Quacera's Market Radar

The Budget Proposal

As written, the White house proposed $3.8 Trillion 2013 budget admits to a deficit of $1.3 Trillion, so revenues are expected to be $2.5 Trillion. If it goes through, our national checking account will be overdrawn by 34%. The proposal assumes that the Treasury will collect $150 Billion extra by increasing taxes on the wealthy & ending some of the perquisites in the Tax code. Of our current deficit, $454 Billion is interest as of year end 2011. Under the proposal, interest payments will rise to $491 Billion in fiscal 2013. This level of interest payments has only been accomplished because the Fed has kept rates at levels not seen since right after WWII: Zero at the short end; less than 2% on the 10 year Treasury’s & 3.11% for 30 year money. The Fed has already said it will not raise rates until at least 2014. As of 2011, we have a total Government debt of $15.536 Trillion putting our national interest rate at 2.92%. The new budget will raise the debt to $16.836 Trillion. We have a dilemma often seen before but rarely regarded as worrying by governments: If the stimulus policies, designed to heal the wreckage of successive government financed booms-turned-to-bust of the past 20 years, finally do work, rates will have to rise. If the policies fail, the economy will limp along with an ever increasing debt burden and even if current rates stay where they are and deficits continue to grow at the proposed $900 Billion per year, the 2.92% rate will increase the interest alone by roughly $26 billion per year. Assuming the numbers presented by the White House actually come true, we will have interest payments of more than $500 Billion in 2013 and should the world decide that - as with the PIIGS, Iran, Iceland etc. - our debt is too risky, they will stop buying our bonds and rates will rise. If rates rise just to the long term average of 6.67% on the 10 year, we could see interest costs above $1.1 Trillion. Making matters worse, our average T bond matures in about 3 years, so about $8 Trillion will have to find new lenders within 6 years. This is a trap of our own making & getting out of it will not be without tears.

Sources: U.S. Dept. of Treasury; Federal Reserve; babylontoday.com

Popular Delusions

 

We know what does not work. Governments that promise what they can never deliver, fail. Those promised benefits become the rallying point for both sides of the fiscal argument. Governments cannot create real economic growth, jobs or wealth by fiat. It takes hard work which doesn’t always succeed and politicians can never deliver on promises that they can eliminate work, thrift & risk by “enlightened” policy. The deception that economic success is achievable by reducing everything to mathematical equations that are then formulated into law is losing its power due to its own inevitable failure. Debt deflations are the result of debt created wealth and cannot be stopped by anything other than the reduction of prices to a clearing level. Force, as applied by the Fed, ECU, U.S. Treasury, Bank of Japan, etc. using schemes that involve money printing or debt induction only serve to slow the price clearing mechanism. Marching in the streets doesn’t work any better unless the marchers can bring about the reversal of the policies that have slowed the process. Usually however, street marchers bring about an unwanted change which only worsens the situation. As a reference see: The French revolution or the Weimar Republic.

 

Seasonally Adjusted toTaste.

 Since 1939, the average "seasonal adjustment" used by the BLS has been

104.9 %The number reported would have been 205,000 less (84% less) if the BLS had used the

average seasonal adjustment factor for all January’s since 1939. It’s just statistics!

Lies, Damn Lies and Statistics & the Friday Employment Report

BY: Glenn Holderreed  www. quacera.com glenn@quacera.com

“There are three kinds of lies, lies, damn lies and statistics “ a quote attributed by Mark Twain to British Prime Minister Benjamin Disraeli although subsequent research failed to find it in any of Disraeli’s works. So, while the authenticity of the quote is questionable the sense certainly applies to Friday’s Employment Report issued by the Bureau of Labor Statistics, wildly cheered as proof the U.S. economy is enjoying a sustained recovery.

Well, maybe, but there is some controversy; it may not be a lie, or a damn lie, but it certainly is statistics.

