Posts filed under ‘economy’
USA Inc.: Buy, Hold or Sell?
If the U.S. was a company, would you buy, hold, or sell the stock? A voluminous report put out last year by Mary Meeker sought to answer that very question. Since we’re in the thick of the presidential elections, why not review the important financial state of our great nation.
For those of you who may not know who she is, Mary Meeker is the well-known partner at Kleiner Perkins Caufield & Byers, who is also affectionately known as the “Queen of Internet.” Apparently, beyond her renowned expertise in analyzing and valuing tech companies and start-ups, she also has the knack of dissecting government statistics and distilling wonky numbers down to understandable terms for the masses. “Distilling” may be a generous term, given the massive size of her 460-page report, USA Inc., but nevertheless, I am going to attempt to synthesize this gargantuan report even further.
As a visual learner, I think some key cherry-picked slides from her report will help put our multi-trillion debts and deficits in context, so here goes…
The Scope of the Problem
If one spends a few hundred billion dollars here, and a few hundred billion dollars there, before you know it, a trillion dollars will have piled up. Currently our government has run $1 trillion+ budget deficits for three years, and the estimated deficit is for another trillion dollar deficit this fiscal year. If you have ever wondered how many football fields it takes to fill with a trillion dollars of cash, then today is your lucky day. The answer: 217 football fields.
Financial Statements: The Health Thermometer
In order to determine the relative health of USA Inc., Meeker created financial statements for our country, starting with the income statement. As you can see from the chart below, unfortunately USA Inc.’s expenses have been significantly larger than its revenues, creating a “discouraging” trend of negative cash flows (deficits). An entity that takes in $2.2 trillion in revenue and spends $3.5 trillion, cannot sustainably continue this trend for long, before significant financial problems arise. The largest contributing factor to our country’s losses (deficits) has been the exploding costs of entitlements, including Medicare, Medicaid, and Social Security.
As the pie chart shows, the major categories of entitlements comprise a whopping 58% of USA Inc.’s 2010 total expenditures.
Trillion dollar deficits have been the norm over the last three years.
Why Entitlement Spending is a Problem
Why are entitlements such a massive problem? The plain and simple answer to why entitlements are a major issue is that government expenditures are growing too fast. You can’t have expenses growing significantly faster than revenues for 45 years and expect to be in happy financial place.
Another reason for the abysmal spending record is due to politicians horrendous forecasting abilities. Future promises are made by politicians to garner votes today, and when they make overly rosy estimates about the costs of those promises, future generations are left holding the underfunded bag. Meeker points out that when Medicare was instituted in 1966, total future spending of $110 billion turned out to be about 10x more expensive (see chart below) than originally planned…ouch!
No Defense for Defense
Trillion dollar deficits and debts can’t be solely blamed on entitlements, but $700 billion in annual defense expenditures is not exactly chump change. The inopportune timing of the financial crisis in 2008-2009 didn’t help either, while two unfunded wars were being fought. Even if you strip out the wars, defense spending is still obscenely high. Given our poor state of financial affairs, we cannot afford to be the globe’s babysitter (see Impoverished Global Babysitter). Legacy Cold War spending on obsolete ground warfare needs to be reprioritized to 21st Century threats (i.e. focus on unmanned drones and coordinated intelligence). When a government spends more than the top 25 countries combined (see chart below), that country can certainly find some defense fat to trim.
Demographic Headwinds
The out-of-control gluttonous government spending is a threat to our national security, and although I wish I could say time alone will heal our fiscal wounds, unfortunately the opposite is true. Time is our enemy because the ticking demographic time bomb is about to explode, unless government acts to solve our spending problems. For starters, Americans are living longer, which means entitlement spending has accelerated faster than revenues collected, and life expectancy consistently continues to rise. As you can see below, life expectancy has outpaced Social Security age adjustments by +23% over a 74 year period.
Another self inflicted problem contributing to our colossal health care costs is the obesity epidemic. Over an 18 year period, the rate of obesity more than doubled to 32%. Individuals can and should shoulder more of the burden for these belt-busting costs, and government should spend more on prevention and education in this area. Bad drivers pay higher premiums for their auto insurance, so why not have bad eaters pay higher premiums? Genetics certainly can play a role in obesity, but so to do eating habits. The same accountability principle should be applied to smokers who overly burden our healthcare system too.
The USA spends more on healthcare than all OECD countries combined and 3x the OECD per capita average, yet as you can see from the chart below, the USA is not getting a life expectancy bang for its buck. The argument that the U.S. has the best healthcare in the world may be true in some instances, but the overall data doesn’t support that assertion.
The Rubber Hits the Road
The problem is easy to identify: Government spending going out the door is running faster than the revenues coming in via taxes. The solution is easy to identify too: Politicians need to cut spending, increase taxes, and/or do a combination of the two options. Like dieting, the solutions are easy to identify but difficult to execute.
Source: Calafia Beach Pundit – Scott Grannis
Almost everyone wants the government to spend less, but at the same time nobody wants their benefits cut. You can’t have your cake and eat it too. Citing two different studies, Meeker shows how 80% of Americans want a balanced budget as a national priority, but only 12% are willing to cut spending on Medicare and Social Security.
The rubber will hit the road in the next few months when politicians in a post-presidential election period will be forced to face these difficult “Fiscal Cliff” choices – $700 billion+ in tax hikes and spending increases that jeopardize the current recovery and our fiscal future.
Source: PIMCO
As market maven Mary Meeker recognizes, our fiscal situation is quite “discouraging”. With that said, although USA Inc. may have earned a current “Sell” rating, Meeker acknowledges that our country can become a positive turnaround situation. If voters actively push politicians to making difficult but necessary financial decisions to lower deficits and debt, investors around the globe will be ready to “Buy” USA Inc.’s stock.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct positions in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Autumn, Elections and Replacement Refs
Article is an excerpt from previously released Sidoxia Capital Management’s complementary October 1, 2012 newsletter. Subscribe on right side of page.
As September has come to a close, the grand finale of our annual seasons has commenced… autumn. How do we know autumn is here? Well, for starters, the leaves are changing colors; the weather is about to cool; and the NFL replacement referees are watching Sunday football games from their couches.
While 2012 is split into quarters, football games and investment seasons are also divided into four quarters. Right now, the economic fourth quarter has just started and the home team is winning. As we can see from the stock market scoreboard, the S&P 500 index is up +15% this year (+6% in Q3) and the NASDAQ index has catapulted +20% through September (+6% also in Q3). The U.S. home team is winning, but a fumble, blocked kick, or interception could mean the difference between an exciting win and a devastating loss.
