Monday, February 23, 2009

Can We Handle the Truth?

After eight years of the incompetence and deception that were the hallmarks of the Bush administration, the American people are desperate for leaders who are smart and will be honest with them. That was the clear message delivered by voters in November (It Was About Stupid, Stupid - Nov. 10, 2008).

http://www.huffingtonpost.com/larry-gellman/it-was-about-stupid-stupi_b_142770.html

It's also the reason why Barack Obama continues to enjoy high approval ratings among more than 60 percent of Americans even as the economy and stock markets continue to deteriorate.

http://www.nytimes.com/2009/02/24/us/politics/24poll.html

In his first speech to Congress and the nation, Obama was upbeat but mainly he was honest. He made it clear that there was plenty of blame to go around for the mess we're in and that it will take time to address the many challenges we face. He seemed to understand the complexities of the issues and he told us the truth.

This stood in sharp contrast to Bush--who usually came across like a sixth-grader giving a report on a book he hadn't read. Bush would routinely fall back on empty slogans and made statements that proved to be either lies or just mistakes (numerous examples available upon request). With typical acumen, he repeatedly assured us that the economy was fundamentally strong ten months after the current recession began.

The inability to know or speak the truth also is shared by most of our representatives in Washington, the news media, and the angry, judgmental comedians of Right wing talk radio. They are still addicted to misleading slogans, simplistic solutions, and the demonization of a handful of designated bad guys. They continue to be much more a part of the problem than the solution.

The pols and pundits focus on a short list of villains (Madoff, Stanford, and other assorted swindlers, the bank and investment firm CEOs who got rich while helping create this crisis, Washington, the Left, the Right). They repeatedly invoke hot phrases like "nationalization," "bad bank," "toxic assets," "stress test" and such--phrases that few people, including the speakers, really understand. In short, they spread a lot more heat than light.

Here's the truth and if it doesn't set us free it will at least let us know where we stand.

Americans have spent the last 10 years spending more money than we make. In the early 1980s, we saved 9 cents of every dollar we made. That number has dropped in a straight line for the last 25 years and recently we have had a negative savings rate. We have spent more than we have earned for many years and have made up the difference using credit cards and pulling equity our of our homes which until recently had gone straight up in value.

A whole range of businesses sprang up to accommodate our desire for stuff. Now that game is over and we're going back to a more normal environment where we spend less and save more. We will buy fewer things that we don't really need, eat out less, go on fewer vacations and get back to a much healthier financial place but it will be bad for a lot of businesses.

Our government leaders should not be encouraging us to spend more money and buy stuff we can't afford. That's how we got into this mess in the first place. They should not be encouraging the banks to lend more money to companies and people who might not be able to pay them back. That's how they got into this mess in the first place.

We need to stimulate those areas of the economy that improve infrastructure and create the technologies and jobs of the future. We should not be spending trillions to bail out the shareholders and executives of financial institutions that made wild gambles with their money and lost. We should also not keep failed industries with no future on life support just because they employ a lot of people.

All the bluster on cable news and the blogs about nationalizing banks and bailing out the auto industry is pointless. It just gets a lot of people worked up about a decision that has already been telegraphed by the financial markets. No serious investors are buying the banks or automakers. They have become gambling chips for traders who are looking for action in stocks that trade for pennies and go up or down by 20 percent a day. The markets have already accurately determined that many of these companies are hopelessly underwater and functionally bankrupt.


The financial markets are also telling us another important truth that no one seems to get yet. It is going to cost us a whole lot more to finance our national debt in the future. The borrowing costs for the U.S. government have already increased by 50 percent in recent weeks--we have to pay lenders 3 percent to loan our country money for 10 years, up from 2 percent just a couple months ago. And that is just a preview of what's to come (The Next Investment Bubble Has Begun To Pop -- Feb. 19).


http://www.huffingtonpost.com/larry-gellman/the-next-investment-bubbl_b_167442.html


The long term treasury bonds that investors have gobbled up as a "safe haven" will prove to be a disastrous investment. The stocks of companies that make great products, earn a lot of money, and have pricing power are poised to move higher now that many investors have fled the stock market entirely.

