The huge deficit. Through February, the US deficit is $651.6 billion.  The deficit is 10.5% higher than last year (at this time).  February’s deficit ($221 billion) was the larget monthly deficit ever.  (I remember when that was our annual deficit!)  This was the 17^th consecutive month of deficit.

LA could use some help. Los Angeles is asking the government to help them borrow $9 billion to speed construction of 12 new mass-transit rail lines.

Illinois needs a lot of help. Illinois’ Governor said that state income taxes must increase 1%.  Otherwise, payments to public schools will fall 17%.  The state faces a $13 billion deficit for the next year.  Even with the tax increase, there will be a $4.7 billion deficit.

Employment

Unemployment has peaked? One economist said that we’ve never seen unemployment drop .4% and then go on and hit new highs.  In other words, he argued that since unemployment has come down from 10.1% to 9.7%, unemployment has peaked.

Forecasts for a big jobs report in a few weeks. Some economists are predicting that the March employment report (which we will get in early April) could be a one time blip on the positive side (in the range of +300K jobs).

Municipalities can’t hire. State and local governments are the biggest employer in the US (15X as many employees as Wal-Mart).  But, state tax revenue dropped 11% for the year that ended in September.  So, don’t expect hiring.

We’re going to solve the unemployment problem by hiring every American to count every other American. In Texas, the Census is still looking for 25,000 applicants from “hard-to-count” communities.  These are populations with language or cultural barriers.  They expect to have a total of 100K workers in Texas at the peak.

No summer jobs. In 2000, 45% of 16 – 19 year-olds had summer jobs.  That number is expected to be 28.5% this year.




Credit Markets

Big debt issuance. In 2010, US companies have already issued $195.2 billion of debt.  Last year, companies had issued $166.8 billion by this point.

Narrow spreads – it’s all backed by the US government. Spreads between Fannie and Freddie bonds and Treasuries narrowed to the smallest spread ever (61 bps).

Credit default swaps. There is approximately $25 trillion of credit default swap exposure outstanding.  There is approximately $80 trillion of debt outstanding in the world.

Greece is paying more than they expected. Greece is paying 6.25% on its recently issued debt.  If rates remain at that level, Greece will pay approximately $1 billion more in interest than expected.




China

China property bubble. China’s property prices are 10.7% higher than a year ago.  Their CPI is 2.7% higher.  Sales of residential properties have increased 37% in the first two months, but that is less than the 50% rate of last year.

China trying to slow speculation. In China, buyers must now put 40% down on second homes.  First time buyers must put 30% down.

China is an export machine. China’s February exports increased 45.7% YOY.  Imports grew 44.7%.




Random

Fewer VC firms. The number of active venture-capital firms was 1,023 in 2005.  It has dropped to 794 at the end of 2009.  I would like to see more stats on this…it wouldn’t surprise me to just see that the existing firms are bigger.

Fraud alert!!! There are 5MM households behind on their mortgage payments.  The government has a new plan where lenders must accept short sales (based on real estate agents information on the minimum acceptable level!!!).  The government will pay people $1,500 to walk away from their homes and will give $1000 to the lender.  Get ready to hear stories about insane amounts of fraud in the next year.

I think politicians should have to register with the police; I’d want to know if one was moving into my neighborhood. I hadn’t kept up with the Eric Massa story.  Apparently, he resigned from Congress.  He was accused of sexual harassment – groping some of his staffers.  At one point, he said he tickled one of his male aides until he couldn’t breathe.  Now that I know that’s not allowed, I will also stop tickling my male students.




PART 2: My Blog Supporting the Alumni Business Conference

http://blogs.mccombs.utexas.edu/alumni-news/2010/03/09/a-message-from-mr-manners/

A Message From Mr. Manners

Well, another year has passed and it’s time for the 5th Annual Alumni Business Conference.  As you will see when you arrive, Jim Nolen and I still look marvelous. I don’t know how we do it. (As my wife said to me recently, “you look the same as you looked in college; and that explains why you didn’t get married until you were in your 30s.’)

I want to tell you a little bit about what I’m going to speak about this year. In 2007, I taught you how you too could make money in real estate with no money down. In 2008, I showed you how to get rich by investing in Lehman Brothers. My March 2009 tip was to buy Greece. So I understand that there are a few of you who might not be able to afford this year’s seminar.  But for those of you who didn’t take that advice (or even better, did opposite), I think we’ve got a really useful lecture for you.

I decided that I’ve already made you enough money in past years. I’ve also come to realize that not all of our attendees care about money. So, I’m going to teach you about something that will allow everyone to succeed: manners.

Most importantly, there are going to be important, practical takeaways.  You’re going to leave my session being able to:

1. Look a banker in the eye and appear sincere when you say, “you deserve your bonus; I’m happy you got it. And for what it’s worth, I was shocked that the AOL / Time Warner deal didn’t work out.”
2. Have a smile on your face when you tell your friends at Goldman, “you really do do God’s work. How can I join the Church of the Rich?”
3. Learn how to outsource, so that you can take certain burdens off of your spouse (special guest speaker: Tiger Woods).
4. Politely make your point to family and co-workers who are self-centered and can’t balance their checkbooks by smiling and referring to them as “Congressmen.”
5. Smile without laughing when young people say that they plan to rely on Social Security.

Normally, you’d pay hundreds of dollars for lessons like this. But, we’re offering all of this for much less.  Before I tell you the price, I’m going to throw in one added extra. As an educator, I’m going to show you how I completely eliminated that college tuition liability that was destroying my personal balance sheet. As a result, while many of you foolishly set aside hard-earned money each month saving for your kids’ education and living with less luxury than you deserve, I am able to spend everything I make.

How do I do it, you ask? Once a week, sometimes twice if I feel like it, I let my kids know that they’re really not college material. I point out mistakes they’ve made and things that they don’t know. When my children ask where I work, I tell them “at a University, but you don’t need to worry about that; it’s only for smart kids.” It really only takes about six weeks (on average) for kids to lose their confidence. You’ll start to see results in even less time. (My kids stopped making eye contact after about three weeks.)

Look, I’ve probably just saved you hundreds of thousands of dollars. The least you can do at this point is write a small check to the Business School and pick up a few more tips like this. Practical education my friends…that’s what it’s all about.

I hope to see you on March 25th and 26th at the Alumni Business Conference. It only costs $130 and we’ll have lots of fun. My actual topic will be “You Can’t Handle the Truth!”
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Farrell\'s Article Link




Don’t read my writing as an endorsement of this.  Rather, my view is that there is a low probability / high impact event out there and you should think about it and assess what the probability is.  If you want to think about a low probability / high impact event, lets imagine that it was March 2007…would you have believed that in the next 18 months, Bear Stearns and Lehman would be gone, and Merrill would be part of Bank of America?




Farrell’s article is actually a description of a paper written by Harvard’s Niall Ferguson, a leading financial historian who says that imperial collapse can happen much more suddenly than historians imagine.  He’s quoted as saying, “A combination of fiscal deficits and military overstretch suggests that the United States may be the next empire on the precipice.”




Ferguson’s article was just published in Foreign Affairs.  So Farrell’s brief piece got me interested in reading the source document.  (You can buy a pdf of Ferguson’s paper for 99 cents online.  I don’t like to flaunt my wealth, but I went ahead and bought it.  I figured that if the US is coming to an end, I wouldn’t miss the 99 cents.  If the world doesn’t end, Jenny will get one less Christmas present next year.)




Now, having read the actual source document, I’m not sure that Farrell’s piece actually does it justice.  But, Farrell brought it to our attention and got people thinking about it, so that’s good.




Here are some of the important thoughts from Ferguson’s paper:

1. All empires, no matter how magnificent, are condemned to decline and fall.

2. Historians believe that civilizations reach their demise gradually.  It is often the result of their attempt to defeat other civilizations (sometimes for commerce).  Most historians believe that it is part of a natural (albeit slow moving) cycle.  In addition to imperialism, other causes could include abusing their natural environments.  For example, civilization can grow beyond its agricultural supply and civil war can ensue.

