Dan’s Blog

Records and Namesake Debacles

Dan Calandro - Monday, November 25, 2013

A few stories are dominating the investment world today. First, the Dow Jones Industrial Average reached a new milestone by closing over 16,000 for the first time in its history, closing the week 16,065. The S&P 500 market average also set a record at Friday’s close (1,805). Add to them the dismal performance of gold, now down 28% in the most recent twelve months, and reason would expect the underlying economy to be stable and growing at a brisk pace.  

So not the case, which is perhaps best reflected in the 15-51i strength indicator. It's up just 1% in the most recent twelve months (compared to a 24% Dow gain in the same time), and is still off 10% from its all-time high reached in September 2012. See below.

11-22-13

In the two year period stock market strength is up 45% and the market average added 33%; gold is down 25% and the economy has gone nowhere – stocks and gold are telling the same backwards story. Their performances should be flip-flopped.

The economy continues to limp along; unemployment remains stubbornly high, consumers are tight, and banks still aren’t lending. Inflation is low but so is wage growth. And a large section of the Market, the healthcare industry, is in complete disarray – thanks to the implementation of the Affordable Care Act (ACA). 

The healthcare industry is approximately 1/6th, or 17%, of the U.S. market economy. Right now insurers don’t know what they can sell or how much they should charge for it; businesses aren’t sure if they should pay tax penalties or continue providing benefits to employees (taxes, of course, are much less expensive than healthcare premiums); and individual employees don’t know if they have coverage, don’t know how much their healthcare costs will rise, and don’t know if and how it will impact their wages and employment.  

I know this to be true.  

In my other life I own and operate a certified small business, that is, one with less than thirty full-time employees. According to the ACA, companies like mine were supposedly "grandfathered" and "exempt" from any kind of ACA impact – yet our policy, a Blue Cross-Blue Shield product held since 1999, was recently cancelled. A new policy was offered in its place and it is more expensive, provides less coverage, and increases co-pays and expenses to employee by more than $6,000 for families and $3,000 for individuals.  

That is not good for markets.  

Up to this point I have refrained from calling the ACA "ObamaCare" because I thought it was trite. But I’ve had a change of heart. The Affordable Care Act is not affordable and it does not increase care. The name is a total misnomer.

ObamaCare is spot on. President Obama signed the big government act that Democrats rammed through Congress against standard operating procedure and public sentiment. President Obama himself has referred to the ACA as "ObamaCare." He said he liked the name, and was proud of it. And when you think about it, the program is emblematic of the Obama presidency, a bureaucratic and fiscal disaster, a symbol of the ineptitude and corruption of big government. 

Perhaps it is ironic that I start referring to the ACA as ObamaCare while at the same time its namesake, President Obama, has begun referring to it by its legal name, the Affordable Care Act. 

Who could blame him for not wanting to be associated with such a debacle?

Many people seem to forget that in order for ObamaCare to work Medicare (healthcare for seniors) had to be cut and Medicaid (healthcare for the poor and unemployed) had to be expanded. So is there any surprise that UnitedHealth Group recently dropped thousands of doctors from its Medicare Advantage plans? 

We often hear about the redistribution of wealth inherent in the socialist system. But what we never hear about is the redistribution of assets like doctors and healthcare services that are currently going on in the healthcare industry today. To cut services to seniors is a travesty on its own, but it will also cause prices for end-of-life care to rise dramatically.  

ObamaCare negatively affects a significant portion of the market and stocks haven’t yet factored it into current pricing. Investors beware! 

The problem with big government is that it only gets bigger and more corrupt until it is stopped. For instance, Freddie Mac recently announced that it would make a $30 billion dividend payment to the U.S Treasury for debts it received during the ’08 bailout. Great, I thought, Americans are getting paid back. And then I read the fine print: Freddie Mac took a $24 billion tax credit in order to make the dividend payment.

Really???

Yes, in the world of big government a tax break in exchange for dividend income is a means of good payment, a reason to celebrate the practice of government bailouts. According to some, Freddie has "paid back" – albeit, after their complete destruction of the housing and credit markets – and then you hear of their new venture. Yeah, the Federal Housing Financing Agency (and offshoot of the FHA) is creating a new venture that will perform some "back-office functions" that Fannie and Freddie currently handle separately. The company is named Common Securitization Solutions, LLC. 

Does that sound like a back-office service provider to you? 

