Wednesday, June 30, 2010

Ticket to Ride

She said that living with me
Was bringing her down
For she would never be free
When I was around
--The Beatles

Students taking macroeconomics are presented with the following equation that expresses the composition of gross national product (GNP):

C + I + G = GNP

C = consumption
I = investment
G = government

The essence of Keynesian theory is to ignore I and focus on C and G. And during economic downturns, the Keynesian solution for propping up GDP is always to increase G. We're doing it right now in multiple thirteen figure (read: $ trillions) size.

This article points out the folly in viewing government spending as accretive to aggregate output. Essentially government expenditures come out of the hide of personal expenditures. As such, perhaps the above identity is more accurately written as:

C + I - G = GNP

The real issue, however, is why we focus on aggregate measures like GNP or GDP in the first place. What does more national output or spending really tell us? After all, how much we have produced may mean little if production ill suits user needs. An increase in consumption may not be a good thing if we need to borrow from the future in order to consume more today.

Obsessing over a measure such as GDP, and doing whatever it takes to boost it period after period, seems a ticket to the poor house.

"All aboard!"

Tuesday, June 29, 2010

Landing Zone

Had a brother at Khe Sanh
Fighting off the Viet Cong
They're still there
He's all gone
--Bruce Springsteen

Short term traders have staked out SPX 1040 as the front line where bulls and bears are currently doing battle. With such focus on a granular level, it is often helpful to elongate the time horizon for better forward-looking perspective.

When looking at multi-year price behavior on a weekly basis, we can see that we've had multiple lows touch the 1040ish level over the past 10-12 months. An axiom of technical analysis is that support gets weaker with each test. Including today's close, we been down to this level 5 times in 2010 alone. As such, chances that a bearish resolution to the current battle seems pretty high--certainly higher than previous squirmishes here over the past coupla months.

Should this level be decisively breeched, then it appears that 950 becomes the next broad level of support. That's about 90 handles lower from here.

From where I sit, SPX 950ish seems a reasonable place to re-evaluate risk/reward--for both disposition of intermediate term short positions and adding long side exposure for a trade.

Rest assured, however, that this LZ will feel plenty hot, particularly if we should happen to arrive there sooner rather than later...

position in SPX

Make Believe

"Guangzhou is a chemical weapons plant masquerading as a fertilizer plant. We know this. The Chinese know that we know. But we make-believe that we don't know and the Chinese make-believe that they believe that we don't know, but know that we know. Everybody knows."
--Travis Dane (Under Siege II)

As world markets sell off this morning, the media is pointing at a miscalculated Chinese leading indicator series as the primary culprit.

Because any measure contains error, some random and some systemic, data that form a series should be viewed with some skepticism. Aggregate economic series generated by government sources are even more likely to be jaded due to political motivations to do so.

As such, it never ceases to amaze me a) how much faith collective markets seem to place in the numbers released by Washington et al. and b) how much 'surprise' markets express when admission of error inevitably surfaces.

position in SPX

Monday, June 28, 2010

Pyramid Power

One summer never ends
One summer never begins
It keeps me standing still
It takes all my will
--The Motels

In order to really 'print money' in our current system, initial credit offered by the Fed needs to be pyramided many times thru the banking system via loans and leveraged investments. When the system is functioning, an initial dollar of credit can be levered 10 times or more.

It's not functioning right now.

Bank loans continue to fall. Until this trend reverses, hard to argue that we're seeing much in the way of inflationary forces.

The tone, instead, is one of deflation.

position in SPX

The Doctor Is In

Yeah, a storm is threatening
My very life today
If I don't get some shelter
Lord, I'm gonna fade away
--Rolling Stones

Every now and then I run across a piece that causes me to mutter 'well done.' John Hussman's note for this week is one of those.

Depth of thought always characterizes Dr J's work. Recently, however, I've found his reasoning and conclusions particularly thought proking. This week's piece is one of those I'd recommend to anyone trying to figure out where we're headed.

You may not agree with his conclusions, but you'll also need to determine where his underlying thought process is flawed.

That may be challenging in this case.

position in SPX

Sunday, June 27, 2010

Who's Zooming Who?

You came to catch
You thought I'd be naive and tame
You met your match
I beat you at your own game
--Aretha Franklin

A group of people with the same bad habit meet to discuss their problem. It is an addictive behavior they share--one that's rung up such a tab that it's unlikely to be paid in full.

Back home, each group member's support network have been quite clear on what needs to be done to break the addiction. Change your behavior. Start making amends. Pay back you debts. There is much hand wringing among group members, and collective agreement on the need for change.

So the group resolves to make a pact. Someone whips out a sheet of paper and the members write down what each promises to do in order to kick the habit.

"Yes, yes, that'll work!"


"Road to recovery!"

Exclamations intensify as members add their plans to the list.

After each contibutes to the promisory document, all that is left is to indicate when the remedial behaviors will commence.

The enthusiasm quickly leaves the room. Members look at each other in sadness. Shoulders sag. Some leave the meeting. One of the group picks up the pen and jots next to the Effective Date label:


The G-20 meeting thereby ends.

