instrumental in developing the now famous S&P/Case-Shiller Home Price Index. I had the pleasure of interviewing him a couple of years ago shortly after he released the second edition of his prescient book, "Irrational Exuberance." I call the book prescient because the first edition correctly called the top of the stock market in 2000; and the second edition correctly called the top in housing.
As everyone knows, housing prices are still falling. Shiller expects them to keep falling for quite some time since the monthly year-over-year declines are still accelerating. Actions taken by government officials may slow these price declines, but eventually the market will have to find its equilibrium. In fact, it would probably be better for our economy if the government did not intervene and allowed this process to proceed as quickly as possible.
Shiller pointed out that the price gains seen in recent years were historically unusual. From 1890 to 1990, housing prices appreciated at about the same rate as inflation. Starting in 1990, however, prices took off as home buyers began to view a house more as an investment rather than just a place to live.
Shiller pointed out that for many home owners, their house is their most valuable asset. Unlike other assets, however, it was nearly impossible to hedge against a drop in value. But he has helped develop financial derivatives linked to the Case-Shiller indexes that allow home owners to do just that. Shiller believes the existence of such instruments make it much less likely that a housing bubble will develop again in the future.
Interestingly, Shiller said that in every market he examined, lower-priced homes exhibited the greatest price increases during the recent housing bubble. He attributes this to the widespread availability of sub-prime mortgages, which sometimes did not even require a down payment or the verification of income. This made it possible for individuals, who would not have otherwise qualified for mortgages, to buy homes. As a result, lower-priced homes saw the biggest increase in demand, and therefore, the biggest percentage increase in price. But now, this is also where most of the pain is being felt. Unfortunately, other segments of the housing market and the wider economy are not entirely immune. They, too, are feeling some pain.
As everyone knows, housing prices are still falling. Shiller expects them to keep falling for quite some time since the monthly year-over-year declines are still accelerating. Actions taken by government officials may slow these price declines, but eventually the market will have to find its equilibrium. In fact, it would probably be better for our economy if the government did not intervene and allowed this process to proceed as quickly as possible.
Shiller pointed out that the price gains seen in recent years were historically unusual. From 1890 to 1990, housing prices appreciated at about the same rate as inflation. Starting in 1990, however, prices took off as home buyers began to view a house more as an investment rather than just a place to live.
Shiller pointed out that for many home owners, their house is their most valuable asset. Unlike other assets, however, it was nearly impossible to hedge against a drop in value. But he has helped develop financial derivatives linked to the Case-Shiller indexes that allow home owners to do just that. Shiller believes the existence of such instruments make it much less likely that a housing bubble will develop again in the future.
Interestingly, Shiller said that in every market he examined, lower-priced homes exhibited the greatest price increases during the recent housing bubble. He attributes this to the widespread availability of sub-prime mortgages, which sometimes did not even require a down payment or the verification of income. This made it possible for individuals, who would not have otherwise qualified for mortgages, to buy homes. As a result, lower-priced homes saw the biggest increase in demand, and therefore, the biggest percentage increase in price. But now, this is also where most of the pain is being felt. Unfortunately, other segments of the housing market and the wider economy are not entirely immune. They, too, are feeling some pain.
Wednesday, April 09, 2008
Forbes Roundtable Discussion
About once every quarter, the Forbes Investors Advisory Institute hosts a roundtable discussion with some leading investment strategists and portfolio managers. Wally Forbes moderated one such discussion last night at Forbes headquarters. Panelists included Barbara Marcin of GAMCO, Mike Holland of Holland & Company, Joe Battipaglia of Stifel Nicolaus, Rich Peterson of Thomson Financial, and me. Most participants were bearish about the economy. Views on the stock market, however, were more varied with some being bullish and others expecting only mediocre returns at best for quite some time. The Forbes video department filmed the discussion and expects to post highlights on Forbes.com within a few days. We also expect to prepare a transcript for subscribers to the Forbes Growth Investor and Special Situation Survey investment newsletters. They will be notified when it is ready.
Monday, April 07, 2008
Olympic Boycotts
As a former track and field athlete, I can't help but comment on the commotion surrounding the upcoming Olympic Games in Beijing. China is coming under severe criticism for its crackdown in Tibet, as well as its cooperation with the government of Sudan, which is accused of perpetrating genocide in Darfur. The most recent developments involve protesters in France accosting a wheelchair bound athlete who was carrying the torch.
Like it or not, the Olympic Games have long been politicized. President Jimmy Carter made the Olympics a political issue for Americans when he kept our team out of the Moscow Olympics in 1980. Carter's boycott was meant to protest the Soviet Union's invasion of Afghanistan. The Russians eventually vacated Afghanistan, but not because of the boycott. Ironically, the U.S. military now finds itself mired in that very country.
As you might imagine, the Russians were not pleased with the U.S. led boycott. They felt America was trying to embarrass them. Therefore, it came as no surprise when they retaliated by boycotting the very next Olympic games, which conveniently were held in Los Angeles.
I was never an Olympic caliber runner, yet I had the opportunity to train with runners who were. In fact, one of my former track coaches was a member of the 1980 team. As you can imagine, he was not happy to see all his training go for naught. After making the Olympic team, all he got was a trip to the White House and a handshake from the man who kept him from competing in Moscow.
I am not saying that China's policies should not be protested. Indeed, they should be vigorously protested. However, an Olympic boycott is not going to do much good. It certainly is not going to convince China's leaders to change their ways. On the contrary, a boycott will probably make them close ranks and become even more belligerent than they already are. Those who are really serious about delivering a strong message to China should seek other ways. Boycotting Chinese made goods, for example, would be more effective than boycotting the Olympics. But are consumers willing to pay higher prices for goods manufactured elsewhere?
Like it or not, the Olympic Games have long been politicized. President Jimmy Carter made the Olympics a political issue for Americans when he kept our team out of the Moscow Olympics in 1980. Carter's boycott was meant to protest the Soviet Union's invasion of Afghanistan. The Russians eventually vacated Afghanistan, but not because of the boycott. Ironically, the U.S. military now finds itself mired in that very country.
As you might imagine, the Russians were not pleased with the U.S. led boycott. They felt America was trying to embarrass them. Therefore, it came as no surprise when they retaliated by boycotting the very next Olympic games, which conveniently were held in Los Angeles.
I was never an Olympic caliber runner, yet I had the opportunity to train with runners who were. In fact, one of my former track coaches was a member of the 1980 team. As you can imagine, he was not happy to see all his training go for naught. After making the Olympic team, all he got was a trip to the White House and a handshake from the man who kept him from competing in Moscow.
I am not saying that China's policies should not be protested. Indeed, they should be vigorously protested. However, an Olympic boycott is not going to do much good. It certainly is not going to convince China's leaders to change their ways. On the contrary, a boycott will probably make them close ranks and become even more belligerent than they already are. Those who are really serious about delivering a strong message to China should seek other ways. Boycotting Chinese made goods, for example, would be more effective than boycotting the Olympics. But are consumers willing to pay higher prices for goods manufactured elsewhere?
Friday, March 28, 2008
Even Buffett Isn't Perfect
I gave a talk Wednesday night in White Plains, NY about my forthcoming book, Even Buffett Isn't Perfect. I was quite pleased with the response, so I am posting a short excerpt here. The book is available for pre-order at a significant discount at Amazon.com and Barnesandnoble.com, as well as a number of other book sellers.
Buffett firmly believes the rich should pay more tax. So why would he choose to give so much of his money to these various foundations rather than allow the government to take a huge chunk from his estate after his death? The only reasonable explanation is that Buffett is convinced that these foundations will spend his money much more wisely than the government would.
Many of the megarich, including Buffett, favor the estate tax. Yet they continue to take advantage of the loophole in the law that allows them to avoid the tax by giving their money away before they die. What explains this paradox? Perhaps the answer lies somewhere between guilt and altruism. They may feel guilty about having so much money, yet they don't trust the government to spend it wisely. But as conservatives point out, we don't need the estate tax to get the same result. Those who feel guilty are free to give their money to whomever they want--even the government. But they should not force the same on others.
Buffett firmly believes the rich should pay more tax. So why would he choose to give so much of his money to these various foundations rather than allow the government to take a huge chunk from his estate after his death? The only reasonable explanation is that Buffett is convinced that these foundations will spend his money much more wisely than the government would.
Many of the megarich, including Buffett, favor the estate tax. Yet they continue to take advantage of the loophole in the law that allows them to avoid the tax by giving their money away before they die. What explains this paradox? Perhaps the answer lies somewhere between guilt and altruism. They may feel guilty about having so much money, yet they don't trust the government to spend it wisely. But as conservatives point out, we don't need the estate tax to get the same result. Those who feel guilty are free to give their money to whomever they want--even the government. But they should not force the same on others.
Monday, March 24, 2008
Grand Theft Investment Bank
J.P. Morgan's acquisition of Bear Stearns is starting to look more and more like a crime with the Federal Reserve and Treasury Department guilty of aiding and abetting. Government officials orchestrated grand theft investment bank.
As of yet, of course, there is no definitive deal. Yet Morgan almost got away with "buying" Bear for just $2 per share. The government, it seems, was desperate to close a deal and just as desperate to punish Bear's shareholders. Morgan was smart enough to realize they were the only bidder in the game. They could name any price they liked and that's exactly what they did.
But shares of Bear immediately started trading well above the offer price. And now, after only one week, Morgan decided it needed to allay some of the ill will it's initial offer created. So it decided to increase its offer--by five times! If this does not confirm that Morgan's initial offer amounted to highway robbery, I don't know what does.
With Morgan's new offer the government is still assuming most of the risk by guaranteeing Bear's toxic mortgages. But instead of doing this through Morgan, it could have done the same thing directly through Bear. Either way, the burden to taxpayers is the same. By working through Morgan, however, the government can be sure that Bear's employees and shareholders get absolutely pummeled.
One day a lot of hard questions will be asked about exactly what went on. Harvard professors are probably already working on a case study. Dozens of books will eventually be written on the subject. In the final analysis, it will become evident that, with the government's help, J.P. Morgan almost stole Bear Stearns.
As of yet, of course, there is no definitive deal. Yet Morgan almost got away with "buying" Bear for just $2 per share. The government, it seems, was desperate to close a deal and just as desperate to punish Bear's shareholders. Morgan was smart enough to realize they were the only bidder in the game. They could name any price they liked and that's exactly what they did.
But shares of Bear immediately started trading well above the offer price. And now, after only one week, Morgan decided it needed to allay some of the ill will it's initial offer created. So it decided to increase its offer--by five times! If this does not confirm that Morgan's initial offer amounted to highway robbery, I don't know what does.
With Morgan's new offer the government is still assuming most of the risk by guaranteeing Bear's toxic mortgages. But instead of doing this through Morgan, it could have done the same thing directly through Bear. Either way, the burden to taxpayers is the same. By working through Morgan, however, the government can be sure that Bear's employees and shareholders get absolutely pummeled.
One day a lot of hard questions will be asked about exactly what went on. Harvard professors are probably already working on a case study. Dozens of books will eventually be written on the subject. In the final analysis, it will become evident that, with the government's help, J.P. Morgan almost stole Bear Stearns.
Thursday, March 20, 2008
On the Road in New Orleans and Austin
I was in New Orleans yesterday taking part in a market forecast panel discussion sponsored by the CFA Society of New Orleans. The event was held at the Bourbon House. Vinny Catalano, president and global investment strategist of Blue Marble Research, moderated the discussion. The audience included Don Chance, my financial derivatives professor at Virginia Tech, and Pat Mooney, a former student of mine from a CFA review course I used to teach in Boston. Both are now working in Louisiana.
The other panelists included Mark Freeman, an investment advisor, and Dek Terrell, an economist from Louisiana State University. Interestingly, Dek talked about Louisiana's strong economy. Louisiana, which is heavily dependent on the oil industry, is actually benefiting from the high oil prices that are haunting the rest of the nation. He pointed out that there are pockets of desperation in Louisiana, but for the most part, the state is doing well.
Mark warned the attendees that volatility in the stock market is likely to continue, but he had a favorable view overall.
I focused my discussion on the continuing acceleration in the drop in housing prices. Almost all of the problems we are seeing in the financial sector are related to housing. Until housing prices start falling at a decelerating rate, we will not be approaching bottom. I also warned that high energy prices are taking a big toll on consumers. We are already seeing a decline in gasoline demand due to these prices. However, I said oil prices are more likely to fall than rise. Current prices are more the result of the weak U.S. dollar and less a result of strong demand or limited supply. For more than a week I have been trying to short the USO, an oil ETF, to take advantage of the expected decline. But my brokerage firm claims they have no shares in inventory available to short.
Today I am in Austin and will take part in a similar discussion sponsored by the CFA Society of Austin. This event will take place at the Austin Club. I'm also hoping to visit Roux, a trendy restaurant owned by my cousin Dan Janjigian.
The other panelists included Mark Freeman, an investment advisor, and Dek Terrell, an economist from Louisiana State University. Interestingly, Dek talked about Louisiana's strong economy. Louisiana, which is heavily dependent on the oil industry, is actually benefiting from the high oil prices that are haunting the rest of the nation. He pointed out that there are pockets of desperation in Louisiana, but for the most part, the state is doing well.
Mark warned the attendees that volatility in the stock market is likely to continue, but he had a favorable view overall.
I focused my discussion on the continuing acceleration in the drop in housing prices. Almost all of the problems we are seeing in the financial sector are related to housing. Until housing prices start falling at a decelerating rate, we will not be approaching bottom. I also warned that high energy prices are taking a big toll on consumers. We are already seeing a decline in gasoline demand due to these prices. However, I said oil prices are more likely to fall than rise. Current prices are more the result of the weak U.S. dollar and less a result of strong demand or limited supply. For more than a week I have been trying to short the USO, an oil ETF, to take advantage of the expected decline. But my brokerage firm claims they have no shares in inventory available to short.
Today I am in Austin and will take part in a similar discussion sponsored by the CFA Society of Austin. This event will take place at the Austin Club. I'm also hoping to visit Roux, a trendy restaurant owned by my cousin Dan Janjigian.
Monday, March 17, 2008
Is Bernanke's Job on the Line?
Over the weekend, the Federal Reserve orchestrated the takeover of Bear Stearns by J.P. Morgan for $2 per share. This is an almost unbelievable development. Bear Stearns, which started 2007 with a $22 billion market capitalization, is now valued at only $250 million! Some observers argue that this is better than the alternative--bankruptcy; but some Bear Stearns shareholders are wondering if that is really true.
There are two big problems leading to this latest crisis in financial markets. The first is falling housing prices. This is something that was easily foreseen. Many well known and respected economists, including Robert Shiller, Gary Shilling, and Nouriel Rubin, have been warning for years that housing prices could not possibly keep appreciating. Simple reversion to the mean dictated that prices had to fall considerably just to get back to long-term trends. Excessively easy access to mortgages created the housing bubble. Now that banks are tightening their lending standards, the air is coming out of the balloon.
The second problem is the Fed. It no longer has the confidence of investors. Instead of providing targeted liquidity to frozen credit markets, the Fed has destroyed the value of the dollar and created a tremendous amount of inflation in dollar-denominated commodities by aggressively cutting interest rates. Foreign tourists are having a ball vacationing and shopping in the U.S., and foreign investors are gobbling up our decimated assets, which are even cheaper than they appear when priced in euros and yens. Americans, however, are paying a steep price.
Treasury Secretary Henry Paulson (jokingly known as Mr. Strong Dollar) is trying to assure investors that we're just going through a blip. He wants us to believe that there is light at the end of the tunnel. Mr. Paulson, along with President Bush, will be out of work in 10 months. How much longer will Ben Bernanke have his job? To be fair, he can't be fully blamed for all of the ills in the economy. Some of the seeds of the current crisis were sown before he took office. Nonetheless, it is starting to look as if Mr. Bernanke's tenure at the Fed will not be setting any records.
There are two big problems leading to this latest crisis in financial markets. The first is falling housing prices. This is something that was easily foreseen. Many well known and respected economists, including Robert Shiller, Gary Shilling, and Nouriel Rubin, have been warning for years that housing prices could not possibly keep appreciating. Simple reversion to the mean dictated that prices had to fall considerably just to get back to long-term trends. Excessively easy access to mortgages created the housing bubble. Now that banks are tightening their lending standards, the air is coming out of the balloon.
