Dan’s Blog

Crossroads

Dan Calandro - Sunday, August 25, 2013

The most important news came from the Middle East again this week, as it is becoming more and more evident that chemical weapons were used in the civil war in Syria. This was a "red line" President Obama warned the Assad regime not to cross. That statement now forces the hand of the president – either he act and drag America into another military conflict, or back-off and become even weaker and less influential in the region. 

Neither option is good. And it has proven Obama’s grand foreign policy plan to be nothing short of a cataclysmic failure. 

As if that wasn’t bad enough, more affirmation appeared this week that the president’s domestic agenda hasn’t fared much better that his international policy – more than half of the mortgages that were modified under Obama’s Home Affordable Modification Program (HAMP) have defaulted yet again; and because of multi-trillion dollar deficits accumulated so far in his administration, Congress doesn’t have the pocket change to begin funding his signature healthcare law (the Affordable Care Act.) 

Regardless of their feel-good names, big government programs never deliver – Social Security is not secure and Medicare is broke, care for veterans is grossly inadequate compared to what Congress receives, and multi-trillion dollar stimulus programs haven’t stimulated anything but the pocketbooks of Wall Street bankers.

Perhaps the latter is why investment markets have once again shrugged off the specter of financial doom and international crisis. Stocks were mostly flat in the week and gold added only modestly to its rebound, up another 2%. Below is a two year chart.

8-23-13a

The comparison between stock market strength and gold is even more interesting in a five year chart. As you will see below, the Dow Jones Industrial Average has been unable to reach the performance level of Nominal GDP since the last market top (October 2007).  That’s why your portfolio needs to beat "the market." If not, your portfolio will lose money in Real terms. 

8-23-13b

Gold and the 15-51 Indicator took two completely different roads to the same endpoint. That means something, for sure, exactly what I’m not certain. However, what I do know is this: Market conditions aren’t rosy but life has been very good for the Dow this year, and since gold and the Indicator won’t travel the same exact path from here, this puts them all at a crossroad.  

Stay tuned…

Contrary Conditions

Dan Calandro - Sunday, August 18, 2013

This week the Dow Average lost 2.2% and bond values continued to fall – but stock market strength and gold both added 4.5% in the trading week. While mixed messages and smoke and mirror economics are continuing themes in "the market," recent activity actually makes a lot of sense. The chart below shows the most recent twelve months of investment activity; a discussion follows.


8-16-13a

Look at the spike in yields – the 10 Year T-Note is up a whopping 61% in the period with most of the rise coming in just the last few months.  

What does this mean? 

One of the basic tenets of finance is: A dollar today is worth more than a dollar tomorrow. To illustrate this, consider that a dollar today is only worth $.98 next year with 2% inflation (a.k.a. the cost of money). 

In the same vain, if someone borrows $1 today and must repay it along with 5% interest in one year’s time the borrower’s current value of a dollar is $1.05 (the value of a current dollar plus the cost of debt). The future value of that money when payment becomes due is $1.03 adjusted for inflation, where future value is equal to: principal plus interest less inflation.  

Under this same theory, rising yields also causes the future value of a dollar to rise, as more interest must be paid for a dollar borrowed today. Continuing with our example above, if interest rates were to double to 10% the current value of a dollar borrowed is $1.10 and the future value of the repaid dollar is $1.08 – less the 2% inflation rate. 

Did you see that?—when interest rates went up (from 5% to 10%) so did the future value of money (from $1.03 to $1.08). That’s strict theory.  

But nothing is absolute.

Currencies that seemingly rise from weak monetary policies should not be considered a sign of future strength. Instead, rising yields in weak monetary environments (like we are experiencing today) indicates inflation – not strength. The expectation of future inflation (due to weak monetary policies) causes the current value of a dollar to fall because investors know that it will be worth less in the future. This market dynamic drives yields higher against the will of government powers because more interest is demanded by investors to cover the cost of the falling dollar. In short, inflationary pressures – not monetary strength, is currently causing yields to rise.

That’s the reason gold was up strongly this week.

These same dynamics ring true in the stock market where stocks in high demand generally produce higher valuations – but not necessarily stronger companies. For instance, Apple was up 10% this week and it drove the 15-51 Indicator higher because activist investor Carl Icahn took a significant position in the company and is pushing CEO Tim Cook to increase and accelerate the Apple stock buyback program – a move that would limit supply and cause an additional rise in stock price. 

But one shouldn’t misinterpret a resulting rise in Apple’s stock price to be due to strength. Instead, the move would result from a shift in corporate policy to a strong stock pricing posture. In other words, a much more aggressive stock buyback program doesn’t make Apple a stronger company even though its stock price has risen substantially. It’s strictly an effect of its corporate monetary policy.    

Just as higher yields do not automatically make a stronger currency – higher stock prices do not make a company stronger.  

Many TV pundits and Wall Street power brokers misrepresent a rising Dow Average as "strong" which they purport indicates strong, or strengthening, stocks and/or economics. But nothing can be more shortsighted. In fact, people who subscribe to this position are always the same people who get blindsided by major stock market corrections – and Wall Street is full of them. 