Big government initiatives corrupt markets, distort reality, and mislead investors and voter alike.  The Market is a mess right now and "the market" doesn’t seem to know it – stock market records and government debacles have it distracted. 

Don’t make the same mistake.

Stay tuned…

ShieldThe road to financial independence.™

The New Subprime Mortgage Crisis

Dan Calandro - Sunday, November 10, 2013

Okay, there’s a lot to talk about so I’m going to get right into it. The stock market continued to trade at all-time highs last weak amid more confusion and misinterpretation of recently released economic data. Yields took an unexpected 5% jump in the week while stocks stayed their over-valued course. See below.

11-8-13a

The initial estimate for third quarter GDP was recently released and the growth rate came in way above what many economists had reasonably expected (2% growth). Instead, the first glimpse into 3rd quarter market activity showed a seemingly strong 2.8% growth rate. However, almost one-third of the total growth rate came from inventory buildups at store level, most likely in anticipation of the holiday season. The most telling piece of this economic news came from its most significant component: Consumers posted a modest 1.5% rise in spending for the quarter, a pace the Wall Street Journal describes as "torpid." 

Lethargic is my word. 

Jobs data was also released which raised the unemployment rate to 7.3%. The most interesting caveat in this report was the labor participation rate, which is now at the lowest level in 35 years – way back to 1979 and the days of Jimmy Carter.

President Obama must be so proud. 

The same economic diseases continue to infect much of the world. In a surprising move, the European Central Bank (ECB) cut its equivalent to the Federal Funds Rate to .25%, citing sluggish economic growth and persistently high unemployment to continue into the foreseeable future. The ECB had been trying to hold their main interest rate above the U.S. key rate (long been at .25%) to increase the value of the Euro against the U.S. dollar.  The ECB made the move for the same reasons America did – with hopes that it will "stimulate" economic activity that would produce more jobs. 

But America has long proven that this easy money formula doesn’t work. At best it facilitates higher national deficits, irresponsible sovereign debt levels, and an extremely inflated stock market. 

Speaking of national debt, the U.S. Treasury announced plans to launch a new floating interest rate T-Note that will pay a higher interest rate as market rates rise – you know, should inflation suddenly appear and cause yields to rise. (But who’s expecting that?) The new variable rate T-Note is the Treasury’s first product introduction since 1997, and is set to hit the bond market early next year. The move, of course, is to spur investor demand for an ever increasing supply of U.S. government debt. It’ll be interesting to see how these yields play-out in the 2014 marketplace.

As mentioned in last week’s blog, quantitative easing (QE) fills the demand gap for U.S. government bonds that exists from free-market deficiency. This is to keep yields low. 

The Fed prints new money to purchase new government debt using low economic output, high unemployment, and low price inflation as selling points to substantiate its QE policy. But inflation does exist, just take a look at the stock market, and economic growth and unemployment aren’t any better for it – while the fiscal position of the U.S. continues to deteriorate under pressure of greater annual deficits and larger national debt levels – all facilitated by the Fed’s easy money position.

Today, the Federal Reserve is doing exactly what Fannie Mae and Freddie Mac did during the subprime mortgage crisis! They encourage irresponsible lending by making debt and deficit too easy to obtain. Back then, Fannie and Freddie guaranteed any kind of mortgage paper, even bundles of notorious home-loan applications that included no income or employment verifications for borrowers. These guarantees dramatically increased the demand for high-risk subprime mortgages, which made it easy for Fannie and Freddie to issue more mortgage debt and guarantees than the market could reasonably afford. These government sponsored agencies, Fannie and Freddie, created a debt balloon that was unsustainable. And in the fall of 2008, that debt balloon burst and the inflated stock market corrected. 

Just as Fannie and Freddie inflated housing market debt running up to the ’08 crash, the Federal Reserve is now inflating a national debt balloon by making it too easy for U.S. government to expand debt and deficit to unsustainable levels. 

Of course, U.S government debt is backed by the full faith, credit, and net worth of the American taxpayer. Remember, the Federal Reserve purchases toxic assets from Wall Street banks with the QE money it prints. Much of the "toxic assets" are subprime mortgage paper created during the last financial debacle. The underlying asset to that paper, then and now, is U.S. land and American taxpayer dollars – because it is We the Taxpayers who are forced to bailout irresponsible borrowers, public and private.    

