Depression Still in the Cards

Depression Still in the Cards

March 28, 2010

Economic Tea Leaves

    The economy continues in the doldrums with pluses and minuses about neck and neck but with a slight upward bias.  Indications are that bias is due to the government stimulus and little else.  We see an endless flow of reports of low volume in the stock markets, people not only sitting on the sidelines but actively pulling money out of mutual funds, small business (creators of almost all jobs) do not trust this economy and consequently are not hiring, and such.

    So much economic data is subject to manipulation that I like to look elsewhere such as how state and local governments are doing.  Here we see reports that many states, counties and cities are on the brink of financial ruin: revenue is falling from income taxes, sales taxes, and property taxes to name the main income streams for these units of government necessarily resulting in draconian cuts in services.  These are clear indications of an economy continuing to falter.

    As has been typical in the past, the more government intervenes in the business cycle, the more it delays but does not change the outcome except perhaps for the worse.  Greed is ever present though is it subdued by fear every once in a while.  The more greed flourishes the more brazen we become at pushing the limits and transcending them.  It eventually becomes so outlandish that it crashes the system.  Left to its own devices, the socio-economic system crushes and banishes the most outlandish while the rest of us suffer through a depression.  Then in time, the business cycle swings up and eventually we go through the same cleansing process yet again.  We learn, but as those who went through the process eventually die off, their knowledge goes with them.  What is left is what we can learn from history, but that has shown to be insufficient of quell runaway greed.  As it rockets upward, the same old litany of rationalizations quell our fears and grease the tracks for evermore greed.  Two good examples:  "We know a lot more now and have it under control";  "Times are different now and the old rules don't apply".  Sound familiar?

    The fly in the ointment is government.  When the system starts to crash and burn, government officials feel compelled to bring all of its power to bare on the problem under the illusion (usually prompted by one economic theory or another) they have the power to avert a depression.  At great risk to society, government can delay a depression, and many have argued that government has shown that it can make the eventual depression even worse.  Why?

    Look at our current situation as an example.  Most generally concur that outlandish greed within the financial system is what triggered our recent race toward depression.  The usual rationalizations were heard.  The government response has been to borrow heavily to save the very financial institutions that got us in this mess along with the executives of these institutions.  This has been exceptional in its blocking of the cleansing process:  most of the rascals are still there.  Our government, at our expense, has saved them, and to no great surprise, they continue to do the same things that headed us toward depression a short while ago.  The continuing response of government is to set up an expanded and improved set of rules for financial institutions.  One little problem:  the scoundrels and their financial institutions are still in place who have already demonstrated they have exceptional expertise in skirting rules to their own advantage.  Now these scoundrels are newly rewarded and invigorated from their government bailout believing, I am sure, in the wonders and rightness of their abilities.  Now what?

    It seems reasonable to me to presume the scoundrels will persist and succeed in recreating (or continuing) the economic depression.  This time, however, our government will be so far in debt that it will have little choice but to finally let it happen.  How long will all this take?  Not very long I suspect, as presently the scoundrels are hard at work.  The high national debt load will also hamper and slow the recovery making it all the more painful for all of us.

    It is important to remember, however, it is still possible the U.S. may somehow "muddle through" but the light at the end of that tunnel appears to be dimming.

Stock Market Tea Leaves

    For the same reasons listed before, the market continues up.  This is made all the more easy due to the low volume of trading.  Many are on the sidelines waiting to see what happens next, and they show little interest in jumping in.  There is a lot to be said for staying on the sidelines until the market looks very attractively priced.  The rule of buy low and sell high carries far less risk than buy high and hope to sell even higher.  About the only things I see that may be attractive, and only for the very adventurous, are some short and ultra short ETFs.

