This week we look at two brief essays for your Outside the Box. The first is my friend Barry Habib talking to us about where mortgage rates are headed. Barry gives us a very simple, but logical analysis on why rates are headed up. Then we jump to Spencer Jakab writing in the Financial Times about the problems in the municipal markets. Seems we may be under funded on our public pensions by about $3.5 trillion. As a tease to his column:
"Taking a page out of Greece's playbook, the peeved treasurer of America's largest state fired off letters this week to the chiefs of Goldman Sachs and other banks questioning their marketing of credit default swaps on California's debt . The instruments, he complained, "wrongly brand our bonds as a greater risk than those issued by such nations as Kazakhstan."
"Insulting indeed, but who exactly should be insulted?"
It helps if you have seen Borat, or at least a trailer, but the message is the same.
I am off to Phoenix and San Diego, the NYC next week, so I will be writing on the road. Have a great week.
I have been writing about sovereign debt risk for some time. Japan, Spain, Italy and Portugal are all facing serious fiscal deficits and funding problems within a few years. But Greece may be the first country to hit the wall. In today's Outside the Box, we look at a short column by Ambrose Evans-Pritchard of the London Telegraph on the problems facing Greece. Greece will soon be faced with deciding which bad choice to make among a very small set of really bad, difficult choices.
And then we turn to a piece by Edmund Andrews in the New York Times about the funding problem facing the US. The US is going to have to borrow at a minimum $3.5 trillion in the next three years according to Obama administration officials, and it is likely to be much higher. And rates are likely to be rising. As Andrews notes "Even a small increase in interest rates has a big impact. An increase of one percentage point in the Treasury's average cost of borrowing would cost American taxpayers an extra $80 billion this year." If interest rates were at the same level as a few years ago, interest costs on the debt this year would be $221 billion more than they actually were.
We are not yet Greece or Japan. But we are working on it given the current direction. At some point the bond market is not going to "go along" for the ride. Read these pieces and think about them.
As I often write, if something cannot happen then it won't. Greece cannot go along the same path they are on. While today we are blithely ignoring the debt problem, the US cannot continue with massive deficits without serious consequences.
With that being said, for those in the US, I wish you a very Happy Thanksgiving. My intention is to write a letter this Friday as usual, assuming I can roll out of bed after the feasting. I am told by very reliable sources that thanksgiving calories do not count, and I intend to take advantage of that.
Your still hopeful we will find a way to Muddle Through analyst,
There is the strong possibility that policy makers in the US and UK will not time the transition from the current quantitative easing to a more tightened monetary policy. That is not because they are no competent. It is because the task is very tricky and there is no play book outlining the steps. This is not Tom Landry (former Dallas Cowboy coach) pacing the field with a play for every situation already planned and practiced well in advance.
The odds favor they will either be too late or too early. Getting it "just right." The Goldilocks play, would be more than fortunate. In fact, there may be no right play to call. They may be forced to choose between a slower economy and/or inflation/deflation. And as this week's Outside the Box authors note, there is also the possibility of yet another asset bubble, making the choices even more risky.
Those who are absolutely positive about which of a variety of outcomes will emerge have a level of clairvoyance with which I am not familiar. It makes risk asset (like stocks) investing particularly tricky right now. This is a time to be nimble and avoid creating opportunities for large losses if you are wrong.
We will start this week's OTB with a few paragraphs from the Bank Credit Analyst about the Great Depression and then move on to a piece from the London office of Morgan Stanley on the problems facing central bankers.
And on a less ominous but more important note, the Muscular Dystrophy Association (MDA) has issued a warrant for my arrest which goes into effect on August 26th! I will be held at the PM Lounge in the Joule Hotel from 3-6. My bail is set at $2,400, which will benefit local families living with neuromuscular disease. No one person can set me free. It will take a little help from all of my friends, family, colleagues and enemies! Please use the link below to visit my Bail Page and help me post my bond by contributing in any way that you can. Thank you for having a big heart! And come see me in jail!
And now, the thoughts from BCA.
There is a debate in academic circles on the lessons of the current economic crisis. While most ivory tower debates are of little concern to our daily affairs, this debate should concern you, as it will inform those who hold central bank and political power. Remember, there is no playbook of rules for what to do in deflationary, deleveraging recessions. They are making it up as they go along.
