Things Your Stockbroker Won't Tell You

Bonds outperform stocks.

Well, it's only partially true. It depends on your time frame.

Most investors have been subjected to the mindless drumbeat that stocks outperform in the long run. How long is the Long Run? Ten years? Nope. Twenty years? Nope. Thirty? Maybe.

In an extreme case, bonds outperformed stocks for well over a 50-year period (from 1803 to 1871). That's a long run. Yes, stocks outperform, if your investment horizon is around a century or so.

From 1932 to 2000, stocks beat bonds handily. But in the period from 1968 to 2009, bonds outperformed.

A good place to start is to look at how much you have invested in bonds versus how much you have invested in stocks.

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Source:

Michael Santoli. Stocks Through a Wide-Angle Lens
Barrons. March 30, 2009.
http://online.barrons.com/article/SB123819638720161459.html

Chart courtesy of Barrons

© 2009 Michael Cale

Russia, China Support Gold-Backed Currency

It is truly an upside-down world when countries like Russia and China are receptive to a gold-backed currency and the U.S. and U.K. are opposed, or lukewarm. A currency backed by gold, by definition, limits government spending (and discourages war). 

The Gold Standard was the anchor of world finance in the 19th Century but began breaking down during the First World War as governments engaged in unprecedented spending. It collapsed in the 1930s when the British Empire, the US, and France all abandoned their parities.

It was revived as part of fixed dollar system until US inflation caused by the Vietnam War and "Great Society" social spending forced President Richard Nixon to close the gold window in 1971.

The world's fiat paper currencies have lacked any external anchor ever since. It is widely argued that the financial excesses and extreme debt leverage of the last quarter century would have been impossible - or less likely - under the discipline of gold.¹

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Source:

1.Ambrose Evans-Pritchard. Russia backs return to Gold Standard to solve financial crisis.
Telegraph. March 31, 2009.
http://www.telegraph.co.uk/finance/financetopics/g20-summit/5072484/Russia-backs-return-to-Gold-Standard-to-solve-financial-crisis.html

© 2009 Michael Cale

The 'Banks Are Not Lending' Myth

An incessant refrain in today's news is that government must do something about these bad investments that banks and other financial firms have made, even if it involves unprecendented steps.  The reason for this is 'to get banks lending again'.

More specifically (and just this week):

"to jumpstart the secondary markets that support consumer and business lending" and to relieve conditions are "limiting their ability to lend" -- US Treasury¹

"a strategy to... restart lending" -- President Obama²

It's a myth. 

Banks are lending.  They are lending to businesses.  They are lending to consumers.  They are making real estate loans.  Consumer loans, especially, are experiencing healthy growth.







It's true that lending standards have tightened.  But that is a welcome development.  Lending standards had fallen far too low.  'Ninja' loans (No income, no job, no assets) and the like were irresponsible, at best.

But overall lending is higher than it was a year ago.  The rate of loan growth has slowed, but it is still growing. 

So if banks are lending to businesses, consumers, and for real estate, what is all this talk about banks not lending?

Banks are not lending to other banks.  Why is this such a crisis?  Because banks have long ago become dependent on such sleight-of-hand tactics as sweeps, repurchase agreements, and brokered deposits in order to meet their capital requirements. 

For example, in more normal financial environment, a bank in New York could 'borrow' money from a bank in Tokyo while the Japanese bank is closed and then 'pay' back  the loan at closing time in New York.  So the depositor's money can count as 'money in the bank' twice in a single day.  This, and other types of shenanigans complies with banking rules and has been going on for decades.

What has changed is now banks are doubtful that they can really know the financial health of the financial firm on the other side of the transaction. This, despite all the post-Enron regulation that was supposed to provide so much transparency.

Banks are lending, to just about anyone except other financial companies.  When you hear politicians or journalists talk about 'banks not lending' they are likely speaking of inter-bank loans.  If not, they are being either ignorant or deceitful. 

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Sources:

1. US Treasury. Treasury Department Releases Details on Public Private Partnership Investment Program.
Press Release tg-65. March 23, 2009.
http://www.ustreas.gov/press/releases/tg65.htm

2. The Associated Press. Part I of text of Obama's news conference.
March 24, 2009.
http://www.google.com/hostednews/ap/article/ALeqM5gkyWk2MK7xeDw2b1jPhFS6KsvPegD974ORSO0

All charts courtesy of St. Louis Fed

© 2009 Michael Cale

They Used To Have An Empire

A couple of interesting, unrelated, stories out of the UK this morning.

First, the British treasury tried to borrow 1.75 billion pounds (about $2.5 billion) yesterday. But bond buyers didn't have that much of an appetite.