Saturday, June 26, 2010

Dry Docked

"I told you to speak your mind, Jack, but Jesus..."
--Admiral Jim Greer (The Hunt for Red October)

The Baltic Dry Index (BDI)  is a composite of global cargo vessel shipping rates. Many view this measure as an decent indicator of global trade strength. Freight rates tend to correlate with general supply and demand.

During the credit crunch of 2008, the BDI underwent a breathtaking decline, cratering more than 90% over the span of a few months. Then, the index led general markets higher in early 2009, climbing from under 1000 to over 4000 by mid 2009.

Since then, the BDI has essentially been stuck in a trading range. However, it recently marked a lower low, which negates the previous uptrend technically in place.

A Baltic Dry that's loosing traction certainly seems like a negative on the margin.

positon in SPX

Friday, June 25, 2010

Front Runners

The drinks flow
People forget
The big wheel spins, the hair thins
People forget
Forget they're hiding
--The Who

Members of the bicameral 'financial reform' committee are congratulating themselves for coming to agreement on what is being billed as the biggest financial system overhaul since the 1930s. The Depressionary reference should tell you something.

The wording of the bill should also tell you something. The current title is the Restoring Financial Stability Act of 2010. When bills are worded as gerunds you know you have trouble that will be hard to shake. Moreover, the bill is being abbreviated the Dodd Frank bill, after two of the most damaging bureaucrats w.r.t. finance that Washington has ever subsidized (and that's saying something).

Toddo offers that 'we needed to do something' as he discusses some of the bill's marquee provisions related to derivatives and prop trading. Not sure I agree bro when the actions lead us closer to the abyss. The bill contains nice slabs of requisite pork as well, including provisions that protect 'low income, minority, and underserved communities' affected by failing financial firms (can you say moral hazard and taxpayer burden?), and mandatory affirmative action hiring practices of regulatory agencies.

Revenge of the SIGs. It's all sadly comical.

Bank panics and failures always relate to one issue: excessive leverage. Leverage entials borrowing funds in order to increase potential returns. Of course, leverage also increases risk, or the potential for loss, as well.

When markets go down, lower prices reduce the value of assets held by excessively leveraged firms below the value of their, creating conditions of insolvency. We know leverage is the core issue because conditions of insolvency are difficult, if not impossible, to achieve with no borrowed funds.

In other words, take away the leverage, take away the insolvency. No politicians, or their sponsoring SIGs, want to do that, though.

So how do firms get levered? Two things are necessary. One is an entity or entities willing to supply ample quantities of credit. The other is willingness to borrow, or appetite for risk, among the debtors. Absent either of these conditions, leverage cannot occur.

In unhampered markets these two conditions are regulated by fear of loss. Lenders dial back on credit issuance if they feel borrowers will not be able to pay them back. Borrows dial back on borrowing if they feel less able to repay what they owe.

The probability of 'excessive' leverage building in systems regulated by purely by the natural fear of loss is low. Losses sting. And catastrophic losses, or outright failure, kills.

Yet we observe conditions of excessive leverage routinely. To anyone practicing reason, this should suggest that something must be muting the natural regulatory mechanisms of the market. I'll leave that for you to ponder. The questions you, or anyone truly interested in solving the problem of 'excessive leverage' in our financial systems should be asking, are twofold:

1) Where does the large supply of credit come from? What might reduce concerns among suppliers about the risk of extending too much credit?

2) What drives firms to borrow so much? What might reduce concerns among borrowers about the adverse consequences of excessive debt?

Hint: The Dodds Frank bill does nothing to address these fundamental issues. Indeed, it is more likely that the bill escalates the problem.

position in SPX

Thursday, June 24, 2010

Bird Brief II

"You're not the only one who does research."
--Darby Shaw (The Pelican Brief)

In the film The Pelican Brief, a big campaign contributor (who, ironically, is a Gulf oil driller) to the president's campaign, appears to be knocking off Supremes in order to pave the way for more favorable judicial treatment. When the president and his chief of staff figure out that any connection to Mr Oil would unleash a political halocaust in their direction, they decide to turn their hats around and become environmentally friendly in future decisions, as well as disavowing any current friendship with Mr Oil.

Like, oil and water (sorry), politics and consistency don't mix well.

The Gulf spill currently and correctly positions British Petroleum (BP) as antagonist in the story. But is BP THE antagonist--or are there accomplices worthy of mention? Given the Special Interest Group (SIG) world we live in, it's hard to be intellectually honest without exploring ties between BP and the federal government.

It doesn't take long to find connections. BP has been a big political contributor for years and significantly so to the current administration. Moreover, as Ron Paul notes, BP has been a size acquirer of government subsidies, a big promoter of competition-reducing regulation, and a major lobbyer for cap and trade legislation. It would be interesting to slap a dollar estimate on these endeavors. Clearly, this company is not a free market operator; it has relied on government to help protect its franchise.

SIG city, baby.

Because of the highly regulated state of the oil industry, and the general axiom that regulation often generates more problems than it solves, it is also worth asking whether government actions may have increased the chances of a deepwater accident.

There is evidence to support this thesis as well. More than a month ago we noted the 1990 legislation that limited non-cleanup liability related to a spill at $75 million. Not only is this a laughably low number but it theoretically caps the consequences of potentially reckless behavior. Furthermore, the Deepwater Royalty Relief Act, signed into law in 1995, incentivized drilling for oil far offshore, which is clearly riskier (as we all now clearly observe) than drilling in shallow depths. Since the DRRA's passage, deepwater drilling has multiplied many fold.

