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Don Coxe
THE COXE STRATEGY JOURNAL
published by
Coxe Advisors LLC
Chicago, IL
THE COXE STRATEGY JOURNAL
The Power of Zero
The US economy grew 3.5% in the Third Quarter, and all the major economic
numbers now being reported suggest this one will be even stronger. Stock Only Lehman was
prices are soaring. allowed to experience
the Schumpeteresque-
In case, you’ve forgotten:
slaughter reserved for
Sixteen months ago we were heading into the Midnight Massacre, when capitalist cupidity and
Messrs. Bernanke and Paulson launched the rescue of Fannie, Freddie and stupidity.
Wall Street.
That swiftly evolved into the Age of Bailouts, with Congress enlisted in
emergency funding for Wall Street’s biggest, boldest and brashest bankers
on a scale that made IMF rescues of entire nations look like chump change.
Only Lehman was allowed to experience the Schumpeteresque-slaughter
reserved for capitalist cupidity and stupidity. Operating with scripts and
strategies conceived on the fly, varying prescriptions of emergency assistance
were extended, under panic conditions, to Citigroup, Merrill Lynch, Morgan
Stanley, AIG and Goldman Sachs.
Since then, the Obama Administration and the Pelosi-led Congress have been
moving to take charge of some of the commanding heights and strategic
valleys of the US economy. Highlights: takeovers of General Motors and
Chrysler, a deficit of 12% of GDP, $790 billion in handouts and assistance
under the rubric of economic stimulus, a costly new national health care
system, and a vast array of tax and trade global warming programs whose
tentacles will reach into almost every sector of the economy.
To date, his rescue operations are succeeding. As Joe Biden put it, “A year ago
we were talking about falling into Depression. Now we’re talking about the
shape of the recovery.”
November 1
everything his thrilled backers wanted, but we knew that he wanted to be a
transformative President and he cited Reagan as such a leader—even though
he said Reagan had the wrong views.
We are leaving our cautious Asset Mix unchanged. Risk assets—other than
US real estate prices—are bubbling upward everywhere, but the big banks’
balance sheets remain overloaded with the unmarketable unmentionables,
and US regional banks—the backbone of the real economy—are now being
engulfed by their exposure to commercial real estate and consumer loans as
unemployment continues to climb.
I. Capitalism’s Triumph
Every week, someone publishes an analysis of the global economy by noting
that the triumph of free trade and free markets across most of the globe
began in the Reagan-Thatcher era. Now, they agree, it’s over. Each month,
“If it moves, tax it;
Washington’s reach into the American economy expands rapidly, while the
if it keeps moving,
economy expands—at best—grudgingly.
regulate it; and if
It is certainly true that almost no one predicted the suddenness and scale it stops moving,
of US government intervention in the West’s flagship economy that had subsidize it.”
been, until last year, a testimony to the wisdom of Milton Friedman and the
courage of Ronald Reagan. (The cheerful Reagan charmed voters by teasing his
opponents. He summed up Democratic economics as, “If it moves, tax it; if it
keeps moving, regulate it; and if it stops moving, subsidize it.” He summed
up the goal of his policies toward the Soviets: “We win; they lose.”)
The political bipartisanship began with the Midnight Massacre of July 13,
2008 but lasted only until the grandiose goals of the new Administration
were revealed. The Pelosi-Obama stimulus package passed with no Republican
votes in the House, despite heavy lobbying from some segments of the
business community, notably General Electric, which became Obama’s
most dedicated corporate cheerleader—itself and through MSNBC—after
receiving many billions in low-cost loans to its flagging finance subsidiary,
GE Capital.
Twenty-seven years ago, when the newborn Reagan and Thatcher Revolutions
seemed headed for death from double-digit interest rates, Chairman Volcker
declared victory over inflation and began expanding the money supply and
cutting interest rates.
For those who didn’t manage money during that recession, the fed fund rates
at the time that great easing began must seem surreal: 18%.
November 3
The Power of Zero
Those rates were not only punitive for businesses and potential homebuyers,
Why not, they asked, but they meant that money market funds were well-nigh-irresistible
take those huge investments—huge, risk-free returns with zero market volatility.
risk-free upfront
We can recall the challenges we faced in convincing pension fund clients
returns from Cash?
about our asset mix in late 1982: zero Cash, with the balance being roughly
equally divided between long-duration bonds (19 years) and equities—with
minimal exposure to commodities. Why not, they asked, take those huge risk-
free upfront returns from Cash, rather than bet on a sustained, steep drop in
interest rates and inflation and a sharp, sustained economic recovery?