The 40-year bonds ended the day with a yield of 4.55%. The US 30-year bond has a yield of 3.5%.

Britain's fiscal deficit is expected to hit 8% of GDP this year and 11% next year.

What if the government wants to borrow money and no one is lending? It means interest rates on government bonds are going higher.

Second, a local governing council hired an aircraft with thermal imaging devices to monitor homes and businesses for energy use. Those with high energy use received a visit from local authorities.

Britain now has more than four million CCTV cameras - a fifth of those in use around the world - and around 8,000 speed cameras.

Almost 500 local authorities have been using anti-terrorism powers brought in under the controversial Regulation of Investigatory Powers Act to launch a string of bizarre investigations.

These have included checks on dog fouling, putting bins out on the wrong day and people trying to cheat school catchment area rules.¹

Perhaps a better title for this series would be: They Used To Be Free.

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Source:

1. Andrew Levy. Council uses spy plane with thermal imaging camera to snoop on homes wasting energy.
Daily Mail. March 24, 2009.
http://www.dailymail.co.uk/news/article-1164091/Council-uses-spy-plane-thermal-imaging-camera-snoop-homes-wasting-energy.html

2. Kim-Mai Cutler. U.K. Bond Auction Fails for First Time Since 2002.
Bloomberg. March 25, 2009.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aQGG.mWeZ4eU&refer=worldwide

© 2009 Michael Cale

Continuing Troubles in Eastern Europe

The economic crisis continues to take its toll on Eastern Europe.

Last month, Latvia's government fell. Then Hungary's premeir resigned after attempting to comply with an IMF bailout. Now the government of the Czech Republic has suffered a no confidence vote.

But the Czech crisis has unnerved investors even more because the country has been seen as a rock of stability. It kept a tight rein on credit and avoided the stampede into euro and Swiss franc mortgages that occurred in other parts of Eastern Europe.¹

Industrial output in the Czech Republic fell 23% in January as auto production slowed.

European banks account for the lion's share of the $1.7bn of foreign loans to the region – a considerable chunk on short maturities that must be rolled over this year. Austrian banks have lent the equivalent of 70pc of Austrian gross domestic product.¹

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Source:

1. Ambrose Evans-Pritchard. Czech Republic joins East Europe's falling dominoes.
Telegraph. March 25, 2009.
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/5045771/Czech-Republic-joins-East-Europes-falling-dominoes.html

© 2009 Michael Cale

Comparing Recession Duration

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Source:
Minneapolis Fed

© 2009 Michael Cale

Old and Young Compete For Jobs

The New York Times chronicles how the old and the young in Florida are competing with each other for entry-level jobs.

Retirees with inadequate savings are going back to work. The young and unskilled seek that first job. Both groups see the other as having the advantage.

The proportion of older Americans who hold jobs has also risen strongly — 16 percent of Americans 65 and over had jobs last month, up from 11 percent 10 years earlier. But for workers age 16 to 24 the percentage with jobs has fallen to 49 percent, from 59 percent a decade ago. As for Americans age 25 to 29, 74 percent now have jobs, down from 81 percent a decade ago.

“Younger people are taking an extreme pounding,” said Andrew Sum, director of the Center for Labor Market Studies at Northeastern University. “It’s worrisome because they’re not developing the experience and the soft skills that they’ll need and the nation’s economy will need.”¹

The story notes the drop in employment over the last two years, but fails to note that it's not only the recession. 

Teenage employment was dropping well before the recession due to the increase in the minimum wage. Raising the price of entry-level jobs means less will be demanded. In today's economy, this adversely impacts the young and the old.

See: Teenage Unemployment Rising
March 8, 2009

Minimum Wage Up, Teenage Employment Down
February 14, 2007

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Source:
1. Steven Greenhouse. Young and Old Are Facing Off for Jobs.
New York Times. March 20, 2009.
http://www.nytimes.com/2009/03/21/business/21age.html?_r=1&hp

© 2009 Michael Cale

Monetizing Debt

The Fed announced they will 'print' $1.2 trillion to purchase debt and mortgage-backed securities. This is an effort to keep interest rates low to encourage borrowing.

Yesterday's announcement amounts to a recognition by Fed leaders that the economy has gotten much worse than they had forecast at their last policymaking meeting, in January. It also is their attempt to show market participants that, three months after cutting short-term interest rates to zero, they still have more tools to try to bolster the economy.

