An eclectic approach to better trading and investing. Finding market inefficiency. Discussing and applying the best ideas and methods from several disciplines.
On a regular basis I try to take some quiet time and consider the real agenda for the individual investor. For eight years there has been a recurring theme: Fear.
The events of 2008 served to underscore the fear lesson. I have a prediction that we can check out in about ten years:
For most investors, the biggest cost of 2008 will not be their losses from that year, but from missing a lifetime of opportunity.
The Factual Background
What is happening in the world economy is a matter of objective, factual record. It has improved dramatically. The economic future via the ECRI and the objectively measured risk via the St. Louis Fed Stress Index are also available each week. I make this information readily available in a weekly article (encouraged and nurtured by my SA editor - thanks Evelyn).
In building my investment record I have found it important to avoid emotion and focus on such data. The facts show that this is a lonely position! Most others write laundry lists of "headwinds" or "tailwinds".
The Public Perception
The general public does not see this progress. The top concern for people of both political parties (71%) is the economy. This is followed by excessive worry about budget deficits (64%). Check out the lastest Gallup Poll results for the full story. While the reasons for this extreme pessimism are beyond my scope here, it partly relates to the never-ending political campaigning. There is always a full-court press against the economic policies of the incumbent.
The "man-bites-dog" media emphasis contributes. Stories about economic progress are boring and may even be labeled as naive.
The CEOs of America’s leading companies anticipate higher sales and plan to increase capital expenditures and employment over the next six months, according to the results of Business Roundtable’s first quarter 2011 CEO Economic Outlook Survey.
“With today’s survey results, the last three quarters have shown steady improvement in the CEO economic outlook. Our CEOs see momentum in the economy over the next six months, with increased demand fueling greater investment and job creation,” said Ivan G. Seidenberg, Chairman of Business Roundtable and Chairman and CEO of Verizon Communications. “This shift continues a trend as reflected in recent employment data, with the private sector leading the way in creating more jobs.”
Corporations have been cautious during the economic rebound. Inventories are thin and so is the base of employees.
There will be "mean reversion" in inventories, in employment, and in revenues. These are all important trends.
The Messengers
When I look at the gap between reality and public perceptions, it is natural to ask how this can be. In the age of the Internet we have more information than ever. Despite the information, the individual investor has not been helped.
One important source of information is the community of economic bloggers. Tomorrow I will head for the annual conference sponsored by the Kauffman Foundation. This group is a very interesting mixture of professional economists (university and institutions), journalists, entrepreneurs, and those whom I have described as "pop economists."
Here is their current take on the economy -- much more positive than the public.
I go into the conference with a long list of questions. The "investment perspective" may be under-represented in the group. Many of the items that I think are most important are of little interest to professional economists.
Even if the top pros wrote about these topics, most readers would not believe them. I'll give an example in my conclusion.
Kauffman's point man on the conference, Tim Kane, has graciously shared the survey data for some additional analysis. To my surprise, there is little difference between the two groups I have described as "blogging economists" and "economic bloggers" despite the obvious self-identification at the meeting. This is something that I need to reexamine in my observations.
Investment Implications
I have a long list of economic topics where public perceptions are inaccurate. I will have this list in mind. Meanwhile, here is one great example.
There is a current obsession with the imminent end to QE II. Pundits who have been consistently wrong about the economic rebound, Europe, banks, corporate profits, and assorted other issues, have ascribed any progress to this relatively modest Fed program.
Since they were wrong about the cause, they are going to be wrong about the effect. I was especially impressed by the savvy discussion from Josh Brown, one of our featured sources who is getting well-deserved recognition, in yesterday's interview on Fast Money.
This is a good "heads up" for investors. Don't obsess about the Fed. Watch the data.
I am working on some specific stock ideas, but quite frankly, my current holdings are doing very well. The biggest challenge for most investors was not getting scared out by a small decline accompanied by big news.
Meanwhile, I am going to identify some good themes at the Kauffman Conference. I'll post something if I have time.
World tensions continue to mount. Economic data were soft, yet the market rallied. How can this be?
There are many skeptics of the most hated rally in history. Conspiracy theories abound. Anyone who is not a regular, loyal, and convinced reader has missed this rally. If they remained on board (judging from emails and calls) they bailed out at the wrong time last week.
Why have so many been so wrong for so long? How can the market rally in the face of so many worries?
My own answer is a simple one: Stocks are attractively priced relative to other assets. On a risk/reward basis the value is better than it was at the market bottom. The general pressure from the really big money is to the upside. In the last few months I published two articles showing this -- one from a big-time private wealth fund manager and another from the most successful hedge fund manager.
Some newbie hedge fund types are in denial, looking for political or economic conspiracies to explain their poor analysis. This pop econ approach has grown like Facebook, but it does not mean that the information and analysis is reliable. Last week I demonstrated that the bond pundits were dangerous for investors. The list of misinformation and disinformation is so long that it is hard to fight. The widely cited Bill Gross commentary about funding the US debt did not even mention the daily trading ($550 billion) in Treasury securities. And this does not include the deep and liquid futures market. It is a big and self-serving scare, as I pointed out.
How does this relate to stocks?
Here is the explanation from Bill Miller of Legg Mason (same name as my dad, but no relation):
Regular readers of "A Dash" may remember that I offered the same analysis early last December. You could have made 7% in a few months from that article, pointing out that the risk/reward was better than the market bottom. The analysis is still correct. While the market has rallied, so have earnings.
Most observers foolishly focus on absolute prices instead of a dynamic system of earnings, interest rates, economic prospects, and risk.
Let's turn to our regular weekly review, but I shall return to the investment prospects in my conclusion.
Background on "Weighing the Week Ahead"
There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.
In most of my articles I build a careful case for each point. My purpose here is different. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but some will disagree. That is what makes a market!