    As a Sociologist, I look at the mood of our country and see anger in its many forms festering and growing in strength.  It is still only an undercurrent, but further economic down trending will likely only make it worse.  Keep an eye out for this breaking surface as this does not bode well for being long the markets.  This is a far cry from expecting anarchy, a need to lock and load, or a need for survivalist training.  It would mean, in my opinion, that a great many people would then be increasingly likely to take mostly lawful actions to promote substantial change.  This could take the form of a shift away from political parties and toward independents, a strong "vote the rascals out" in local, state and national elections, and such.  Democracy is by nature a flexible system, though sometimes it takes a serious wake-up call to get sweeping change.  If all this fails, which seems unlikely from this perspective, only then does anarchy become all too possible.  This seems the least of our concerns at this time.

Enough Said

    This concludes A Read of the Tea Leaves.  I have met my personal objectives and have laid out the dynamics of current markets as I understand them.  To continue would largely result in repeating myself.  I think once is enough.  As noted earlier, I have not expected to be correct in everything - that would be totally unrealistic.  It will be of interest to me to see how all this plays out over time.

    I hope those who have read this have enjoyed the process and that it has increased you interest in reasoning through the markets.  May your investing be beneficial.

Inflation Or Deflation Or ?

Inflation Or Deflation Or ?

by

Stanley C. Clayton, Ph. D.

February 13, 2010

Economic Tea Leaves

    Decisions, decisions - investing is full of them.  So is governing especially in today's environment of many governments around the world trying desperately to cope with not enough money and too much debt coupled with struggling economies.  As we watch this play out, many of us are trying to anticipate whether there will be inflation or deflation or are we even asking the right question?  Science long ago developed The Scientific Method for answering questions of science.  Once in a while scientists come up with an answer of substantive value.  Wait!  Why are not all the answers of value?  Because most scientifically derived answers are to the wrong questions.  This is not unique to science as humans spend most of their time answering the wrong questions - that is just life.  Answers easily roll off the tongue while finding the right question is a tough slog.

    Today, we have clear deflation in home prices in many U.S. geographic areas - serious and continuing deflation.  Recently, commercial property has been added to the declining mix.  Meanwhile, if you do much grocery shopping, you can not miss the fact that food prices continue to relentlessly inflate.  We currently have both inflation and deflation at the same time.  There is nothing unusual about this as having some of each is the norm.  So, which will it be?  The answer that is always correct is: both.  That answer tells us there is something wrong with the question as its answer is of no value.

    A substantially better (but surly not the "right") question is to ask how important elements of inflation and deflation are working out for the dominant part of the economy - the consumer?  Usually at about 70% of sales, understanding their condition and outlook is instrumental for most investors.

    As we all know, a great many consumers are in tough shape, and the rest are worried they may follow suite.  Life on the float, as it has been known, no longer is the much sought after condition.  Many have been leaning the hard lesson that as your debts increase so do your risks.  Risk seemed like a foreign concept that had no place in the modern world.  House prices had risen for so long that it was obvious to most that their prices would rise forever.  Everything was coming up roses - until it did not.  House prices started to decline, and decline some more, and the decline continues through today and beyond.  That was the major risk few people factored in.

    In desperation, many started trying to sell assets such as an extra car, boats, RVs and anything else they thought they could get along without.  Then only to find out the market for these things suddenly was thin, and the occasional buyer was not willing to pay much (a little talked about sector of deflation).  The economy was tanking, and many became worried about their job, or finding themselves under employed or unemployed.  This level of deflation in such important parts of their lives weighted very heavy on them: most of their important financial assets were deflating.

    As if this were not enough of a burden, inflation is alive and well.  Many of the essentials the consumer must buy like food, electricity, fuel, clothes and such continue to rise in price.  This inflation is making it worse for the consumer.  What little wealth they have left from deflation of their assets is being eaten up faster and faster by the inflation of the essentials they have to buy.  They are being hammered by deflation and hammered by inflation all at the same time.

    While this was going on, the government continued to compute its usual figures on inflation.  Lo and behold, net net we have a stable economy - inflation and deflation cancel each other out.  As a statistician from a sociological perspective, I know full well how averages can sometimes be very misleading.  The above example of the consumer attests to this.  In this case, it hides the horrific plight of the consumer.  It makes things appear fine when they are not.

