What Ever Happened to Mayberry?
November 22, 2010
Good morning. There was conflicting news in the market last week that had the market moving fairly violently on an intraday basis, only to close almost exactly unchanged. The SPY closed up a whole .09, at 120.29, after trading as low as 117.59 on Tuesday. The VIX closed down a solid 12% at 18.04, reflecting confidence that nothing bad will happen in the upcoming Thanksgiving week, or maybe for the rest of the year. Normally that would be the case, quiet trading before and after the holiday, but the recent few years have been anything but normal. We shall see. The conflicting news has to do with the economic situation on one hand, complete with China growth restriction efforts, international resistance (and even anger) to the Fed’s new monetary expansion policy, continued lack of any meaningful growth in job quantity or quality, massive budgetary issues at all levels of government, etc. On the other, there is continued growth in profit (and even revenue in some cases) in the large corporations, a slight improvement in the labor market, some increase in the manufacturing sector, and a solid increase in Leading Economic Indicators (virtually all due to the expanding money supply and the steepness in the yield curve, and a small increase in the hours worked per week).
One thing is for sure, if you are a talking head on TV (not to be confused with the always calm and reasoned people on “Stocks and Jocks“) you can justify any position or opinion on the economy or the market with several stories and numbers virtually every week. If you want to be bullish (or only sell buy-type products with no ability to hedge) you can easily quote some statistic about earnings growth in the last year, extrapolate it out five years, and say the market is very cheap. Or you can look at the growth in earnings, chalk most of it up to one time cost cutting, look at an economy barely growing at 2% (despite massive fiscal and monetary stimulus), say no way in hell is that type of earning extrapolation appropriate, and predict a stagnant market for years (or worse). Who is right? To be very blunt, no one knows. Opinions, as they say, are just that, opinions. I defy anyone to go back in history and find a set of circumstances quite like this, even though everyone seems to draw conclusions based on their own narrow reading of their version of history. However, there seem to be certain pieces of what is happening that have gotten so skewed that some predictions are possible. I have said for quite a while that the Fed would run the risk of any further monetary easing backfire on them, and have market interest rates actually go up due to increased inflationary expectations. To me it was always way too risky to chase returns into the long term fixed income markets at 3-5%. Now we have seen losses in the fixed income area of over 10% since late August. Seems like not a big deal, but be mindful that in the last eighteen months to two years more retail investment dollars have gone into bond funds than stock funds, so a large chunk of middle America’s piggy bank is down a lot in a short period of time.
Will the elections save us? After all, we sent this big message for government at all levels to “shape up or you are next.” Discounting Illinois, seemingly a hopeless case, there was significant change in many states and the federal congressional makeup, can they do anything to help and, if so, when? I really believe, and will be happy to buy beers around if I am wrong, that they will be slow and ineffective. It has been a time honored tradition in government to do virtually nothing worthwhile, or do it slowly, and when the resilient economy rights itself sort of on its own, to take credit like the carpetbaggers of old. To be fair, I am not sure anyone (at least I admit it, this is a tough set of problems a long time in the making) is really capable of coming up with an ironclad ten-point program to get us out of this mess.
Why is that, it should not be so tough? Just give me term limits, throw the illegals out, cut government workers, get us back morally to Mayberry (a place that never existed), cut my taxes, or do any one rallying cry thing from whatever faction you happen to be listening to, won’t that do it? I would say not even close. It is easy to simplify, and easy to criticize, but a real solution is elusive in virtually any area. Let’s take on a big one, China. What should we do, and once “we” decide how do we get consensus to get it done? Simple question, is China the solution or a lot of the problem, or both? I have an older second cousin (brilliant mining engineer from the old school). He visited China thirty or forty years ago in an effort to sell China some very high end mining machinery. Well, the Chinese said thank you very much, we will buy one of every type machine you make. These guys might have been a bunch of old machine grinders from Ohio, but they were not stupid. It was obvious to anyone out of third grade that they were just going to copy whatever they bought, so they refused to sell the machinery. There is no doubt that the Chinese (as a society, not as a people) care very little about property rights, patents, etc. Ask Bill Gates how many copies of proprietary software he has sold there compared to the amount of computers we estimate to be there. Take a look at the Wall Street Journal last week and see the article about “their” advances in high-speed trains that look exactly like those of their co-operating partners of the past from Europe, Japan, and Europe (we, sadly, have no remaining train technology to steal). Or did you happen to see the new Chinese airliner that looks remarkably like the 787 they are helping to build?