Our leaders have hard decisions to make and they must make them wisely. But instead, Congressional Democrats are using the stimulus package as an excuse to fund a variety of spending programs they favor. Republicans are making a worse choice. They are following the lead of Rush Limbaugh--who has repeatedly stated that he wants Obama and the country to fail--and are saying "no" to everything except tax cuts.

Only Obama and the financial markets are telling us the truth. Not only can we handle it, most Americans are thrilled to finally have a president who is smart enough to know what's going on and honest enough to share both the good and bad news with the people who elected him.

Monday, February 16, 2009

The Next Bubble Has Started To Pop

The nasty problem with most investment bubbles is that they tend to keep inflating long after prudent people point out their existence. Over time, the rational folks who warn of trouble ahead lose their credibility and investors decide that we live in a new world where the old rules just don't apply. So when the "pop" finally comes, lots of people lose lots of money.

That was the case with the Tech Bubble of the late '90s. Alan Greenspan warned of irrational exuberance in the stock market in 1997 but when the dot-com stocks just kept rising, people assumed that Greenspan and Warren Buffett were just old fogies that didn't understand the internet age. Three years later, the bubble popped and billions in wealth vaporized.

The same was true of the real estate bubble that has devastated developers and speculators in the Sun Belt during the last year or two. For years, home prices just kept rising and rising long after a number of economists warned that trees never grow to the sky. Those old fogies didn't understand that with thousands of Baby Boomers retiring every day, it was impossible to have too much real estate in Las Vegas, Miami, Phoenix, San Diego or the other warm places that all the retirees wanted to move.

Since most of the speculation was financed with borrowed money, that bubble popped quickly and violently and has played a major role in creating the financial crisis we are facing today.

The next bubble--in U.S. Treasury notes and bonds--will be the most shocking in recent memory--not due to leverage but because investors have flooded into bond funds specifically because they are supposed to be the most conservative, low-risk investments in the world.

This flight to the illusion of safety has created so much demand for U.S. Treasury debt that, despite its precarious financial condition, our government has been able to borrow money at very low rates of interest.

All the conversation and reports from Washington for the last month have focused on the financial crisis and the stimulus plan that is being enacted to jump-start the economy. (By the way, am I the only one who thinks that a "stimulus package" sounds like something offered in the back room of a gentleman's club?--But I digress).

While the pols and pundits have been silent, the financial markets are flashing huge warning signs. The price of gold has gone up by 30 percent and the U.S. government's long term cost of borrowing has gone up by almost 50 percent during the last month. The markets are coming to the conclusion that in the absence of tax increases (which are not even being considered by Republicans or Democrats), our government will pay for its multi-trillion dollar deficits, bailouts, and stimulus plans by simply printing more money.

That money will be borrowed from countries and fund managers who are already demanding a higher rate of interest to cover the inflation risk they are taking by loaning trillions to an insolvent country.

As rates go up, bond prices go down. Most U.S. Treasury bond funds were down about 5 percent for the year before last Friday when the popping noise increased in volume. There was an auction of 30 year treasuries on Thursday where bonds were price to yield 3.54 percent. By Friday afternoon, those bonds had lost 4 percent of their value in one day and are now priced to yield 3.70 percent.

Think about that. Investors lost 4 percent of their money in one day by buying "safe" U.S. government bonds. Over the long holiday weekend, the news channels were full of conversation and discussion about the final version of the Stimulus Plan. Did you hear any conversation or reporting at all about the massive drop in bond and bond fund prices from any politicians or reporters? Have any of them even discussed the meaning of gold's increase from $700 to $950 an ounce in just the last few weeks?

Of course not. That's because the politicians and news media have all decided that they will only discuss whether the stimulus package will work--not how we're going to pay for it. The financial markets--and the countries and funds that are financing our spending--didn't get the message. They are becoming obsessed with how we're going to pay for this and what multi-trillion dollar deficits will do the buying power of the dollar in years to come. Our creditors will continue to demand--and get--higher interest rates from us going forward. As treasury bond yields go up, bond and bond fund prices will plummet.

