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Thursday, September 30, 2010

Municipal JENGA...new and improved.....*Now with much larger pieces.....

Today the policies of the FED are punishing savers and rewarding debtors, as a result investors are searching hungrily leaving no stone unturned for higher yield. Just today as I was in the car in the space of 1 hour I heard 5 separate ads for investments stressing yield, two ads were for annuities and the balance for municipal bonds. To start with due to my inflationary bias I would not want to be invested in annuities even with an inflation kicker nor would I want to hold bonds of any duration at this juncture.

As I drove along and listened one of the ads was touting the safety of Municipal bonds and how they never defaulted during the “Great Depression”. The statement that municipal bonds did not default in the 19030’s is patently false. In a 1964 study entitled “The Post War Quality of Municipal Bonds” the author George Hempel at University of Michigan -  Ann Arbor, showed that at the peak of the great depression in 1935 as many as 3,252 municipal bonds recorded default.  Furthermore, the quality of the bonds was considered to be investment grade; about 80% of the bonds were rated Aaa at the beginning of the depression and roughly 95% were rated Aa or better.

So while the general public has rushed in to the US Government bond bubble driving rates to the basement, they are now taking aim at municipals through the same prism of safety and yield. The companies on the radio and I am sure TV are looking to capitalize upon this trend and are feeding into the yield safety play. The municipal bond market of today is significantly more treacherous than is being billed.

Just yesterday the Analyst Meridth Whitney released a report that she has compiled for the past two years entitled the “Tragedy of the Commons”. In this report she points out that the states are highly levered to the housing market for tax revenue and that housing is not projected to do very well creating another hit to revenue. She does not go on and make the connection that the municipalities are more dependent on housing taxes than most states since many states impose income taxes as well; although both are vulnerable since neither can print money or run deficits like the US Government. Whitney does state that Municipalities do receive 1/3 of their budgets from the State so there is a ”trickle down” effect if there are shortfalls. The study goes on to explain that the State funding gap which is the deficit between spending and revenue is estimated at 192 billion or 27% of total budgets for Fiscal 2010, so there is a worry about the municipalities.

According to Whitney the worst states are 1) California, 2) New Jersey, Illinois, Ohio (Tie), 3) Michigan, 4) Georgia, 5) New York and 6) Florida. She lists the best states as 1) Texas, 2) Virginia, 3) Washington and 4) North Carolina. As for Pennsylvania, Maryland and Massachusetts they are rated neutral.    Moreover, Whitney’s contention is that States will make their budgets at the expense of Municipality funding, which will be left on the side of the road.  This coming shortfall has potential negative implications for the way things are funded or not funded in various states as well as politicians eyeing large pools of money dedicated for other uses or programs, but will now instead be raided to close budget gaps. This will only temporarily fix any shortfalls and will exacerbate the future shortfalls in multiple areas.

So on the one hand we have analysts talking about the problems with the states and their revenue and on the other hand bond houses promoting Municipal bonds as safe and in some cases guaranteed investments. The investing public is being warned but the siren song of safety and yield is drawing in investors. At the same time we find out that the companies that provide the insurance for these securities face their own problems. The municipal insurer MBIA has lost it coveted AAA rating and just two days ago was downgraded by Morningstar to BAnother insurer AMBAC was also rated on the 27th by Morningstar with a C. While Assured Guaranty, the one being touted as the insurer on the radio ads here, received a rating of BBB by Morningstar. None of the major insurers that play in the Municipal bond space are in such strong shape that they could withstand a string of defaults, leaving the investor holding the bag.

The bottom line, to paraphrase quote the Oldsmobile ad(remember them a victim of the last recession) “This is not your grandfather’s depression”. While there can be parallels drawn to the great depression this situation has the potential to play out very differently. My recommendation is to fully research the bond you are interested in if you plan to play in the Municipal market. One must check the detailed situation and financials of each level, the state, and municipality because they are interdependent. Moreover, if you must invest in Municipals avoid revenue bonds and stick to GO or General Obligation bonds as those are required to be paid from the budget. The reason this is a small but critical factor is that if there are defaults GO bonds will be paid if there are bailouts. Conversely, revenue bonds which the state or municipality are not obligated under the budget to pay but is paid through funds collected via revenue from the project which could falter. Lastly, if the bond sports a guarantee make sure to check the company ratings and see how well they are reserved. In light of the ratings fiasco's during the sub-prime meltdown one has to do their own diligence and can not blindly accept the ratings as their fail safe.

Right at this moment the Municipal bond market reminds me of a big game of financial "Jenga". one wrong default and the tower could come crashing down, just like the kids game with the little wooden blocks.

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Wednesday, September 29, 2010

King Cotton or King Dollar....

Is it just me or has anyone else noticed that the futures price of cotton is ramping up pretty dramatically. What do the cotton traders know that we don’t? Could it be a run on cotton in anticipation of the FED’s QE2? Of course I am making fun of the commodity rise and QE2 here. Most people believe that if we could stop the FED from printing\monetizing dollar bills that we could save tons of paper and hence the rainforests. What people don’t know is that the US Dollar bill is not actually made from paper, but instead it is a special cotton linen blend; which is why if you look closely you can see the fibers particularly the red and blue single fibers integrated in to the bill. I am guessing that to keep the public fooled the US Government uses preshrunk cotton, but I digress.

In all seriousness my wife and I were out to dinner this past Saturday with friends and I got in to a discussion about the Dollar. I like talking with my friend about economic issues and business as he has been a CFO for a variety of companies. He is also is Ivy League educated, so he is a pretty knowledgeable fellow with strong opinions. The conversation actually started off with the subject of the original TARP bailout and whether or not we were truly on the brink of financial Armageddon, which I believe was over blown by the media just like H1N1 and the anthrax scares etc… Would there have been problems due to the credit market freeze up, of course, but this simplistic view does not take in to account lines of credit and other means of funding that are on contract and would have been unaffected. We agreed to disagree and this is not the focus of this post, instead it was just a little color commentary.

So as we discussed the Dollar we talked about the concept of beggar thy neighbor where all currencies are debased against each other. At the moment all governments around the world are engaged in a game of devaluing their currency against everyone else’s in an effort to restart their economy. Presently, if your currency is weak it will drive exports; that is if you have a manufacturing sector that can export. My friend’s argument was that all will be well if the governments around the world keep devaluing currency against each others. Today all the currencies are what is called FIAT currencies, no it has nothing to do with the Italian car company, but instead it means that they are not backed by anything tangible such as gold or land.

In the land of FIAT currencies the US Dollar for the moment is considered the least toxic of the superfund sites. The problem is that this is a race to the bottom since you can only devalue to zero. Given the debt and problems of the economies and governments worldwide there appear to be few winners in this currency war. There have been many arguments showing pretty graphs demonstrating that the US’s situation is “less bad” then other countries such as Greece, however, all the graphs, charts and articles I have seen are misleading. They are misleading because they never include all the debt of the US, specifically I am talking about the unfunded or off balance sheet liabilities. An article was recently published quoting Larry Kotlikoff and the unfunded liabilities including social security, medicare , various wars and other items now totals in excess of $200 Trillion…..NO THAT IS NOT A MISPRINT IT IS TRILLION WITH A “T”.