We could discuss other regs as well, such as those that have prohibited drilling on big land-based fields such as those in Alaska which has also pushed oil exploration and production offshore. However, it seems clear that government regs have dealt moral hazard and and other cards onto the table that elevated risk of an accident.

As such, government appears a noteworthy accomplice in the Gulf spill story. Don't expect government officials to bill themselves as such, though.

no positions

Of Crisis and Opportunity

Most of freedom and of pleasure
Nothing ever lasts forever
Everybody wants to rule the world
--Tears for Fears

Some folks claim that the Kanji symbol for crisis is a combination of danger plus opportunity, altho my Chinese friends tell me this is not true. Politicians, however, certainly grasp the crisis/opportunity relationship. The poly sci axiom is that people are willing to cede power to government in times of perceived threat. Politicians are eager to exploit this.

We saw it after 9/11 with the Bush administration ignored Constitutional boundaries w.r.t. the war on terror and individual privacy. Both the Bush and Obama administrations expanded government power during the credit meltdown. And now we see the Obama administration seeking control over oil and gas production in conjunction with the Gulf spill. It's a bipartisan effort, for sure.

The Court has been complicit in this mischief, routinely looking the other way as the federal government continually oversteps its authority. As such, it was good to see that New Orleans judge toss out the drilling moratorium.

Perhaps that's a start.

no positions

Wednesday, June 23, 2010

Muni League

All we do
Crumbles to the ground
Though we refuse to see

If you're a hammer, then the whole world looks like a nail. If you're bearish on the economy/markets, then you're prone to see all info as supporting your bearish case. Confirmation bias, personified.

Of the many shoes that can drop to further the case of those banging with Boo, few loom larger than the funding crisis facing nearly every government on the planet. The world is drowning in debt--so much so that sources are waning that are willing or capable of extending more credit. The sovereign debt crises, led off by Iceland last yr and now the EU this yr, frames the situation well.

At home, it is becoming more apparent that the US will face municipal funding problems before the country-level Treasury bond problem. Widening bond spreads currently lay odds of about 25% for outright default for California and Illinois. In addition to states, of course, we have local municipalities whose coffers are empty as well.

Should these municipalities default, then well over $1 trillion in muni bond value is at risk.

Personally, it's hard for me to see how this doesn't happen in dramatic fashion. Then again, such a vision supports my view...

In any event, I want to try to stay as far away from the muni bond market as possible in case of a big time implosion.

no positions

Tuesday, June 22, 2010

Half Empty

Drawn into the stream
Of undefined illusion
Those diamond dreams
They can't disguise the truth
--Level 42

It's hard not to wonder whether yesterday was an important reversal day--particularly given today's downside follow thru.

Major indexes are also starting to sport a multi-month head-and-shoulders look, with perhaps the right shoulder currently in the process of being traced out.

Consistent w/ this past weekend's musings, I was a seller yesterday and today of most long stock and commodity positions. Remaining long positions are a slug of GLD and a sliver of Microsoft (MSFT). Both of these are for sale on any significant lift.

Thus far, I've been unsuccessful in adding to my short exposure. Haven't found entry points that 'feel' right. Managing short side risk is much more difficult than managing long side exposure--particularly in an environment where you know policymakers will try/are trying everything in their power to prop up prices. It's hard to fully express a bearish view in such an environment.

However, one silver lining of paring longs over the last coupla days is that I'm 'net short' for the first time in a while. As a percentage of total assets, let's call it ~3% net short.

Nothing radical, but at least directionally consistent w/ my view...

position in GLD, MSFT, SPX

Leaking Losses

Come out upon my seas
Cursed missed opportunities
Am I part of the cure
Or am I part of the disease?

Not quite apples to apples, of course, but asking why Washington focuses on British Petroleum (BP) while largely ignoring Fannie Mae (FNM) and Freddie Mac (FRE), who are 'leaking' as much money per quarter as BP has pledged in entire clean up escrow, is a good question. After all, using the $145 billion figure (which is likely conservative), cost of GSE probs so far is equivalent to about 6 Gulf oil spills.

We know the reasons. Salience and vividness effects make a major oil spill nicely exploitable from a political standpoint.

Moreover, Fannie and Freddie are government creations. Thus these institutions are likely to be protected rather than criticized and disassembled. Near the bottom of the article there are some nice quotes from bureaucrats who were already circling the wagons around the GSEs years before the bubble burst (more in this vid clip).

It is rare indeed that government points fingers at itself.

no positions

Monday, June 21, 2010

Barrier Reef

Face to face, each classic case
We shadow box and double cross
Yet need the chase

The Merchant Marine Act of 1920 (a.k.a. the Jones Act) stipulates that all goods transported by water between US ports be carried on US ships built in the US by US firms and crewed by US citizens. This is obviously a protectionist measure that caters to a number of special interest groups (SIGs).

It is easy to see how this act and affiliated SIGs have slowed response to the Gulf oil spill problem. A number of specially fitted foreign vessels, hailing from norther Europe and elsewhere, are available to assist in cleanup. Thus far, these ships have largely been 'locked out' of the Gulf by the Jones Act.