The new purchases come with risks. They will balloon the value of the assets the Fed holds by about 50 percent, to more than $3 trillion. That could make it tricky for the central bank to draw that money out of the system once the economy starts to recover. The Fed would probably find it difficult to sell such massive volumes of assets, and if it doesn't handle the task adeptly, the nation could face high inflation because too much money would be in circulation.¹

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Source:

1. Neil Irwin. Fed to Pump $1.2 Trillion Into Markets.
Washington Post. March 19, 2009.
http://www.washingtonpost.com/wp-dyn/content/article/2009/03/18/AR2009031802283.html?wprss=rss_print/asection

© 2009 Michael Cale

GDP and S&P 500 by Decade

The nation's GDP and the stock market are only loosely related, and that is over very long time periods (like several decades).

A comparison of the two over decades shows that GDP shows consistent growth while the stock market is much more volatile, even over 10-year periods.


Chart courtesy of EconomPicData

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Source:
Jake. GDP vs. S&P by Decade
EconomPicData. March 16, 2009.
http://econompicdata.blogspot.com/2009/03/gdp-vs-s-by-decade.html

© 2009 Michael Cale

Our Miscalculations of the Future

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Source:
http://www.ted.com/talks/view/id/420

© 2009 Michael Cale

A Stroke of Insight

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Source:
http://www.ted.com/talks/view/id/229

© 2009 Michael Cale

Flirting With Inflation

The Federal Reserve is flirting with inflation. They have expanded the monetary base by an unprecedented amount. Let's take a look first in dollars, then in percentage terms.




Charts courtesy of St. Louis Fed

The reason we haven't seen inflation yet is that the Fed also began paying interest on reserves that banks hold with the federal reserve. This keeps much of the expanded monetary base on deposit and out of the economy.

In the most recent issue of Review, published by the St. Louis Fed, William Gavin takes a look at the monetary base.

Whether this large increase in the monetary base is a harbinger of rapid inflation in the future depends on how the Federal Reserve and the U.S. government act when financial markets return to more-normal behavior and the recession ends. ¹

The key is that the Fed will have to drain reserves when the economy begins to recover if it is to prevent a rapid acceleration of inflation. ¹

If the Fed can successfully unwind this expansion of the monetary base without it leaking out of the banking system and into the economy, we may avoid the worst of it.

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Source:
1. William T. Gavin. More Money: Understanding Recent Changes in the Monetary Base.
Federal Reserve Bank of St. Louis Review. March/April 2009.
http://research.stlouisfed.org/publications/review/09/03/MarApr09Review.pdf

© 2009 Michael Cale

The End of the Euro

What we are witnessing in Europe may prove to eventually be the end of the Euro.

The errors that led to our current predicament are well-known. A small army of economists – Austrians, Monetarists, and Keynesians – warned that central banks were playing with fire by fixing the price of credit too low and ignoring asset bubbles. The $6.7 trillion in reserve accumulation by China, Japan, and the petro-powers drove bond yields too low for safety.

Credit signals were gravely distorted. In Britain, Gordon Brown poured petrol on the fire by pushing the fiscal deficit to 3% of GDP at the top of the cycle. Wretched man. However much we rage at Sir Fred or Citi-wrecker Chuck Prince, let us not forget that this crisis was confected by governments. To blame the free market is to miss the bigger point.

...We are now faced with the post-debt wreckage. The task at hand is to hold our societies together as best we can...

As it is we have seen industrial production collapse in every region. The drops in January were: Japan (-31%), Korea (-26%), Russia (-16%), Brazil (-15%), Italy (-14%), Germany (-12%). Falls that took two years from late 1929 have been compressed into five months...

The ECB has cut rates to 1.5%, but since they need to be minus 1% on the Taylor Rule, this leaves the breach as wide as ever. The Bundesbank is blocking any serious move towards quantitative easing.

Given that Germany's economy is imploding (Deutsche Bank sees 5% contraction this year) one wonders if the Bundesbank would be less hawkish if the D-mark still existed. Even their hard-money brothers at Switzerland's SNB are cash printers these days.

So has monetary policy in euroland been paralysed by squabbles at a calamitous moment, blighting every member state? Almost certainly.¹

I occasionally have called attention to the current sad state of England's governance (They Used To Have An Empire).  But their decision to remain outside of the European Monetary Union seems to have been a very wise one.

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Source:

1. Ambrose Evans-Pritchard. Thanks to the Bank it's a crisis; in the eurozone it's a total catastrophe.
Telegraph. March 8, 2009.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4958395/Thanks-to-the-Bank-its-a-crisis-in-the-eurozone-its-a-total-catastrophe.html

© 2009 Michael Cale

Teenage Unemployment Rising

Two years ago, Congress increased the minimum wage. At the time, I explained how this would increase teenage unemployment.

Chart courtesy of EconomPicData

The recession is also a large factor in the rise in unemployment, but price controls on labor certainly are contributing to the problem.