Another game divided into four parts is the game of presidential politics. However, presidential elections are divided into four years – not four quarters. Five weeks from now, we’ll find out if our Commander in Chief Obama will get to lead our team for another game lasting four years, or whether backup quarterback Mit Romney will be called into the game. The fans are getting restless due to anemic growth and lingering joblessness, but for now, the coach is keeping the president in the starting lineup. Both President Obama and Governor Romney will take some head-to-head practice snaps against each other in the first of three scheduled presidential debates beginning this week.
Bernanke Changes Rules
The New York Jets have Tim Tebow for their secret weapon (1 for 1 yesterday!), and the United States economy has Ben Bernanke. Although our home team may be winning, it has required some monetary rule-changing policies to be instituted by Federal Reserve Chairman Ben Bernanke to keep our team in the lead. Just a few weeks ago, Mr. Bernake instituted QE3 (3rd round of quantitative easing), which is an open-ended mortgage buying program designed to lower home buying interest rates and stimulate the economy (see Helicopter Ben to QE3 Rescue). The short-term benefits of the $40 billion monthly bond buying binge are relatively clear (lower borrowing costs for homebuyers), but the longer-term costs of inflation are stewing patiently on the backburner.
Source: Calafia Beach Pundit (Scott Grannis)
As you can see from the chart above, August median home prices are up +10% for existing single-family homes over the last year. Housing affordability is at extremely attractive levels, and although the bank loan purse strings are tight, a modest loosening is beginning to unfold.
Economy Playing Injured
Our starters may still be playing, but many are injured, just like the jobless are limping through the employment market. Encouragingly, although unemployment remains stubbornly high, the number of people collecting unemployment checks is a lot lower (-1.25 million fewer than a year ago). Not great news, but at least we are hobbling in the right direction (see chart below).
Source: Calafia Beach Pundit (Scott Grannis)
Time for Fiscal Cliff Hail Mary?
If a team is losing at the end of a game, a “Hail Mary” pass might be necessary. We are quickly nearing this fiscal Armageddon situation as the approximately $700 billion “fiscal cliff” (a painful combo of spending cuts and tax hikes) kicks in at the end of the year (see PIMCO chart below via The Reformed Broker).
Running trillion dollar deficits in perpetuity is not a sustainable strategy, so for most people, a combination of spending cuts and/or tax hikes makes sense to narrow the gap (see chart below). Last year’s recommendations from the bipartisan Simpson-Bowles commission, which were ignored, are not a bad place to start. What happens in the lame-duck session of Congress (after the elections) will dramatically impact the score of the current economic game, and decide who wins and who loses.
Source: Calafia Beach Pundit (Scott Grannis)
Heated debates continue on how the gap between expenses and revenues will be narrowed, but regardless, Democrats will continue to push for capital gains tax hikes on the rich (see tax chart below); and the Republicans will push to cut spending on entitlements, including untenable programs like Medicare and Social Security.
Source: The Wall Street Journal
The game is not quite over, but the fourth quarter promises to be a bloody battle. So while the replacement refs may be back at home, the experienced returning refs have been known to blow calls too. Let’s just hope that autumn, the season of bounteous fecundity, ends up being a continued trend of sweet market success, rather than a political period of botched opportunities.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct positions in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Fiscal Cliff: Will a 1937 Repeat = 2013 Dead Meat?
Source: StockCharts.com
The presidential election is upon us and markets around the globe are beginning to factor in the results. More importantly, in my view, will be the post-election results of the “fiscal cliff” discussions, which will determine whether $600 billion in automated spending cuts and tax increases will be triggered. Similar dynamics in 1937 existed when President FDR (Franklin Delano Roosevelt) felt pressure to balance the budget after his 1933 New Deal stimulus package began to rack up deficits and lose steam.
What’s Similar Today
Just as there is pressure to cut spending today by Republicans and “Tea-Party” Congressmen, so too there was pressure for FDR and the Federal Reserve in 1937 to unwind fiscal and monetary stimulus. At the time, FDR thought self-sustaining growth had been restored and there was a belief that the deficits would become a drag on expansion and a source of future inflation. What’s more, FDR’s Treasury Secretary, Henry Morgenthau, believed that continued economic growth was dependent on business confidence, which in turn was dependent on creating a balanced budget. History has a way of repeating itself, which explains why the issues faced in 1937 are eerily similar to today’s discussions.
The Results
FDR was successful in dramatically reducing spending and significantly increasing taxes. Specifically, federal spending was reduced by -17% over two years and FDR’s introduction of a Social Security payroll tax contributed to federal revenues increasing by a whopping +72% over a similar timeframe. The good news was the federal deficit fell from -5.5% of GDP to -0.5%. The bad news was the economy went into a tail-spinning recession; the Dow crashed approximately -50%; and the unemployment rate burst higher by about +3.3% to +12.5%.
Source: New York Times
Source: Blue Mass Group
What’s Different This Time?
For starters, one difference between 1937 and 2012 is the level of unemployment. In 1937, unemployment was +14.3%, and today it is +8.1%. Objectively, today there could be higher percentage of the population “under-employed,” but nonetheless the job market was in worse shape back then and labor unions had much more power.
Another major difference is the stance carried by the Fed. Today, Ben Bernanke and the Fed have made it crystal clear they are in no hurry to take away any of the monetary stimulus (see Hekicopter Ben QE3 article), until we have experienced a long-lasting, sustainable recovery. Back in early 1937, the Fed increased banks’ reserve requirements twice, doubling the requirement in less than a year, thereby contracting monetary supply drastically.
Furthermore, we live in a much more globalized world. Today, central banks and governments around the world are doing their part to keep growth alive. Emerging markets are large enough now to move the needle and impact the growth of developed markets. For example, China, the #2 global superpower, continues to cut interest rates and has recently implemented a $158 billion infrastructure spending program.
Net-Net
Whether you’re a Republican or Democrat, everyone generally agrees that job creation is an important common objective, which is consistent with growing our economy. The disagreement between parties stems from the differing opinions on what are the best ways of creating jobs. From my perch, the frame of the debate should be premised on what policies and incentives should be structured to increase competitiveness. Without competitiveness there are no jobs. At the end of the day, money and capital are agnostic. Cold hard cash migrates to the countries in which it is treated best. And where the money goes is where the jobs go.