So not only are we in a race to the bottom but a global confidence game as well, and this cannot end well. The implications for the Dollar are that it along with most currencies will end up in the dust bin of history like so many FIAT currencies before it. It is the devaluing of currency and loss of confidence in FIAT money that is boosting gold and silver prices worldwide, since all the currencies are devaluing against each other they all need to devalue against something and that something is precious metals. This group of metals are called precious because they are hard to come by unlike currency which these days can be created in massive quantities by a few keystrokes. The prior debt fueled boom and now the debt fueled recovery only serve to undermine the currencies and place a put under precious metals, since they are no ones liability and are not subject to random dilution. Instead the cure for the debt bust and now debt recovery is going to be more debt which sows the seeds of a massive inflation as more will need to be printed and monetized to keep the game going.

For the record I am not a gold bug nor do I recommend that you run out and buy 100% of your assets in precious metals bullion or stocks, but instead you should look for a pull back to add a percentage of your portfolio as insurance. Many of you are thinking that the metals have had quite the run and this is the peak, to that I say I have heard that argument going all the way back to $325 an ounce on gold and $5 on silver. As of this moment the public is asleep at the switch regarding the precious metals market, don’t believe me call up 10 of your friends and ask them if they have any precious metals related instruments. I would venture to guess that few if any have money in this area. You will know it is time to be cautious when your mail man, barber, taxi driver is chatting you up about how much they are making from their metals investments, just like the dot com mania. Unless the government meaningfully reforms its profligate ways and we allow the markets to actually function without intervention and continual debt and money printing the story for precious metals will not change.
Other cultures view precious metals differently than the West and the US in particular. Here in the US we have not experienced a significant negative monetary event in the economy since the 70’s, which will be viewed as small once the scale of the current mess is understood. As a result of a benign monetary environment the insurance value of precious metals have been derided and mocked by the Keynesians for decades. The main arguments against precious metals are that you can’t eat it, it does not pay interest and it relies on other people to value it and bid the price up. Last I checked there are thousands of financial instruments none of which you can eat, many of which pay no interest or dividend and all of which require other people to make a market in the security in other words bid up the price, yet they are recommended and promoted regularly.

The arguments don’t hold water, instead it is a smoke screen. The reality is that a piece of metal is no ones liability, there is no counterparty risk. The limiting factor of precious metals is why the monetarists despise them, because a system of currency bound by anything that cannot be easily printed restricts growth of government and also money supply; which ironically would aid the FED in its true job of price stability. The FED and monetarists have not complied with their own mandate for if they had a Dollar of today would not have the purchasing power of a nickel in 1913, instead a Dollar would be more constant. It can be argued that gold in particular is a constant and that the Dollar is the variable in terms of store of value. The bottom line is that I believe precious metals, while they may fluctuate in price since nothing goes up in a straight line, is going higher over the foreseeable future. As I have stressed in prior posts in today’s world return of capital is just as if not more important than return on capital. You will not get rich on bullion but you maintain your wealth. The precious metal stocks could potentially make you rich, but they are far riskier and should only be played once you have the necessary insurance.

Disclosure : Long Bullion, Gold and Silver Shares

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Tuesday, September 28, 2010

You can be young without money but you can't be old without it. Part 2

What is the next step in money education as your child enters the teen years. Each family handles money differently and will have a unique approach.  By the time your child reaches Middle School their allowance should be of a decent amount, what the amount should be needs to be determined by the family; I can only speak to what we have implemented in our household.  The allowance figure we settled upon for our daughter was enough to allow her to go to the movies and buy a snack each week. Now our daughter does not actually go to the movies each week, instead she saves the money and uses it to buy things she wants like I-tunes account funding and make up. The idea is that your child should be responsible for their entertainment dollars and specific items that are beyond the prevue of parental buying which is decided on a family basis. This allowance concept works well even in to high school’s freshman year where you want your child to focus on getting and education rather than acquiring spending money.

Once your child begins their sophomore year they have gotten the hang of the big changes that come with attending High School. Starting in their sophomore year you can implement a more advanced system to educate your child on saving and budgeting. You can set up an account with your bank specifically for your child and have a debit card attached to the account. Then you set up parameters regarding what are the child’s responsibilities toward their monthly expenses as well as what they can expect in support from you. For example, in our household our daughter who is now on this system is responsible for her cell phone bill and entertainment; and at specific times of year clothes and or gifts have become her responsibility.

We encourage our daughter to save money and think about what she is spending on but ultimately she is responsible for managing the account. She knows that she gets a specific dollar amount cash infusion on the first of each month and that at least her cell phone bill is deducted on the second to last Friday of the month; so she can plan accordingly. If she does not have enough cash in her account to cover the cell bill then just as in real life the phone is shut off(taken) until she can reactivate it. Times where she needs to buy clothes or gifts additional funds are added, however, she has to decide what she can afford within the scope of her own funds and is not allowed to ask for additional funds. This is no different than you dear reader not being able to go in to your boss’s office and asking for a raise because you spent too much.

While this system can be implemented using any type of savings or checking account I highly recommend an account that provides a debit card. The debit card provides several terrific features. First the debit card is more flexible than a straight ATM card since it can be used at point of sale or even online in many cases. The debit card also reduces the child’s desire to walk around carrying lots of cash since they know they can swipe it at the Starbucks and use it in place of cash. Additionally, a kid’s use of the debit card over cash provides them with an audit trail so they can remember where and how they spent their money; which is a valuable tool for them to understand where they are wasting money too.  Furthermore, the debit card can be set up with no overdraft so once the child has exhausted the funds and tries to use the card the transaction or cash withdrawal will be refused automatically, in this way there is no chance of them running up the overdraft as a surprise for you. You will also have to make the time at least at the beginning to review their account with them so they can understand the statement and see their money flow. Later on the child can be introduced to checks and actually paying bills; which would be especially prudent before the child leaves to go to college so they understand how to handle the bills.

Once they are a sophomore their world also opens up to the idea of a part time job to supplement the funds that you provide to them. In many states kids can obtain part time employment after school beginning at the age of 14 and having a job introduces them to both more financial freedom as well as introducing them to the satisfaction of earning their own way. With a part time job, assuming it doesn’t affect their school work, a child can keep up with the growing expenses of today’s youth, for example, if you have not checked the prices of the latest games for a Sony Playstation 3, they are pretty high. Of course as a parent you must still provide guidance and spending rules especially early on in their experience with a part time job. In other words, if you have family rules about certain things you need to make it clear upfront that even though they are earning the money they still cannot purchase certain things that are objectionable or participate in activities that you would be against funding. You are still the parent and need to guide the child at these formative stages. If as a parent you invest the time in teaching your children the basics of financial responsibility it will not only be a benefit to them but will pay you dividends of peace of mind in the long run. As a parent you never stop worrying about your children and you always will but you can worry less if you arm them with the proper skills and values to be happy productive and responsible members of society.

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Monday, September 27, 2010

You can be young without money but you can't be old without it.

I received many responses to my blog post entitled, “Piece of mind a few bucks at a time” and have decided to touch on a topic in a similar vein. Given the tenuous nature of the economy at this juncture people’s money and economic concerns come to the fore; this leads to the conundrum of the subject of money and the kids. Raising kids is an expensive proposition according to an article I read on MSN Money ; for those that earn $70K or more  a year the total expenditure to raise a child was pegged at $269K to $284K depending on location.  There is more than just the cost of having and raising children that is important to consider. As the title of this post, which is a quote from Tennessee Williams, implies attitudes about money formed as a child can have a great impact and consequences as an adult. One has to consider how to talk to and teach their kids about money; depending on the age of the children determines the tact taken.