3. Leaders (politicians) have little incentive to address long-term problems.  Many times, problems won’t manifest themselves for a hundred years.  Thus, the demise of civilizations often take quite some time.

4. The US has long-term threats.  The CBO suggests that public debt could rise from 44% (before the crisis) to 716% by 2080 given likely changes.  If current policies remain the same, the debt will be 280%.  Regardless, we don’t have the political will to make changes (cut entitlements or increase taxes).   China’s GDP is expected to overtake the US sometime between 2027 and 2040.

5. Ferguson asks…but what if this is not a slow cycle, but something capable of sudden acceleration (maybe we could call this “the Toyota view of the world”).

6. Great civilizations are complex systems that have many interacting parts.  These parts operate “on the edge of chaos” – where they are stable for long periods of time.  Then, some small trigger can set it off.  After it gets set off, historians arrive and tell a story about the event and how there were “long term causes.”  Often times, the historian misunderstands the complexity, but the story is satisfying.

7. More often than not, the calamity is actually caused by something very proximate in time.  They are not culminations of long stories.  They are breakdowns of complex systems.

8. A small input to a complex system can have an effect that is amplified.  As an example, you can give too much of a vaccine to a patient and you can kill him.  Some people who study complexity believe that it’s impossible to make predictions about future behavior (because of all of the possible outcomes of a complex system).   (The size of the system’s breakdown is often hard to predict.  You don’t know how much damage will occur with a forest fire.)

9. There are countless empires that collapsed very quickly.  The most recent example is the Soviet Union.

10. Now, turn your attention to the United States.  You should be scared of a precipitous decline (don’t try to think of the stages).  Most collapses are associated with financial crises.

11. We are currently running a huge deficit and our publicly held debt is going to double within the decade.  Interest payments will increase from 8% of revenue to 17%.

12. These numbers could weaken the worldwide confidence that the US can withstand any crisis.

13. Most likely, there will be some event that happens that changes the thoughts of the world.  The common belief will no longer be in US viability.

14. It may be that the public will suddenly reassess the credibility of our fiscal and monetary policy.  If investors suddenly question our solvency, interest rates will rise and our interest payments will become tremendous.

15. If this happens, the US will no longer have the money to finance our military programs.

If all this happens, historians will enter the picture and tell us a story.  But in reality, things will have happened very suddenly.




My Thoughts on This

This is a scary story and it always scares me more when I hear a story like this from someone smart.  For those of you who have heard me speak in the last couple of months, you’ve heard my description that I believe that we are headed (in the long-term) for a financial crisis of epic proportion – similar to what third-world countries have faced in the past.  I don’t think that this will happen immediately, but I describe it as something that will certainly occur in our children’s lifetime.  I always laugh at the complacency with which listeners respond.  Most frequently they ask, “so how should I position my portfolio?”




I do have certain disagreements with Ferguson’s theories.  He blames the current crisis solely on the mismanagement of monetary policy (I think that there’s much more to it).  I also think that our crisis is a story that has been a long story – when you look at Social Security and Medicare / Medicaid.




Unfortunately, I really disagree with Ferguson’s description of our debt.  Our problems are MUCH WORSE than he described.  About ten days ago, the Treasury Department put out their annual report which estimates the present value of the unfunded liability for Social Security, Medicare / Medicaid and Veterans’ Affairs.  The amount is $52 trillion.  I’ll talk more about this amount in future blogs.  But the bottom line is that this just a disaster and there’s really no solution.  It would be no different than you or I having $10 million of debt.  For most of us, working harder, saving more and cutting our expenses won’t solve the problem.  It’s too late.




This all really scares me.  I think that the educated people of our civilization have a duty to start learning more about our fiscal issues.  It’s the only way that we’re going to have a chance of affecting the outcome.




Finally, I’ll end with the thought that hopefully this is all crazy and I’m crazy for telling you to think about it.  But here’s a question for you…think about all of the past dynasties…do you think any of the citizens thought that their dynasty was going to end?
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1. Some Results of the Great Recession

Four day work week. There are approximately 15,000+ school districts in the country.  More than 100 have moved to a four-day school week.  Obviously, this helps with budgetary shortfalls.  (Jenny homeschools two of our kids – maybe we should try this to solve our budgetary issues.)




Increased coupon usage. The number of coupons redeemed increased 27% from 2.6 billion to 3.3 billion in 2009.  This was the largest percentage increase in the 20 years the data has been collected.  CouponMom.com has 2.2 million members – up from one million in January 2009.




Everyone is feeling the recession. IBM’s Chairman and CEO saw his 2009 compensation drop by $200,000 to $24.3 million.  Hopefully someone will tell him about couponmom.com.




Junior liens (which sometimes make it difficult to work out a short sale on a house). There are $1.05 trillion of junior-lien home loans outstanding as of September 30^th.  Approximately 75% ($766.7 billion) are held by commercial banks.  Most of the rest is held by savings banks and credit unions.  Many of these loans are worthless due to the drop in home prices.




We have a deficit and we’re cutting taxes. Los Angeles has a $200MM budget shortfall that could cause layoffs (and supposedly) creates the risk of bankruptcy.  But last week, they cut taxes for internet companies.  These are tough issues.  Cities don’t want companies to leave.




Money flowing out of US stocks. In 2010, worldwide investors have pulled $15.3 billion from US stock funds (which includes ETFs).  Approximately $2 billion has gone into emerging market stocks.  Last year, $65 billion went into emerging market stocks and $20 billion in US bonds.




The Greek Prime Minister is pushing the US to investigate currency speculators who are driving down the value of the euro.  I think he learned this lesson from the US when we banned short selling during the financial crisis – implying that everything was the fault of the evil hedge funds.  I’m not sure why anyone would question the value of the euro when the EU controls monetary policy but not fiscal policy and they have countries that no one wants to lend to because people cheat on taxes and strike when there are austerity measures announced.  Those evil hedge funds…how dare they.




Greek tax and court officials, sanitation workers and local government workers are planning strikes this week. In a recent survey, 48% of Greeks disagree with labor unions’ stance (against the austerity measures) and 45% agree.




E. W. Scripps shares were off as much as 20% on Monday morning. Managers were given 1.8MM shares after they vested on Friday.  Apparently, they were all sitting by the computer on Monday morning hitting the sell button.  This is what happens when management goes a year without bonuses.




Woe is me! I was emailing back and forth with a good friend yesterday (both of us are 45) and we were talking about the fact that our generation hasn’t done great.  We’ve had no stock returns in the last ten years, no home price appreciation since 2003, job markets that are much more competitive than what our parents had, 401(k) plans instead of pensions and we pay more for our health care.  Of course, our kids are going to have it even worse.




2. Interesting Article from Paul Krugman

In Paul Krugman’s weekly NY Times piece, he wrote about a recent research paper that identified the common characteristics between Ireland and the US with respect to each country’s housing bubble and ensuing financial crisis.  The point of the paper and Krugman’s article is to say that we have attributed the problems (in the US) to many things (such as Fannie / Freddie, the Community Reinvestment Act and exotic financial instruments)…but these are things that they didn’t have in Ireland.




Apparently, the paper identified four common features between the US and Ireland:

1. irrational exuberance – the belief that high prices would go higher
2. cheap capital – China financed the US and Ireland was financed by the EU and especially Germany
3. players had the incentive to take risk (they did not bear the risk of loss)
4. regulatory imprudence

I have not read the research paper yet.  But here’s a link to Krugman’s article and that has a link to the paper.

http://www.nytimes.com/2010/03/08/opinion/08krugman.html?ref=opinion




3.  A Few Random Stories

I wish I had Cablevision as my cable provider! Disney blacked out ABC stations to Cablevision holders for a short while, saving them from having to watch the Academy Awards.  Who watches this crap?  Next time I get a teaching award, I’m going to start crying and thanking all the people who made it possible.  Why would we watch these freaking idiots?  I’m not sure, but if I only had two choices, I would consider watching skating over this.




