Thursday, July 23, 2009

Tax policy set to deter economic growth:

“Read my lips, no new taxes,” “If you make less than 250,000 dollars, your taxes will not go up by one dime.” Over time we have heard these lofty pledges by candidates running for the American presidency. In the current case, while President Obama may honor that pledge for a little while on the income tax front, it is clear that taxes on the fringe are all set to rise. From new taxes proposed on investment transactions, to cap and trade (hidden tax on consumers), to sin taxes on liquor, and cigarettes, and dare I say gasoline, to new inheritance taxes, and taxes on the wealthy to pay for the health care bill, to continuing on with the highest small business taxes in the world, it is safe to say that the current administration and its Congress is hell bent on raising revenues while honoring its central campaign pledge for as long as it can. Please note in a rare and possibly unnecessary confession, I just don’t want you to think I am a hard core Republican (we are just getting to know each other after all) that I voted for these Democrats this time because I thought they were going to govern from the center and also because I was appalled by the Bush presidency. At this point, I think it highly unlikely they would earn my vote again. Anyhow, a budget crisis due to optimistic growth projections and a California-esque inability to cut spending in any meaningful way, spending that is annually above what we are technically entitled to enjoy based on what we produce, may force the President to renege on such promises, but that is a bit off in the future. In any event, trickle-down economics has been abandoned, and while I still sometimes agree with Al Sharpton’s assessment: “We didn’t get the trickle, we got the down,” it is hard to argue that creating conditions for the issuers of jobs to succeed should be something to ignore to the degree that we are leaning towards. Keep in mind, as a framework, that taxes on Britain’s highest tax bracket just jumped from 40% to 50% in response to their budget crisis. Many people I know in the industry are thinking about relocating to other more tax-favorable locations in Europe. For a financial based economy like England has, this may turn out to be more troublesome than envisioned. But time will tell if this is just noise. In any event, Republicans are currently rolling in their graves as current policy appears to be as far left as Bush was right. In a nation that describes itself as centrist, I find it incredible that we cannot seem to get a centrist in office, someone who is morally liberal, fiscally conservative, and is mindful of the underprivileged.

Practical market advice—2 scenarios:

I am going to tell you my market thesis. Scenario 1: I suspect we rally a tad in mid July (we are actually doing that now), followed by heavy selling through mid August. That will be when I will aggressively look for entry points into stocks that performed well during the March to June rally, stocks whose prices have corrected substantially. Commodities are an obvious choice, as is technology, a bright, promising sector well along on an almost decade consolidation. A further deployment of stimulus funds, coupled with increased production due to tightened inventories, amongst other short-term positives may drive the expected fall rally to be quite strong and could realistically propel the S&P as high as 1050-1100. At that point, I will sell virtually everything, get short, turn off the computers and relax for the remainder of 2010 and beyond. In a nutshell, this is what I am expecting and I have a reasonably good feeling about this. So, those anxious to make some money back, I would at least consider your strategy along these lines. In mid-August, hopefully after this deeper market correction, I will start to get serious. That’s my plan, just thought I would let you know, it is the type of practical commentary that I shall aim to convey in these newsletters, tangible things that may help you in your personal decisions. Please understand this is just my opinion, and the timeframes indicated are essentially rough guidelines as next week’s action could enhance or violate this thesis. But the general point is this: at some point this summer if the S&P finds itself lower than currently and that’s when I will look to make some purchases.

Scenario 2 (The straight shot thesis): We continue to rally without any major disruption to S&P 1050-1100 and I then get short everything under the sun except for shiny things that can conduct electricity. This possibility will keep me from looking for shorts here. In this case obviously, the rally would occur now and the later fall would be the bloodbath. Markets just seem to be in no-man’s land here. This scenario is as plausible as the first so be wary.

Speaking of Debt

Speaking of debt: DEBT, DEBT, DEBT Consumer debt, bank debt, mortgage debt, government debt are at levels we have never seen before, even in relation to GDP, with perhaps the only time we were close being during World War II ((at least in terms of public sector debt). This is a major problem!

“The Entitled Society”-- pretty amazing. I suspect many older Americans are so fearful of this nuveaux moral fabric, this complacency, this by definition “We are the United States, of course everything will be fine” attitude. In a society where consumer spending accounts for 70% of economic growth, one can see just how vital a healthy and willing consumer is to the system. Unfortunately, the consumer spending numbers that we are using as our ‘normal’ reflect one off-deviations from the drivers of such spending, namely job and income growth. They stand belly out, belt unbuckled, after home equity loans, signature loans, car loans, mortgages, all of it. As the consumer continues to nurse its hangover and realign its balance sheet, consumer spending will remain soft, slowly contracting back to a new normal level that more properly corresponds to income.

