Tuesday, January 30, 2007

Japan should raise rates

It's simple, and not conventional wisdom. Japan should begin a gradual raising of interest rates. Their central bank's rationale for not raising rates is their chronically weak economy and lack of consumer spending. They miss the point.

The financial big shots of the world love Japan's low, or no, interest rate policy. They can borrow in a stable democracy that is financially strong and reinvest elsewhere with an arbitrage that is just wonderful. It's called the "carry trade". In a globalized economy, the wealthy of Japan support this as well.

This situation, however, guarantees a perenially weak Japanese economy. Their demographic is one of an aging population that was devastated by the Nikkei and real estate collapse of the late 80's. This conservative aging population has no appetite for "speculative" investing in equity or property markets. Staying in fixed income investments means almost no income at this point. That simply means that they do not spend, they do not consume, and they do not pass on their wealth to the younger generation because they fear for their own financial security. Modestly raising interest rates will over time spur consumption and revitalize the domestic Japanese economy. This may seem counterintuitive, but just look at the U.S. experience in recent years and there is a model.

Shortsighted Japanese bankers and industrialists fear interest rate increases as their export dominated economy always wants a currency, the yen, that is competitive. On top of that they can participate in the global hedge markets in a way that the great majority of Japanese cannot. Their view is wrong. A robust Japanese domestic economy is a long term necessity, and interest rate increases will underscore the confidence in the turnaround that has taken place finally in this economy and that can thrive with better management.

Sunday, January 28, 2007

"Dirty Pretty Things"

"Dirty Pretty Things" is a film that I picked up at my local library today. Whatever I expected from the title I got much more. When you get the unexpected treat it seems sensational, so I don't really know how good this film is. For those with great local libraries, a good video store, or a NetFlix subscription this is one that should be at the top of your list.

It's a BBC film that seems to have no major awards or notices, except for the usual "two thumbs up" from Ebert and Roper and positive comments by Rex Reed and Rolling Stone on the DVD cover. The story of a Turk and a Nigerian and their lives as illegal immigrants in London, and the sinister world they discover, is mesmerizing. It's a well made film.

Today's New York Times business pages

Today's NYT business section has a few articles that are particularly interesting. They are as follows:

---"The Hard Rain That's Falling on Capitalism" by Ben Stein---Ben Stein is to capitalism what Calvin Trillin is to food. He's a believer and he writes well and with self deprecating humor. In addition to the article title, he begins with a Dylan quote from "Gotta Serve Somebody", and then goes into the benefits of capitalism for his parents and himself and states that "this miracle has been vibrant in the lives of hundreds of millions of Americans who have gone from nothing to something, thanks to the dynamics of capitalism". He then moves, however, to the abuses of the system that have grown in recent years. In a few short paragraphs it's all there. He observes that capitalism "is built on man's notion that he can trust his neighbor with his money, and that if the neighbor misbehaves, the law will chase him and catch him, and that the ladder of law has no top and no bottom, that even the nobles get properly handled(Bob Dylan again) once they get caught. If that trust disappears, if the system is no longer for the ordinary citizen but only for the tough guys, how much longer can the miracle last?"

---"A Growing Aversion to Ticker Symbols" by Andrew Ross Sorkin---this is an article about the trend of public companies going private. Whether because of Sarbanes Oxley, legal liability to shareholders and trial lawyer extortionists, or media scrutiny, the desire to go private is growing. One buyout banker, unnamed, is quoted as saying "you know, it's ironic, Calpers(the activist Calfornia state pension board) screams when a public company CEO is making a lot of money, but are completely content as a limited partner in a private equity firm to pay him a fortune when the company is private".

---"Now You, Too, Can Enter the World of 007 Finance" by Paul J. Lim---this article details the ability of a modest individual investor to use easily accessible ETF's and basic hedging strategies to have their own little hedge fund. It uses as an example an individual who says that he does not fancy himself as an amateur George Soros. He does however want a portfolio without the expenses and market returns of mutual funds, one that is "a spicier portfolio, keeping 75% of assets in stocks and bonds that he deems 'secure from fiasco' and 25% in more speculative investments".

