All knowledge is ambiguous.
J S Hapgood, British Ecliastic, The Observer, 1991
America makes prodigious mistakes, America has colossal faults, but one thing cannot be denied: America is always on the move. She may be going to Hell, of course, but at least she isn’t standing still.
E E Cummings, US poet, Vanity Fair, May 1927 ‘Why I like America’.
It has always been my contention that the only way to be a successful investor is to avoid the disasters. I say this because it only takes one bear market to wipe out years of hard-earned profits. In essence, stock market participants should realize from the outset that losses come with the territory. Being wrong is not a weakness, but staying wrong is.
Source unknown.
A hunch can be trusted if it can be explained.
Max Gunther, The Zurich Axioms.
INTRODUCTION
Four mornings of each week we participate in a telephone conference with 3 offices of a brokerage house.
On Monday 2 March 2009 we wrote a memo for circulation outlining the case for a market bounce. Our conclusion under ‘Reasons for Optimism below was : "There is currently no hard evidence that the bottoming process is complete in market terms and there is accelerating evidence that the local and global economies are performing ever-more poorly. BUT the market bounce will lead the economic bounce. The combination of lower interest rates and stimulus packages will work. The vexatious question is WHEN. The market itself should tell us. The bottom is a process, not an event. So expect bounces, retracements.. ….then at some time, consolidation…. and later a faltering advance as the good news begins to overtake the bad."
This memo is not re-produced to show how clever or knowledgeable we have been, but to demonstrate the value of documented thought which can then be translated into action. THINK< ACT< REVIEW are Ecinya constants and knowledge is ephemeral, and mistakes are a constant irritating niggle. Profits won on one adventure can quickly disappear in the next act of folly. Performance over time must be measured, and mistakes and victories are a source of learning.
MORNING MEETING – MONDAY 2 MARCH, 2009
From ECINYA: This is not meant to be exhaustive or definitive, just a few thoughts to assist your own deliberations…. grist for the mill.
BACKGROUND
Remember this is a ‘made in America’ recession.
On Friday 27 Feb the S&P 500 made a new closing low of 735.
From the October peak of 1565 this means that the S&P has now fallen 53.0%. We want to see the S&P quickly get above 835. Overall we are looking for a triple, or quadruple bottom in the S&P, so far we have had two bottoms, one completed (752), one possibly completed (735).
Concurrently the XAO has fallen 52.1% from its November peak of 6853 to last Wednesday’s low of 3281. A lower low today is likely. We want to see XAO move towards 3450-3500, which would represent a minimum bounce of just 5%.
The prior low on the S&P was 752 on 20 November and the bounce from that level was 24% to 934 on 6 January.
Our market in XAO terms has been consonant (in harmony with) these moves. The XAO bounce from the previous low was 5.9% from 3300 to 3496.
We all know what is required – US housing to stabilise, US and global banking to stabilise etc
BUT things are ‘getting worse before they get better’. Last week it was Royal bank of Scotland, Pacific Brands, CitiBank.
Governments and central bankers are stimulating the ailing patients – local economies, bank nationalizations, corporate re-capitalisation. We have moved from a ‘debt is divine’ mentality, to ‘debt is a diabolical travesty’. All, seemingly, in a time horizon that leaves us (almost) speechless. Markets appear to be grossly over-sold.
In Australia the earnings season so far is poor, commodity prices have generally halved, the government is almost panic stricken etc. With the Victorian bushfires we have an unfortunate dampener on confidence offset by the magnificent response to the tragedy, bringing the Victorian water problems into sharp focus. In Queensland we have an opposite natural disaster with major floods. Given the possibility of such natural problems occurring, with their consequent impact on lives and economic activity, it is regrettable that we create from time to time man-made economic problems such as those encapsulated in the expression ‘global financial crisis.’
CONTEXT TO LAST FRIDAY’S US S&P 500 CLOSING LOW
There are 3 cuts to quarterly US growth following the end of the quarter. At the end of the first month the ‘advance’ number appears, end-second month the ‘preliminary’ number issues, and end of third month the ‘final’ number. The advance number for Q4/ 2008 was negative 3.8% (annualised) issued end-January, the February preliminary number released on Friday by the Bureau of Economic Analysis was negative 6.25%.
This was the biggest contraction in real GDP since the first quarter of 1982.