The second problem is the Fed. It no longer has the confidence of investors. Instead of providing targeted liquidity to frozen credit markets, the Fed has destroyed the value of the dollar and created a tremendous amount of inflation in dollar-denominated commodities by aggressively cutting interest rates. Foreign tourists are having a ball vacationing and shopping in the U.S., and foreign investors are gobbling up our decimated assets, which are even cheaper than they appear when priced in euros and yens. Americans, however, are paying a steep price.
Treasury Secretary Henry Paulson (jokingly known as Mr. Strong Dollar) is trying to assure investors that we're just going through a blip. He wants us to believe that there is light at the end of the tunnel. Mr. Paulson, along with President Bush, will be out of work in 10 months. How much longer will Ben Bernanke have his job? To be fair, he can't be fully blamed for all of the ills in the economy. Some of the seeds of the current crisis were sown before he took office. Nonetheless, it is starting to look as if Mr. Bernanke's tenure at the Fed will not be setting any records.
Tuesday, March 11, 2008
Physician, Heal Thyself
Saying that Eliot Spitzer is a hypocrite is stating the obvious. Yet it is a little gratifying to see this "holier than thou" crusader get caught in his own ethical lapse. Spitzer made a career of ruining the reputations of numerous businessmen; not by convicting any of them of doing anything criminal, but by threatening to indict their companies if they didn't resign.
Richard Grasso, Ken Langone, and Hank Greenberg are still trying to get their reputations back. Take Grasso for instance. What was his big crime according to Spitzer? He was paid too much. That's undoubtedly true. Personally, I think anyone who gets paid more than me is paid too much, but that doesn't constitute a crime. Spitzer also went after a number of directors at the NYSE, but he decided to give former New York State comptroller H. Carl McCall a pass. Perhaps he felt he needed McCall's support in his ambitious quest to become governor.
Today's Wall Street Journal mentioned a speech Spitzer gave to the New York Society of Security Analysts in 2003. I was there. I remember being disappointed that the NYSSA chose to invite Spitzer to address our membership. I watched as investment professionals fell all over themselves to shake Spitzer's hand, as if doing so somehow certified their high ethical standards. When Spitzer delivered his speech, he joked about indicting people in our profession. It became very evident to me that this man was focused more on promoting his career than he was in protecting investors from criminals. What goes around, comes around.
Richard Grasso, Ken Langone, and Hank Greenberg are still trying to get their reputations back. Take Grasso for instance. What was his big crime according to Spitzer? He was paid too much. That's undoubtedly true. Personally, I think anyone who gets paid more than me is paid too much, but that doesn't constitute a crime. Spitzer also went after a number of directors at the NYSE, but he decided to give former New York State comptroller H. Carl McCall a pass. Perhaps he felt he needed McCall's support in his ambitious quest to become governor.
Today's Wall Street Journal mentioned a speech Spitzer gave to the New York Society of Security Analysts in 2003. I was there. I remember being disappointed that the NYSSA chose to invite Spitzer to address our membership. I watched as investment professionals fell all over themselves to shake Spitzer's hand, as if doing so somehow certified their high ethical standards. When Spitzer delivered his speech, he joked about indicting people in our profession. It became very evident to me that this man was focused more on promoting his career than he was in protecting investors from criminals. What goes around, comes around.
Monday, March 10, 2008
SIFMA at Wharton
I just returned from the Wharton School at the University of Pennsylvania. The Securities Industry and Financial Markets Association (SIFMA) is holding a one-week conference for its membership. They kicked off the event this morning with a panel discussion entitled "Wall Street Comes to Wharton." I was honored to take part in the discussion, which focused on the economy and the markets. Bob Stovall, Managing Director and Global Strategist at Wood Asset Management, hosted the panel. Other panelists included Sam Stovall, Chief Investment Strategist at Standard & Poor's; Randall Eley, President of the Edgar Lomax Company; and Michelle Girard, Managing Director and Senior Economist at RBS Greenwich Capital.
Housing prices got a lot of attention. All panelists agreed that prices will continue to fall for some time. However, Michelle pointed out that realtors are reporting a pick up in interest from buyers looking for bargains. Nonetheless, I said I was more concerned about the fact that the drop in prices is still accelerating. Although I am hopeful that prices will start falling at slower rates in the very near future, I expect overall housing prices to keep falling throughout 2008 and perhaps into 2009. I also warned that problems could spread in the commercial sector and banks could soon start announcing writeoffs of commercial mortgages.
Sam Stovall talked about historical trends and pointed out that it is rare for stocks to fall as much as they have without a meaningful recovery within a year while the Fed is aggressively cutting interest rates. Sam's point was that it is more risky to be out of the market right now than it is to be in it because stocks could rally strongly and unexpectedly. While I certainly believe stock prices could go lower in the short term, I am more confident that they will be at higher levels 3-5 years out. As a result, I would agree with Sam. Take advantage of strong sell-offs by doing some bargain hunting.
Randall Eley is a value manager who favors large-cap blue chip companies. He, too, has a bullish long-term outlook. Stocks he likes right now include Chevron (CVX), Bank of America (BCA) and Home Depot (HD).
Housing prices got a lot of attention. All panelists agreed that prices will continue to fall for some time. However, Michelle pointed out that realtors are reporting a pick up in interest from buyers looking for bargains. Nonetheless, I said I was more concerned about the fact that the drop in prices is still accelerating. Although I am hopeful that prices will start falling at slower rates in the very near future, I expect overall housing prices to keep falling throughout 2008 and perhaps into 2009. I also warned that problems could spread in the commercial sector and banks could soon start announcing writeoffs of commercial mortgages.
Sam Stovall talked about historical trends and pointed out that it is rare for stocks to fall as much as they have without a meaningful recovery within a year while the Fed is aggressively cutting interest rates. Sam's point was that it is more risky to be out of the market right now than it is to be in it because stocks could rally strongly and unexpectedly. While I certainly believe stock prices could go lower in the short term, I am more confident that they will be at higher levels 3-5 years out. As a result, I would agree with Sam. Take advantage of strong sell-offs by doing some bargain hunting.
Randall Eley is a value manager who favors large-cap blue chip companies. He, too, has a bullish long-term outlook. Stocks he likes right now include Chevron (CVX), Bank of America (BCA) and Home Depot (HD).
Thursday, March 06, 2008
In Defense of Peter Lynch
Peter Lynch is a legend in the investment world. If you ask investors to name America's all-time best money managers, Warren Buffett would no doubt come out on top. But chances are Peter Lynch would be close behind.
Lynch managed Fidelity's Magellan fund for 13 years. Under his watch, assets under management ballooned to $14 billion. He authored several books on investing and coined the term "ten-bagger," which describes a stock that goes up 10 times in value. He was famous for walking around shopping malls and paying attention to what people were buying. Today, he spends a great deal of time on philanthropy.
Yet the man who is so revered by investors, stands a little tarnished. You see, Lynch accepted gifts from brokerage firms that were seeking Fidelity's business. This is considered a big no-no in the mutual fund industry because gifts from brokers might be construed as bribes. A manager who accepts a gift might feel pressured to channel business in that broker's direction.
Because Lynch managed so much money, you might expect to find that it took hundreds of thousands of dollars in bribes to buy his business. You would be wrong. What is the value of all the gifts Lynch received? A grand total of $15,948! The man who managed billions of dollars on behalf of investors all over the world got into trouble for accepting $15,948 worth of tickets to sporting events and a rock concert. He didn't even use many of the tickets he received.
I have no doubt that Peter Lynch is a man of integrity--an honest man of high ethical standards. Obviously, he would have been smarter not accepting any gifts whatsoever. But there is absolutely no evidence that Magellan shareholders were harmed in any way. On the contrary, Mr. Lynch delivered outstanding market-beating returns to his investors. In my view, if a man like Lynch can get into trouble for something like this, there is something wrong with the system. The government barked up the wrong tree in this case. My respect for Mr. Lynch has not been diminished in the least.
Lynch managed Fidelity's Magellan fund for 13 years. Under his watch, assets under management ballooned to $14 billion. He authored several books on investing and coined the term "ten-bagger," which describes a stock that goes up 10 times in value. He was famous for walking around shopping malls and paying attention to what people were buying. Today, he spends a great deal of time on philanthropy.
Yet the man who is so revered by investors, stands a little tarnished. You see, Lynch accepted gifts from brokerage firms that were seeking Fidelity's business. This is considered a big no-no in the mutual fund industry because gifts from brokers might be construed as bribes. A manager who accepts a gift might feel pressured to channel business in that broker's direction.
Because Lynch managed so much money, you might expect to find that it took hundreds of thousands of dollars in bribes to buy his business. You would be wrong. What is the value of all the gifts Lynch received? A grand total of $15,948! The man who managed billions of dollars on behalf of investors all over the world got into trouble for accepting $15,948 worth of tickets to sporting events and a rock concert. He didn't even use many of the tickets he received.
I have no doubt that Peter Lynch is a man of integrity--an honest man of high ethical standards. Obviously, he would have been smarter not accepting any gifts whatsoever. But there is absolutely no evidence that Magellan shareholders were harmed in any way. On the contrary, Mr. Lynch delivered outstanding market-beating returns to his investors. In my view, if a man like Lynch can get into trouble for something like this, there is something wrong with the system. The government barked up the wrong tree in this case. My respect for Mr. Lynch has not been diminished in the least.
Monday, March 03, 2008
Oil Sets All-Time High
Oil prices set an all-time high today on both a nominal and inflation-adjusted basis. Yet gasoline prices are still below their May 2007 highs. Interestingly, oil prices were much lower last May. But gasoline prices surged anyway due to problems at refineries. Today, however, it is oil, the raw material for making gasoline, that is just starting to push gasoline prices higher.
But oil prices are not climbing because of a lack of supply. Instead, they are rising due to demand for oil futures contracts. Investors are pouring money into the commodity because the Fed is trashing the dollar. Because oil is a dollar denominated commodity, it provides a hedge for investors worried about a falling dollar. They are looking for ways to preserve the value of their dollar denominated assets. Eventually, these higher oil prices will drive up the price of gasoline, too.
In the past, higher gasoline prices had little effect on consumption. This is because it takes time for consumers to adjust their behavior. You don't immediately dump your SUV and buy a Civic just because gasoline prices spike. But if you are convinced that higher gasoline prices are here to stay, the next time you are in the market for a new vehicle, you will consider something more efficient. After several years of watching gasoline prices climb higher and higher, consumers are making the switch.
These days automobile manufacturers can't sell SUVs and pick-up trucks without making large concessions. In fact, GM just reported a 19% drop in light truck sales. Consumers are doing the math and they now want more efficient vehicles. At $3 per gallon, if you drive 12,000 miles per year and get 20 mpg, a 50% improvement in mileage saves you $600 per year. At $4 per gallon, you will save $800 per year. If there are three cars in your family and they rack up a total of 36,000 miles per year, at $4 per gallon, the total savings adds up to $2,400 per year.
The government can take steps to encourage conservation. CAFE standards, however, are not the way to go. A better approach is to put a floor on gasoline prices. While I'm no fan of higher taxes, it cannot be denied that taxes are a great way to affect behavior. If we want to reduce our dependence on foreign oil, we should encourage people to consume less gasoline. The best way to do that is to make driving more expensive. However, any incremental revenue the government generates from a floor on gasoline prices should be used to offset other taxes or to fund research into alternative technologies. Using it for general funding purposes would be nothing but a big waste.
But oil prices are not climbing because of a lack of supply. Instead, they are rising due to demand for oil futures contracts. Investors are pouring money into the commodity because the Fed is trashing the dollar. Because oil is a dollar denominated commodity, it provides a hedge for investors worried about a falling dollar. They are looking for ways to preserve the value of their dollar denominated assets. Eventually, these higher oil prices will drive up the price of gasoline, too.
In the past, higher gasoline prices had little effect on consumption. This is because it takes time for consumers to adjust their behavior. You don't immediately dump your SUV and buy a Civic just because gasoline prices spike. But if you are convinced that higher gasoline prices are here to stay, the next time you are in the market for a new vehicle, you will consider something more efficient. After several years of watching gasoline prices climb higher and higher, consumers are making the switch.
These days automobile manufacturers can't sell SUVs and pick-up trucks without making large concessions. In fact, GM just reported a 19% drop in light truck sales. Consumers are doing the math and they now want more efficient vehicles. At $3 per gallon, if you drive 12,000 miles per year and get 20 mpg, a 50% improvement in mileage saves you $600 per year. At $4 per gallon, you will save $800 per year. If there are three cars in your family and they rack up a total of 36,000 miles per year, at $4 per gallon, the total savings adds up to $2,400 per year.
The government can take steps to encourage conservation. CAFE standards, however, are not the way to go. A better approach is to put a floor on gasoline prices. While I'm no fan of higher taxes, it cannot be denied that taxes are a great way to affect behavior. If we want to reduce our dependence on foreign oil, we should encourage people to consume less gasoline. The best way to do that is to make driving more expensive. However, any incremental revenue the government generates from a floor on gasoline prices should be used to offset other taxes or to fund research into alternative technologies. Using it for general funding purposes would be nothing but a big waste.
Tuesday, February 19, 2008
Fed Rate Cuts Are Near an End
While many investors are betting the Fed will continue cutting interest rates, I'm starting to believe we are very near the end of this rate-cutting cycle for several reasons.
First, the Fed has already been extremely aggressive with its recent rate cuts, slashing them 225 basis points since September. Because interest rate reductions spur economic activity with a lag, the rate cuts delivered so far are probably just starting to kick in. The Fed would prefer to wait and see if more monetary stimulus is really needed.
Second, the fiscal stimulus package recently signed into law by President Bush takes a lot of heat off the Fed. While tax rebates are not as effective as tax cuts, they do give the economy a bit of a boost. This makes it much easier for Ben Bernanke and the Fed to hold off on further cuts.
Third, the stock market appears to be stabilizing. This also makes it easier for the Fed to stand pat. Bernanke was strongly criticized for reacting more to the stock market than to economic data. He no doubt is hoping stable stock prices persist.
Fourth, recent economic weakness put inflation on the back burner. But inflation cannot be ignored anymore. Any further evidence that headline inflation is creeping into the core rate will make it very difficult for the Fed to keep cutting rates.
The FOMC's next meeting is almost a month away. A lot more economic data will be released between now and then. You can bet the Fed is hoping that more rate cuts will not be needed.
First, the Fed has already been extremely aggressive with its recent rate cuts, slashing them 225 basis points since September. Because interest rate reductions spur economic activity with a lag, the rate cuts delivered so far are probably just starting to kick in. The Fed would prefer to wait and see if more monetary stimulus is really needed.
Second, the fiscal stimulus package recently signed into law by President Bush takes a lot of heat off the Fed. While tax rebates are not as effective as tax cuts, they do give the economy a bit of a boost. This makes it much easier for Ben Bernanke and the Fed to hold off on further cuts.
Third, the stock market appears to be stabilizing. This also makes it easier for the Fed to stand pat. Bernanke was strongly criticized for reacting more to the stock market than to economic data. He no doubt is hoping stable stock prices persist.
Fourth, recent economic weakness put inflation on the back burner. But inflation cannot be ignored anymore. Any further evidence that headline inflation is creeping into the core rate will make it very difficult for the Fed to keep cutting rates.
The FOMC's next meeting is almost a month away. A lot more economic data will be released between now and then. You can bet the Fed is hoping that more rate cuts will not be needed.
Wednesday, February 13, 2008
Baseball Takes Center Stage in Congress
CNBC has been airing the Congressional questioning of Roger Clemens and Brian McNamee all morning. This is about as interesting as Britney Spears' travails. I thought CNBC was a business channel.
This also explains why we are so turned off by our political leaders. After delivering a fiscal stimulus package, Congress has nothing better to worry about than steroid use in baseball? Is it just me, or does anybody else see a problem here?
This also explains why we are so turned off by our political leaders. After delivering a fiscal stimulus package, Congress has nothing better to worry about than steroid use in baseball? Is it just me, or does anybody else see a problem here?
Monday, February 11, 2008
Dow Becomes More Finance Heavy
Dow Jones & Co. announced changes to its prestigious Industrial Average today. Altria Group and Honeywell are being dropped. Bank of America and Chevron will be added.