There is no single silver bullet to solve the competiveness concerns of the United States. Like baseball (since playoffs are quickly approaching), winning is not based solely on hitting, pitching, defense, or base-running. All of these facets and others are required to win. The same principles apply to our country’s competitiveness.
In order to be a competitive leader in the 21st century, here are few necessary areas in which we must excel:
Education: Chicago school unions have been in the news, and I have no problems with unions, if accountability can be structured in. Unfortunately, however, it is clear to me that for now our system is broken (a must see: Waiting for Superman). We cannot compete in the 21st century with an illiterate, uneducated workforce. Our colleges and universities are still top-notch, but as Bill Gates has stated, our elementary schools and high schools are “obsolete”.
Entitlements: Social safety nets like Social Security and Medicare are critical, but unsustainable promises that explode our debt and deficits will not make us more competitive. Politicians may gain votes by making promises in the short-run, but when those promises can’t be delivered in the medium-run or long-run, then those votes will disappear quickly. The sworn guarantees made to the 76 million Baby Boomers now entering retirement are a disaster waiting to happen. Benefits need to be reduced and or criteria need to be adjusted (i.e., means-testing, increase age requirements). The problems are clear as day, so Americans cannot walk away from this sobering reality.
Strategic Government Investment: – Government played a role in building our country’s railways, highways, and our military – a few strategic areas of our economy that have made our nation great. Thoughtful investments into areas like energy infrastructure (e.g., smart grid), internet infrastructure (e.g., higher speed super highway), and healthcare (e.g., human genome research) are a few examples of how jobs can be created while simultaneously increasing our global competitiveness. The great thing about strategic government investments is that government does NOT have to do all the heavy lifting. Rather than write all the checks and do all the job creation from Washington, government can implement these investments and create these jobs by providing incentives for the private sector. Strategic public-private partnerships can generate win-win results for government, businesses, and job seekers. If, however, you’re convinced that our government is more efficient than the private sector, then I highly encourage you to go visit your local DMV, post office, or VA to better appreciate the growth-sucking bureaucracy and inefficiency.
Taxes / Regulations / Laws: Taxes come from profits, and businesses create profits. In order to have a strong and competitive government, we need strong and competitive businesses. Higher taxes, excessive regulations, and burdensome laws will not create stronger and more competitive businesses. I acknowledge that reckless neglect and consumer exploitation will not work either, but reasonable protections for consumers and businesses can be instituted without multi-thousand page regulations. Reducing ridiculous subsidies and loopholes, while tightening tax collection processes and punishing tax dodgers makes perfect sense…so why not do it?
Politics are sharply polarized at both ends of the spectrum, but no matter who wins, our problems are not going away. We may or may not have a new president of the United States this November, but perhaps more important than the elections themselves will be the outcome of the “fiscal cliff” legislation (or lack thereof). If we want to maintain our economic power as the strongest in the world, solving this “fiscal cliff” is the key to improving our competiveness. Avoiding a messy 1937 (and 2011) political repeat will prevent us from becoming dead meat.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct positions in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Helicopter Ben to QE3 Rescue
Faster than a speedy credit default swap, more powerful than a federal funds interest rate cut, and able to leap a tall Mario Draghi in a single bound, look…it’s Helicopter Ben! How did Federal Reserve Chairman Ben Bernanke become a monetary superhero with such a cool nickname as Helicopter Ben (a.k.a. “HB”)? Bernanke, a former Princeton University professor, has widely been known to be a diligent student of the Great Depression, and his aviation nickname stems from a 2002 speech in which he referenced dropping money from a helicopter to combat deflation. While investors may worry about HB’s ability to fight the inflation thugs, there should be no questions about his willingness to implement accommodative, deflation-fighting monetary policies.
Chairman Bernanke may not epitomize your ideal superhero, however this slightly past middle-aged bearded and balding man has helped mastermind some of the most creative and aggressive monetary rescue efforts our country and globe has seen in the history of man (and woman). This week’s money-printing QE3 announcement solidified Bernanke’s historic capital saturating ranking.
Since Helicopter Ben’s heroic appointment as Federal Reserve Chairman in 2006 by George W. Bush, Bernanke has instituted numerous monetary gadgets in hopes of meeting the Federal Reserve’s dual mandate, which is i) to achieve low inflation and ii) to strive for maximum employment. Arguably, given the anemic growth here in the U.S.; the recession in Europe; and slowing growth in the emerging markets (i.e., China, Brazil, India, etc.), slack in the economy and static labor wages have largely kept inflation in check. With the first part of the dual mandate met, Bernanke has had no problem putting his monetary superpowers to work.
As referenced earlier, Bernanke’s bazooka launch of QE3, an open ended MBS (Mortgage Back Securities) bond binging program, will add $40 billion of newly purchased assets to the Fed’s balance sheet on a monthly basis until the labor market improves “substantially” (whatever that means). What’s more, in addition to the indefinite QE3, Bernanke has promised to keep the federal funds rate near zero “at least through mid-2015,” even for a “considerable time after the economic recovery strengthens.”
HB’s Track Record
Throughout superhero history, Superman, Spider-man, and Batman have used a wide-array of superhuman powers, extraordinary gadgets, and superior intellect to conquer evil-doers and injustices across the globe. Bernanke has also forcefully put his unrivaled money-printing talents to work in an attempt to cure the financial ills of the world. Here’s a quick multi-year overview of how Bernanke has put his unique talents to print trillions of dollars and keep interest rates suppressed:
Rate Cuts (September 2007 – December 2008): Before “quantitative easing” was a part of our common vernacular, the Fed relied on more traditional monetary policies, such as federal funds rate targeting, conducted through purchases and sales of open market securities. Few investors recall, but before HB’s fed funds rate cut rampage of 10 consecutive reductions in 2007 and 2008 (the fed funds rate went from 5.25% to effectively 0%), Bernanke actually increased rates three times in 2006.
Crisis Actions (2007 – 2009): Love him or hate him, Bernanke has been a brave and busy soul in dealing with the massive proportions of the global financial crisis. If you don’t believe me, just check out the Financial Crisis Timeline listed at the St. Louis Federal Reserve. Many investors don’t remember, but Bernanke helped orchestrate some of the largest and most unprecedented corporate actions in our history, including the $30 billion loan to JPMorgan Chase (JPM) in the Bear Stearns takeover; the $182 billion bailout of AIG; the conversion of Morgan Stanley (MS) and Goldman Sachs Group Inc. (GS) into bank holding companies; and the loan/asset-purchase support to Fannie Mae (FNMA) and Freddie Mac (FMCC). These actions represented just the tip of the iceberg, if you also consider the deluge of liquidity actions taken by the Fed Chairman.
