More from Guy Geldworth, Market Bull

Life is jittery in the office these days. Just trying to take care of our clients' portfolios. We emphasize uncorrelated measures as we try to moor assets in safe harbors, yet it appears there's nowhere to hide. I have to say it, the deregulated market seems to have been the tipping point of the end of a thirty year growth market dominated by the bulls. No more, it appears. (These words are ineffable in the office, of course. It took forever just to admit we were in a recession.) Are we heading for a "deep recession" or a depression? A depression!? That's what some bold technicians are saying as they see strong parallels in the charts comparing the 1929 market and today's.

But what really prompts this posting (Thank you Jack Sands, for the space) is the ignoble way some in the media are already undermining an authority not yet manifest in going after president-elect Obama. "Obama recession," they're saying. Huh?! Obama is just now putting his cabinet in place, is just barely ascending the "bully pulpit," and Wall Street is already discounting equities, and projecting blame on the newly elected. Oh well, as they say in Britain: (President) Bush is forgotten but not gone."

I understand the wealthy (many of our clients) want a flat tax rate, nothing progressive for them, a 17% flat tax rate would do. That saves them a bundle, but what about the middle class? The poor? I understand the fear they have of a "leftest" increase in the capital gains tax rates. All personal perspectives, mind you. Very personal. To heck with the rest of the culture "out there." "We have to protect our own." The phrase my fellow Americans takes on a whole new meaning.

But to the point of this posting. Below, I list quotations issued from a few bright minds concerning unrestrained capitalism and the unwholesome mixing of private capital with government. Notably, in their recent campaigns for presidency, Barack Obama and John Mccain spent nearly $1 billion. Who'd they get these sums from? What may these contributors want and get from the future president? Worse yet, consider the use of public funds to heal the wounds of private capital--the current use of public money as a "back stop" to bail out corrupt investment bankers. Most importantly, see Thomas Jefferson's concern over the dangers of a politically uninformed body politic.*

I am in accord with all expressions below, particularly those emphasizing the responsibility of citizens to inform themselves, then to act.

I might have my CFA, but I'm also, it turns out, a believer in a democratic republic, one who, nevertheless, will try to keep his rich clients rich, hopeful that they share my values, even as I remain dubious of that possibility in the near future. I'm perhaps like many of you, still a few feet away from becoming a Public Citizen.

In 1816 Thomas Jefferson warned of "a single and splendid government of an aristocracy founded on banking institutions and moneyed incorporations" which would mean "the end of democracy and freedom".

A few decades later in 1864, Abraham Lincoln warned: "I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety of my country. . . . corporations have been enthroned and an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people until all wealth is aggregated in a few hands and the Republic is destroyed." Thirteen years later, the Gilded Age commenced, a period of growth and vast corruption.

Albert Einstein: "... under existing conditions, private capitalists inevitably control, directly or indirectly, the main sources of information (press, radio, education). It is thus extremely difficult, and indeed in most cases quite impossible, for the individual citizen to come to objective conclusions and to make intelligent use of his political rights. "

Noam Chomsky: "The press is owned by wealthy people who only want certain things to reach the public."

Jefferson again: "Ignorance and sound self-government could not exist together: the one destroys the other. A despotic government could restrain its citizens and deprive the people of their liberties only while they were ignorant."

*Jefferson could never completely separate education from government. With the fullest faith in the ability of man to govern himself, Jefferson nonetheless realized that self-government could be assumed successfully only by an enlightened people.

"If you're after getting the honey, hey, then don't go killing all the bees"

It's true and alarming that the bee population of the United States is diminishing. Bees remain an indispensable component of stable agriculture systems.

It's also a fact that the value of an average American's estate--mostly the equity of his or her home--has diminished precipitously in the last forty years. Now the Federal government will bail out publicly traded firms (privately held) whose toxic debts average Americans will ultimately pay off in a deflationary economy over the coming years. It appears that market players have not been discouraged from gaming the system because they understand 1) they will not be seriously monitored or regulated, and 2) when they ultimately break the bank after taking their gains, the government will step in and help put the game back together.

