Paybacks Are Indeed a (well you know …)

Young Billy Economy had just graduated from high school.  He had earned decent grades, but had not received any scholarships.  He did not have any money saved up for college, but he did have a long-range plan.   He would borrow money for college, study arduously, get a degree, get a great job with a high salary, work very hard and then someday, have a big-ol’-pile of money.     

So he applied for a student loan and was approved.  However, in this fable, he received his entire four-year loan in one lump sum up front.  Billy sat and looked at the newly acquired funds.  And then Billy had an epiphany.  “If my goal was to acquire a big pile of money” thought Billy, “then I have achieved my goal very fast without having to do all that work!”

Then Billy took the money, ran off and partied like a rock star.  He frolicked with the chicks from “Bankers Gone Wild”.  He engaged in multiple encounters with that promiscuous “dame” Becky Housing.  He injected derivatives.  He engaged in back-door financing and sub-prime deals.

He was having a great time with his wild, lascivious, lifestyle until one morning when he awoke and called the bank to get more money.  To his utter surprise he was told his account was dry.  He rolled over and found a fat, ugly, Greek, woman in bed next to him. (Bloggers note:  I think Greek women are very beautiful and know several attractive Greek ladies, however for purposes of the story, this woman was lacking important assets).

“Shall we do it again, dahling?” she purred.

“I’m out of money! exclaimed Billy.

“Get out of my bed now, you worthless piece of crap”, she demanded.

So now young Billy found himself broke and forlorn.

Now you might think this is a modern, economic-based, version of the story of the Prodigal Son, but it isn’t.  There is no wealthy father to bail Billy out and Billy is not at all repentant.  He is sorry that the money ran out, but he is not sorry for his behavior.

You might think that Billy is back to “square one”, but in effect he is much worse off than when he started.  He now owes the bank for the large student loan and he can’t get another loan because he wasted the first one.  He still needs to get a degree and now he is behind schedule.  He will have to work his way through college, which means it will take him much longer to graduate.  And unfortunately his first job is a night shift telemarketing job soliciting contributions for a political campaign. “No ma’am, he’s not inept, he just needs a few more years to really fix things.  Now can I put that on your Visa card?”

The Lesson

We basically partied like economic rock stars starting in the mid-90’s.  We feasted on cheap foreign-made goods.  We created a big Internet bubble. We pumped up the money supply and threw cash around at random.  This fueled an enormous housing bubble that did not pop, but exploded.  Our government watchdogs and regulators showed the same discipline as Secret Service agents with Columbian call girls.

And we all benefitted.  We didn’t object to these actions because people don’t care about the sins of others if it benefits them.  The problem is that after the crash, we did not all suffer equally.  Some of the worst offenders kept their illicit profits, while many innocent people lost their jobs and/or their homes.  A free-market, capitalist, system is not fair, just like life.  I think the aughts (00’s) should be labeled the “Enron Decade” because the total books “were cooked”.  Our stocks weren’t as valuable as we thought they were.  Our houses weren’t as valuable as we thought they were.  And our economic growth was based on lies.

Because we were irresponsible for so long, the Great Recession didn’t take us back to “ground zero”.  It put us in a big hole, just like Billy Economy.  That is why we can’t “snap back” from this recession as we have from previous ones.  This is why growth has been so anemic.   This is why unemployment remains so high.  Yes, bad choices made by the current administration have contributed to our lack of progress, but if the economy had been managed “perfectly”, things would be better, but certainly not yet good.  

It is going to take several more years of tough work to dig us out of this mess (just like Billy again).  Some people have said we are going to experience a “lost decade” (economic stagnation) similar to Japan.  I prefer to label it a “Payback Decade”, a payback for our years of “reckless” economic behavior.  And in this case, payback is indeed a bitch.

Feelings, Really Bad, Feelings

Feelings, nothing more than feelings,
trying to forget my feelings of love

Last October I detailed the giant “economic smack down” between Warren Buffet and the Economic Cycle Research Institute (ECRI).  ECRI was forecasting a recession and Buffet said emphatically there would be no recession.