Earlier this month I wrote (It's Time To Own Stocks and Stuff - Feb. 5) that it is time to invest in hard assets and solid companies with strong balance sheets and pricing power. Investors should set aside the cash they'll need over the next couple years plus whatever else they are willing to invest for zero return to enable them to sleep at night. The rest of it should go into good stuff--not bonds.

Investment in long term bond funds at this point is neither conservative nor safe. U.S. Treasuries were the one asset class that didn't lose value last year. That's because there was limited supply and seemingly unlimited demand as panicked investors tried to move out of harm's way.

Based on the popping noise coming from the markets, this year may be very different.

Wednesday, February 11, 2009

Dumb. Dumber, and Dumbest

As we watch the actions and listen to the comments of our Congressional leaders, one can only hope that they're really smarter than they seem and that they just can't help themselves.

We now know the reasons that we are facing an economic crisis. Banks and other financial institutions loaned too much money to people who couldn't pay them back so those borrowers could overpay for homes, cars and lifestyles we really couldn't afford. Our government did the same, spending trillions on wars and other stuff while lowering taxes on the richest among us.

At the end of the day, we and our government spent too much and took in too little while the agencies that were supposed to be regulating all this were either incompetent or asleep at the switch. Too many bad investments were made with too much borrowed money by people, banks, and government. The bubble popped, equity disappeared, loans can't be repaid, and people have stopped spending.

So armed with all this insight and with a true financial crisis upon us, our President and Congressional leaders are on the case with a plan to help stimulate the economy. Reasonable people can disagree over whether any stimulus plan will really do any good. But if the government is going to spend more borrowed money, it seems pretty clear that it should be spent on things that will create jobs, build infrastructure, and get that money coursing through the system.

Instead of being smart and focusing on the matter at hand, however, House Democrats have been dumb. Their hard-wired Liberal instincts caused them to lace their proposal with a broad range of spending programs to benefit the arts, education, family planning and other priorities that all make sense but which really have nothing to do with economic stimulus.

Republicans have been dumber. Instead of trying to work with the Democrats, they are lining up to pledge fealty to Rush Limbaugh who has repeatedly stated that he wants President Obama to fail. Instead of learning from the voters who rejected them so sweepingly last November, Republicans have chosen to pretend the last eight years never happened. They continue to harp on the need for lower taxes and then when Democrats compromised, they pledged to vote "no" anyway.

Does anyone with half a brain believe that high taxes are the problem? Taxes are lower than at any time during our lifetime and the economy has fallen off a cliff. People didn't stop spending because their taxes are too high. They stopped spending because they are losing their jobs, losing their net worth, and losing hope.

But dumbest of all has been the media. Instead of focusing on the complexities of the real issues, the media has focused on satisfying the public demand for villains--a handful of people who can be blamed for this mess.

Swindler Bernard Madoff, former Merrill Lynch CEO John Thain, and the Congressional pillorying of big bank CEOs have received 24-7 coverage on all the cable channels, blogs, and print media. Each of the targeted individuals deserve to be blamed for a wide range of irresponsible and perhaps illegal actions. Each of them has a lot to answer for.

But at the end of the day, a few individuals did not create this mess and their firing and/or imprisonment won't solve it. By focusing on blame and anger, the media has made it easier for most people to ignore the wave of schizophrenia that is running rampant in public conversation.

When the depth of and reasons behind the economic crisis began to surface, the banks were harshly criticized for lending too much money to too many people. Now the banks are being criticized for not making enough loans to enough people.

The government was criticized for spending too much money and not collecting enough in tax revenues to pay our bills. Now it is being criticized by Democrats for not spending enough money to get us out of this mess and by Republicans for collecting too much revenue in taxes from companies and individuals.

Individuals were criticized for spending and borrowing too much money and not saving enough. Now we're being criticized for paying off our bills and not spending enough.

