2010Oct31 Week In Review: Looking Up -- or down?
"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."
-- Thomas Jefferson /Letter to the Secretary of the Treasury Albert Gallatin (1802)
Economists, like weather forecasters, are privileged to continually update their outlooks. Data from the Economic Cycle Research Institute (ECRI) suggests the economy is still strengthening, and there is no “double dip” in front of us. That would be good news but is in contrast to the consumer spending tracked at Consumer Metrics.
If ECRI is correct, the Fed will have more difficulty justifying another round of easing. The reported decrease in unemployment claims this week may be a sign of improvement in the labor market. However, the numbers are “advance unadjusted” which for the statistically inclined seem inconsistent with last week’s report from the DOL.
President Obama publicly confirmed that this year’s health care legislation was just the initial step towards a more expansive government program. With Medicare Advantage already being curbed in some states, the over-65 population may begin some political push-back as more are denied coverage. This election cycle has an increase in doctor’s running for national office with nearly three quarters of them opposed to the government’s plan. Resolution for our health care future remains elusive.
Foreclosures continue to dominate the industry. Banks are faced with 50 states differing legal requirements to foreclose on a property. In an attempt to mitigate their own costs and facilitate their processing, banks are asking for meetings with attorney generals. Having facilitated loan processing by failing to properly execute, review or file documents, banks seek short cuts now that may deny due process to delinquent home owners.
Buyers are increasingly reluctant to purchase 1) for fear a prior owner may show up with a legal right to possession and 2) with a hope that prices may still be lower in months ahead.
Quick resolution or not, the continuing decline in home values threatens the banking industry’s financial stability and increases the probability of another tax payer bail-out under the “too big to fail” precedent. The quote above from Thomas Jefferson seems appropriate for today. The Fed’s efforts to support home values through cheaper money cannot create demand and interferes with the normal process for deflating bubbles. Cheap money created the bubble from which major banks became the dominant beneficiaries. Tax payers should not be asked to protect banks or their bond holders from the bank’s prior mistakes.
Since this quarter’s reports of estimated earnings began three weeks ago, forecasts for the S&P-1500 have been increasingly bullish. The only sector without improvement is telecom services which is slightly more than 1% of the index. With the positive trend expected to continue and a two month rally in stocks, you might assume investors were interested. However, the Investment Company Institute reports that fixed income mutual funds have continued as investors’ dominant choice. Equity exchange traded funds in September were an exception.
Investors’ fear has periodically pushed the price of Treasuries so high that the interest rate was negative. Prior to this week, inflation protected treasuries (TIPs) had escaped the negative interest rate event. Apparently, the Fed’s continuation of current policies has raised inflation concerns among TIPs purchasers to accept a -0.55% rate for five years.
Money flowing into bond funds continues pushing prices up and yields down. Combined with the Fed’s zero interest rate policy, investors seeking income are accepting larger commitments to higher credit risks than traditionally considered prudent. With domestic bond yields so low, officials at PIMCO have warned that the bull market in bonds is over. Not surprisingly, emerging market bonds have benefitted and exhibit signs of another bubble.
PIMCO’s game plan is to shift investments into non-USA holdings. Whether our expanding money supply is justified through Keynesian economic theory, supporting real estate prices or job creation, it has devalued our currency. A continuation of the policy keeps pressure on the Dollar making PIMCO’s decision necessary and absolutely rational. Our portfolios emphasize non-US holdings.
The long-term moving averages of equity funds continue improving. Unfortunately, long-term investing is subject to previously unknown risks.
One of the new risks is the Fed’s actions of pushing money into the system which has an immediate impact on prices. The risk lies in not knowing how much or how long the Fed will continue. We do not find Mr. Bernanke asking the primary dealers in Treasury securities for advice reassuring.
High frequency trading is another risk which regulators and markets have yet to understand. This week a new record was set in “quote stuffing” at 23.3 quotes per millisecond all of which were cancelled before being filled. The average holding time for a stock position on the NYSE has dropped to 11 seconds re-defining long-term.
Though most investors name October, historically, September is the worst month for stock market returns. In spite of our weak economic environment, neither month brought a big draw down. The remainder of the year has typically been more rewarding than not with positive trends favored through May. At this moment, we can hope that history does repeat itself.
“When the facts change, I change my mind. What do you do, sir?” - John Maynard Keynes
Our plan is “the plan will change.” What is your plan?
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