---"Is the Fix Worse Than the Problem" by Gretchen Morgenson---this describes a proposal in Congress to address the excesses in executive pay. The problem with this, well detailed here, is that the bill's attempts to address deferred compensation will mainly affect middle income employees, and be especially onerous to those who are near retirement and have had the good sense to save during their careers. Such a horrible bill might seem unlikely, but when looking at already existing attacks on the financially responsible middle class like the AMT, the lack of cost of living indexes for taxes(i.e. two working members of a family with two children making in total $100,000 in New York City are just scraping by, and the same demographic makes that much money in many areas of the country and there's a swimming pool in backyard, but the tax rates are the same), and the thresholds for tax exempt savings plans, college tuition benefits etc. all have the same big blind spot(one could say red states vs. blue states but the Democrats are absolutely oblivious to this issue as well). This article is well detailed. Intuitively it seems correct and troubling, and hopefully the facts are right as Morgenson's work is not always distinguished by credible sources.

Davos wraps up

The annual Davos World Economic Forum was held this past week. Coverage by Bloomberg News expressed surprise that, while attendance was large and high profile overall, attendance at meetings and presentations on global political issues in areas of interest such as the Middle East, North Asia, and Africa was sparse. Since the Davos website describes in a subtitle the Economic Forum as "Committed to Improving the State of the World", the Bloomberg reporter's comment would seem to be the right reaction. In fact, however, Davos has been and remains primarily a world financial trade fair, at least until these substantial political threats start tangibly disrupting markets.

Davos highlighted four major issues this year; global trade talks, climate change, technological change, and globalization effects in general. Attendees represented major financial institutions, global corporations, global investors and central bankers. Representing many financial firms are a senior representative like the CEO, but just as often, perhaps more often, a non-executive Chairman or Vice Chairman, meaning someone with stature who is in the process of retiring. In addition the firm representatives below that are senior deal makers, the hands-on rainmakers who are there to win business, entertain, even have associates give out expensive trinkets(it's amazing to see how much very wealthy people like to receive free stuff).

That there is such a forum to discuss climate change, global economic trends, and avoiding unfair trade barriers is a good thing. Expecting this forum to address global political issues is a stretch, even though political issues will at times radically impact economic issues. Perhaps there needs to be something like a Davos II, in which governments are represented by senior officials, not just central bankers, and corporations are represented by their leaders, leaving the deal folks behind. That would be a different and possibly a more important dialogue about global prosperity and peace.

Tuesday, January 23, 2007

Citigroup regroups

Citigroup announced another management change. The two supposed heir apparents to the CEO position, Todd Thomson and Sallie Krawcheck, were removed from their positions. It was incredibly bizarre to those in the know that either of these managers were viewed as potential CEO's of the powerful Citigroup franchise. Whether by guile or luck they managed to appeal to the ego of Sandy Weill before his departure.

Sallie is a normal, smart, and self-effacing person who was a well-regarded securities analyst before moving to Citi. She had no meaningful management experience. She has a penchant for saying the wrong thing at the wrong time to gain approval, and then charming her way out of it. It was a definitely a stretch for her to be the CFO of Citi. The best thing one can say about Todd Thomson is that he is smart but arrogant. He is way way ahead of himself. The most impressive thing about meeting Todd is not intelligence or competence but just how impressed Todd is with himself.

So in a down market Citigroup was up yesterday as a small bit of reality seemed to be seeping into the consciousness of this exceptional franchise. At the same time Citigroup purchased ABN's mortgage portfolio, balance sheet assets and servicing, with only a press release from the business. $9billion in assets and $224billion in servicing and no corporate comment? Since there is no leadership at Citi, the businesses are running the show. In a conglomerate it makes sense for a business manager to get bigger and if successful there follows more attention and bigger bonuses. There should be some corporate strategy attached but at Citi there is none. The CEO office, as far as strategy, has an "Out to Lunch" sign dangling on the door knob.

Citigroup is a franchise with a significant competitive advantage in international banking. Chuck Prince seems to be a custodian who was appointed by Weill to deal with legal issues and to not upstage his departure. Get a leader in, get the lightweights out, and the stock can move to $80 in the next two years.