Remember Savings and Loan "S & L bailout" nearly twenty years ago? According to Timothy Curry and Lynn Shibut, "the savings and loan crisis of the 1980s and early 1990s produced the greatest collapse of U.S. financial institutions since the Great Depression. Over the 1986–1995 period, 1,043 thrifts with total assets of over $500 billion failed. The large number of failures overwhelmed the resources of the FSLIC, so U.S. taxpayers were required to back up the commitment extended to insured depositors of the failed institutions. As of December 31, 1999, the thrift crisis had cost taxpayers approximately $124 billion and the thrift industry another $29 billion, for an estimated total loss of approximately $153 billion." It appears that Americans have a lethal case of political amnesia. Either that, or they are very forgiving, particularly to those who have great wealth and power and who use them as "back stops" (see below) when the casino runs out of money.

It is presently clear that socialism funds capitalism, non market spectators fund the speculators. Great game.

This past September 15th, 2008, the Dow Jones Average lost "only" 500 points. Some remain sanguine. After all, the U.S. economy is a $15 trillion economy. The United States can even absorb a $2 trillion bill for war in Iraq not to mention bailing out the two federally instituted and publicly traded investment Goliaths Fanny Mae and Freddy Mac.

Larry Summers, who together with Robert Rubin (a principal architect of the present Russian economy) helped deregulate the market in the Bill Clinton years. Presently, they feel chastened. "We need regulators regulating risk, transparency not opaqueness. The buyer and seller need equal views of the real price of an asset. Real disclosure, not opacity" they now say. A little late. These insights would have been put to better use when they enjoyed political power.

Prognosticators are saying that we are at the beginning of an economic recession in Europe and Japan with the risk of global recession. Market won't return to equilibrium until 2010, economy in 2011. They might wish to blame "toxic CDO's."

Toxic CDO's (Collateralized Debt Obligations from Derivatives) sold by Goldman Sachs and other investment banks in a deregulated market environment(See Glass-Steagall Act) have reached other parts of the globe like viral birds. Politicians and journalists have termed any "bailouts" by tax payers a moral hazard issue. Translation: Deregulated market gamblers who have disrupted the market will be salvaged by the very people they hurt most, average citizens. That is, the people are bailing out capitalists who are gaming the market taking big wins up front until the bubble market collapses. Warren Buffet and others saw this coming. Few listened.

Capitalism is supposed to be a system in which players have the freedom to succeed as well fail according Tom Petruno, market beat writer for the Los Angeles Times. We may ask: Is it also a "moral hazard" to take away one of those "freedoms" from the rich and powerful?

An important bit of history: The Glass-Steagall Act Provisions of the 1930s in the wake of market corruption and the Great Depression prohibited a bank holding company from owning other financial companies. The reason, conflict of interest, too easy to cheat. However, these measures were repealed on November 12, 1999, by the Gramm-Leach-Bliley Act, which ultimately passed in the Senate by a 90-8-1 vote, and in the House by a 362-57-15 vote. The bill was signed by President Bill Clinton, but could have been signed by Ronald Reagen or any of the Bush's. Warning: Phil Gramm now counsels "reformer" John McCain on economic matters.

More on the term "back stop": According to Andrew Sorkin of the New York Times, Lehman wanted the the FED (read tax payers) to "back stop" the losses of Bear Stearns, Lehman, Merrill Lynch, Morgan Stanley, Goldman Sacks, which were never depository banks serving common people. Yet common people will "back stop" the failures of these giants whose executives made deca millions and who, with their witty share holders will walk away with many billions of dollars. Bernie Sanders, Independent Senator from Vermont, thinks they ought to help pay for the bail out. What fair-minded person will disagree?


Nevertheless, Morgan Stanley and Goldman are the only two large firms left standing, "back stopped" by the people, uh, government. So...the people do subsidize capitalism--capitalism is socialized. is that be right?! If this is so, how many Americans really understand capitalism as it plays out in America?