Dropping Honeywell is a bit odd since the company has been doing well for a prolonged period. Honeywell's predecessor company, Allied Chemical, was added to the Dow average in 1925. Honeywell's comparatively small size was cited as the reason for removing it, yet there are three stocks that remain in the index that have even smaller market capitalizations. General Motors, a seriously troubled company, is one of them.
Chevron was previously in the Dow index. It was dropped in 1999 when both Microsoft and Intel were added, which marked the first time (and so far the only time) Nasdaq-listed stocks were added to the index. This raised expectations that more would follow. Some observers are disappointed that today's additions did not include a mega-cap technology company such as Google or Oracle.
Bank of America's inclusion increases the Dow's weighting in financials. The Dow also includes JPMorgan Chase, Citigroup, American International Group, and American Express. Is this the committee's way of signaling a bottom in this beaten up sector?
Dropping Honeywell is a bit odd since the company has been doing well for a prolonged period. Honeywell's predecessor company, Allied Chemical, was added to the Dow average in 1925. Honeywell's comparatively small size was cited as the reason for removing it, yet there are three stocks that remain in the index that have even smaller market capitalizations. General Motors, a seriously troubled company, is one of them.
Chevron was previously in the Dow index. It was dropped in 1999 when both Microsoft and Intel were added, which marked the first time (and so far the only time) Nasdaq-listed stocks were added to the index. This raised expectations that more would follow. Some observers are disappointed that today's additions did not include a mega-cap technology company such as Google or Oracle.
Bank of America's inclusion increases the Dow's weighting in financials. The Dow also includes JPMorgan Chase, Citigroup, American International Group, and American Express. Is this the committee's way of signaling a bottom in this beaten up sector?
Monday, February 04, 2008
Bearish on Economy; Bullish on Stocks
The following commentary was released last week to subscribers of the Forbes Growth Investor:
Regular readers know that I have been bearish on both the economy and stocks for quite some time. While I certainly enjoyed the ride, I could not understand why stocks were rallying so strongly during the first half of 2007. Although the sell-off that began in mid-July did not surprise me, I was perplexed by the full and rapid recovery that immediately followed. Unfortunately, as we all know, those gains did not last very long. The S&P currently stands about 12% below its October peak.
It was obvious that economic conditions were deteriorating. There was much discussion about the housing bubble and the subprime mortgage crisis. Every rational investor had to be worried about the potential ramifications of these problems and the real possibility that they would spread to other sectors of our economy. Yet I found it incomprehensible how the eternal optimists kept downplaying these concerns. I don’t know how many times I was told that subprime mortgages represent just a tiny fraction of all mortgages, or that housing prices would never fall on a nationwide basis.
One prominent and perennial bull, who once chided the media for giving bears too much air time, recently argued there is “so little evidence of serious trouble” in the economy. Admittedly, this remark came before the 0.6% fourth-quarter Advance GDP figure was released, and before the Dept. of Labor said initial jobless claims jumped to 375,000, pushing up the four-week average by more than 10,000 to 325,750. Yet there has long been more than a little evidence that the economy was headed for trouble.
As for the argument that subprime mortgage problems would be contained, almost all financial institutions have already announced massive writedowns. This is no surprise. What is surprising, however, is a recent release from pharmaceuticals giant Bristol-Myers Squibb. Bristol said it took a $275 million impairment charge in the fourth quarter due to soured investments in auction rate securities (i.e., collateralized debt obligations backed by mortgages and credit card loans). Furthermore, Bristol no longer considers these investments liquid and has reclassified them from current to non-current assets. I suspect Bristol won’t be the only major non-financial company revealing these kinds of writedowns.
There is much debate about whether or not a recession is coming. In my view, it has already arrived. But whether or not it’s an “official” recession is largely irrelevant. The Federal Reserve is obviously so alarmed it has slashed interest rates at a record-breaking pace without regard to the inflationary consequences. Washington politicians are also alarmed. They are pushing through a fiscal stimulus package many observers thought would take months to reach the president’s desk. This combination of strong monetary and fiscal stimuli will prevent a recession from becoming too deep or prolonged. While I remain bearish on the economy for the time being, as I explained on my blog (http://janjigian.blogspot.com) on Jan. 21, I am turning more bullish on stocks. I believe stocks have fallen enough to be attractive to all investors except those with very short horizons. It’s time to allocate more money to this asset class. This month’s Citigroup recommendation conveys my conviction that some of the best opportunities for long-term gains will come from the oversold financial sector.
Regular readers know that I have been bearish on both the economy and stocks for quite some time. While I certainly enjoyed the ride, I could not understand why stocks were rallying so strongly during the first half of 2007. Although the sell-off that began in mid-July did not surprise me, I was perplexed by the full and rapid recovery that immediately followed. Unfortunately, as we all know, those gains did not last very long. The S&P currently stands about 12% below its October peak.
It was obvious that economic conditions were deteriorating. There was much discussion about the housing bubble and the subprime mortgage crisis. Every rational investor had to be worried about the potential ramifications of these problems and the real possibility that they would spread to other sectors of our economy. Yet I found it incomprehensible how the eternal optimists kept downplaying these concerns. I don’t know how many times I was told that subprime mortgages represent just a tiny fraction of all mortgages, or that housing prices would never fall on a nationwide basis.
One prominent and perennial bull, who once chided the media for giving bears too much air time, recently argued there is “so little evidence of serious trouble” in the economy. Admittedly, this remark came before the 0.6% fourth-quarter Advance GDP figure was released, and before the Dept. of Labor said initial jobless claims jumped to 375,000, pushing up the four-week average by more than 10,000 to 325,750. Yet there has long been more than a little evidence that the economy was headed for trouble.
As for the argument that subprime mortgage problems would be contained, almost all financial institutions have already announced massive writedowns. This is no surprise. What is surprising, however, is a recent release from pharmaceuticals giant Bristol-Myers Squibb. Bristol said it took a $275 million impairment charge in the fourth quarter due to soured investments in auction rate securities (i.e., collateralized debt obligations backed by mortgages and credit card loans). Furthermore, Bristol no longer considers these investments liquid and has reclassified them from current to non-current assets. I suspect Bristol won’t be the only major non-financial company revealing these kinds of writedowns.
There is much debate about whether or not a recession is coming. In my view, it has already arrived. But whether or not it’s an “official” recession is largely irrelevant. The Federal Reserve is obviously so alarmed it has slashed interest rates at a record-breaking pace without regard to the inflationary consequences. Washington politicians are also alarmed. They are pushing through a fiscal stimulus package many observers thought would take months to reach the president’s desk. This combination of strong monetary and fiscal stimuli will prevent a recession from becoming too deep or prolonged. While I remain bearish on the economy for the time being, as I explained on my blog (http://janjigian.blogspot.com) on Jan. 21, I am turning more bullish on stocks. I believe stocks have fallen enough to be attractive to all investors except those with very short horizons. It’s time to allocate more money to this asset class. This month’s Citigroup recommendation conveys my conviction that some of the best opportunities for long-term gains will come from the oversold financial sector.
Friday, February 01, 2008
We Can Thank Buffett for the Microsoft/Yahoo Deal
Shares of Yahoo soared following today's announcement that Microsoft made a bid for the company. Microsoft is offering $31 per share for Yahoo, which represents a 62% premium over Yahoo's previous closing price.
Microsoft is obviously hoping a Yahoo acquisition will allow it to compete more effectively against Google. Analysts are already debating whether or not the deal makes sense. However, other than the timing, there is really nothing surprising about the deal. As I pointed out last June (Speculating on a Microsoft and Yahoo! Deal) Susan Decker's promotion to president of Yahoo made a deal between Microsoft and Yahoo all the more likely. This is because Decker had also been recently appointed to Berkshire Hathaway's board of directors. Not coincidentally, Bill Gates, Microsoft's founder, also sits on the Berkshire board.
When all is said and done, Yahoo sharesholders should thank Warren Buffett for today's offer from Microsoft. After all, Buffett was instrumental in bringing together the major players in this deal.
Microsoft is obviously hoping a Yahoo acquisition will allow it to compete more effectively against Google. Analysts are already debating whether or not the deal makes sense. However, other than the timing, there is really nothing surprising about the deal. As I pointed out last June (Speculating on a Microsoft and Yahoo! Deal) Susan Decker's promotion to president of Yahoo made a deal between Microsoft and Yahoo all the more likely. This is because Decker had also been recently appointed to Berkshire Hathaway's board of directors. Not coincidentally, Bill Gates, Microsoft's founder, also sits on the Berkshire board.
When all is said and done, Yahoo sharesholders should thank Warren Buffett for today's offer from Microsoft. After all, Buffett was instrumental in bringing together the major players in this deal.
Friday, January 25, 2008
Only Tax Cuts Work in the Long Run
I was asked several times this past week about the presidential candidates and their plans to revive the economy. How the candidates would get us out of recession is largely irrelevant. After all, whoever wins the election will not actually enter the White House until a year from now. Hopefully, the recession will be over by then.
I know that not everyone believes we are actually in a recession, but whether we are or aren't is also largely irrelevant. The fact is that economic growth has slowed tremendously and some regions of the country are experiencing contraction. In any case, the situation is dire enough that something must be done to revive the economy.
I explained on MSNBC and on the Leon Charney Report, which airs in the New York City area, that an economic recession is a bit like a patient who is having a heart attack. First the doctor treats the heart attack--usually with surgery and medication--then once the patient has been stabilized, the doctor addresses the long-term health issues. He might prescribe a change in diet and an exercise program. The goal is to make the patient healthier in order to reduce the odds that he will suffer another heart attack in the future.
From what I've been hearing so far, the Democrats' proposals address the heart attack. They are looking for ways to immediately revive the economy. But they are ignoring the long-term health issues. I'm not seeing anything on their table that would keep the economy healthy over the long term and reduce the odds of another recession.
The Republican candidates, on the other hand, are focused on the long term. They all want to reduce tax rates on individuals and corporations. Mike Huckabee is even proposing to eliminate the income tax entirely and replace it with a national sales tax. Lower taxes will certainly go a long way to ensure the long-term health of the economy, but they don't do much to address the immediate problem.
Yesterday, government officials announced agreement on a $150 billion economic stimulus package. They plan to mail checks to about 117 million families. They even proposed allowing Fannie Mae and Freddie Mac to temporarily purchase mortgages well above the current $417,000 limit. These proposals are well and good, but they merely treat the heart attack. They don't do anything to ensure the economy's long-term health. Hopefully, the Senate will add such measures before a final bill reaches the president's desk.
I know that not everyone believes we are actually in a recession, but whether we are or aren't is also largely irrelevant. The fact is that economic growth has slowed tremendously and some regions of the country are experiencing contraction. In any case, the situation is dire enough that something must be done to revive the economy.
I explained on MSNBC and on the Leon Charney Report, which airs in the New York City area, that an economic recession is a bit like a patient who is having a heart attack. First the doctor treats the heart attack--usually with surgery and medication--then once the patient has been stabilized, the doctor addresses the long-term health issues. He might prescribe a change in diet and an exercise program. The goal is to make the patient healthier in order to reduce the odds that he will suffer another heart attack in the future.
From what I've been hearing so far, the Democrats' proposals address the heart attack. They are looking for ways to immediately revive the economy. But they are ignoring the long-term health issues. I'm not seeing anything on their table that would keep the economy healthy over the long term and reduce the odds of another recession.
The Republican candidates, on the other hand, are focused on the long term. They all want to reduce tax rates on individuals and corporations. Mike Huckabee is even proposing to eliminate the income tax entirely and replace it with a national sales tax. Lower taxes will certainly go a long way to ensure the long-term health of the economy, but they don't do much to address the immediate problem.
Yesterday, government officials announced agreement on a $150 billion economic stimulus package. They plan to mail checks to about 117 million families. They even proposed allowing Fannie Mae and Freddie Mac to temporarily purchase mortgages well above the current $417,000 limit. These proposals are well and good, but they merely treat the heart attack. They don't do anything to ensure the economy's long-term health. Hopefully, the Senate will add such measures before a final bill reaches the president's desk.
Monday, January 21, 2008
Too Late to Turn Bearish
It's funny how stock market bulls often turn bearish after prices have already fallen. I've been a bear for quite a while and found myself debating a number of bulls over the past year. One well-known bull even argued that by giving bears like me an equal amount of air time, the media was falsely creating the impression that economists were split on the issue of future growth.
Today there are no serious economists left who are predicting strong growth. The most bullish among them, including Fed Chairman Ben Bernanke, are predicting only weak growth. Many believe a recession is quite likely. Some, like myself, believe a recession has already arrived. Even non-farm payroll growth, perhaps the most encouraging economic measure all along, is starting to show serious signs of strain.
Today I had an interesting conversation with Professor Michael Goldstein of Babson College. He and I worked together over a decade ago when we were both on the faculty at Boston College. Michael was preparing for a television interview about the stock market. He reminded me that a year ago both of us were scratching our heads trying to understand why stocks were rising so rapidly. At that time, we were both concerned about falling house prices and their detrimental effects on consumer spending. Today we are just as concerned about rising credit card defaults.
Dow futures are currently indicating a very weak opening tomorrow morning. The Dow may immediately plunge 500 points or more. Michael and I think it could even dip below 11,000 soon--at least on an intra-day basis. However, we also agreed that significant declines below that level are unlikely.
Most long-term investors should take a contrarian view. At this time, they should be thinking more about buying than selling. It isn't yet time to jump in with both feet, but it is time to start thinking about taking advantage of serious dips. Some Special Situation stocks we continue to favor include SVU, RKT, and PERY. These also are stocks that I personally have been buying.
Today there are no serious economists left who are predicting strong growth. The most bullish among them, including Fed Chairman Ben Bernanke, are predicting only weak growth. Many believe a recession is quite likely. Some, like myself, believe a recession has already arrived. Even non-farm payroll growth, perhaps the most encouraging economic measure all along, is starting to show serious signs of strain.
Today I had an interesting conversation with Professor Michael Goldstein of Babson College. He and I worked together over a decade ago when we were both on the faculty at Boston College. Michael was preparing for a television interview about the stock market. He reminded me that a year ago both of us were scratching our heads trying to understand why stocks were rising so rapidly. At that time, we were both concerned about falling house prices and their detrimental effects on consumer spending. Today we are just as concerned about rising credit card defaults.
Dow futures are currently indicating a very weak opening tomorrow morning. The Dow may immediately plunge 500 points or more. Michael and I think it could even dip below 11,000 soon--at least on an intra-day basis. However, we also agreed that significant declines below that level are unlikely.
Most long-term investors should take a contrarian view. At this time, they should be thinking more about buying than selling. It isn't yet time to jump in with both feet, but it is time to start thinking about taking advantage of serious dips. Some Special Situation stocks we continue to favor include SVU, RKT, and PERY. These also are stocks that I personally have been buying.
Thursday, January 17, 2008
Bernanke Deserves Blame for Sell-Off in Stocks
Ben Bernanke testified in Congress today. Investors reacted by dumping stocks. Some insist that the sell-off had little to do with his remarks and more to do with other factors, such as Merrill Lynch's disappointing results. I doubt this is the case. After all, Merrill Lynch announced its results early this morning and the market was holding up well--at least until Bernanke's testimony got under way.
The Chairman's remarks made it clear that he is very worried about the economy. Although he said the Fed is still not forecasting recession, he clearly indicated that growth will be disappointing. He mentioned the troubled banks, mortgage-related problems in the residential market, signs of weakness extending into the commercial market, weakening employment figures, and an uptick in core inflation.
Bernanke strongly hinted that the Fed will cut interest rates once again. Some investors are disappointed that the Fed may not actually implement a cut until the Jan. 30 meeting. They want a cut right now.
Bernanke also asked Congress for fiscal stimulus. He apparently believes things are so bad that interest rate cuts alone are not enough to stimulate the economy. The mere fact that he was asking Congress for tax relief made investors nervous.
Cutting taxes is the best way to prevent recession. But Bernanke was not arguing for the kinds of tax cuts Republicans favor. Instead of cutting tax rates or making the Bush tax cuts permanent, he expressed a preference for something immediate but temporary. His comments were well-received by Democrats.