Here are the GDP results since then:

Q3 = 1.8%

Q4 = 3.0%
Q1 = 1.9%
Q2 = 1.8% (expert panel estimate).
 

So the winner is Buffet in a rout.  In the same post I tried to split the difference between the two behemoths and forecasted a very mild recession with GDP near 0% during the time period.  And I was wrong.  I based this forecast on the belief that the best economic cycle model (ECRI) could be that wrong.

And neither could ECRI.  The Chief Operating Officer of ECRI will not admit they made a wrong call.  He instead claims that the forecast is still correct and that the recession just hasn’t happened yet.  I think a better explanation is that the economy is moving so slowly that it can’t even get to a recession.

The reason that ECRI has not backed off its recession prediction is that even though the economy continues to grow, the ECRI model never has stopped “flashing red” and it is flashing even brighter than it was nine months ago.  Say you have a warehouse of flammable material.  You install the best, state-of-the-art, smoke alarm system you can buy.  One day the smoke alarm sounds.  Firefighters rush to the warehouse, inspect the entire facility, but find nothing unusual.   So you have the system thoroughly inspected and tested and determine that it is functioning fine.  You then reactivate it and immediately the alarm sounds again.

Something is definitely wrong.  Last year there were logical reasons the economy sputtered after a hopeful start.  This year the economy is slowing for no apparent reason. (Unless you count Obamacare) I would be tempted to label this the “Molasses” recovery because it is moving so slowly.  But I won’t because molasses is sweet and this economy is anything but sweet to the millions of unemployed.   The latest employment report was sickening.  Forget 8.2%, the Wall Street Journal calculates the “real” jobless rate at 14.9%. 

Patti Domm (CNBC) has labeled this the “Zombie Economy”.  I said early this year the economy was wearing ankle weights, now it seems more like a ball and chain.  Last year I said it was the “Grocery Cart” recovery.  The wheels of this cart are now locking up.

So where are we?  We are slowing down from around an estimated 1.8% growth rate in Q2.  I think that number is high because the recent statistics for Q2 are weaker than Q1, so I’ll go with 1.5%.  Unfortunately, the question must be asked again: Are we now headed for recession?

Recessions are extremely difficult to predict, and very few economists are forecasting one now, even after the horrible jobs report.  Recessions are like diseases, they begin long before you realize something is wrong. The best model we have, the ECRI, was unreliable last year. The ECRI still says recession.  Buffet said in early June that the possibility of recession was low (not as positive as last October).

In December of 2007 I called my colleague Economist Pat because I thought the economy was getting worse.  I told him that it “feels” like we are entering a recession and he agreed.  I remember this conversation because the last recession ended up starting that month.

And I have a similar feeling now.   It feels like the economy started to recede in late June or early July.  I say feel, not think or even believe.  For the record, Economist Pat does not think a recession is imminent this time.

I do think this recession be extremely mild.  It could be a six-month period of just under 0% growth.  This is basically the same forecast I gave last October which was in fact “wrong”.  This recession will not be that traumatic because the economic was not growing that fast.  There won’t be massive layoffs because companies cut drastically during the previous recession and have been very careful in adding workers.  So expect very weak hiring, sort of like the June jobs report (get it?).  The stock market will retreat, but not that much.  So stay on guard and please let me know what you think.

And now we can say goodbye to the hopes of a strong economic recovery in 2012:

Teardrops falling down on my facew we can say goodbye to trying to forget my feelings of hope (love)

Feelings wo-o-o, feelings ....

Follow Up: I posted this on July 9.  On July 10, Lakshman Achuthan, ECRI COO, said in an interview on Bloomberg Televison he believes the economy is already in recession.

A Brick By Brick Housing Recovery

The dust has finally settled down
The sun is shining on these pieces that are scattered all around
This house was everything we knew …

Brick by brick, we can build it from the floor
If we hold onto each other, we'll be better than before.
And brick by brick,
we will get back to yesterday …. (Train)

Last December I described the housing market as being “constipated” and said the market would continue to “skid” on the bottom before finally starting to recover around March 2012.