Pretty brave people. Approximately 62.9% of eligible voters turned out in Iraq, despite bombs and various threats.  As a reference point, in the 2008 election in the US, 61.7% of eligible voters turned out (although 64% of people claimed they voted when asked by the Census bureau!).




Placement firm Challenger, Gray and Christmas says that the first week of the NCAA tournament may cost US employers as much as $1.8 billion in unproductive wages. The math is based on $18.70 hourly wage with 58.3 million people watching games and filling in pools.  Each 20 minutes cost $362.2 million.  Using this math, there’s no telling how much money Tiger Woods cost corporate America.  In reality, how much do most people goof off on a typical day…

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Consumer spending accounts for approximately 70% of GDP (in normal times).  Consumer spending is premised on income and borrowing.  (While borrowing ticked up in January, it’s been very weak for the past two years; asset / collateral levels are lower, banks are less willing to lend and consumers want less credit.)  In order for consumers to have income, they must have jobs.  So without jobs, we’ve got problems.  In addition, unemployment exacerbates our deficit: fewer people are paying taxes and more people are receiving transfer payments.




The Jobs Report is particularly important because there is uncertainty in the market as to what the current jobs status is.  Below, I will take you through some of the arguments used by bulls and bears.




Background

The “jobs report” is actually called “the employment situation” and it really is comprised of two reports:

1. The Household Survey
2. The Establishment Survey

The Establishment Survey is larger. The Household Survey is a sample of 60K households.  The Establishment Survey covers 140,000 businesses and government agencies (covering ~ 410,000 worksites and approximately one-third of all nonfarm payroll employees).




Each of the two surveys has some advantages. The Household Survey includes the self-employed, unpaid family workers and private household workers.  It also includes people who are on unpaid leave.  The Household Survey doesn’t duplicate people (whereas a person could be on two payrolls).  Unfortunately, the Household Survey is more susceptible to “puffery” from participants and requires a much larger change to be considered significant.




The Establishment Survey is larger and is based on hard data.  Contrary to common thought, the Establishment Survey does include small firms.  Approximately 40% have fewer than 20 workers.  The Establishment Survey also has an adjustment to account for business births and deaths.




There are two headline numbers: the unemployment rate (9.7%) comes from the Household Survey and the number of jobs lost (36K) comes from the Establishment Survey.  The numbers are not always consistent.




Severe Weather

Many commentators are suggesting that severe weather may have affected the numbers, but the BLS can’t quantify it.  It’s very hard to determine the impact.  Certainly, people might not have been hired due to the storms.  With that said, some people found employment because of the storm (cleaning up, doing repairs, etc.).  The joke going around is that bosses couldn’t get to work to fire people.  Many people think that the storm results in undercounting jobs because the job numbers jumped in 1996 in the month after some big storms.

Severe storms shouldn’t have a huge impact.  In the Employment Survey, if you were paid for the period including Feb. 12, you were counted as employed (even if it was for one hour).  You have to have been off for the entire period in order for the storm to matter.  In the Household Survey, you were counted as employed if you missed work for weather-related events, even if you were not paid for time off.  On the flip side of all this…it’s hard to create jobs when then world is shut down because of snow.




Bullish Arguments About the Employment Situation

Job losses have abated. Nonfarm payroll employment dropped 36K in February.  This continues the trend of fewer job losses and is a particularly strong number given the inclement weather.  Remember: from November 2008 – March 2009, we were losing more than 600K jobs per month!




The February data corroborates the January numbers. January’s loss was only 26K and February was 36K.




In both surveys, the number of unemployed people was close to unchanged. In the Household Survey, the number of unemployed person was essentially unchanged at 14.9MM.  The Payroll Survey showed an increase of 36K unemployed people.




The Household Survey (unlike the Payroll Survey) showed a huge increase in the number of people who are employed. The number of employed increased 541K and 308K in January and February.  During that time, the labor force grew by 453K.  This is (1) population growth of 74K; and (2) 378K fewer people are “not in labor force” (re-entrants).  This increase in jobs shows why the unemployment rate (which we get from the Household Survey) dropped from 10% to 9.7% in January (and stayed at 9.7% in February).




The unemployment rate stayed at 9.7%. There has been a lot of fear that we would head toward 11%.  The fact that the number has stayed in single digits is better for confidence and it can be a self-fulfilling prophecy.




Temporary services increased jobs. Temporary help services added 48K jobs.  Since September 2009, this has risen 284K.  This is often a precursor to full-time jobs.




Other important sectors have stopped losing jobs. Manufacturing was unchanged.  Retail employment was unchanged.




The number of long-term unemployed has dropped. The number of long-term unemployed (27+ weeks) has decreased from 6.3MM to 6.1MM.




Past job losses weren’t as bad as we had thought. December was revised from     -150K to -109K and January was revised from -20 to -26K.  If you combine the past two months, we actually lost 35K fewer jobs than we had thought; when you combine those changes with the 36K jobs we lost in February, it basically nets out to zero!




The unemployment rate is not terrible for those with a college degree. For those with a college degree or higher, the unemployment rate was 5%.  One year ago, it was 4.2%.




We’re seeing fewer industries lose jobs. The diffusion index, which weights the number of industries increasing employment vs. decreasing employment, is 48.  It was 17.1 a year ago.  A reading of 50 indicates equal balance.




Bearish Arguments

We need 125K – 150K jobs to be created to satisfy new entrants each month. This is misleading right now (we don’t see “new entrants”) because people are leaving the labor force, but once we start creating jobs, we will return to this normal situation.  As a result, losing 36K jobs is not a great report.




In addition to the 125K – 150K jobs described above, we need to create significantly more jobs in order to reduce the unemployment rate. If we create an addition 150K jobs per month (bringing the total monthly jobs number to ~300K), it will take approximately 4.5 years to recover the 8.4MM jobs lost since December 2007!




If it weren’t for the civilian labor force shrinking, the unemployment rate would be approximately 11%. The civilian labor force has shrunk 900K in past year.  If you had the same participation rate (65.7% of the population participating in the labor force) as one year ago, that would mean that the unemployment rate would be approximately 11%.  (Here, I’m assuming that 65.7% of the population was part of the work force and the number of employed is “as stated”.)




Understand the craziness of the participation rate. During the year, the population grew by 2.085MM.  If ~65% of people are in the work force, we should have had 1.3MM more workers.  Instead, we had 900K fewer.  That means that the 2.085MM (of population growth) plus the 900K who left the work force increased the “not in the work force” category by 2.975MM.




The number of persons working part time for economic reasons increased from 8.3MM to 8.8MM. In January, this number had decreased, but it turned back up in February.  These are people who had their hours cut or who were unable to find a full-time job.  These people are considered employed, but many are dissatisfied with their situation.




Approximately 2.5MM people were marginally attached to the labor force. This is an increase of 476K in February.  These are people who are not in the labor force even though they wanted and were available work.  While these people had looked for work in the past year, they had not looked in the past month (and as a result, they are not considered to be part of the labor force – and are not counted as unemployed).

Among the marginally attached, there were 1.2MM discouraged workers in February (up from 473K last year).  Discouraged workers are not currently looking because they believe that no jobs are available to them.  The remaining 1.3MM marginally attached workers had not searched in the past four weeks because of school or family.




Certain industries might not see a return to their peak employment levels. Construction employment fell by 64K in February – similar to past six months.  Since December 2007, construction employment has fallen by 1.9MM.




While the number has decreased (from 6.3MM), there are still 6.1MM people who are considered “long-term unemployed” – jobless for 27 weeks or longer. The average time of unemployment is 29.7 weeks.  The median is 19.4 weeks.

For most people, this can decimate their savings and have long-term repercussions on spending.  This can also have an impact on family issues for some.

The increase in temporary jobs may show a new trend – to use temp workers rather than provide benefits or commit to full-time employees.   One example of temporary jobs that is skewing our data is the use of Census workers.  This month, we hired 15K temporary workers for the Census.  If it weren’t for the census workers, the report would have been a loss of 51K.