That wasn’t all that would fall from the Reagan and Thatcher revolutions…
The free market team’s stand against the faltering Bolsheviks, and their strong
economies at a time of economic stagnation in Russia and its occupied
territories in Western Europe, led to political unraveling in the Communist
world; the Wall fell and two years later the Communists were gone—even
from the Kremlin. (On his trip to England in 1979, Deng Xiaoping learned
why free economies were outperforming Russia and China, and he returned
to launch the Sino-Capitalist Revolution which keeps astonishing the world,
It was also bad news for leftists across most of the Free World. They had
convinced themselves that, as the leader of Canada’s New Democratic Party
put it after returning from a trip to Russia shortly before the Fall, “I admire
their economics, but not their politics.” It turned out that everywhere, like
Germany under National Socialism, “Good Communists” were as rare as
“Good Nazis.” Free markets and free economies worked: socialism didn’t.
There were no Nobel Peace Prizes for Reagan or Thatcher. Instead the prize
for the end of the Cold war went to …
Mikhail Gorbachev.
Gorbachev’s Nobel was the beginning of the rewriting of the history of Reagan
and Thatcher’s roles in Communism’s fall. The culmination of this process
is arriving in the torrent of new books that airbrush out those doughty anti-
Communists from the portrayals of friendly people reaching out to hug each
other from both sides of the Wall—Pyramus and Thisbe writ large.
November 5
The Power of Zero
But the reality of the Presidency is that handsome is as handsome does. His
approval ratings have descended from the Heavenly to the ordinary. All polls
disclose that while most Americans still like and admire him personally, they
disapprove of his policies.
Percent
Then Now
A year ago, Obama was impressing the nation (and, we admit, us) by unveiling
his economic policy team that included the magisterial Paul Volcker. Volcker
has been rarely seen since; three weeks ago, he corrected an interviewer
who said that the financial community felt that in recent months he’d been
marginalized. Volcker said, “I did not have influence to start with.”
Based on our recent trip to visit European clients, and numerous emails
from foreign clients across much of the world, many global investors are
alarmed about Obama’s policies and are reducing their exposure to US assets
accordingly.
The dollar’s decline may be one symptom of these doubts about the actions
of Obama and the Democratic Congress.
November 7
The Power of Zero
88
The US deficit/GDP ratio is above 12%—at World War II levels, and is the
highest in the G-7, except for the UK. It is, for example, more than twice
Canada’s. Few Americans would have expected that America would make
Italy look restrained and prudent in comparison. There is widespread
disappointment about how all that money has been spent, but as Keynes
observed, paying workers to dig ditches and then refill them is better than not
spending the money at all when consumer and business spending collapse
and Depression looms.
Last week, The Economist, which backed Obama enthusiastically during the
election campaign, published a full-page critique of his pro-union policies
titled “Love of Labour.” Contrasting his recovery policies with Reagan’s
response to the Air Traffic Controllers’ strike, it said, “Mr. Obama is the most
pro-union president since Jimmy Carter, at least.” It went on to describe the
implications of Obama’s backing for the unions’ top priority—card check—
which would abolish secret ballots for union representation.
Abroad, his popularity remains high (except in Israel, where his approval
rating is a mere 4%), as evidenced by his Nobel Peace Prize. However, as his
attempt to replicate Tony Blair’s success at charming the IOC into awarding
Chicago the Olympic Games demonstrated, he has been notably unsuccessful
in translating that popularity into significant diplomatic successes.
Perhaps the biggest difference between him and Reagan is in his views about
American history. He was raised in the post-Sixties era, when the Left—abroad
and within the US—routinely demonized America for its alleged racism and
imperialism.
On balance, a year after he won the Presidency, and while he still enjoys
widespread good will, Obama has only begun to prove his effectiveness (1)
in managing the US economy without damaging the nation’s longer-term
financial position, and (2) in protecting America’s interests abroad.
Last week’s three off-year elections certainly do not prove that voters have
suddenly forgiven Bush and are ready to reinstate Republicans. Obama was
not on the ballots, unemployment was still climbing even after the economists
said the recession had ended, and the Democrats’ deficits had scared a
majority of independents into switching their preference to the Republicans.