Capitalism generally refers to an economic system in which the means of production are all or mostly privately owned and operated for profit. Why not private equity bailing out private players? Clearly, that's not the American way.

Unless the House of Representatives turns down the bill sent to it by the Senate, Secretary of the Treasury Henry Paulson and his boys have the rest of us by the throats. That's a great game they've got going. The plutocrats use ordinary people to save their bacon. Paulson and his cronies got us into this mess, and now, for our own good, we must pay the ransom to salvaging the credit market they helped destroy while getting rich. (Paulson is worth roughly $500 million. It's scandalous, but the bewildered and quietly angry populous does nothing, having forgotten how to participate in a democracy. The capitalists take all the benefits in the form of profits (except for the shareholders who didn't sell in time) and the people get to socialize the losses: public money is put at stake to bail out private gambles in the market largely in the form of exotically packaged derivatives, mortgages placed in the world market as a speculative asset class. When it fails, the lenders get bailed out, not the distressed borrowers who "deserve" to take the hit because they should have "done their due diligence."

Bees don't "do due diligence." They generally work hard and trust that everyone is pulling for the common good. Huh. Silly bees. More truly, silly bee keepers. They're going to lose the hive eventually. As the song goes: "If you're after getting the honey, hey, then don't go killing all the bees."

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Mr. Buffett has spoken: We are in a recession

From the desk of Guy Geldworth:

The jury is in, we are in a recession. Not that most folks who fear job loss or reduced hours, or who have, in fact, experienced it, have doubted it.

Billionaires Warren E. Buffet and Charles T. Munger, Buffet's long-time partner at Berkshire Hathaway Inc., have declared it so. Buffett at the recent Berkshire shareholders meeting in Omaha is a skeptic of the classic criterion: the economy must experience two consecutive quarters of negative growth. His own definition: "...when most people and businesses (are) not doing as well as they were three, six, or nine months before." Obviously, the super rich and those who shill for them like Larry Kudlow (see below) will not respond "yes" to this definition. No discernible change in their income, their material lives.

So, Shush! Don't tell Kudlow of CNBC, the financial channel's market cheerleader whose boss is parent company NBC, which is owned by General Electric. And don't tell our own Guy Geldworth. (We are hopeful Guy's own job is secure when we read headlines such as "UBS may slash 8,000 jobs amid write-downs" in the Los Angeles Times, 5/5/2008.)

But Guy (whom we still love only because he's young and, at heart, principled) and Larry are market guys who've been getting a lot of cheap money from the Fed for years. Additionally, they're dealing with the element who have the money (there's plenty of it around) and who are waiting for another Boom to deploy it in our recent market history of Boom & Bust, Boom & Bust...

Don't worry, there will be another bailout, but after the fall election. Thus, when the market is safe for the "common folk" we'll give a call to Guy because he is, after all, a market guy. But for now, here are the facts. You make the deductions and act accordingly.

• The first quarter numbers are in: GDP growth increased only 0.6%, but even this sickly number is misleading because inventory buildup also increased and indicates actual negative growth.
  
• Exports are diminishing. Both the Chinese and European economies are slowing in their growth. One reason, the dollar has stopped its decline and growth has its own limits.
  
• Economist Paul Krugman has called current banking conditions similar to the bank run of 1930-31. Confusingly, he feels we are not in a recession. I suppose we must crawl through this maze of seemingly contradictory facts and factoids.

OK, the hard numbers. Fasten your seat belts, it's going to be a bumpy ride:

• While the banks have "only" declared $200 billion in losses, $1.2 trillion of losses are yet to come. We know about the huge write downs stemming from the sub prime mortgage debacle. Still to come will be the losses stemming from consumer debt: credit card defaults, automobile loan defaults, student loan defaults.
  
