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!

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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)

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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.   

 

Dr. Hope and Joe Economy

The Setting: A few years ago Joe Economy was very sick.  He had ingested toxic assets and suffered a painful bubble burst.  His physician Dr. Bushwack had not done a very good job attending to Joe but now Joe had a new doctor, Dr. Hope, who promised Joe’s family that he would soon return Joe to good health.

Nurse: Doctor, the patient doesn’t look so good.

Dr. Hope:  That’s not a problem.  I am Dr. Hope and I am here to change things!

Nurse:  So you’ve treated many patients like Joe before?

Dr. Hope: Actually Joe is the first patient I’ve ever dealt with, but how difficult can it be? In addition, I did sleep in a big, white, mansion last night.

Joe: Help me, Dr. Hope

Dr. Hope:  The problem is that you are just laying there, Joe.  We need to get you up off the bed and get you stimulated!  Now get over here and grab this shovel and look as if you are about to dig a hole.

Joe: How is this going to help?

Dr. Hope:  If people see you digging holes, then they will start digging holes and then they will load and dump dirt all over the place and you will get better.  That is my aspiration!

Joe: I don’t think you know your aspiration from a hole in the ground, but I will give it a try.

Dr. Hope: See, it’s good being stimulated. Isn’t it?

Joe: I still don’t feel so good. I think I better lie back down. Oh no.

Nurse: The patient has just dumped a load in his britches. What should I do now?

Dr. Hope: Change!

Nurse: Dr. Hope, your patient isn’t getting better.

Dr. Hope: Oh no, he’s not my patient; he is Dr. Bushwack’s patient. And it’s DR. Bushwack’s fault that Joe’s not getting any better.  Dr. Bushwack was a terrible doctor and the failure of any of my actions will be and will ever continue to be, Dr. Bushwack’s fault.

Joe: Help me Dr. Hope.

Dr. Hope:  What you need to do now Joe is to go get your clunker of a car, drive it to the car dealership and trade it in for a brand-new.

Joe:  But my car isn’t a clunker and I don’t have the money for a new one. I don’t think this is going to work.

Dr. Hope: No problem Joe, here’s a stack of cash to help buy the new car. When people see everybody buying cars, this will motivate them to buy more stuff. And when they buy more stuff, you are going to start to feel great.

Joe:  Okay I bought the car and that was fun, but I don’t feel so good now. Oh no.

Nurse: Joe just cashed some clunkers in his shorts.  What should I do?

Dr. Hope: Change!

Nurse: Your patient, I mean Dr. Bushwack’s patient, still looks very weak.  What now doctor?

Dr. Hope: Joe, get up over here and hold this solar panel.

Joe: Why?

Dr. Hope:  It will show people that you are working in a green job.  Green jobs are great because they put people to work and stop global warming.

Joe:  Okay, I’ll hold this thing, but you do realize it’s cloudy today and this thing isn’t going to provide much energy.

Dr. Hope: Nurse, shine some lights on Joe so it looks like it’s sunny.

Joe:  This seems a bit like an artificial stimulus.

Dr. Hope: Just keep smiling and go green Joe.  Here’s another truckload of greenbacks to create even more green jobs.

Joe: I still not feeling so hot. Oh no.

Nurse: Your patient, I mean the patient, has just created some global warming in his pants and it looks like he’s gone green! What now?

Dr. Hope: Change!

After all his actions failed to improve the health of the patient, Dr. Hope stopped trying to stimulate the patient. Joe, now with rest and the proper medication, began to heal naturally.  He started to feel better on his own, his recovery had begun.  He got up from his bed and started to slowly move forward.

Joe:  I’m feeling better now.  It’s time for me go.

Dr. Hope: Look! My patient is healed! My recovery plan worked!

Joe: Whatever. I think I’ll just be moving along now.

Dr. Hope: Let me give my patient a big hug.

Joe: Please keep your *$!% hands off of me!

And at this Joe started moving ahead even faster.

Dr. Hope: Look at him go! I’m an excellent doctor after all!

Smells Like 3% To Me

At the beginning of the year many economists said that economic growth would be weaker in Q1, 2012.  Q4, 2011 GDP came in at 3%, but much of the increase was attributed to a build-up of inventory that was not expected to be repeated the next quarter.  Few other reasons were given for the slowdown.

My expert economic panel forecast Q1 GDP to be 1.9% in January and adjusted it up slightly to 2.1 in the March forecast.  I never really bought into a lower number based on inventory changes alone.  The Q4 inventory build-up was a reaction to inventories being much too low in Q3.  They were too low because sales were much better than expected. (A good thing!).  Then businesses added to stocks in Q4 in anticipation of even higher sales (Another good thing!).  In a growing economy, I do not believe inventory increases are a bad thing, I think it is a good thing.

