What are the facts?

Government Shutdown: Good News or Bad News for the Economy?

But there are reasons to think this would be good.

I already knew that.  In fact, I can think of all kinds of good possible outcomes if the government shuts down.  I'm still waiting to hear what would be so bad about a government shutdown.

Be that as it may, the article explains how a government shut down could help ease the passage of a debt limit increase.  Basically, a government shut down is supposed to lead to market turbulence (which it apparently has, unless you subscribe to the notion that I do: that stocks are in general overvalued and due for a correction), Republicans will be blamed, and "outside players" will pressure the GOP to cut a deal.  Please.  This isn't a good.  It's more of the same.  Many of the problems we in the U.S. face today are the result of a whole lot of deal cutting and compromising.  Instead of compromising between two ideologies, why not just give up the ideology and do what's best?  Anybody that thinks that the actions of politicians demonstrates their willingness to stand up for what they believe is right is just plain wrong.  It is a demonstration of their unwillingness to think rationally about each situation.  This doesn't apply to just Republicans; it applies to all politicians.  They need to learn to separate their thinking from their emotions.  But, that might lead them in a direction they don't really want to go: they may realize how wrong they've been.

But the author of this article has issues of his own:

This is a fact.

I think somebody needs to reeducate the author about the difference between fact and opinion.  There's barely anything factual in the article, and certainly not the "fact" that this statement refers to:

[E]veryone knows that if the government shuts down, and the polls ask which side is responsible, the majority will say the Republicans.

Speculation about what's going to happen in the future is just speculation, not fact.  But here is a fact:: I blame the Democrats for any shutdown because they passed Obamacare in the first place.  It wasn't popular then, and from what I've heard from people around here, it isn't now.  The Democrats want to claim as fact that Obamacare is popular now, apparently thinking that Obama's reelection means people like Obamacare.  Obamacare isn't popular with me, and it isn't with a lot of people.

Anyway, it's time for politicians to stand up and say "When the facts change, I change my mind.  What do you do?" (a quote sometimes attributed to Keynes, but called in to question here).  What I mean by that is that politicians need to consider the facts as they are currently.  Instead of pushing some ideological agenda and then allowing the other party to gut that agenda with their own ideology, let's take a look at what is really the best for our country, and for individuals.  Too often, with compromise, we end up with legislation that doesn't accomplish what it's supposed to accomplish, all because the politicians are worried that their constituents may not think that the best thing is, in fact, the best thing and not something to be compromised.  Take a look at the "Three-Fifths Compromise" for an example.  The compromise was meant to gain support for the new Constitution, and while it achieved that, it can also be argued that it ensured that voters in slave states had greater say in the government than they would have had; it ensured a higher rate of importation of slaves to gain additional voting power; and in the end, it led to slavery lasting much longer than it probably would have without it.  Is that good?

I usually save this sort of rant for my personal blog, but happened on the article while looking for business news.

Take a few days off and what happens?

I admit it.  I got bored.  The news was the same, day after day.  So, I took a break.  Suddenly, volatility is up, gold has its biggest drop ever, and the market shows that even QE won't guarantee that stocks won't fall.  So, what happened?

First, let me say this.  I've always been puzzled by the guys that say there are any sort of fundamentals in the price of gold.  There aren't, any more than there is in dollar bills.  I think those guys believe what they say, at least to a point, because it makes them feel better about earning a living trading worthless hunks of metal, hoping to find the next bigger fool.

This is the way I see what happened.  People have been piling into gold for years now, convinced that something REALLY bad is going to happen.  Only, nothing happens, so the rise in the price of gold gradually slows as people run out of cash and, worse, run out of borrowing capacity to buy gold.  The price begins to stagnate, and people begin losing interest.  They get bored, just like I did.

Then, something happens in a small country that the majority of people haven't ever heard of before, or at least have no idea where it is.  Cyprus says it's going to sell its gold reserves to pay its debts.  This shouldn't really be a shocker to anyone.  I mean, why do people suppose that governments own gold?  It's a store of value and how does one unlock that value?  SELL.

So, the government needs to raise some cash and decides to sell some gold, and it's as if the world hadn't thought that was possible.  Some people start selling, then the bears join in and start shorting.  Stop losses start kicking in along with margin calls, investors need to sell to cover those.  Eventually, the price of gold gets low enough, and there are enough margin calls that some gold investors start selling stocks, or other holdings.  While I can't say for sure, that's what I think happened earlier this week.

Today, now that the markets are closed, stocks are down again, and gold is up a few bucks, but still below $1,400.  10-year treasury yields are down again, showing there is some money moving back to safe haven investments.  Since gold is up a bit, it seems that there are some that still think gold is a safe haven.