For very young children it is difficult to broach complicated topics and they do not really need to know nor would they understand the implications of your monetary situation. If you have young children it is up to you to manage the situation and not get caught up in purchasing beyond your means. The costs associated with children can really add up quickly when one doesn’t stop to think about what they are spending and if it is right or necessary. One can spend an absolute fortune on those little outfits that the kids would look so cute in or the full blown petting zoo for their first birthday party. There is a bit of “keeping up with the Jones’” going on here and we all fall in to this trap sooner or later. One needs to stop and ask themselves the question... who am I really buying this for? Is this item really going to benefit my child or is it really for me?

As the child gets older things get more complicated. Sooner or later your child will want various toys, games, or clothes. Children are exposed to items that they will want through multiple sources like friends, Television, or even just being out in the store with Mommy and Daddy. It is amazing how even at a young age it becomes important for kids to not only get the latest toy, but also its impact on their perceived social status.  It always amazes me when I am in a store and see a child of no more than 4 years old haggling with a parent for some pricey item using the argument that “Timmy has one I want one too”. It is at this point that lessons about money and value can be taught in a painless fashion. However, it has been my experience that parents take one of two paths; 1) either a flat out No! or 2) they acquiesce and purchase the item. Now granted I don’t know the household situation or what deals have been struck ahead of time, but time and care can be taken now to lay the foundation for kids to learn how to be good with money, shopping and learning to live within their means; something so many adults are lacking.

First, to avoid the conflict parents can set expectations up front before entering the store. One has to state the objective before entering the establishment, “Timmy we are here to buy X and then we are going home for lunch”. A statement like the preceding sets the stage and also gives the parent an out when Timmy sees the new “Despicable ME” action figure. “No, Timmy we are here only to get X like I said”. Obviously, it is never that simple but if you set the agenda this  not only allows you to negotiate your way out of an impulse purchase, but also teaches your child that one can go into a store without having to buy everything they see.

As the child gets a little older and shows more maturity, this allows a better understanding of more significant monetary concepts and new more complicated ideas can be introduced. Parents should help their child make the link between wanting an item and earning and or saving toward an item. Parents need to figure a way for their child to earn some of the things that they want beyond that which the parents are willing to purchase. Due to labor laws and practicality parents are not going to put their kids out in the workforce to earn money to buy toys or clothes, so one needs to be a little creative here.  For example, one could offer to the child that if they perform specific tasks they would earn a certain amount that is held  in an account for them toward a goal.

Implementing a scenario such as the aforementioned does several things to promote good money management and self esteem. The child learns that money is earned and the goals are a good thing to have, and you can show them their progress; which gives them a sense of accomplishment. The concept of deferred gratification is something that is missing in today’s get it for me yesterday society, instead the mantra is buy it now and worry about how to pay for it later, though it is changing. Moreover, a child that earns an item will put more value on it and take better care of the item.  Let’s face it at every age, but especially when kids are young they don’t want to listen to their parents but instead need to learn lessons on their own. In this vein I am paraphrasing Mark Twain who once said, “When I was 18 years old my father was the dumbest man to walk the face of the earth, but when I turned 21 I was astounded by how much the old man learned in 3 years”.  The point is that they will not realize it but you are aiding them in developing good financial habits and promoting their emotional intelligence but you will be giving them a leg up in the future,  potentially helping avoid future financial pitfalls.

Although there are many schools of thought on the subject, in my household, we felt that around first grade was the right time to start the kids with a small allowance. The allowance was not tied to any specific chores but instead it was just given to be used for their discretionary purchases. They could save their allowance or combine it with other funds earned for larger purchases. This method allowed my son at the age 8 to purchase a Nintendo Gameboy which he later sold after saving enough for a Nintendo DS, both of which remained in excellent condition.  He kept saving and had later purchased a Sony PSP that he has had for 3 years and recently was able to sell it since he kept the unit in great condition.  Although the kids are free to do what they want with the allowance we encourage them to save what they can and also to donate some of the money to charity.  The allowance is a small painless way to teach your kids how to save as they can see for themselves that if they run out an blow all of it on Pokemon cards the day they get it they will not have other money unless they can convince you to pay for something. Kids are surprisingly smart in this way and figure out very quickly that if they are responsible for acquiring specific items they want they will learn to save and crudely budget.

I did mention charity as the old saying goes charity begins at home. In light of the situation that has been brewing for the past few years we have made a conscious effort instill the idea of charity. To my kids charity is not only money but time, volunteering counts, however, this article is focused on the monetary. We give to various charities as do the kids. Moreover, the kids know that we donate food every week on the way back from the grocery store. We have set aside a small portion of our food budget to buy canned goods and cereal every time we shop and then donate the purchase to food banks here in the Boston area. Additionally, in these hard times my kids have seen me give a dollar or two to people holding signs on the side of the busy roads here in Boston. Giving money to these poor downtrodden souls has allowed me to demonstrate charity in action and explain in simple terms that we are fortunate and you should always help where you can, a lesson that is priceless for only a dollar or two.

So far we have covered the easy stuff because the older ones kids get the more complicated the situation gets. Tomorrow we will continue to look at money issues as the kids move up through the preteen\teen years.

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Friday, September 24, 2010

GM: Government Motors, Government Mischief Or A New General Motors?

As a follow up to a prior post “Why is no one bothered?”, I find myself writing about General Motors once again. There are several issues going on here that have all made it in to the various mainstream news outlets, yet it appears that the reading public sees these things and is either too busy or complacent to be bothered with the chicanery they are funding.

First, there is a an AP article in Bloomberg Businessweek online entitled “Analyst: GM could print money as sales recover”. On the face of it the article appears as a nice piece showing the recovery in GM and discussing the IPO rumored to be happening in November. The analyst in the article makes very optimistic assumptions about GM’s prospects and vehicle sales figures to conclude the a) GM will “print” money and b) that the shares of the IPO should fetch a fair value of $134 per share. Moreover, the article makes the assumption that GM could still make money even if vehicle sales in the US slump to 10.5 to 11 million units; currently sales figures are running at 11.5 million. This assumption is on the heels of an announcement by GM that the four brands sales decline 11% from 2009 “cash for clunkers” level (GM’s Website 9/1/2010 sales and production release) . The releases from GM have been touting large percentage increases in sales versus 2009, point in time where few people wanted to buy a vehicle for economic reasons let alone from GM a company in bankruptcy. If it was not for the “cash for clunkers” programs GM would probably be reporting triple digit sales increases instead of just double. Another Item I have noticed is that while inventories have been running well below 2009 levels when GM could barely give away their vehicles they are creeping up and need to be watched carefully as an indicator of management efficiency.

The assumptions for the auto industry and GM in particular are way to rosy in my opinion. Between the on going weak job and credit markets I believe this is going to be a much tougher slog than the analyst is expecting. While there may have been a spurt of activity for a couple months from the incredibly depressed levels of last year it remains to be seen if this was an aberration or the start of a trend. In my estimation there will always be some underlying demand and it could be that just coincidentally people’s vehicles give out in waves which may account for the surge in demand over the seven month period starting in January 2010. I also believe that all the manufacturers discounting promotions as well as “cash for clunkers” created a demand pull situation; meaning the manufacturers pulled sales forward instead of allowing for a longer term more even distribution.

