Archive for November, 2012

So This Is Compromise?

Friday, November 30th, 2012

“We are both heading for the cliff.  Who jumps first is the Chicken.”

                                                                                                      – Rebel Without A Cause

Post-election, both Democrats and Republicans have promised to compromise and avoid the fiscal cliff.

So what would you consider a compromise?  A little tax increase, perhaps, along with some spending cuts, then call it a day?  That’s not happening.

Apparently, by “compromise,” they mean not giving an inch.  With the end of the year just a month away, both parties seem to be digging in and playing a game of chicken.

President Obama doubled down by calling for a $1.6 trillion tax increase – twice the increase that will take place if no action is taken and we go over the fiscal cliff.  Media has focused on a couple of Republicans who have said that they will break their pledge of no tax increase … but mostly there has been talk and no concrete plan for avoiding the fiscal cliff.

Remember the scene in “Rebel Without a Cause,” where two cars race toward a cliff and the first driver to jump out of the car is “the Chicken?”  The winner went over the cliff and died in a fireball as his car slammed into the ground.

Real life is resembling that 1955 film, but this time when the car goes over the cliff we will all be along for the ride.

Looking Over the Fiscal Cliff

Tuesday, November 27th, 2012

You’ve heard plenty about the fiscal cliff.  But little attention has been paid to what’s beyond it.

What’s beyond it is another higher, steeper cliff.

The federal debt now exceeds $16 trillion and Congress will need to vote shortly to raise the debt ceiling in order to keep the government operating.  We’re running an annual budget deficit exceeding $1 trillion, so the debt will only get higher.

The longer we try to maintain the status quo, the more difficult it will be to bring the debt back in line.  We’re reaching the point where every dollar in the federal budget will be needed just to service our debt.  That means your taxes will no longer go toward building new highways, helping the poor or protecting the United States.  They will be needed to pay off the enormous debt that the President and Congress have incurred.

The only way to keep the government functioning under those circumstances, even if we cut spending and raise taxes, will be to incur more debt.

The bigger issue, though, is the unfunded liabilities from government entitlement programs.  According to The Wall Street Journal, we have already incurred $86.8 trillion in liabilities for Medicare, Social Security and future retirement benefits for federal employees.  If we could freeze time and incur no further liabilities, we would still need to pay out $86.8 trillion.

Both Medicare and Social Security are “pay as you go” systems.  As baby boomers retire, payment for these two entitlements will come from those who are still in the workforce.  As they are a much smaller population than the baby boomer generation, they will need to pay more or both Medicare and Social Security will collapse.

But how much more will be needed?  A commentary in The Wall Street Journal, “Why $16 Trillion Only Hints at the True U.S. Debt,” includes the following glum assessment:

“When the accrued expenses of the government’s entitlement programs are counted, it becomes clear that to collect enough tax revenue just to avoid going deeper into debt would require over $8 trillion in tax collections annually.  That is the total of the average annual accrued liabilities of just the two largest entitlement programs, plus the annual cash deficit.

“Nothing like that $8 trillion amount is available for the IRS to target. According to the most recent tax data, all individuals filing tax returns in America and earning more than $66,193 per year have a total adjusted gross income of $5.1 trillion. In 2006, when corporate taxable income peaked before the recession, all corporations in the U.S. had total income for tax purposes of $1.6 trillion. That comes to $6.7 trillion available to tax from these individuals and corporations under existing tax laws.

“In short, if the government confiscated the entire adjusted gross income of these American taxpayers, plus all of the corporate taxable income in the year before the recession, it wouldn’t be nearly enough to fund the over $8 trillion per year in the growth of U.S. liabilities.”

It’s A Correction for Nasdaq, Russell Indexes

Friday, November 16th, 2012

Stock markets have become increasingly bearish since the election.

With the fiscal cliff approaching, and little confidence that Democrats and Republicans will agree on a solution to avoid it, the Nasdaq Composite Index, which includes many technology stocks, and the small-stock Russell 2000 Index are now in correction territory.

A bear market takes place when the market drops 20% or more.  A correction takes place when the market drops 10% or more.  Both indexes are down more than 10% since reaching highs in mid-September.

As The Federal Reserve Board’s quantitative easing drove investors to put money in riskier assets, both indexes soared earlier this year.  Since the third round of quantitative easing (QE3) began, though, both indexes have been heading down.

While Republicans agreed immediately after the election to accept some increase in taxes, President Obama has said that he will seek $1.6 trillion in tax increases, which is twice what he previously suggested and is far off what Republicans are willing to accept.

In addition to being driven down by the fiscal cliff, markets are being depressed by continuing turmoil in Europe, and the economic slowdown and change in leadership in China.


Until recently, markets were heading up, driven higher by quantitative easing programs in Europe, as well as the U.S.

Noting that quantitative easing was no longer having a positive impact on the markets and that, in fact, the market spikes it caused were starting to ebb, we shared the following chart with clients in our monthly letter.

The “Draghi Spike” refers to European Central Bank (ECB) President Mario Draghi.  The “FOMC Spike” refers to the U.S. Federal Open Market Committee, led by Fed Chairman Ben Bernanke.

The S&P 500 is now within striking distance of the low end of the Draghi spike, at which point any gains from the latest rounds of quantitative easing will have been erased.