• The Fed has "only" $400 billion in reserves with which to cover losses, yet the losses amount to $1.6 trillion.
• What do the banks do with the "easy" Fed money? Many are not even loaning to themselves. Home loans? Yes, you can borrow, but your rates won't decline. Yet it was your dollars the Fed used to provide cheap cash to the banks. Should you be concerned?
• Related point in housing: Thus far, there have been 200,000 foreclosures nationwide, yet 2,000,000 are projected to follow. "Look for the banks to sell more preferred stock, and bonds in order to "look like they've been doing something" when the inevitable next bailout jackpot occurs after the election. They will want to look good." (Jack Rasmus).

Linkage among: Income Inequality, the Banking Financial Crisis, and the Recession

• More from Jack Rasmus: The United States economy has accumulated $12 trillion in debt in the last six years. $5 trillion in government debt, $4 trillion in consumer debt, and $3 trillion in business debt. This debt should have in some way helped to finance a stimulus to the economy but basically failed. Mr. Rasmus maintains that while some money has gone into financing the Chinese financial boom, from which some American investors have profited, much has gone into off shore tax shelters or was squandered in high risk ventures such as hedge funds.
  
• Thus, a lot of the "debt/stimulus" money wound up in speculative ventures looking for big payoffs such as the current ethanol bubble. While all too many Americans are hungry to fuel their gas tanks with government subsidized corn-based fuel, (part of the $12 billion debt/stimulus) others abroad are simply hungry. One-third of the increase in price of food is related to higher price of corn. Are we Americans not concerned with foreign approval?
  
• Fact: There is actually a surplus of capital which will eventually find its way back into the economy when it is safe.
  
• Fact: For most Americans asset prices are falling, particularly in the value of their homes; and they are incurring greater amounts of debt as living costs rise and the level of their income falls in relative value.
  

One must ask, why trust most pundits on television? They merely work for those who wouldn't know about or seem to care about average people. They're just looking for the next "Bush" to continue the party for the few.

They don't have to look too far. He comes in the form of a former naval aviator, multi-millionaire senator who helped bail out a fraudulent banker who bilked common people of their life savings in the last big boom/bust cycle in the late 1980's.*

How soon we forget department

*In the 1980s when John McCain was embarking on his political career in Arizona, Charles Keating, an Arizona banker, son of a developer, was convicted of racketeering and fraud in both state and federal court after his Lincoln Savings & Loan collapsed, costing the taxpayers $3.4 billion. His convictions were overturned on technicalities; for example, the federal conviction was overturned because jurors had heard about his state conviction, and his state charges because Judge Lance Ito (yes, that judge) screwed up jury instructions. Neither court cleared him, and he faces new trials in both courts.)

Though he was not convicted of anything, McCain intervened on behalf of Charles Keating after Keating gave McCain at least $112,00 in contributions. In the mid-1980s, McCain made at least 9 trips on Keating's airplanes, and 3 of those were to Keating's luxurious retreat in the Bahamas. McCain's wife and father-in-law also were the largest investors (at $350,000) in a Keating shopping center; the Phoenix New Times called it a "sweetheart deal." (CNNfn Web Site, December 2, 1996). (Jack Rasmus)

In today's American judicial system, lack of conviction often is no indication of innocence, particularly when a political figure like McCain steps before the bench.

Recession or Depression: More from Guy Geldworth

From the Desk of Guy Geldworth:

As you will recall, when I posed the thought of a Recession to Mr. Geldworth , who holds his CFA badge of authority, he responded with the word "uncertainty."

Uncertainty may still the word according to "lagging measures," but to many, it feels like a recession. You know the saying: When your neighbor is out of work, he's unemployed, when you are out of work, it's a recession.

While I'm still employed, I'm saying saying at least we're in a narrow recession. The CEO of Wells Fargo, a three-star bank has said: "We have not seen a nationwide decline in housing like this since the Great Depression." And from other experts: "It is now clear that the U.S. and global financial markets are experiencing their worst financial crisis since the Great Depression," according to economist Nouriel Roubini.