Back to that analyst David Whiston’s call that the IPO for GM shares could have a preliminary fair value of $134 per share and could be a good investment, I am suspicious. Just yesterday I read an article in the Washington Post that according to the inspector general of the government’s bailout program, in order for the US to recoup its $50 Billion it needs to sell its 61% ownership stake for $134 a share. Now this could be coincidence that the analyst agrees with the inspector general and is justifying it in his article, however, the figures are coming from the government and one could have made a fortune over the last decade by investing opposite of what the government tells you. If you need an example of this just look at all the reassurances and estimates regarding subprime, remember how it was all contained and would not affect the general economy? On this issue I am like Missouri “Show Me”. I am not buying the sizzle here and believe that investors that purchase the new GM shares for $134 will be sorely disappointed as the rosy assumptions will not be met in the near future as the economy gyrates, so will GM and its share price .

In a separate issue there was an article tn the Wall Street Journal yesterday titled, “GM Resumes Political Giving”. I had written an earlier piece titled “Why is no one bothered” which dealt with the topic of GM resuming political donations while still on public life support. Regarding the current GM Political giving the timing is interesting to say the least as they are contributing to US Senators right as the time nears for the IPO. It seems to me that while on public funds they should be restricted from making contributions to anyone or organization. Additionally, the current donations may be perfectly legitimate and unrelated to the IPO, but it does have the appearance of politically greasing the skids ahead of the offering.

I guess time will tell if GM is a good investment, but I find it difficult to tell if Uncle Sam is selling snake oil or not. Call me skeptical but I would not buy GM and neither should you.

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Thursday, September 23, 2010

Deflation..We Don't Need No Stinkin' Deflation......

Reading between the lines in the markets is a tricky business; however, there are sign posts that can help divine the probable future. At this point in time everywhere you look at least in the mainstream media, economists and officials are being shown as fearing deflation. If this message is true then why are Gold, Silver and Commodities rallying?

The FED in its latest policy statements has proclaimed that it stands ready to do anything and everything to jumpstart the economy and prevent deflation. The FED stands ready to pour money in to the system and monetize bonds or any other asset class at will. The FOMC feels that it has the wiggle room to monetize and purchase whatever it feels necessary since the inflation rate is “somewhat below” its target. The deflationists including the FED are wrong in my opinion and the gold, silver and commodity markets are beginning to reflect this reality.

The measures used to gauge inflation, the CPI and PPI are both Jerry rigged indexes that are used to manage government COLA(cost of living adjustments)  payouts for programs tied to the underlying indices; like social security and Medicare.

The CPI for example is altered whenever any of its components rise in price, for example as the housing market in the early 2000’s was flying and  in order not to reflect that inflationary input housing prices were replaced in the equation. The housing price component was subsequently replaced with owner’s equivalent rent to stem the rise. To put this phenomenon in other terms if steak is part of the basket of goods and services and steak prices rise then hamburger or chicken may be substituted in place; as the assumption is that the consumer will switch to the less costly substitute, instead of reflecting true costs.  Additionally, a practice called hedonic indexing is used to contain the inflation driving inputs. The way this indexing works is as follows: let’s say that a computer costs $1,000 in 2009, but in 2010 a comparable model cost $1,200. The $1,200 computer maybe reflected as costing $1,000 in the indexing process because the indexing methodology takes in to account the technological upgrades like a faster processor or some other additional feature. As a result of the incremental improvement in technology they “rate” the $1,200 computer as truly costing $1,000 due to the fact that you are getting more bells and whistles; regardless of the fact that you are still paying the $1,200. Don’t you wish that you could hedonically index your bills, groceries or taxes?

So the fact that the FED relies on faulty statistics that are taken at face value at least by the mainstream media and politicians, which gives them cover to carry out their monetization schemes.  I would contend that there is inflation in the system and it is being masked by two factors: 1) faulty statistics and 2) pent up dollars residing outside the US.

The assumption that the statistics are faulty comes to light when you live and shop in the real world there is inflation. I say this because everything you need like food and healthcare goes up in price year after year while the assets and things you may want like stocks, home prices or Plasma TVs are either flat or down. Of course you can’t eat your plasma TV so that doesn’t really help you in the inflation scenario.

As for the second point, the pent up dollars worldwide by itself is not inflationary at least not at the moment, but instead it sits and waits for the most inopportune time. If you are at all familiar with electronics you know a capacitor is an electronic device the stores a charge that can be discharged at a later point. The continual US Trade deficits have charged the “inflation capacitor” to a very high level and there are Trillions of dollars that are waiting for a catalyst to be discharged. In essence this is a future source of inflation.

In my estimation the deflationist camp along with the FED are making a poor assumption that there is no nor will there be any inflation. The deflationists feel that due to the size of the debt that all the destruction of debt will have a deflationary impact regardless of how much the FED prints they cannot offset the downward pressure. I would also point out just as the Wall Street disclaimers go “past performance is not a guarantee of future performance”, just because inflation has not roared yet does nto mean that it won’t rage in the future.  I would contend that there are four factors that will stoke inflation and that the deflationists have the timing backwards, meaning that inflation will precede a true deflation.

First, the FED will print and monetize at will as they have demonstrated in the recent past by doubling their own balance sheet and creating as steep rise in the money supply.

Second, the FED is working overtime to accomplish a “devaluation” of the dollar, which is why Timmy “Turbo Tax” Geithner was out brow beating the Chinese to try and coax them in to revaluing their currency. Whenever you hear the FED or Treasury speak about some currency being undervalued it is because they want the dollar to devalue against all currencies to spur trade and growth. Realistically they also want to devalue the dollar as a way to arrest the perceived deflation, which is exactly what FDR did during the “Great Depression”.  This devaluation will lead to inflation as everything will cost Americans more especially since we import so much of what we consume.

Third, the “inflation capacitor” effect will drive foreigners to repatriate a very significant portion of dollars that currently reside outside of our borders. Once foreigners recognize that the dollar is depreciating they will not want to hold them instead they will want to get value for them. For many years currencies have been viewed as a store of value and medium of exchange, but once the devaluation takes hold the store of value aspect will evaporate.

Fourth, once the repatriation and devaluation of the dollar begins the FED and Treasury will find it increasingly difficult to finance the monumental deficits and the unconventional methods that the FED now talks about will become common practice. The FED will be forced to monetize both for funding and to keep interest rates from going through the roof by purchasing treasuries further fueling inflation.

The risk is that the momentum of inflation rises as people worldwide see the store of value aspect of the currency continually reduced, which could result in a hyperinflation. To understand one of the reasons inflation itself occurs is because of excessive money printing, but combined with a loss of confidence in the currency can result in a hyperinflation. Let’s hope it does not ever come to hyperinflation as that is something I believe no one would escape unscathed.

It is my contention that the reason behind the rise in Gold, Silver and Commodities is a canary in the coal mine and not a bubble as is starting to be widely pushed in the media. You can protect yourself if you place money in the right areas and the canary is chirping.

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Wednesday, September 22, 2010

Our Summers Of Discontent.....

With the announcement that Larry Summers is leaving the Obama economic team there is much buzz in the media. The speculation is that this is an opportunity for the administration to patch up its rift with business by seeking out a candidate from the business world or hire an individual that is a member of an underrepresented group. To me it seems that the administration would be wise just to bring in the best and brightest regardless of what sector they hail from or their ethnic background. Right now we need leadership that understands economics, has business experience as well as know how to address the problems facing all of us. The replacement of Larry Summers will say more about the seriousness and direction of the Obama administrations’ economic focus and ability to execute than all the speeches on the economy that ring hollow to the general public.