I am proud to say that the last major stock market correction that caught me off guard was Black Monday, October 19, 1987, when I was a senior in college – which by the way, was when the seeds of LOSE YOUR BROKER NOT YOUR MONEY were originally sown. But I digress… 

Strong dollar conditions under strong money policies that produce higher yields indicate strength; just as pro-growth economic policies under responsible fiscal governance that produce strong economic growth and higher stock prices indicate strength. Contrary conditions are inflationary and ripe for correction.  

Unfortunately that’s the condition we're in. 

With established interest rates already near zero, and with all the monetary tricks being employed to keep rates at all-time lows, it looks like the Fed is finally losing control of yields – a condition that will really shake-up world financial markets. 

Since the U.S. economy emerged from "recession" in 2010, the Dow Average is up 42% and the 15-51 Indicator added 88% – while Real GDP grew at just 7%. As a result, both portfolios remain substantively inflated. See below.

8-16-13bb


Major stock market corrections always follow a prolonged and rapid rise in prices.

Plan ahead, stay tuned – and let me know if you need help.

See Last Week’s Blog:

Prelude to Mutiny

Prelude to Mutiny

Dan Calandro - Sunday, August 11, 2013

These are the dog days of summer and as usual nothing much has changed this week. And while little has changed today, something big is about to happen that could do what many pundits think the Federal Reserve’s QE program hasn’t.

In a Wall Street Journal on-line article entitled: Small Business in IRS Sights, August 9, 2013, we learn that the IRS is launching a new program aimed at closing the "tax gap" (the amount in taxes between what small businesses owe and pay) which the IRS asserts is created by the under-reporting of cash sales. Twenty thousand small business owners were recently contacted to get the new program rolling. More will certainly follow.  

Of course, self-righteous governors are sending the IRS to collect additional taxes under the guise of equity – "to eliminate an unfair advantage that non-compliant businesses have over compliant ones." How transparent.  

By small businesses they mean local markets, community mom and pop retailers – middle class market participants – who often pay tax rates twice those paid by the biggest corporations like General Electric, Google, and facebook. 

Make no mistake: This IRS program is an attack on the middle class.

As we now know, the IRS is used as a political hit machine directed by the highest levels of the executive branch of government. The president, who espouses to be a middle class advocate, is now sending his revenue hit squad to audit them in the name of "fairness" and under the presumption of guilt until innocence can be proven.  

So let’s skip ahead and say that an entire audit of 100% of these small businesses was performed and it produced additional taxes, penalties, and interest to the tune of $157 billion (approximately 35% of the reported tax gap in the aforementioned WSJ article.)

What economic benefit is truly had?

The government, already with a $600 billion deficit so far this year, would have a couple extra bucks to waste on stimulus spending that produced nothing but an irresponsible level of national debt, the worst job recovery in history, stagnant economic activity, and an over-inflated stock market.  

The middle class, on the other hand, gets higher taxes, less earnings and dwindled savings. If their businesses are able to survive many will have no choice but to raise prices to cover the higher costs of operation. And then, low and behold, broader market inflation will become a real problem – something QE hasn’t yet delivered.

The government’s job is to manage the market economy. Currently on the monetary side the Fed will keep printing new money until their definition of inflation tells them to stop. This leeway provides fiscal governance an argument to raise taxes, to indict the middle class without probable cause under the guise of "fairness," and to continue recklessly spending ungodly amounts of money on political pipedreams, payoffs, and kickbacks that add no value to the economic base.  

Indeed, everyone ought to pay their fair share of taxes. But when mom and pop shops pay 35% and GE pays 15% under the same tax code "fair" is anything but equitable. GE got bail-out money during the ’08 financial crisis. Mom and Pop had no such luck – and if they had to skim a couple of bucks here and there to bail themselves out then who could blame them. They still paid a much higher percent of taxes on their net income than the biggest and most profitable companies did.  

Fixing the tax code should be government’s second order of business before sending their henchmen out to harass the middle class. Their first priority should be to stop handing billions of dollars of free new money to highly profitable Wall Street banks. That would be a fine start towards fair and equitable.

To send the IRS out after small business owners at a time like this and under these Market conditions is not only stupid but a prelude to mutiny.  

And that’s not good for markets, profit, and stocks.  

Stay tuned…

Shield
The road to financial independence.™

Food Stamps & QE

Dan Calandro - Thursday, August 08, 2013

The U.S. economy added just 88,000 jobs in March, proving once again that any talk about recovery is misplaced. 

Food stamp recipients, on the other hand, rose 1.8% year-over-year amid early released news of President Obama’s new budget that curbs Social Security benefits.  

Social Security is an entitlement to people who have paid into it for more than 40 years of working service. Remember, individual employees contribute 7.65% to Social Security and Medicare – and their employer matches the same amount. In other words, Social Security and Medicare taxes amount to 15.3% of every individual’s earnings.* Call me crazy, but I do believe that these people are entitled to a reliable benefit at retirement that fulfills the promise of the social benefit plan that they invested in. 

Yet they are the first ones on everybody’s hit list – Republicans and the President – to incur benefit reductions.  