Jack Sands: So, have we skipped the Recession? Indeed, are we headed for a Depression?

Guy Geldworth: (laughing) A Recession? No, not strictly. A Depression, certainly not. In the Depression over 24% of the workforce was unemployed; in the United States in April, we had 4.8% unemployment. GDP registered a 0.6% gain--industrial production has been slightly up. There's still a debate whether the stock market is in a correction or a heavy bear market.

Jack: What about the housing recession. What about the banks still tight with credit. Fed Chairman Ben Bernanke's efforts haven't seemed to help.

Guy: It takes time for those economic stimulus checks to find their way into the economy.

Sands: I'm told the people who need them most will simply pay off debts.

(Pause)

Geldworth: I repeat, you can determine what a recession looks like by measuring real GDP, real income, employment, industrial production, and wholesale-retail sales. Employment is not bad, industrial production is slightly up, real income is uncertain at this point, and yes, wholesale-retail sales are down, housing market, down. Just too spotty.

Sands: So, we're on the downside of a cycle that smells like either a Recession or a Bear Market, bad sentiment, high volatility...

Geldworth: I believe so. We just have to let things run their course. The bank failures are a necessary, sloppy characteristic of capitalism. Call it dirty if you like, but in the long run, these excesses will be cleansed, and equilibrium will be back. A new cycle.

Sands: How do you know when the new cycle is on the way?

Geldworth: Contrarian signals is one way. According the the ISE index an increasing number of puts are being purchased indicating too much negative sentiment, a classic reversal signal.

Sands: I'll tell my out-of-work neighbor to get out his happy money.

Geldworth: If he has the inclination. Remember to tell him, Asset Allocation using non correlated measures. (see posting of 11 March 2008, "The Semantics of Recession")

The semantics of "Recession"

From the Desk of Guy Geldworth:

Note: Guy Geldworth, who holds a CFA, will occasionally collaborate with this blogger on matters concerning the market and economy. Guy will treat the technical part; I will weigh in on the language part--mostly semantics: "the study of the meaning and use of words and phrases, the form rather than the structure, Concise Oxford Dictionary.

Jack Sands: There has been much discussion lately of recession. The "R" word reemerges from time-to-time because markets, after all, are subjected to cycles.

Guy Geldworth: I prefer the word "uncertainty," but will speak to the word you used. By definition, a recession consists of "two back-to-back quarters in which gross domestic product (GDP) declines year-over-year." That's two back-to-back quarters of negative growth, but this is considered a "lagging measure," which is a blunt instrument, in my opinion. Since the early 19th century, there have been roughly six recessions and three depressions. You can also determine what a recession looks like by measuring real GDP, real income, employment, industrial production, and wholesale-retail sales. (Wikipedia).

Jack: So, gauging a recession seems to bear (bad pun) on determining whether certain conditions are met measured by numbers, and if met, when the conditions began and seem to be subsiding.

Guy: Yes. To get a sharper picture of those conditions it's necessary to look at more recent market history since today's economies operate in a much more complex world. Let's look at the market since the mid part of the last century. Since 1960 there have been twelve bear markets, seven of which occurred during a recession. Bear market: "a market that has dropped at least 20% by major indexes from recent highs" (Los Angeles Times); "a market that is accompanied by widespread pessimism. Investors anticipate further losses and are motivated to sell. A bear market is one in which negative sentiment feeds on itself in a vicious circle. The most famous bear market occurred after the 1929 stock market crash and lasted two years." (Wikipedia, the free encyclopedia).

Jack: Besides the numbers, Bear markets seem to deal a lot with sentiment, that is, a feeling of things going bad.

Guy: Yes, if enough people feel bad enough, they will begin acting as though there is a recession (by selling off their equities) which then may assure one.

Jack: Hate to be thick, but it brings me back to our question: What is a recession? It seems to built by both numbers and emotion.