So if the base is 3% growth, what did the economic indicators say in the recently completed Q1? :

→ The ISM manufacturing index remained in the “growth range” each month and indicated no slowdown in production.

→ The Bloomberg Consumer Comfort Index is currently at its highest since March 2008 (very early in the Great Recession).  The Gallup survey confirms consumer confidence is growing.

→ The Chicago Fed National Activity Index (CFNAI) shows the economy growing at just above a 3% clip.

→ The ECRI Weekly Index (measures leading economic indicators on a weekly basis) is at its highest point since last August.  The government’s index of leading economic indicators also predicts continued growth.

→ Retail sales continued to grow, up 1.1% in February and preliminary March numbers are very positive.

→ Auto sales were described as “robust” by one analyst with sales much higher than last year.

→ Housing probably bottomed out in Q1 (my call).  Regardless, housing is turning from a drag on economic growth to a very small positive. This transition had to help the economy in Q1.

→ The job market keeps growing and the unemployment rate keeps falling.

→ The inventory-to-shipments ratio remained stable through the quarter which means businesses did not over-stock in Q4 and steadier growth has occurred in the last six months.

The Analysis

It is difficult to believe that the economy slowed down at all in Q1.  With all the positive news, you can make a strong argument that it improved over the previous quarter.  However you do have to factor in the negatives of high unemployment, rising gas prices and weak housing data.  Be careful when reading economic commentaries due to the political biases in an election year.  The President’s critics will make things sound worse than they really are and his proponents will spin things the other way.

I’m not an economist, so I am not going to get out my calculator and calculate Q1 inventories.  What I will do is apply what my friend Mark refers to as “Kentucky Windage” and my friend Terry calls “putting his fingers in the air”.  And if I stick my nose in the air, it smells like a Q1 GDP growth rate of 3%.  Which means the economy was somewhat stronger in Q1, with some negative inventory effect.  And while the economy could smell sweeter, it smells much better than the noxious fumes of the last few years.                                                                                      

The Forecast

It did appear that the economy was stronger in January and February than in March.  Last month job growth slowed, the stock market retreated and gas prices rose.  Gas prices will rise more in Q2 due to the switch over to the more expensive summer blends.  If the increase in price follows historical patterns, average gas prices (as reported by the government) will peak around $4.90 a gallon.  I believe this will indeed slow economic grow, but it will not stop it.  Using the same KWM (Kentucky Windage Method), let's shoot for a 2.6% GDP for Q2.

Note: “Kentucky Windage” is a term related to marksmanship, not college basketball.  It is incorrect to say: “Kentucky had much windage at the 2012 NCAA Basketball Tournament.”

Don’t Let Curtis Mismanage Your Money

Last time we looked at macroeconomic fundamentals, now it’s time to review some personal investment fundamentals. These are basic and you’ve heard them all before, but a friendly reminder never hurts.  The great thing about these principles is they apply to investment professionals managing multi-million dollar funds or someone who is just trying to handle his 401-K.

Number One: Diversify Your Investments

The important idea here is to spread your risk of making a bad decision.  Risk is your enemy, so your need to minimize it.  Even a brilliant investor makes mistakes, so we need for those mistakes to have minor impact.
 

My grandfather Tom had savings accounts at all six major banks in his city. He did this because he had lost money in the Great Depression due to bank failures.  This was his diversification strategy in case another depression occurred.

As a practical example, here is how I have increased diversification in the GeoDon Fund (the portfolio I inherited from my grandfather George):

      ·       Increased the number of stocks from 20 to 27.

·       Diversified within the energy sector of the fund by having stocks in petroleum, natural gas, propane, uranium and a utility.

·       Put an investment dollar limit on any new stock added to the fund, just in case I pick a dog.

When investing in mutual funds:

·       Make sure your mutual funds aren’t investing in the same type of securities.  For example, if you own three “large-cap” funds, you really aren’t diversified.

·       Your 401-K should be divided among at least three different mutual funds.  If your program doesn’t have three good funds, it is time to utilize a self-directed option.

And regarding minimizing mistakes:  My worst investment of 2008 was buying bonds from the Bank of Greece (You can start laughing now).  Why did I do this?  The bonds were paying a whopping 9% and of course a country like Greece was not going to go broke! (You can laugh even harder now).  The important thing is that I bought three other more stable bonds at the time, so my Greek bond investment was small and of course it was soon to get much smaller.  But diversification limited the loss in my big, Greek, investment screw up.