This outcome is no surprise.  As with government stimulus spending, the positive impact of quantitative easing is temporary.  In addition, each successive round becomes less effective than the previous round.

It wouldn’t matter if quantitative easing had no other impact, except to boost the stock market, but that’s not the case.  It also encourages risky investment and can cause new problems, such as inflation.

And it really does nothing to heal a sick economy.  It’s like drinking alcohol to relieve stress.  It hides the problem, rather than addressing it.

The latest quantitative easing program was supposed to help ease unemployment.  That seems not to have happened.

Neither stimulus spending nor quantitative easing have had much of an impact on the economy.  So what do we do now?

The Good News: No More Election Ads

Friday, November 9th, 2012

In the wake of Tuesday’s re-election of President Obama, the Dow Jones Industrial Average fell 434 points in two days, a drop of 3.3%.

That’s better than when he was first elected.  After a 305-point rally on Election Day 2008, the DJIA fell 486 points, or more than 5%, on the day after, which was the largest post-election drop ever.

In 2008, the housing bubble had burst and we were dealing with the biggest financial crisis since The Great Depression.  Today, we still have not recovered from the financial crisis, but face a “fiscal cliff” and continuing troubles in Europe.

The fiscal cliff, which combines $800 billion in tax increases and government spending cuts, has investors spooked for many reasons.  Unless action is taken:

  • Corporate dividends will be taxed like earned income, increasing the tax from 15% to a top rate of 39.6%.
  • The Affordable Care Act adds a 3.8% on investments, so the tax on dividends could nearly triple overnight.
  • The top tax rate on capital gains will increase from 15% to 20%.
  • Income taxes and estate taxes would also increase, and many more Americans would be subject to the alternative minimum tax (AMT).
  • The re-election of President Obama, who favors tax increases, makes it more likely that the increases will take place.
  • With Republicans controlling the House and Democrats controlling the Senate, Congress is divided and it will be difficult to reach an agreement that would avoid or reduce the impact of the fiscal cliff.

Of course, there’s plenty of time between now and the end of the year to deal with the issue.  But Congress will be on holiday for much of the time between now and the end of the year.

Meanwhile, in Europe

While Europe’s sovereign debt crisis received little attention during the busy election season, it’s not because the crisis has abated.

Once again, Greece is the little country that can’t, as it increasingly appears that “the Greek ‘austerity’ vote was merely theater,” as Zerohedge put it.  The resulting news in Europe this week is that European finance ministers may delay approval of the next bailout payment for Greece from November 16 to late November, when they will hear a full report on Greece’s compliance (or lack thereof) with the terms of the bailout.

The unveiling of the Outright Monetary Transactions (OMT) program in September by the European Central Bank (ECB) boosted market confidence that Europe was doing something about its problems.  But, like America’s ongoing quantitative easing, Europe’s OMT won’t eliminate economic problems.  Lower interest rates just make it less expensive to keep borrowing more and more money.

Maybe that’s why economic confidence in Europe has sunk to a three-year low.

So the economic misery continues, but at least we won’t have to see or hear any more election ads.

WOW! Manufacturing Index Up 0.2%!

Friday, November 2nd, 2012

“Been down so long, it looks like up to me.”

Furry Lewis

This is what passes as positive economic news these days: The Institute for Supply Management’s (ISM) reported Thursday that its index of purchasing managers edged up to 51.7% from 51.5% in September.

Wow!  A whole 0.2% gain!

Yet it was positive enough to send the Dow Jones Industrial Average up 1% (136.16 points) yesterday, in the last Thursday before the Presidential election.

It was the biggest gain since the latest round of quantitative easing (QE3) was announced on Sept. 13, 2012 – but it doesn’t erase the market drop that has taken place since then.

The gain in the ISM index is up from a three-year-low of 49.6% in August and it’s better than the 50.5% index projected by economists in a MarketWatch survey.

But put the figure in perspective.  Any number above 50% signals expansion, while a number below 50% means contraction.  Whether the number is 51.7%, 50.5% or 49.6%, it signals that the economy is standing still.  Statistics have a margin of error, which renders a gain or a loss of 0.2% meaningless.

Let’s assume, though, that the trend is upward.  After all, ISM’s new order index, which is based on future sales, moved up from 52.3% to 54.2%.  If the growth rate for September continues, after five months, the index could reach 51%!

That’s about as exciting as the 2.1% growth in gross domestic product (GDP) that we reported last week.

Economic Data Doesn’t Create Jobs

Speaking of meaningless statistical changes, the bigger news, reported today, is that the unemployment rate ticked back up to 7.9% from 7.8%.

Just last month, the U.S. Bureau of Labor Statistics, amid a great deal of skepticism, announced that the unemployment rate had fallen below 8% for the first time in nearly four years.  So much for positive trends.

Many even viewed the latest data as positive news, as 171,000 new jobs were added in October, which is higher than the expected 125,000 new jobs.  Regardless, there are not enough new jobs being created to make a dent in the unemployment rate.

As with the ISM index, it doesn’t matter much whether the jobless rate is 7.9%, 8.1% or 7.8% — especially given that it counts part-time workers as being fully employed and doesn’t include people who have given up looking for work.

The take away from this is that too many people have been out of work for a long, long time, and that stimulus programs, monetary policy and other government efforts have done little to change that.