Stock Market Tea Leaves

    OK, but how does all this play out in investment markets?  First, we should recognize that many consumers are not homeowners, nor do they have to worry about selling that extra car, boat or RV they do not have.  While these people are an important part of our society and they are severely impacted by inflation of everyday essentials, in terms of dollars spent by consumers, they represent a smaller percentage.  However this is changing as their ranks are rapidly swelling from an influx of former homeowners, and from new entrants into the job market who are unable to find work or become under employed.  The spending of the wealthy does not total much as there are relatively few of them.  The conclusion seems obvious: the consumer is in a position of substantially reduced capacity to spend, especially on non-essentials.  They also seem to be gaining a better understanding of the risks of "life on the float".  The folly of buying consumer items on credit is a lesson being learned the hard way by many.  This further reduces their capacity to spend.

    This analysis adds to the argument that the investor may be looking down the wrong end of a double barrel shotgun: a double dip recession - or is recession the right word?

  

       

  

      

Tea Leaves 020710

U.S. Debt - Trouble Ahead For Markets ?

by

Stanley C. Clayton, Ph. D.

February 7, 2010

Economic Tea Leaves

    Our nation, businesses, families, and individuals face considerable economic headwinds.  Perhaps foremost among these is debt.  In Tea Leaves, I take a longer perspective than most looking primarily at where we are in the overall scheme of things especially as it applies to investing.  I have argued that we appear to be in the early phases of nation decline following more the pattern of England rather than the Roman Empire.  Today we look at the role of national debt in that decline, and then the implications for investing in such an environment.

    The actions of the Federal government in response to the “crisis” are perhaps best understood as a desperate and often frantic effort to recapture the glory days of our republic when we were the unquestioned powerhouse of the world.  One of the many measures of this decline is the shift from being the greatest creditor nation to the greatest debtor nation.  In the 1980's, we crossed the line into debt and have not looked back.  Now Congress has increased the debt limit to 14.3 trillion dollars.  A few trillion here or a few trillion there, does it really matter?  Many economists of the Keynesian school of thought would argue no.  After all, it is only about 85% of GDP (gross domestic product).  That is a correct calculation, but I find it is an erroneous interpretation.  I suggest we are in the process of learning the hard way and in real time that Keynesian economic theory has critical flaws.  Downplaying the importance of debt is one of them.

    Just to get a feel for just how much $14.3 trillion debt amounts to in terms we can grasp, look at this.  Interest per year on that amount of debt at 2.5% = $3.975 Billion.  Estimated (from U.S. census data) number of households in USA 2010 is 121.1 million.  Interest divided by number households equals on average about $3,000.00 per year interest only owed per household per year.

    $14.3 trillion means that each family in the U.S. is on the hook for about $160,000.  If we could all sell our homes and apply the proceeds to the debt, we might have it about paid off, but then we would all experience living on the streets.

    These are not precise numbers, but they are close enough for us to get the picture.  Debt matters and it matters big time.  Life on the float may be fun while it lasts, but it has its way of ending in tears.  As many individuals, families, and businesses large and small have discovered, as your dept goes up, so do your risks.  Pushed far enough, even the slightest setback results in insolvency (bankruptcy).  At the national level, it is often referred to as national default on its debts.  The challenge then becomes to avoid nation failure.

    Where are we now?  We have passed the tipping point or the point of incipient decline, and with every increase of the national debt, the downhill slope steepens.  It not only increases national risk, but it increases the headwinds for all of us.  National debt sucks money out of the economy that could be used, for example, by businesses.  It means increased taxes through either or both directly by increasing taxes, or indirectly through inflation.  With highly skilled stewardship, our nation can follow a somewhat graceful decline to several notches lower.  Without such stewardship, however, it could get ugly.

Ultimately, the voter will determine the outcome: be very careful who you elect to office at all levels of government.  Only the best will do.

    How long will all this take?  It is likely to follow an uneven geometric decline.  It has started with a rather steep decline, but it is likely to ease, voters willing, during this decade (2010's), then settle more slowly for decades to come.  Look to the ups and downs of England over the past 200 years for guidance on this issue.  Can the decline be avoided entirely?  I suggest that is the wrong question.  It may be more productive to ask what actions can we take as individuals and as a nation to limit our decent to a level that is still rather agreeable.