I don't have a good idea of how much foreign cleanup capacity is out there; the mainstream media has certainly not be very 'investigative' in this regard. However, a 'no brainer' a month ago or more would have been to waive the Jones Act to get as much clean up capacity to work ASAP. Yet here we are today, with the protectionist measure still in the way.

A fundamental axiom is that government will generally be slow to anticipate and respond to crisis situations. One reason for this is the mesmerizing effect of SIGs on bureaucrats.

no positions

Sunday, June 20, 2010

Deflation Station

They gave you life
And in return you gave them hell
As cold as ice
I hope we life to tell the tale
--Tears for Fears

From a macroeconomic standpoint, the great debate at present concerns whether inflation or deflation lies directly ahead. Despite recent government stimulus initiatives, I continue to favor the deflation side of the ledger.

An important pro-deflation observation over the past year or so is that the massive stimulative monetary and fiscal policies have yet to result in significant credit creation. Sure, the Fed is lending free money to banks, and the banks are subsequently buying longer dated Treasuries to rejuvenate their balance sheets in classic carry trade fashion. But little of this 'stimulus' is making its way into the rest of the monetary system in terms of credit expansion. Without the 10:1+ pyramiding effect of new credit, then inflation is dead in the water.

Long time deflatonist Bob Prechter recently was the subject of an informative interview in this regard. He notes that broad monetary aggregates and money velocity continue to decline in the face of all this stimulus.

He also observes that commodity indexes such as the CRB have yet to claw back to even 50% of their pre-2008 highs. In a serious inflationary environment, commodity prices would surely be trending much higher by now, he suggests. For whatever reason this observation particularly resonated with me--perhaps because I recently put on a bullish commodity position. When I look at a 3 yr chart of the CRB (above), the recent rise in commodities does look pretty pathetic.

Inflationists counter that, because the US government owns a printing press, at some point they'll merely start printing dollars and dropping them from helicopters per Ben Bernanke's early 2000s promise. Prechter suggests that darkening social mood may drive voters to exert pressure on politicians to keep them destroying the currency in this manner. After all, in many ways printing a paper blizzard constitutes the 'nuclear option.'

I've been wondering the same thing myself. It does seem that whether or not government resorts to the actual printing of physical currency (a la Weimar, Zimbabwe) is the ultimate 'endgame' issue in the inflation/deflation debate. Inflationists think it is a layup. Deflationists like Prechter don't think it's so obvious.

Prechter suspects that the April stock market highs may be multi-year highs, and that we're about to commence a 'super cycle' deflationary contraction that will carry markets to generational lows by 2016.

To him, the proper asset allocation is all cash--spread across various instruments to hedge against default risk. If one considers gold a form of cash, then Prechter's recommendation align well with Richard Russell.

Have to admit that this interview edges my needle a bit more to the deflationary pole. And it has me wanting to lighten my long commodity and stock exposure on any strength in the next few days.

Regardless of whether you favor an inflationary, deflationary, or even a neutral bias, listening to the case presented by Prechter seems a worthy endeavor. At the very least, you will have tested his arguments against your power to reason, and you'll be managing risk in a more informed manner.

position in SPX, commodities, gold

Saturday, June 19, 2010

Shoulder Shrug

I thought it was clear
The plan was we would share
This feeling just between ourselves

At the end of last year, we noted the potentially bullish reverse head and shoulder pattern setting up in long term treasuries. The implication at the time was that an outlook that favored inflation appeared to be increasing.

Fast forwarding to today, we can see that the 'reverse dandruff' pattern in bond yields may be in the process of being negated. Rates have recently moved lower commensurate with the stock market decline and an overall flight from risk. Plus, yields have yet to follow equities higher during the past week's stock market rally.

Perhaps markets are reconsidering inflationary prospects in favor of a more deflationary scenario. Specific to 10 yr yields, would think that any move down thru 3% (30 TNX) would be a confirmatory signal in that regard.

position in SPX

Friday, June 18, 2010

Machine Head

When it all was over
We had to find another place
Swiss time was running out
It seemed that we would lose the race
--Deep Purple

Nice story of Henry Hazlitt's battle vs the establishment during the Bretton Woods period. Hazlitt became an editorial writer for the New York Times in 1934 and used this position to rail against the growing collective movement, particularly w.r.t. monetary policy. It really is quite amazing that the NYT printed such views--given the paper's modern day position as an organ of the State.

Particularly interesting to me was Hazlitt's observation (remember that this was 1944) that Americans had come to believe that government-sponsored organizations provided machinery that could solve any problem. If the president was behind a program, then this machinery 'could make water run uphill or to keep rocks from falling.'

This observation is completely transferrable to current times. Relative to the Gulf oil spill, for instance, it seems that many if not most Americans are looking to President Obama for the 'solution' to the problem, and expect the Federal government to organize in a manner that will make things whole.

Similar dependency behavior was displayed during the credit meltdown and health care episodes.