Saturday, January 20, 2007

Possible big issues

As a follow up to the prior post, the following is a list of a few of the big issues that could possibly do significant damage to the equity markets. Of course any point in time has its troubles ahead. We seem to have our share today. The issues here range from cyclical to structural, political, and medical. This is an incomplete list of course but there's enough here to augur against a 100% equity weighting. And the issues are:

---U.S. consumer credit---Those below the top 10% in wealth in the U.S. are awash in mortgage and credit card debt. Many adjustable rate mortages have been resetting to higher rates based on the advantaged rates offered at the outset as well as, with three year paper, the higher rates that exist today. The impact of this is only beginning to be felt. Credit card companies are now for the most part in their sweet spot(from their financial perspective) with lots of balances being carried and lots of late fees being paid. But the credit card business is a balancing act and too far in the wrong direction can bring a reversal of fortunes quickly. We have recently seen some issues in specific companies and segments of the credit card market(a few companies with higher delinquencies) and the mortgage market(some sub-prime portfolios troubled). It can be normal for companies with less technological capability or flawed underwriting standards to be the first to have issues. The question is whether issues will move into the broader market for consumer credit. With unemployment at low levels and the economy still solid most market participants are ignoring this potential issue. With wage growth low, however, and the accessing of credit ingrained in day to day life, there will likely be a day when the line will be crossed and credit, that old achilles heel of banking, will be an issue.

The new Congress question---this is a simple concern that could be important. Will a combination of conservative protectionist Republicans and labor dependent Democrats pass trade legislation that damages U.S. economic and political interests overseas and leads to inflation in the U.S. Some say that the primary focus, if legislation comes, will be China and that the wonder of globalization will quickly shift sources to other countries for many goods. That's perhaps wishful thinking and the precedent of trade barriers would be negative. Nancy Pelosi is too smart to want this but some heavyweights like Chuck Schumer(who is also smart) don't seem to care about the impact, or else see this as a bargaining chip. That could backfire.

Foreign affairs issues---Iraq, Iran, North Korea, that's the focus now, and there is plenty to worry about that could lead to some sort of shock scenario that can't be factored into valuations. But the issues with these countries are well known. Iraq's chaos is thoroughly documented, Iran is a dangerous provocateur but nothing more than that at the moment, and if North Korea does anything to mess with the Asian region prior to the 2008 Olympics, China will squash them like a bug. There are other countries, however, that should be on the radar screen and if they blow, it would exacerbate dangers in the world today. The two of most concern are Pakistan and Indonesia.

The credit derivatives market---this is the financial market that is relatively untested. It is a valuable portfolio management tool that in the long run will mitigate risk as it allows market participants to buy risk in strips and weight their portfolios with a certain degree of precision and with diversification within risk tiers. The counterparty risk, particularly as it relates to investors, has not been through a credit cycle and does have significant potential to be at least a short term disruption when it is tested, maybe worse.

Avian flu---this is perhaps an over the top concern compared to the others. It is just another distant threat in the minds of most market participants, and it may well be. It is a concern, however, among those who focus on it, much more so than is widely known. Humans have contracted it, but the good news is that it is now difficult to pass from human to human. Apparently the virus now only attaches itself to the lower parts of the lungs so that the usual means of spreading epidemics(breathing, sneezing, handshakes, kissing etc.) are not happening. If the disease adapts and begins to inhabit the upper part of the lungs, globalization would stop dead in its tracks, so to speak.

Terrorism---self explanatory threat to major countries that everyone is aware of and cannot be predicted.

There are, as stated at the outset, many more issues that one could choose as personal favorites or fears. As I reread this before posting, I'm not quite sure why I wrote it, as I've had a pretty good day and expect to sleep well tonight. I guess the point is that there are many extant issues that should temper one's enthusiasm for risk, even in an equity market as benign as the one we have had recently.

"Can't get any better"

An old Wall Street story tells of a CEO whose company just reported their highest quarterly earnings ever. He goes on the conference call with investors and securities analysts and enthusiastically says, "This is great. It can't get any better than this!". He and his company are shocked when the stock sells off significantly. The Street, however, looks forward and if things are not getting better...

On the personal side, at a Wall Street reception a few years ago I met up with a business acquaintance of mine who was CEO of a small company and I asked the usual, "How's it going?" He responded, "Don't pinch me. I might wake up." A year later he was in jail. True story, sad story, he's a really good guy.