    Tea Leaves will devote a portion of these pages in the future to that question.  We will find there are constructive things we can do and actions we can avoid that provide a sound basis for cautious optimism about our chances. 

Stock Market Tea Leaves

    Past general market predictions remain unchanged.  The current market is one of the rough spots predicted.  While it could be the beginning of a major decline, remember the Fed is still in easy money mode.  This makes a stiff decline difficult.  As noted before, people are uneasy.  Sooner or later a major market turn down seems likely, and the high U.S. debt appears to me likely to play an important role.  Notice in this past week that Moody's stated that the U.S. Aaa investment status may soon be in jeopardy because of its debt.  Even more troubling is that Timothy Geithner (Treasury Secretary) publicly claimed that will never happen.  Such government denials often portend the denied event.  Why?  Because no high ranking government official will bother to deny something that obviously has no merit.  Such an event would have major implications throughout, the stock market included.  It is interesting that in such a case, easy money could quickly become seen as part of the economic problem and thereby become a negative rather than a positive for markets.  Tea Leaves has argued that easy money has been the major driver of the 2009 market rally.  If that becomes as much a negative, well... .

    Remember the focus of Tea Leaves  is long term market understanding.  Short term timing is not within its purview.

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Tea Leaves 012310

U.S. Debt Calamity In The Making ?

By Stanley C. Clayton, Ph.D.

January 23, 2010

    This is a Special Edition of Tea Leaves.  The format is different, and the content is especially timely.

Worth a look

    Recently there was a very telling juxtaposition of events.  On January 13, 2010, the Committee on the Fiscal Future of the United States (24 renowned experts) published their report saying, in essence, that the finances of the United States is nearing catastrophic debt conditions, and though the hour is late, prompt, dramatic and painful economic restructuring could yet save the day.  The solution, simply put, is that we must vastly reduce spending plus increase revenue - not tomorrow sometime, but today.  They are not the first to come to this conclusion, and likely will not be the last.  Just 2 days later, as reported by Bloomberg news on January 15th, a member of Congress reported that an effort within Congress to set up a mechanism to limit the U.S. debt is doomed to failure before it can even get started.  Interesting!

    Surprised?  Of course not.  You have seen this sort of thing time and again where a learned commission recommends and Congress ignores.  So?  Why even bring it up?  It just may be important. 

   This reminds me of a boating situation I recently witnessed.  I live along a gentle bend of a popular river that is used by boats of all shapes and sizes.  That day I noticed about a 50 footer at full cruising speed taking a straight line on the gentle bend.  Not a good idea.  I called out to my wife, "Look, he's not turning".  As we rushed to the window I thought, "This is going to be ugly".  It was too late for him to turn, but the captain suddenly slammed it into full reverse missing disaster I am sure by no more than inches.  In about the time it takes to change one's drawers and clean up a little, the vessel began slowly cruising on down river.  I suspect the captain learned an important lesson that day: someone has to steer the ship - not just some of the time but all of the time.  Even auto-pilot requires constant human vigilance, especially on a river.

   Our "ship of state", as we are often reminded, constantly sails in challenging waters frequented by storms of all descriptions and with obstacles of all kinds.  As a member of the crew (citizen), you notice the officers (elected government officials) are fully distracted locked in endless debate as if the ship can successfully sail on auto-pilot alone.  What do you do?  Is "I don't wanna think about it" going to work for you?  Is it time to dance?

    You have seen argued in Tea Leaves that our Nation is indeed in serious economic trouble.  It has perhaps been hard to believe, granted, but this committee report seals the case.  Below is the citation information, with two direct quotes, followed by a link where you can see their full report.  