HB Creates Acronym Soup
In order to provide a flavor of the vastness in emergency programs launched since the crisis, here is an alphabet soup of program acronyms into which the Fed poured hundreds of billions of dollars:
- Term Asset-Backed Securities Loan Facility (TALF)
- Term Auction Facility (TAF)
- Money Market Investor Funding Facility (MMIFF)
- Commercial Paper Funding Facility (CPFF)
- Primary Dealer Credit Facility (PDCF)
- Asset-Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF)
- Temporary Reciprocal Currency Arrangements (Swap lines)
- Term Securities Lending Facility (TSLF)
Plenty of acronyms to go around, but these juicy programs have garnered most of investors’ attention:
QE1 (November 2008 – March 2010): In hopes of lowering interest rates for borrowers and stimulating the economy, HB spearheaded the Fed’s multi-step, $1 trillion+ buying program of MBS (mortgage backed securities) and Treasuries.
QE2 (November 2010 – June 2011): Since the Fed felt QE1 didn’t pack enough monetary punch to keep the economy growing at a fast enough clip, the FOMC (Federal Open Market committee) announced its decision to expand its holdings of securities in November 2010. The Committee maintained its existing policy of reinvesting principal payments from its securities holdings and to also purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011 (an equivalent pace of about $75 billion per month).
Operation Twist (September 2011 – December 2012): What started out as a $400 billion short-term debt for longer-term debt swap program in September 2011, expanded to a $667 billion program in June 2012. With short-term rates excessively low, Bernanke came up with this Operation Twist scheme previously used in the early 1960s. Designed to flatten the yield curve (bring down long-term interest rates) to stimulate economic activity, Bernanke thought this program was worth another go-around. Unlike quantitative easing, Operation Twist does not expand the Fed’s balance sheet – the program merely swaps short-term securities for long-term securities. Currently, the program is forecasted to conclude at the end of this year.
The Verdict on HB
So what’s my verdict on the continuous number of unprecedented actions that Helicopter Ben and the Fed have taken? Well for starters, I have to give Mr. Bernanke an “A-” on his overall handling of the financial crisis. Had his extreme actions not been taken, the pain and agony experienced by all would likely be significantly worse, and the financial hole a lot deeper.
With that said, am I happy about the announcement of QE3 and the explosion in the Fed’s money printing activities? The short answer is “NO”. It’s difficult to support a program with questionable short-run interest rate benefits, when the menacing inflationary pressures are likely to outweigh the advantages. The larger problem in my mind is the massive fiscal problem we are experiencing (over $16 trillion in debt and endless trillion dollar deficits). More importantly, this bloated fiscal position is creating an overarching, nagging crisis of confidence. A resolution to the so-called “fiscal cliff,” or the automated $600 billion in tax increases and spending cuts, is likely to have a more positive impact on confidence than a 0.05% – 0.25% reduction in mortgage rates from QE3. Once adequate and sustained growth returns, and inflation rears its ugly head, how quickly Helicopter Ben tightens policy will be his key test.
Until then, Bernanke will probably continue flying around while gloating in his QE3 cape, hoping his quantitative easing program will raise general confidence. Unfortunately, his more recent monetary policies appear to be creating diminishing returns. Even before QE3’s implementation, Helicopter Ben has witnessed his policies expand the Fed’s balance sheet from less than $900 billion at the beginning of the recession to almost $3 trillion today. Despite these gargantuan efforts, growth and confidence have been crawling forward at only a modest pace.
No matter the outcome of QE3, as long as Ben Bernanke remains Federal Reserve Chairman, and growth remains sluggish, you can stay confident this financial man of steel will continue dumping money into the system from his helicopter. If Bernanke wants to create a true legendary superhero ending to this story, the kryptonite-like effects of inflation need to be avoided. This means, less money-printing and more convincing of Congress to take action on our out-of-control debt and deficits. Now, that’s a comic book I’d pay to read.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct positions in JPM, AIG, MS, GS, FNMA, FMCC, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Floating Hedge Fund on Ice Thawing Out
These days, pundits continue to talk about how the same financial crisis plaguing Greece and its fellow PIIGS partners (Portugal, Ireland, Italy & Spain) is about to plow through the eurozone and then ultimately the remaining global economy with no mercy. If all the focus is being placed on a diminutive, calamari-eating, Ouzo-drinking society like Greece, whose economy matches the size of Maryland, then why not evaluate an even more miniscule, PIIGS prequel country…Iceland.
That’s right, the same Iceland that just four years ago people were calling a “hedge fund on ice.” You know, that frozen island that had more foreign depositors investing in their banks than people living in the country. Before Icelandic banks became more than 75% of the overall stock market, and Gordon Gekko became the country’s patron saint, Iceland was more known for fishing. The fishing industry accounted for about half of Iceland’s exports, and the next largest money maker may have been Bjork, the country’s famed and quirky female singer.
In looking back at the financial crisis of 2008-2009, as it turned out, Iceland served as a canary in the global debt binging coal mine. In order to attract the masses of depositors to Icelandic banks, these financial institutions offered outrageous, unsustainable interest rates to yield-starved customers. How did the Icelandic bankers offer such high rates? Well of course, it was those can’t-lose American subprime mortgages that were offering what seemed like irresistibly high yields. Of course, what seemed like a dream at the time, eventually turned into a nightmare once the scheme unraveled. Ultimately, it became crystal clear that the subprime borrowers could not pay the outrageous rates, especially after rates unknowingly reset to untenable levels for many borrowers.
At the peak of the crisis, the Icelandic banks were holding amounts of debt exceeding six times the Icelandic GDP (Gross Domestic Product) and these lenders suffered more than $100 billion in losses. One of the Icelandic banks was even funding a large condominium project in my neighboring Southern California city of Beverly Hills. When the excrement hit the fan after Lehman Brothers went bankrupt, it didn’t take long for Iceland’s stock market to collapse by more than -95%; Iceland’s Krona to crumple; and eventually the trigger of Iceland’s multi-billion bailout by numerous constituents, including the IMF (International Monetary Fund).