In looking at the Wall Street Economics Panel of 52 economists, 9 (17%) are predicting that Q1 of 2009 will be more than negative 5.9%. Paul Kasriel of Northern Trust is an economist that we have an extremely favourable view of, and he is currently forecasting negative 6.4% Q1, to be followed by negative 2.5% Q2, negative 0.8% Q3, and a positive fourth quarter of 2.2%. (Kasriel is the recipient of the 2006 Lawrence R Klein Award for Blue Chip Forecasting Accuracy).
In looking at past stimulus periods (in particular the 30’s) Kasriel had this to say in early February:
“If the federal government embarks on a large spending spree and the Fed "prints" the money to fund the spending, then the pace of real economic activity is bound to increase. How long it will take for higher prices to begin to erode real activity is another question. But never underestimate the initial positive impact on aggregate demand of that powerful combination of increased federal government spending/tax cuts and a central bank running the monetary printing press at a high speed.”
“It is not my role to endorse government policies. It is my role to forecast the impact of government policies on the economy. I believe that large increases in federal government spending that are monetized by the Fed and the banking system will result in a recovery in real economic activity. When that recovery sets in depends on how quickly the federal government increases its spending and by the magnitude of that increase. We can debate whether tax rates should be cut or federal spending should be increased. We can debate what kinds of spending should be increased. We can debate whether the federal government should increase any of its spending. But the facts of the 1930s appear to be pretty clear – monetized increased federal government spending does result in increased real economic activity in the short run.”
“The economic data are likely to be abysmal through the first half of this year. The popular media will reinforce the gloom of the data. The same pundits who did not see this downturn coming will not see the recovery coming either. My advice to you is to keep your eye on the index of Leading Economic Indicators. If history is any guide, the LEI will signal a recovery well ahead of the pundits.”
Ecinya caveat: Though all forecasts are to be approached with a healthy degree of scepticism, Kasriel has cogent arguments to support a ‘things will get better’ thesis.
EXCERPTS FROM THE MARCH 2 EDITION OF TIME MAGAZINE – “Obama’s Rx for the budget”
“How does the White House buy time to spend now without spooking the markets or stoking fears that the US intends to inflate its way out of debt. Obama’s aides say they can do it by winding down the war in Iraq, cutting fat and raising taxes on the wealthiest Americans – and later, by entitlement reform.”
“From his hard-edged inaugural vow that ‘Our time of standing pat, of protecting narrow interests and putting off unpleasant decisions – that time has surely passed’, to his frequent promise of smarter government, Obama has reflected a national consensus that the old way of doing business is bankrupt. The result of getting the stimulus package passed was not perfect according to Obama, but he said ‘My bottom line was, am I getting help to people who need it?”
Ecinya comment: That politicians need to be approached with a healthy degree of scepticism is axiomatic. The Obama administration seems capable of getting it right over time, the Bush administration showed no signs of ever getting it right at any time. Obama’s critics will be prominent and noisy. We can but wait and see. We are hopeful, almost to the point of confidence, but Keynes once said “Fundamental change does not occur quickly.”
MAJOR REASONS FOR OPTIMISM
There is currently no hard evidence that the bottoming process is complete in market terms and there is accelerating evidence that the local and global economies are performing ever-more poorly. BUT the market bounce will lead the economic bounce.
The combination of lower interest rates and stimulus packages will work. The vexatious question is WHEN. The market itself should tell us. The bottom is a process, not an event. So expect bounces, retracements…. then at some time, consolidation…. and later a faltering advance as the good news begins to overtake the bad.
Plenty of things can go wrong.
Black swans are now in vogue and flying everywhere (disequilibrium). White swans are the norm (equilibrium) and the periods of sustainable growth over the course of history have exceeded periods of severe, or soft, recession. One recession in a long period of growth (though some of it was fraudulent) does not seem unreasonable.
Using our ancient acronym of ICE – Interest rates, Confidence and Earnings we can currently say : Interest rates are going down, Confidence will return only when global confidence has a bounce, and soon the EARNINGS focus in Australia should be on fiscal year ended 30 June 2010. IF analysts behave as they have in the past earnings forecasts will be wound back excessively as this reporting season passes.
ANECDOTAL EVIDENCE IS IMPORTANT IN ANY TRANSITION FROM EARNINGS DECLINE TO EARNINGS RECOVERY. MARKETS DON’T RECOVER FROM A SINGLE CATHARTIC EVENT, BUT FROM AN ACCUMULATION OF DATA AND A GRADUAL RE-BUILDING OF CONFIDENCE.
The world economy is still running at around $US70 trillion compared with $60 trillion in 2006. The BIG thing that has happened is the implosion in the American banking system and the flow-on impact to the real economy – “From Wall Street to Main Street.”