The problem is, though, that gold isn't all that safe if the global economy sinks into deflation, and talk of deflation is becoming more common.  When the Fed and other central banks turned on the printing presses, I don't think anyone really thought that deflation was a legitimate concern.  All the talk was about inflation, and the price of gold skyrocketed over the years.

Of course, we may never see deflation.  If that becomes a real threat, the Fed may very well crank up the QE.  It's hard to say just how much good that would do, though.  The global economy needs to correct, and sooner or later I think it will regardless of what central banks do.  I do think that monetary policy might be able to soften the blow, but then again, it might not.  In fact, it might make things worse.

Times like this point out the importance of having a well-diversified portfolio.  Unfortunately, people don't like to diversify because, by definition, they have to invest in stuff they don't really think is going to do as well as what they really want to invest in.  So, during good bull markets, the diversified investor doesn't make quite the spectacular gains that others are.  But when the bull market ends, and it always does, they shouldn't suffer the losses either.

Forget statistics

Dow Winning Streak Captivates Traders, Tests Statisticians

"The odds are we won't go ten days, but the odds were we wouldn't go nine days," says Hugh Johnson, chairman & CIO at Johnson Advisors, in the attached video. "This is a pretty unusual experience, but markets don't go straight up, and you and I and probably everyone who is watching knows that instinctively."

Forget about odds.  Statistics (odds) are only meaningful when there is something random going on, and when the future is expected to resemble the past.  I'm unaware of any time in history when the Fed has taken on this kind of asset purchasing, and consequently, don't expect the future of this market to bear any real resemblance to the past.  This market isn't random, it's manipulated.  True, there may be a correction sometime soon, but statistics won't help you determine when that's going to happen, nor will statistics help you determine how big the correction will be.  Suffice it to say that the higher stock prices get, the riskier stocks are. 

Ignoring the market and economy

A short while ago, Bill McBride over at Calculated Risk posted an article on Business Cycles and Markets . The article asks why we care about exactly when recessions start or stop or whether we’re in a recession right now. Of course, the answer is that, if one can know when the start of a recession is in real time, then the investor can close his positions and reopen them at the bottom. And sure enough, if an investor could do that he would make a whole lot more money from his investments than if he just held through the recession. Interestingly, in the period starting in 2000, though, an investor would have done better if he missed the timing some.


Then I got to thinking about the last recession, and after stocks had lost nearly half their value, people were asking me what to do. My response was, “Well, nothing now, other than keep investing in whatever you’ve been investing in. If you thought it was a good investment before, then it’s an even better investment now.” I don’t know how many people actually did that, and nobody has thanked me for that bit of wisdom, even though, if they followed my advice, their investments would be worth a lot more now than they were before the crash with their added investment at much lower prices.


Then I started thinking about how the stock market is just now approaching the same level as it was in 2000 or so, for the second time. And people have said to me that it seems like they’re not really making anything in stocks. Of course, they’re not if they keep selling when the market tanks. I actually think they only think that because they see that the stock market is still not any higher than it was back in 2000.


And, eventually, I started thinking “What if someone just regularly invested on the first trading day of the year, oblivious to whatever was going on at the time? And what if he was the unluckiest person and always bought at the high for that day? And what if, in fact, he was so unlucky he only started investing in January 2000?” For one thing, he would have slept a lot better during the dot com bust and financial crisis, rather than lying awake worrying about what to do. For another, he wouldn’t have any idea whether he was making money or not. He at least would be oblivious to the fact that stocks have pretty much not gone anywhere since 2000.


So, I decided to have a look. For simplicity, I just assumed that dividends were paid at the end of the year, and reinvested. As it turns out, our uninformed investor would have made a 1.6 percent annualized return over this period of time, and this return is mostly due to dividends. Bear in mind, though, that this is just about the worst case scenario for an investor. He started investing at the top of the dot com bubble, and always bought at the highest price on the first trading day of the year.


So, I don’t know if there’s really any lesson in that. Of course, if I went back further, the results would have been significantly better. And it’s entirely possible to have done a lot worse. Panicking at the bottoms comes to mind as a major problem our investor friend isn’t in danger of having. And, the way the market is acting these days, it’s possible our hypothetical investor might end up being a lot better off if he keeps with the plan. Well, maybe.

EDIT: Soooo, I made a bit of a blunder on this post.  In figuring that 1.6 percent return, I just calculated the return on the total investment over 13 years, which of course is incorrect.  It was late when I wrote it, and it's even later now so I'm not inclined to fix it.  The point is still the same.  Most of the returns resulted from dividends, which isn't surprising given that stocks have just risen again to the same level.