National debt is simply a mortgage that if gone badly will leave American taxpayers on the hook to bail-out irresponsible borrowers (government) in dollars greatly devalued by central banks (Federal Reserve.) This is a wealth destroyer.  

So in many ways this QE-boom is very similar to the previous housing-boom. 

But as much as they are the same they’re polar opposites. Economic growth (especially consumer spending) during the housing-boom was robust; unemployment was low, inflation was tame, taxes were lower, and the national debt was somewhat reasonable. 

So not the case in this QE era. 

Another important distinction this time around is how much the dramatic increase in money supply is tied to low interest-rate government debt. When yields ultimately rise beyond these historic lows it will cause bond values to fall. Wall Street banks who are currently mandated to purchase U.S. Treasury debt with a portion of QE money will suffer huge losses under such a circumstance. This is, not to mention, that the U.S. dollar will also correct and fall in value at the same time of correction. And before you know it, banks will be in big trouble once again.  

"Too big to fail" is alive and well. 

Today’s condition is so reminiscent: another irrationally exuberant stock market during another subprime mortgage crisis destined for another ugly correction.

Fear not.

The easiest way to make money with investing, without a doubt, is by knowing where investments are in the current market cycle and taking appropriate actions to achieve your desired objectives. Below is a chart perspective that I haven’t shown for a while. It begins at the last "market bottom" way back in 2009 and extends through today.  

11-8-13b

The only thing hard to see in the chart above is the separation between Real and Nominal GDP, as both advanced 16% for the period, or 3% per year. "The market," as indicated by the DJIA, more than doubled in the same timeframe, gaining 123%. Stock market strength via the 15-51i boldly added 221% in the period, and gold was up 40%. 

In a nutshell, stocks are over-valued and gold is under-valued (as it is below "fair value"). Stock market strength is where it should be (above the Dow average) and the bottom for the next major correction, as I see it today, should be around 7,063.

Stick to your plan and make appropriate adjustments… and let me know if you need help.

Stay tuned…

ShieldThe road to financial independence.™

What Corrections Are All About

Dan Calandro - Sunday, November 03, 2013

What Corrections Are All About

Nov 03, 2013

I often find myself torn between two sides – the Obama I hoped for and the one I got. He consistently says one thing and does another, and sometimes I totally agree with him, am proud of him, and hold him in high regard. But those times are too rare and too short-lived. 

The assassination of Osama Bin Laden was an American victory, an incredible display of military expertise and precision in one of the world’s worst neighborhoods. It was a tough call (an operation in Pakistan can’t be considered anything less than a high risk proposition), and it was a good call. It was a proud day for all Americans.  

But the tragedy in Benghazi wiped all of that good feeling away. It was as great a failure as the Bin Laden hit was a success. Benghazi still sticks hard in the craw. And while a terrorist leader of that attack was recently abducted by a team of U.S. Special Forces in Libya (another brilliant display by them) a trial in a U.S. courtroom seems way too good for the massacre’s ringleader. Benghazi, even with this most recent capture, doesn’t make any American proud.  

And as reported just this week, a Taliban leader with a long rap sheet was killed by a U.S. drone strike in Pakistan. While the killing of madmen is always good news to a peace loving world, it seems like only yesterday that President Obama promised to dramatically restrain the use of U.S. predator drones. He made the statement while meeting with the new leader of Pakistan.

This, of course, is not to mention that one day the Obama administration is spying on its Allies and the next day they’re collecting data on the Pope – while all along collecting information on every single American. 

What ever happened to the Rights of Privacy? 

Like many Americans, the world can’t seem to figure out President Obama either. 

Markets feel the same way. When you talk to real people on the street nobody is feeling good about the economy or the actions and behavior of U.S. government. Even so, there are always some businesses doing well in bad markets. This is just as common as some companies doing poorly in economic booms. Both happen all the time, in every cycle. The good, bad, and the ugly will always be part of the American experience. 

The same is true for major market indexes like the DJIA, the S&P 500, and the 15-51 Indicator, where only a few companies (stocks) drive the majority of their total movement. Those companies are big, strong, and above-average performers. So it’s only natural for their collection to outperform the economy (Nominal GDP). But that doesn’t make a strong market. 

Today’s stock market is an opportunistic one blinded by the lust of QE greed with little regard to Market fundamentals. In other words, this is a QE driven stock market rally, a bubble if you will, that can only be sustained with consistent new Fed money. In fact, a stronger economy will actually deflate stock market valuations and cause a correction.  