Bitter Medicine First, Improvement Next
Today, four years after the subprime implosion and Lehman debacle, the hedge fund on ice known as Iceland is beginning to thaw, and their economic picture is looking much brighter (see charts below). GDP growth is the highest it has been in four years (4.5% recently); the stock market has catapulted upwards (almost doubling from the lows); and the Iceland unemployment rate has declined from over 9% a few years ago to about 7% today.
Source: Trading Economics
Source: Trading Economics
Re-jiggering a phony economy with a faulty facade cannot be repaired overnight. However, now that the banking system has been allowed to clear out its excesses, Iceland can move forward. One tailwind behind the economy has been Iceland’s weaker currency, which has led to a +17% increase in foreign tourist nights at Icelandic hotels through April this year. What’s more, tourist traffic at Iceland’s airport hit a record in May. Iceland has taken its bitter medicine, adjusted, and is currently reaping some of the rewards.
Although the detrimental effects of austerity experienced by the economies and banks of Greece, Spain, and Italy crowd out most of today’s headlines, Iceland is not the only country to make painful changes to its fiscal ways and then taste the sweetness of progress. Let’s not forget the Guinness drinking Irish. Ireland, like Greece, Portugal, and Spain received a bailout, but Ireland’s banking system was arguably worse off than Spain’s, yet Ireland has seen its borrowing costs on its 10-year bond decrease dramatically from 9.2% at the beginning of 2011 to about 7.4% this month (still high, but moving in the right direction). The same can be said for the United States. Our banks were up against the ropes, but after some recapitalization, tighter oversight, and stricter lending standards, our banks have gotten back on track and have helped assist our economy grow for 11 consecutive quarters (albeit at uninspiring growth rates).
The austerity versus growth debate will no doubt continue to circulate through media circles. In my view, these arguments are too simplistic and one dimensional. Every country has its unique culture and distinct challenges, but even countries with massive financial excesses can steer themselves back to a path of growth. A floating hedge fund on ice to the north of us has proven that fact to us, as we witness brighter days beginning to thaw Iceland’s chilly economy to expansion again.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in Lehman Brothers, Guinness, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Markets Race Out of 2012 Gate
Article includes excerpts from Sidoxia Capital Management’s 2/1/2012 newsletter. Subscribe on right side of page.
Equity markets largely remained caged in during 2011, but U.S. stocks came racing out of the gate at the beginning of 2012. The S&P 500 index rose +4.4% in January; the Dow Jones Industrials climbed +3.4%; and the NASDAQ index sprinted out to a +8.0% return. Broader concerns have not disappeared over a European financial meltdown, high U.S. unemployment, and large unsustainable debts and deficits, but several key factors are providing firmer footing for financial race horses in 2012:
• Record Corporate Profits: 2012 S&P operating profits were recently forecasted to reach a record level of $106, or +9% versus a year ago. Accelerating GDP (Gross Domestic Product Growth) to +2.8% in the fourth quarter also provided a tailwind to corporations.
• Mountains of Cash: Companies are sitting on record levels of cash. In late 2011, U.S. non-financial corporations were sitting on $1.73 trillion in cash, which was +50% higher as a percentage of assets relative to 2007 when the credit crunch began in earnest.
• Employment Trends Improving: It’s difficult to fall off the floor, but since the unemployment rate peaked at 10.2% in October 2009, the rate has slowly improved to 8.5% today. Data junkies need not fret – we have fresh new employment numbers to look at this Friday.
• Consumer Optimism on Rise: The University of Michigan’s consumer sentiment index showed optimism improved in January to the highest level in almost a year, increasing to 75.0 from 69.9 in December.
• Federal Reserve to the Rescue: Federal Reserve Chairman, Ben Bernanke, and the Fed recently announced the extension of their 0% interest rate policy, designed to assist economic expansion, through the end of 2014. In addition, Bernanke did not rule out further stimulative asset purchases (a.k.a., QE3 or quantitative easing) if necessary. If executed as planned, this dovish stance will extend for an unprecedented six year period (2008 -2014).
Europe on the Comeback Trail?
Source: Calafia Beach Pundit
Europe is by no means out of the woods and tracking the day to day volatility of the happenings overseas can be a difficult chore. One fairly easy way to track the European progress (or lack thereof) is by following the interest rate trends in the PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain). Quite simply, higher interest rates generally mean more uncertainty and risk, while lower interest rates mean more confidence and certainty. The bad news is that Greece is still in the midst of a very complex restructuring of its debt, which means Greek interest rates have been exploding upwards and investors are bracing for significant losses on their sovereign debt investments. Portugal is not in as bad shape as Greece, but the trends have been moving in a negative direction. The good news, as you can see from the chart above (Calafia Beach Pundit), is that interest rates in Ireland, Italy and Spain have been constructively moving lower thanks to austerity measures, European Central Bank (ECB) actions, and coordination of eurozone policies to create more unity and fiscal accountability.
Political Horse Race
Source: Real Clear Politics via The Financial Times
The other horse race going on now is the battle for the Republican presidential nomination between former Massachusetts governor Mitt Romney and former House of Representatives Speaker Newt Gingrich. Some increased feistiness mixed with a little Super-Pac TV smear campaigns helped whip Romney’s horse to a decisive victory in Florida – Gingrich ended up losing by a whopping 14%. Unlike traditional horse races, we don’t know how long this Republican primary race will last, but chances are this thing should be wrapped up by “Super Tuesday” on March 6th when there will be 10 simultaneous primaries and caucuses. Romney may be the lead horse now, but we are likely to see a few more horses drop out before all is said and done.
Flies in the Ointment
As indicated previously, although 2012 has gotten off to a strong start, there are still some flies in the ointment:
• European Crisis Not Over: Many European countries are at or near recessionary levels. The U.S. may be insulated from some of the weakness, but is not completely immune from the European financial crisis. Weaker fourth quarter revenue growth was suffered by companies like Exxon Mobil Corp (XOM), Citigroup Inc. (C), JP Morgan Chase & Co (JPM), Microsoft Corp (MSFT), and IBM, in part because of European exposure.
• Slowing Profit Growth: Although at record levels, profit growth is slowing and peak profit margins are starting to feel the pressure. Only so much cost-cutting can be done before growth initiatives, such as hiring, must be implemented to boost profits.
• Election Uncertainty: As mentioned earlier, 2012 is a presidential election year, and policy uncertainty and political gridlock have the potential of further spooking investors. Much of these issues is not new news to the financial markets. Rather than reading stale, old headlines of the multi-year financial crisis, determining what happens next and ascertaining how much uncertainty is already factored into current asset prices is a much more constructive exercise.