There are certain groups that are disproportionately impacted by the recession. The teenage unemployment rate was 25%!  This has long-term repercussions in their career.  Minorities are also suffering from high unemployment rates.  Blacks and Hispanics have very high unemployment rates – 15.8% and 12.4% respectively.




While almost as many industries are adding jobs compared to those that are losing jobs in the past month, we are far below our employment levels one year ago. Virtually every industry (Table A-14) has higher unemployment than one year earlier.




The more inclusive unemployment rate ticked up from 16.5% to 16.8%. This means that one in six Americans is either unemployed, underemployed (they’ve accepted part-time work when they want full-time work) or they are too discouraged to look for work.  (In the past year, approximately 500K people have become discouraged and have stopped looking for work.)




Conclusion

If the “weather blamers” are correct, the next payroll report could be a great report and could change consumer confidence.  If they’re wrong, pessimism will reign.  My gut feeling is that we’re going to see a good number next month, but we’re still in for a very long haul before we get back to 5% unemployment.




What do you think?  If you’re interested in sharing your thoughts, tell other readers your prediction for two questions: (1) what do you think next month’s job number will be; and (2) how long will it be before we get back to 5% unemployment?

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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Back in black! The Dow rose 47 points, putting it in the black for the year.  Disney, Coke and Boeing were all upgraded by large banks.  In addition, the weekly jobless claims number was good.




Everyone is waiting for Friday’s employment numbers. The rate is expected to increase from 9.7% to 9.8% and the median forecast is for a loss of 25K – 75K jobs (depending on who is doing the survey).  I’ll be writing about the report on Monday.




Greece is offering approximately $6.7 billion of ten-year bonds.  There was heavy bidding on the offering.  The yield is approximately 6.3%.  This is approximately 3% higher than the benchmark risk-free mid-swaps rate.  It is a 3.26% premium over ten year German bonds.




2. Economy

There was contrasting economic data released on Thursday. The weekly jobless claims number was lower than the prior week.  There was some fear that this number was going to go back over 500K.  Instead it was 469K.  But, unit labor costs declined in Q4 – indicating no inflation fears and maybe no purchasing power for consumers.  The ten-year note increased 4.32 to yield 3.61%.




The weekly jobless claims number. Initial jobless claims was 469K, a 29K decrease from the 498K reported last week.  The four-week moving average is just under 471K.




Labor productivity increased at a 6.9% annual rate during Q4. This was a 7.6% increase in output, but .6% more hours were worked.

From Q4 2008 to Q4 2009, productivity increased 5.8% (output declined .2% and hours fell 5.7%).

Unit labor costs fell 5.9% in Q4.  This means productivity increased faster than compensation.  Unit labor costs fell 4.7% from a year ago.  This is the largest four-quarter drop since the data has been collected (1948).




New orders for manufactured goods were up 1.7%. Excluding transportation, orders increased .1%.  New orders have increased nine of the last ten months.




Good same store sales. Comparable store sales at retailers increased 4% for 28 companies.  This was the best report in six months.  In addition, approximately 82% of retailers beat earnings expectations.  It helped to keep inventories low – fewer markdowns.  Interestingly, Destination Maternity had a 9.3% drop in February sales.  I’m wondering if that means couples are not having babies because of the recession or women are buying their stretch pants elsewhere.  I’m pretty sure that if I keep sitting in front of this computer, I’m also going to need some stretch pants.




What a shock – the FHA may be in trouble. Some economists from the NY Fed and NYU say that the FHA is in worse shape than they are letting on.  The study authors said that approximately 40% of mortgages insured by the FHA are under water and as many as 14% may be at least 15% under water.  The FHA estimates that at 6%.  While we don’t know that this study is correct, the FHA has taken its market shares from 2% to 25% — and that in itself creates risk.




3. Politics

The jobs bill. The House voted 217 – 201 for a $15 billion jobs bill.  Now, the Senate must approve the bill.  This is the bill which gives a payroll tax credit to employers who hire people who have been unemployed for at least two months.  Separately, the Senate is currently working on a bill to renew tax cuts and provide emergency assistance for the unemployed.




Too big to fail? The TARP oversight panel said that it was clear that the markets believe that some financial institutions are too big to fail.  A Treasury Department representative said that there is no guarantee for these institutions.  Of course, the market temporarily lost the belief in the government backstop after Lehman failed – and that didn’t work out that well.  Unfortunately, I’m not sure that “too big to fail” is a bad thing if we’re going to have companies that create systemic risk.




4. Lets Bring Back the Robber Barons

I read a really interesting article today, “Lets Bring Back the Robber Barons.”  I’ve put the link below.  The basic idea was that we need the entrepreneurs who develop new products that create new jobs (“Market Entrepreneurs”).  We don’t need the “Political Entrepreneurs” – those people who game the political system to make a fortune as the result of government subsidies.  We can’t think badly of these people who get filthy rich – they will benefit society along the way.




Three paragraphs from the bottom, the author wrote something that I didn’t understand.  He transitioned (or didn’t transition?) into talking about Sheila Blair (FDIC Chief) attacking bank bonuses.  It seems that the author was arguing that we can’t worry that a few people are going to get filthy rich (like the robber barons) – because those are the people who will create jobs.




I don’t know if I misunderstood the author, as I believe he was saying that the bankers are just a necessary by-product of the robber baron attitude that we need.  I thought that this was hilarious, since the bankers really fall into the category of “Political Entreprenurs” (as described by the author) rather than “Market Entrepreneurs.”  Regardless, let me give you a totally different spin.  I agree with the author’s sentiment on the robber barons, but I completely disagree with the thought that the bankers are just a necessary by-product.




As a general rule, bankers are smart guys (and they are mostly guys) who are hard working, ambitious and love money.  And there’s nothing at all wrong with any of  that.  The problem is that we’ve got these smart, ambitious people working in a profession that creates very little value for our society.  What if bankers were not allowed to make more than $250K / year in the US?  What would happen?  Most of these people would find a way to make oodles of money elsewhere.  They would start businesses and create jobs.  If we lost share to the Europeans and the Asians in banking…the joke would be on them in the long-term.  We’d be creating companies and value.




We have a real problem in this country.  So many of our smartest people are either working on transactions (M&A, trading, etc.) at banks or fighting over scraps (lawyers at law firms).  It’s a total waste of brainpower and ambition.  We need these people doing something useful.




Maybe the way to promote capitalism is to force these guys to actually do something valuable.  I want people to get rich – but do it by creating value for society.  One of the funny things in life is that sometimes things are the exact opposite of what we expect.  Maybe the greatest move towards capitalism would be to regulate salaries.

http://www.realclearmarkets.com/articles/2010/03/04/bring_back_the_robber_barons_98370.html




5. Random

What a messed up world we live in. The House Foreign Affairs Committee endorsed a resolution (by a 23-22 vote) declaring the Ottoman-era killing of Armenians to be genocide.  This happened almost 100 years ago!  Turkey immediately recalled their ambassador from Washington.  Just to be clear…Obama was against this and tried to stop it and when George W. was in office he was also opposed to this.  This is your Congress at work.  (Of course, it may be that I’m just sympathetic to Turkey because I’m still hearing about things that I did wrong when Jenny and I were dating.  That was also almost 100 years ago.)




I’ve written three pages and I haven’t mentioned the Chinese government. Three officials from the Chinese company that sold tainted milk were sentenced to close to five years in jail.  The irony is that the alleged culprits received a shorter sentence than some activists who have complained about the government’s reaction to this disaster.
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The Dow dropped 9.22 points.  It had been up 60 as a result of a decent jobs report from ADP.  The beige book had some mixed news.  Later in the day, some healthcare stocks reported bad news (lack of effectiveness of drugs) and the President said he was going to continue to push the healthcare debate.




The euro rallied against the dollar.  The weakness in the dollar helped commodity prices.  Looking at the euro, the question is whether Greece will live up to their promises and whether there will be problems with other countries.




Oil settled at $80.87. While inventories were larger than expected, the stronger economic news carried the day.




