The Barnard Observer

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Home  Vault  Misc  Contact                                                           c2003-09 Thomas Barnard

This is Where Sisyphus Starts Huffing and Puffing

Work on Your Instrument

I remember watching Paul Newman in an interview from the Actor’s Studio speaking about his “instrument”, which I took to mean his body as an instrument, as in an orchestra or a play.  I rather cotton to that metaphor.

And so it is that I am ever continuing to develop my “instrument” in the on-going theatre of the stock market (as I suppose we all are).  In my last musings, I thought we might get up to 9,500, or even higher.  Maybe we still will.  At 8450, we are up 31% off the bottom, which is a decent rally, and about 77 days into it.

I have been wondering these past few weeks what would provoke me to sell out, and I found out what it was.  On Thursday (May 21, 2009) the market sold down on two developments.  One was the continuing bad unemployment figures with 611,000 jobs lost in April.  And the other being that S&P put the UK in the negative outlook camp, which means it might lose its coveted AAA rating.  Markets were concerned that the USA might also be in jeopardy of losing its highest ranking.  Me, too.

My concern is that there will be more jobs lost over the summer, that even if GM does not go into bankruptcy now, more jobs will be lost, and that the flow of news will continue to be bad enough to overwhelm the bulls and their green shoots talk.

All the borrowing the government has done, and so easily, may turn out to have consequences.  The rating agencies will not be happy if the government receipts are dramatically less than its expenditures.  And so we come to the place where everyone will have opinions, mine is simply that I wish the Congress had been more careful about the money spent.  This rating problem may also curtail some of the programs Obama would like to do.  (Although the government, among its purchases, could buy the rating agencies and thus dissolve this nasty little bugger of a problem).

The rating agencies may well force Obama to raise taxes, which he wants to do anyway.  I wonder if rating agencies understand enough macro-economics to know what rate taxes should be.  Raising taxes can retard the growth of the economy, although not necessarily.  On the other hand, the Clinton years were fine, even with higher taxes.  Although the Clinton years were stellar, in the full blossom of innovation - the personal computer, internet and cell phones.  And it doesn’t take a genius to know that taxes should not have been lowered when we started a war.  If taxes had been kept level, perhaps we would not be in quite the same pickle we are in.

China

Wake up, fellow Americans.  While you were leaning on that broom, China was fast at work.  One thing China has begun doing is currency swaps, swapping yuan for Argentine pesos, for example.  They have been vocally unhappy about the American policy of constantly devaluing the dollar.  So, it looks like they are setting up the yuan as a shadow reserve currency.

Meanwhile, they are swapping dollars for real assets all over the world.  Recently, they came to the aid of an Australian company mining rare elements.  A friend of mine who developed some of Angola’s oil assets, was disheartened when his multi-national sold their share of his handiwork to China.

Inflation and Deflation

This is a real problem.  The government is trying to swell the money supply, and create inflation.  One of the desired effects of this would be to once again cause real estate to rise, and this would make a lot of homeowners who are upside down (with mortgages greater than their market value) bob up again.

I’m not sure that is going to play out as planned.  There are several mechanisms that create inflation:

Wage push inflation.  When economies are strong, and unions can demand higher wages.  Where’s the strong economy?

Low interest rate inflation.  We just experienced this.  Low interest rates meant lower monthly payments which meant that prospective buyers could afford a more expensive home, and bid them up.  The problem here is that homebuilders and mortgage companies exhausted the supply of buyers, at least temporarily.  Who is going to borrow to pay up for a new house?

Also working against inflation is the continuing supply of unemployed, who will not be able to pay up for anything.  Moreover, this continuing supply of unemployed will have trouble with the mortgage payments they have, which means the supply of problem mortgages will increase.  And so, I don’t see the inventory of unsold homes coming down.

Expectations.  Inflation is ruled by expectations.  If inflation is expected to rise simply because the government is borrowing more than it should, then prices could start to rise.  This would force the Fed to raise interest rates to stabilize prices, and that would be deflationary.  On the other hand, perhaps we will find that even though the government has taken steps that ordinarily would cause inflation, they will come back and tell us in economic jargon that the velocity of money speeded up or slowed down tremendously, which prevented inflation.