As Hazlitt constantly noted, reliance on government to solve these problems approaches the height of folly. Not only are bureaucrats short the skills and incentives to effectively deal with such issues, but relying on government machinery inevitably results in loss of individual freedom in exchange for State shackles.

position in oil

Double Trouble

Live those dreams
Scheme those schemes
Got to hit me
Hit me
Hit me with those laser beams
--Frankie Goes to Hollywood

Another sage post by John Hussman. He highlights the downtrend in the ECRI leading indicators index. This series has a good recession forecasting record.

He also offers his 'Aunt Minnie' checklist of recession criteria. He concludes that further weakness in the Purchasing Mgrs Index to 54 or below would provide a 'hard signal.'

His current asset allocation comments seem reasonable as well.

Thursday, June 17, 2010

Higher Order

"It's the bottom of the ninth. The score is tied. It's time for the big one."
--Goose (Top Gun)

The most bullish chart thru my lens right now is gold. Classic cup and handle look w/ the yellow metal knock-knock-knocking on all time highs.

The fundamental/structural explanation behind this action is easy to grasp. Governments around the world are monetizing debt. And more money printing appears eminent. Pepple want to convert their 'worth less' paper money into a store of value.

For five thousand years, the go-to store of value has been gold.

I've reinitiated a position in GLD w/ intent of adding more. Have also been building a position in SLV.

positions in GLD, SLV

Wednesday, June 16, 2010

Fading Fannie

Why don't you all just f-f-f-fade away
--The Who

Funny how this story pretty much came and went with little fanfare. When historians look back on this period, however, the influence of the GSEs will likely loom large.

Even now, with their reduced market values, Fannie and Freddie remain instruments of government policy. GSEs originated in the late 1930s to express the New Deal policy of putting those who could not afford houses into houses. That policy has shifted to one of across the board buying of mortgages to keep the wheels on the real estate market wagon.

In fact, when one thinks about it, perhaps it's better for bureaucrats if Fannie and Freddie exit the public eye. Out of sight, out of mind...

no positions

Tuesday, June 15, 2010

Hit and Run

Cromwell: "I have evidence that Sir Thomas [More], while he was a judge, accepted bribes."
Duke of Norfolk: "What! Goddammit, he was the only judge since Cato who didn't accept bribes! When was there last a Chancellor whose possessions after three years in office totaled one hundred pounds and a gold chain?"
--A Man for All Seasons

Leave it to the Washington Post to print a piece raising conflict of interest questions between Ron Paul's congressional assignments and his gold holdings. Like many of these 'drive by' insinuations, the reasoned reader is left to conclude that the writers either don't understand the investment thesis behind gold, or they hope that readers latch onto the superficial soundbite only and not think things thru.

Gold is an insurance policy against government malfeasance. History demonstrates that politicians will ultimately destroy a currency under fiat regimes. Gold helps individuals hedge that risk.

When Ron Paul buys gold or gold mining shares, he is essentially putting his money where is mouth is w.r.t. what he constantly warns against in Washington: excessive government, debt, money printing, etc.

If he truly wanted to 'talk his book' and game the system, then he would be doing what the majority of politicians are doing--enacting policies that are certain to destroy the dollar's purchasing power over time.

As Paul notes toward the end of the piece, the real solution to conflict of interest issues is to reduce the scope of government so that there is less chance of mischief.

Associating Ron Paul with the herd of Washington politicians who are lining their pockets via corrupt behavior is laughable.

position in gold

Monday, June 14, 2010

Food Fight

"The Almanac says it's time to start plantin'."
--Myra Fleener (Hoosiers)

Although Howard Simons presents some interesting analyses and they're almost always thought provoking, this one provokes me into thinking that he's missed the mark when it comes to agricultural commodities.

Near the outset, he claims that the constant dollar price of wheat has declined 77% since the end of WWII while world pop has more than tripled. To be sure, farming efficiency has improved dramatically over the past few decades but some data that supports his claim would have been more convincing.

He goes on to graph the relationship between 'relative CPI' per the BLS and general commodity index prices. The relationship portrayed is not that strong when you really look at it (again, perhaps some correlation data might add insight). Plus, as Mr Simons acknowledges, the CPI data are a highly tortured lot.

His final graph plots ag returns versus other asset classes since 1991. Since ags are currently below other assets classes at the end of the horizon, he concludes that this asset class is an unworthy investment. However, if the end of the horizon happened to have been late 1997 or early 2008, then ags would have come out on top. As an aside, it's strange that he did not anchor all series to the beginning time period.

Note also from this graph that ags tend to be uncorrelated to other asset groups--a characteristic that facilitates diversification.

Like all asset classes, commodities go thru cycles--some long and some short in duration. One thesis on commodities, including ags, is that we're early in a long cycle upleg--one that actually got going about 10 yrs ago. Off those lows in 2001, ag prices increased by a factor of about 5 before the 2008 pullback. Current prices are about double 2001 levels.

Historically, these long cycles tend to last 15-20 yrs in commodities. When I consider factors likely to color the future, such as growing food demand by developing countries and lagging farm capacity, and combine them with the technical long cycle pattern, it's hard for me to arrive at similar conclusions to Mr Simons. (It is, of course, such differences that make markets). To me, agricultural commodities seem an interesting investment idea--from both a growth and diversification p.o.v.

position in ags

Sunday, June 13, 2010

May the Force Be With You

"Did you hear that? They shut down the main reactor. We'll be destroyed for sure. This is madness."
--C3PO (Star Wars)

One way to conceptualize effects of market interventions is by using force field analysis. I first became familiar with force field analysis in my quality management days when it provided a useful tool for improvement teams seeking to evaluate problem causes and implement remedies. Kurt Lewin (1943) was one of the first to express the concept in the context of change management.