The ten-year treasury yield increased slightly (to 3.623%) based on economic strength.




The VIX (volatility index) has dropped 15 of the past 16 days.  This is somewhat strange given all of the unknowns out there.




In British pound terms, the FTSE world index is at all time highs. That’s because the pound has lost value.  In dollar terms, investors are down 25% from the all-time high.




2. The Economy

The ADP jobs report showed a loss of 20K jobs in February, fewer than expected.




The Fed’s Beige Book (a summary of economic evidence from each district) said that nine out of 12 districts showed improved economic activity.  But there was weakness in loan demand and the commercial real estate market.




The service sector (ISM nonmanufacturing purchase managers’ index) expanded faster than expected.  The index rose from 50.5 to 53.




3. Car News

Could Toyota’s problems get worse? There have been 10 complaints of sudden acceleration of Toyotas that had previously been fixed.  If these reports turn out to be true, this could really be devastating for Toyota.




Nissan has always wanted to be Toyota. As a result, Nissan is recalling ~540K trucks, SUVs and minivans because of problems with brake-pedal pins and fuel gauges.




The Toyota problem has turned out to be a great thing for consumer safety.  Car companies are now afraid to sit on information and fight recalls.




4. Greece

Greece announced their plan to cut their deficit by $6.5 billion. Some of the cuts include a 2% increase in the VAT, a one year freeze on public employee pension and a 30% reduction in public employee bonuses.  Everyone is watching to see how much of a premium investors will require when Greece sells ten-year bonds in the next week.




Investors seemed happy about Greece’s cuts, but now people are wondering what will happen to their economy.  If the cuts push the economy further into recession, Greece’s problems will not be solved.  The bottom line is that once you get into debt, there’s no easy way out.




The Greek Prime Minister said that Greece would turn to the IMF for an emergency loan if the EU does not provide support.




5. Politics

Charles Rangel stepped down temporarily as Chairman of the House Ways and Means Committee.  He was replaced by Pete Stark from California, but there will be a vote among Democrats to determine who will be the chairman in the future.




The Volker rule was sent to Congress on Wednesday.  The proposal is intended to limit banks from speculative trading (since they have access to low cost deposits).




President Obama has three openings for Fed governors in which he needs to fill.




6. Bill Gross’ Letter

I’ve had several people forward Bill Gross’ most recent letter to me.  That makes sense…it was really good.  Here’s a summary of his thoughts:

1. Workers in developed countries saw their real income hurt because of globalization.
2. Governments promoted asset price appreciation and leverage so that economic demand would not suffer.
3. When people became overleveraged and asset bubbles burst, we started to lose our belief in lower taxes, deregulation and leverage.
4. The bond market and banks started to limit credit.
5. This led to recession and deleveraging (people reducing their debt level).
6. This also led to the belief in more regulation and “de-globalization.”
7. Government stepped in (on the monetary policy side) with lower interest rates and purchasing of securities (to lower interest rates).
8. Government fiscal policy turned to heavier spending at the same time that tax revenues declined.  This led to deficits that were very large as a percentage of GDP.
9. It seemed like the government did its job – replacing the private sector.  Stock multiples returned to normal ranges as did credit spreads.  GDP growth resumed.

10. Everyone could believe in capitalism again.  Asset prices would bail us out.

11. Dubai, Iceland, Ireland and Greece reminded us that the model was flawed – governments can’t just keep leveraging themselves.

12. Maybe government debt will lead to sovereign defaults.  But even if there are no defaults, all of this government debt will be a drag on GDP.

13. Maybe we can’t get out of a debt crisis by having the government issue more debt.




Gross then effectively argued that in the short term, there was an “arbitrage opportunity” (my words for his description).  We could replace private debt with public debt and this lowered the cost.  The government seems like it is lower risk.

But, after a while we start to see credit deterioration.  Investors require higher rates from sovereign debt.  We see the premiums on credit default swaps increase (on sovereign debt).  We also see the risk of inflation result in higher rates.

So now the question is whether government bonds are really just as risky as the debt that they guarantee?  Sovereign debt yields should look more like the highest rated risky bonds.

In sum, it’s difficult to solve a debt crisis by issuing debt.  But, it’s particularly difficult if:

1. you already have a lot of debt
2. you have unfunded liabilities
3. you will experience higher interest rates (which will cost the government dearly)

7. Random




The biggest banks in the US and Europe paid 10% more for compensation than they did in 2008.




Lots of cash on hand…time to spend it. The 382 nonfinancial firms in the S&P 500 have $932 billion in cash and short-term investments.  That is 8% higher than Q3 and 31% higher YOY.  With the market 29% below its peak, companies are using cash for acquisitions.  Nearly 50% of deals this year have been all cash (double the 24% rate in 2008).  There were also 62 share buybacks announced in February, the most since September 2008.  Buybacks were up 37% in Q4 versus Q3.  In addition, in Q4 there were 79 dividends increased and only two reduced compared with 58 increases and 41 reductions in Q4 of 2008.
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Stocks were up a whopping 2.19 points. In the absence of any other big news, investors are waiting for Friday’s employment report.  Earnings season is basically done and investors realize that the Greeks will never change and will have to eventually be dealt with.  But, we still wonder what is going to happen to our economy.




Speaking of Greece…there’s a great article in the WSJ.  The EU limits budget deficits to 3% of GDP and government debt can’t exceed 60% of GDP.  But, other than 2006, Greece has always violated the 3% rule.  In addition, they’ve never been within 30% of the 60% rule.  Finally, every year since 1997 Greece has revised their deficit numbers upward!  In 2009, they initially estimated a 3.7% deficit before hitting 12.7%.




Supposedly Greece will announce their “new and improved” austerity plan on Wednesday.  This plan will cut their budget by $5.4 billion and reduce their deficit by 4%.  They need a positive reaction so that they can sell approximately $5 billion of bonds.  I’m sure that the Greek citizens will have a positive reaction…assuming you consider a strike to be positive.




Attention may be turning to England. The pound hit a 10 month low against the dollar.  The British have a deficit that is 12.5% of GDP.  British household debt is 170% of annual income (compared to 130% in the US).




Be careful of being right! The Justice Department is investigating a group of hedge funds that made bearish bets on the euro.  Ultimately, the government is trying to figure out whether they were colluding to manipulate the price.  Apparently, this would be an infringement into the government’s territory – because governments collude all the time to affect the currency markets.  But here’s the thing…governments have very little success doing this, so I’m not sure why I believe the hedge funds (with much less fire power) can move the price of a currency.  I simply don’t see how an investigation like this could ever be successful.  It’s not as if there wasn’t bad news out there about the euro.




There are more and more people arguing that credit default swaps should be reserved for investors who hold the underlying bonds.  In other words, I shouldn’t be able to buy insurance on your house or your driving.  We start to create a situation in which I have an incentive to create a dangerous driving condition for you.  Most importantly, when my purchase of CDS leads to higher prices and this is interpreted as fear about a company or country, the increased financing costs could create a self-fulfilling prophecy.




If tax rates increase, it will be interesting to see what happens to demand for muni bonds. (Of course, this demand could be offset by the horrendous condition of many issuers.)  In addition, if the muni interest exemption is taken away in the future (but left for already outstanding bonds), it could lead to a rush of issuances.  In 2007, 6.3MM out of 143MM returns claimed $76 billion in tax-exempt interest.




2. The Economy

KC Fed President Thomas Hoenig said that our zero percent fed-funds rate is “inviting future excesses” and that higher rates will not derail the economy.  Mr. Hoenig dissented in January when the FOMC voted to leave rates unchanged.




Approximately 37% of all borrowers who have 30 year conforming fixed-rate mortgages pay rates of 6% of higher. This represents $1.2 trillion of debt.  Many could lower their rates by 1% if they refinance.  Yet, refinancing applications are at their lowest level in the past year.  Many people can’t refinance because they’re under water.  Others cite the high fees to refinance.




In a survey of 1,000 executives, more than 60% say that their workforce will be the same in a year.  Approximately 30% see an increase and 7% see a decrease.