Stocks on Sale for a Discount
Source: Calafia Beach Pundit
A lot of the previous concerns (flies) mentioned is not new news to investors and many of these worries are already factored into the cheap equity prices we are witnessing. If everything was all roses, stocks would not be selling for a significant discount to the long-term averages.
A key ratio measuring the priceyness of the stock market is the Price/Earnings (P/E) ratio. History has taught us the best long-term returns have been earned when purchases were made at lower P/E ratio levels. As you can see from the 60-year chart above (Calafia Beach Pundit), stocks can become cheaper (resulting in lower P/Es) for many years, similar to the challenging period experienced through the early 1980s and somewhat analogous to the lower P/E ratios we are presently witnessing (estimated 2012 P/E of approximately 12.4). However, the major difference between then and now is that the Federal Funds interest rate was about 20% back in the early-’80s, while the same rate is closer to 0% currently. Simple math and logic tell us that stocks and other asset-based earnings streams deserve higher prices in periods of low interest rates like today.
We are only one month through the 2012 financial market race, so it much too early to declare a Triple Crown victory, but we are off to a nice start. As I’ve said before, investing has arguably never been as difficult as it is today, but investing has also never been as important. Inflation, whether you are talking about food, energy, healthcare, leisure, or educational costs continue to grind higher. Burying your head in the sand or stuffing your money in low yielding assets may work for a wealthy few and feel good in the short-run, but for much of the masses the destructive inflation-eroding characteristics of purported “safe investments” will likely do more damage than good in the long-run. A low-cost diversified global portfolio of thoroughbred investments that balances income and growth with your risk tolerance and time horizon is a better way to maneuver yourself to the investment winner’s circle.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in XOM, MSFT, JPM, IBM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Darwin Meets Capitalism & Private Equity
Source: Photobucket
A rising discontent is spreading like wildfire in the wake of a massive financial crisis that erupted in the U.S. during 2008, and is now working its way through Europe. Irresponsible governments across the globe succumbed to the deceptive allure of leverage, and as a result racked up colossal debts and gargantuan deficits. Now governments everywhere are toggling between political gridlock and painful austerity. Citizens are feeling the pain through high unemployment, exploding education costs, crumbling social safety nets, and a general decline in the standard of living.
As a result of these dramatic changes, the contributions of capitalism are being questioned by many, whether it’s the Occupy Wall Street movement attack on the top 1%, or more recently the assault on private equity’s relevancy for a presidential candidate.
Although the media may prefer to sensationalize economic stories and tell observers, “This time is different” to boost viewership, usually the truth relies more on the nuanced evolution of issues over time. If Charles Darwin were alive today, he would understand that capitalism and democracies are evolving to massive changes in globalization, technology, and emerging markets. Darwin would appreciate the fact that capitalism can’t and won’t change overnight. Whether capitalism ultimately survives or goes extinct depends on how it adapts. Or as Darwin characterizes evolution:
It is not the strongest of the species that survives, nor the most intelligent, but the most responsive to change.
Will Capitalism Survive?
Capitalism and democracy fit like a hand in a glove, which explains why both have thrived for generations. Never mind that democracies have been around for centuries and their expansion continues unabated (see Spreading the Seeds of Democracy), nevertheless pundits feel compelled to question the sustainability of these institutions.
I guess the real response to all those experts who question the merits of capitalism is what alternative would serve us better? Would it be Socialism like we see grinding Europe to a halt? Or perhaps Communism working its wonders in North Korea and Cuba? If not that, then surely the Autocracies in Egypt and Libya are the winning formulas? The Occupy Wall Streeters may not be happy with their personal plight or the top 1%, but I don’t see them packing their bags for Greece, the Middle East or China.
There is arguably a growing disparity between rich and poor and the game of globalization is only making it more difficult for rising tides of growth to lift up our middle class. The beauty of capitalism is that money goes where it is treated best. Capitalism sucks money to the areas of the world that are the freest, most open, transparent, and practice the rule of law. Some of these components of American capitalism unquestionably eroded over the last decade or so, but the good thing is that in a democracy, citizens have the right to vote and elect growth-promoting leaders to fix problems. Growth comes from competitiveness, and competitiveness is derived from education, innovation, and pro-growth policies. Let’s hope the 2012 elections get agents of change in office.
Darwin & Private Equity
Republican Presidential primary candidate Mitt Romney has been raked over the coals for his prior professional career at private equity firm, Bain Capital. I’m convinced Charles Darwin would see private equity’s involvement as a critical factor in the process of global commerce. Businesses are like species, and only the fittest will survive.
Private equity firms prey upon weak businesses, looking to restructure and reorganize them to become more competitive. If private equity companies are bullies, then their business targets can be considered weaklings. Beating wimps into shape may not be fun to watch, but is a crucial evolutionary aspect of business. The fact of the matter is that deteriorating, uncompetitive companies cannot hire employees…only profitable, viable entities can createsustainable jobs. So our public policy officials have two choices:
• Prop up uncompetitive businesses inefficiently with tax dollars that save jobs in the short-run, but lead to bankruptcy and massive job losses in the future. Other unproductive tariffs and bailouts may garner short-term political votes, but only lead to long-term stagnancy.
OR
• Trim fat, restructure and reorganize now – similar to the swift pain experienced from extracting a rotted tooth. Jobs may be cut in the short-run, but a long-term competitively positioned company will be able to grow and create sustainable long-term jobs.
I can’t say I agree with all of private equity practices, such as leveraged recapitalizations – the practice in which private equity companies load up the target with debt so big fat dividends can be sucked out by the principals. But guess what? By doing so the principals are only reducing their own future exit value through a potential IPO (Initial Public Offering) or company sale. Moreover, if this is such an evil practice, lenders can curb the practice by simply not giving the private equity companies the needed borrowing capacity.
Capitalism and its private equity subset have gotten quite a bad rap lately, but I believe these forces are essential aspects for the rising standards of living for billions of people across the planet. When first introduced, Charles Darwin’s theory of evolution by natural selection was critically examined by many non-believers. Although capitalism will be forced to adapt to an ever-changing world and its merits have been questioned too, the chances of capitalism going extinct are about as likely as the extinction of Darwin’s evolutionary theory.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Magical Growth through Manufacturing Decline
In a data driven world, we can never get enough numbers. The market magicians and the media machines have no problem overhyping or overselling the importance of each pending data-point. With a quick economic sleight of hand, the industry pundits have converted the average investor into a frothing Pavlovian dog, begging for another market shaking statistic. One of the supposed earth-rattling data points is the monthly ISM Manufacturing Index figure, but the release of the ISM number alone isn’t enough for the audience. The real fun comes in determining whether the monthly number registers above or below a schizophrenic 50 level – a number above 50 indicates the manufacturing economy is generally expanding (August came in at 50.6).