See Minimum Wage Up, Teenage Employment Down

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Source:
EconomPicData. The Death of the Teenage Worker.
EconomPicData. March 6, 2009.
http://econompicdata.blogspot.com/2009/03/death-of-teenage-worker.html

© 2009 Michael Cale

Cratering Employment

Employment is falling at the fastest rate in 50 years.



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Source:
Chart courtesy of St. Louis Fed

© 2009 Michael Cale

Inflation and Commodity Rally

“The government has created a massive increase in the monetary base, and it means we are entering a massive inflation cycle,” Pento said in a telephone interview from Holmdel, New Jersey. “Inflation will be intractable. All of these commodities will start to act as an alternative to currency and start to pick up. Gold should be the primary investment, and energy and base metals should be secondary.”¹

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Source:
1. Millie Munshi. Stimulus Cash to Spur Inflation, Commodity Rally: Chart of Day.
Bloomberg. March 5, 2009.
http://www.bloomberg.com/apps/news?pid=20601109&sid=aIwFmyvJJiv4&refer=exclusive

© 2009 Michael Cale

Understanding the AIG Mess

Barry Ritholtz at The Big Picture describes how AIG was part stable, solvent insurance company and part reckless, insolvent hedge fund.

Forget the good bank/bad bank, I have an even bigger beef with this INSANE absurdity: Why are the taxpayers making good on hedge fund trades gone bad?

... This was nothing more than a giant scam, perpetrated by the people who were running the AIG hedge fund.

It was exempt from any form of regulation or supervision, thanks to the Commodities Futures Modernization Act. This ruinous piece of legislation was sponsored by former Senator Phil Gramm (R), supported by Alan Greenspan (R), former Treasury Secretary (and Citibank board member) Robert Rubin (D), and current presidential advisor Larry Summers (D). It was signed into law by President Clinton (D).  It was the single most disastrous piece of bipartisan legislation ever signed into law.

As you might have guessed by now, this portion of AIG is the INSOLVENT half.

Here is the question that every single taxpayer should be asking themselves: WHY AM I PAYING $1000 TO BAIL OUT THIS GIANT HEDGE FUND?

Of all the many horrific decisions that Hank Paulson made, this may be his very worst. That is a very special description, given his track record of incompetence and cluelessness.¹

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Source:

1. Barry Ritholtz. Solvent Insurer / Insolvent Insurer.
The Big Picture. March 4, 2009.
http://www.ritholtz.com/blog/2009/03/solvent-insurer-insolvent-insurer/

© 2009 Michael Cale

Miracle On The Hudson

A simulation of CACTUS 1549 with Air Traffic Control Audio, complete with a stationary 'flock' of birds to show the approximate impact point.

The controllers mistakenly use the Cactus 1529 call sign for a short time, instead of 1549.

It would be interesting to see a similar re-enactment someday with the internal (within cockpit) audio.




http://www.youtube.com/watch?v=GChobnO5YU4

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© 2009 Michael Cale

At Least We're Not Europe

The U.S. banking system is a mess. In Europe, things are much, much worse.

U.S. banks were regulated by their total leverage ratio, basically the ratio of debts to assets. European regulations were based on risk-weighted assets, which allowed banks to accumulate more debt.

Much of the debt was lent to Eastern Europe. Many Formerly Behind the Iron Curtain citizens bought homes and got low interest rate mortgages denominated in Euros, or Swiss Francs, or another currency (including Japanese Yen). Now many of those mortgages have become dramatically more expensive now that local currencies have collapsed.

The exposure of European banks is enormous, and not just to risky mortgages. They are massively over-leveraged. Think Bear Stearns, only now there are many of them spread through several countries.

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© 2009 Michael Cale

Re-thinking the Long Run

Peter Bernstein has an interesting piece in the Financial Times:

On a total return basis, the Ibbotson data show that the S&P 500 has underperformed long-term Treasury bonds for the last five-year, 10-year, and 25-year periods, and by substantial amounts.

Relying on the long run for investment decisions is essentially relying on trend lines. But how certain can we be that trends are destiny? Trends bend. Trends break. Today, in fact, we have no idea where any trend lines might begin or end, or even whether any trend lines still exist.¹

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Source:
1. Peter Bernstein. The Flight of the Long Run.
Financial Times. February 25, 2009.
http://www.ft.com/cms/s/0/267900e0-0360-11de-b405-000077b07658.html

© 2009 Michael Cale

Is Your Bank Safe?

If your bank is safe, they will not be participating is the various government plans to 'save' the banking system.

The list of banks that have opted out of these programs is here:

http://www.fdic.gov/regulations/resources/tlgp/optout.html

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© 2009 Michael Cale