The basic idea behind force field analysis is to identify forces that work for and against a situation that bring it to static rest. Then, by adding additional forces or taking some away, a sense can be obtained about the dynamics of subsequent interventions.

In the case of pure, unhampered markets, the dominant forces are optimism about a prospective good's utility, and pessimism about the good's utility. Optimism exerts upward pressure on prices and pessimism exerts downward pressure. These opposing forces balance each other at some point when markets 'clear,' thereby providing a natural regulating mechanism.

There are, however, people with particular interests who tend to be dissatisfied with the equilibrium that results from the free market's natural regulatory process. Sometimes, individuals might feel that the equilibrium is established at too low of a price and in need of stimulation--perhaps via low interest rate policy in the case of central banks, or loan guarantees in the case of Fannie Mae (FNM) and Freddie Mac (FRE). In other situations, individuals might feel that equilibrium is established at too high of a price and in need of suppression--perhaps via regulatory oversight of industry, or by outright price ceilings.

The figure above shows the outcome of one hypothetical group of interventions. In addition to the market forces of optimism and pessimism, additional interventionary forces are present, some designed to push prices higher and some designed to push prices lower. In this particular hypothetical, the end result is that prices stabilize at a level higher than the unhampered, free market price. As price moves further from the unhampered price, risk relative to reward increases.

Now suppose that a particular political administration decides that it would prefer less industrial oversight and subsequently removes the regulatory agency previously serving as 'watchdog.' As indicated by the figure above, with the suppressive regulatory force now removed, stimulative forces move the market higher, and prices stablize at an even higher level than before. Risk relative to reward has increased further.

Over the past couple of years, various pundits have claimed that free markets have failed, offering as evidence the seeming cause and effect between reduced regulatory oversight in various sectors and riskier situations that generated economic hardship. However, such claims ignore the fact that other interventionary forces were present when those regulatory forces were reduced or removed.

Unless regulation constitutes the only interventionary force imposed (and it rarely does), removal of regulatory forces usually does not create a free market situation. Indeed, removal of a single interventionary force may not even make a market 'more free.' Instead, the removal of one interventionary force may merely motivate a situation that makes an already hampered market riskier (as portrayed by our final figure above).

Risks that subsequently become realized are the consequence of interventionary action--not the lack of it.

Left unhampered, markets seek to balance risk and reward. Intervention hampers the natural balancing mechanism, and over time almost inevitably leads to increased risk--something counterintuitive and perhaps even incomprehensivle to proponents of government interference in markets.

position in SPX


Lewin, K. 1943. Defining the "Field at a Given Time." Psychological Review, 50: 292-310.

Friday, June 11, 2010

Golden Rule

Say that you'll never, never, never, never need it
One headline, why believe it?
Everybody wants to rule the world
--Tears for Fears

Nice quotable quote on gold recently by the one guy in DC who both gets it and is not afraid to say it:

"Gold is not a typical investment. It is a defense against the predictable behavior of goverments to debase a fiat currency under its absolute control. The people who run the printing presses have trouble shutting them off. In order to limit one's exposure to this reckless behavior, it is wise to exchange unsound assets for sound ones."

position in gold

Home Wreckers

Our house, was our castle and our keep
Our house, in the middle of our street

This piece employs various data to argue that housing markets are likely to remain soft for some time. An increased percentage of homes sold constitutes properties that have been foreclosed or where borrowers are in 'distressed' condition w.r.t. to mortgage payment. Zillow data show that nearly 30% of all homes listed in its website have been sold for a loss over the past couple of months.

Data also suggest that, despite soft conditions, only 25% of sellers have been willing to lower their asking price. We don't know whether this might reflect optimism about future conditions, the 'need' for a certain selling price in order to avoid bringing money to the table for closing, or what. There is also evidence to suggest that, of those sellers in major metro areas that have lowered their asking price in the last 18 months, at least 40% of those properties are still on the market.

Finally, home sellers must increasingly compete with rental properties. Over the past 40 yrs, supply of rental units has nearly doubled, and vacancy rates are at record 10%+ levels. Moreover, supply of rental properties is likely under stated because some home owners are renting out their distressed properties in order to pull in some income.

These data certainly jibe with my observations. I routinely monitor three local markets here in Cincy. These areas and the price ranges I track would represent mid-to-upper level markets. Over the past yr, homes for sale have increased by at least 1/3. I would guess that about 1 in 4 lowers price within 3 months. And based on what does sell, those that are rigid on price seem to be dreaming given current market conditions. I should also note that there are more rental properties for sale in these markets than previously.

Should this continue for a few more months, I'd place the chances of more government stimulus for the housing markets by yr end as pretty good.

Thursday, June 10, 2010

Storm Shudders

There's a quiet storm
And it never felt like this before
There's a quiet storm
That is you

Higher than normal hurricane activity is forecast in the Gulf this season. This would surely complicate spill clean-up efforts. I wonder whether there are any precedents to draw from in this regard.