Think about it. In order to keep the QE money flowing Wall Street applauds every time poor market fundamentals (like weak job numbers) present themselves. This a world where bad economic news sends stock prices higher. The reason for this is simple: this stock market rally is not driven by the economy; it’s driven by QE money, which is fueled by poor economic data.   

On more than one occasion the Federal Reserve has been clear: a significant improvement in the unemployment rate will bring about an end to QE. Remember, Wall Street banks are in the money business. It is when the money-spigot is turned off that they will finally realize that stocks are extremely over-valued in relation to economic output. When QE ends a correction will ensue, and once again, Wall Street will be "surprised" by the severity of the event.

Weak politicians and public governors like dovish Federal Reserve chairman, Ben Bernanke, have no stomach for higher yields, and in fact, are scared to death of them. Higher yields will throw Europe and bond markets into a tizzy. Yields will spike dramatically and cause world turmoil. There is little doubt.  

But higher interest rates and a stronger dollar are exactly what America needs right now. It will provide banks incentive to lend money to businesses for growth and expansion, something that’s not happening right now. That’d be good for the economy, and because the U.S. is the dominant market in world GDP, higher interest rates would ultimately be better for the world over the long-term. There would be some interim pain, no doubt, but it would be worth it. 

Easy money proponents have no guts to take the tough medicine – and Wall Street knows it. That’s the reason they send stock prices sharply lower and spike yields higher every time word of a QE taper is mentioned. This behavior is a penalty for the Fed turning off the money-spigot. The movement is intended to extort weak governors into continuing poor monetary and fiscal policies, which is bad for markets, investments, and economies.

The chart below shows a comparison of stock prices, gold and yields since January 2011. Some special notes have been added to highlight key Federal Reserve announcements.

The first note, signified by a green diamond in the below chart, was the Fed’s initial announcement of a third quantitative easing effort, called QE3, in September 2012. It was an open-ended commitment of bond purchases without a specific expiration date. 

The second note is almost a year later, in May 2013, when Fed Chairman Bernanke first announced a taper of QE3 could arrive soon (signified by the red diamond.) Look at what yields did since that time.


11-1-13


QE money gives Wall Street banks plenty of firepower to manipulate valuations for multiple asset classes of investments simultaneously, including stocks, bonds, and commodities like gold. Remember, trillions of QE money has flowed into banks fast and furiously since its inception several years ago. As a result, Wall Street banks have an arsenal of new money to manipulate markets.  

QE is like handing guns to drug cartels and then not expecting to be targeted by those very same guns -- an obvious outcome to most rationale people.

The moment QE is tapered, and ultimately terminated, yields will automatically rise because insufficient demand for new U.S. government debt already exists in the marketplace.

Poor fiscal policy is causing the Treasury to produce more government paper than there is natural demand. This excess supply of T-Notes causes yields to rise; a move that provides additional incentive for lenders to lend. 

To combat this dynamic (higher yields) the Federal Reserve prints new money via QE and then hands it to Wall Street investment banks under the mandate that a portion of the funds are used to purchase U.S. Treasury securities – to thus fill the demand gap left by free-market investors, and to keep yields low.

In other words, QE is a function of central government deficit, as new money must be printed to fill the demand gap of U.S. Treasury debt. If fiscal deficits widen (e.g. due to increased spending for Medicaid expansion as a result of the implementation of the Affordable Care Act) the demand gap in U.S. government bonds will also widen; so in order to keep rates low the Fed will have to increase the amount of QE – in other words to print more new money so Wall Street banks can buy more U.S. Treasury securities.

It’s a vicious cycle, and so reminiscent of the subprime mortgage debacle.  

This too shall end. But if you ask me only two conditions will slow QE momentum: 1) a significant advance in economic performance and/or unemployment, or 2) an inflationary condition that causes yields to rise beyond the Fed’s control.

Bernanke and his ilk simply don’t have the guts to cut QE before one of those two conditions force their hand. 

And when yields begin to rise, whether it is because of a QE taper or inflationary condition, bond and stock values will hit the skids (and it will be ugly) and gold will rebound. Such a movement will bring all asset classes back in-line with Market fundamentals. 

That is, of course, what corrections are all about.  

Stay tuned…

ShieldThe road to financial independence.™


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