Friday, January 29, 2010

All Engine No Transmission

Taken with a grain of salt, this morning the headline read:

WASHINGTON (MarketWatch) -- Coming out of the worst recession in generations, the U.S. economy grew at the fastest pace in six years during the fourth quarter of 2009.

Uh huh. Out the blocks the Dow rose more than 100 points and then reason drifted in. If one assumes the report today to be good news and we are still at this moment trading at a 30 point loss for the day, it is very troubling indeed. Bull markets rise on bad news and bear markets tend to fall on good news. Misleading news? I'm not sure, except that such things eventually come home to roost.

The headline 5.7% quarter on quarter annualized GDP growth looks halfway decent unless one is a economics wonk. Removing the adjustment of inventories to sales to more accurately look at true demand, we get to a lackluster 2.2% annual rate of growth. If we take out the foreign trade sector we find domestic growth of 1.7%.

The massive amounts of monetary and fiscal stimulus would, in a "normal" recession be creating growth over 10% and begs the question, what happens if public debt stimulus fades this year? Aggregate hours worked in the private sector FELL in the fourth quarter, so equating to a 5.7% growth rate stretches credulity. Domestic demand is little more than flat in the end analysis. Is it any wonder that President Obama singled out export growth an economic driver in the future in his State of the Union address? Domestic economic demand for the next few years looks tepid at best. We HAVE to look elsewhere.

What are the investment implications of this call to export arms? (Excuse the unintended pun) In domestic equity investments those companies with substantial export capabilities likely offer better prospects. Secondly, the likely driver of increased exports will be a weaker dollar to enhance international competitiveness. In that vein a longer term perspective on commodities and precious metals should also prove useful. Shorter term the asset bubble that we are once again experiencing, including commodities, may may take a breather in this still substantial deflationary environment.

It will be years before this economic python swallows this debt pig.

John Barnyak
Stonehouse Asset Management

Thursday, January 28, 2010

That's another fine mess.....

Lately, well, more than just lately, I’ve been trying to find value somewhere in any market. Stocks, bonds, commodities, and I don’t see much at all. But I am not alone.

After the Fed has created over a trillion dollars out of thin air, and all asset classes have ramped up, there’s not much left. In a recovery that is almost entirely government based it still doesn’t look like a self sustaining recovery. Much like 2005 to 2007, institutional investors are looking for ways to project earnings adequate to fund pensions at statutory levels.

The State of Wisconsin investment board, responsible for $78 Billion has found their new holy grail. Borrow. Use leverage to pump up returns to keep the wolf away from the door. Wisconsin is adopting a strategy of borrowing from 4% to 20% of the portfolio value to buy fixed income investments.

After becoming disillusioned with the use of hedge funds and illiquid private equity investments pension managers are scurrying to find higher returns in a disturbingly familiar way. This is how bubbles are created. And as we have heard, there is no predicting when they have run their course. The yields available in safe fixed income are too low to provide sufficient returns. So we move back up the risk ladder to find the target return.

Why these managers weren’t leveraging early last year when bonds were priced for value is a mystery. The problem is that the bond market is so vast that this bubble could continue to inflate for a couple more years in a deflationary market. So for yield, corporate bonds provide some of the answer, but with much more risk than a year ago.

Much like 2005/6 when the real estate bubble was about to blow up, global asset allocation is piling into fixed income at the end of a very long secular bull bond market. The allocation of bonds to equities remains underweight. In a deflationary environment for the next couple years bonds are still reasonable and apt to benefit from such activities as Wisconsin’s strategy which will work until it doesn’t. Then it will pop.

Stay balanced and don’t expect any free lunches in this market.

John Barnyak
Stonehouse Asset Management

Tuesday, January 26, 2010

Tipping Point?

Sadly it would seem that financial analysis has become so entangled in political analysis it is impossible to do one without the other.

Ten years ago Malcolm Gladwell wrote the popular book, The Tipping Point. A tipping point is an otherwise small event that precipitates a massive social change. I would suggest we may be near such a point.

Over the past eighteen months the world has endured the deepest and most prolonged recession since the 1930’s. The unemployment rate is the highest in a generation, the debt of the country and its citizens is at unprecedented levels and the obligations for the future are being swept under the rug. Yet the market rebounded fabulously last year. All the while the fundamental reasons for the meltdown remained intact and borrowing trillions from the public to give to the private sector was the best that could be come up with.

The item which has galvanized me to again write here is the Supreme Court ruling of last week which clears the way for corporations to exercise their constitutional rights as citizens. Corporations now have the same rights to contribute millions (or billions) to political candidates as you and I. With an election process that continues to see ever increasing cost (price) while seemingly moving further away from coherent debate this seems like a holly stake to the heart of government by the people.

According to Senator Mitch McConnell (R) from Kentucky, "For too long, some in this country have been deprived of full participation in the political process." The statement alone makes me cringe as if by limiting campaign contributions from Exxon or Pfizer or Citibank somehow disenfranchised the individuals managing them. In a nation that increasingly seems to be a ‘one dollar, one vote’ democracy, this court ruling seems to underline all the more emphatically the entwining of politics and our current style of capitalism. Having given countless banks a free pass on insolvency by loosening FASB accounting rules or given sufficient taxpayer capital to them to avoid or delay the impact of horrific business management decisions, we have seemingly moved from Wall Street to Every Street.

Normally in a Supreme Court ruling I find disagreeable, I can see both sides of the argument and play devil’s advocate on either side. However this ruling opens a path for the disenfranchisement of us all. Not since the Court ruled in favor of slavery in the Dred-Scott case has a ruling been so detrimental to the common good and public policy.

I wonder, could this be a tipping point, one way or another? As one client said, just how much more will the people accept?

John Barnyak
Stonehouse Asset Management