Paul Voker said that there was not risk that dollar would serve as the world’s reserve currency.  But, he warned of risk of inflation.




The Economist had an article about how bad the decade was for us (2000 – 2010).  Real GDP growth was 1.9% per year.  For the prior six decades, this had been 3.9%.  Only the 1930s were worse (.9% / year).  From 1940 – 1999, the number of workers grew 27% per decade (on average).  In the last decade, it fell .8%.




3. The Car Market

Ford catching GM. Ford’s light-vehicle sales increased 43% in February, resulting in them beating GM by 55 cars! GM’s sales rose 12%.  Both GM and Ford experienced large increases of fleet sales.  It’s been over ten months since Ford beat GM in a month (Feb. 2008).  Toyota’s sales fell 8.7%.  Chrysler’s sales were basically flat.  Honda’s sales rose 13% and Hyundai rose 11%.




Here’s the bad news…February’s industry wide car sales were estimated at an annualized rate of 10.6MM.  We’re still far below the 17MM annual sales that we had been at a few years ago.




GM is recalling 1.3MM cars because the power steering could fail.  I think GM and Toyota should do a joint venture and produce a car that accelerates on its own and loses steering.  Of course, when we don’t have hearings about this, the Japanese are going to complain that Toyota was treated differently (in order to help the US profit).




4. A Microcosm of the US

The Post Office is considering eliminating Saturday delivery. They have a $7 billion deficit this year and potentially $238 billion over the next ten years!  They are becoming significantly less important, having delivered 177 billion pieces of mail last year, down from 213 billion in 2006.  Apparently, a huge problem for the USPS is that they must make an annual payment of $5.5 billion to prepay expected medical benefits for retirees.  The bottom line is that the USPS is a microcosm of the US.  Our expenses (led by healthcare) are out of whack and we need drastic changes.




5. China

For a really interesting piece on China, see the link below.  It’s written by a Chinese dissident (now living in London).  He makes several interesting arguments, including:

1. The absurd 11 year sentence given to Liu Xiaobo was really done to get the attention of foreigners, not the Chinese
2. China has opened their economy in order to help maintain control over its people
3. The world’s democracies have lost their willingness to stand up for their beliefs
4. As a result of the global crisis, democracies are willing to put commercial interests ahead of human rights – and this will make people question democracy
5. Sentencing Liu Xiaobo to 11 years was a way of forcing countries to decide: are you going to fight about human rights or do you want access to China’s markets
6. As the US and other democracies choose the Chinese markets (over standing up for human rights), the Chinese people will realize that economic modernization will not set them free

http://www.project-syndicate.org/commentary/ma4/English




6. Politics

Apparently, Charles Rangel (D, NY) is close to losing the chairmanship of the House Ways and Means Committee (a powerful committee because of its role in writing tax law).  He has been accused of several unethical acts.  Even some Democrats are turning on him.  I’d love to see the percentage of Democrats that are in tough elections that have turned on him versus the percentage who are not in tough elections (who have turned on him).   He says that he won’t step down.




Kentucky Republican Bunning got what he wanted (a way to pay for the passage of unemployment benefits extension) and has relented.  Apparently, some of his Republican colleagues were starting to distance themselves from him.  Benefits are expected to be extended on Wednesday.




7. Enron Back in the News

The Supreme Court heard Jeffrey Skilling’s appeal on Monday.  Commentators always try to read the leanings of the Justices.  I saw several articles that argued that the Justices seemed very interested in Skilling’s complaints about the jury selection process.  Two issues seemed to have their interest:

1. the trial judge should gave granted the motion to change venue (move the trial out of Houston) because Skilling couldn’t get a fair trial there
2. the jury selection process was cursory – it took only five hours, jurors were not questioned enough and as an example, a prospective juror was allowed to remain even though she said she had lost $50 – $60K in the fraud.  It seems pretty obvious that you can’t have the victim of a crime be a juror.  (The defense used one of their peremptory challenges to strike this juror.)

8. Random

This scares me.  The Pentagon is going to transfer smart-bombs to Pakistan.  I’m wary when I hear of giving advanced weapons to countries that lack political stability.




Maybe I’m Chinese! Apparently, while Tiger Woods is losing sponsorships, he is gaining popularity in one place…China.  According to this short article (link below), the Chinese respect men who have had more mistresses.

http://www.sbnation.com/2010/2/28/1329865/tiger-woods-china-tag-heuer-china-is-ridiculous




It was ten years ago this month that the stock market peaked. I mentioned that to Jenny this morning and she said, “that’s’ interesting, it peaked four years after you did.”
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The Dow gained 78.53 points.  There was positive news about manufacturing and consumer spending as well as optimism about the ending of the Greek tragedy.




The Russell 2000 (small caps) gained 2.2% on speculation of increased M&A activity.  (Small firms are more likely to be acquired.)




The dollar gained .5%.  Oil closed at $78.70.




The WSJ reports that oil has a 60% correlation with the Dow and this is 8X the five year average.  Agricultural commodities have a 33% correlation with the Dow and this is 2.3X the historic average.




The WSJ wrote that it might be time to reverse the Greek bet.  In other words, if the EU bails out Greece, the credit default swaps will decrease in value.  I mentioned a week or two ago that no one really expects Greece to default on this go around.  Personally, I think speculating on credit default swaps of Greece is crazy – but I’m just a poor public school teacher – so if you listen to me, you’re a moron.




2. Economy

The Institute for Supply Management index was 56.5 in February (down from 58.4 in January).  A number > 50 represents expansion (and this was the seventh consecutive month above 50).  Their employment index increased from 53.3 to 56.1.  This was the third consecutive increase and the highest reading in five years.




The personal consumption expenditures price index increased .2% in January (vs December) and was 2.1% higher YOY.




The savings rate was 3.3% in January.  This is down from 4.2% in January and the lowest since October 2008 (2.9%).  We’re Americans.  We’re already saving less.




Global chip sales increased .3% in January.  They are 47% higher than last January!




3. Financials

Sticks and stones may break our bones. Goldman listed “adverse publicity” to their laundry list of risk factors.  They say that this publicity could hurt morale.  Personally, you could write all the bad things about me that you want if I get a decent size bonus.  But I’m used to being insulted.  I’m married.




The WSJ reported that seven of the largest global investment banks reduced their compensation relative to revenue.  This seems pretty silly.  Revenues in 2008 were very low – so the ratio numbers were misleadingly high.




4. Government

A single Senator, Jim Bunning (R, KY) blocked a $10 billion bill that would have extended unemployment benefits and other programs.  As a result, 100,000 people saw their benefits expire on Monday, doctors saw a 21% reduction in payments for treating Medicare patients and 41 transportation projects came to a halt.  There is another bill in the works that will be retroactive (to get these people their benefits) although some people say that the unemployed people will have to reapply (and that will cause delays).  Bunning said that he is not opposed to extending the benefits, but he wants to know how we will pay for this.




Quitter! Donald Kohn, Vice-Chairman of the Fed announced his retirement.  He has only worked at the Fed for 40 years!  There is speculation as to who will replace him.  Some think it will be Daniel Tarullo, Obama’s appointee who is focusing on improving regulation.




5. Notes from the Evil Side

Boo hoo hoo…we’re capitalist pigs. Toyota’s president blamed their problems on a focus on profit and market share.  The focus on profit led to excessive cost cutting.  Sorry Mr. T, but you can focus on profits and market share and still do business in a moral way.




The Madoff bankruptcy judge ruled that investors who had taken out more than they put in (to Madoff’s funds) were “net winners” and should not share in any of the recovery.  Approximately half of the investors were “net winners.”  The net winners argue that they were relying on their account statement and were equally injured.




I hope all of my friends at GS appreciate that I put the GS story in the financials category and not here.  Part of the problem is that if I put it here (in the Evil Side category), I would have proven them right about the adverse publicity.  Wait a second, this means that these guys were right again.  They’re freakin’ amazing!