The next elections are a year away, by which time the economy should be
stronger, the rage over the 1990-page health care bill might have dissipated,
and the Republicans will still lack a Newt Gingrich-style leader to put together
the various resentments and enthusiasms into a winning coalition. It took
rare talent for the current leadership to lose the 23rd Congressional District
in New York the Republicans had held for 72 years.
Obama may fear serious voter backlash about the scale and wisdom of the
new programs being legislated, but at least for now, he doesn’t need to fear
the Republicans. The Republican Party is leaderless, and frequently clueless,
so Obama doesn’t need to be a Roosevelt or Reagan to stay on top.
November 9
The Power of Zero
The US and British economies are performing at roughly the level they were
during the late stages of the 1981-82 recession—when corporations’ and
consumers borrowing costs’ were infinitely higher. That inflation could be
in the zero range would also astonish them, even though the biggest factor
in their first election victories was the runaway inflation of the Carter and
Callaghan era—when “malaise” was the Presidential euphemism for the
spreading despair.
It’s because those Zero rates tell us that the financial system’s problems that
triggered the economic collapse aren’t going away quickly—and could even
be getting worse.
Reagan and Thatcher didn’t have to deal with serious demographic problems
that meant housing prices could not—for the first time since World War
II—leap in response to plunging interest rates. Reagan and Thatcher didn’t
have to mortgage their nations’ futures to bail out bad banks, which, upon
being rescued, diverted the succor they were given to rebuild their devastated
capital to speculation and bonuses, thereby making their saviors—politicians
and taxpayers—look like suckers.
Nor did they have to face the certainty that interest rates and inflation would
have to go up sometime—and that could be very inconvenient for both the
politicians and the economic recovery.
Despite the current deficit of 12% of GDP, and despite increasing grumbling
about Washington’s willingness to incur huge deficits in bad times and good,
the foreign support of the dollar by buying Treasurys continues. There has
been one little-remarked change in the investment strategy of America’s
Sugar Daddy #1: in recent months, China has been rolling over its maturing
Treasury notes into T-Bills. It thereby chooses to forgo interest of 2%–3.4%
in favor of near-Zero yields. What power, one wonders, does Beijing think,
comes from a Zero return in a weakening currency? And why is that putative
power growing so relentlessly?
November 11
The Power of Zero
A Zero yield has been the Bank of Japan’s policy for most of the time since its
Triple Waterfall Crash commenced nearly 19 years ago. Our personal favorite
member of the BOJ’s Board then, was its only female, Eiko Shinozuka. She
consistently voted against near-Zero deposit rates. She claimed to represent
the generation that had pulled Japan out of its desperate condition after
World War II through its hard work and high savings rate. With state
pensions being so modest, and with the children of postwar generations
being less willing to perform the historic role of looking after their parents
and grandparents, people had to save for their old age—and nobody on
Planet Earth seemed to live as long as the Japanese. Amazingly, these people
did save remarkable amounts, and their favored deposit institution was the
Post Office, particularly after the banks began to implode. As interest rates
on deposits fell by more than 90%, “her people” were driven into penury to
prop up the bad bankers.
She reiterated those vigorous objections at almost every BOJ Board meeting,
and the male gerontocrats who made up the rest of the Board thanked her for
her contribution—and continued to make the near-Zero-cost contributions
to the banks.
Led by the Fed, central banks across the OECD have been Japonized.
They drive rates of bank deposits and money market funds toward Zero to
stimulate borrowing and enrich a flagging, flabby banking system.
But the problems of the thrifty members of the lower- and middle-classes
who are losing so heavily from Zero yields may not continue endlessly in a
Japonaise stasis. They could get worse: today’s extreme monetary policies and
humongous deficits are laying and fertilizing the seeds of the next inflation,
which will be characterized, in the early stages, by sharp increases in the prices
of such necessities as food and fuels. Milton Friedman correctly predicted in
1973 that fast monetary expansion at near-Zero real yields would ultimately
trigger inflation—and he was vindicated when US CPI reached double-digits
during the next recession.
We were there to discuss when and how governments and central banks
should employ exit strategies from their current expansionary policies. With
one exception (a portfolio manager who insisted government deficits should
be expanded until unemployment reached zero), the panel agreed that the
level of current monetary expansion and deficits was unsustainable and
potentially dangerous.
Mr. Dodge was particularly eloquent on the high risks of maintaining current
monetary and fiscal policies. He is really worried about the potential for
worrisome inflation and much higher interest rates that would choke off any
recovery.