Market news today

Wall Street trips and falls on cloudy Italian election

Well, I'm not so sure this drop was all about Italy, although it may have been the catalyst.  Instead, I think it's more about what's happening right here in the U.S.  Only a few days left before we start seeing spending cuts.  And, of course, the market is still up quite a bit this year, so it needs a rest.

At any rate, based on what I've read about the upcoming cuts, I think we're heading for a recession.  And given that nobody really seems to expect it, or at least they don't seem to think it will be that bad, I think it may very well be really bad.  I don't think the government will be able to do much, and the Fed has already pretty much exhausted its bag of tricks.  The only thing that seems to be holding our economy together right now is people's apparent confidence in the economy.  But that confidence seems to be misplaced, at least in my opinion.

So, not surprisingly, stocks are down, bond yields are down, and gold is up.  Looks pretty much like a flight to safety, of sorts.  I wouldn't really call bonds safe, though.

More value to whom?

M&A deals lift shares, suggest more value in market

The question should be, more value to whom?  Just because one company finds value in merging with a competitor doesn't mean investors should find the same value in either company.  Of course, in most cases it would be nice to see the value in the target to the acquirer before the acquirer does since that would definitely benefit the investor, but then, you could wait for years for the acquirer to recognize the value.  No, I think M&A action really is more of an indication that companies are less competitive and see this a some sort of solution, which it is in the short run.  In the long run, though, new competitors will enter the market, and these companies will still be unable to compete.

When will it be time to panic?

Stocks end higher for sixth straight week, tech leads

Turns out, there was some actual positive news, and stocks ended higher again last week.  It's old news, though, meaning it doesn't reflect the tax hikes that took place in January.  Still, the relatively good earnings are a good sign, the trade deficit came out smaller than expected, China's growth bodes well for the global economy, and there are signs that employment may pick up. On the other hand, from a few days ago:

NYSE Margin Debt Rises To Fresh Five Year High As Short Interest Slide Continues

[margin debt]  rose for the fifth consecutive month, reaching $331 billion - the highest since February 2008, when the market was declining, and back to the levels from May 2007 when the market was ramping ever higher to its all time highs which would be hit 3 short months later, and just as the subprime bubble popped.

 I just have to wonder when panic is going to set in.  I think we'll see some more positive action for a while.  The market almost can't help but rise.  But, I really think that's going to change soon.

I'm not humbled

Dow’s Run to 14,000 Humbles the Worriers — For Now

I'm a worrier, but I'm not feeling terribly humbled.  At this point, everyone should be worried, but instead the exchanges cheer as they watch the Fed's cash push the indexes to multi-year highs, then slap each other on the back as if they're some kind of geniuses.  Of course, now the big back slapping show is drawing in more retail investor money, in part because there just aren't any returns anywhere else, so perhaps there is some reason to celebrate.

"So far in 2013, the "risk" has resided in over-thinking the situation by focusing on the potential pitfalls and complications that might arise from a slow-growth economy, peak corporate profit margins, policy dysfunction and stock prices that had already doubled since the March 2009 market bottom."

Over-thinking?  No, the risk is under-thinking, a phenomenon that is occurring with greater and greater frequency.  The analysis of the market is becoming something like "It went up, therefore it will go up."  The kind of "thinking" that results, eventually, in crashes.  In the meantime, though, this "thinking" looks like sheer genius.

 The rest of the above-linked article proceeds to analyze the current market in terms of historical markets.  But today's stock market is not really comparable to past stock markets, so, it's really not a good idea at all to compare this year, which sported a great January, to past years that also started with a great January.  This time is different, although we still really can't say whether this year will end up all that different.  The end result could be the same, but for significantly different reasons.

Then again, the assumption that this year will somehow resemble past years could lead to a significant, bad outcome, and that's what I'm worried about.  The days of "buy and hold" investing really are over.  Of course, if you've paid much attention to the stock market over the last decade or so, you would already know this.

So, how can we avoid being "humbled" in the future?  By simply admitting that we don't really know what's going to happen, or at least admitting we don't know when it will happen, and act accordingly.  Diversify.  Keep some cash.  Buy some whiskey.  Learn to live sustainably.  And, recognize that the more the stock market went up yesterday, the more ready you need to be to pull the trigger and sell tomorrow.

No surprises

Fed Keeps Stimulus Amid Signs of Weak Economy

"Markets showed relatively little reaction to the GDP report, in part because it reinforced expectations that the Fed will continue to provide stimulus as long as the economy is weak."

