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The Money Pit

January 12, 2009

Good morning. The first full week of the New Year felt like a slower version of some of the weeks of the old year. The SPY fell from $92.96 to $89.09 (4.2%) and the VIX advanced from 39.18 to 42.81, as the ongoing fears of unemployment and access to credit continue to weigh on the market. We had a nice upside earnings surprise in Monsanto (MON), up almost 20% in one day, but most earnings announcements are bringing a steady stream of bad forecasts going forward, cuts in planned capital spending, and either hiring freezes or layoffs of some kind. Employment numbers on Friday (even the government kid glove numbers) were awful, with the total number of jobs lost equal to 632,000 including revisions. It was the worst year, in total numbers, since 1945, when we were happily mustering people out of the armed services. One could make the argument that since there are more people now the 2.6 million jobs lost in 2008 is not as high on a percentage basis, but when you think of the people not counted, non-registered workers, part time workers, non salaried workers, etc, maybe it is as bad.

Can the government (and the new President) make the save? On the table is a stimulus package of $650-800B, depending on which article you read. It is supposed to be targeted towards infrastructure improvements, which should be an investment in the future and generally are badly needed. Of course, this is in addition to a now estimated $1.2 T deficit without the stimulus package. That’s right, $1.2T in stimulus in one year and the economy is contracting. The current onus is to do this additional thing as fast as possible, as boldly as possible, to be as much like Roosevelt as possible, and maybe to think before you act as little as possible.

Why am I so negative on how this is going? I had a good weekend, watched the Irish basketball team win with a good mix of family and friends. I know we need something, I think the new President has his head on straight; we need to put people back to work, etc. I think my negative thinking comes from the fact that we are already $1.2T in the stimulus hole (this year) and we are losing more jobs, not less. For the most part the first 1.2T has been burned on a lot of the people that caused the problems, and a lot of it is being looted by people that should at least have lost their jobs, if not been executed (think China) or thrown in jail. If we send another $800B down the same sort of corrupt, semi-criminal path, how does that help anything? States like Louisiana, Illinois, and various other states, counties, and municipalities we could all name are perfectly capable of soaking up that amount and more is the same old sorry procurement system with little, if any, new significant job creation. I think, even though times are tough and fast action seems warranted ,we need to take a breath and do things right for once. We cannot afford another $800B, on top of the $1.2T, where we say, “Where did it go?” “Did it work?” I think we need four to six months to seriously plan what kinds of projects, who is going to do the procurement, who do the workers work for, what ages of workers are targeted, the pace of the projects (influencing greatly the amount of new hires), etc.

A lot of my thinking is influenced be a fellow I used to work with at Pullman. He was in Program Management, and had essentially spent his whole life in procurement of fairly large government projects. He showed me a whole stack of books and papers written on how effective procurement was done, and how the people going out for bid (in addition to being honest) needed to know as much or more about the designs, costs, build rates, etc. as the bidders in order to do it properly. None of that reminds me of the current no-bid pay-to-play system used in Katrina, Homeland Security, or the state of Illinois. I just do not see that sort of dedication or talent in government at any level in these corrupt times (I get the ridiculously high bid, sell it to a sub-contractor, and move to the south of France) to suddenly be able to efficiently manage hundreds of projects simultaneously in the next few years. We start wasting numbers like $2T a year and it will not take long to dig too big of a hole to escape from.

Having said all that, what about this market? I do not think I am the only one with concerns, and I think a lot of the issues troubling others and me are already reflected in the current market levels. It is important to look not only at the bad news and lousy market of last week, but also what can happen if all of a sudden the news were to improve. An example of that would be Monsanto, and how some surprising relative good news caused an immediate 20% jump. To enter the market at these levels, with appropriate protection, with an eye towards selling some of this historically high call option premium going forward is certainly something worth considering. We have been putting some money to work whenever we can find the protective put spreads at a level that gives us a solid chance to cover the spread price plus with call sales going forward. The XLE is certainly interesting at this level. We also have been doing some repair strategies for those with individual stocks, and may consider the same thing for those in the PIP should the opportunity present itself. Right now the volatility levels would indicate a potentially profitable year even if the market stagnates at these levels. Everyone needs to be aware of how this high market volatility can help your profitability going forward, and be aware of the opportunities in some of the fixed income areas. We are here with time to talk, let’s make sure we are all on the same page going forward. In addition, let’s hope the market gives us at least a little cooperation.

Jon and I also have had some talks with several new potential outlets for the radio show. I will keep you posted.