November 13
The Power of Zero
The first sign that the foreign central banks who’ve been trying to protect
their currencies from over-appreciation against the dollar may be reassessing
their forex strategies came with last week’s announcement by the Reserve
Bank of India that it was swapping a portion of its holdings into 200 tonnes
Zero T-Bills form the of gold the IMF is selling. That helped send gold to new highs.
base of a debased
MacroMavens, a routinely brilliant and thoughtful contrarian research
debt market.
publication produced by our friend Stephanie Pomboy (who presciently
predicted the Crash with her in-depth studies of banks’ balance sheet
problems and the unfolding real estate collapse), issued the following chart
last month:
2.9 3.19
2.6
2.3
2.0
1.7
1.4
1.06
1.1
0.8
Feb-03 Oct-03 Jun-04 Feb-05 Oct-05 Jun-06 Feb-07 Oct-07 Jun-08 Feb-09 Oct-09
Nominal Real
The chart displays the extent of the monetary masochism of the banks abroad
whose purchases keep yields across the curve on Treasurys, Fannie and
Freddie at unrealistically low yields. Zero T-Bills form the base of a debased
debt market.
We have participated in many such portfolio designs over the decades, and
well recall how high rates of return on Cash bedeviled the process. When
the risk-free rate was as high—or higher—than the historic long-term rate
of return on equities, it meant committees had to use the long-term rates on
Cash to build the model. That was accomplished by assuming a lower rate
going forward, because the duration of Cash is near-zero. Moreover, as of
August 1982, when the Reagan bull market began, the Constant Dollar Dow
Jones was at 1929 levels, indicating that the only real returns that had been
earned on equities in 53 years were dividends.
The obvious answer might be, “Easily. It means all asset classes are hugely
attractive relative to Cash and no allowance for Cash will be made apart from
minimal liquidity concerns.”
A more thoughtful answer should be, “Zero Cash means big problems for
overall construction. Assuming that a Fund needs to earn a nominal 7%
overall, net of fees and costs, then the higher the Cash component, the higher
must be the rate of return assumptions for the other asset classes. Without
tinkering with those assumptions, then the higher the Cash component, the
higher the risk and volatility the portfolio must assume. Such asset classes as
Junk Bonds, Leveraged Loans, and small Emerging Markets might have to be
quite big commitments for the Fund to meet its objectives.”
November 15
The Power of Zero
Last week, the Bank of America summed up the disappointments of our era
for institutional investors. It noted that there were 42 trading days left this
year, and the S&P would have to rise 42% to deliver a Zero rate of return for
the past decade.
Apart from that nitpick, what that number shows is that capitalism has failed
its most basic test—delivering higher returns to investors than was paid on
risk-free government bonds. And this was the best of all times in the best of
all capitalist worlds: classic economic liberalism was becoming the fashion
everywhere outside North Korea, most of the Arab world, and Cuba. There
were more playing fields for multinationals than ever, corporate tax rates
were generally declining, there were no major wars, the supply of highly-
educated engineers, MBAs and CFAs was at record levels, and business was
more respected than it had been since the onset of the Depression.
Constructing a pension fund portfolio and projecting its forward returns in the
These bankers toil
Age of Zero could be termed “a faith-based initiative.”
not much, but they
One of the biggest cheerleaders for the 1990s US bull market was Jeremy spin like mad...
Siegel. The first edition of his best-selling Stocks for the Long Run came out in
1994. His data demonstrated the near-certainty of stocks as winners showing
inter alia “For horizons of 20 years or more, bonds are riskier than stocks.”
Then came Nasdaq’s Triple Waterfall Crash and a recession, and his “Absolute
Law” had joined the phlogiston theory in history’s trash heap.
After the 2008 Crash, we were hit with blizzards of advice about how wise it
was to hold Cash. Some money managers got heavily into Cash before the
Crash, and many other managers assured worried clients that they would
be holding higher levels of Cash until the next bull market was established
(whenever that happened).
Consider the lilies of the field, how they grow. They toil not, neither do they
spin: And yet I say unto you, not even Solomon in all his glory was arrayed
like one of these.
Cash was splashed among the B5 to array their balance sheets, which were
looking Gandhian in their skinniness. But the B5 re-deposited a huge slug of
those funds with the Fed as excess reserves: why go through all the nuisance
involved in making loans to individual companies? They also bought up the
Treasury curve. These bankers toil not much, but they spin like mad: they
keep trying to convince us that they didn’t cause the Crash, and they really
deserve their big bonuses.