6. Really Important Story: CEO Hedging

Business Week reported on an academic study about CEO hedging (as well as directors and executives).  While CEOs still own the shares after entering these hedging transactions, you have to dig through the footnotes to understand that the CEO no longer has downside risk.




The BW article focused on two primary ways for an executive to hedge:

1. prepaid variable forward contract – executive receives cash advance of up to 85% for shares that he will eventually sell to bank.  Executive collects dividends and still is the technical owner.

2. collars – option strategies in which you give up most of your upside as compensation for getting rid of your downside.




The academic study examined 2,010 hedging transactions by 1,181 executives at 911 firms between 1996 and 2006.  On average stocks had increased 17% – 31% prior to the executive’s hedge.  Shares in companies where the CEOs, directors and other top executives had hedged using a variable forward sale underperformed the market by 16.2%.  The underperformance was 25% for collars.




Realize that this is still going on. In 2009, there were 107 times when executives hedged.  The information on the hedge is contained in Form 4. They are not listed in the tables (that are the focus of Form 4).  Companies must disclose an exercise price and the “dollar value locked in.”




So here’s the issue…should CEOs be allowed to hedge?  Without question they should.  But if this study is correct, it’s hard for me to believe that we are not seeing systemic insider trading.  In other words, when insiders are consistently right (especially with the large excess returns), how can I believe that this is random?  They have to be using material, nonpublic information.  And don’t forget…insiders profited on the downside during a ten year period in which the stock market was up over 100%.  Pretty impressive?




I have not read the academic paper yet.  I just downloaded it and skimmed it.  It looks very interesting.  I’ll try to mention more about it in the next month when I read it.  But, here’s a link to it in case you want to read it:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1364810




The paper, “Insiders’ Use of Hedging Instruments: An Empirical Examination,” was written by J. Carr Bettis (Arizona State), John M. Bizjak (Portland State) and Swaminathan L. Kalpathy (SMU).




7. Random

My big break!  In the past, I’ve thought about appearing on Jeopardy.  But Jenny explained to me that I didn’t know anything except a little bit about finance and that there were likely to be some other categories on the show.  That was probably good advice.  But finally, there’s a show that I think I can dominate…”The Marriage Ref.”  It’s time for America to stand up for me and see how misunderstood I am.  I’m pretty confident that America will tell Jenny that she’s wrong to be offended when I introduce her as “my first wife.”




Hotel rates fell 14% last year according to Hotels.com. The average hotel price was cheaper in 2009 than in 2004 (when the index began).  Jenny suggested that this meant we could travel more.  I had to break it to her that LaQuinta’s prices hadn’t dropped that much.
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1. Markets

The Dow went up 4.23 points on Friday to end the month at 10,325.26.  For the month, this was an increase of 2.6%.  The month was highlighted by fears about Greece and the Fed raising rates, Bernanke’s assurances that rates wouldn’t rise and a slew of corporate earnings.




Insider transactions. According to Vickers Weekly Insider Report (as mentioned in a NY Times article), the ratio of the numbers of shares that insiders sold over the previous eight weeks to the number they bought dropped to .45 in the weeks before the bear market that ended.  That was the lowest level since December 1990.  Of course, the market rallied both times.  By November 2009, the ratio reached 5.21 – signaling a potential decline.  Now, the ratio is back to 3.52 (which they interpret as less pessimistic).  The long-term average is 2.5.

WSJ asked whether a run on the sterling is next. The pound hit a nine month low against the dollar and a six-week low against the euro.  They described three fears:

1. the depth of the recovery
2. worries that the BOE will print money
3. political uncertainty (unclear winner in upcoming elections and no agreement about how to deal with their deficit)

Appreciation depreciation. It’s interesting to think about the fact that if China lets the yuan appreciate, the yuan-based value of their Treasury holdings will drop significantly.




Correlations increasing? In the first two months of 2010, the Dow is down 1% and the Dow Jones / UBS Commodity Index is down 3.8%.  Some investors are afraid that these two asset classes are starting to sync up – which is what they did during the financial crisis.




Copper prices are rising. Chile is the largest producer of copper.  It looks like prices are up ~5% as a result of the earthquake.

2. Economy

Q4 GDP revised up from 5.7% to 5.9%. The enhanced numbers reflected more of what we already knew provided strength: a slowdown in inventory liquidation.  This accounted for 3.88% of GDP growth (up from a previously reported 3.39%).




Existing home sales fell 7.2% in January to a SAAR of 5.05MM units.  After the spurt from the tax credit, the market has returned to a weak state.  Inventories rose to a 7.8 month supply (from 7.2 months).




The University of Michigan / Reuters consumer sentiment index dropped to 73.6 in February from 74.4 in January.  People were more optimistic about current condition and less optimistic about the future.




Permanent job losses? Thirteen percent of companies cut pay between late 2008 and October 2009 and 29% of those planned to rescind the cuts in the following 12 months.




Government has not cut employees. Private businesses have fired 8.5 million workers (7.4% of those on private industry payrolls) since employment peaked in December 2007.  Local government, on the other hand, kept hiring through September 2008 and since then has only fired 141,000 employees (less than 1% of the 14.6MM on their payroll).  Job security and a pension (for many)…that’s a pretty nice deal.




Time to renegotiate? The FDIC is putting together a plan to test whether cutting mortgage balances would prevent foreclosures.  I came across an article arguing that homeowners should do this on their own.  They should tell the lender that “you’ll lose 50% if I default, so you should reduce my balance by x%.”  To me, this just doesn’t make sense.  If I was running a bank, I’d have no idea of which underwater borrowers will default and which will honor their agreement.  If I start negotiating, many borrowers who wouldn’t default may knock on my door.




3. Sovereign Debt

Brutal! The Greek Prime Minister said “brutal steps” were necessary to solve the country’s finances.  Supposedly, the current steps will only reduce the deficit from 13% of GDP to 11%.  The goal is to get this down to 9% in this year.

Additional austerity measures could include increasing the VAT (currently 19%), more cuts of public-sector pay and more tax on luxury goods.  The EU has asked Greece to discontinue one of two extra monthly payments that public sector workers receive.




Japan’s debt is 229% of GDP.  They are considering increasing taxes.  While normally this is considered to be bad for an economy, one thought is that a plan to increase taxes over time will help to increase inflation expectations (which would be good in Japan’s deflationary environment).  But, as I’ve said many times, 95% of Japan’s debt is owned domestically – and this should prevent a run.




Harvard Professor Martin Feldstein says that we don’t need to worry about inflation in the US. One of his key arguments is that we will not have to print money because we are able to borrow to finance our deficit.  I just don’t understand this argument (which was also made by the ratings agencies).  At some point, investors could decide that they don’t want to finance us.




4. Corporate Governance and Banks

Citi reduces board. Citi is cutting their board from 17 seats to 15.  This is a move in the right direction.  While varied expertise can be helpful, the accountability of smaller boards is important.




I wish your shareholders did so well! Ken Lewis left Bank of America with $83MM in compensation and benefits.




5. Buffett’s Letter to Shareholders

If you want to learn about business, a great thing to read is Buffett’s letters to his shareholders.  (I have my Investments class read a compilation of these letters.)  This weekend, Buffett released his 2009 letter.  You can find it at this link:

http://www.berkshirehathaway.com/letters/letters.html




In the letter, he discusses the beauty of float (in both his insurance business and his derivatives contracts which is effectively selling insurance on the markets), the social compact in the regulated energy business (where the company promises to make huge investments on behalf of the public and the state guarantees a satisfactory rate of return), the fact that Berkshire groups the railroad business with his regulated energy businesses and the difficulties that have existed in his more cyclical businesses (such as housing).




Buffett argued that factory-built homes struggle because buyers don’t qualify for loans that are guaranteed by the government.  As a result, lower income buyers are paying significantly higher rates for their homes.  It will be interesting to see if this jawboning leads to any new legislation.