Alex Witt of MSNBC asked me about the political repercussions of all this. The bottom line is that things don't look good for the Republicans. Right or wrong, the party in power gets the credit if the economy does well. Likewise, voters blame the president and his party if a recession occurs. Voters demand change. At this point, an economic recession would improve the Democrats chances of taking the White House this fall. But with Democrats controlling both Congress and the White House, taxes are sure to go higher. Then we'll really know what a recession feels like.
The Chairman's remarks made it clear that he is very worried about the economy. Although he said the Fed is still not forecasting recession, he clearly indicated that growth will be disappointing. He mentioned the troubled banks, mortgage-related problems in the residential market, signs of weakness extending into the commercial market, weakening employment figures, and an uptick in core inflation.
Bernanke strongly hinted that the Fed will cut interest rates once again. Some investors are disappointed that the Fed may not actually implement a cut until the Jan. 30 meeting. They want a cut right now.
Bernanke also asked Congress for fiscal stimulus. He apparently believes things are so bad that interest rate cuts alone are not enough to stimulate the economy. The mere fact that he was asking Congress for tax relief made investors nervous.
Cutting taxes is the best way to prevent recession. But Bernanke was not arguing for the kinds of tax cuts Republicans favor. Instead of cutting tax rates or making the Bush tax cuts permanent, he expressed a preference for something immediate but temporary. His comments were well-received by Democrats.
Alex Witt of MSNBC asked me about the political repercussions of all this. The bottom line is that things don't look good for the Republicans. Right or wrong, the party in power gets the credit if the economy does well. Likewise, voters blame the president and his party if a recession occurs. Voters demand change. At this point, an economic recession would improve the Democrats chances of taking the White House this fall. But with Democrats controlling both Congress and the White House, taxes are sure to go higher. Then we'll really know what a recession feels like.
Wednesday, January 16, 2008
Family-Owned Businesses Fear Higher Taxes
PricewaterhouseCoopers (PwC) invited me last night to dine with the CFOs of a dozen privately owned family businesses. These companies ranged in size from about $20 million per year in revenues to $2 billion. Executives from publicly traded companies have plenty of opportunities to meet with one another, but those from privately held family businesses often do not. Last night's dinner was put together to address this situation.
Since my focus is primarily on publicly-traded equities, I welcomed the opportunity to meet executives from the other side. Although I work for a privately-held family business, I rarely get a chance to meet executives from other such companies. The evening was a wonderful learning experience. In particular, PwC had compiled an interesting survey of privately-owned family businesses. Many of the findings were surprising to me. One was not. It turns out these executives worry a great deal about government regulation and taxation. In fact, two-thirds of respondents felt that tax simplification and/or tax reduction should be a priority for government over the next three to five years.
I have written often about the tax burden in the Forbes Growth Investor and elsewhere and wondered why the stock market had been doing so well even when it became increasingly apparent that the Democrats stood a good chance of taking the White House. A Democratic president combined with a Democratic majority in Congress spells higher taxes. Even if the Republicans manage to hold onto the White House, the Bush tax cuts are likely to expire--another way to spell higher taxes. It is difficult to argue that stocks can thrive in a high-tax environment--at least not until they first sustain a sizable sell-off. Perhaps that is what we are going through right now.
Since my focus is primarily on publicly-traded equities, I welcomed the opportunity to meet executives from the other side. Although I work for a privately-held family business, I rarely get a chance to meet executives from other such companies. The evening was a wonderful learning experience. In particular, PwC had compiled an interesting survey of privately-owned family businesses. Many of the findings were surprising to me. One was not. It turns out these executives worry a great deal about government regulation and taxation. In fact, two-thirds of respondents felt that tax simplification and/or tax reduction should be a priority for government over the next three to five years.
I have written often about the tax burden in the Forbes Growth Investor and elsewhere and wondered why the stock market had been doing so well even when it became increasingly apparent that the Democrats stood a good chance of taking the White House. A Democratic president combined with a Democratic majority in Congress spells higher taxes. Even if the Republicans manage to hold onto the White House, the Bush tax cuts are likely to expire--another way to spell higher taxes. It is difficult to argue that stocks can thrive in a high-tax environment--at least not until they first sustain a sizable sell-off. Perhaps that is what we are going through right now.
Friday, January 11, 2008
By How Much Will Citi Cut the Dividend?
Citigroup is scheduled to announce fourth quarter financial results on Tuesday morning. Analysts are projecting a loss of almost a dollar per share. Investors are keen to hear how much more mortgage-related writedowns there will be. As for the dividend, they are no longer wondering if it will be cut. The only question left is by how much.
The board of directors is reportedly meeting on Monday. You can bet the dividend will be a high-priority topic of discussion. Although company officials have said a number of times that the dividend is safe, no one believes this anymore. Cutting the dividend is the surest way to preserve capital. And you can bet the new investors from Abu-Dhabi will insist upon it.
Citigroup has a long history of consistent dividend increases. Yet management knows that the company can save almost $11 billion in one year alone by eliminating the dividend entirely. It can save $1 billion simply by taking back the 10% increase implemented just one year ago. Management also knows that investors are expecting a dividend cut, so it's an easy thing for them to do. The consensus is calling for a 50% reduction. If that turns out to be the case, the stock may stage a bit of a rally. However, a cut of less than 50% should cause the stock to surge.
The board of directors is reportedly meeting on Monday. You can bet the dividend will be a high-priority topic of discussion. Although company officials have said a number of times that the dividend is safe, no one believes this anymore. Cutting the dividend is the surest way to preserve capital. And you can bet the new investors from Abu-Dhabi will insist upon it.
Citigroup has a long history of consistent dividend increases. Yet management knows that the company can save almost $11 billion in one year alone by eliminating the dividend entirely. It can save $1 billion simply by taking back the 10% increase implemented just one year ago. Management also knows that investors are expecting a dividend cut, so it's an easy thing for them to do. The consensus is calling for a 50% reduction. If that turns out to be the case, the stock may stage a bit of a rally. However, a cut of less than 50% should cause the stock to surge.
Monday, January 07, 2008
Bremmer Warns of U.S. Decline
Ian Bremmer, president of the Eurasia Group, is one of the smartest guys I know. That's why I pay close attention to what he says. And what he is saying right now is not just surprising; it is scary.
He just released a report called the Top 9 Risks of 2008. Because the Eurasia Group is a political risk advisory and consulting firm, some of the items on the list are not at all surprising. What is surprising, however, is that he now considers the United States the #1 risk on his list. Bremmer argues that America's influence is on the wane. The risk is that the country will disengage from the world, erect barriers to trade, and make immigration more difficult. In short, the U.S. is losing both the political will and capital to lead the world. Go to Eurasia Group to learn more.
He just released a report called the Top 9 Risks of 2008. Because the Eurasia Group is a political risk advisory and consulting firm, some of the items on the list are not at all surprising. What is surprising, however, is that he now considers the United States the #1 risk on his list. Bremmer argues that America's influence is on the wane. The risk is that the country will disengage from the world, erect barriers to trade, and make immigration more difficult. In short, the U.S. is losing both the political will and capital to lead the world. Go to Eurasia Group to learn more.
Friday, January 04, 2008
Oil Prices Likely to Drop as Recession Fears Grow
As shown in the graph above, both oil (blue line) and gasoline (red line) prices have surged over the past five years. However, oil prices have about tripled while gasoline prices have only done a little more than a double. The prices of these two commodities were tracking together quite closely until around June 2007. Since June, however, gasoline prices have remained relatively stable while oil prices have continued to rise.
Yesterday, oil broke above $100 per barrel. Speculators are getting much of the blame. The divergence between oil and gasoline prices gives some credence to this theory. After all, looking strictly at supply and demand considerations it is difficult to understand why oil prices have gone up so high. While it is certainly true that oil-producing regions of the world are not very stable, and that the world is consuming all it produces, there are no shortages.
As today's numbers show, the economy is no longer producing a sufficient number of jobs. The unemployment rate jumped to 5%. The U.S. economy is slowing and the probability of recession has risen significantly. While gasoline prices may go up in the short run, it is much more likely that an economic slowdown will cause oil prices to fall over the longer run. Look for oil to drop to $70 per barrel this year.
Thursday, January 03, 2008
Stocks Will Struggle in 2008
Following is my commentary from the January 2008 issue of the Forbes Growth Investor, which was released earlier to subscribers:
The stock market ended 2007 with a whimper. The closely followed S&P 500 Index managed to post only a 3.5% gain for the full year. Investors could have done about as well simply by holding cash and avoiding risk entirely. Although the other major indexes did somewhat better than the S&P 500 (see page 6 of newsletter for their full year returns), 2007 was a lackluster year overall.
Troubles in the housing market are largely to blame for weak stock returns. In fact, shares of home builders and financial companies were particularly hard hit during the year. As of now, prospects for stocks in 2008 do not look all that promising as the housing bubble has yet to fully deflate. According to the most recent reports, problems in housing are likely to get worse before they finally bottom. New home sales were down 34% year-over-year in November. Existing home sales were down 20%. If home sales continue at current rates, it will take more than nine months to clear the inventory of new homes on the market and more than 10 months to deplete the inventory of existing homes.
But it’s not just sales that are falling. Housing prices are collapsing as well. In October, the S&P/Case-Shiller 10-City Composite Home Price Index posted its biggest decline ever, falling 6.7% from a year ago and 1.4% from the previous month. This index is down 7.3% from its June peak. More worrisome, however, is that the rate of decline is accelerating.
All along, the more optimistic economists had been telling us not to worry. They said the sub-prime market was relatively small and its troubles would not spread to the rest of the housing market. They were wrong about this. What’s worse, it now appears that housing problems are spreading into nonhousing areas as well. Evidence is mounting that credit card delinquencies and defaults are rising. According to one study conducted by the Associated Press, outstanding balances on credit card accounts that are at least 30 days late jumped 26% from a year ago. Those that are 90 days late jumped 50%. The same study found an 18% increase in defaults. With the holiday shopping season having just ended, it’s a sure bet that these numbers will get worse.
Investors are just starting to realize that credit card problems are related to the housing and mortgage debacles. Because lending standards have been tightened, even otherwise creditworthy borrowers cannot easily tap the shrinking equity in their homes to pay off their credit card bills. And the so-called sophisticated institutional investors are less willing now than they once were to purchase securitized credit card loans.
Prospects for stocks in 2008 do not look good indeed. Housing and consumer spending are not the only things to worry about. Economic growth is slowing, yet persistently high energy prices and rising core inflation give the Fed little room to cut interest rates. Even the jobs market, which had long remained a bright spot in the economy, is starting to make investors nervous. Many economists now expect reduced growth in non-farm payrolls and an increase in the unemployment rate. The Dec. payroll figure and unemployment rate will be announced on Jan. 4. Anything out of the ordinary for either measure could create tremendous volatility for stocks.
The stock market ended 2007 with a whimper. The closely followed S&P 500 Index managed to post only a 3.5% gain for the full year. Investors could have done about as well simply by holding cash and avoiding risk entirely. Although the other major indexes did somewhat better than the S&P 500 (see page 6 of newsletter for their full year returns), 2007 was a lackluster year overall.
Troubles in the housing market are largely to blame for weak stock returns. In fact, shares of home builders and financial companies were particularly hard hit during the year. As of now, prospects for stocks in 2008 do not look all that promising as the housing bubble has yet to fully deflate. According to the most recent reports, problems in housing are likely to get worse before they finally bottom. New home sales were down 34% year-over-year in November. Existing home sales were down 20%. If home sales continue at current rates, it will take more than nine months to clear the inventory of new homes on the market and more than 10 months to deplete the inventory of existing homes.
But it’s not just sales that are falling. Housing prices are collapsing as well. In October, the S&P/Case-Shiller 10-City Composite Home Price Index posted its biggest decline ever, falling 6.7% from a year ago and 1.4% from the previous month. This index is down 7.3% from its June peak. More worrisome, however, is that the rate of decline is accelerating.
All along, the more optimistic economists had been telling us not to worry. They said the sub-prime market was relatively small and its troubles would not spread to the rest of the housing market. They were wrong about this. What’s worse, it now appears that housing problems are spreading into nonhousing areas as well. Evidence is mounting that credit card delinquencies and defaults are rising. According to one study conducted by the Associated Press, outstanding balances on credit card accounts that are at least 30 days late jumped 26% from a year ago. Those that are 90 days late jumped 50%. The same study found an 18% increase in defaults. With the holiday shopping season having just ended, it’s a sure bet that these numbers will get worse.
Investors are just starting to realize that credit card problems are related to the housing and mortgage debacles. Because lending standards have been tightened, even otherwise creditworthy borrowers cannot easily tap the shrinking equity in their homes to pay off their credit card bills. And the so-called sophisticated institutional investors are less willing now than they once were to purchase securitized credit card loans.
Prospects for stocks in 2008 do not look good indeed. Housing and consumer spending are not the only things to worry about. Economic growth is slowing, yet persistently high energy prices and rising core inflation give the Fed little room to cut interest rates. Even the jobs market, which had long remained a bright spot in the economy, is starting to make investors nervous. Many economists now expect reduced growth in non-farm payrolls and an increase in the unemployment rate. The Dec. payroll figure and unemployment rate will be announced on Jan. 4. Anything out of the ordinary for either measure could create tremendous volatility for stocks.
Thursday, December 20, 2007
Interest Rates v. Tax Rates
David Wessel wrote an excellent article in today's Wall Street Journal about the need to stimulate the economy. While everyone agrees that the economy is slowing and needs a boost, Wessel wonders if it is better for the Fed to continue cutting interest rates, or if a tax cut would be more effective. He pretty much rules out hope for a tax cut arguing that Congress is unlikely to agree to one.
That's too bad because the Fed cannot realistically cut rates anymore, and because tax cuts are indeed much more effective in stimulating economies. Even former Clinton-era Treasury Secretary Lawrence Summers is now pushing for tax cuts.
Why can't the Fed cut rates? Because inflation is rising. Since September, the Fed dropped both the discount rate and the fed funds rate by a hundred basis points each. Although it takes time for interest rate cuts to stimulate the economy, these recent cuts appear to be having little (if any) effect. They have, however, helped to trash the dollar. While U.S. exports have risen, which is certainly a good thing, so has the level of inflation. Higher inflation makes it very unlikely that the Fed will keep cutting rates.
Many economists are hoping that lower interest rates will soon revive the housing market. But the Fed's actions have not lowered mortgage rates. Furthermore, the housing market will remain in the doldrums for quite some time. There is simply too much inventory on the market. And no rational person would buy a house if he expects the price to keep falling--even if he could get a zero percent mortgage.
That brings us back to tax cuts, which of course are not popular with the liberal set. Liberals argue that tax cuts typically benefit only the wealthy. Yet if tax cuts must be implemented, liberals would rather see those in the lower income brackets get the cuts.
But how is that possible? After all, by definition tax cuts only benefit those who actually pay taxes. Because our income tax code is so progressive, those in the lower income brackets hardly pay any tax at all. How many Americans realize that the bottom 50% (by income) of our population pay only 3% of all individual income taxes? How could Congress possibly deliver a meaningful tax cut to this group? The only way to truly help those in lower income brackets is to implement policies that stimulate economic growth and create opportunities for all members of society.
For many working Americans, the tax burden is much too heavy. The combination of federal income taxes, state income taxes, property taxes, sales taxes, and all those other hidden taxes can easily eat up more than one-half of income. Property taxes, in particular, have literally gone through the roof in many parts of the country. If politicians really want to stimulate the housing market, the most effective way would be to immediately cut property taxes and limit how high they could go in the future.
That's too bad because the Fed cannot realistically cut rates anymore, and because tax cuts are indeed much more effective in stimulating economies. Even former Clinton-era Treasury Secretary Lawrence Summers is now pushing for tax cuts.
Why can't the Fed cut rates? Because inflation is rising. Since September, the Fed dropped both the discount rate and the fed funds rate by a hundred basis points each. Although it takes time for interest rate cuts to stimulate the economy, these recent cuts appear to be having little (if any) effect. They have, however, helped to trash the dollar. While U.S. exports have risen, which is certainly a good thing, so has the level of inflation. Higher inflation makes it very unlikely that the Fed will keep cutting rates.