November 17
The Power of Zero
Source: St Louis Federal Reserve, database: FRED® (Federal Reserve Economic Data)
Source: St Louis Federal Reserve, database: FRED® (Federal Reserve Economic Data)
But the courts could pose a problem for the holders of these dubious
products.
As millions of the
Wall Street packaged vast numbers of mortgages of quality ranging from mortgages in those
hopeless to malodorous to acceptable to high quality. Because of their putrescent packages
variety—regional and otherwise—the Street arranged to create a servicing went into arrears...
agency that would handle the payments and enforce the covenants.
All those math and physics PhDs who built the products, and the bankers
who distributed them, never thought about a principle in mortgages that
dates back to the 14th century and the emergence of Courts of Equity. (That’s
where the word “equity” comes from.)
November 19
The Power of Zero
They dance to the The answer is that near-Zero borrowing costs at a time banking systems are
global risk music of being flooded with funds—both from government-insured deposits and
the markets. the buildup of liquidity from the Fed—constitute an historically-unique
inducement to the big banks and to their leading hedge fund clients to
borrow and speculate.
Last week, according to The Wall Street Journal, the World Bank expressed
alarm about “asset price bubbles in equity markets across Asia, and in real
estate in China, Hong Kong, Singapore and Vietnam,” and the IMF chimed
in with fears “that surging Hong Kong asset prices are driven by a flood of
capital ‘divorced from fundamental forces of supply and demand.’’’
Hong Kong, of course, pegs its currency to the dollar, which means it
outsources its monetary policy to Ben Bernanke. The Zero rate automatically
means a weak dollar—here and in Hong Kong. To a somewhat lesser degree
it means a weak renminbi.
Central bankers have soothed us with assurances that rapid monetary growth
will not trigger inflation as long as economies remain weak. But they said that
in the 1970s, and commodity inflation proved them wrong.
The price of oil in recent months has traded almost in inverse lock-step with
the value of the dollar. This isn’t the longer-term adjustment that characterized
the 1970s—it’s occurring in real-time.
This daily activity mocks the reliance traders used to place on actual data
about oil supplies and demands—particularly the weekly data about US
supplies of oil and refined products.
The banking crisis was tied initially to subprime and other illiquid and
unmarketable assets. The Fed, the Bank of England and the European Central
Bank have taken trillions in overpriced toxic assets from the banking system,
directly, and through support of mortgage lenders such as Fannie and
Freddie, the Federal Home Loan Banks, and various European lenders. (The
Financial Times cites a Bank of England study that pegs total government and
central bank aid to private financial institutions at $14 trillion, which it calls
“socialism for the rich.”)
November 21
The Power of Zero
100
...Main Street was
90
watching in horror
the trillions going to 80
Wall Street while the
70
lenders communities
needed most were 60
57.34
cutting back on
50
lending... Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09
As clients are aware, we have long believed that the real US economy depends
far more on the health of Main Street banks than on the machinations of the
B5. And Main Street is hurting: more and more regional banks are folding,
and the FDIC Fund that insures bank deposits is the next government money
pool to face drainage. (The huge Federal Housing Act pool is also being
drained rapidly, but it’s lumped into overall Treasury statistics and can be
replenished without special legislation.)
The “Tea Party” rages about the stimulus and bailout programs were signs that
Main Street was watching in horror the trillions going to Wall Street while
the lenders communities needed most were cutting back on lending, and
were buckling under the weight of their heavy exposure to local construction
loans backed by mortgages on properties whose values were plunging.
The realization that the trillion-dollar deficits are destined to continue, even
when the economy gets back to sustained growth, frightens them. They hear
that they will be subject to much higher taxes on “the rich,” and hear that the
term “rich” means people who earn more than $500,000 a year. (According
to The Wall Street Journal, if the tax rate in 2007 were 100% on Americans
earning over $500,000 a year, that would have generated just over a trillion
in Treasury receipts.)
The 1990-page health care legislation not only has the “millionaire’s taxes”
on those earning above $500,000, but imposes high extra taxes on small
businesses which do not offer health care to their employees.
Doubtless, local bankers will be looking at the effects of these permanent tax
increases and mentally marking down their customers’ ability to service their
loans in future years.