Number Two: Review Your Investments Periodically

Three years ago I worked with my financial advisor to restructure my wife’s IRA.  We selected seven strong mutual funds that were consistent with the strategy for the account.  I did not have time to review this account since then because of all the other financial decisions I had to make. I realized there was a problem in January when the account showed 0% growth for 2011.  Based on the investments, the account should have grown in the 3-6% range.

These were good funds three years ago, but not now.  Most of the funds had new managers who were not as skilled as the previous ones.   The account was diversified, but it was diversified among a group of lousy funds.   I moved the money to better mutual funds and it was like feeding a starving man.  The account immediately jumped to life and is now showing much improved results.

It is always a red flag when a strong performing mutual fund changes managers.  The investment firm will tell you that the fund strategy and philosophy will not change and they expect the fund to continue to produce excellent results blah, blah, blah. But if you are not careful, your fund could end up being managed by Curtis Painter.

Who is Curtis Painter?  He is the guy who replaced Peyton Manning as the quarterback of the Indianapolis Colts last season.  Curtis wore the same uniform, played in the same stadium, ran the same plays, but somehow did not achieve the same results as Peyton. The chances of the new fund manager being as good as the previous fund manager of a very successful mutual fund are very low. You should watch these funds closely and be ready to bail at the first sign of trouble.

Number Three: Manage Your Risk and Return

Everyone complains about the low interest rates paid on current certificates of deposits.  It is hardly worth tying up your money to receive a rate under 1%.  I believe the rules of risk and return still apply, but the problem is that the world has become a much more risky place. 

Therefore to gain a larger return, you will need to assume more risk.  To get the same 3-6% returns that you previously got with CD’s, you can invest is short-term bond funds.  Of course there is more risk because your principle is not insured.  Some good funds in this category are FGCIX, WBRRX, LALDX.  I do not own these funds, but I do own BAGSX and PSTCX which should provide slightly higher returns, with of course higher risk.  However to my knowledge, none of these funds has investments in the Bank of Greece.

Picking the Losers Instead of the Winners

In my last post I speculated that if the economy grew modestly, but adhered more to fundamental economic principles, that it might be beneficial to us in the long run. There are several economic “fundamentals” that we need to get back to after many years of wild, ravenous, living.  Let’s look at some:

1.    Investment Capital Should Flow As To Maximize the Best Long-Term Gains

One of the enduring, damaging, effects of the housing bust is the misallocation of capital.  So much money flowed into the housing industry that other emerging industries suffered.  These industries should have been getting more capital and growing faster. The industries would be larger and stronger now and be creating more jobs.

In addition, people went to work in the construction and mortgage industries because that’s where the money was.  It would have been much better if people would have been learning (by working in) or training for the jobs needed in our current and future economy.  Freddie the House Flipper was raking in big bucks, but house flipping is a very specialized skill that is only valuable under unique circumstances.  Now Freddie has lost his money and may not have the education and skills necessary to find a good job in this economy.

2.    The Government Should Concentrate On Just Being the Government

It is not the role of the government to save companies by buying them.  The government should have managed the bankruptcy of General Motors to provide stability, but the government is supposed to be the “referee” of the economy.  You can’t be the referee and play in the game at the same time.  The Obama administration blatantly picks the winners in the game.  Examples include green energy companies, the Chevy Volt (okay maybe it picks losers instead) and the waivers given to select companies regarding the new healthcare laws.  The government is supposed to try to “level the playing field” not change the rules to benefit voting constituencies. The market should determine the winners and losers not the government.

Also, the government is supposed to be the “watchdog” so crises like the housing bust never happen.  But the bankers and housing industry threw the watchdogs some juicy T-bone steaks and the Washington fat cats were too busy stuffing their faces to growl, let alone bark.  With the loosening of mortgage rules the government not only didn’t halt the crash, they helped create it. It also failed to stop Bernie Madoff’s Ponzi scheme even when it was alerted about it several years prior to the collapse.  The government did a horrible job regulating commerce in the aughts (00’s). 

3.    The Government Should Regulate – Not Punish

The government’s response to the housing bust is to punishment the banks, not truly regulate them.  The new financial reforms that some people are so proud of end up punishing the innocent banks that followed the rules and did not exploit sub-prime loans. 

The government needs to tighten and improve its regulation processes.  When you punish the banking industry, you punish the employees, you punish the stockholders and you punish the innocent banks.  It’s like when your grade school teacher got so upset that she punished the whole class for the bad behavior of one student.  Some of the bad banks are finally getting punished.  There should also be specific penalties for specific people at specific banks.  This will increase future accountability for executive decisions.

4.    Everyone Who Earns An Income Should Pay Income Tax

Low wage earners should pay very little tax, but everyone should pay something.  Everyone should know how it feels to have the government’s hand in your pocket. This is part of the principle of shared sacrifice.  This unites us, not divides us. We are not a healthy, free-market, democracy if a large percentage of people pay no income tax.