What's the point? The equity markets have not had even a mild correction since the mid-May to mid-June '06 period. It almost seems that when issues of concern appear, the market gains momentum as it takes advantage of the cautious and bearish, and heads higher. Equities have been exceptional in the last 6 months, and the extent of the surprise is evident in the fact that so many mutual fund managers(some true professionals) missed their benchmarks in 2006. At this point these "can't get any better than this" and "don't pinch me" anecdotes may have some relevance.

U.S. equity market values are by no measure extreme, corporate earnings growth is good if not great, and the Goldilocks scenario seems to be solidly on track. One problem however--healthy markets rarely if ever go straight up. There need to be at least modest corrections to allow new buyers a chance to catch up and jump in, and give holders a moment of caution so they take another look at the values in their portfolio, not just the momentum.

For this equity market to have a healthy 2007 there need to be some breaks for consolidation and rethinking. If not, the table may be set for a correction that is unhealthy, one of those that feels uncontrolled and does some real damage, especially to those investors, both hedge fund institutional and retail investors, who have used leverage or margin loans to participate in the party.

These concerns, however, are about normal market valuation and market cycles. The other big issue for the market is that it is for the most part ignoring some factors that could have a serious impact if they were to materialize. That is perhaps the only sane way to function. The next post may address these bigger issues that scare some of us in the news but don't seem to scare us in the market.

Wednesday, January 17, 2007

Excerpt from Third Avenue Funds letter to shareholders

On October 6, ENS posted an excerpt from Third Avenue Funds quarterly report. I follow today with one from their latest quarterly report, again written by Martin Whitman, the 82 year old portfolio manager of the $9.3 billion Third Avenue Value Fund.

Whitman again discusses the emphasis in SEC and FASB disclosure requirements on short term earnings results as reported, with less emphasis on metrics that give investors, as opposed to traders, the information that they need. He writes, "The best hypothetical standard for disclosure, to my mind, ought to be what is required for making sound judgements by those who are long-term unsecured creditors, holding privately placed debt instruments; and not the average investor who thinks he, she, or it are vitally affected by day-to-day, or hour-to-hour, price fluctuations. This is because, at bottom, the average investor cannot be protected unless he, she, or it, protect themselves. The present emphasis on serving short-run interests seems to be ruining U.S. capital markets for publicly-traded equities."

He does go on to say, "It ought to be noted, however, that it is hard for TAVF management to complain about the disclosure system. Over the last 40 years the SEC has done a magnificent job in improving disclosure for buy-and-hold investors such as TAVF."

Later in his comments Whitman does express more concern, "Third Avenue is harmed by non-productive regulation as embodied both in GAAP, as currently constituted, and the Sarbanes-Oxley Act of 2002. Also, frivolous stockholder lawsuits are a problem, especially the class of lawsuits labeled 'fraud on the market'. As things exist now, no foreign issuer is likely to access U.S. capital markets unless they absolutely need U.S. capital. TAVF invests heavily in foreign securities. Further, many small companies, now publicly traded, are thinking about 'going dark', i.e., no longer being subject to regulation by the SEC. Needless to say this environment is not conducive to the well being of the U.S. economy, which for many years, at least since 1933, has benefitted from having the deepest, most efficient, best informed capital markets ever known to mankind."

And needless to say, I really enjoy Mr. Whitman's commentary.

"Kickin' Out The Footlights...Again"

Today brought a real treat. I picked up "Kickin' Out The Footlights...Again...Two Icons Collide---Jones Sings Haggard, Haggard Sings Jones". In this current album, George Jones and Merle Haggard combine to sing each others songs and four duets. The music seems to come so easily to them and their band. If I wanted to write something that sounded like a cliche out of a music reviewer's pen I would say "they don't perform their music, they are their music". I don't know the staying power of this CD and I don't care, because today it was just perfect. The duets, "Footlights", "Born With the Blues", "Sick, Sober and Sorry" and "Don't Get Around Much Anymore" pretty much tell the story and Jones and Haggard and their musicians do it right.

An unexpected pleasure in the CD liner notes was one of the photographs of the two. It 's an instant laugh out loud.

Monday, January 15, 2007

"60 Minutes", a few observations

Here are a few quick observations on last night's "60 Minutes".