Many economists are hoping that lower interest rates will soon revive the housing market. But the Fed's actions have not lowered mortgage rates. Furthermore, the housing market will remain in the doldrums for quite some time. There is simply too much inventory on the market. And no rational person would buy a house if he expects the price to keep falling--even if he could get a zero percent mortgage.
That brings us back to tax cuts, which of course are not popular with the liberal set. Liberals argue that tax cuts typically benefit only the wealthy. Yet if tax cuts must be implemented, liberals would rather see those in the lower income brackets get the cuts.
But how is that possible? After all, by definition tax cuts only benefit those who actually pay taxes. Because our income tax code is so progressive, those in the lower income brackets hardly pay any tax at all. How many Americans realize that the bottom 50% (by income) of our population pay only 3% of all individual income taxes? How could Congress possibly deliver a meaningful tax cut to this group? The only way to truly help those in lower income brackets is to implement policies that stimulate economic growth and create opportunities for all members of society.
For many working Americans, the tax burden is much too heavy. The combination of federal income taxes, state income taxes, property taxes, sales taxes, and all those other hidden taxes can easily eat up more than one-half of income. Property taxes, in particular, have literally gone through the roof in many parts of the country. If politicians really want to stimulate the housing market, the most effective way would be to immediately cut property taxes and limit how high they could go in the future.
Friday, December 14, 2007
Brain-Enhancing Drug Scandal
On the heels of Senator George Mitchell's report on the abuse of performance enhancing drugs in baseball, comes word that the phenomenon had been quite common outside the world of sports as well. New rumors have surfaced out of Sweden alleging that at least one-fourth of all Nobel laureates had at one time or another used brain-enhancing drugs to boost their intellectual capabilities. Critics claim their Nobel prizes were unearned and should be rescinded. One disgruntled scientist said, "These findings are truly unfair to all of us scientists with lower IQs who played by the rules. I think the world should immediately stop using whatever inventions those cheaters created!"
Tuesday, December 11, 2007
Ominous Warnings From the Fed
Today's Fed statement was filled with ominous warnings. It made references to slowing economic growth, the housing correction, softer business and consumer spending, strains in financial markets, elevated energy and commodity prices, inflation risks, and increased uncertainty. In other words, there is no good news to report.
Although the Fed cut the fed funds rate and the discount rate by a quarter point each, the market was strongly disappointed. Many investors were hoping for bolder action, perhaps a half-point cut in both rates. At the very least, investors were expecting more clarity from the statement. They exhibited their disappointment by selling stocks. Almost immediately, the Dow shed more than 200 points.
The Fed's comments make it clear that the probability of recession is much higher than many economists (including those at the Fed) had been forecasting. Yet with higher food prices, and with oil prices still flirting with the $90 per barrel level, the Fed knows it cannot focus solely on core inflation numbers anymore. The Fed knows that high food and energy prices will inevitably work their way into the core figures.
The Fed is truly between a rock and a hard place, officiating a game of tug-of-war between slowing growth and inflation. My view is that the Fed did the right thing by cutting the fed funds rate by just a quarter point. A steeper cut would have contributed to the dollar's weakness. However, I believe the Fed could have been a more aggressive with the discount rate. Given the slowing economy and the real potential for recession, there is no need to keep the discount rate a half-point above the fed funds rate.
Although the Fed cut the fed funds rate and the discount rate by a quarter point each, the market was strongly disappointed. Many investors were hoping for bolder action, perhaps a half-point cut in both rates. At the very least, investors were expecting more clarity from the statement. They exhibited their disappointment by selling stocks. Almost immediately, the Dow shed more than 200 points.
The Fed's comments make it clear that the probability of recession is much higher than many economists (including those at the Fed) had been forecasting. Yet with higher food prices, and with oil prices still flirting with the $90 per barrel level, the Fed knows it cannot focus solely on core inflation numbers anymore. The Fed knows that high food and energy prices will inevitably work their way into the core figures.
The Fed is truly between a rock and a hard place, officiating a game of tug-of-war between slowing growth and inflation. My view is that the Fed did the right thing by cutting the fed funds rate by just a quarter point. A steeper cut would have contributed to the dollar's weakness. However, I believe the Fed could have been a more aggressive with the discount rate. Given the slowing economy and the real potential for recession, there is no need to keep the discount rate a half-point above the fed funds rate.
Friday, December 07, 2007
Cruisn' For an Economic Bruisin'
Because I have been swamped, I haven't had an opportunity to post to my blog lately. I arrived home early this morning from the 12th Forbes Cruise for Investors, which went through the Panama Canal. A cruise, of course, is lots of fun. But it was also work for me and the other speakers. We started in Costa Rica on Nov. 30, went through the Canal, and stopped to visit St. Lucia. I disembarked in Antigua. The cruise is still proceeding on its was to Miami where it will end in a few days.
On my half of the cruise were Steve Forbes, Gary Shilling, Bob McTeer, Pete du Pont, and John Goodman. Rich Karlgaard served as the host. Gary, who has been right about the housing market all along, is still bearish on the economy and stocks. It was good to be around someone who is more bearish than myself. It made me feel like a good guy. The other speakers were more optimistic.
While on the ship, I learned about the Bush adminstration's plans to freeze certain subprime mortgage resets. Clearly, there are obvious moral hazard problems with doing something like this. It will be seen as a bailout of those who made imprudent decisions. Even so, I don't believe that even this measure will prevent housing prices from falling further. Freezing monthly payments may slow foreclosure rates modestly, but it won't solve the problem.
Given the continuing troubles in the housing market, I am posting below my comments from the December issue of the Forbes Growth Investor. This commentary was released to our subscribers several days ago:
It is not a pleasant topic, but the time has come to talk about recession. Although the probability of recession has obviously risen by a significant amount in recent months, most economists, including those at the Federal Reserve, are still betting the U.S. will be able to avoid one. Yet almost all economists, even those at the Fed, have lowered their projections for growth.
Minutes from the Fed’s Oct. 30-31 meeting reveal the new thinking. Most notably, the Fed is now projecting that economic growth will range from 1.6% to 2.6% for 2008, down from the 2.5% to 3% projection made just four months earlier. It is important to realize that the Fed is predicting anemic growth, but not recession. This, however, does not provide much comfort.
Not long ago, the so-called real estate experts claimed that housing prices never fall on a national basis. Those who said things were different this time were ridiculed. That argument is now settled. Not only have prices fallen; they are still plunging. The quarterly S&P/Case-Shiller U.S. National Home Price Index fell 1.7% sequentially in the third quarter, the biggest drop in its 21-year history. This index is down 4.5% year-over-year, and the rate of decrease has accelerated. This means that more than $11,000 of value has been erased from a home that was worth $250,000 a year ago. Of course, in some parts of the country, the story is much worse. In Tampa, you can now fetch just $222,250 for a house that was worth $250,000 a year ago.
Given losses of this magnitude, it is no surprise that foreclosures are up. Particularly hard hit have been homes financed with subprime adjustable-rate mortgages. The Fed estimates that monthly payments on more than two million such mortgages will be reset by the end of 2008. We will see many more foreclosures between now and then.
The real estate market is in a downward spiral. Falling property values contribute to foreclosures, and rising foreclosures contribute to falling property values. When a house is foreclosed, all the houses in that neighborhood lose value. In fact, Global Insight, an economic consultancy, recently estimated that property values will fall by $1.2 trillion in 2008. Foreclosures are being blamed for about half that amount.
In recent years, local governments have reaped a windfall in revenues by taxing all those inflated properties. That game will come to an end as homeowners demand that assessments be brought down to more realistic levels. Financial institutions are just starting to write down the values of their securitized subprime mortgage portfolios. Citigroup provides just one example of how devastating this can be for stockholders. The stock started the year at $55 per share. It is currently the biggest loser in the Dow Jones Industrial Average year-to-date.
Given the extent of the housing debacle, and a stock market that could potentially go much lower, why wouldn’t the economy go into recession? The Fed’s lowered growth projections are still too rosy. Perhaps the Fed is betting that the shrinking dollar will cause a huge boost in exports. We are certainly seeing some of that already. While it is true that a weak dollar can help prop up the economy in the short run, over the long run the U.S. is better off having a currency that everyone wants to hold. It's time for Treasury officials to do more than just give lip service to a strong dollar policy.
On my half of the cruise were Steve Forbes, Gary Shilling, Bob McTeer, Pete du Pont, and John Goodman. Rich Karlgaard served as the host. Gary, who has been right about the housing market all along, is still bearish on the economy and stocks. It was good to be around someone who is more bearish than myself. It made me feel like a good guy. The other speakers were more optimistic.
While on the ship, I learned about the Bush adminstration's plans to freeze certain subprime mortgage resets. Clearly, there are obvious moral hazard problems with doing something like this. It will be seen as a bailout of those who made imprudent decisions. Even so, I don't believe that even this measure will prevent housing prices from falling further. Freezing monthly payments may slow foreclosure rates modestly, but it won't solve the problem.
Given the continuing troubles in the housing market, I am posting below my comments from the December issue of the Forbes Growth Investor. This commentary was released to our subscribers several days ago:
It is not a pleasant topic, but the time has come to talk about recession. Although the probability of recession has obviously risen by a significant amount in recent months, most economists, including those at the Federal Reserve, are still betting the U.S. will be able to avoid one. Yet almost all economists, even those at the Fed, have lowered their projections for growth.
Minutes from the Fed’s Oct. 30-31 meeting reveal the new thinking. Most notably, the Fed is now projecting that economic growth will range from 1.6% to 2.6% for 2008, down from the 2.5% to 3% projection made just four months earlier. It is important to realize that the Fed is predicting anemic growth, but not recession. This, however, does not provide much comfort.
Not long ago, the so-called real estate experts claimed that housing prices never fall on a national basis. Those who said things were different this time were ridiculed. That argument is now settled. Not only have prices fallen; they are still plunging. The quarterly S&P/Case-Shiller U.S. National Home Price Index fell 1.7% sequentially in the third quarter, the biggest drop in its 21-year history. This index is down 4.5% year-over-year, and the rate of decrease has accelerated. This means that more than $11,000 of value has been erased from a home that was worth $250,000 a year ago. Of course, in some parts of the country, the story is much worse. In Tampa, you can now fetch just $222,250 for a house that was worth $250,000 a year ago.
Given losses of this magnitude, it is no surprise that foreclosures are up. Particularly hard hit have been homes financed with subprime adjustable-rate mortgages. The Fed estimates that monthly payments on more than two million such mortgages will be reset by the end of 2008. We will see many more foreclosures between now and then.
The real estate market is in a downward spiral. Falling property values contribute to foreclosures, and rising foreclosures contribute to falling property values. When a house is foreclosed, all the houses in that neighborhood lose value. In fact, Global Insight, an economic consultancy, recently estimated that property values will fall by $1.2 trillion in 2008. Foreclosures are being blamed for about half that amount.
In recent years, local governments have reaped a windfall in revenues by taxing all those inflated properties. That game will come to an end as homeowners demand that assessments be brought down to more realistic levels. Financial institutions are just starting to write down the values of their securitized subprime mortgage portfolios. Citigroup provides just one example of how devastating this can be for stockholders. The stock started the year at $55 per share. It is currently the biggest loser in the Dow Jones Industrial Average year-to-date.
Given the extent of the housing debacle, and a stock market that could potentially go much lower, why wouldn’t the economy go into recession? The Fed’s lowered growth projections are still too rosy. Perhaps the Fed is betting that the shrinking dollar will cause a huge boost in exports. We are certainly seeing some of that already. While it is true that a weak dollar can help prop up the economy in the short run, over the long run the U.S. is better off having a currency that everyone wants to hold. It's time for Treasury officials to do more than just give lip service to a strong dollar policy.
Monday, November 19, 2007
Shorting Starbucks Paid Off Big. Time to Cover?
Regular readers of this blog know that I have been bearish on Starbucks (SBUX) for quite some time. Here is what I said in August 2006:
Perhaps the latest Starbucks report is a harbinger of things to come. Starbucks reported disappointing growth and the stock took a big hit. Management blamed it on too much demand for blended drinks that take a long time to prepare. That's unique. Growth slowed because demand was too strong. With gasoline prices pushing north of $3 per gallon, I suspect the real story is that consumers are wondering how much sense it makes to pay $16 a gallon or more for coffee.
In October of that year I said:
Starbucks is another stock that appears overvalued. It is selling for 51 times expected earnings, almost 4 times sales, and 11 times book value. That seems like a lot to pay for what amounts to a chain of restaurants. Of course, Starbucks has tremendous growth prospects, but that doesn't warrant buying the stock at any price.
In May 2007 when gasoline prices broke above $3.20 per gallon, I said:
Companies like Starbucks and Whole Foods that sell overpriced and unnecessary goods might find that growth will slow. These two stocks have already fallen well off their highs. Chances are they will go lower still.
And in July 2007, after Starbucks announced a price increase that came out to nine cents per cup on average, I warned:
There seems to be little skepticism on Wall Street about Starbucks' recently announced price increase. The company admitted again that higher costs are pinching profits. It is struggling with higher dairy prices, higher fuel prices, and higher energy prices.
Well last week Starbucks announced earnings and the stock got hammered. Although the company continues to make good money, growth is slowing. Worse, store traffic actually fell. It seems that even Starbucks addicts are not able to cope with the latest price increase.
This company is caught between a rock and a hard place. Does it raise prices to protect margins at the risk of lower volumes? Or does it hold the line, absorb higher costs, and watch margins shrink? Of course, if dairy or energy prices were to start falling, Starbucks would become a buy once again. But it's not yet time to start buying the stock. However, if you shorted Starbucks at much higher levels, you may want to start thinking about covering at least part of your position.
Perhaps the latest Starbucks report is a harbinger of things to come. Starbucks reported disappointing growth and the stock took a big hit. Management blamed it on too much demand for blended drinks that take a long time to prepare. That's unique. Growth slowed because demand was too strong. With gasoline prices pushing north of $3 per gallon, I suspect the real story is that consumers are wondering how much sense it makes to pay $16 a gallon or more for coffee.
In October of that year I said:
Starbucks is another stock that appears overvalued. It is selling for 51 times expected earnings, almost 4 times sales, and 11 times book value. That seems like a lot to pay for what amounts to a chain of restaurants. Of course, Starbucks has tremendous growth prospects, but that doesn't warrant buying the stock at any price.
In May 2007 when gasoline prices broke above $3.20 per gallon, I said:
Companies like Starbucks and Whole Foods that sell overpriced and unnecessary goods might find that growth will slow. These two stocks have already fallen well off their highs. Chances are they will go lower still.
And in July 2007, after Starbucks announced a price increase that came out to nine cents per cup on average, I warned:
There seems to be little skepticism on Wall Street about Starbucks' recently announced price increase. The company admitted again that higher costs are pinching profits. It is struggling with higher dairy prices, higher fuel prices, and higher energy prices.
Well last week Starbucks announced earnings and the stock got hammered. Although the company continues to make good money, growth is slowing. Worse, store traffic actually fell. It seems that even Starbucks addicts are not able to cope with the latest price increase.
This company is caught between a rock and a hard place. Does it raise prices to protect margins at the risk of lower volumes? Or does it hold the line, absorb higher costs, and watch margins shrink? Of course, if dairy or energy prices were to start falling, Starbucks would become a buy once again. But it's not yet time to start buying the stock. However, if you shorted Starbucks at much higher levels, you may want to start thinking about covering at least part of your position.
Wednesday, November 14, 2007
The Pro-Tax Buffett
The Pro-Tax Buffett is the title of the ninth chapter of my new book, Even Buffett Isn't Perfect, which is due for release in May 2008. Warren Buffett's Congressional testimony delivered today convinces me that the title of the chapter is apropros.
Buffett favors higher taxes on the so-called rich. He favors both higher income taxes and higher death taxes. Estate taxes take their biggest toll on those whose estates are not very liquid. This group includes small farmers, ranchers, and business owners. These individuals typically oppose the estate tax because it often means that heirs must kill the business to pay the tax. Yet many of the mega-rich including Buffett favor this tax. Perhaps it is because they feel a little guilty about being so rich. Perhaps it is because they are convinced that charities would suffer if there was no estate tax and no loophole available to escape it. Yet, as a number of conservative commentators have pointed out, even if there is no tax, anyone who feels strongly about leaving his money to the government is free to do so. However, they should not force others to do the same thing. Furthermore, if they really believe this tax is a good thing, they should not take advantage of loopholes to escape it.