This forecast was very accurate.  Usually a correct prediction made just four months out is not impressive, but few people were forecasting this.  Back then, people were panicking because the market hadn’t “bottomed out”.  Now people are panicking because the market isn’t recovering fast enough.

The problem is that people are using charts, graphs, and models based on historic data to compare and forecast the current economic and housing recovery.  You can’t do this because many traditional indicators are still malfunctioning.

This was a very damaging recession.  There is no quick bounce back.  There is only a slow, sometimes excruciating painful, and climb out.   Imagine a long distance runner who falls down the side of a hill. He gets up, brushes himself off, climbs back up the hill and rejoins the race.  He bounces back and is able to finish the race, albeit at a much slower time than if he had not fallen.  Contrast this to a runner who falls and breaks his arm.  There is no bounce back.  And he won’t be finishing this race or any race until his arm is healed.

When will the housing market start to race again?  We may not have the old models to help forecast, but we have a new one.  Many industries crashed during the recession and have since started recoveries.  Housing was the last to hit bottom because it had the furthest to fall.  If you look at what happened in the capital equipment, transportation equipment, and recreational vehicle markets, there is a sequence to the recovery process:

1.     Crash – the industry suffers a severe, unprecedented, drop in sales.

2.     Skid – the industry hits the bottom, but does not begin a recovery.  It slides on the bottom for almost a year.

3.     Walk – the industry begins to show increased sales, but at a very modest rate.

4.     Run – the industry gains momentum and sales return to healthy (but not peak levels)

The housing market stopped skidding around March and started walking in April.  We will be walking for a while before we run (forecast at end of post).

The Current Housing Market

Housing Starts, New Home Sales, and Existing Home Sales are all up 15-30% over last year, but this sounds better than it actually is.  Remember 15% over a very low number is still a weak number.  And there has not been consistent growth from month to month in some of the statistics.  This causes “panic” from some people, but it is characteristic of the “walking stage” of this recovery.   

Another hopeful sign is that housing prices actually increased on average in the March-April time frame for the first time in many months.  This was not expected to happen until later this year. 

But there are factors holding back the market.  Listings are very low, down around 20% from a year ago. People cannot sell their homes easily if their mortgage is underwater. Unemployment is still high so people are not getting jobs and buying a house.  People are not changing jobs so they are not moving to new locations.  Prices are still much lower than peak so many people are waiting for a stronger market before putting their house up for sale.  And banks are still holding back on some repossessions because prices are too low.

Sales are also being slowed by tight credit.  Mortgage rates are low but it is one giant teaser rate.  It looks very appealing, like a swimsuit model, but you are not getting any of that unless you have a “super fine” credit score.

There are some positive factors.  There is less slack in the market than was previously thought.  The shadow inventory (repossessions or future repossessions) is smaller than expected.  This is because it is not in the banks’ interest to repossess too many houses and people are not “walking away” from underwater mortgages as much as feared because they still need a place to live.  Bankers and customers continue to work together to prevent foreclosures.  This is an example of the free market at work.

Basic economics is the key to housing recovery.  Low inventories (supply) lead to higher prices.  Higher prices lead to less people being “underwater”.  Higher prices also lead to higher inventories and this will ultimately lead to a strong housing recovery.  But this process takes time.

The Forecast

The “walk” phase will last through 2012, but each quarter should be stronger than the preceding one.  Based on what has happened in other industries, look for the housing market to start “running” around March of next year.

    

I’m Voting For Ross Perot (just 20 years too late)

The main arguments against the President of the United States needing corporate business experience are:

1.     It’s not really needed since presidents have functioned fine without it.

2.     The last time we tried it (Herbert Hoover), it was a disaster.

 

In response the second argument: People are still trying to figure out what caused the Great Depression and while Hoover made mistakes, I don’t think his business background caused him to make bad decisions.  And I don’t think the notion “we tried that once 83 years ago and it didn’t work” holds much validity in 2012.