Note: according to the “not seasonally adjusted” data in December there were 132,962,000 people receiving some kind of paycheck while in January there were only 130,263,000 on the payroll. Seems a bit bleak, but not so! According to the “seasonally adjusted” data 132,166,000 employed in December jumps to 132,409,000 by the end of January, and increase of 243,000. This is all statistically proper. January layoffs from the holiday season were below normal so the statisticians show that as an employment gain. It wasn’t as bad as usual so it must be better than expected. Of course, there may not have been as many holiday employees added in December so the layoffs would be low, but that will come out in a revision, which no one will see. Statistics! Still, those 243,000 statistical souls are not collecting real paychecks. No matter how you look at it there are approximately 2.7 million fewer individuals receiving wages at the end of January than there were in December. But the statisticians are pleased, Wall Street is elated, and the mainstream media is thrilled; the mythical seasonal soul may not be real but he/she/it is statistically significant. Finding them at the mall, or the auto dealers may be a bit tough as they seem to fit the official definition of “poltergeist.” A poltergeist is a paranormal phenomenon which consists of events alluding to the manifestation of an imperceptible entity. So there we have it: The increase is poltergeist employees, which are also much cheaper than the regular skin and bones type and everyone is happy. Mark Twain may have lied about Disraeli but they both seemed to understand something about the relationship of statistics to reality. http://www.bls.gov/news.release/empsit.t17.htm

[In thousands]

ESTABLISHMENT DATA
Table B-1. Employees on nonfarm payrolls by industry sector and selected industry detail

Industry	Not seasonally adjusted				Seasonally adjusted
	Jan. 2011	Nov. 2011	Dec. 2011(p)	Jan. 2012(p)	Jan. 2011	Nov. 2011	Dec. 2011(p)	Jan. 2012(p)	Change from: Dec.2011 - Jan.2012(p)
Total nonfarm	128,327	133,172	132,952	130,263	130,456	131,963	132,166	132,409	243

New Virus

 

Apparently Economic Illiteracy is catching. For the past 5 or so years, getting a ticket to see a Phillies game in Philadelphia has been nearly impossible. Not so in Washington DC where its team, the Nats, have been doing poorly and where the stadium remains largely empty during most home games. Since Philly is less that a two hour drive from DC, Philly fans make the journey any time their team plays there. Now, according to the Washington Post, the management of the Nationals has decided to ban Philadelphia fans in what they are calling a ‘Take Back the Park’ campaign. This means that if you buy your tickets with a credit card it has to be registered in Maryland, DC or Virginia otherwise they will refuse to sell it to you. This not only smells illegal under the plethora of "rights” laws we live with but eerily, also rhymes with the kind of thinking that emanates from the rest of the seat of government and has put us into the financial condition in which we find ourselves. The proximity and similarity of this kind of loopy economic thinking is too close to excuse. We may be on the verge of a medical discovery that, if  proven, will explain much about what happens to seemingly normal people who wind up working in the Capitol

The Frog In Boiling Water

It has been demonstrated that when put into water that is slowly heated, a frog can adjust its body temperature so that even if the water reaches boiling the creature will not recognize it and die rather than hop out. We are not sure that all frogs would fail to remove themselves but as this Youtube link demonstrates there is something that happens to make it impervious to ever increasing heat: http://www.youtube.com/watch?v=svpsLZDgFK4

Our reason for bringing this up is that we believe the investing & even the non-investing voters are being gradually & systematically anesthetized to the risks and consequences of Fed & Treasury policies. Beginning in our experience with the inflation & stagflation of the 1970s, these well intentioned plans for income redistribution and economic control have given us failed wage & price controls, inflation in the teens followed by huge increases in interest rates, several major recessions, investment bubbles in commodities, stocks & real estate; collapsing S&Ls & major banks, auto company bailouts and not a few wars. Each episode has reached a point where our salvation arrives in the form of some government intervention that includes de-facto devaluation of the currency that lowers the value of labor & savings in the name of propping up the status quo. We have become used to it and as we all know, the more pain or inconvenience we suffer the more we ignore it & adjust our behavior to divert attention and assets in a positive direction. We generally – most of us – understand the possible consequences but the longer we go without having to deal with those the less likely we think they will come about. Unfortunately, like the outcome for our Mr. Frog, the water will boil and those who haven’t extricated themselves in time will suffer the same fate as previous generations who were anesthetized to the economic significance of government folly.