Committee on the Fiscal Future of the United States, Division of Behavioral and Social Sciences and Education, NATIONAL RESEARCH COUNCIL and NATIONAL ACADEMY OF PUBLIC ADMINISTRATION

What we firmly agree on is the need for strong action now to adjust the long-term relationship between federal government spending and revenues—the urgent need to put the budget on a sustainable path. We also agree that this is going to be one of the biggest political challenges the nation has ever faced. (p. 209)

In sum, tackling the fiscal crisis is perhaps the toughest kind of political problem. Given its characteristics, quick, decisive action to put the nation’s budget on a sustainable course may be improbable. Yet if action is not taken in the near future, the nation will face a calamity, and the possible actions will be fewer and far more disruptive than what is now possible. Thus, now is the time to debate alternatives, to choose, and to act. If this is done, the nation’s fiscal course can be corrected in ways that avoid the worst pain. (pp. 210-211)

http://www.scribd.com/doc/25152731/Choosing-the-Nation-s-Fiscal-Future-Full-Report

Tea Leaves January 2010

A READ OF THE TEA LEAVES

By Stanley C. Clayton

January 12, 2010

     Economic Tea Leaves

    There has been more to the administration's "green shoots" than it appeared to me in May 09, but not much. The economy continues to struggle and appears now to be close to a standstill: gains here about offset losses there.  Where does it go from here and how does it get there?  Let's see what we can figure out.  

    Bernanke (Fed Reserve) has been in the news for a while cautioning Congress that they must hold down spending as he can only do so much in creating the money to pay for deficit spending.  He has given the President the same message, and he is telling the rest of us that it may be necessary to raise interest rates and to stop monetizing debt.  While this could be nothing more than "jawboning", I suspect it is more likely keeping his options open in case he needs to make a significant change in Federal Reserve actions.  It was not that long ago when the media reported Bernanke was saying that he can create unlimited sums of money, and that the Federal Reserve would buy as many Treasury bonds as needed.  Something has rattled his cage.  He has not said why, as far as I know, but it could well be in response to concerns such as those listed in November Tea Leaves.  They bear repeating here.

 1.  Governments and investors around the world are increasingly worried about the expanding supply of dollars decreasing the value of the dollar which reduces the value of the trillions they have invested in U.S. bonds and such.  2.  When bonds go down, interest rates are pushed up which runs up the cost of servicing the U.S. debt and slows the U.S. economy.  3.  This is forcing other countries to work hard to replace the dollar as the sole currency for international trade settlements.

We are likely to see more comments in the media like the following:

"At some point, if the U.S. does not address proactively its deficit outlook and its debt outlook, there will be a financial-market revolt," says Roger Altman, chairman of investment firm Evercore Partners and an assistant Treasury secretary in the late 1970s. Mr. Altman says that while he doesn't expect such a revolt to happen in the next couple years, "if we let this go past 2012, we're playing with fire."  Wall Street Journal January 5,2010 by Mark Whitehouse.

And like this:

Bond guru Bill Gross at Pimco in Newport Beach this week has ramped up his warnings to the Obama administration and the Federal Reserve about the perils of unfettered government borrowing.  In an interview in Time magazine on Tuesday, Gross suggested that Pimco, which manages nearly $1 trillion in mostly fixed-income assets, now feels more comfortable owning German government debt than U.S. Treasury debt... .    Los Angeles Times, Bill Gross puts U.S. on notice about debt binge, by Tom Petruno, January 6, 2010.

As we move forward in time, the Federal Reserve will come under increasing pressure for restraint.  But this comes at a time of need for further bailouts in one form or another.  December Tea Leaves discussed the current onset of another giant wave of mortgage resets at least as large as we experienced in 2007 though 2008.  This time, however, commercial real estate mortgages also are in trouble, as has been widely reported in the media, adding further to the troubles.  These events could hardly come at a worse time for the Federal Reserve, because they have made the natives restless on planet earth.  The following quote relates to this.