But why isn’t food stamps – which are not an entitlement – at the top of the list? 

There are currently fifty million people in the U.S. population on food stamps – some 15% of all people. This is embarrassingly way too high almost five years after the market meltdown; not to mention that there are many people receiving food stamp benefits in America that are not American. 

America has a welfare problem first and foremost, a government corruption problem in the second – and yes, an outdated social entitlement system that needs a drastic overhaul in the third. Why not attack them in that order? By overlooking the first two to focus on the third is further proof that current American governance has no clue how to fix the Market. As such, Real recovery cannot begin. 

This unfortunate state – a lackluster market economy, a poor jobs market and escalating welfare programs, and incompetent fiscal management – force the hands of an all too willing Federal Reserve to think twice about stopping its printing presses and irresponsible monetary programs, like quantitative easing (QE).    

If trillion dollar fiscal deficits, and trillion dollar currency print runs, all of which amounted to $7 trillion of new debt, couldn’t bring unemployment down to 5% by now – then continuing to do so is more insane than hopeful, and more corrupt than helpful.

Let’s acknowledge one thing: "free stuff" means much less than that which is hard earned. Free stuff can make a populous stupid, not to mention dependent on government assistance. QE, for example, is food stamps for white collar investment bankers. 

Take Goldman Sachs, a recipient of government bailout funds and QE proceeds – a.k.a. free money. This week they announced the creation of a new unit dedicated to "high risk debt" for companies with "no credit ratings." (Remember, they’re too big to fail, and therefore, dependent on government assistance and taxpayer funded bailouts to cover their failures.) But here’s the best part – Goldman said that the people who will be managing their new junk bond business "have no prior experience managing" such an operation. Does that sound smart?

Hey, when money is free and easy – losing it is no big deal. And since losing free money is easy, it requires no experience. 

In spite of the Market’s dysfunction, the Dow Jones Industrial Average is up 11% this year. That’s because new money handed to investment banks creates inflation in easy to manipulate market indicators like the Dow Jones Industrial Average and S&P 500. The 15-51 Indicator is telling the true story, and continues to lead "the market" by several months. See below.

4-5-13

Food stamps, like QE, are artificially inflating a very weak market. 

Stay tuned…

ShieldThe road to financial independence.™

* Social Security is applied to the first $113,700 of wages per year. Medicare is taxed on all wages. 

Smoke & Mirrors

Dan Calandro - Sunday, August 04, 2013

The big news this week was in regards to Gross Domestic Product (GDP), defined as the value of all goods and services traded in markets for a territory. In its most recent report on economic activity, the U.S. made a couple of changes to GDP calculations. 

First, the U.S. modified the chained period to calculate Real GDP. Prior to the change, Real GDP priced market activity in terms of 2005 dollars; now it prices Real GDP in terms of 2009 dollars. Second, GDP activity was expanded to include items such as research and development, and investments in intangible assets like patents and trademarks; and in addition, a change was made in the method of accounting for employer funded pension plans.

The combination of these modifications added $500 billion to GDP.

Call me a cynic, but this move is so transparenly political it reeks. It is clearly a move made to substantiate government spending and debt levels when the underlying economy simply cannot. And since no other country uses the new U.S. definition of GDP, it is easy to deduce that the changes were made solely to inflate GDP closer to the escalating national debt levels - and I'm sure Washington wants the world to follow.

Doesn't that sound just like Washington DC today?

While one-half trillion dollars is a significant adjustment indeed, it doesn’t change the economic picture to any great extent. New GDP figures also slightly changed the action zone, the high point (a.k.a. irrational exuberance) now stands at 15,068. Below is a ten year chart comparing the Dow Jones Industrial Average to Real and Nominal GDP.  

8-2-13

In Real terms, stocks haven’t traded this high in the last twenty years – not even at the peaks of the housing and tech booms!

So why does "the market" continue to trade at multiples like these?

Inflation, plain and simple.

Many TV pundits often defend Ben Bernanke’s and the Fed’s easy money policy by citing that no inflationary problem exists – that the general rise in prices for goods and services is "tepid." But these people overlook the asset bubble (a.k.a. inflation) being created in the stock market, courtesy of the Fed’s addiction to QE.

More new money always creates inflation somewhere. The spread between Real and Nominal GDP is inflation. Inflation, as shown in the chart above, is anything but tepid with approximately 3,000 points of inflation, or 19% of its value, currently in stock prices today.      

The reason the economy is barely growing in Real terms is because QE isn’t doing anything to expand the economic base. It’s being used to artificially inflate the stock market – to put on the façade that economic conditions are better than they actually are. 

This is political smoke and mirrors.

The last two economic booms had legitimate catalysts: housing and technological advances. The internet opened local markets to the world, juiced employment, created wealth and circulated money to all four corners of the Market. The housing boom did much of the same. But there is no economic boom going on right now. Economic growth, even under the new calculation, stinks at best.

As such, this is a smoke and mirrors stock market run, built and sustained solely on the Fed’s addiction to poor monetary policy and QE. 

And like all pyramid schemes, this bubble too will burst.

Stay tuned…

ShieldThe road to financial independence.


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