Bush interview:

---The word "victory", after lasting into December, has finally been eliminated from the vocabulary in relation to Iraq.
---It seems as if part of the price for getting the interview was having the CBS guy say "Democrat" Pary, as opposed to the commonly used "Democratic". He did it twice, and I'm sure the small minded Karl Rove thinks that's some kind of accomplishment.
---Bush called for Iraqi gratitude, which was perhaps appropriate three years ago. Today with limited infrastructure, few jobs, and escalating violence, gratitude seems to up there with victory as a word that's out of touch.
---Bush almost uniformly used the words "I", "my", and "me" in answering any question. That's opposed to "we" or "our" etc. that could refer to the U.S. people, the U.S. government, or even his own inner circle of advisors and the military.

Duke lacrosse segment:

---Based on all of the disclosures to date, if Nifong just gets disbarred he should count his blessings. If an officer of a U.S. corporation was exposed for this type of intentionally deceptive activity, they would be charged with a crime for defrauding shareholders. Why are the taxpayers of North Carolina different from the shareholders of a corporation.

Sunday, January 14, 2007

New Yorker Cartoon Caption Contest

About every six weeks on average I will enter the weekly New Yorker cartoon caption contest, as I did today. It seemed like a good week to give it a try again.

With each entry I am certain that my entry has the right blend of ingredients; clever, subtle, intelligent, and of course humorous. I have never advanced. It's likely that most entrants are creating captions that would make their friends smile at the least, as they would know the context. It is also likely, and almost certainly so in my case, that many captions would make no sense at all to a broader audience. Despite that, I will persist on infrequent occasions and for two weeks there will be, in my mind, the possibility that my name will go through the backdoor into the magazine of Cheever, Updike, Liebling, Parker, Sontag, Flanner, Trillin, Capote, and so so many others.

Saturday, January 13, 2007

Always the same mistake, or is it

On the surface President Bush always makes the same mistake, and in the last week he has done so in a major way that will possibly have disasterous consequences.

It all started four years ago when he began the Iraq invasion and occupation without getting any consensus among, or even having any meaningful discussion with, many of our important democratic allies. He did have consensus from much of Congress and the American people. Even after the WMD rationale was discredited, Congress and the electorate were primarily behind the President due to the success in Afghanistan and the desire to support the troops in Iraq and gain a somewhat acceptable resolution. On foreign policy and domestic policy issues Bush, however, has not been one to reach out, except to those whose support he could count on.

There were two decisions this past week that followed this pattern of making the same old mistake. First, when he made his Iraq policy statements on Wednesday he had definitely not sought out a cross section of Congress or other influential and concerned American people(business leaders, academics, former military leaders, former successful government leaders etc.). Second, when he attacked the Iranian consulate in Kurdish northern Iraq, he did not even consult or inform the regional Kurdish government.

The first mistake could lead to an unmitigated disaster. With such obvious dissent among much of Congress, other Americans of influence, and the U.S. voter, it gives the Shiite militias, the Sunni militias, and outside insurgents an unprecedented opportunity. If they can make the "surge" fail, they believe that the U.S. will be forced to withdraw. So it is now possible that the sectarian violence will slow down and most violent action will be focused on U.S. forces. It is likely that warfare, terrorism, insurgency, whatever you want to call it, will increase rather than decrease in the coming months. We have obviously seen the willingness of Islamists to die for their cause. This situation is not the fault of those who do not support President Bush. It is the responsibility of Bush/Cheney for not coming to some sort of consensus, or even meaningful discussion, with a broad cross-section of leadership. As in 2003, what was the rush?

The second mistake actually led to a several hour stand-off between U.S. forces and the Kurdish forces who were protecting the Iranian consulate. For the Kurds, who have been the most supportive of the ethnic groups in Iraq, this is a stab in the back that could have grave consequences for them. The Kurds have long aspired to autonomy and they have been seen historically as threats by southern Iraq, Iran, and Turkey. They are of Indo-European descent and are not Arab. When the U.S. inevitably withdraws, they could be victims of genocide that will make Saddam's atrocities there look minor. That Iran's diplomatic immunity is ignored in the Kurdish territorial region by the U.S. leader Bush, who will be back in Texas when the Kurds are slaughtered, is just not the way an American should behave.