Today we have a short essay by Niall Ferguson published last week in the Financial Times. It speaks for itself, and you should take a few minutes to read it.
There is a reason I call this column Outside the Box. I try to get material that forces us to think outside our normal comfort zones and challenges our common assumptions. And this week's letter from Hoisington Investment Management Company does just that.
Let me give you two quotes to pique your interest: "Monetary policy works by creating the environment for a renewed borrowing and lending cycle. This cycle would require that the debt to GDP ratio, which is already at a record level, grow even higher. Would such an outcome really be that desirable when the controlling problem of the U.S. economy is too much improperly financed debt? If the Fed were able to engender an increase in the debt to GDP ratio, this might merely serve to postpone the reckoning of the current debt levels while laying the foundation for an even more vicious unwinding down the road."
And: "The only really viable option for federal stimulus is a permanent reduction in the marginal tax rates, as highlighted in the research of Christina Romer, incoming Chair of the Council of Economic Advisors. This would have the benefit of raising after tax rates of return, but the drawback in the short run of still having to be financed by an increased budget deficit. Over time, a massive reduction in marginal tax rates would be beneficial, but the operative word is time. Refunds, or transitory tax relief, will have no better results in stemming the recessionary tide in 2009 and 2010 than it did in the spring of 2008."
Van Hoisington and Dr. Lacy Hunt give us a seminar on the current bailout programs that is not the usual analysis we see in mainstream media. This week's letter requires you to think, but it will be worth the effort.
Hoisington Investment Management Company (www.hoisingtonmgt.com) is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4-billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies. And now let's jump right in to the essay.
Yesterday I sent you an Outside the Box from Paul McCulley who supports the government and Fed activity (in general) in the current economic crisis. Today we look at an opposing view from Bennet Sedacca of Atlantic Advisors. He asks some very interesting questions like:
- Shouldn't the consumer, after decades of over-consumption, be allowed to digest the over-indebtedness and save, rather than be encouraged to take risk?
- Shouldn't companies, no matter what of view, if run poorly, be allowed to fail or forced to restructure?
- Should taxpayer money be used to make up for the mishaps at financial institutions or should we allow them to wallow in their own mistakes?
I think you will find this a very thought-provoking Outside the Box.
I mentioned in last Saturday's letter a report by Louis Gave of GaveKal fame on whether inflation may be waning and its importance. Louis gave me permission to use it as this week's Outside the Box. It is typical of the thoughtful analytical work they do.
Louis and his partners and associates at GaveKal write some of the more thought-provoking material I read. They really challenge my position on numerous matters, causing me to look at many items from a different view. That of course, makes this particular piece good for Outside the Box. Whether you agree or disagree, you need to know why you hold a position. If you can't articulate the "against," how can you be sure you truly understand the "for"?
I think given the current debate on inflation, this week's Outside the Box is a must read. While it may look longer, there are a lot of very important graphs here. And thanks to Doug Harrison for helping with the tricky technical aspects of getting this letter out today. It was a lot more than a simple cut and paste, and way beyond my pay grade.
And congratulations to Louis and his wife Kelly who by this time may have a new child. She was due any minute on Friday. I trust you are enjoying your summer. I will be on Larry Kudlow's show tomorrow evening and then having dinner with he and Louis' father Charles (and Tiffani of course). And expect an announcement about a new survey in the next few days.
This week's Outside the Box will challenge a few of your base assumptions. Paul McCulley, the managing director at PIMCO, offers us a kind word for inflation and the reasons that the Fed will be on hold for a lot longer than the markets currently think. And part of that is to avoid a real recession or even a depression. Getting this debate right is important.
These are indeed interesting times we live in. I look forward to being with Paul at the end of July on our Maine fishing expedition, where he can defend his proposition to the group of economists and analysts gathered there. Have a great week.
This week in Outside the Box we look at two brief essays which give us different perspective on the Continuing Crisis. The first is by Mohamed El-Erian, the co-chief executive and co-chief investment officer of Pimco. His book, 'When Markets Collide: Investment Strategies for the Age of Global Economic Change', will be published by McGraw Hill in June, and it will be on my summer reading list. El-Erian argues in the thought-provoking piece from the Financial Times that the crisis is still far from finished, and that those who think we are returning to more placid times may be surprised when volatility suddenly becomes even more pervasive.