While his replacement is important, looking at the exit of Larry Summers brings to mind a phrase from America’s favorite pastime baseball; three strikes and you are out!  In recent months we have seen the departure of Peter Orszag, the former Director of the office of Management and Budget, a smart guy with direct access to every detail about what is transpiring in the economy; although all his economic work experience is either in the think tank or political arena. So here the umpire calls strike one.

Soon after Orszag’s announcement Christina Romer, the 25th Chairperson of the Council of Economic Advisors, left her executive office post, but will remain on the President’s “Economic Recovery Advisory Board, a nongovernmental advisory group. Romer was also part of the team that put together the economic recovery that we are supposedly experiencing.  Romer’s position in the Obama administration not only gave her access to the same data as Orszag but also required her to craft policy that is implemented. Like Orszag, Romer is obviously well educated but has also only worked in academia, government and think tanks. So her departure leads the umpire to call strike two.

Now the headlines are reporting that Larry Summers is leaving his post in the Obama administration to return to Harvard to teach.  This is the third high level departure from the administration in short order   that has both crafted current policy and has knowledge and access to all the economic data. If the economy was truly on the mend and things were getting better I do not believe that Larry would be leaving just yet to return to insulated academia. The umpire calls strike three.

BREAKING NEWS..As I am writing this there is yet another departure from the economic area of the Obama Administration. It is being reported that Herbert Allison, who is part of the US Treasury Department, the current administration official overseeing the TARP funds will be making his exit as well.. Do we call strike four?

Layer on top of all this the fact that for the first time that I can recall congress is not going to present a budget before the midterm elections but instead will wait until next year.

What is it all these people know that we don’t or that the Media is not telling us. I suspect that the administration officials are making their exit before things come to a head and the “extend and pretend” economy tanks causing both headaches for the administration and dimming these people’s later employment prospects. As for Congress the figures must be far out of whack and they fear that it will affect the midterm elections. We are not being told what is truly going on here instead I believe that something wicked this way comes.

After all we were told that the huge nearly $1 Trillion “stimulus” that was going to fix things was predicated on the following: The unemployment rate would peak at 8%, which it obviously broke above. The Administration is busy touting statistics that things are improved or could have been worse, however, the figures are suspect and the American public is not seeing any recovery. All the people leaving the Administration as well as Congress all had a hand in constructing the current economic frame work.

No wonder things, be it precious metals and commodities, are rising. The reasons for people to run to these sectors are many:

1)      Huge economic uncertainty

2)      Massive deficits and deficit spending

3)      Budget busting on the Federal and State level here and abroad

4)      Huge outside deficit financing requirements

5)      Hints at the next Quantative Easing (QE2) IE money printing

6)      Large Tax increases on the horizon

7)      High chronic unemployment with no end in sight

8)      Continual regulations and taxes from Washington(who knows the unintended consequences)

9)      Precarious situation in currencies

10)   Winding down of the stimulus

11)   Poor Sentiment

Disclosure: Long Gold, Gold Stocks, Silver and Silver Stocks as well as other sectors..

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Tuesday, September 21, 2010

That's The Way America Crumbles..

There is an old saying, “the trend is your friend”.  To survive in today’s market you need to identify the trends in place or ones that are gathering steam. One  trend that is becoming apparent is the infrastructure theme. Look around the United States and you find all infrastructure, from water systems to electrical capacity, are in disrepair due to neglect. At this point in time two forces are coming together to power this trend going forward, 1) is a growing recognition that the infrastructure across the US is shall we say less than adequate for the 21st century and 2) the current administration has begun to target this sector.

The first driver is absolutely needed in order for the US to compete in the world market as well as get our economy back on track. The infrastructure theme is very palatable to the administration since it accomplishes several goals at once. Renewed infrastructure projects can give a boost to the economy in the short run by providing new construction jobs. Longer term the projects assuming they are properly targeted will help America remain competitive in many areas by either: reducing waste, improving productivity, containing costs and insuring that the capacity(of all utilities, transport and economic essentials) is both adequate and reliable.

Many of our rivals around the world have embraced new technologies and their infrastructure is decades younger. Their infrastructure makes the state of our infrastructure look what you would find in the best banana republic. Our country has gotten in to this pickle because for decades we have not invested nearly enough in improving all flavors of infrastructure. The lack of investment stems from the fact that it is not sexy and does not garner votes for politicians. If you think about it Dear Reader, is a better campaign point to tout the fact that your administration spent $1 million to upgrade a town water pipe preventing water leakage and potential disruption or that same money is spent on a new community center for Friday night bingo that the townspeople will see and use often. Infrastructure is not sexy because we take it for granted. When you come in your house you flip the switch to turn on the light and it comes on instantly (well provided you use a soon to be banned incandescent light), so we never give a thought about the power grid unless there is a power failure; the same is true about your water etc…

The Congress and Administration appear to have caught on to this theme as there has been more and more of a push to fund infrastructure, which I believe would be a beneficial use of public money to provide a foundation for revitalization. On Labor Day President Obama proposed to invest $50 billion in infrastructure projects, which I applaud as long as they are logical and targeted to address shortcomings. Additionally, I came across an article published today entitled “Senate panel to consider infrastructure bank” that appeared today on forconstructionpros.com. Moreover, the house has a similar bill that was proposed in 2009, H.R. 2521. So clearly the “trial ballons” have been launched and the move is afoot to get funding.

The need to replace, upgrade or build new infrastructure is not only vital to our future growth, but will be also quite costly. In December of 2009 the American Public Works Association (www.apwa.net) produced a report on some of the infrastructure of the US. The report includes some startling numbers that are required for infrastructure. According to the report the transportation sector will require $225 Billion of investment annually for the next 50 years and each billion dollars spent would produce 34,700 jobs. The report also looked at the water\waste water sector which will require $23billion annually for the next 20 years.  So as you can see we are talking some big bucks here regardless of what the economy does, in fact it could be argued that these sectors could be used to stimulate the economy.

There are various ETFs that invest in infrastructure, for example : PowerShares Water resources ETF (NYSE: PHO), iShares Infrastructure Fund (IGF), PowerShares "CleanTech" (PZD) and Market Vectors Nuclear Energy (NLR). Additionally, one could investigate companies that play in the infrastructure space such as: Shaw group NYSE:SHAW, Flour Corp NYSE:FLR, Jacobs Engineering(NYSE:JEC), or Foster Wheeler (NASDAQ:FLWT). Another angle on this is to look at companies that make equipment that are utilized in infrastructure building like : Caterpillar (NYSE:CAT) , Bucyrus( NASDAQ:BUCY) or Joy Global (NASDAQ:JOYG). There are many more companies that make equipment, materials, provide construction management or engineering than can be listed here.

The purpose of this post is to provide food for thought in identifying where the economic activity and spending will be going. I view this sector as one to watch and invest in when the specific issues are cheap to reap the long term gains.
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Monday, September 20, 2010

Honey, I Blew Up The Middle Class.. Incredible Shrinking Middle Class PT 2.

I have to begin by stating how much it bothers me that so many of my fellow Americans are in such dire straits. It is unfortunate that we are living in a time where the American dream is so threatened for so many under the guise of change and cloak of politics. There are so many reasons and causes that have pushed America to the current situation, that one could write thousands of pages on the subject.

Additionally, after giving it much thought I do not want to write this piece specifically on how to profit off of others misfortune, but instead to point out some of the drivers that are prolonging and deepening the recession(which I believe history will look back and qualify as a depression) as well as forestalling any chance of real recovery.