Prior to the Bush tax reforms, estates that were valued above $675,000 were taxed. The federal tax rate reached as high as 60% on large estates. Under the current law, this non-taxable limitation escalates to $3.5 million by 2009. Estates above $3.5 million will be taxed at 45% in that year. In 2010 the estate tax will be completely repealed. There will be no estate tax in 2010. However, in 2011 it comes back with a vengeance, hitting estates worth more than $1 million.
Just imagine the kinds of discussions that are underway in law offices across the country as wealthy clients try to plan their futures. Pity the old and sick. Their heirs are praying they hang on until 2010, but they may also be hoping they kick the bucket before 2011.
Chances are good that Congress will once again tinker with estate taxes sometime in the near future. Most Americans would not object to an estate tax that was reasonable and fair. However, taxing estates above $1 million at rates approaching 50% hardly seems reasonable. Some have suggested a 15% tax on estates above $10 million. Liberals think this is inadequate. Conservatives think even this is too much. Regardless of which party controls Congress and who sits in the White House, we can only hope that our politicians reach some sort of reasonable compromise on this issue before too long.
Buffett favors higher taxes on the so-called rich. He favors both higher income taxes and higher death taxes. Estate taxes take their biggest toll on those whose estates are not very liquid. This group includes small farmers, ranchers, and business owners. These individuals typically oppose the estate tax because it often means that heirs must kill the business to pay the tax. Yet many of the mega-rich including Buffett favor this tax. Perhaps it is because they feel a little guilty about being so rich. Perhaps it is because they are convinced that charities would suffer if there was no estate tax and no loophole available to escape it. Yet, as a number of conservative commentators have pointed out, even if there is no tax, anyone who feels strongly about leaving his money to the government is free to do so. However, they should not force others to do the same thing. Furthermore, if they really believe this tax is a good thing, they should not take advantage of loopholes to escape it.
Prior to the Bush tax reforms, estates that were valued above $675,000 were taxed. The federal tax rate reached as high as 60% on large estates. Under the current law, this non-taxable limitation escalates to $3.5 million by 2009. Estates above $3.5 million will be taxed at 45% in that year. In 2010 the estate tax will be completely repealed. There will be no estate tax in 2010. However, in 2011 it comes back with a vengeance, hitting estates worth more than $1 million.
Just imagine the kinds of discussions that are underway in law offices across the country as wealthy clients try to plan their futures. Pity the old and sick. Their heirs are praying they hang on until 2010, but they may also be hoping they kick the bucket before 2011.
Chances are good that Congress will once again tinker with estate taxes sometime in the near future. Most Americans would not object to an estate tax that was reasonable and fair. However, taxing estates above $1 million at rates approaching 50% hardly seems reasonable. Some have suggested a 15% tax on estates above $10 million. Liberals think this is inadequate. Conservatives think even this is too much. Regardless of which party controls Congress and who sits in the White House, we can only hope that our politicians reach some sort of reasonable compromise on this issue before too long.
Tuesday, November 13, 2007
Today's Rally May Be Short-Lived
The Dow rallied 320 points today. Most analysts are crediting the rally to Wal-Mart's better-than-expected earnings, and comments out of Goldman Sachs saying it won't be posting any significant writedowns. Other analysts are saying the market rallied simply because it was short-term oversold. In other words, stocks went up today because they had gone down in previous days.
I am happy to see today's rally in Wal-Mart because the stock is on my recommeded list in the Special Situation Survey. I'm also happy to see the nice rebound in Citigroup because I started buying it just a few days ago (see Can Citi Maintain the Dividend). Yet I remain cautious on stocks overall. We will be seeing more mortgage-related writedowns. Yestereday's announcement from E*Trade won't be the last. Furthermore, problems could soon arise with securitized credit card obligations.
Although oil prices backed off more than $3 per barrel today, they remain extraordinarily high. This means gasoline prices will be going up significantly from current levels--just in time for the holiday shopping season. With consumer spending likely to slow, the weak dollar may be the only thing keeping our economy out of recession.
I would use strong rallies like today's to hedge positions. The UltraShort ProShares ETFs are a good way to accomplish this.
I am happy to see today's rally in Wal-Mart because the stock is on my recommeded list in the Special Situation Survey. I'm also happy to see the nice rebound in Citigroup because I started buying it just a few days ago (see Can Citi Maintain the Dividend). Yet I remain cautious on stocks overall. We will be seeing more mortgage-related writedowns. Yestereday's announcement from E*Trade won't be the last. Furthermore, problems could soon arise with securitized credit card obligations.
Although oil prices backed off more than $3 per barrel today, they remain extraordinarily high. This means gasoline prices will be going up significantly from current levels--just in time for the holiday shopping season. With consumer spending likely to slow, the weak dollar may be the only thing keeping our economy out of recession.
I would use strong rallies like today's to hedge positions. The UltraShort ProShares ETFs are a good way to accomplish this.
Thursday, November 08, 2007
Can Citi Maintain the Dividend?
Citigroup's dividend yield keeps rising as the stock keeps falling. A month ago, the yield was about 4.5%. At last look, it had reached 6.8% as the stock fell below $32 per share. The initial sell-off in the stock had to do with news that the company would write-off an additional $8-11 billion in sub-prime CDOs. But the stock has continued to fall because many investors are betting that the dividend will have to be cut in order to shore up capital.
So far at least, the board has indicated that the dividend will be maintained. But suppose it is cut? Will that drive the stock price lower? It may, but I doubt it will go much lower. In fact, investors may view a dividend reduction as good news. It could signal the board's determination to get serious about the company's financial problems.
My view is that Citigroup has reached a low enough level to justify the risk of buying some shares. That's exactly what I just started doing. My investment will likely be dead money for a while, but taking a page from Warren Buffett's book, it should pay off handsomely in the years ahead.
So far at least, the board has indicated that the dividend will be maintained. But suppose it is cut? Will that drive the stock price lower? It may, but I doubt it will go much lower. In fact, investors may view a dividend reduction as good news. It could signal the board's determination to get serious about the company's financial problems.
My view is that Citigroup has reached a low enough level to justify the risk of buying some shares. That's exactly what I just started doing. My investment will likely be dead money for a while, but taking a page from Warren Buffett's book, it should pay off handsomely in the years ahead.
Thursday, November 01, 2007
Fed Rate Cuts Imperil the Dollar
The Federal Reserve is on a mission. By slashing interest rates, you may get the impression the Fed is out to save the economy. Instead, it is trashing the dollar.
It now costs almost $1.45 to buy one euro. It costs $2.08 to buy a British pound. Gold is $800 per ounce, and oil, which is denominated in dollars, costs more than $95 per barrel. There seems little doubt that we will soon break the dreaded $100 mark. One hundred dollars is exactly the price Osama bin Laden suggested the West should be paying for a barrel of oil soon after he attacked America on Sept. 11, 2001.
Investors, however, are cheering as the Fed devalues our currency. The Dow rallied 138 points in response to the latest interest rate cuts. The Fed reduced the discount rate by a quarter point to 5%. At the same time, it reduced the fed funds rate by a quarter point to 4.5%. With oil and gold prices near record levels, you might think that reasonable people would expect stocks to be struggling a bit. Reason, however, seems to be in short supply on Wall Street.
The Fed justified its latest rate cut by saying that economic expansion is likely to slow in part due to the housing correction. Furthermore, it said core inflation readings have improved. Apparently, no one at the Fed drives a car, buys food, or heats his home.
Those who have mortgages that are about to adjust to higher levels might want to send the Fed a thank you card. The Fed has given them an opportunity to switch into fixed-rate loans. Unless significant penalties are involved, refinancing in this manner should payoff over the long term.
The Fed’s action came the same day the Department of Commerce released its advance estimate for third quarter GDP. Although the figure is subject to revision, growth was a much stronger-than-expected 3.9%. It is no surprise that exports contributed to this growth. They surged 16.2% because the weak dollar makes American goods cheap abroad.
With growth near 4% it seems odd that the Fed would risk inflation by cutting interest rates. Core inflation may be tame, but headline inflation is not. The Fed is obviously looking ahead, and apparently it does not like what it sees. It may be worried that the sub-prime mortgage mess has not fully settled. It may also be concerned that consumer spending will eventually take a hit. Consumers, however, are weathering the housing bust and high oil prices fairly well.
But consumers don’t buy crude oil. They buy gasoline and heating oil. Despite high crude prices, gasoline prices have remained well off their spring highs. But how much longer can that last? Either gasoline prices must rise, or oil prices must fall. Gasoline inventories may fall in coming weeks as refiners start producing more heating oil. And with Thanksgiving just around the corner, demand for gasoline is likely to rise. Don’t be surprised if gasoline prices surge 20 to 30 cents per gallon by the end of this month.
It now costs almost $1.45 to buy one euro. It costs $2.08 to buy a British pound. Gold is $800 per ounce, and oil, which is denominated in dollars, costs more than $95 per barrel. There seems little doubt that we will soon break the dreaded $100 mark. One hundred dollars is exactly the price Osama bin Laden suggested the West should be paying for a barrel of oil soon after he attacked America on Sept. 11, 2001.
Investors, however, are cheering as the Fed devalues our currency. The Dow rallied 138 points in response to the latest interest rate cuts. The Fed reduced the discount rate by a quarter point to 5%. At the same time, it reduced the fed funds rate by a quarter point to 4.5%. With oil and gold prices near record levels, you might think that reasonable people would expect stocks to be struggling a bit. Reason, however, seems to be in short supply on Wall Street.
The Fed justified its latest rate cut by saying that economic expansion is likely to slow in part due to the housing correction. Furthermore, it said core inflation readings have improved. Apparently, no one at the Fed drives a car, buys food, or heats his home.
Those who have mortgages that are about to adjust to higher levels might want to send the Fed a thank you card. The Fed has given them an opportunity to switch into fixed-rate loans. Unless significant penalties are involved, refinancing in this manner should payoff over the long term.
The Fed’s action came the same day the Department of Commerce released its advance estimate for third quarter GDP. Although the figure is subject to revision, growth was a much stronger-than-expected 3.9%. It is no surprise that exports contributed to this growth. They surged 16.2% because the weak dollar makes American goods cheap abroad.
With growth near 4% it seems odd that the Fed would risk inflation by cutting interest rates. Core inflation may be tame, but headline inflation is not. The Fed is obviously looking ahead, and apparently it does not like what it sees. It may be worried that the sub-prime mortgage mess has not fully settled. It may also be concerned that consumer spending will eventually take a hit. Consumers, however, are weathering the housing bust and high oil prices fairly well.
But consumers don’t buy crude oil. They buy gasoline and heating oil. Despite high crude prices, gasoline prices have remained well off their spring highs. But how much longer can that last? Either gasoline prices must rise, or oil prices must fall. Gasoline inventories may fall in coming weeks as refiners start producing more heating oil. And with Thanksgiving just around the corner, demand for gasoline is likely to rise. Don’t be surprised if gasoline prices surge 20 to 30 cents per gallon by the end of this month.
Wednesday, October 31, 2007
Top 100 Companies in Muslim World
It is not surprising that some of the biggest companies in the Muslim world are found in the oil and gas industries. After all, Islamic countries sit on about two-thirds of the world's proven oil reserves, and oil prices are at all-time nominal highs.
What is surprising, however, is the diversity of businesses represented. I recently interviewed Rafi-uddin Shikoh, editor of DinarStandard, an online publication that tracks business in the Muslim world. His website lists all kinds of interesting information including top brands and top scientifically productive countries.
You can watch this MoneyMasters interview starting tomorrow (Thursday) morning.
What is surprising, however, is the diversity of businesses represented. I recently interviewed Rafi-uddin Shikoh, editor of DinarStandard, an online publication that tracks business in the Muslim world. His website lists all kinds of interesting information including top brands and top scientifically productive countries.
You can watch this MoneyMasters interview starting tomorrow (Thursday) morning.
Monday, October 29, 2007
Here & Now Interview
Oil prices are going through the roof, yet stocks are rising, too. Contrary to popular opinion, one has little to do with the other. Nonetheless, it is common to hear reporters blame a sell-off in stocks on rising energy prices. They often say things like "Stocks fell today because oil went up $2 a barrel." The truth, however, is that the two are not negatively correlated over the long term.
Yet rising commodity prices are a cause for worry. The two commodities that get much of the attention are oil and gold. Both are near all-time highs. Both may be telling us to expect higher inflation.
So far, gasoline prices have not budged much. Given the recent surge in oil prices, this is a bit surprising. It probably won't last. Either gasoline prices will rise, or oil prices will fall.
To hear more about the recent rise in oil, listen to my recent interview on Here & Now, a radio program broadcast out of Boston.
Yet rising commodity prices are a cause for worry. The two commodities that get much of the attention are oil and gold. Both are near all-time highs. Both may be telling us to expect higher inflation.
So far, gasoline prices have not budged much. Given the recent surge in oil prices, this is a bit surprising. It probably won't last. Either gasoline prices will rise, or oil prices will fall.
To hear more about the recent rise in oil, listen to my recent interview on Here & Now, a radio program broadcast out of Boston.
Thursday, October 25, 2007
Ian Bremmer on MoneyMasters Discusses Political Risk
China has the world's fastest growing major economy. It surged 11.5% in the third quarter. But China's economy still pales in size compared to the U.S. Even though China's population is more than four times larger than America's, it's economy is only about one-fifth as large. In fact, with a gross domestic product of more than $13 trillion, the U.S. economy is about four times larger than Japan's, which has the world's second-largest economy. The U.S. accounts for about one-fourth of total world GDP.
This is why an economic slowdown in the U.S. could have dire consequences for the entire planet. California's economy alone accounts for about 13% of U.S. GDP. California, of course, is literally on fire. According to the latest accounts, the wildfires are finally under control, but the damage to the economy has yet to be fully assessed. About a million people have been displaced and approximately 3,000 homes have been destroyed or damaged. I doubt, however, that even the home builders thought this was a good way to get rid of excess inventory.
Most forecasts for U.S. growth are still positive, but they are shrinking. It is becoming increasingly difficult for economists to argue that the U.S. will avoid an economic recession. Investors are still hoping the Fed will come to the rescue. In fact, stocks rallied yesterday on rumors that the Fed was about to cut the discount rate once again. I'm not betting on it. And I'm not betting on a Halloween rate cut either. I continue to expect poor returns for U.S. equities for the near future. While investing abroad may seem riskier, investors should keep a healthy exposure to foreign stocks. The lower correlations should provide diversification benefits.
For a more in depth discussion of some of the world's hot spots, watch Pricing Political Risk. It's a short interview with Ian Bremmer of the Eurasia Group, a leading political risk consultancy that caters to many of Wall Street's top investment banks and hedge funds.
This is why an economic slowdown in the U.S. could have dire consequences for the entire planet. California's economy alone accounts for about 13% of U.S. GDP. California, of course, is literally on fire. According to the latest accounts, the wildfires are finally under control, but the damage to the economy has yet to be fully assessed. About a million people have been displaced and approximately 3,000 homes have been destroyed or damaged. I doubt, however, that even the home builders thought this was a good way to get rid of excess inventory.
Most forecasts for U.S. growth are still positive, but they are shrinking. It is becoming increasingly difficult for economists to argue that the U.S. will avoid an economic recession. Investors are still hoping the Fed will come to the rescue. In fact, stocks rallied yesterday on rumors that the Fed was about to cut the discount rate once again. I'm not betting on it. And I'm not betting on a Halloween rate cut either. I continue to expect poor returns for U.S. equities for the near future. While investing abroad may seem riskier, investors should keep a healthy exposure to foreign stocks. The lower correlations should provide diversification benefits.
For a more in depth discussion of some of the world's hot spots, watch Pricing Political Risk. It's a short interview with Ian Bremmer of the Eurasia Group, a leading political risk consultancy that caters to many of Wall Street's top investment banks and hedge funds.
Tuesday, October 16, 2007
Double Standards
China is extremely upset that the Dalai Lama will be awarded a Congressional Gold Medal. The White House is in favor of this award. It brushed aside China's objections. President Bush plans to attend the ceremony to honor one of the world's greatest spiritual leaders.