The trick can often be surprising, but more surprising to me is the importance placed on this relatively small, disappearing segment of our economy. With the manufacturing sector now accounting for just 11-13% of GDP (see also Manufacturing – Losing Out?), shouldn’t we be focusing more on the “Services” sector of the economy, which accounts for roughly 75% of our country’s output, up from 62% in 1971 (source: Earthtrends). I believe economist Mark Perry at Carpe Diem captured this phenomenon best in his post from earlier this year (Decline of Manufacturing – The World is Much Better Off ):
The fact of the matter is that manufacturing has been declining as a percentage of GDP over the decades just as the broader economy has seen massive growth. While manufacturing got chopped in half, as a percentage of GDP, from 1970 to 2011 we have seen GDP balloon from about $1 trillion to $15 trillion. If manufacturing declined by another 50% of GDP, I’d do cartwheels to see another 15x increase in economic expansion. I acknowledge the existence of certain synergies between product development and product manufacturing, but these benefits must be weighed against higher domestic costs that could make sales potentially unviable.
Déjà Vu All Over Again
This isn’t the first time in our country’s history that we’ve experienced explosive economic growth as legacy segments of the economy decline in relative importance. Consider the share of jobs agriculture controlled in the early 1800s – a whopping 90% of jobs were tied to farms (see chart below). Today, that percentage is less than 2% in the wake of the U.S. becoming the 20th Century global superpower. History has taught us that technology can be a bitch on employment, as robots, machinery, processes, and chemistry replace the demand for human labor. As Perry points out, there is no doubt that “tractors, electricity, combines, the cotton gin, automatic milking machinery, computers, GPS, hybrid seeds, irrigation systems, herbicides, pesticides” replaced millions of farming jobs, but guess what…American ingenuity ruled the day. As it turns out, those economic resources freed up by technology and productivity were redeployed into new, expanding, job-fertile areas of the economy like, “manufacturing, health care, education, business, retail, computers, transportation, etc.”
Source: Carpe Diem
More Apples or More GMs?
The farming lobby still cries for its inefficient, growth-muffling subsidies today, but many unproductive, unionized domestic manufacturing industries are also screaming for government assistance because cheap foreign labor and new technologies are stealing manufacturing jobs by the boatloads. So at the core, the real question is do we want government and investments supporting more companies like Apple Inc. (AAPL) or more companies like General Motors Company (GM)?
As you may know, by flipping over an iPhone, any observer can clearly notice the product is “designed by Apple in California – assembled in China.” It is clear that Apple and its customers value brains over manufacturing brawn. At $371 billion and the most valuable publicly traded stock in the universe, Apple is dominating the electronics world, all the while hiring employees by the thousands. These facts beg the question of whether Apple should revamp their manufacturing supply-chain back to the U.S. to save more domestic jobs? Of course the result of a manufacturing strategy shift to a higher cost region would make Apple less competitive, force them to charge consumers higher prices for Apple products, and open the door for competitors to freely steal market share? Would this strategy create more incremental jobs, or fewer jobs? I think I’ll side with the Steve Jobs philosophy of business, which says “more profitable businesses must fill more job openings.”
If this Apple case study isn’t illustrative enough for you, maybe you should take a look at companies like GM. The U.S. automobile industry has historically been notoriously mismanaged, thanks to a horrific manufacturing cost structure, anchored by unsustainable pension and healthcare costs. Should investors be surprised that an uncompetitive, bloated cost structure leaves companies like GM less money to invest in new products and innovation? This irrational cost management contributed to decades of market share losses to foreigners. If I’m the job creation czar in the U.S., I think I’ll choose the Apple path to job creation over GM’s route.
Global Competitiveness = Jobs
With a 9.1% unemployment rate and the recent introduction of the American Jobs Act, there has been plenty of emphasis and focus on job creation. At the end of the day, what will create durable, long-term job creation is innovative, competitively priced products and services that can be sold domestically and abroad. How do we achieve this goal? We need an education system that can teach and train a workforce sufficiently to meet the discerning tastes of a global marketplace. Government, on the other hand, needs to support (not direct) the private sector by investing in strategic areas to help global competitiveness (i.e., education, energy independence, basic research, infrastructure, entrepreneurial capital for business formation, etc.), while facilitating a business environment that incentivizes growth.
Regardless of the policy mixtures, the common denominator needs to be focused on improving global competitiveness. Excessive focus on a declining manufacturing sector and the monthly ISM data will only distract decision makers from the core issues. If the economic magician’s sleight of hand diverts investor attention for too long, we may see more jobs disappear.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, and AAPL, but at the time of publishing SCM had no direct position in GM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page
A Serious Situation in Jackson Hole
Source: Daily Fill
Federal Reserve Chairman Ben Bernanke graced his presence once again upon the glorious skyline of the Grand Tetons in Jackson Hole, Wyoming for the annual Economic Policy Symposium organized by the Federal Reserve Bank of Kansas City. The event has been made famous for Bernanke’s famous 2010 QE2 (quantitative easing) speech and he once again did his best to confuse people this year with his cryptic and masterful “Fed Speak” techniques. While reporters from around the globe covered the event, we at Investing Caffeine were fortunate enough to access MTV’s Jersey Shore cast member’s, Mike “The Situation” Sorrentino, exclusive interpretation of Bernanke’s speech. Here’s how “The Situation” translated Bernanke’s talk:
Mr Bernanke: “The financial crisis and the subsequent slow recovery have caused some to question whether the United States, notwithstanding its long-term record of vigorous economic growth, might not now be facing a prolonged period of stagnation.”
The Situation’s Take: “Looks like this economy is f’d up big time. This is gonna be some sick dry-spell.”
Mr. Bernanke: “The pace of recovery in the United States has, for the most part, proved disappointing thus far… it is clear that the recovery from the crisis has been much less robust than we had hoped.”
The Situation’s Take: “These economist chumps would have more luck chucking darts at Snooki’s booty than they would hitting their predictions. Let’s call Joey, my booky, and I’ll show you how the Situation works his magic.”