One more factor putting upward pressure on crude as well.

position in crude

Wednesday, June 9, 2010

Squibb Kick

Words are so cheap but they can turn out expensive
Words like conviction can turn into a sentence
--General Public

Each May/June the American Society of Clinical Oncology (ASCO) holds a meeting for docs, producers, analysts, and other interested parties. Primarily, the ASCO event is an avenue to showcase and discuss latest cancer treatment technologies. If there's something big brewing in this sector, then ASCO is often where it goes public.

In advance of this year's ASCO, I read a BW article on Bristol Myers Squibb's (BMY) experimental medicine ipilimumab. 'Ipi' has been making a splash for its reported efficacy in reducing tumor size and frequency in some advanced melanoma patients. What interested me is ipi's focus on freeing up the body's immune system to do its thing on cancer cells--reminiscent of the old monoclonal antibody (MAB) approach of first gen immunity motivators.

Post ASCO, sharp cookie David Miller has presented the limitations of ipi, and there are many. He also notes concerns with BMY's trial design and potential for a limited indication should the medicine ultimately pass FDA muster.

You can see from the chart that the ASCO buzz was enough to pop BMY stock a few percent, which is not an uncommon short term effect of a successful ASCO presentation.

If you've followed this company for a while, you know that BMY has hit one pothole after another which has shaved more than 50% off the stock's value over the past decade. Promising candidates like ipi, however, suggest that perhaps Bristol's innovation engine may be getting into gear, kick started perhaps by recent acquisitions in the biotech space from which ipi came. In ipi's case in particular, I'm hopeful that it revives focus on immune system enhancers as I sense value in treatments that empower the human body's natural cancer killing capacity.

Valuation-wise, there are some things to like. BMY's free cash flow has been increasing--in FY 2009 it amounted to about $3.3 billion. Using a '$15 billion in mkt value for every $1 billion in FCF' rule of thumb implies a 'fair value' of about $49 billion for the company. Current enterprise value = $41.5 billion mkt cap + $6.4 billion debt = about $48 billion, suggesting that the current price is at or slightly below 'fair value.' BMY has been building cash; currently it stands at $6.8 billion, meaning that it is holding more cash than debt. The stock yields more than 5% as well.

It is easy to list issues populating Boo's side of the ledger including: potential downside surprises in a developmental medicine that has been getting lots of hype; a looming patent cliff--blockbusters Plavix and Abilify go off patent in the next coupla yrs; BMY's prolonged slump, which could be indicative of lack of managerial capacity; and overall macro economic issues which threaten to depress stock values across the board.

Nonetheless, I sense enough positives to initiate a small position in BMY at these levels. Nothing crazy, but having some skin in the game will help me follow the story. Plus, the 5% coupon provides margin for error.

position in BMY, SPX

Extinct Possibility

Open the door, get on the floor
Everybody kill the dinosaur

After racking up some nice gains this morning, domestic stock markets flipped over as folks began focusing on share price declines in British Petroleum (BP). The stock is off another 15% today on huge volume.

Perhaps more importantly, BP credit spreads have been blowing out big time today (below).

This is classic prelude-to-bankruptcy type of action. More than one person on the 'Ville has noted similarity between today's trading patterns in BP securities and those in Lehman as it began its death spiral in 2008.

As such, it's worth pondering who might be on the sell side of BP credit default swaps as the spectre of bankruptcy looms larger. Likely more than one institution would be on the hook for some big insurance payouts if BP goes to zero.

What probably concerns the markets most, then, is who's short all those BP CDSs?

position in SPX

Tuesday, June 8, 2010

Surfing for Silver

"You have to set an example even in the face of stupidity. Everybody who reads comic books knows that the Kirby Silver Surfer is the only true Silver Surfer. Now, am I right or wrong."
--Lt Commander Ron Hunter (Crimson Tide)

Last week starting nibbling on silver again. With gold flying at all time highs, seems like 'poor man's gold' may have some catching up to do.

Three yr chart has a bullish 'cup-and-handle' or 'reverse head-and-shoulders' shape. When coupled w/ the money printing macro scenario, I'm diggin' White Lightning's risk:reward here.

position in SLV

Obstruction of Justice

You were under the impression
That when you were walking forward
You'd end up further onward
But things ain't quite that simple
--The Who

Tony Crescenzi suggests that the world is reaching a 'Keynesian endpoint' w.r.t. government spending. A novel label for the timeless concept that you can't borrow and spend your way out of debt and spending problems.

Imbalances have been building as politicians enacted Keynes' interventionist policies over the past century. Government balance sheets are now approaching 'exhaustion' (per Tony's term) and are struggling to squeeze out more deficit spending.

As governments run out of interventionary ammo, latent market energy turns kinetic to rebalance natural economic systems.

Natural law cannot be permanently obstructed.

Monday, June 7, 2010

Edge of Night

"I'm holding on too tight. I've lost the edge."
--Cougar (Top Gun)

Not sure today's hard close is what Hoofy wanted to see.