Timing & Value

We use value along with our QPM Radar™ technical analysis. Value stocks & bonds protect portfolios better than growth but can sit dead for years or become even more valuable. To manage a portfolio for clients who expect good returns it is not enough to say 'well, we own value and you will see how it works out sooner or later'. Technical analysis can define when the market decides that your value discovery is valid. So do your homework, be patient and invest when the rest of the world sees what you already know.

Missing the Target

"Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!" The Red Queen to Alice in “Through the Looking Glass” by Lewis Carroll.

 In his press conference this week, our Ben stated that the Fed is considering adding an Inflation Target of up to 4% to its to-do list. He extolled the virtues of this concept in a book he wrote, “Inflation Targeting: Lessons from the International Experience.”,(Princeton University Press, 1999). Despite the fact that such targets have been abject failures in the ECU & U.K. and appear to act like over-confidence builders causing greater risk taking, the helicopter pilot in Chief thinks this would be a great idea to further drain the bank accounts of the citizenry. Leaving interest rates at zero for what seems like an indefinite period hasn’t worked especially if you’re retired and living on your principal. Now he wants to subject you to a competition with him to see if you can keep home & hearth together while he runs up your living costs.

Why we developed QPM Radar™

The IMF on Tuesday released its forecast for economic growth in 2012. It expects the world economies to grow by 3.3% and the U.S. at the same 1.8% as we did in 2011. These predictions are subject to constant revision but if the IMF is correct and the historical ratio of S&P 500 earnings growth equaling 4 time GDP holds, the 1.8% figure equates to S&P earnings of $106, up from the $99 in 2011. The long term average S&P Price to Earnings ratio is about 15.8 times and if achieved would put the S&P at 1675. To compound matters, historical market volatility averages 20% per year and applying that figure to the 1257.60 close in 2011 we can expect a range of 1000 to 1500. This all presumes no major economic upheavals or unexpected surprises.

Among the known risks we see for the year are:

• Iran currency collapse leading to a mid-east war
• U.S Budget deficits and debt issues
• European bank defaults causing
• World-wide recession
• China hard landing

The positives could include:

• Real Estate prices bottoming
• Euro chaos leading to a strong dollar & equity prices
• Decreasing unemployment
• Lower oil prices
• Congress & the President agreeing to a budget & fiscal restraint
• China soft-landing

While we don’t see inflation as a 2012 issue, it could occur unexpectedly due to any number of confidence crushing events or a combination thereof causing a bond sell off that forces rates up. A run on the dollar could push oil & commodity prices up and dramatically increase the deficit as well as destroy any positive economic conditions. This could then lead to a major downturn in stock prices. Lows in the past century were always at P/E ratios under 10 times earnings. The lows of 1919-21, 1932-34, 1938, 1942, 1949, 1974 & 1982 all occurred between a 4.78 & 10 P/E. If we assume this happens here at 7.5X, we see the risk down to 800 on the S&P 500.

Given this range of possibilities, we prefer to allow stock prices & momentum to give us a better sense of direction. Like a GPS device can pinpoint where you are and tell you how to get where you want to go, QPM Radar™ provides a clearer roadmap for the investment portfolio decisions we have to make on behalf of our clients. We use standard valuation techniques to arrive at what we want to invest in but we also patiently wait for our technical system to determine when we act on them.

Iran

 

The danger is mounting as the world puts the economic squeeze on the thugs running Iran. The EU ministers seem not to be displaying their normal dither as they are expected to turn the screws even tighter on Monday by banning Iranian oil purchases. Already the Riyal is collapsing and if this proposed sanction actually takes place the death of the currency is all but certain. The government is currently printing Riyal bank notes so fast its prices are changing by the hour. Gold and – the irony of it all – U235 prices have soared. How the regime will react is probably too predictable and it will not be positive. Our markets might become even more volatile if this ends in a military explosion.