None of these non-sequitors is being discussed in any serious way in Washington, in blogs, on the news shows, or in newspapers. Instead, we have dozens of reporters sitting outside Bernie Madoff's apartment and helicopters providing constant aerial TV coverage when he drives to and from the courthouse. We have hundreds of pieces written about John Thain's outrageous $1.2 million office redo and his $15,000 wastebasket. CNBC brought us all seven hours as the CEOs of the biggest banks were publicly whipped by a House committee.

This stuff is entertaining and helps people vent, but is all this coverage really necessary? Is any of it enlightening?

All of the important commentary is coming from the financial markets which are speaking volumes. They are telling us that no matter what we do, it is going to cost more to borrow money going forward and that there is less confidence in the buying power of the dollars and paper currency of all kinds going forward.

After a disastrous nose dive during the fourth quarter of 2008, stocks have done very little during the last few months. But it now costs the U.S. Government 40 percent more to borrow money for 10 years than it did two months ago (rates have climbed from 2.00 percent to 2.80 percent) and gold prices have skyrocketed by more than 30 percent from $700 to $950 an ounce during that period.

And while the news media is telling us constantly about falling real estate prices and rising foreclosures, the stock index tracking prices of the U.S. homebuilders has actually risen by more than 40 percent since November.

The markets are telling us that the government can't spend trillions of dollars that it doesn't have on bailouts and stimulus plans without consequences. They are also looking beyond the public posturing and outrage to the future.

The stocks of our largest banks and automakers are no longer investments but are trading vehicles which often see their prices go up or down 10-20 percent a day. No one is investing in these companies--people are just trading them back and forth from the long and short side. These companies all losing lots of money and owe several times what they are worth and while the companies will probably survive in some form, there may be nothing left for current shareholders.

That's the main reason that nothing has been done to get the toxic assets off the books of our banks. If those assets were bought by an investor at a fair price, the banks would realize such great losses that they would become insolvent. The banks can only afford to sell those assets at an artificially inflated price and, thus far, not even the government has been willing to pay up.

But instead of constructive discussions, all we get from the media is meaningless prattle about good banks and bank banks and instant reviews of the "performances" by Timothy Geithner (he bombed), Ben Bernanke (more of the same), and President Obama himself (still love him).

On top of that, the media and politicians of both parties are constantly repeating the lie that American taxpayers are paying for all this. If we were, then gold prices and interest rates wouldn't be going through the roof.

The fact is that we are paying the lowest tax rates of our lives and the Stimulus Plan being passed by the Senate will have us pay even less in taxes. Taxpayers aren't paying for this and we never will. Instead, the investors and foreign countries who hold our bonds and currency will pick up a big chunk of the tab as they get repaid in dollars that will buy much less than the dollars they loaned us.

We are in a mess and it is becoming increasingly clear that only time--maybe a great deal of time--will enable our financial system to get back on track. But I would certainly feel better if our elected leaders acted like they had a clue. It would also be nice if the media would try to entertain and titillate us less and inform and enlighten us more.

Thursday, February 5, 2009

It's Time to Own Stocks and Stuff

There have been so many lies and distortions coming out of Washington and the news media that it's hard to know where to begin setting the record straight. But I'll try.

The biggest lie is that American taxpayers are going to be paying for the massive stimulus and bailout packages that will soon be approved.

Fact: no American is paying higher taxes. The last time I looked we were all paying taxes at the lowest rate in our lifetimes. Most of us are paying less tax because we are earning less. In addition, many of us have a reverse annuity--capital losses we can never outlive--so we won't be paying any capital gains taxes for a long time either. And all the talk in Washington is about lowering tax rates--not raising them.

So, at the end of the day, American taxpayers aren't paying for any of the stimulus and bailouts and it is unlikely that neither we nor or children ever will. Do you think any Republican or Democratic congress or administration will ever have the guts to raise taxes by the tens of thousands of dollars per American to pay off the debt we are incurring as a result of this crisis?

Democrats in Congress seem to be focused on showering billions on the special interest groups that helped elect them while the Republicans have missed yet another opportunity to be wise and nuanced. Instead they just keep harping on lowering taxes. People have not stopped spending because their taxes are too high. They've stopped because they have lost their jobs, lost their hope, lost their net worth, and are scared to death about the future. And there is no conversation at all about how we will ever pay for all this.