And, of course, the Fed did say they would continue to provide stimulus.  Nothing new there.

GDP Shows Surprise Drop for US in Fourth Quarter

"The U.S. economy posted a stunning drop of 0.1 percent in the fourth quarter, defying expectations for slow growth and possibly providing incentive for more Federal Reserve stimulus.

The economy shrank from October through December for the first time since the recession ended, hurt by the biggest cut in defense spending in 40 years, fewer exports and sluggish growth in company stockpiles."

Well, this is a little earlier than I expected, but I wouldn't really call it "stunning."  The way I see it, the good news is where the shrinkage came from, well, except for the exports.  And, as a lot of people are saying, there were a lot of "one-off" items that hurt GDP, sort of like one-time charges on a company's earnings. 

The main question for stocks is whether the Fed stimulus is going to outweigh what is, in my opinion, a likely recession.  One may also wonder how this might affect the federal government's plan to reduce the deficit.

Optimism

Everybody seems to be getting on board with making optimistic predictions for economic growth this year, but I think it's still a little early to be jumping on the bandwagon.  The data that I'm seeing is, well, old data that doesn't reflect the tax increases that went into effect earlier this year.  Still, we do have the Fed pumping more cash into the financial markets, so I don't see much at all to worry about at this point, unless the reports of planned increased hiring come to fruition, in which case, we may see inflation begin to tick up and the Fed put an end to the easy money available in financial markets.

1600?

Amazingly, or perhaps not so much, analysts seem to be edging up their forecasts for the S&P for the year.  So far, the only rationale for this upward revision appears to be because the S&P 500 is up.  It goes something like this: "Well, we broke through the psychologically important 1500 level, so, outside of that pesky fiscal cliff thing in March, it's pretty much clear sailing to 1600."  I'm really expecting something much lower than that, but then, I usually underestimate the irrationality of markets, so we'll see.  I actually think that once we start to see the effect of the tax increases in the economy, we'll see a lot of analysts reversing their optimism.

A simplistic view

Sometimes, it’s a good idea to try to simplify really complex systems. Other times, simplifying is a really bad idea. Economic models typically oversimplify by appending the term “ceteris paribus,” or “other things equal” when explaining theories. Well, if it’s good enough for them, it’s certainly good enough for me. So, here’s my take on the stock market, given the Fed’s easing, ceteris paribus.

The way I see it, the Fed is pumping $85 billion per month into the financial markets. As time goes by, that means that other investors will be “crowded out” of the less risky investments that the Fed is buying, providing additional incentive to investors for investing in risky assets. So, let’s make another simplifying assumption: that the Fed has already crowded investors out of the low risk investment arena, leaving nowhere to get real returns other than with risky assets. In other words, we are going to assume that the $85 billion that the Fed is pumping into lower risk investments is pushing another $85 billion into stocks.

$85 billion per month is approximately $1 trillion per year. Given a current market cap in the U.S. stock market of about $16 trillion, this represents a market value increase of about 6.25%.

But, all other things equal never holds. In September 2012, the Fed was projecting economic growth of about 3%. If we assume that corporate profits as a percentage of GDP will remain the same, then we can determine the approximate returns in the total stock market: (1.0625 X 1.03) - 1 = 9.4%, actually pretty in line with the 10% number I’ve seen around.

Unfortunately, things have changed a bit since the Fed estimated 3% GDP growth this year. I major factor, in my opinion, is the 2% increase in payroll taxes that came about at the start of the year. So, simplifying again, instead of 3% growth, we may see only 1% growth. Given that outcome, we might expect a market return of (1.0625 X 1.01) – 1 = 7.3%.

Finally, let’s look at where the market is now since the start of the year. We’ll use the S&P 500 for simplicity again. We ended 2012 at 1426.19 and closed on Friday at 1485.98, for a change of 59.79. We’re up a little over 4%, which leaves only 3.3% for the rest of the year according to this simple analysis.

I actually think, though, that 3.3% growth by the end of the year might be a somewhat optimistic. The last I heard, the federal government still had to make some tough choices about spending cuts. I think that any cuts in entitlement spending may very well push our economy into recession, being that growth is expected to be so low without those cuts.

The point is that, I arrived at these outcomes using a really simplistic approach. So, it wouldn’t surprise me in the least if the actual outcome is significantly different than what I’ve arrived at here. This is the meaning of risk, and I don’t think risk is being priced into the market at all these days. Which means, ultimately, that when pricing assets, it’s probably a good idea to overestimate the risk looking ahead.