The second is by good friend and Maine fishing buddy David Kotok, the chief investment officer of Cumberland Asset Managers (www.cumber.com). He was recently in Africa where he met with the head of the central bank of a small country with headline inflation of 10%. The problem is that "core inflation" is 5% and food inflation is 15%, yet accounts for 50% of the GDP. He asked a group of financial thinkers (including your humble analyst) to ponder what that central banker should do. Do you set high rates and target overall inflation or set lower rates and not worry about food inflation.
Why should we worry about inflation in a small African country? Because the principles are the same, and it makes a real difference where the Fed comes down at the end of the day on this very question.
This week's reading should be very helpful and thought-provoking. I hope you enjoy this read as much as I did.
This week's Outside the Box is from my friends at Hoisington Management. While somewhat technical, they make the case that a slowdown in consumer spending is inevitable. This is worth taking some time and thinking about. Quoting: "This means that consumer spending increases should be approximately zero for the next three years. Further exacerbating the problem is the personal saving rate which declined from 5.2% in the decade of the 1990s to average 1.3% in the last seven years, and now stands at 0.3%. Should declining wealth, rising unemployment and poor economic conditions cause consumers to begin to save and lift the rate back to the 1.3% average of the past seven years, real consumer spending would experience a multi-year contraction."
If they are right, and the evidence of their research is compelling, then we are in for a much tougher time than the recent stock market rallies suggest. The stock market is not always a leading indicator. This week's letter suggests that businesses that depend on the US consumer for growth may be in trouble.
This week's Outside the Box is going to be a little different. I am going to write about the extraordinary action by the NY Fed to foster the Bear Stearns deal with JP Morgan, and give you three brief notes from Michael Lewitt of Harch Capital Management and Bob Eisenbeis (former executive vice-president of the Federal Reserve of Atlanta) of Cumberland Advisors.
The subprime problem, we were told, would not spread to other markets. It would be "contained." And it has, according to Jim Grant. He quipped last week that it has been contained on planet Earth. The risks coming from rising defaults in the US (now above 600,000 and rising from just 200,000 a few years ago) are clearly spreading to markets far beyond the subprime world.
This week's Outside the Box talks about the next two dominoes that could fall: junk bonds and counterparty risk in the various credit default swap markets. Ted Seides is the Director of Investments at Protégé Partners, LLC, a hybrid fund of funds that invests in and seeds small, specialized hedge funds. He writes this week's piece in Peter Bernstein's Economic and Portfolio Strategy, one of the most respected of market analysis letters. You can learn more about the letter at www.peterlbernsteininc.com.
This piece is a little longer than most letters, but it is one of the more important editions of Outside the Box this year. This is a must read. You absolutely need to understand the nature of the systemic risk we are facing, and Ted does a great job of explaining in very clear terms the nature of the risks that we have created din our modern markets. I have left the footnotes in, and they are at the end of the letter.
This week in a very special Outside the Box we have an investment outlook tour de force. My friend and South African business partner Dr. Prieur du Plessis gathered a group of some of the more interesting investment managers in the industry, along with your humble analyst, and let us have the opportunity to opine on what is driving various markets and their respective implications.
We begin with the U.S. economy, addressing the underlying implications of the real estate market, interest rates, liquidity, and the ever precipitously depreciating dollar, procuring an assessment of these collective market drivers and their respective effects on the U.S. economy, the stock market, bond market, and commodities market.
Thereafter, we incorporate macroeconomic drivers that will impact our respective outlooks be they the influence of the Asian Tiger economies, Yen Carry Trade, and the ample liquidity derived from vast foreign currency reserves on account of currency manipulation, and the respective consumption patterns of the developing countries on the global economy.
We conclude with an assessment of the risks to domestic and global economies from the market drivers and offer advice we have humbly been forcefully taught throughout the years by the always hard task-master, the market.
Today's "Outside the Box" will feature an essay by good friend David Kotok of Cumberland Advisors. In his article, David discusses what the development of a global economy means for currencies and the financial markets. He distills the foreign exchange markets into 4 major countries and explains both the policies and risks faced by the central banks of these nations, and how they affect you.