The path of least resistance will be to just keep printing more and more money and inflate our way out of it. That way it will be the Chinese and the other sovereign and institutional investors who have been making 10 and 20 year loans to the U.S. Government at a 2 percent interest rate that will get slammed.

Many U.S. investors who moved their money out of "risky" stock funds into "safe" government bond funds will get hammered as well and they won't even know what hit them. These funds are not safe and can lose a lot of their value. Most of them have already started to move down.

For 20 years, the value of baseball cards went up and up and people who "invested" in them made a fortune. People looked at the cards as collectible pieces of American art. Then, a couple years ago, people suddenly looked at the cards and all they saw was a piece of paper with a picture on it. The bottom fell out of the market overnight.

The same thing could happen to paper money.

But while the news media has been reporting about "good" banks, "bad" banks, bailouts, stimulus, Madoff, and the greedy fat cats on Wall Street--something far more important has been happening and received very little attention.

Since the first of the year the price of gold has gone up more than $100 an ounce, oil and other commodities prices have stopped falling, and the rates that lenders are demanding to loan money to the federal government has gone up by 40 percent. The yield on 10-year U.S. treasury bonds has gone from 2.00 percent to 2.80 percent in just a few weeks. Those "safe" bond funds are dropping in price.

The word is getting out--through the markets, not the news media--that dollars and other world currencies may just be viewed as pieces of paper with nothing behind them. Investors are moving more and more into "stuff" and the companies that make it.

If that trend continues then a couple of things will happen. First and foremost, interest rates will rise dramatically and the value of long term bonds (and the funds that invest in them) will drop hard. The investments that sounded the safest will turn out to have been very risky. Cash, money markets, bank CDs and such will yield more and more but their buying power will drop faster than the returns go up.

The only way to stay ahead of the game will be to own the investments that have been labeled as "risky." Hard assets, real estate, energy, and a broad range of companies that make essential products and which have pricing power should start to do well. There is a glut of real estate and oil on the market right now, but prices will bottom sooner than most people believe as our dollars start buying less and less stuff.

Technology, bio tech, small cap stocks, and emerging markets--deemed to be the riskiest of the risky--could actually do the best in this environment. These are companies that develop and manufacture very useful stuff.

This may not happen today or tomorrow. It may not happen at all. I've been wrong before. Often. But I believe we are headed into this new environment sooner rather than later.

People should keep money that they're going to need during the next couple or years in the bank. The rest should be going into stocks and stuff.

Tuesday, February 3, 2009

Stock Market Update -- What We Learned In January

I caught a lot of flak last week when I wrote that "Things are Differenter Than They Seem." I heard from my fourth grade English teacher who was mortified (with good reason) but I also was roundly criticized by a number of my friends in the business who accused me of being blind to the harsh and gloomy realities of the worldwide financial disaster and the relentless flow of horrible economic news.

The numbers would seem to be on their side. We are finishing the worst January in the all-time history of Januarys for the stock market averages as most of the major U.S. indices lost yet another 10 percent. That comes on the heels of an absolutely wretched end of 2008 during which every asset in the world lost much of its value. How can any reasonable person be upbeat in this environment?

Here's how. I stand by my statement of last week. Beneath the surface, this month has been very different. Unlike last quarter when forced hedge fund liquidations drove the prices of everything straight of a cliff, there have in fact been some winners during January. The stocks that have done the worst have been banks and financials (which may be worth zero) and those companies that make products that people want but don't need. Retailers, auto makers, hotels, casinos, and such continue to do quite poorly.

But there were companies and sectors that reported good results and saw their stock prices go up. I repeat what I have said many times: It's not time to be bullish and it's not time to be bearish. It's time to be smart.

So what have the markets taught us during the last month? A number of important lessons:

1. Anyone who is thinking of refinancing their home had better do it right now. My daughter was looking into refinancing last week and watched as rates went up three times in two days--from 5.25 percent to almost 6 percent.

