Morphing Into Moral Issues

November 14, 2011

Good morning. A nice Veteran’s Day rally on Friday had the SPY closing up on the week after a serious down move on Wednesday following a spike in Italian debt rates to well over the supposed 7% danger level. The SPY closed up 1.18 (.9%) at 126.66, with the ranges being a low of 122.86 on Wednesday after a high of 128.02 on Tuesday. The VIX was up slightly (.11) to close at 30.15, but had a spike to 36.43 during Wednesday’s sharp sell-off. In general the market remained driven by news from Europe, but it does seem that, in the absence of bad news out of Europe, the direction appears positive. There is a clear, but slight, improvement in a lot of the economic numbers recently, most notably some steady increases in private sector hiring. The issue, however, given the extreme amount of stimulus on the Federal level, is whether the positive movement is sufficient given the amount of stimulus applied. Simply put, and this is the question of the decade, is whether the economy will “catch fire” quickly enough and become self-sustaining in time for the stimulus to be withdrawn before we are overcome by the debt burden. How that question is eventually answered by reality probably defines U.S. economic history for the next generation at least. Right now all of us have an opinion, but I think we are in uncharted waters and no one really knows.

I think the economic problems are morphing quite rapidly into moral issues, and in some ways I am more concerned with those types of problems than the economic ones. The connections are tricky, but in some ways the moral issues, or surely the gravity of the moral issues and their prosecution and punishment (if any, for the properly connected) tend to change given the economic times. Let’s say, for instance, that some nefarious person steals 200 lb. of ground beef from a Costco. If caught (and there is a question of whether anyone — especially our police– even care enough to look for him or her) the penalty is probably getting fired (if an employee) and maybe a prosecution with probation if anyone really pushed it. I suspect the police would tell Costco to tighten their security, and care less and less if it continues to happen. What, however, if we were heading out on a ship (maybe even a warship) that was to be at sea for a month and that 200 lb. of ground beef represented 20% or more of our meals? After working on deck for 10 hours in a rough sea, only to find that there was no dinner because some “enterprising soul” sold the chow, the story is a lot less humorous or forgivable. I would wager you would not want to be that “enterprising soul” when discovered, he may find out that sharks get hungry too. Even though the “crime” is the same as maybe that same person used to do every month at Costco the relevance and seriousness has changed because of the situation.

Along the same lines it really surprises me how the groups that benefit from the “largess” of government and the imbalances present in many Corporate Board Rooms do not seem to be sensing the situation changing and at least being more careful doing their usual nefarious deeds. The City of Chicago, rather than even pausing in their almost rabid race to reward donors and pay for absurd City employee gambits, have kept people busy even trying to keep up with a rash of new taxes and fees. It is almost like it is a race to steal the average person’s last nickel, and they seem to have no fear whatsoever of a backlash. The latest, in addition to cameras, dog license fee increases, possible $1,200 for ten-inch weeds on your property, etc. is a proposed water bill of $1,000 per year by the end of the decade. Or maybe by the time the outrage happens (if ever) they feel they will have stolen enough to leave flush. Plus there is always that possibility that the outrage will be just the “vote with your feet” variety and it will be never even be felt other than in a stray column or two by a do-gooder. On the State level, the new corporate tax increases (to 7%) have been accompanied by both outrage, and some firms getting them lowered (or waived) in return for some sort of political quid pro quo (and I do not mean just jobs). On the Federal level (in addition to the myriad of give-away programs already announced), we have the Campaigner in Chief talking about adding $1 billion in funding to hire health care workers, where the money would go to doctors, community groups, local governments, etc. the exact same groups that are historically rife with corruption (but will vote for him). What does anyone think the real opinion the average political hack has for the average citizen, some sort of doddering fool that not only expects, but also relishes getting lied to and fleeced? What was the line in Animal House? “Thank you sir, may I have another?” Is it going to take an armed revolt to stop this someday? I am the most non-violent man there is, but I am swiftly coming to the conclusion that most of the current political “people” we have passing out our collective wealth are not going to stop their current ways because someone writes an op ed piece or the last election got a little closer. It will just make them steal more and faster.