Mr. Bernanke: “Manufacturing production in the United States has risen nearly 15 percent since its trough, driven substantially by growth in exports. Indeed, the U.S. trade deficit has been notably lower recently than it was before the crisis, reflecting in part the improved competitiveness of U.S. goods and services.”
The Situation’s Take: “Trashed girls at the clubs like me a lot more after some drinks, just like the trashed value of the dollar makes foreigners like our exports.”
Mr. Bernanke: “Temporary factors, including the effects of the run-up in commodity prices on consumer and business budgets and the effect of the Japanese disaster on global supply chains and production, were part of the reason for the weak performance of the economy in the first half of 2011; accordingly, growth in the second half looks likely to improve as their influence recedes.”
The Situation’s Take: “When I’m chasing tail, hangovers temporarily slow me down sometimes too. What Big Ben and the U.S. financial situation needs is some 5-Hour Energy drink, a tanning session, and a quick pump of the biceps at the gym.”
Mr. Bernanke: “We indicated that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”
The Situation’s Take: “I feel you Benjamin. Keeping rates low is like having a permanent 2-for-1 happy hour at the club for the next two years. Now, that’s what I’m talkin’ bout!”
Mr. Bernanke: “The Federal Reserve has a range of tools that could be used to provide additional monetary stimulus. The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery.”
The Situation’s Take: “I hear ya Ben. Sometimes you gotta pull out the secret weapon, just like I have to flash my secret weapon…boom – these monster abs! Keep those secret tools coming Benny. I don’t care if it’s QE3, QE4, QE-infinity – just don’t listen to the haters.”
Mr. Bernanke: “I have confidence that our European colleagues fully appreciate what is at stake in the difficult issues they are now confronting and that, over time, they will take all necessary and appropriate steps to address those issues effectively and comprehensively.”
The Situation’s Take: “Everybody needs to put faith in their wingman sometimes.”
Mr. Bernanke: “Our K-12 educational system, despite considerable strengths, poorly serves a substantial portion of our population.”
The Situation’s Take: “Don’t mess with me Benny. C’mon, just take a look at me. I’m living proof of how our schools are the bomb! After all, the Situation learned his best moves with the ladies during high school.”
Mr. Bernanke: “Most of the economic policies that support robust economic growth in the long run are outside the province of the central bank…As I have emphasized on previous occasions, without significant policy changes, the finances of the federal government will inevitably spiral out of control.”
Situation’s Take: “Don’t let them politician punks make you do all the heavy lifting and flush the economy down the toilet. Looking this good ain’t easy and fixing the U.S. of A. ain’t either.”
Federal Reserve Chairman Ben Bernanke covered a lot of ground in his Jackson Hole speech. Given the mounds of complex data and dismal state of our economic situation, who better to translate and provide cutting edge analysis than Mike “The Situation” Sorrentino. Investing Caffeine appreciates the exclusive access given to us, but now I’m off to more important tasks at hand – before I do my fist pumping at the club tonight, I need to go work my abs and apply a nice spray tan.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: For those taking this article seriously, please look up “parody” in the dictionary. Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page
Rating Agencies to Government: Go Back to College!
Remember those days as a young adult, when you were a starving student in college, doing everything you possible could in your power to not run out of money (OK, if you were born with a silver spoon in your mouth, just play along). You know what I’m talking about… Corn Flakes for breakfast, PB&J for lunch, and maybe splurge with a little Mac & Cheese or Top Ramen for dinner. Well, the rating agencies, especially Standard & Poor’s (S&P) with their long-term sovereign credit rating downgrade on the U.S. from AAA rated to AA+ rated, are signaling our U.S. government to cut back on the champagne and caviar spending and go back to living like a college student.
Rent-A-Cops Assert Power
The rating agencies may have been asleep at the switch during the tech bubble (Enron & WorldCom) and the financial crisis of 2008-2009 (i.e., ratings of toxic mortgage backed securities), but they are doing their best to reassert themselves as credible security rating entities. By the way, as long as S&P has some wise critical advice for the U.S. government regarding fiscal responsibility, I have a suggestion for S&P: When providing a fresh ratings downgrade, please limit error estimations to less than $2,000,000,000,000.00 – this is exactly what S&P did in its ratings downgrade. Time will tell whether S&P can maintain its role as credit market policeman or will be mocked like those unarmed, overweight rent-a-cops you see at the shopping mall.
In reality, S&P’s moves represent little fundamental change, especially since these moves have been signaled for months (S&P initially lowered its outlook on the U.S. to negative on 4/18/11). I know there will be some that panic at this announcement (won’t be the first or last time), but should anyone really be shocked by an independent entity telling the U.S. government they are spending too much money and hold too much debt? If my memory serves me correctly, Americans have been screaming S&P’s same message for years – I think the rise of the Tea-Party, the results of the mid-term elections, and the tone of the debt ceiling debate may indicate a few people have caught onto this unsustainable fiscal disaster.
Two Simple Choices
As I have said for some time, these horrendously difficult issues will get resolved. The only question is who will resolve this negligent fiscal behavior? There are only two simple answers: 1) Politicians can proactively chip away at the problem with solutions my first grader has already identified (spend less and/or increase revenue); or 2) Financial Market Vigilantes can rip apart financial markets and force borrowing costs to the stratosphere. Option number one is preferable for everyone, and for those that don’t understand option number two, I refer you to Greece, Iceland, Ireland, Portugal, Italy and Spain.
If you’re getting sick of listening to debt and spending issues now, I will gently remind you this is an election year, so the nauseating debates are only going to get worse from here. I encourage everyone to make a game of this fiscal discussion, and do enough homework to the point you have informed, convicted opinions about our country’s fiscal situation. Unlike in periods past, when Americans could take a nap and ride the U.S. gravy train to prosperity, the ultra-competitive globalized game no longer allows us to rest on our laurels of being the world’s strongest superpower. There are a lot more people playing in our game outside our borders, and many of them are stronger, faster, smarter, and more efficient. Decisions being made today, tomorrow, and over the next year will have profound effects on millions of Americans, myself included. So as the government prioritizes spending programs and debates methods of raising revenue, I advise you to go back to your college days and decide whether you prefer Corn Flakes, PB&J, and Mac & Cheese. If voters don’t pressure politicians into doing the right thing, then we’ll all be collecting food stamps from the Financial Market Vigilantes.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MHP, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