The first argument merits more discussion.  In the past we have elected many successful military generals as presidents.  This is logical because the men proved themselves leaders on the battlefield.  More importantly if the biggest threat facing the country was another war, who better to lead the country than a former general?  In times of peace, we go for politicians but we still tend to favor those with executive government experience (governors and mayors).

There have been successful presidents who have not had much first-hand business knowledge.  So it is true that corporate business experience was not needed in the to be an effective president. 

However the world has changed greatly in the last 25 years.  The United States has gained more military superiority which reduces the chances of fighting a defensive war.  But we also lost much of our economic superiority as the “world economy” blossomed.  In addition many industries were deregulated which fostered competition, but it also increased the complexity and variability of our economy.  The biggest challenge we face today is worldwide economic competition.  What do you fear most: China’s military or China’s manufacturing?

A President of the United States may not have needed business acumen in the past, but will definitely need it in the future.  If you are expected to manage an economy, it helps to understand one.  And we know what the alternative is: Career politicians produce more politics and less action.

We have not had a “Business-President” in a long time.  The last business-presidential candidate we had was Ross Perot in 1992. 

Perot’s main message was:

1.     Government spending was out of control and we shouldn’t borrow money to pay for our reckless spending.

2.     Government programs, including Social Security and Medicare, were very poorly managed and in need of major reforms.

3.     Both political parties were irresponsible and lacked the backbone to stop the spending and fix the problems.

And now 20 years later it is obvious that Perot was correct and a visionary.  Visionaries are mocked because they see the truth long before other people do.  Perot described the situation in 1992 by using an array of charts and graphs (precursor to a PowerPoint presentation) and the expression “giant sucking sound” (to describe jobs leaving America).  Many people dismissed Perot because he looked funny, he talked funny and he sounded like a crazy man.   But knowing what you know now if you could go back in time, who would you vote for president in 1992?

 

Provided Perot could accomplish his goals in eight years as president and turn the reins over to a like-minded leader in 2000, how much better off would we be today?  Sure we still would have had recessions due to the business cycle, but we would be so much better off economically that we are now. And it doesn’t matter who you blame for the current mess. Clinton, Bush and Obama have all contributed.  

So the last time we had an opportunity to elect a candidate with strong business experience, we did not do it.  This was a mistake the country (myself included) made and we have paid enormously for this choice for the last 20 years. The problems are now much worse and we are running out of time.  Elections matter and corporate business experience is vitally important.  Where will we be 20 years from now if we don’t get our financial house in order soon?

Taking Care of Business (Experience)

Taking care of business every day
Taking care of business every way

I discussed the need for political leaders to have corporate business experience in the post “California Dreaming” (April 2010).  At that time Meg Whitman (former CEO of E-Bay) and Carly Fiorina (former CEO of Hewlett-Packard) were running for governor and senator respectively in California.  My argument was that to solve the country’s economic (business) problems, you need people with real business experience.  Unfortunately both the women lost. Now California is depending on Gov. Jerry Brown to fix its fiscal mess and it is not going so well.

It appears that once again I was ahead of the curve.  Now the main issue in the presidential campaign is the value of business experience.  Several commentators are claiming that corporate business experience does not qualify you to be President of the United States and that this experience is irrelevant when evaluating presidential candidates.  Obviously I disagree.

This argument is ludicrous.  It’s referred to as the executive branch of government.  Hello! Do you think someone who has been a business executive might have learned something relevant to serving in the executive branch?  The President is also referred to as the Chief Executive of the United States.  Chief executive of a large corporation, chief executive of a large country: can you maybe see how experience in one might be useful in the other?