So to the matter at hand let’s identify some of the predominant trends. The biggest underlying trend that is going to be driving the American economy for years to come is Government. Dear reader, don’t take the prior statement the wrong way; I am not anti-government, but instead I am in favor of the founding father’s view of small responsible government. Today the sheer size of the government and the amount of resources needed to make it function is massive and getting larger every time anyone in government opens their mouth. Even if we cut the size of government in the near future the debt that has been issued to fuel government largess is still remains. Moreover, it seems apparent that the government will not cut itself unless there is a crisis that forces the issue.

The leaders at all levels of our government do not understand economics and how an economy functions.  Our leaders seem to feel that it is both the government’s job and responsibility to create jobs since the private sector is unable or unwilling to do so. However, government has never been able to create wealth and jobs here or anywhere else; for if it had the USSR and the Eastern bloc would have never fallen and China would not be reforming its government toward a capitalist style model.

As it currently stands there at about 107 Million Americans employed in the private sector where as there are 22 Million workers at the Federal and State levels of government*. So the ratio of government workers to private sector employees who support them is approximately 5 to 1. Additionally, the average job at the Federal level has a cost including benefits of $123,000($40,000 of which are benefits), the State level is better weighing in at $70,000 including benefits and of course the private sector bringing up the rear at $62,000 with $10,000 in benefits.  This trend is unsustainable it will not stop the government from trying to keep this train on the tracks. The cost to private workers and the general economy through taxation and government borrowing to maintain this job illusion is dragging down the whole system. Should you expect Dear Reader that leadership of the US would comprehend this fact when individuals like Nancy Pelosi are quoted as stating and I am paraphrasing here, “The fastest way to reduce unemployment is to give more unemployment checks”. Today this is what passes for economic logic and one wonders why we have such a mess on our hands.

A second trend that goes hand in hand with the aforementioned one is the tendency of government to believe that it has to create regulation and provide big business in particular with a safety net in the name of public good. All the regulation and harebrained schemes that are jammed in to every law passed are both creating uncertainty that is freezing up business and adding the burden of cost on to the productive sectors of the economy. For example buried deep within the Obamacare healthcare bill is a clause requiring all businesses to file a 1099 with the IRS for purchases of $600(cumulative) or more per year. On the face of it this regulation seems pretty straight forward and easy until you inspect the draconian nature of it.  Whether you own a business or work in one I am certain that in the course of your regular business you either sell or buy more than $600 worth of goods and services from multiple vendors, all of which will now necessitate filing a 1099 form with the IRS. This regulation will be a burden of sorts for large companies because they will have to hire additional staff to handle the paper work; but for small business there is no benefit only cost and could force many who are currently teetering on the edge to shutter. The intent of the regulation is to capture more revenue by the IRS for the government, however, the reality is that it will burden the small business sector who drives 80% of the job growth in the country and both increase unemployment and slow any recovery as well as reduce the very revenue it was intended to capture. In fact it appears that the only job growth as a result of this regulation will be at the IRS who intends to add 16,000 employees to its rolls as a result.

A third trend is the Federal Reserve’s policies to punish savers and reward the reckless. The FED continues with its cheap money and bailout policies all the while facilitating congress’ drunken sailor spending (Yes I know that is an insult to drunken sailors since they are spending their own money unlike the FED\congress who is spending yours and your kids\grandkids) it continues to put the US in jeopardy by debasing the currency. In fact the problem is so huge that it is almost never talked about in the media because the numbers are so staggering that most people cannot even comprehend the issue. In a recent article featuring Lawerence Kotlikoff , a well know Boston University Economics Professor (who is no  slouch receiving a BA in Economics from Univ of Penn and a PHd in Economics from Harvard) ,  points out that the “off balance sheet” deficits from the FED\Congress spending orgy is now in the range of $202 Trillion…yes that is Trillion with a “T”.  Kotlikoff states that the unofficial deficit is about 15 times the official deficit; and one should also note that the official deficit is roughly equal to the current GDP of the US.   The problem here is that the Congress and the FED are now “boxed in” as there is no way out of this mess. Given the current political and regulatory climate and the lack of will to endure any kind of cuts or taxes at some point the market is going to force the issue. The US is in the untenable situation that we cannot tax our way out nor can we grow our way out.  Of course as you know the US is not the only country with large deficits much of the world is facing this conundrum so there is no one out there to save US like the EU at least temporarily saved Greece. The difference is that the US Dollar is the world’s reserve currency and that has afforded the US the ability to rack up all this debt while abusing the privilege of its currency stature. Given or deficits and slow growth the only way out that the government will find acceptable is ultimately what veteran newsletter writer Richard Russell coined “inflate or die”, since debt default is not in the US government lexicon unlike let’s say Russia circa 1997. Currently, the FED and many deflationists out there fear deflation; however, just as in the great depression a debasement of all currencies will instantly put a stop to any deflation.  It appears to me that as time moves on the FED is ever closer to having to make Havenstein’s choice. Havenstein was essentially the FED reserve chairman of Weimar Germany after WWI, who printed and debased the currency at each slower juncture in the economy ultimately resulting in a hyperinflation.

To sum up I fear for the middle class, or what is left of it as the trends are for more government, more regulation, slow or declining job market and the potential for currency debasement resulting in large inflation.  You won’t hear these thought in the mainstream media, but looking at what is happening and historical parallels can allow you to think outside the box. The results of the policies in place will lead to opportunities for people who can deploy cash in to the right areas; such as being short housing, mortgage brokers, banks, title companies and other areas of finance that help the middle class afford items that would normally be out of reach like high end autos etc… as well as being long things people need and tangible items.

*All these figures are derived from reports on the Bureau of Labor Statistics site www.bls.gov

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Friday, September 17, 2010

Part two of yesterday's post to be published over the weekend

Due to unforeseen circumstances the second part of the blog post from yesterday will be published over the weekend. I apologize for any inconvenience.

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Thursday, September 16, 2010

The Incredible Shrinking Middle Class....

Today I picked up on an article on “Drudgereport.com” that 1 in 7 or roughly 14.3% of all Americans live at or below the poverty line, which works out to be about 45 million people. According to the article 2009 saw the largest single year increase in the poverty rate since these records have been kept, starting in 1959. Further, the US poverty rate ranks third from the bottom amongst developed nations.

Fortunately there are some safety nets in place to prevent wide spread starvation that could lead to civil unrest and chaos, but is taking its toll. Statistics provided by the various government safety net providers bear this out.  The food stamp program now provides 41 plus million with a subsidy and year over year participation in the program has skyrocketed by about 20%. 17% of all Americans are receiving aid from one anti poverty organization or another.  50 Million Americans are now on medicare which is taxing that program. 10 million or so of our fellow Americans are receiving unemployment benefits, which is up 60% since last year and quadruple the number in 2007. Of all households in the US 28% have at least one person looking for a job. Bankruptcy rates have risen 20% year over year from the period ending June 30th.  14% of all mortgages are delinquent or in foreclosure and 25% of Americans have credit scores below 599.

This is not a pretty picture and the fact that the statistics are rising is not a good thing either. The article that I culled these statistics from goes on to discuss the blame game and hints that Americans are more concerned with the latest TV show while politicians are to busy getting elected to really address the problems. While I agree with the assessment my interest is what can be gleaned from this information to help ourselves, remember knowledge is power and in the case of investing it is profit.