David R. Kotok co-founded Cumberland Advisors (www.cumber.com) in 1973 and has been its Chief Investment Officer since inception. David's articles and financial market comments have appeared in The New York Times, The Wall Street Journal, Barron's, and other publications. He has also appeared on CNN, CNBC, and Bloomberg TV. David is also one of the organizer's of the annual Shadow Fed fishing weekend each summer which I am privileged to get to attend.
I hope that you find this article to be both educational and thought provoking.
A reader forwarded the following article to me last week and suggested it might make a good Outside the Box. This week's article comes from Rodney Dickens, Head of Research for ASB Bank, New Zealand and I thank him for letting me share his thoughts with my readers. Rodney has been analyzing the fixed income markets for two decades and has some insights into the current trends in global interest rates.
Rodney refers to the US Fed as the "global custodian of inflation" and finds an interesting relationship between the Fed Funds Rate and G7 capacity utilization. He then goes on to look at China's role in inflation and the current trend in commodity prices. These factors all lead to the conclusion that interest rates will continue to go up globally and that is why it was picked for this week's Outside the Box.
This week's letter is from John P. Hussman, Ph.D., President of Hussman Investment Trust. His firm is one of the few that has employed hedging techniques, similar to the hedge fund world, in a mutual fund structure. John is also one of the really, really, really smart guys in the running money business. John manages the Hussman Strategic Total Return Fund - HSTRX and the Hussman Strategic Growth Fund - HSGFX.
Hussman's Weekly Market Commentary on August 22, 2005 takes a look at the relationship between stock market valuations, interest rates and inflation. He takes a look at what has happened to this relationship in the past and fills in the "omitted variables" other market cheerleaders seem to leave out.
This is a very short piece, but it is an important analysis of market valuations and why some people (including the Fed) might not be seeing statistical relationships the right way.
Once again we take a look at some comments from the HCM Market Letter written by Michael Lewitt of Harch Capital in Florida. This is a private letter for his clients and we are excited to have permission to share it with you. Michael is one smart guy with a deep understanding of the markets, especially the credit markets, and how they work. The firm manages domestic and offshore debt and equity hedge funds and separate accounts.
I really look forward each month to getting Michael's insights. Michael recently traveled to Europe and Israel and offers some insights on global economic conditions. In classic economics the markets should be falling and interest rates spreads widening, but we currently see the opposite. Michael examines some of the market reactions and interest rate trends taking pace and that is why it was picked for this week's Outside the Box.
This week's letter is once again from two of my favorite economists, Van Hoisington and Dr. Lacy Hunt of Hoisington Investment Management Company in Austin, Texas. They specialize in management of fixed income portfolios for large institutional clients by setting long-term investment strategies based on economic analysis. They have been one of the most successful of bond managers in the country. (I have no affiliation with them.) I eagerly read all of their writing and analysis, and find it to be some of the most thought-provoking anywhere.
Their second quarter 2005 Quarterly Review and Outlook looks at the secular forces that are keeping inflation and long term interest down and why that might continue for an extended period of time. They argue that interest rates only look high from a 1945-1990 reference point and that in fact they may now be closer to the long term historical average and that is why I picked it for this week's "Outside the Box."
This week's commentary comes from Douglas Greenig of RBS Greenwich Capital in Greenwich, CT. I have been reading his material over the years and always find it solid and thought-provoking.
In this piece, we get one more look at Greenspan's "Conundrum." Douglas looks at some of Greenspan's arguments for the strange behavior of the bond market. He then offers up his own theory of why long rates have stayed low and why they are likely to remain there. Many market watchers, like Bill Gross of PIMCO, are starting to look at why long rates have stayed low and predicting they could go much lower. Douglas offers up some new ideas and that is why it was picked for this week's Outside the Box.
This week's letter is by Richard Duncan who is based in Hong Kong and is one of the brightest financial analysts I know. Richard is the author of one of my favorite books called The Dollar Crisis: Causes, Consequences, Cures. A new paperback edition that is revised and updated is now available at Amazon for under $14.
Richard said this piece is really an updated version of one of the new chapters in The Dollar Crisis. It looks at the federal deficit, the dollar, Greenspan and offers another explanation for why the longer end of the yield curve has stayed low while the Fed is raising rates on the short end.
Can the current account deficit undermine the Fed's ability to control US interest rates? Let's find out in this week's Outside the Box.