The VIX

VIX Hits Pre-Crisis Levels

Yeah, the VIX is getting pretty low.  So low, it might make you worry.  I don't think it should, though, at least not yet.  Here's why.

The VIX is based on option pricing.  A large part of option pricing is based on the volatility of the underlying asset.  The higher the volatility, the higher the value of the option.  So, when investors expect greater volatility in the future, the demand for options increases, and pushes the option price up.  But, the problem is that investors typically don't expect higher volatility in the future unless the market is already more volatile.  So, using the VIX as a measure is almost, well, redundant.  If the market drops, the VIX rises, because investors are reacting to the current volatility and expecting it to get higher.  Of course, then there are other investors who will see the VIX rise and interpret that as increasing volatility in the future and either sell, increasing volatility now, or buy the VIX, increasing the apparent expected volatility.  Either way, it's sort of yet another self-fulfilling prophecy, of which the world of finance has a multitude.

Emerging market bond funds

Just a quick observation here:


Rich bond yields you’re likely missing : Emerging markets gain popularity with income investors


Just guessing, but I have to say that the yield on these emerging market bond funds is probably too low for the risk. Is it better than treasuries? Yes. But, I wouldn’t put my money in treasuries either. These yields are artificially low, and just because one is higher than another doesn’t make it a good bet. And just because emerging market bond funds are not directly affected by the Fed’s actions doesn’t mean that there hasn’t already been a Fed effect on those bonds.
 

The new contrarian

Is the Crowd’s Cheery Mood Reason to Fear the Rally’s End?

Yeah, the Fed is kind of ticking me off.  I usually take a contrarian viewpoint when it comes to the market, and I have to say that the last week or so has had me thinking it was nearly time to get out of the market.  But, the Fed is doing a bang-up job manipulating the markets, leaving next to nowhere to invest.  So, even though investor sentiment is almost high enough to make my skin crawl, I'm still betting with the Fed.  After all, according to the article, "$22 billion in new money entered equity mutual funds," and the Fed is kicking in about $85 billion a month into fixed income, so it seems to me there's still some room to grow.  The thing is, the longer this goes on, the worse I think it's going to be at the end.  We'll see though.  In the meantime, I'll just be take the opposite outlook on the market as the Fed has on the economy, and I should be good.

Mediocre job growth

Mediocre job growth points to slow grind for U.S. economy

 Not surprisingly, today's nonfarm payrolls report probably couldn't be any better for the stock market.  It wasn't so high that investors might get spooked that the Fed might end easing, and it wasn't so low as to illicit fears of a recession.  Still, I would suggest not letting your trading finger get too far from the trigger.

The government needs to just give up

Wall Street rebounds on House session, but off for 4th day

The story says that the market recovered most of its early losses because the House said it would work over the weekend.  I'd be more optimistic if the government just gave up trying to fix anything.  

I forgot to mention...

In my last post about the real reason for the market tanking last Friday, I forgot to mention one thing: Because so many analysts and journalists jumped on the lack of action towards a resolution of the fiscal cliff, many investors will now believe that to be the reason for the drop on Friday, and with continued inaction on the part of the government, these investors will also sell.  So, we have a case here of a faulty analysis becoming a self-fulfilling prophecy.

That's not why the market tanked

Everywhere I look, the conventional wisdom is that the market tanked today because of the government's inability to act to avoid the fiscal cliff.  The problem with this explanation is that by now most people should realize that the government isn't going to act until they've milked this latest "crisis" for all the political gain they can get from it, and so the lack of action should have come as no surprise to anyone.  I think the real reason for the drop is much more subtle and complex than that.  In a nutshell, though, today's market action had more to do with the upward revision of GDP as well as the unemployment figures.

Why?  A while back, the Fed announced it would be buying $40 billion a month in MBSs.  More recently, the Fed announced they would buy another $45 billion a month in long bonds.  This is effectively driving all the low risk investment returns down to such low levels that the only rational thing for anybody with some money to invest can do is to invest in riskier assets, like stocks.

The Fed has said that it will keep easing until unemployment gets down to 6.5 percent, and unemployment has remained stubbornly high, so it may seem a bit premature to be worried about the end of quantitative easing.  But I suspect that the smart money is already pulling some out, to avoid the last minute rush when it becomes apparent that we have reached the end of easing.  Unemployment has been edging down, and if GDP growth is even a little better than expected, the drop in unemployment could happen relatively quickly.

The take-away from all of this is that I would expect to see more of the same irrational investor behavior as we say before the Fed started the recent rounds of easing, i.e. rallying on bad economic news and and falling on good news.