Happy Groundhog Day

Punxutawny Phil knows its not different. Same thing, different year, and yet the masses are hopeful.

"Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that 'this time is different.' That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy."

- This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)

The Reinhart/Rogoff book is one of the stars of the financial books published in 2009 and for students of markets and history it is a good, if at times weighty, read. Much of what we presume to be conventional wisdom is in fact thinking constrained by our relatively short term experience. Reinhart and Rogoff looked back over hundreds of years to find parallels and the McKinsey Group found 32 examples of financial crisis followed by sustained deleveraging such as we are experiencing now. At a time of such uncertainty we are well advised to look at events from 30,000 feet and not from within the maelstrom.

Looking at centuries of debt cycles the Reinhart/Rogoff book reports that on average a country's outstanding debt nearly doubles within three years of the crisis. Unemployment rates on average increase seven percentage points and remain elevated for five years. Finally, once a nation's public debt exceed 90% of GDP economic growth slows by 1%.

Many of the historic models and forecasts being touted this year are based on post WW-II experience which may turn out to be less than useless, even harmful. Trillions of dollars of financial espresso can get the consumer pretty jacked. It doesn't mean necessary that it is sustaining.

Instead of econometric models of the past 40 years an analysis must look for examples, sometimes centuries old for relevant examples of deleveraging economies. Ironically the assets that look less risky now are in the developing nations. That is also where the growth is likely to be found, where the consumer sector is still very young, where national debt levels are low, where reserves are high and trade surpluses abound. The developed world has lost its position as drivers of the global economy.

Each of the developed markets presents its own challenges for investors in both equities and bonds. Japan has its aging population and need for external financing. The U.S. has large deficits and exploding entitlements on the horizon, and Europe faces such disparate members one wonders how it will remain united. Germany the extreme saver and producer while at the other end Spain and Greece are awash with debt.



It's never different, but you may need to be the better part of 100 years old to remember when it looked like this.

John Barnyak
Stonehouse Asset Managment

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

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

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

Color Me Puzzled

Never before have I seen and heard such a disparity of opinion and certainty as in the current economic and investment arena. The economists are generally glum and fact based. The sell side investment wags are buoyant and perky. The Chief Investment Officer of one investment house stated, "we feel like this market still has some room to move higher. We're still at levels that are lower than we were before Lehman Brothers. We are vastly better off than we were then."

God help us if this gentleman should ever think we are not doing vastly better. Since the time of the Lehman collapse things have improved as follows:

We have lost 6.2 million jobs

The unemployment rate is 10.2% versus 6.2%

Real GDP is down 3%

Housing starts are down 30%

Auto sales are down 23%

Bank Credit has contracted 8% or $500 billion

Household net worth has declined $7 Trillion

Home Prices are down an average of 10%

Office vacancy rates are up 3.5% to 17.2%

Apartment vacancy rates are up to 11.1%

Consumer confidence is down 11 points to 47.7.

The U.S. budget deficit has tripled on the back of a government engineered "recovery".

Never has a market recovery been so powerfully driven by deflating employment, credit, wages and rents.

The macroeconomic challenges of our country are daunting and fundamentals are out the window as ad hoc solutions are pulled out one after another. Seems like a shell game of trying to buy time for the great and powerful Oz behind the curtain.

John Barnyak

Hats on, Hats off

With apologies to the Karate Kid, last week the CNBC the staff dusted off their Dow 10000 caps and donned them in celebratory hurrahs. For the 27th time since 1999, the Dow crossed 10,000. Pretty special moment obviously.

I had an aunt who crossed her thirty-fifth birthday almost as often. Some celebrations are more about rolling eyes and making wishes than reality.

(oops, just crossed again, hats off)



(click on image for clearer image)



John Barnyak
Stonehouse Asset Management

Back in the Saddle

As my wife said to the doctor, "he's says he's never sick. It's because he never goes to the doctor." Sure enough I went, and got sick. I liked my way better. Now I am back to following the markets stressfully and doing all those ridiculous things I've heard rumors of, like eat better, lose weight, get some sleep. Silly things really, but I'm giving them a try.

With that out of the way, let's kick off with the Financial Times takes on banks with a bit of tongue in cheek.

http://www.ft.com/cms/4fe40d1a-07b4-11dd-a922-0000779fd2ac.html?_i_referralObject=10664514&fromSearch=n

The Financial Times video cannot be embedded into the blog, but past the above link in your browser to view.