Feels like we may once again be at the edge. Tomorrow should be interesting.

position in SPX

Capital Punishment

"Can we keep this...between us? I'd hate to lose my teaching job."
--Mutant Biker (Weird Science)

Peter Atwater discusses government's increasing influence on managerial decision making. As government gains more control over the processes that oversee production, we move closer toward socialism.

As Peter suggests, the greater we move in this direction, the lower the returns on capital.

The implication for investors is that valuation models need to discount less efficient capital allocation that accompanies a more socialistic structure. If this is done, then stock prices seem to be way too high.

position in SPX

Sunday, June 6, 2010

Open Season

This wouldn't be the first time
That things have gone astray
Now you've thrown it all away
--Bryan Adams

Never know what'll happen between now and tomorrow's open. Currently Asia markets off a coupla percent and US futes down a percent. Euro also slipping to new lows for the move.

Would 'think' that if (big if) US markets open in the hole tomorrow morning, then Snapper better make an early appearance. Otherwise, Boo may redefine his terms.

position in SPX

Saturday, June 5, 2010

Point of No Return

Today I found a message floating
In the sea from you to me
Wrote that, when you could see it
You cried with fear, the point was near

While some of the assumptions/projections in this type of work can be debated, the general finding seems clear. We're rapidly approaching, or already past, the point of no return w.r.t. debt.

Note the per capita estimates toward the end of the missive. (Public debt + private debt + unfunded liabilities)/US population = multiple sixe$ per citizen.

The real scary thing is that we're doing little, if anything to reverse course. By most measures, it seems to be full speed ahead.

Friday, June 4, 2010

Broken Glass

You declared you would be three inches taller
You only became what we made you
Thought you were chasing a destiny calling
You only earned what we gave you
--The Who

On top of out-of-left-field concerns last nite came re Hungary's solvency, this morning's job numbers disappointed. As soon as the payroll numbers hit the premarket tape, futes lost about 2%.

Things got uglier from there, with major indices down 3% or so on the day.

When gazing at the chart above my first thought is, boy, glad I'm not a day trader. These big daily reversals have to be jacking up the stretcher count.

My second thought is that this is an ugly chart. The major indices are once more in precarious position on the back of today's sell off. We're once again perched on support reflected by the Feb lows. Textbook technical analysis suggests that support weakens each time it's tested (as layers of demand are stripped away each time). We've now been down here four times in the last month. As noted by the 'whiskers' on the candlestick chart above, the previous three times we bounced intraday for a temporary reprieve.

That didn't happen today.

If Boo gets his groove on from here, things could get ugly.

position in SPX

Thursday, June 3, 2010

Executive Action

"This person, they...they go in the front door, then they go out a window and down a rope in the middle of the night? If I could do something like that, I'd be the star of my AARP meetings."
--Luther Whitney (Absolute Power)

Many credit FDR as the president who elevated executive power far beyond its Constitutional constraints. Of course, prior presidents, such as Abraham Lincoln, had been sidestepping the Constitution when it seemed convenient.

It seems clear, however, that the trailblazer for the modern US president was Theodore Roosevelt. In conducting foreign affairs, for instance, Roosevelt once noted that 'It is of enormous interest of this government to strengthen and give independence to the Executive in dealing with foreign powers.'

To be sure, the Framers toiled to produce a design that would squelch such a dominant executive.

But such a design is useless if no one follows it.

Freedom of Association

Most of freedom and of pleasure
Nothing ever lasts forever
Everybody wants to rule the world
--Tears for Fears

Lew Rockwell discusses freedom of association--the freedom to choose who you affiliate with and do business with. He notes that there are those in the media and in government that have been denouncing this freedom. It appears, he suggests, that we no longer trust freedom and are willing to speak out in favor of it.

He may be right.

I'm increasingly amazed (and saddened) at the extent to which the sovereignty of the individual is outright chastized. And that folks are reluctant to defend liberty.

Not sure the reason. Fear, greed, laziness, abication of personal responsibility, fear of reprisal, ignorance...

All the while, people shift power to the State and seem to willingly escalate conditions of despotism.

Wednesday, June 2, 2010

Squatter's Squalor

It's like I told you
Only the lonely can play
--The Motels

More evidence that the economy has been buoyed partly because many folks are using former mortgage money to fund their lifestyles.

The above chart also offers insight into one driver of the growing 'shadow inventory' in housing. What happens to the house prices if/when this growing supply hits the market?

Tuesday, June 1, 2010

General Management

Bud Fox: "It's called pasta now, Dad. Spaghetti's out of date."
Carl Fox: "Yeah, well so am I."
--Wall Street

Almost makes you want to take the other side of the trade when folks start questioning GE's management style and calling it 'out of date.'

I recall similar tone during the Internet run up when 'new economy' managers were criticizing the decision-making styles of their 'old school' counterparts. Slow, too much structure, risk averse, etc.

Most of those doing the critiques are long gone.

That said, I can't get excited about GE's stock. This company is still leveraged big time, sporting nearly $700 billion (yep) of liabilities against just over $100 billion in equity. Most of the debt run up has been a function of the former GE Capital (now split into Finance-Business and Finance-Consumer). Moreover, unlike others who have cut their leverage over the past couple of yrs, GE has not.

While there is much to respect about GE's managerial processes and some of their business (like energy and water), as long as it remains a 'financial in drag' I'll stay away.

no position