Well, there’s the economist for you.  More garble-de-gook equations explaining everything to us in the aftermath.

This inflation/deflation issue is a never-ending struggle, and long term, inflation saw its peak in the early 1980s, and if we are now in the part of the cycle where deflation is going to hit its nadir, perhaps we are not quite there yet as the housing bubble unwinds, the energy bubble unwinds, the stock market bubble unwinds.

I like Ben Bernanke, who is a Great Depression expert.  Of course, the problem is that we screw up in new ways.  For example, this time (going back to 1999) we achieved extraordinary bubble prices in the stock market with PE’s going to an all time high of 44 on the S&P 500 even without the availability of buying stocks with 90% borrowed money as was the case in 1929.  However, back in 1929 most people had a much higher percentage of equity in their homes and 90% loans on homes was unheard of.  Which is simply to say there will be excesses in free market economies.

Gold is usually an indicator of how well the government has been doing with inflation, and gold has gone up quite a bit in the past few years, but even the inflation hawks at the Dallas Reserve Bank say there is no inflation in the economy.

What Kind of a Recovery Were You Expecting?

If you were expecting a great recovery, my question is:  why?  There is no pent-up demand for housing.  People seem to be making do with their autos.  Where is this great recovery going to come from?

2010.  A great movie, but that's not my point.  My point is what happened in 1945.  The first year of the baby boom.  65 years later is:  2010.  A new boom of retirees is not what makes for a boom economy.  In fact, it will be a drain.  This will bring into bold relief what has been happening to the major manufacturing companies for the past couple of decades:  unfunded liabilities.  Unfunded liabilities will be no easier problem for the government than it has been for Bethlehem Steel, Chrysler or General Motors.   The government will have no other choice but to cheat pensioners by lowering benefits or pushing up the age you can receive them.

Think about what is going to happen to GM.  Whatever happens GM will be a ghost of its former self.  Brands are going to dropped - Saab, Hummer, Saturn, and others.  This means that GM's revenues will be much smaller than they were before.

A pal of mine complained that even though we've pumped $600 billion into the banks, he still cannot get the loans he wants.  This has happened because now standards are higher.  On commercial loans they want more equity on the part of the borrower.  Why?  Because banks do not know when real estate prices will bottom, so they need more protection.

Where are the great new products that will drive the economy?  The iPhone is just a rehash of stuff that's been around with a kool keyboard, but I'm told it's just a toy, so far.  Electric cars are still a dream.  $10,000 for a battery is too much.

As I see it, there is no great recovery in the offing.  I see slow years ahead.  Bumping off the bottom with continued high unemployment.

In the News

Home values lower in the Schiller-Case Index

Korea detonates atomic bomb

Mortgage applications down 14.2%

Consumer confidence index up, reading jumped from 40.8 to 54.9

GM bondholders do not approve conversion plan

40 months inventory of homes over $700,000

Sales of existing homes up 2.9%

Cash

Hopefully, the market will shrug off the news about the UK, and the GM bankruptcy, the unemployment figures, and housing starts, and still hit 9,500 or 10,500.  But I think this is where Sisyphus starts huffing and puffing.  PE's are still too high.

By the way, Sisyphus sounds like he would fit in with the CEO, trader crowd.  Avaricious and deceitful, he was famous as the craftiest of men.  He seduced his niece, stole his brother’s throne, and betrayed Zeus’s secrets.  He felt he was a peer of the gods.  When Zeus had had enough, he forced Sisyphus to roll a boulder up a steep hill, but before he could reach the top, it rolled down again.  And to do this without end.

I don't see many good choices for investors.  My take is most stocks will be headed down.  Cash sounds like a good idea about now.  I would be perfectly happy to be wrong about this.  I would love to see a strong recovery take hold.  I still own my fliers.  I haven't talked about them much, but they're still there and looking like they'll do what I expected them to do.  So, if there is a recovery, those long term stocks will protect me.

May 27, 2005