We have not even mentioned yet currency manipulation, human rights issues, etc. so this should be easy. Slap a tariff on them, ban any products that even remotely look like they were stolen from someone, etc. Quite easily done (QED). Whoa! Not so fast, do you realize the size of that line of lobbyists outside. Let the first one in. He says, “My client is AAPL, and we have invested tens of millions in China, to the point where we make no phones, or tablets, here. Those guys aren’t so bad, can’t really trust them, but they keep their people in line and willing to work for what all workers should work for (as little as I can pay them with nary a benefit in sight). You will kill my business, and, by the way, why do you think I sent you that check last election?” Next! Oh, Mr. Coca-cola? Yes, I realize that there are a billion people over there that are just waiting to get hooked on sugar and soft drinks, and yes I know what a billion people time three cokes per week equals. Who is next, Mr. McDonalds? How many restaurants do you already have there? That is your area of quickest growth? Enough, let’s sneak out the back door, forget our “solutions” and find a martini someplace.
A solution is hard to come by, and the Tea Party people do not seem that bright or organized enough to solve these types of problems. Yet they have to be solved, China is front and center on whether we can compete going forward. They are the worst nightmare of free trade, a major power that is not willing to let their currency float like everyone else, combined with the ability to stop any civil unrest that might lead to wages and other things becoming competitive there. It should be noted that this is not a new problem for the U.S. (history is worth something). There was serious disagreement here in how to deal with the expanding Nazi Germany in the 30’s, with Joe Kennedy leading the charge for what an improved trading partner a “unified” Europe would be. Never mind the part about unified being synonymous with enslaved. The issue (thanks, I guess to the Japanese) never really was resolved here internally, as to whether business trumps morality. I am sure there would have been many here happy as can be selling things to a Nazi Europe. I am not comparing the Chinese to Hitler at all, I am just pointing out that it is not the first time we have had these sorts of issues. Can we solve them this time without a war?
Why spend all the time, and words, on this one issue? Just to illustrate how difficult it is, or would be, to resolve any one of the countless issues we are buried by. What should we do about the absurd under-funded pension situation? Should we say that those supposedly covered by the various broke governmental agencies absolutely deserve their full pensions no matter what, and raise taxes so people with no hope of a pension have to pay dearly for others to have one? That would be interesting, and will eventually cause a riot, but the alternative is to go back on legal contracts signed by legitimate (but maybe challenged) elected officials and lay waste to 225 years of contract law. Another tough one and we are only up to two issues. Get ready to work, you freshmen political geniuses.
What about the market? Very interesting last week, having such a bumpy ride only to end up unchanged. I think the euphoria regarding the GM IPO was somewhat justified, but will probably be fleeting. It would be hard to root against the new company, even though the road to get back to being a legitimate business was strewn with a lot of casualties. The fact remains that not many would have predicted GM coming so far in 18 months, and for a little while I choose to focus on that rather than the cost to others and the moral hazard involved. As far as QEII, the phenomenon of the Fed pouring money into the economy and foreigners raising money here cheaply for investment abroad has caused a serious “leak” in what the policy might do for us. Everyone criticizes Japan for not using monetary stimulus enough, and forgets the part about everyone going to Japan, borrowing at low rates, not doing anything there, and buying mortgage-backed securities here. Why are we surprised that the same thing is happening now here? I think we have to remain careful about investing in longer term fixed income securities, they have come down some, but if inflation goes even to 3% they have a long way further to go on the downside. I think we still need to stay protected in our positions, but we still should be a little longer in case the market wants to trickle up for the remainder of the year. The XLE remains a possibility, although the problems with the mortgage foreclosures seem to be growing, not lessening. At some point we should get a little invested in some of the basic materials, but the significant sell-off in those areas last week is cause for concern. My favorite remains the XLE, and I continue to hope for some sort of pull back in that area to get us more involved. We also should look at some of the relative laggards like MSFT, I think they have more going for them moving forward than the market is seeing.