“New York, December 29, 2009 – Data through October 2009, released today by Standard & Poor’s for its S&P/Case-Shiller¹ Home Price Indices... .  The turn-around in home prices seen in the Spring and Summer has faded with only seven of the 20 cities seeing month-to-month gains, although all 20 continue to show improvements on a year-over-year basis. All in all, this report should be described as flat.” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s. “Coming after a series of solid gains, these data are likely to spark worries that home prices are about to take a second dip. Before jumping to conclusions, recognize that the one time that happened at the beginning of the 1980s, Fed policy saw dramatic reversals, which is very different from the stable and consistent Fed policy we have today. Further, sales of existing homes – those included in the S&P/Case-Shiller Home Price Indices – have been very strong in recent months, working off the inventories of houses for sale. At the same time, housing starts remain weak, fears that the market will be swamped by a wave of foreclosures are heard and government programs aimed at the housing market will expire in the first half of 2010.  [December 29 www.scribd.com/doc/24592453/S-P-Case-Shiller-Home-Price-October-Results] 

1 Case-Shiller® and Case-Shiller Indexes® are registered trademarks of Fiserv, Inc.

Of particular interest is the remark about fears the housing market will we swamped by a wave of foreclosures.  Recall back to the Credit Suisse chart of mortgages in the December 2009 Tea Leaves.  This chart quantifies the size of the foreclosure wave.  It is of tsunami proportions like the one in 2007-8 that caused so much economic and social destruction.

    This time around, however, there are some differences that may prove to be worth noting.  The Federal Reserve has bought over one trillion dollars of toxic mortgages from banks and other lending institutions such as Fanny Mae and Freddie Mac, yet large amounts of this toxic debt appears to remain on the books of these institutions.  Banks usually like to tell the world how well capitalized they are, but have you heard much of this lately?  As many of these toxic mortgages blow up (borrowers unable to maintain payments), mortgage backed securities (known as MBSs) containing these toxic mortgages will suffer as well.  Should this come to pass, it will be like land mines going off all over the world, because this is where these MBSs have been sold.

    That is only one side of the problem.  The another is that if foreclosures sky rocket again, this will force vast numbers of people out of their homes.  This would greatly increase the glut of homes on the U.S. market driving home prices yet lower.  Just what we need.  Yet another side is the toll it would take is not only would family economies involved, but the psyche of each of us as we real from its direct and indirect impacts.  Accompanying this would be a variety of social changes some of which would have significant implications for our entire society as well as for the stock market.  This would not be merely a double dip for stocks, but a "slam to the mat" for our entire social system.  As the time draws closer and if this event moves from a probability to more of a certainty, Tea Leaves will cover this in some detail.

    It is still possible there may be an alternate future where somehow we muddle through without a major market meltdown.  As this plays out, there will be decisions yet to be finalized or implemented that could influence the outcome.  For example, the Fed may choose to risk yet more by extending the loose money policy, or other countries may have substantial difficulty formulating just how they will seek to get out from under the U.S. dollar influence.  This is a fluid situation well beyond the usual.

    This is a good place to remind the reader that I do not know the future.  I seek to marshal what I sense are the relevant facts, reason them through, and speculate on what seems likely to happen.  While I am a scientist, this is not science.  It is forecasting, pure and simple, warts and all, imperfect even at its finest moment.  

    Stock Market Tea Leaves

    As you have likely surmised, my sense is the stock market may yet have a serious tumble: we may get to play 2007-2008 all over again, or if not, be in the doldrums until everyone is ready to scream.  Should either develop, the up side is that the Fed has prepared banks and other lenders as best it can - a potentially positive influence.  The down side is the Fed may well be reaching its practical outer limits, as we have discussed, and be forced to restrict its actions - a potentially negative influence.  As discussed in October Tea Leaves (see the archive located page right), the tendency of investors likely will be to continue buying as long as the Fed continues flood the world with dollars.  Buying is likely to be tempered if the economy shows signs of faltering after the effects of Christmas have passed, for example, or the home foreclosure rate spikes up again, or the rise of widespread commercial real estate troubles, or all of these.  This reminds me of the saying "may you live in interesting times" and why it is considered a curse.

    What should you invest in and what should you avoid?  That is up to you as Tea Leaves is not an investment advisory service.  I consider this an educational adventure.  If you have taken the trouble to reason this through with me, and integrate it with your other knowledge, you may find it useful in investing.  It certainly is useful to me, as it forces me to think this through more systematically and completely than I might otherwise.  Besides, thinking is a joy in itself - almost as good as being able to laugh all the way to the bank!