5.    The Government Is Not A Sugar Daddy

The more the government helps some people, the more these people learn to become dependent on the government.  In many cases it would be better if the government “helped” people by helping them find jobs through training, etc. instead of just handing out free stuff.  There is a limit to how much assistance the government should provide and we have crossed that line a long time ago.  Now we have a significant percentage of the population dependent on the government for their needs.

This entitlement mindset is getting way out of hand.   Last week it was reported that a recent $1 million winner of the Michigan Lottery was caught receiving food stamps.  This has happened in Michigan before, however what made this noteworthy was the woman’s response.  She was in no way remorseful. She argued that she was in fact entitled to the food stamps because “she was not working and has bills to pay”.   These bills included mortgage payments on her two houses. 

The Chevy Volt

Is The Economy Recovery A “Slam Dunk”?

Déjà Vu All Over Again

Almost all the experts have agreed that an economic recovery has begun. Now the discussion is on how weak or strong the recovery is and if it will last. Many descriptions of the current recovery include the words: slow, modest and sluggish.

But it is a recovery. Last year at this time the economy also had shown some strength but then financial troubles in Europe, unrest in the Middle East and high gas prices derailed the train. It’s a good thing we don’t have to worry about any of those things this year. What? ….. Hey, wait a minute.

Yes those stupid, irresponsible, Greeks. For years their government overspent to the point that they were actually spending and ran up huge deficits. The politicians kept providing larger and larger benefits and entitlements to keep the people happy and ensure they would stay in power. They are definitely not as smart as we are because we ….. whoops, moving on….

Then you have the situation in Iran. We don’t want them to have nuclear bombs because they will use them to threaten their enemies to get what they want. Of course we are threatening them with our military might until they do what we want. Obviously Iranian nuclear bombs are a bad thing, but again it seems a bit hypocritical.

Last month President Obama basically said we have all the petroleum we need so we have no need for a new pipeline that would provide more oil from Canada.  This month he is very concerned that gas prices are too high and is going to do everything possible to bring them down.  Of course basic economics says that an increase in supply (FROM A NEW PIPELINE IN CANADA PERHAPS) would create lower prices.  Idiots will argue that the pipeline will not lower prices now, but if you don’t like paying more for gas in the present, why would you want to pay even more in the future?  We have just hit the “Hypocrite Trifecta”.

A Weighted-Down Economy

 

The economy is growing but is being weighted down by a weak housing market, high unemployment, consumer and business caution, a still healing financial system, and new regulations.  The housing market was overstimulated for years and is just starting its recovery (I predicted a February recovery months ago).  There remains a significant structural unemployment issue that requires funding for worker training and a stable housing market so more people can move to where the jobs are.  Everyone is still cautious due to the whole economic and world situation. The credit markets are healing slowly.  And the new regulations due to the Healthcare Act and other mandates are causing uncertainty and barriers that hinder growth.

The fact that the economy is still growing at around a 2% rate with all these obstacles is really a testament to how strong and resilient the U.S. Economy really is.  If there was nothing weighing it down, I think current economic growth would be in the 5-7% range.

So I think this economy is running with ankle weights. Athletes wear ankle weights to strengthen their legs while walking and performing everyday activities.  I wore them as a teenager, probably because I thought it was a cool thing to do.  Looking back on this I initially thought that it was a huge waste of time and appeared very foolish since I never became much of an athlete.  (My old ankle weights are pictured here.  The fact that I still have them qualifies me to appear on the TV show "Hoarders")

However, on second thought there was one athletic feat that I did accomplish that is impressive. I could dunk a basketball.  I am 6’ 3” tall, however although I was not fat, I was “big-boned”. So it took some serious strength to lift this thick body that high off the ground, but this white man could jump.  In addition, my knees are unusually strong.  So I have to guess that wearing the ankle weights did provide a benefit.

My New Theory

And considering the benefits of wearing ankle weights leads me to a new theory:  Maybe the economy will be stronger in the long run because it is still moving forward despite significant obstacles.  A slow recovery might be better than a fast recovery if the economy gets “restructured” in the right way.  This may set the foundation for solid long-term growth.

Think of it this way, we drove our car too fast and recklessly and drove it right into the ditch.  Things got bent and parts were damaged.  Now you could haul it out of the ditch, jump back in the car and drive it on down the highway.  Or you could take the time to repair the damage and replace the parts before starting up again.

The U.S. economy is still incredibly resilient. If we can make through the new obstacles and get better policy decisions from our government, it will be time to “slam dunk” again.