Based on my observations of many years of business experience, here is a list of skills business executives must learn and display to be successful:

  

-        How to take responsibility for your decisions (and not blame others)

-        How to lead a diverse group of people to achieve corporate goals (leadership skills)

-        How to make good decisions, how to make unpopular decisions, how to recover from bad decisions. (decision making skills)

-        How to allocate and utilize assets wisely

-        How to evaluate and hire outstanding talent

-        How to develop and execute strategic plans

-        Understand how a “sub-macro” economy works and how to generate profit under constantly changing conditions

-        How to build and motivate teams

-        How to develop strong leaders to serve under and after you

-        How to influence others one-on-one (how to create “buy-in”)

-        How to listen to the opinions of others and use the information to choose the best course of action

-        Understand the importance of strategic alliances and loyalty

-        How to compete against strong rivals

-        How to unite opposing factions without “taking sides” 

Now let’s make a list of the skills that have been lacking in our government leaders the past several years. Well, um, eh, I guess we don’t need to make another list.  We can just use the one above.  Well isn’t that interesting.  Maybe you don’t need business skills to be President; but you may need them to do the job well. 

And those commentators arguing otherwise still don’t get it.  I’m guessing that they never worked in an organization other than journalism or government.  After generating much criticism after writing their initial articles, a couple of them tried to defend their positions by claiming that it is not being “Socialist” to criticize someone’s business success.  I happen to agree with this.  When you make this type of inane argument, you don’t sound like a Socialist.  No, you sound like a freakin’ Communist.  

Bankers Gone Wild! – Watch Them Flash Your Cash!

Cue some wild party music …..

Host 1:  Welcome to another exciting episode of “Bankers Gone Wild”.  Today we are going to follow the wild hijinks of J.P. and her two banking buddies Morgan and Jamie as they party in the exotic Derivative Islands.

Host 2: Yes, the Derivatives are a dangerous, yet exciting, place for wild bankers to frolic.  There are shark infested waters and many places for naughty financiers to get into trouble.

Host 1:  Looks like the girls are getting very drunk on a combination of cheap money and greed.

Host 2: Wow, that’s a lot of loose cash.  I just hope they are able to control it!

Host 1:  Oh no!  They’ve started buying!  Whoa, look at them buy.  It’s like they are just buying anything.  Buy, Buy, Buy! 

Host 2:  Those girls are really moving that cash! They are awesome!  They are totally out of control!

Host 1: Oh no! They have started to really lose it.

Host 2: Yeah, they are really wasted. Isn’t it great?

Host 1: No, I mean the cash.  They are losing it. They are wasting it big time. This often happens when investing in the Derivatives.

Host 2:  Wow, they are losing every time!  Lose, lose, lose.  Those loses are really racking up!

Host 1:  They’ve just blown through a billion dollars!  Maybe we should say something.

Host 2:  Girls, you’ve lost a lot. Maybe you should slow down a bit.

Host 1:  Oh no!  They don’t care. Now their flashing us their assets!

CENSORED --  CENSORED  -- CENSORED

Host 2: Hey, they’re right back at it.

Host 1:  Look at all that cash. It’s flowing right down that rat hole! Lucky rats!

Host 2:  Here we go again. Lose, lose, lose!

Host 1: These bankers have gone super wild!

Host 2: Look, they just blew through their second billion and now they are lying exhausted on the beach.

Host 1:  Hey, girls.  You just lost two billion dollars in the Derivatives. Aren’t you even a little embarrassed?  What do you have to say for yourselves?

Host 2: What’s that? You say it doesn’t matter because you still have plenty of cash.  Oh great, here we go again.  Now they are flashing us their balance sheets!  Look at that bottom line!  Look at those TIPS! (Treasury Inflation-Protected Securities)

CENSORED --  CENSORED  -- CENSORED

The Solution

The simple solution is to revert back to how the banks were structured in the past. Banking operations were separate from investment firms.  This set-up worked fine until it was changed and it has not worked well ever since.

Making this change would:

1. Reduce the size of the major banks in a logical, non-disruptive, way.  To reduce the size of the banks in other ways would require wise government choices and that of course is an oxymoron.

2. Really eliminate “too big to fail”.  First, the banks would naturally be much smaller.  Second, and more importantly, the banks would not be able to make the risky investments that could cause them to fail.  The banks would again be safer and depositors could be confident that their banks would not take major risks with their money.