Turkey is extremely upset that the House Foreign Affairs Committee passed a resolution condemning the Armenian Genocide. The White House is almost as upset as the Turks. Before the vote, President Bush went on national television begging the committee not to vote on this non-binding resolution. Now that the resolution has passed, Bush is begging Speaker Nancy Pelosi to prevent it from reaching the floor of the House for a full vote.
Let me see if I've got this straight. The White House does not care how China feels, but it is bending over backwards to please Turkey. The White House is not arguing that the Armenians did not suffer a genocide. It just thinks that recognizing genocide is less important than hurting Turkey's feelings.
Armenians are being told that this is not a good time to vote on this measure. So when exactly is a good time? Armenians have been waiting for almost 100 years. Before the fall of Communism, they were told that Turkey was too important to upset because it bordered the Soviet Union. During the Clinton administration they were told that Turkey was too important to upset because it was a key ally that was friendly with Israel and supported our efforts in the Middle East. Now they are being told that Turkey is too important to upset because it borders Iraq.
To make its displeasure known, Turkey has threatened to invade Iraq and cut off U.S. supplies. Instead of reminding the Turks that we give them billions of dollars in foreign aid every year to buy their cooperation, the White House is begging Turkey for forgiveness. As for China, it couldn't care less.
Turkey is extremely upset that the House Foreign Affairs Committee passed a resolution condemning the Armenian Genocide. The White House is almost as upset as the Turks. Before the vote, President Bush went on national television begging the committee not to vote on this non-binding resolution. Now that the resolution has passed, Bush is begging Speaker Nancy Pelosi to prevent it from reaching the floor of the House for a full vote.
Let me see if I've got this straight. The White House does not care how China feels, but it is bending over backwards to please Turkey. The White House is not arguing that the Armenians did not suffer a genocide. It just thinks that recognizing genocide is less important than hurting Turkey's feelings.
Armenians are being told that this is not a good time to vote on this measure. So when exactly is a good time? Armenians have been waiting for almost 100 years. Before the fall of Communism, they were told that Turkey was too important to upset because it bordered the Soviet Union. During the Clinton administration they were told that Turkey was too important to upset because it was a key ally that was friendly with Israel and supported our efforts in the Middle East. Now they are being told that Turkey is too important to upset because it borders Iraq.
To make its displeasure known, Turkey has threatened to invade Iraq and cut off U.S. supplies. Instead of reminding the Turks that we give them billions of dollars in foreign aid every year to buy their cooperation, the White House is begging Turkey for forgiveness. As for China, it couldn't care less.
Tuesday, October 09, 2007
A Shock to the Economic System
Today's release of the Fed's minutes from the Sept. 18 meeting gives us a better understanding of what the FOMC members were thinking when they decided to slash interest rates by 50 basis points.
For starters, the Fed "marked down" its estimate for fourth quarter GDP growth. It also "trimmed" its growth forecast for 2008. It raised its forecast for unemployment. And because business executives are growing cautious, the Fed now expects capital spending to be scaled back. Finally, the Fed trimmed expectations for both core and headline inflation.
All in all, the Fed was very concerned about the outlook for economic activity, and less concerned about inflation. The housing market deteriorated much faster and further than the Fed expected. The minutes said subprime mortgages are "essentially unavailable," that there is "little activity" in nonprime mortgages, and that borrowers of prime jumbo mortgages "faced higher rates and tighter lending standards."
But the Fed is not entirely ignoring inflation. It expressed concern about rising benefit costs and labor costs and said the weakening dollar had the potential to heighten inflation risks.
It appears that the Fed was hoping to shock the markets with a large one-time interest rate reduction. Given the strong rally in stocks ever since those cuts were made, it looks like the Fed succeeded. However, the remarks in the minutes of the Sept. 18 meeting also indicate that those who are expecting additional interest rate cuts are likely to be disappointed.
For starters, the Fed "marked down" its estimate for fourth quarter GDP growth. It also "trimmed" its growth forecast for 2008. It raised its forecast for unemployment. And because business executives are growing cautious, the Fed now expects capital spending to be scaled back. Finally, the Fed trimmed expectations for both core and headline inflation.
All in all, the Fed was very concerned about the outlook for economic activity, and less concerned about inflation. The housing market deteriorated much faster and further than the Fed expected. The minutes said subprime mortgages are "essentially unavailable," that there is "little activity" in nonprime mortgages, and that borrowers of prime jumbo mortgages "faced higher rates and tighter lending standards."
But the Fed is not entirely ignoring inflation. It expressed concern about rising benefit costs and labor costs and said the weakening dollar had the potential to heighten inflation risks.
It appears that the Fed was hoping to shock the markets with a large one-time interest rate reduction. Given the strong rally in stocks ever since those cuts were made, it looks like the Fed succeeded. However, the remarks in the minutes of the Sept. 18 meeting also indicate that those who are expecting additional interest rate cuts are likely to be disappointed.
Friday, October 05, 2007
Can We Trust the Data?
Today's jobs report was certainly encouraging, but it raises an important question. Why does the government bother to release preliminary results if they are so unreliable?
The Bureau of Labor Statistics, which is responsible for tracking the data, said a month ago that August non-farm payrolls fell by 4,000. This spooked the markets. It convinced many economists that the economy was slowing much faster than they had anticipated. Most economists said the loss of jobs increased the probability of recession. It also put tremendous pressure on the Fed to cut interest rates. Because the jobs number was so weak, the Fed slashed both the fed funds rate and the discount rate by 50 basis points.
But today, the August figure was revised. It turns out that the economy did not lose 4,000 jobs after all. Instead, it actually created jobs. In fact, according to the most recent data, non-farm payrolls increased by 89,000 in August. Had the Fed known that, it may not have cut rates at all. In any case, it is now evident that the Fed went overboard.
Yet it must also be pointed out that even the 89,000 figure is not final. It will be revised one more time. We won't know until a month from now exactly how many jobs were created (or lost) in August.
In any case, today's data makes it much less likely that the Fed will lower rates again at its next meeting at the very end of this month. Given Chairman Bernanke's concerns about inflation, further rate cuts are highly unlikely.
The Bureau of Labor Statistics, which is responsible for tracking the data, said a month ago that August non-farm payrolls fell by 4,000. This spooked the markets. It convinced many economists that the economy was slowing much faster than they had anticipated. Most economists said the loss of jobs increased the probability of recession. It also put tremendous pressure on the Fed to cut interest rates. Because the jobs number was so weak, the Fed slashed both the fed funds rate and the discount rate by 50 basis points.
But today, the August figure was revised. It turns out that the economy did not lose 4,000 jobs after all. Instead, it actually created jobs. In fact, according to the most recent data, non-farm payrolls increased by 89,000 in August. Had the Fed known that, it may not have cut rates at all. In any case, it is now evident that the Fed went overboard.
Yet it must also be pointed out that even the 89,000 figure is not final. It will be revised one more time. We won't know until a month from now exactly how many jobs were created (or lost) in August.
In any case, today's data makes it much less likely that the Fed will lower rates again at its next meeting at the very end of this month. Given Chairman Bernanke's concerns about inflation, further rate cuts are highly unlikely.
Wednesday, September 19, 2007
The Fed Comes to Rescue After Saying It Won't
First of all, I apologize for not posting in a while and thank those of you who have noticed. The fact is that I've been incredibly busy. On top of everything else I normally do, I'm in the process of putting the finishing touches on a book I have been writing. That process is now near completion so I hope to be posting again on a regular basis relatively soon. However, yesterday's interest rate cuts by the Fed were so over the top, I had to make some comment.
Last Friday on Kudlow & Co. I predicted the Fed would cut the fed funds rate by 25 basis points and would leave the discount rate alone. Larry was calling for much bigger cuts in both. He was right. Yesterday, the Fed announced 50 basis point cuts in both interest rates.
My take on all this is that we can now officially change the name of the "Greenspan Put" to the "Bernanke Put." This aggressive action goes a long way in convincing investors that the Fed will always come to the rescue no matter how many times it says it won't. No one cares anymore that only about a month ago Bernanke warned that the Fed would not bail out investors when they make bad financial choices. He just proved that the Fed will do exactly that.
Furthermore, the Fed would not have taken such bold action unless it was absolutely convinced that the probability of recession has risen dramatically. It is interesting to note that not one member of the FOMC dissented. The decision to cut rates received unanimous support.
Today's disappointing housing numbers indicate that recession may be nearer than we thought. The CPI indicates that inflation is under control. But the CPI is likely to jump next month especially when energy prices are taken into account. Even though gasoline prices are well off their highs, oil prices keep setting new records. This divergence can't last. Either oil prices must come down or gasoline must rise. I'm betting that in the near term the latter is more likely. In any case, I'm sure at least a few hedge fund managers are buying gasoline and shorting oil.
While it was nice to see that the rate cuts caused a strong rally in stocks, you might want to take advantage of the opportunity to trim your long positions. I suspect we are going to give up all of the recent advance.
Last Friday on Kudlow & Co. I predicted the Fed would cut the fed funds rate by 25 basis points and would leave the discount rate alone. Larry was calling for much bigger cuts in both. He was right. Yesterday, the Fed announced 50 basis point cuts in both interest rates.
My take on all this is that we can now officially change the name of the "Greenspan Put" to the "Bernanke Put." This aggressive action goes a long way in convincing investors that the Fed will always come to the rescue no matter how many times it says it won't. No one cares anymore that only about a month ago Bernanke warned that the Fed would not bail out investors when they make bad financial choices. He just proved that the Fed will do exactly that.
Furthermore, the Fed would not have taken such bold action unless it was absolutely convinced that the probability of recession has risen dramatically. It is interesting to note that not one member of the FOMC dissented. The decision to cut rates received unanimous support.
Today's disappointing housing numbers indicate that recession may be nearer than we thought. The CPI indicates that inflation is under control. But the CPI is likely to jump next month especially when energy prices are taken into account. Even though gasoline prices are well off their highs, oil prices keep setting new records. This divergence can't last. Either oil prices must come down or gasoline must rise. I'm betting that in the near term the latter is more likely. In any case, I'm sure at least a few hedge fund managers are buying gasoline and shorting oil.
While it was nice to see that the rate cuts caused a strong rally in stocks, you might want to take advantage of the opportunity to trim your long positions. I suspect we are going to give up all of the recent advance.
Monday, August 27, 2007
Rove + Gonzales = Trouble for Republicans
A professor once joked that the best way to turn a Democrat into a Republican was to let him graduate, get a job, and see how much he has to pay in taxes. Indeed, when I was in college, most of my classmates had Democratic leanings. I preferred to remain independent. But as time went on I noticed I had more in common with Republicans, and that is the way I usually voted.
Many years later I took a job in Massachusetts. Almost everyone in the state was a registered Democrat, so I decided to register as a Republican. I did so just in time to help elect William Weld, a Republican, governor. I have been a registered Republican ever since.
This is why it pains me to see the Republican party struggling so much in recent months. The Bush administration, in particular, is falling apart. A number of high-ranking officials have resigned. Karl Rove and Alberto Gonzales are only the most recent.
It is becoming more and more difficult for me to believe that the Republicans will be able to hold on to the White House in 2008. There does not appear to be a single Republican candidate who can energize the core of the party and at the same time attract a critical mass of Democrats.
The Democratic candidates have many flaws, yet their constituents appear quite satisfied with them. In my opinion, unless the Democrats completely blow it, this election belongs to them, which of course makes me all the more bearish on stocks. I believe a Democrat in the While House, along with a Democratic Congress, spells higher taxes. I expect stocks to go lower as more and more investors reach the same conclusion.
Many years later I took a job in Massachusetts. Almost everyone in the state was a registered Democrat, so I decided to register as a Republican. I did so just in time to help elect William Weld, a Republican, governor. I have been a registered Republican ever since.
This is why it pains me to see the Republican party struggling so much in recent months. The Bush administration, in particular, is falling apart. A number of high-ranking officials have resigned. Karl Rove and Alberto Gonzales are only the most recent.
It is becoming more and more difficult for me to believe that the Republicans will be able to hold on to the White House in 2008. There does not appear to be a single Republican candidate who can energize the core of the party and at the same time attract a critical mass of Democrats.
The Democratic candidates have many flaws, yet their constituents appear quite satisfied with them. In my opinion, unless the Democrats completely blow it, this election belongs to them, which of course makes me all the more bearish on stocks. I believe a Democrat in the While House, along with a Democratic Congress, spells higher taxes. I expect stocks to go lower as more and more investors reach the same conclusion.
Friday, August 10, 2007
2% Growth is Bullish?
Brian Wesbury wrote an especially amusing op-ed in yesterday's Wall Street Journal. He argued that the business media are giving too much time to those who are bearish. Citing numerous surveys, he claimed that the vast majority of economists are bullish. Therefore, according to Wesbury, by giving bears and bulls an equal amount of time, viewers are getting the incorrect impression that economists are torn about economic growth.
I found this amusing for a couple of reasons. First, his definition of a bull is one who is forecasting at least 2% GDP growth. Not too long ago, 2% would have been considered bearish. In fact, I've been portrayed as the bear on a number of television debates because I was forecasting less than 3% growth.
Furthermore, he ignores the fact that almost all economists have been ratcheting down their forecasts. They may still be predicting growth, but they are getting less and less optimistic.
He also ignores the fact that it rarely pays for forecasters to disagree with the masses. They want to make sure their forecast is not too far off from the average forecast. This way, if they are wrong, they can simply shrug their shoulders and say, "Hey, that's what everybody was expecting."
As for me, I still think the probability of recession is rather low. I think 2% GDP growth is still a reasonable estimate. So why am I a bear? It is not because I expect a recession. It is because I expect stocks to go lower. Despite the recent sell-offs we've been seeing in the markets, I think there is still a ways to go before we hit bottom.
I found this amusing for a couple of reasons. First, his definition of a bull is one who is forecasting at least 2% GDP growth. Not too long ago, 2% would have been considered bearish. In fact, I've been portrayed as the bear on a number of television debates because I was forecasting less than 3% growth.
Furthermore, he ignores the fact that almost all economists have been ratcheting down their forecasts. They may still be predicting growth, but they are getting less and less optimistic.
He also ignores the fact that it rarely pays for forecasters to disagree with the masses. They want to make sure their forecast is not too far off from the average forecast. This way, if they are wrong, they can simply shrug their shoulders and say, "Hey, that's what everybody was expecting."
As for me, I still think the probability of recession is rather low. I think 2% GDP growth is still a reasonable estimate. So why am I a bear? It is not because I expect a recession. It is because I expect stocks to go lower. Despite the recent sell-offs we've been seeing in the markets, I think there is still a ways to go before we hit bottom.
Saturday, August 04, 2007
Rising Volatility Means Stocks Can Go Lower
Given the sell-off in stocks we are now seeing, I decided to post my recent comments from the Forbes Growth Investor:
Volatility is back on Wall Street. There were 21 trading days in July. The range between the Dow’s high and low exceeded 100 points on 13 of those days. It exceeded 200 points on six days.
The CBOE Market Volatility Index is another way to monitor volatility. This index measures implied volatility from the prices traders are willing to pay for stock options. Implied volatility was rather low during the second half of 2006. It started rising in late February 2007, breaking through its 200-day moving average. It has now reached its highest levels since 2003. Traders love this kind of market. It gives them plenty of opportunity to make quick profits by jumping in and out of stocks. Long term buy-and-hold investors, however, may not pay much attention. They should. Rising volatility can sometimes signal a major turning point in the market. In 2003 it signaled the start of a bull market. Today, it may be telling us just the opposite.
Rising volatility means investors are getting nervous. They no longer feel confident about the market’s overall direction. Of course, much of the current volatility is being blamed on woes in the sub-prime mortgage market and on worries that those problems will spread to higher quality mortgages. Yet even today, there are those who seem to be completely discounting the deterioration in housing. They seem convinced that the housing market is about to bottom and that any further problems—if they do occur—will have only a minimal impact on consumer spending.
Economists will debate exactly how much investors should worry, but one thing is for
sure: This bull market is getting old. As a result, many investors are sitting on sizable gains. When they see stock prices gyrate excessively, they can’t help but think about taking profits. They probably should take some money off the table.