Guy: That's my point. I'll repeat: a recession consists of two back-to-back quarters of negative growth, and let me emphasize often influenced by negative sentiment in a period of uncertainty. That's my story, and I'm sticking to it. But let me continue with the "recent history." Of the seven bear markets that occurred in a recession, the average length of the recession was eleven months. During those eleven months, the average number of months it took the market to hit the trough (its low point) was seven months. The drawdown period from peak to trough (gauged by market charts and technical analysis) during that period was 23.4 months. (Drawdown: "the measure of the decline from a historical peak in some variable; unrealized losses) Concise Oxford Dictionary.

Jack: Depending upon your positions, if you had some idea about this history, the market "rhythms," of recessions and bear markets, you might be able to ride it out without panicking and selling, at least your good positions.

Guy: Now we're getting to the punch line with respect to what's happening presently. An important current fact: the "final number" is not in for Q4 , 2007 (a measure of fiscal fourth quarter growth or lack thereof in the economy. Fourth quarter: November, December, January, 2007). We could be negative right now, but let me emphasize, of the six recessions I referred to earlier, only twelve percent experienced a downturn. (a downturn can be considered to be a consequence of an expansion reaching an unsustainable state, that is corrected by a brief decline). So we may ask, how bad is a "recession" by definition as compared to a non recession? How bad is a downturn, given that downturns are brief?

Jack: OK, now you're talking about the semantics of it all.

Guy: Without meaning to bore you, it's important to further note that the five bear markets that have occurred since 1960 took place in a non recessionary period.

Jack: A lot of negative sentiment.

Guy: Precisely, and the average number of months of the market decline was seven months. The drawdown during that decline, unrealized losses if you didn't sell, was 21%. Pretty scary, especially if you're not familiar with market history and its rhythms. Incidentally, the number of months to recovery from the trough was thirteen months.

Jack: So, if you could hang on, and you sold the dogs, you'd begin to see your balance sheet returning to normal.

Guy: Even advancing if you got in early enough, if your timing was right.

Jack: Still, is it a sign of weakness to go to cash in these environments, or to investments other than pure equities?

Guy: Certainly not. Always have some cash, 10, 15, 20% based upon your age and risk tolerance. We can get to that. The important point here is that if you look at things like sentiment indexes such as the ISE sentiment index, smart money starts working when the index hits historical lows.

Jack: The opposite of what a lot of folks believe. So, we should see higher equity prices by year's end?

Guy: Depends upon your sentiment, and sentiment, in my opinion, should depend upon your reading of fundamental and technical data of companies and economies. Again, if we are negative right now or have been according to our recession formula, and the Fed (Federal Reserve System, the Central Bank of the United States governed by the Open Market Committee) doesn't get over involved, then yes, we should see higher prices for equities. I believe the Fed should hold tight with lowering rates until the next meeting because, although the weak dollar serves some but not all in overseas trade, it dampens the domestic environment, particularly oil which is priced in dollars. It's a domino effect, a weak dollar causes further weak sentiment, further tightening of the credit markets, and on and on.

Jack: So what does a person do in this period of "uncertainty"?

Guy: If I had to make not one, but two points, number one would be: in our current situation, use the word "uncertainty," not "recession," and operate from that "semantic" vantage point in charting your asset allocation and diversification course of action. And while charting that course, my second point: use non correlated measures. (Correlation does not imply causation, that is, correlation between two variables does not imply that one causes the other. Correlation is a logical fallacy that implies that two events that occur together are claimed to have a cause-and-effect relationship. (In Latin: cum hoc ergo propter hoc, or, post hoc ergo propter hoc). If you use a broker or financial consultant, ask what informs their portfolio constructions. If they use a lot of correlations, I'd say find another individual or firm.

Jack: You make correlated measure sound like a kind of voo doo.

Guy: You're not going to get me caught up with that.

Jack: Until the next time, then.

For a further look into the semantics of "Recession"see: "UCLA Experts Don't Buy Recession"

and, "Will the R-Word incite the bears?"