One thing is for sure we need action, simplification and real sensible change not left or right wing dogma.  It appears to me that change is coming but unfortunately at a glacial pace, as reflected by the Tea Party impact in the current election cycle. Not get to political but it is going to take this crisis period that we are currently in to come to a head before we get real change; I just hope it is change for the better and not worse. I mean if you look back throughout history you can find examples of crisis and change. The example of crisis leading to change that is familiar to most people is the post Weimar Republic scenario that paved the way for Hitler. I am not suggesting that we should expect that here in America but one would be foolish to think that type of scenario could not happen; just look at all the things that could never happen but did since 2000.

We as a nation need to come to terms with the cold hard facts that what has been done for the past 30 years or so and particular since 2000 has not worked; but instead created false prosperity and severe imbalances that have yet to be corrected. I believe that it was Einstein that said,  “the definition of insanity is trying the same thing over and over and expecting a different result". This is exactly what we as a nation have been doing since this crisis has begun. It seems that regardless of who is in power the same solutions are being applied, print our way out, monetize our way out, attempt to raise taxes, borrow further to finance and this is digging the hole deeper. Everyone knows when you are in a hole and trying to get out the first rule is stop digging.

I think much of the problem is a societal shift in attitude. The original can do American appears to have become outnumbered by those that believe the government can fix everything and that everything should be equal and fair. I am not sure when the average American became so dependent on government for survival and problem solving but we will not solve these problems until we take back the government and scale it down. This crisis will only get worse as the government keeps pulling levers with the intent of getting the economy going. We as a nation have to correct the imbalances that built up and return to the fundamentals that made America great in the first place. Policies that are akin to trying to cure a heroin addict by giving them more and more heroin are counterproductive as are the tax schemes to “redistribute”  which are as effective as trying to raise the level of water in your swimming pool by scooping buckets of water from the deep end and pouring the in to the shallow end.

Well we have established that there are some powerful trends and that things are likely getting worse not better and that change to fix this is arriving at a snail’s pace. So since we can’t change things what can we do to keep from disappearing like so many of our fellow Americans? That is for tomorrow’s blog post, in the meantime I can’t help but feel upset for so many of my Countrymen at the moment; especially in light of the dearth of leadership across the gamut.

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Wednesday, September 15, 2010

Another Tea Party in America.....What does it have to do with investing?

The Boston Tea Party of American Revolution fame was a protest over unfair taxation and lack of representation.  The Boston Tea Party as the name implies occurred in Boston in the harbor, yet yesterday another form of Tea Party took place. This time it is part of a loosely organized grass roots politically and fiscally motivated movement. While this blog is a financial based blog and I have no position in the Tea Movement one must always look at the political landscape when making investment decisions.

To me true investing requires a “trident” approach since there are three interconnected areas that can affect your investments, like it or not. First of the three tips of the "trident" is the economy so one can understand what areas are going to be profitable and why. The second prong of the investment “Trident” is fundamentals of the investment vehicles, this is not to say that vehicles with lousy fundamentals can not appreciate, however, I would term that situation more of speculation. The “Trident’s” third prong represents the political\geopolitical implications for investments.

In light of the Tea Party primary race wins there is a political dynamic that is entering the fray and could potentially lead to increased volatility until it is more clear which party will gain and lose seats in the two branches of congress. If it appears that the  grassroots efforts by the Tea Party does not bear out then the Democrats will retain control and we can expect more of the same efforts that have come to pass in the past 18 or so months. My feeling is that a Democratic retention of both houses will lead to more uncertainty and a market decline. Furthermore, the continuation of the tax and spend policies and ramping up of more regulation will keep small business the largest employers, who create 80% of the jobs, in the country on hold.

On the other hand if the Republicans manage to gain enough seats in one of the houses then the dynamic has changed. The Republicans would be opposed to the vast majority of Democratic proposals and block them at every turn. Dear reader, you may be asking how this could be good for the country. I have only one word that will say it all “gridlock”, meaning nothing of any significance will be achieved during this time and there may be attempts to undo many items implemented over the last year and a half. If we had gridlock then America could get back to business because small and large businesses would be able to get a lay of the land and figure out how to work within the new confines of the recently implemented laws.

Of course I did say that the “trident” took into consideration geopolitical factors and if something on a grand scale such as a huge terrorist attack were to occur on American soil then all bets would be off.

So in a nut shell if the Democrats retain power expect more of the same but worse because the Democrats will take the election as mandate on both their leader and policies. In this case I would be more inclined to hedge my bets with inverse ETFs and precious metals. The flip side if the Republicans take one of the houses of congress I would be more inclined to invest in oil and gas companies, coal companies, defense contractors and some areas of health care(see my blog post on TEVA).

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Monday, September 13, 2010

TEVA.....no not the sandals....

Looking to see what is working in the investment markets today and has a good probability of working in the future is a daunting task. No one really knows where the markets are going with true certainty, dear reader, the best anyone can do is make an educated guess. In order to guess one must have a good business sense and then take in all the available information and formulate an opinion upon which to act. The problem with the opinion making process is that the rules of old don’t necessarily work in the current paradigm and may have permanently changed. Even with a change in paradigm there are certain things that remain constant throughout history; basic human needs, human nature, and the life cycle. So while we as a nation and world are in unchartered territory from both an economic and geopolitical perspective there are still investible themes to be capitalized upon.

I am not a day trader or short term trader by nature as I prefer to identify an investment opportunity that will play out over a period of time instead of looking to turn a quick buck and run with the “hot” money crowd. Given my bias for investing and against raw speculation I am always on the lookout for companies that fit the mold of an investment which can trend for longer periods of time.

In the current environment I am trying to identify companies and trends that can profit and grow based upon factors which have the greatest resistance to market drivers. One theme that has been the subject of tremendous debate and argument is healthcare and the passage of Obamacare. Whether you feel Obamacare is a good thing or bad is irrelevant, instead it needs to be examined and looked at for investment opportunity. Obamacare appeared on the scene under the guise of providing universal coverage but has morphed into a healthcare cost containment program. Now we can debate all day if Obamacare will contain or drive costs, which if my home state of Massachusetts is any example it will escalate costs far more than imaginable, but I would rather focus on the investment angle.

If as is being widely touted the driver for Obamacare is cost then there are a few factors that need to be taken in to consideration. First, by the very nature of the idea we as a country are going to expand the pool of people receiving health services putting strain on an already burdened medical system. Second, the baby boom generation, those individuals born between 1945 and 1964, are approaching retirement age when healthcare demands tend to rise. Third, the increase in demand and limited healthcare dollars will drive further cost containment both through rationing and looking for price reductions.

Given the factors listed above the trend that is highly likely to benefit is the generic drug industry. Ironically, as the trend toward generics gains momentum there is the possibility that the development of new drugs will continue to slow as companies may not be able to recoup enough of the development dollars before the new drug would go generic, but that is a debate for a different post.

My favorite play on the healthcare theme and trend is an Israeli company in the generic drug space. The company is called TEVA Pharmaceuticals and trades on the NSADAQ(TEVA). TEVA trades with a PE of 19.44 vs the industry average of 22.4 and TEVA’s price to sales ratio is at 3.43 vs the industry at 19.6. Furthermore, TEVA sports a Price to book of 2.6 which is 57% of the industry average. Additionally, TEVA’s PEG(Price to earnings growth) ratio is 1.3 at current levels vs the industry which is 7.3. A PEG of 2.0 is considered undervalued relative to expected earnings growth. Moreover, TEVA’s quarterly earnings per share, year over year, is increasing at a rate of 50% while the industry is at 38%. Teva does provide a dividend of 1.36% as of this writing and has boosted it 25% over the last 3 yrs.