It’s likely that housing prices will continue to fall. In fact, the 10-city S&P Case/Shiller Home Price Index recently posted its biggest drop since 1991. Furthermore, oil is trading for more than $78 per barrel and some analysts predict it will hit $100 within a year. Yet so many otherwise meticulous market watchers are simply overlooking the price of this indispensable commodity. To them, the price of
oil does not matter—until, of course, when it does.
Despite seemingly strong GDP growth in the second quarter, stocks are likely to go lower. Those who are truly worried about further declines, but for tax purposes are reluctant to realize gains, should consider hedging their portfolios. One good way to do this is by buying one or more of the UltraShort ETFs. These move opposite in direction to the corresponding index, but by twice as much. For example, the DXD will rise 10% in value if the Dow falls 5%. The SDS provides a similar hedge against the S&P 500. Readers can learn more about these products at ProShares.com.
Volatility is back on Wall Street. There were 21 trading days in July. The range between the Dow’s high and low exceeded 100 points on 13 of those days. It exceeded 200 points on six days.
The CBOE Market Volatility Index is another way to monitor volatility. This index measures implied volatility from the prices traders are willing to pay for stock options. Implied volatility was rather low during the second half of 2006. It started rising in late February 2007, breaking through its 200-day moving average. It has now reached its highest levels since 2003. Traders love this kind of market. It gives them plenty of opportunity to make quick profits by jumping in and out of stocks. Long term buy-and-hold investors, however, may not pay much attention. They should. Rising volatility can sometimes signal a major turning point in the market. In 2003 it signaled the start of a bull market. Today, it may be telling us just the opposite.
Rising volatility means investors are getting nervous. They no longer feel confident about the market’s overall direction. Of course, much of the current volatility is being blamed on woes in the sub-prime mortgage market and on worries that those problems will spread to higher quality mortgages. Yet even today, there are those who seem to be completely discounting the deterioration in housing. They seem convinced that the housing market is about to bottom and that any further problems—if they do occur—will have only a minimal impact on consumer spending.
Economists will debate exactly how much investors should worry, but one thing is for
sure: This bull market is getting old. As a result, many investors are sitting on sizable gains. When they see stock prices gyrate excessively, they can’t help but think about taking profits. They probably should take some money off the table.
It’s likely that housing prices will continue to fall. In fact, the 10-city S&P Case/Shiller Home Price Index recently posted its biggest drop since 1991. Furthermore, oil is trading for more than $78 per barrel and some analysts predict it will hit $100 within a year. Yet so many otherwise meticulous market watchers are simply overlooking the price of this indispensable commodity. To them, the price of
oil does not matter—until, of course, when it does.
Despite seemingly strong GDP growth in the second quarter, stocks are likely to go lower. Those who are truly worried about further declines, but for tax purposes are reluctant to realize gains, should consider hedging their portfolios. One good way to do this is by buying one or more of the UltraShort ETFs. These move opposite in direction to the corresponding index, but by twice as much. For example, the DXD will rise 10% in value if the Dow falls 5%. The SDS provides a similar hedge against the S&P 500. Readers can learn more about these products at ProShares.com.
Wednesday, August 01, 2007
Taking a Gamble on Hooper Holmes
Several years ago, my wife and I decided to buy some life insurance. The insurance company sent a couple of paramedics over to our house to do a basic medical exam and take samples of blood and urine. These paramedics were employed by a company called Hooper Holmes (HH). Unfortunately, the company hasn't been doing so well. It has no profits and revenues are falling. The stock has been falling, too. It has fallen steadily for about seven years and currently sells for $2.65 per share.
Despite all these problems, I recently started accumulating shares of the company. New management took over more than a year ago and I'm betting the worst is over. The gross profit margin is already showing signs of recovery and there is hope that the revenue decline will moderate. Furthermore, the company has no debt outstanding.
This is not a growth story. HH is not operating in a particularly complicated industry. In fact, it's a rather boring business. It's the kind of stuff Warren Buffett might appreciate. There is nothing high tech about it. It should be relatively easy for this kind of company to make some money. Most importantly, HH needs to get expenses under control and bring them down to a level that is appropriate for the reduced amount of revenue it is now generating. At the same time, it needs to find ways to stem the revenue decline.
The company will probably announce second quarter results in about a week or so. I'm not expecting anything spectacular. If it can simply break even and show that revenues are holding steady, that will be enough to attract some buyers.
Despite all these problems, I recently started accumulating shares of the company. New management took over more than a year ago and I'm betting the worst is over. The gross profit margin is already showing signs of recovery and there is hope that the revenue decline will moderate. Furthermore, the company has no debt outstanding.
This is not a growth story. HH is not operating in a particularly complicated industry. In fact, it's a rather boring business. It's the kind of stuff Warren Buffett might appreciate. There is nothing high tech about it. It should be relatively easy for this kind of company to make some money. Most importantly, HH needs to get expenses under control and bring them down to a level that is appropriate for the reduced amount of revenue it is now generating. At the same time, it needs to find ways to stem the revenue decline.
The company will probably announce second quarter results in about a week or so. I'm not expecting anything spectacular. If it can simply break even and show that revenues are holding steady, that will be enough to attract some buyers.
Sunday, July 29, 2007
Ethanol Revisited
I recently read an excellent article in the May/June 2007 issue of Foreign Affairs, which is published by the Council on Foreign Relations. Professors C. Ford Runge and Benjamin Senauer argue in "How Biofuels Could Starve the Poor" that the push for corn-based ethanol is driving up global food prices.
High oil prices have prompted governments to subsidize the development of alternative fuels. Brazil uses sugar to produce ethanol. The U.S. has focused on corn-based ethanol. Although corn production is near record levels, an increasing portion is being dedicated to refine ethanol. This has depleted corn inventories. Furthermore, as farmers plant more and more corn, yields of other food crops are falling, pushing up their prices as well.
Ethanol is expensive to produce. Ironically, high crude oil prices are necessary for ethanol production to be profitable. The authors argue that if oil prices fell back to $30 per barrel (admittedly, not a very likely outcome), corn prices would have to fall to less than $2 per bushel for ethanol production to remain a profitable business. However, at $80 per barrel for oil, ethanol refiners could afford to pay more than $5 per bushel for corn and still make a good return. The tradeoff, of course, is more expensive food.
I commented on much of this back in April when I wrote Ethanol is Not the Solution. I argued that the most promising technology to address our transportation needs in the short term is the plug-in hybrid car. Since then several automobile manufacturers have announced plans to invest more money to research and develop this technology. The farm lobby may oppose these efforts, but success would not only significantly reduce our dependence on foreign oil, it would also bring food inflation under control.
High oil prices have prompted governments to subsidize the development of alternative fuels. Brazil uses sugar to produce ethanol. The U.S. has focused on corn-based ethanol. Although corn production is near record levels, an increasing portion is being dedicated to refine ethanol. This has depleted corn inventories. Furthermore, as farmers plant more and more corn, yields of other food crops are falling, pushing up their prices as well.
Ethanol is expensive to produce. Ironically, high crude oil prices are necessary for ethanol production to be profitable. The authors argue that if oil prices fell back to $30 per barrel (admittedly, not a very likely outcome), corn prices would have to fall to less than $2 per bushel for ethanol production to remain a profitable business. However, at $80 per barrel for oil, ethanol refiners could afford to pay more than $5 per bushel for corn and still make a good return. The tradeoff, of course, is more expensive food.
I commented on much of this back in April when I wrote Ethanol is Not the Solution. I argued that the most promising technology to address our transportation needs in the short term is the plug-in hybrid car. Since then several automobile manufacturers have announced plans to invest more money to research and develop this technology. The farm lobby may oppose these efforts, but success would not only significantly reduce our dependence on foreign oil, it would also bring food inflation under control.
Tuesday, July 24, 2007
Starbucks Raises Prices and Analysts Cheer
There seems to be little skepticism on Wall Street about Starbucks' recently announced price increase. The company admitted again that higher costs are pinching profits. It is struggling with higher dairy prices, higher fuel prices, and higher energy prices.
But consumers are also dealing with higher prices, leaving them with less and less income to spend on discretionary items like Starbucks coffee. So is the nine cents per cup price increase sufficient to preserve profit margins without depressing volumes? Or is it too much of an increase that will turn away some customers and make them wonder why they are paying so much for coffee? These are the questions Starbucks and analysts are grappling with.
Customers are getting squeezed by higher prices for all kinds of things. Food and energy prices in particular are taking a bite out of their incomes. I doubt even Starbucks believes that customers will finance their coffee purchases with stock market gains or home equity loans. The bottom line is that things don't look promising for Starbucks right now. We'll learn more about the company's financials on August 1. In the meantime, I'm sticking with my recommendation to short the stock.
But consumers are also dealing with higher prices, leaving them with less and less income to spend on discretionary items like Starbucks coffee. So is the nine cents per cup price increase sufficient to preserve profit margins without depressing volumes? Or is it too much of an increase that will turn away some customers and make them wonder why they are paying so much for coffee? These are the questions Starbucks and analysts are grappling with.
Customers are getting squeezed by higher prices for all kinds of things. Food and energy prices in particular are taking a bite out of their incomes. I doubt even Starbucks believes that customers will finance their coffee purchases with stock market gains or home equity loans. The bottom line is that things don't look promising for Starbucks right now. We'll learn more about the company's financials on August 1. In the meantime, I'm sticking with my recommendation to short the stock.
Thursday, July 12, 2007
The Real Cost of Living
Wednesday night I argued on Kudlow & Co. on CNBC that inflation is problematic. I mentioned soaring gasoline and food prices. Larry Kudlow took me to task saying those volatile components are rightly excluded when measuring core inflation. He said the prices of other things like televisions and cell phones have been falling. He didn't care for my argument that consumers buy gasoline and food every week, but that they might buy a cell phone only once every two or three years. He said I was being silly.
After thinking about it for a while, I realized that even the costs of watching television or making a phone call have risen. Take television. Granted, quality has improved dramatically, but the cost of watching television has gone up tremendously. I purchased a color television set in 1987 for $299 and paid an additional $200 to have a rotational antenna installed on my house. That allowed me to capture stations from Baltimore to Philadelphia. There were no additional costs involved. I received all my programming for free.
These days you would have to buy a high-definition television set. I know prices for HDTVs are falling, but they still cost about $1,000 or more. You also have to subscribe to premium cable or satellite services that cost at least $60 per month. And even though you can now get hundreds of stations, it is still difficult to find much that is worth watching. So, economists may argue that the cost of a television has fallen if you factor in the vastly improved quality. Yet the fact is that the cost of watching television today is much higher than it was in the 1980s.
As for cell phones, they were certainly a rarity back in 1987. Those who wanted one installed in their car had to pay a fortune. These days cell phones are ubiquitous. Yet I can't say that I have noticed a decrease in the price of making a call. Even cell phone prices don't seem to have fallen much in recent years. Yes, the phones are getting cooler and cooler. They do offer lots of features I never thought I needed. But when you consider all those hidden fees and taxes, the cost of making a call just seems to go higher and higher.
There are many such examples. Technology has brought us lots of products we couldn't even have imagined just a couple of decades ago. And if these products come with added features with only a marginal increase in price, economists actually consider that a price decrease. Yet the cost of daily life keeps rising. Think of all the things you do on a regular basis. You spend money on housing and clothing. You have to eat and drive to work. You might watch television and listen to satellite radio. You might go out to dinner and a movie. You might take a vacation. Perhaps the quality of the things you buy on a regular basis has improved, but the costs of daily life are certainly not falling.
After thinking about it for a while, I realized that even the costs of watching television or making a phone call have risen. Take television. Granted, quality has improved dramatically, but the cost of watching television has gone up tremendously. I purchased a color television set in 1987 for $299 and paid an additional $200 to have a rotational antenna installed on my house. That allowed me to capture stations from Baltimore to Philadelphia. There were no additional costs involved. I received all my programming for free.
These days you would have to buy a high-definition television set. I know prices for HDTVs are falling, but they still cost about $1,000 or more. You also have to subscribe to premium cable or satellite services that cost at least $60 per month. And even though you can now get hundreds of stations, it is still difficult to find much that is worth watching. So, economists may argue that the cost of a television has fallen if you factor in the vastly improved quality. Yet the fact is that the cost of watching television today is much higher than it was in the 1980s.
As for cell phones, they were certainly a rarity back in 1987. Those who wanted one installed in their car had to pay a fortune. These days cell phones are ubiquitous. Yet I can't say that I have noticed a decrease in the price of making a call. Even cell phone prices don't seem to have fallen much in recent years. Yes, the phones are getting cooler and cooler. They do offer lots of features I never thought I needed. But when you consider all those hidden fees and taxes, the cost of making a call just seems to go higher and higher.
There are many such examples. Technology has brought us lots of products we couldn't even have imagined just a couple of decades ago. And if these products come with added features with only a marginal increase in price, economists actually consider that a price decrease. Yet the cost of daily life keeps rising. Think of all the things you do on a regular basis. You spend money on housing and clothing. You have to eat and drive to work. You might watch television and listen to satellite radio. You might go out to dinner and a movie. You might take a vacation. Perhaps the quality of the things you buy on a regular basis has improved, but the costs of daily life are certainly not falling.
Wednesday, July 11, 2007
Life is Good Without a Car or Food
Is there or is there not an inflation problem in the U.S. economy? Anyone who buys gasoline knows inflation is rampant. Filling up the average sized gas tank costs about $50 these days. Just a few years ago you would have needed only about $30. Food prices are also way up. Even Starbucks is complaining that high dairy prices are pinching profit margins.
Yet Fed officials and most economists say inflation is not so bad because they prefer to focus on core inflation. In other words, they want to know how much prices are rising if we exclude gasoline and food. They believe gasoline and food prices are just too volatile to provide a meaningful measure of inflation, so they simply ignore them.
But investors are waking up to the fact that gasoline and food really matter. Consumers know these items are taking a bigger and bigger bite out of their paychecks. The effects are starting to show as consumer spending becomes strained. For example, Wal-Mart has been complaining for some time about higher gasoline prices weakening their customers' purchasing power. It turns out some of those customers are making up for this by resorting to the 5-finger discount. Wal-Mart is getting fed up with the increased levels of shoplifting activity it is seeing, so it announced plans to be more aggressive about prosecuting violators.
In the meantime the housing market continues to implode and foreclosures keep rising. Even S&P and Moody's have finally figured out that sub-prime mortgages are indeed risky. Housing prices are falling nationwide. Of course, the high-end of the market will probably fare well. But average prices are likely to fall enough to put some homeowners in a negative equity position.
As for jobs, so far so good. The economy is still creating jobs and the unemployment rate remains low. Nonetheless, incomes are not doing so hot. According to the Commerce Department, inflation-adjusted incomes actually fell in May. Of course, that's using overall inflation, which includes those volatile gasoline and food prices. Those of you who are lucky enough not to have to drive or eat, well it turns out you're doing pretty well!
Yet Fed officials and most economists say inflation is not so bad because they prefer to focus on core inflation. In other words, they want to know how much prices are rising if we exclude gasoline and food. They believe gasoline and food prices are just too volatile to provide a meaningful measure of inflation, so they simply ignore them.
But investors are waking up to the fact that gasoline and food really matter. Consumers know these items are taking a bigger and bigger bite out of their paychecks. The effects are starting to show as consumer spending becomes strained. For example, Wal-Mart has been complaining for some time about higher gasoline prices weakening their customers' purchasing power. It turns out some of those customers are making up for this by resorting to the 5-finger discount. Wal-Mart is getting fed up with the increased levels of shoplifting activity it is seeing, so it announced plans to be more aggressive about prosecuting violators.
In the meantime the housing market continues to implode and foreclosures keep rising. Even S&P and Moody's have finally figured out that sub-prime mortgages are indeed risky. Housing prices are falling nationwide. Of course, the high-end of the market will probably fare well. But average prices are likely to fall enough to put some homeowners in a negative equity position.
As for jobs, so far so good. The economy is still creating jobs and the unemployment rate remains low. Nonetheless, incomes are not doing so hot. According to the Commerce Department, inflation-adjusted incomes actually fell in May. Of course, that's using overall inflation, which includes those volatile gasoline and food prices. Those of you who are lucky enough not to have to drive or eat, well it turns out you're doing pretty well!
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