I very much hope to be wrong about the dire possibilities for the American troops and the Kurds. That is a hope that to be sure has an American consensus. Bush is taking a huge risk.

But are these really mistakes that Bush/Cheney are making, or are they cynical political actions purposefully taken. Are the reactions of some newly outspoken members of Congress also just an opportunist version of this cynical mindset. A follow up post will discuss that possibility.

Friday, January 12, 2007

Small stock debate

On January 5 the WSJ had an article entitled "In Small Stocks, A Debate Grows--Do Hedge Funds and ETF's Overly Sway Pricing of Shares?" I've been meaning to post something about this for a week, but current events and personal distractions made my markets writing feel trivial for a few days, but I'm back today and need this distraction.

The ideas discussed were basically, first, whether the emerging importance of ETF's(exchange traded funds that are indexed) in small cap land was creating significant new demand that was driving up small company stock prices and, secondly, whether the hedge funds are focusing more on and influencing prices of this market segment.

My thoughts? On ETF's I doubt that this is a big issue. ETF's in the small cap sector are not huge and if they have an effect it would likely just be reasonably short term as the new buying would build liquidity for longer term holders to take gains and move on. Also ETF's that focus on really discreet areas of this market segment like PHO(water investments) and PXN(nanotechnology investments) are small funds with limited volume and therefore would be unlikely to materially affect their sector without a much more significant level of assets. So on ETF's my take is that they are barking up the wrong tree.

Hedge funds, in my view, are an entirely different matter. It's happening, and it's driving up values because they are doing their homework on stocks that are minimally covered by analysts, often covered only by analysts with almost no experience or those who just look at charts or quant screens. I think and hope that I speak from experience.

Over the last year I invested new equity money almost solely in three areas: ETF's; index funds with 10 basis expense ratios like those offered by Fidelity and Vanguard; and buying individual stocks by copying the investments in smaller companies of a few hedge fund managers that I admire. On this last one I tracked the SEC filings of a few value focused hedge fund investors with great track records. These filings must be made when an investor owns 10% of a company. These hedge fund guys that I like buy beaten up, unappreciated stocks that they think deserve a new life, and that's based on their financial analysis and a point of view on the potential growth of the sector they are in. So I look at what their investments are, I read about the companies, and I look at a several year stock price chart to make sure that in acquiring their 10% these guys didn't finish off the punchbowl. And if I like it, I'm a small fry piggybacker on their idea.(Yahoo Finance is a good source for compiling this information)

In brief, here are some recent results. From August to October I made investments in five stocks following this approach. As of today, on average five months later, the aggregate gain on these investments is 33%, with the lowest of the group being 21%. Now it's been a terrific market so the wind has been at our backs, but I like what I see for now. From late November until the end of December I made four more investments with this approach with the returns to date being 12%, 2%, negative 2% and negative 3%. So it doesn't happen overnight and of course it won't happen with all investments at all---so I like to say that if the investment is down 10% I'm out, before I'm down and out.

I don't always follow this good advice for what can be speculative investments. For example in 2002 I piggybacked on a stock at $22 that I really liked, and the hedge fund guy actually pumped it in Barrons. For three years it moved from between $18 and $24. I liked the idea still, the hedge fund guy was still in, so I hung in with some anxiety and in 2005 I increased my investment, again at $22, by 5 times, quintupled it. From that point this pipe and irrigation equipment maker and installer in Nebraska is up 136%. But in March of 2006 I bought another stock using this approach(I liked two of the major holders), but I also was influenced by a CNBC market entertainer. It went down. I added more in June, went down again such that I was down almost 40%. Ouch. It finally revived some in the fall, so I gave up for short term tax loss purposes on that one two weeks ago with a 22% loss. The hedge fund guy is still there so I'll check it again when the 3o day waiting period for recognition of my loss is over. The discipline of a stop loss level is something that I need, but more than that I should certainly know that by the time a CNBC talking head is in on the game, the opportunity is more than likely over.

To the smart people in the market, meaning a select group of hedge fund and private equity types, this small cap investing is not news and I think that it is now a trend. But it is a trend that is focused on finding real value and not speculating on some big growth story or the next ipod or a drug that cures cancer or baldness. It's about companies that have businesses here and now, and if they really fall on their face, the big hedge fund guy and his private equity pals can just buy it, go private and shape it up. It's of course not without risks for small investors like myself but I like the odds.