There will not be the kind of sustained US economic recovery that will drive
a sustained US bull market until the shares of the Main Street (KRE) banks
begin to outperform both the B5 banks and the S&P.
The relatively obscure KRE is, we believe, the most reliable indicator of
whether the panoply of political programs is truly kick-starting a sustainable
US recovery—and whether the optimism of US equity investors is justified.
November 23
The Power of Zero
KBW Regional Bank Index ETF (KRE) relative to KBW US Bank Index (BKX)
June 22, 2006 to November 10, 2009
180
No one can predict the limits on the capacity of the Fed and Congress to keep
finding new money to spend on rescues and stimulus. When the crisis was in
its early stages, Bernanke told Congress, “We’ll do whatever is necessary” (to
rescue the economy). Obama and Congressional leaders have made similar
pledges.
But there are limits on what even the Fed and Congress can do. At some point,
conditions have to return to normal and the regional banks have to take up
the slack. Then—and only then—will investors be able to safely conclude
that the recovery has become the reality to be used in valuing all financial
assets. The life insurance industry wasn’t built on issuing term policies to
cardiac cases in the Intensive Care Units.
Can stock prices fall even as liquidity flows surge amid Zero rates and Zero
monetary restraint?
It is a measure of these frenetic times that Park National’s demise came only
hours after Tim Geithner—at a ceremony in Chicago—awarded the bank
$50 million in tax credits to “to help spur community-development projects
in low-income communities.” (Geithner knew nothing of the closure. The
FDIC keeps bank closures secret until they actually happen. It’s not the first
time Geithner’s been chatting with management of a bank about to vaporize,
but it’s probably the first time that he praised a bank for good management
and gave it a big gift for future programs after it had ceased to function.)
But the good news is that after some bank deaths, there is resurrection. US
Bancorp bought the collection of nine good and bad banks, the FDIC wrote
off $2.5 billion, and Park National has reopened as a branch of Minneapolis-
based US Bancorp.
What? We worry?
November 25
The Power of Zero
650
500
350
200
Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09
Fed Funds
November 1, 2000 to November 10, 2009
Source: St Louis Federal Reserve, database: FRED® (Federal Reserve Economic Data)
For as long as there has been a free market in gold, the most-cited argument
against investing in bullion has been that it’s sterile: it pays no interest or
dividends, so why should anyone own it? It’s not as if it were a painting by
Rembrandt or even Renoir that has unique scarcity value. There’s lots of gold,
there’s lots of gold mines, and nearly all the gold that’s ever been mined is
still above ground and is either in vaults or in jewelry.
5. India announced purchase of half the hoard on offer from the IMF, which
had been weighing on gold prices, and there are rumors that China will
take up the rest. This was the second surprising announcement from
India within a fortnight. The other was that the United Arab Emirates had
displaced such nations as the US, China and Germany as India’s biggest
trading partner in recent months. Apart from tea, and gold in the form
of baubles, bangles and beads, what big-ticket exports other than bullion
could India be sending to that collection of gold-loving states? It’s no
longer exporting rice or sugar.
6. Statistics from across the world confirm that the economic recovery is
gaining steam, so the specter of inflation is moving stealthily from deep
in the primeval forest toward the main path. Travelers beware.
November 27
The Power of Zero
A skeptic might well note that no one predicted the scale of intervention into
financial markets from governments and central banks that began with the
Midnight Massacre, so why should gold claims that need to be satisfied with
futures contracts or other counterparty arrangements be forever immune
from attack?
We do not share these morbid fears, but no longer characterize them as the
particular problems of the perpetually paranoid.
David Dodge began his speech in Denver by saying, “This is a rebound, not
a recovery.” He considers it a snapback from an oversold position, fueled by
record amounts of monetary expansion, subsidies and deficits. He was not
“Stein’s Law”, which has
very confident about the prospects of a sustained recovery, without some
never been repealed,
setbacks.
may be ready to be
We find ourselves bemused by the confidence displayed by forecasters who proved anew...
(1) didn’t predict the Crash, and (2) use charts and tables from past economic
recoveries in proof of their assertions that the best is yet to come—and
nothing really painful lies in between.
The challenges:
3. Bernanke will have used up his entire declared quota of purchases of long
Treasurys and mortgage-backed paper within a few months. Then what?
4. Commercial real estate grows sicker each month, as office and condo
vacancy rates rise, and more and more regional banks go to the wall.