Even though we may not like what is playing out we do need to deal with it the best we can, and even profit if possible. One way might be to shift the bulk of our long-term investments into companies that have had a moral and balanced track record. Maybe in the interest of profit/risk control we should stay away from someone like Goldman Sachs, or the homebuilders that have shown over time that in the good times the insiders make the money and in bad the shareholders shoulder the burden. Or a Nabors (NBR), whose Board decided to give their retiring CEO 20% of the total shareholders cash as a going away present ($100 million). It does not mean that GS or NBR has never been a good buy; I mean maybe we should do our long term investing where there has been balance over time. Maybe a MCD or PG, where (and I do not mean that they are great buys today) the shareholder’s participate, the Board seems to have focus, people seem paid well but properly, etc. In some ways that is one of the goals with PTI’s new Dividend Program, where we are trying (so far with good success) to create a basket of stocks for clients that seem relatively balanced in both leadership and dividend yields, with the hedge being managed by SPY options. We are hoping that what we may give up in basis slippage (it is possible that something bad will happen to one or more of our stocks in this basket that will not be reflected in the overall SPY average) will be more than made up for in overall better returns in these stocks. I will keep everyone up to date as to how this goes in the future. There will always be a way to benefit honestly; hopefully, we just need to keep our eyes open and some powder dry (hard to do at no interest). Trust me, I am not going crazy by saying only the most “moral” should see our money, I am saying that right now we might want to favor those that seem to concern themselves with shareholder well being.

I started by saying that the conundrum is whether the fledgling signs of growth we are seeing is sufficient given the enormity of the stimulus. It is easy to forget or ignore when focusing on a relatively good economic number or when you are a talking head on TV talking up the market, but we are talking about some huge stimulus in the background. I have the Money Supply (adjusted M2) up at an annual pace of 16.8% in the last four months. That is an extraordinary number; I would be surprised if that growth rate was approached in any of the inflation fiascos of the last 40 years (inflation to follow on this mess?). On the fiscal side we have been averaging roughly $100 billion+ per month for close to three years, or roughly $1,000 per household per month the government has been spending (somewhere) on your behalf. Some among us have been extraordinary beneficiaries of this largesse (connected road contractors, Medicaid and Medicare Fraud participants, bar owners in Washington, etc.), but most have just seen their share of the national debt ballooning. In the aggregate, however, it is stimulus, and most would feel it somehow if it were suddenly stopped. There has been a stimulus drain, however, from those pesky state and local governments who have jumped into the Federal “void” and looked to scoop up any available stray dollar, but the offset is somewhat hard to quantify. After all, whatever happens to you and me all state and local politicians and employees they deserve to retire handsomely.

My opinion is that the hole we have dug in terms of debt is greater that the benefits the stimulus has given, and that we are in serious trouble economically. Some of the economic numbers in the U.S. are worse than Italy or Spain. Right now I think we will have to stop the stimulus before it works (if it was ever going to) and it will cause a small but significant contraction, complete with policy-induced inflation.  In any case I really hope I am wrong, this is not an argument I want to win. I don’t think Superman’s father was real happy when, as he predicted, his planet did blow up.

So, I think we need to monitor gold very closely, for if the economy does heat up inflation will probably heat up as well. Gold may be “somewhat” of a hedge for that. We also have to trade aggressively the inevitable wild swings as this all unfolds, meaning rolling our protective puts effectively and buying in calls early if they are profitable (we may get the chance to sell them again). Any hint of inflation picking up must be monitored carefully by anyone with long fixed income positions; those positions could deteriorate very rapidly. We also need to be long-term short bonds, but again taking profits along the way should they happen.