Buffett talked about a few things that are near and dear to my heart.  These include:

1. the fact that we want LOW housing starts (not high housing starts) – in order to bring the housing market back into balance
2. shareholders at many companies have been killed while CEOs (and sometimes directors) have become wealthy.  He said that CEOs for financial institutions must bear full responsibility for risk management – it can’t be outsourced to a committee.  In addition, he said that CEOs can’t have upside without having some downside.  As I frequently complain, this compensation structure is simply a free call option and it leads to bad behavior.
3. Companies always talk about the price of a target company, but don’t talk about the value of their own stock.  In other words, if a company’s stock is undervalued (e.g., trading at $15 when it’s worth $25) and the company issues that stock in order to acquire a company that is only slightly undervalued, the Acquiror loses.  He never mentioned the words “Kraft” or “Cadbury”, but he didn’t have to.  It reminds me of when I overheard Jenny on the phone talking about “worthless husbands” but she never mentioned me specifically…

One of the most important things that Buffett said was in his final paragraph – and he says this all the time.  He said that he was lucky to be born in America and lucky to be born with a “business gene” that is rewarded disproportionately to those who have contributed much more to society.  Buffett frequently says that we won the lottery when we were born in the US – and that’s the truth.  In addition, when you compare the work of business or investing relative to doctors or people who have provided us with infrastructure, it’s incredibly disproportionate to think about compensation.  (Of course, if we start thinking about being paid based on contribution to society, it makes me think that the majority of lawyers should have negative income.)




6. Recognizing Turning Points

For those of you interesting in armchair economics, take a quick look at this article written by Donald Luskin, chief investment officer of Trend Macrolytics:

http://www.smartmoney.com/investing/economy/some-ominous-economic-signs/




Luskin revisited the indicators that led him to conclude that the recession ended in May and why some of these indicators are scaring him again (but only slightly). The key ideas:

1. The top in initial claims for unemployment benefits was in April and that always means that a recession is a month or two away from being done.  On the bad news front, wile the four-week moving average is currently 28% below its peak, it has moved higher in the last few weeks.
2. Consensus earnings expectations for the S&P 500 turned last April.  Unfortunately, these expectations are now growing at a slower pace.
3. Credit spreads fell by May.  Again, these have slightly headed up.  Similar to credit spreads, the dollar reached a top in March (when investors were scared, they bought dollars).  The dollar fell sharply after that.  Again, the dollar has been rising during the last few months.

Best signs of recession:

1. inverted yield curve (10 year UST lower yield than 3 month UST or the Fed Funds rate)
2. annual rate of change falling below zero for the real (inflation adjusted) monetary base

7. Random

Toyota accusations continue. The chairman of the House committee investigating Toyota said that the company withheld records in past court cases and engaged in a “systematic disregard for the law.”  These documents related to rollover cases.




Did you see Apolo Ono? Apolo was disqualified in the 500 for pushing some other skater.  After the race, he said that he thought that he was disqualified because the judge was Canadian and he pushed a Canadian.  Bob Costas later said that Apolo was gracious (because he had a smile on his face while he was whining).  I’m not sure how you could watch the race and think that he comes off as anything but a jackass.  In my opinion, he clearly pushed the guy.  Then, to make those accusations…totally absurd.  And since I’m talking about him, it really frustrates me to hear his medal count mentioned in the same breath as guys like Dan Jansen.




I’ll miss the Olympics! If you haven’t figured it out, I love the Olympics, particularly the real sports. Sunday’s hockey game was a great game. It was interesting to hear people say that the game might be the most important sports victory in Canadian history. If that’s the case, the right team won. I don’t think we would have cared that much. I thought our team played great, but you can’t compare this to 1980 when we had amateurs beating the Soviet professionals.

Gatorade canned Tiger as their spokesman. They decided that he was quenching his thirst in other ways.  I think that this was a very simplistic solution to their problem.  I think that they would have been a ton better off shooting some commercials where he hurriedly comes out of a hotel room, downs some Gatorade and rushes back into the room.  The door shuts, the narrator says “quench your tiger” and Gatorade appears on the screen.
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Slightly shorter blog today as it just seems like a day that is light on news.  Now, on to what I read…

1. Markets

The Dow dropped 53 points. There was bad news about jobs and more concern about Europe.  But, the market had been down almost 200 points and rallied in the afternoon.




Palm dropped 19%.  Apparently, it was a surprise that their smart phones aren’t selling?




Yields dropped (bond prices rallied) as signs of low inflation (high unemployment and weak durable goods orders) accompanied a flight to quality resulting from more concern about Greece and the EU.  In addition, there was very strong demand for the Treasury’s auction of seven-year bonds.




The SEC said that it is examining credit default swaps for potential abuses and destabilizing effects.




2. Economy

Weekly jobless claims increased by 22,000 to 496,000.  This was the highest level in three months.  The four-week moving average increased 6K to 473.75K.  Part of the problem was caused by past snowstorms.  State agencies were processing a backlog of claims.  Regardless, this was somewhat dismal news.  It’s simply reinforcement that we have no real evidence of a recovery in the jobs market.  There’s fear about what will happen when the stimulus spending slows.




Durable goods orders increased 3%, but fell 2.9% if you exclude defense and aircraft.  This led Morgan Stanley to lower their Q1 GDP estimate from 2.5% to 2.2%.




Bernanke continued to warn that investors could lose confidence in the US if we don’t get our budget and deficit in line.  He said that this could affect interest rates and the dollar.  He said, “and those things could directly or indirectly affect the state of the economy.”  You think?




I watched a little of the “bipartisan” health care meeting that President Obama held.  As a teacher, I can best compare it to trying to do a business case with first year students.  No one listens to anything anyone else has to say.  They simply make their prepared statements.  With that said, I don’t want to carry this analogy too far.  It’s insulting to first-year MBAs to compare them to these idiots.  I think that most of our students actually understand how to balance a budget.




JPM CEO Jamie Dimon said that he doesn’t want to raise the firm’s dividend because “there are huge potential negatives out there.”  He said that he worries about a double dip recession.




3. International

The Fed is looking into the transactions that Goldman used to help Greece appear to have lower debt levels.  It’s alleged that JPMorgan set up similar transactions for Italy.




Greece had planned to issue $2.7 billion – $3.4 billion of debt this week.  They have delayed the offering until next week because of the one-day strike and S&P’s threat that the sovereign debt could be downgraded.  Greece is hoping that the markets will be calmed when they issue additional austerity measures.  They are also hoping for more direct support from the other EU members.  Personally, there’s not much that would make me feel better about Greece.  As I’ve said many times, they are structurally unsound; this is not a short-term cyclical issue.  I’m particularly bothered by the strikes during the past two weeks – they serve as glaring evidence that a huge percentage of Greeks just don’t get it.




Betting against the euro. The WSJ reports that several star hedge fund managers are making career bets that the euro will fall to parity with the dollar.  Currently, it’s around $1.35.




No defaults any time soon. S&P said that they don’t expect any sovereign defaults among the EU nations.  They also said that they don’t expect any nation to leave the EU in the intermediate term.




Here’s something Democrats and Republicans can agree on: China! A bipartisan group of Senators asked the President to investigate allegations that China keeps their currency artificially low.  It was also reported that China is conducting stress tests to understand the impact of letting the yuan rise.




4. Random

Shares of Rosetta Stone (RST) increased more than 10% after the close when they announced good earnings.  The company makes software to learn foreign language.  This is more evidence that it won’t be long before we’re all speaking Chinese.




I found this on cnn.com (Sports Illustrated), where they had the “Quote of the Day” from the Olympics:

My name is Odd-Bjoern Hjelmeset. I skied the second lap and I f—– up today. I think I have seen too much porn in the last 14 days. I have the room next Petter Northhug and every day there is noise in there. So I think that is the reason I f—– up. By the way, Tiger Woods is a really good man.
– Norway silver medalist Odd-Bjoern Hjelmeset, on his performance in the men’s 4 x 10 relay (Writer’s note: By far the craziest quote released by the VANOC information desk over the past 13 days.)




Now, I think my students will understand the problem whenever I have a bad lecture…
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