So hedge funds are absolutely focused on small cap stocks and in my view finding real value. And it's interesting stuff, if one is so inclined. It still feels a little trivial in the broader perspective, but then again it's a distraction.

Saturday, January 06, 2007

Free trade?

Employment, inflation, new home sales, old home sales, retail sales. It's all important and moves the markets from day to day. The biggest overhang on values today, however, is the issue of free trade. Will the Democratic party controlled Congress use their power to impose tariffs that move the world away from free economic interaction?

As a matter of economic policy and political policy it is hard to believe that Nancy Pelosi, Chuck Schumer and most intelligent Democratic politicians believe that it would be sane to start putting up trade barriers. If they move in this direction they would be supported by a meaningful number of Republican retards in the House. The White House would obviously oppose such actions but, as with the immigration issue, the President cannot necessarily overcome the racial bias of our popularly elected officials and their constituents.

Do Pelosi and Schumer and company actually believe that huge tariffs on China will solve America's industrial issues and the problems of a Madison Ave. driven and credit card and mortgage company enabled spendthrift economy. They simply see it as a bargaining chip for a higher minimum wage, a rollback of tax relief for the wealthy, and a political way to declare some victories after a period of no leadership of consequence and no accomplishment to speak of. Unfortunately their grandstanding on trade could turn into something that is real if they push their talk too far.

America would of course like to influence economic integrity in other countries on issues such as a living wage, child labor, health care, human trafficking, and political freedom. Putting up barriers to trade will not help. There is much to do right here on these issues as well.

The Democratic Party's traditional constituency of labor unions that promotes trade barriers seems to be a hierarchy of old ideas, hopefully no longer corrupt and in concept valuable(GM sold more than half of their 2006 cars overseas by the way). Trade barriers will create inflation, stall economic growth of our multinational corporations and delight European and Japanese competitors(especially in media, technology and finance where the U.S. firms are now in significant leadership positions), and create political friction at a time when we simply need as much cohesion as we can build after the damage Bush has done to our image.

This is a big issue and unfortunately it is possible that the perceived political capital to be gained will overwhelm an intelligent approach.

Tuesday, January 02, 2007

Marginally alarming

The WSJ reported today that margin debt, that is money borrowed from brokers to invest, rose 22% through the first 11 months of 2006 to just over $270 billion. At first glance I thought "so what", it's been a good market year and confidence should be higher. But what I read next was startling. The current level is "not far from the record of $278 billion reached in March 2000".

In 2000 as the Nasdaq declined, almost every market day at around 3pm uncertainty loomed, or one could say chaos. Investors who were pushed to the edge by their margin debt, and potential margin calls, would indiscrimately sell to salvage what they could. It was ugly, especially since the selling was of course not confined to the battered tech sector. Margin debt pressure meant selling anything still breathing, whether a Nasdaq high p/e name, an S&P 500 counter cyclical, or a mid-cap industrial. Nothing was safe.

So this news is troubling in several ways:
---It's a reminder of what happened at these levels in the not too distant past
---It was, to me, a complete surprise. This does not feel like '98/'99 when everyone you met almost anywhere, by their account, was doing exceptionally well in the stock market and was full of confidence about a new era. Yet there is the current number in the WSJ.
---With consumer debt at generally high levels among the broad "middle class" demographic segment, is it possible that there is risk here that is not fully appreciated? Who is using this margin debt and for what purpose, reasoned investment or speculation? And the concern is, has their been enough of a build up to create panicked downturns in the equity and consumer credit markets when the inevitable cyclical valuation and risk driven volatility occurs?

These are reasonable questions but the positive approach suggests that the dynamics of 2000 are not in place now. There is not one sector of the market that has had lottery winning performance. The market p/e is not out of line with past periods, and even if the e comes down in a slowing economy the valuation impacts are likely to be gradual. But, nevertheless, the comparison of margin debt today to the Nasdaq peak in 2000 is worth a little reflection.

Do I really want to own Capital One or E-Trade right now? Is this one of the facts that the bond market sees and equity focused folks don't see? I think I'll choose a video for tonight and think about it.

Best wishes for 2007

The horizon clears
Pretend not to understand
Await good fortune