Unfortunately, what policy makers do not seem to understand, is that you can throw a bunch of money at banks to help their balance sheets, you can line the pockets of every federal agency as we saw with the Omnibus spending bill, but ultimately, you cannot make people spend money if prudence is dictating them otherwise. There is a larger paradigm shift going on here. Consumer attitudes have been dramatically changing, rather quickly I might add. And perhaps rightly so, as the government attempts to essentially fix a problem of too much credit and debt by creating and encouraging its continued expansion. Fortunately, consumers appear wiser this time around and its one of the behavioral adjustments that the government has NOT taken into account as it projects its 3.8% domestic GDP growth rate for 2010 and its 4.5% average growth rate for the following 8 years. I am quite confident that GDP estimates will be ‘shockingly’ downgraded next year as this understanding sets in, and in turn, the budgetary shortfall will be exacerbated as revenues will obviously also fall short of expectations. As a matter of fact, I don’t think we will have to wait that long. I am hearing mumblings of an economic revision to the downside as early as mid-August, thereby raising the numerator (deficits and ultimately debt) and lowering the denominator (GDP) in the all import DEBT TO GDP RATIO. This is going to be a real problem, causing all sorts of what I shall call “new math” arising and it’s not going to be pretty. While I remain somewhat optimistic that the market may see another sizeable rally after some retest of a higher level than the March lows this summer, it is a rally that will run into a brick wall in the early part of next year at the latest, and may very well not materialize at all depending on how more recent action unfolds. The only one ‘surprised’ by the announcement will be the President himself, and his Congress, and the people on CNBC, and a lot of people that do not take the time to read alternative media like The Midnight Rambler. Worse, those surprised will endure a beating in the second half of 2010 tantamount to what they just went through in 2008 (though in Obama’s case, that’s not quite true, as 2008 was a great year for the man, and 2010 should mark the beginning of his political demise). I can’t remember who said it, but the saying goes like this. “It’s not the first loss of 50% that truly wipes out investors, it’s the second.” I suspect there will be a time late this summer when I will recommend buying stocks, but never forget, that is only if they substantially sell off from here, and that it will probably be the last good rally for the next five years (but who knows really, maybe a latent computer bides its time!), a rally to be sold aggressively at its conclusion. But we will talk about this more in the August newsletter. Should the S&P hit 750-800 or so before you hear from me again, please know that I will be buying commodities, Technology, banks, whatever and anything for the final hurrah.

“Big Slice Version”

Employment as a Lagging Indicator: You are either a CNBC anchor or the President himself if you’ve found yourself lingering around the “improvement right around the corner, unemployment is a lagging indicator” store. Or you’re high on Ether, maybe smelling salts. No, I don’t believe for one second that one of you good folks thinks that things are OK. There will be no V-shaped, or rapid economic recovery, this time around. There are simply too many headwinds to long-term growth. Highly questionable economic policies coupled with the ball and chain, the elephant in the room, Atlas’s burden, the all powerful, all mighty, horrible word, DEBT, shall prevent the American economy from doing what we are accustomed to…bouncing back. No, the computer was a tremendous growth engine, changed everything for the better, so many brilliant people, thank you, keep working, but there will be no imminent virtuous cycle of economic growth that fuels its own engine, save a new paradigm created, good luck on that, although I’m sure we do have some of our best men and women on it as we speak!. One of the great claims by the bulls in the recent showing of market strength through early June was that the unemployment data is a lagging indicator, that the economy will be long on its way to recovery before the results trickle down to the jobs data. It was this belief that kept propelling the Dow Jones Industrial Average up 100 and 200 points despite continued readings of massive job loss. The President himself has publically clung to this “statement of fact” in many recent addresses on the state of the nation’s economic health. I may not have the President’s official credentials but I can tell you that, unfortunately, this time it is different. Yes, yes, I know those are dangerous words, words that, over time, can cause one to over-think simple relationships. Nevertheless, it is different this time. Typically the model goes something like this—slowing growth causes the Fed to slash interest rates, which boosts credit, which translates into consumer demand, which improves business balance sheets and production, and ultimately necessitates that business expand to accommodate such growth. Jobs are then created, and long after the stock market and leading economic data have improved, the unemployment data finally kicks in and stamps an official end to the recession. That’s how it’s supposed to work. But we have a problem. The Fed has already taken the Fed Funds Rate to 0%, but with consumer debt so high relative to income plus massive losses still unrealized on bank’s balance sheets, credit has continued to contract. It seems as though consumers are as reluctant to take on credit as the banks are to accommodate them. This, my friends, is a headwind, and a strong one. When I think about it, it almost seems as if jobs, this time around, will be a pre-requisite for truly coming out of the recession. At least maybe, we’ll meet in the middle or something. But we have to get back to more traditional relationships between income and credit, income and housing prices, income and consumption. Yes, I think it is quite safe to say that credit can be expected to contract as long as people continue losing jobs or settling for less employment than desired. This reality should serve to delay any strong recovery, or new virtuous cycle arising from the ashes. Please flush, if you will, the traditional model of moving out of a recession down the proverbial toilet.

Yes Sweetheart, I would like some fresh Basil on my pasta tonight.

Dismantling the V-Shaped Recovery, Obama’s “Rosy Forecast”

“Abridged Version”

Things are bad. Things are going to stay bad for some time, years not months. The government’s forecasts of GDP, deficits, debt, employment will all be revised to the downside over the next year. This is a time to buckle down and to be realistic that a new, virtuous cycle of economic growth requires far lower total debt as a basis for credit expansion. Do not be fooled. Sure we may rally more this summer or fall, but there is another bloodbath in the making. Our political system seems fractured, career politicians manning the ship alongside the invisible hand of major financial institutions. Be smarter than your neighbor. This is the real deal, Evander.