This is a stock on my watch list due to healthcare cost factors, the aging demographic of the baby boomers worldwide. I do feel it is attractively valued; however, it appears to be over extended at the time of this publication. Even though TEVA is in a sector with great long term fundamentals and sports a Beta of .2(meaning it does not really correlate with the S &P 500 performance); I feel that there are better entry points right around the 50 day moving average of $51.50. The caveat to this entry point would be that the decline from the current run up that broke the downtrend should be on average to below average volume if one intends to take a position.

Disclosure: I do not currently have a position in TEVA, but I am actively monitoring the stock for a good entry point. This is not a recommendation for purchase or sale only the author's personal opinion for educational purposes only. Moneta Advisors will not be held liable for investment losses resulting from using this advice. Please do your own due diligence  and consult your financial advisor before investing.

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Wednesday, September 8, 2010

Is IBM’s 3 year note at 1% a deal?

As the risk trade morphs, investors of all flavors are jumping the equity ship in to bonds. First, it was US Government bonds then Municipal bonds and now Corporate America wants is slice of the cheap money pie. I applaud Corporate America for taking advantage of such insanely low rates especially if they put the proceeds to good use expanding business, restructuring higher cost debt or something accretive to shareholder value. In fact if a corporation has the ability to get money at historically low rates and does not to restructure existing debt you have to question the management of the company as to why they are not taking advantage of this window of opportunity to become leaner and meaner.

The flip side of this trend born from the risk trade is a question for you dear reader. Does it make sense for an investor to purchase the debt of the companies?

Let’s take IBM for example, who just sold bonds in an offering at 1% for a three year note. Investors are figuring that they are doing better by about 25 basis points over the comparable term US Treasury. In essence the market is saying that IBM debt is nearly comparable in quality to the “riskless return” of a US Treasury, since the US Treasury has a yield of .8% at the time of this writing.   So if IBM has a “credit risk” nearly comparable to the US Government is one really better off holding the bonds of IBM at 1%.

In my estimation investors are short changing themselves with risk adverse thinking.  Here is why I believe the bonds are a less attractive choice than the equity at this time. Starting with the equity itself, IBM has a forward PE of 10.21 and a PEG ratio of .97.  The industry average for the sector that IBM is in is a PE of over 31 and a PEG ration of 1.57, so versus its peers it is reasonably priced. Moreover, the PE ratio of IBM at the trough of the 2009 bottom was 9.65 so on a forward basis it is pretty close to the panic conditions, even while the company and economy are not at panic levels.

If you purchase the IBM bond you can hold it and receive all your principal back and collect the 1% after 3 years. The type of investor who buys this is the CD investor, because they believe that the company won’t go bankrupt and they will get their money bank and some interest. If you follow that same logic then why not buy the equity stock of IBM. While it is true that the price could fluctuate and there is no true guarantee that if you hold the stock in three years it will be worth exactly what you paid, although based upon the markets risk assessment there is reason to believe it will be equal or higher. As a result of taking on the risk of fluctuation one is compensated with a 2% yield and a chance for appreciation. Sure one might get some appreciation on a 1% bond if rates fall lower, but the odds are it won’t be that significant and if it is the situation could be very dire.

If one purchased the equity one also gets paid the dividend to hold the shares just like the coupon on the bond. The difference is that IBM has raised their dividend 25.3% over the course of the last three years where as the coupon on the bond will not be raised. So a share holder gets paid to wait and as the company goes about its business and IBM has been raising the dividend giving the equity holders a raise each year. So long as IBM performs and it is in a sector that has done reasonably well for the past couple years it should keep raising the dividend providing a means of income growth and potential capital appreciation, can a bond at 1% do that? Not likely.

There are other companies in the market with even better dividends and track records of raising them as well. The key is to buy dividend paying companies that have a track record of raising them at a time of reasonable or undervaluation of the share price.

Disclosure: I own IBM shares
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Tuesday, September 7, 2010

Back to the grind..........

It is said that Labor Day is the unofficial end to summer, because it is back to work and school for the vast majority of Americans; even though the Autumnal Equinox for 2010 occurs on September 23rd. For us here at Moneta Advisors it is also back to work after a much needed vacation, which is why the publication of this blog was halted. Typically the month of August is a slow one in the markets as most traders and fund managers are off to the Hamptons or other greener pastures to while away the hot summer days. During this summer period the markets tend to be lighter on volume and the moves one way or another are not truly meaningful; this summer has been no exception. Although the direction of the market has been a source of great speculation.

Most people think of October as the worst month for equities, however, this is not borne out by historical fact.  It is true that we have had crashes in October at various times in our history that are famous as in October 28 and 29 1929(-23% +/-), 1987(-25% +/-), 1997 (6%+/-).  However, crashes have occurred in many months: Nov '29, Aug '32 Jul '33, Aug '96, Apr '00 and even lately on May 6th '10 also known as the "Flash Crash".

Dow Jones Industrial Average monthly returns

*** Chart from chartoftheday.com (Live Link to Chart of the Day )********

In Addition to all the talk about crashes there has been much hype about the “Hindenburg Omen” and how the conditions have lined up for this to predict a crash.  The Hindenburg omen utilizes the following criteria:

1 -The daily number of NYSE new 52 week highs and the daily number of new 52 week lows are both greater than or equal to 2.8 percent of the sum of NYSE issues that advance or decline on a given day

2 -The NYSE index ishigher than it was 50 trading days ago.

3 -The McClellan Oscillator is negative on the same day.

4 -New 52 week highs cannot be more than twice the new 52 week lows (conversely new 52 week lows may be more than double new highs).

The omen itself has a decent rate of prediction of predicting a decline of some magnitude over the following 40 days once triggered, but this is only when the omen is not a “one off” but confirmed at least 3 times in a two week period.  Additionally, it appears at least to me that if you wish you can back test multiple situations to find points in market history where the “omen” could be viewed as a predictor. The usefulness of the “Hindenburg Omen” is questionable in my opinion as circumstances are different in each market period and will ultimately determine if the omen is fulfilled.

For crashes to occur the market should not be expecting them, instead what we have today is the world’s most advertised potential market crash. As I spent time on the beach this vacation I had the opportunity to chat with people from all walks of life and socioeconomic strata. Based on my conversations it was apparent was that the economy was not nearly as rosy as the media keeps pumping and the vast majority of people are predicting a market event.  There is an old saying the “markets climb a wall of worry” and as Robert Prechter of Elliot Wave Intl has added in recent years “markets slide on the slope of hope”. Clearly we as a nation are in worry mode and I believe that markets will remain choppy and probably move more to the upside. This is not to say that there is no train wreck coming but the timing of it has shifted. You will know that the trend is shifting  again when you are hearing that your barber, a cab driver or one of your family members is beginning to move money out of their bond funds and telling you about these great stocks they are buying and you should too…

In the mean time one is best off looking at what they might want to buy when there is a fire sale or in the vernacular a crash (steep correction). Take the time now to think about what you want out of your investments and watch the items that are of interest….in other words do your homework now. If you are looking to buy downside insurance follow the VIX, options/leaps on the major indices or an inverse ETF. The vehicles I mentioned before provide you with downside protection and or profit and get less expensive as the market rises; so when you are betting that the top is neigh you can protect yourself and reduce your cost to do so. You will need to buy these when everyone around you appears optimistic..just like you don’t buy homeowners insurance as your house burns.

Remember no one ever got rich by “buying high and selling low”, with the exception of buying downside protection when the market is high and selling them at the market low.

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