ECINYA’S theme for 2007 was “A year of living dangerously within a framework of cheerful paranoia” – there was an expectation that Mr Market wanted to take some of our profits. IN January 2008 the theme in our Overview was “A tale of two halves and the long good bye to two half-wits”….. Messrs Greenspan and Bush.
BUT the downturn evolved slowly in 2008 and then the US banking implosion, and its still unfolding disclosures, hit with sudden force and this completely negated prospects for early recovery. Direction was well anticipated, dimension was not.
Remember that we live in a fiat money system.
Bill Bonner (2007) expressed it well, with just a tinge of cynicism : "Clearly, the central bank of Zimbabwe has overdone it. But if the central bank of the USA has overdone it, few seem aware of it. The secret is to give people more money, but not so much more that they realize all they’re getting is pieces of paper. Paper money may be a fraud, but it still represents purchasing power. When more units of it appear, people assume they have more purchasing power. And when they spend more, the merchants think there is more demand and increase production – hiring workers and ordering machinery. Pretty soon there is a boom."
Ecinya comment: Stimulus should work, but some of it will be well and truly wasted.
Macro watch-list: Watch the oil price, China, takeovers, copper, and the S&P 500 for early signs of bounce or resurgence.
SOME INTERESTING COMMENTS FROM DAVID MORGAN
From David Morgan (ex-treasury officer and former Westpac CEO) Saturday’s Weekend Australian.
“The government guarantee: It is now timely to seek to sensibly wind back these initiatives to something more measured and less distortive.”
“The Australian banking sector: The banking sector in Australia in the future will be characterised by a significantly smaller number of much better capitalised institutions, of genuine economic scale by global standards.”
“The outlook for the global economy: We will NOT have another Great Depression. We have learnt the policy lessons from that mistake. But the balance of probabilities is that the global economy is set for the worst recession in the post war period.”
“The global financial crisis: Plainly, we nearly lost the global banking system in the September-November period of 2008.”
THE IDEOLOGICAL DEBATE
Prime Minister Rudd has blamed the ‘neo-intellectuals in a 10 page paper in a recent issue of “The Monthly”.
ON page 12 of the Financial Review under the head-note “Obama prepared for rough budget fight” it is said “United States President Barack Obama has thrown down the gauntlet to Congress in his efforts to secure passage of a US$ 3.55 trillion budget that has drawn howls of protest from a Republican opposition warning of an American decline into socialism.”
BUT debates about various ‘ISMs” do not assist the recovery process. We live in an increasingly integrated world and having over the past several decades transferred manufacturing capacity and skills to Asia, and away from Europe and the USA, it is becoming somewhat appreciated that without healthy debt markets for consumers we now live in a world of excess capacity in almost all goods, from TVs to telephones, from cars to condominiums.
The only ‘ISM’ needed at the moment is ‘common sensISM’ and that requires as its base a banking system that can take sensible lending risks to sensible borrowers. Peter Drucker recognised many years ago that ‘capitalism’ was conceptually deficient and that one absolute standard such as ‘profit’ would not get us very far on a consistent basis. He focused very much on Schumpeter’s thesis of ‘creative destruction’.
Most of the assumptions we base our actions on are obsolete. It is the function of the central bankers and elected officials to manage economies on a sustainable basis. Currently, and to varying degrees, we have been misled.
It is always interesting that economic troubles are mostly enmeshed with significant conflicts – WW ll, Vietnam, and now Iraq and Afghanistan, and the Middle East.
America spends about US$700 billion out of global defence spending of about $1.4.trillion. In economics the cost of one thing is the other thing forgone – this is known as ‘opportunity cost’. Dwight Eisenhower expressed it well (about 1956) when he said: “every gun that is made, every warship launched, every rocket fired, signifies in the final sense a theft from those who hunger and are not fed, those who are cold and are not clothed . The world in arms is not spending money alone. It is spending the sweat of its labourers, the genius of its scientists, the hopes of its children.”
A SOLUTION TO AMERICA’S WOES
Laurence J Kotlikoff published a 14 page essay in the July/ August 2006 edition of The Federal Reserve Bank of St Louis Review, titled “Is the United States bankrupt?” The conclusions were that countries could go broke, that the United States was going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of US financial institutions was necessary to securing the nation’s economic future.
Kotlikoff offered three policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy: a retail sales tax, personalized social security, and a globally budgeted universal healthcare system.
This paper is an easy read and well worth a visit. All is not yet lost.