A number of markets have suddenly started telling us that interest rates are going higher and the price of gold and other hard assets will continue to rise as people do the math and realize that paper money is not a good asset to own when governments are printing more and more of it with nothing to back it.

If Democrats get their way, our government will spend trillions bailing out banks and others and providing "stimulus" to every nook and cranny of the economy. If Republicans get their way, we will cut our current tax rates (the lowest in our lifetimes) which will stimulate nothing but cut government revenues more and raise the deficits even more. Our economy is not hurting because corporate tax rates are too high. It is in the tank because people are losing their jobs, watching their net worth plummet, and owe too much money. What will lower corporate taxes due to address any of these real problems?

No one is even talking about what damage these misguided plans will do to the value of our currency or the level of interest rates that will be required to get lenders and other countries to provide us with the long-term loans need to pay for all this.

But the markets get it. Gold was up almost $100 an ounce last month and the rates on long term U.S. Treasuries--the next bubble to pop--shot up by 20 percent. With all the talk about bad banks, Wall Street bonuses, and jump-starting the economy, did you hear one word on the news about skyrocketing interest rates or gold prices last month? Of course not. That's what I'm here for.


2. A lot of companies have been reporting disappointing earnings and laying off thousands of people. But there are companies that are reporting really good earnings and pretty positive outlooks.

The markets were down about 10 percent last month but a number of stocks were up. Energy stocks seem to be bottoming and companies like Google, IBM, Research in Motion, and Amazon.com all beat their estimates and saw their stocks go up for the month. Biotech and health care companies with consistent revenues and/or promising new drugs seem to be doing better as well.

In addition, stocks and ETFs that pay you to wait for growth are hanging in quite well. Natural gas pipelines are my favorites (yielding 8-11 percent with growth potential) but there are number of sectors that make a great deal of sense.


3. A lot of people have bailed out of the market entirely--which is a positive since they can only help stock prices when they come back. They can't hurt prices any more since they have nothing left to sell. Many of those who remain have become traders who are addicted to the action, short term swings and leverage.

It is telling that the most heavily traded exchange traded index funds (ETFs)-- which are supposed to be conservative diversified investment tools--are actually the "Ultra" funds which are leveraged and provide double the move of the underlying indexes.

There has also been a lot of interest in stocks like Citigroup and Bank of America which have been going up or down 5-10 percent a day or more. That volatility is a sign that people aren't investing in these companies--they are trading them for short term moves either individually or through leveraged ETFs.

Until a couple of years ago, it was almost impossible for most investors to go short or use leverage in a meaningful way. Today, anyone can go long or short on margin the Ultra long or short fund in any industry or sector and get four times the move of that index in either direction. It's just as easy as buying a stock. Billions of shares of these funds trade daily, so lots of people must be doing it. That play a big role in creating the big daily swings in the market.

The volatility in the whole market remains a little numbing. Before last year, there were 17 days in history that the S & P 500 went up or down by 5 percent or more in one days. During 2008 alone there were 17 days when the market moved that much. That is partly due to economic developments but it is mainly due to the leverage that has seeped into every aspect of our financial system.

We are still in the midst of a massive deleveraging mode. People are buying less and doing less as they adjust their lifestyle to cope with the new reality. The millions of people who have lost jobs are making dramatic adjustments but so are the tens of millions who had gotten used to supplementing their income with home equity loans or stock market profits over the last 20 years.

All of these facts and figures support my view of how to invest for the future. We live in a time of great risk and great opportunity. The risk is that we assume that formerly great companies are bargains because their stocks have fallen a lot. Many of these companies will not survive and if they do their stockholders may be wiped out anyway. I've talked a lot about the banks, but bankrupt companies like Nortel and Circuit City as well as former blue chips like Motorola and Eastman Kodak (whose stocks have joined the "priced less than a Happy Meal" club) fit that description as well.

On the other hand, there are great opportunities in hard assets, funds that short long term U.S. Treasuries, and solid companies that are well run, provide needed or productivity enhancing products, solve real problems, and/or pay good dividends. Inefficient markets always provide the greatest opportunities and the distress of one group of investors can create benefits for others who are smart and patient.