3. Allow the investment firms to invest in whatever risky investments they choose with the money they are able to receive from investors (their customers).   Investors would be well aware of the risks.  If the firms make bad investments, they lose all their money and go bankrupt.  No government bailouts, no congressional meetings, no hand wringing, just turn out the lights and close up shop.  This is the way it is supposed to work.  

This would be so simple but the Democrats don’t understand the financial markets so they are intent in punishing the banks.  And the Republicans understand the financial markets too well and want to write the rules with enough loopholes so that nothing really changes.

The French Connection

Those stupid Frenchmen.  They are in the middle of an economic crisis and they just elected a socialist to lead them out of it!  Who do they think they are, California?  Ha Ha Ha Ha Ha!  That is just totally ridiculous.  A socialist!  How dumb.  The only thing worse than electing a socialist in that situation, would be to reelect a socialist during a time of economic calamity. That would be insanely idiotic. Bwahaha, Bwahaha, Bwahaha, hey wait a minute …..

The Stock Market Will Fall In February 2014! (Yes, I am serious)

Smells Like 2.2%, Not 3%
 

The initial Q1 GDP growth estimate was lower than my forecast.  It smells like 2.2% rather than 3%, but to the Obama administration it just plain smells.  My estimate was high, not because of inventory, but because of a reduction in government spending. If this component had stayed constant, GDP would have been 2.8%.

Proponents of smaller government believe it is worth limiting economic growth in the short-term to free up more money for the private-sector in the long-term.  Fans of big government will complain that you are limiting important spending when the economy needs it most.  But that means you should spend more money when the economy is bad because you need to and you should spend more money when things are good because you have more money to spend.  That philosophy is how government got so bloated in the first place.

However the worst news of the GDP report is that the growth of non-residential business investment is continuing to slow.  This should be increasing in a healthy, growing, recovering, economy.  A reduction in business investment is how most recessions start.  Business investment is still increasing, but the trend is ominous.   If you looked at this statistic alone, you would expect a recession to start by the end of the year.

The weak GDP combined with very disappointing April jobs numbers and weaker retail sales means that Q2 GDP will be lower than Q1. This is consistent with my Kentucky windage reading last month.  The problem is growth is decreasing from 2.2%, not 3%.  This means GDP of 1 point something, you fill in the blank because it really doesn’t matter.  I’ll say 1.8 just for reference (or a .4 drop from wherever the revised Q1 ends up).

2012 Model T Forecast 

Last year the Model T predicted an S&P 500 Index high of 1400 for 2011.  The Index peaked in April at 1370 (around 2% lower than the target).  This year the model forecasts the 2012 peak at 1435.  The index hit 1422 (within 1% of the target) in March.

 

The Model T forecast would indicate that there is a good chance that the stock market has already hit its peak for the year or that it will do so soon, provided the current rally has one more surge.  The economy is mirroring last year, so it is logical that the stock market will do the same.  If this is true, look for the market to dip to around 1245 later in this year. 

In calculating the bottom, I am assuming there will not be a “Greek Tragedy” this summer.  I know there could be a “Spanish Disposition” or some “Italian Ice” but I have to inject some degree of optimism into this ugly post.

I do not advocate timing the market with your entire portfolio.  However, if you are thinking about buying stocks, I would wait.  If you are considering harvesting some profits, you should consider doing it now.  It may be a good time to reduce the risk in your mutual funds, IRAs and 401-Ks.

Long-Term Model T Forecast 

The original purpose of the Model T was to predict long-term peaks and valleys of the S&P 500 Index.  For the first time since I began writing this blog, the Model T is predicting the next “major” peak. The model forecasts the S&P 500 will reach 1480 in January of 2014 before the start of the next bear market.  Of course this forecast will change as the inputs to the model change, but you are getting this forecast 20 months in advance.  I’m sure that you will consider this the “Most Interesting Stock Market Prediction In The World”, so plan wisely my friends.