5. The biggest contributor to the 3.5% economic growth of the Third Quarter
came from the Cash for Clunkers program. That is gone.
November 29
The Power of Zero
6. The only US auto company to report positive cash flow in the Third
Quarter—Ford—still struggles with a boom-year-negotiated UAW contract
that means its labor costs are much higher than the other members of
what used to be known as The Big Three. Since the UAW and Washington
The current noise on effectively own those competitors to Ford, there’s slim chance the union
Detroit assembly lines will do anything to strengthen Ford: if Ford collapses, so much the better
could turn out to be a for the union-owned Big Two. Chrysler has no hot new products in the
death rattle. pipeline and an ambiguous management agreement with Fiat. GM is
adjusting to a shrunken product base and its finance subsidiary, GMAC,
has already received four emergency cash infusions from Washington since
the bankruptcy. Hyundai, no friend of the UAW, is the hottest company
in US sales. The current noise on Detroit assembly lines could turn out
to be a death rattle.
7. What may have been the most useful consumer economic stimulus—the
collapse in gasoline prices—is fast becoming a cherished memory. Gasoline
prices have already retraced roughly half their plunge. That most useful
of all “tax cuts” is being chipped away, as other taxes at federal, state and
local levels face inevitable increases.
8. Although overall consumer inflation remains near the Zero level, food
prices continue to rise relative to other costs, and natural gas prices are
no longer at remarkably cheap levels.
November 31
The Power of Zero
Damon Runyon observed, “The race is not always to the swift, nor the battle
to the strong, but that is the way to bet.”
Bond Durations
Years Change
US 5.25 unch
Canada 5.00 unch
International 4.50 unch
Change
Precious Metals 33% unch
Agriculture 33% unch
Energy 22% unch
Base Metals & Steel 12% unch
November 33
The Power of Zero
INVESTMENT RECOMMENDATIONS
The Obama long-term financial projections for the US are high risk and
unsustainable. Forthcoming elections—or a currency crisis—could induce
some discipline, but within the OECD, the US should probably no longer
be accorded top ranking for bonds and stocks.
Watch the performance of the KRE compared to both the BKX and S&P. As
long as the KRE underperforms both of these indices, US-economy-related
stocks remain suspect.
The time to overweight the ETF is when precious metal prices have entered
corrections.
The XAU and other gold stock indices have underperformed bullion for
the past two months because of a succession of bad news announcements
for such heavyweights as Barrick, Kinross and Agnico-Eagle. True, we can’t
be sure there won’t be more reports of disappointing execution among
the miners, but they have the reserves in the ground, and the best of them
have “unhedged reserves in politically-secure areas of the world”. Investors
who believe current prices could hold should do NAV calculations on the
miners based on current gold and silver prices, and they will see excellent
opportunities in the stocks.
With one of the coldest and wettest Octobers on record, Midwest farmers’
crops at October-end were overdrenched, overdue and overrun with blights
and moulds. Recent warmer and dryer weather has improved yields, and
the heaters are working overtime to dry out what has been harvested—and
corn and soybean prices have pulled back slightly from their recent highs.
Global carryovers will not increase this year, which means world food
“surpluses” remain precarious—as evidenced by the sharp run-up in
rice.
6. The base metals stocks have been the global commodity stars. The best
stock market values now could be in the small-caps that are long on ore
and short—or nil—in earnings.
The Canadian oil sands stocks continue to suffer bad press among the
defenders of the planet about alleged environmental misdeeds and risks.
Each dead duck listed in shocked reports sent across the world has been
worth millions in reduced market cap for the companies. (The actual
total number killed in this supposed replay of the Exxon Valdes is what a
few hunting parties would collectively bag on a good weekend.) A major
Canadian institution recently joined this parade of the super-chic by
publishing a supposedly unbiased study on oilsands emissions that was
prepared by two of that nation’s pre-eminent greenhouse gasbags. The
institution could have achieved the same results by retaining Gore—but
Gore costs more. Treat those fashionable emissions with caution—and
treat your portfolio to oil sands stocks.
November 35
The Power of Zero
8. Overweight Canada in both equity and fixed income portfolios, and remain
long the loon against the greenback.
In recent global rankings, Canada ranked #1 in the G-7 for its central bank,
its private banks, and its Minister of Finance (who is the longest-serving
in the G-7—a remarkable feat for a minister in a minority government).
The principal knock on Canada is that it is dull. Dull has become the new
shiny.