Last Week's Data
I wrote last week that the upcoming data were less important than world events. The economic news was rather poor overall, but let's look at the full picture.
The Good
To keep perspective, we should note that most major economic indicators remain in positive territory. There is growing recognition that the economic rally now has a self-sustaining character.
Initial jobless claims remained lower, at 382K, consistent with the gradual trend.
Gallup's job creation poll looks better, but don't get carried away. 83% still see this as a poor time to look for a quality job.
Q410 GDP was revised upward and relied less on inventory building.
Stocks showed a good tone, shrugging off the many worries.
The Bad
The bad news centered on housing and Japan.
Economic growth forecasts weakened. The ECRI Weekly Leading Index fell slightly, to 129.3. The growth index pulled back from the peak, 7.1% to 6.5%. These are still good readings, but everyone is watching the indicator closely.
Risk as measured by the St. Louis Fed Stress Index, remains very low. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to +.155, a bit higher than last week's +.006. I am putting this in the "bad" category since it has moved higher, but these are completely normal readings for a scale measured in standard deviations from the norm. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now. The scale is in standard deviations, so anything short of 1.0 or so is neutral territory. I am doing more extensive research on this indicator.
Various other economic reports. Check out some sources that I follow every week. Steve Hansen has a detailed analysis of each release and other news as well. Even New Deal Democrat was downbeat on last week's data.
NB: The ECRI and SLFSI are actually readings from week-old data.
The Ugly
New Home Sales plunged to a seasonally adjusted annual rate of 250K. New homes cannot compete on the market against distressed properties.
The OldProf's NCAA Brackets. Gone, all gone. Worst year in a decade. Too many black swans.
The Continuing Uncertainty
I think I was on target with last week's comment on this front:
There is a tension in US foreign policy as it relates to revolts against dictators. On the one hand, we applaud the outbreak of democracy around the world. On the other, we note that this movement has the potential to topple both friends and foes. While I have my own opinions about foreign policy, my mission at "A Dash" is to discern the investment implications.
I see an ad hoc policy, lacking a consistent guiding principle. How else can one explain intervention in Libya and a sideline stance in Bahrain?
The turmoil has created a premium in oil prices of $15/barrel or so. Depending upon events in the region, that premium might move either way, but the bias seems higher.
There was a little less uncertainty last week on the Japan front. The human toll is mounting; the economic cost is better defined. Some production is coming back online. Companies are finding alternatives to supply chain issues. We still will not know the full economic consequences for weeks or months.
The Middle East North Africa story continues, with a new threat mentioned each week.
Our Own Forecast
We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned much more cautious. We are continuing our neutral posture in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. This is based on the near-zero ratings for the various index ETFs, which do not at this time suggest selling short. Here is what we see:
Only 29% of our 56 ETF's have a positive rating, down from 45% last week, a continuing trend.
95% of our 56 sectors are in our "penalty box," up from 86% last week. This is an indication of very high short-term risk.
Our universe has a median strength of -23, down from -11 last week, also a negative trend.
The overall picture continued to deteriorate last week. We reduced positions in trading accounts to 20%, holding only the single strongest sector.
[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
Events around the world will have continuing major significance.
On the data front, it is employment week. We'll get Challenger layoff data at mid-week. Did you know that more people quit their jobs than are laid off? Did you know that the economy creates over 2 million new jobs every month? If not, maybe you missed my piece on employment data.
Non-farm payrolls and unemployment will come out Friday. I usually do a preview on Wednesday, but one of my three inputs is the ISM manufacturing index. Sometimes I estimate from the Chicago Index, but even that is not out until Thursday. I will be attending the Kauffman Economic Bloggers Conference, so I might not post on Thursday or Friday.
I'll merely say that I am still not excited about net jobs gain for this week, although I expect to see a major rebound in the months ahead.
On the political front we have a continuing issue about a government shutdown. I have been following this closely --both the polls and the political maneuvering. Leaders of both parties understand that the American people expect government operations to continue and would blame both sides equally. This provides a strong incentive to negotiate, and I expect the bargaining to avoid a shutdown. Were a shutdown to occur, it would be another huge element of uncertainty, an end to necessary payments and services, a drop in confidence, a loss of economic activity, and a major market negative.
Investment Implications
My current market viewpoint is sharply divided, depending upon the time frame.
In short-term timing I look both to my own models and also to the weekly chart show from Charles Kirk. The modest membership fee (which either defrays costs or is donated to charity) entitles you to the chart show, a wonderful organized linkfest, and access to various stock screening approaches. This week Charles discusses his current bearish stance and, as always, precisely what it would take to change his view. If only everyone did the same!
While we are not short, we are under-invested in trading accounts, and not enthusiastic about next week's data.
In long-term timing I adhere strictly to the fundamentals of year-ahead forward earnings, interest rates, economic growth prospects, and measurable risk. Concerning that last element of measurable risk, I don't mean laundry lists of worries that everyone knows about. If there is risk, it shows up in some market metrics, especially credit markets. That is why I follow the SLFSI.
I understand that many others seem to believe that the market has been rising strictly due to Fed intervention. I disagree with this conclusion, so it is on my agenda for further discussion. Meanwhile, I respect and recommend alternative viewpoints, so listen to what Charles Kirk (recently returned from complete immersion with hedge fund types) has to say as well.
The widely held outlook about employment is both dismal and bearish. The popular viewpoint is that there is almost no job creation. That people lose their jobs and remain on unemployment forever, or until benefits run out. That there is a small, stagnant, and unchanging pool of job openings.
While the employment situation remains poor, this consensus view, is so exaggerated that it can cloud our ability to understand and to forecast. This leads everyone to be too pessimistic about the prospects for economic growth and personal consumption.
Here are three important and overlooked facts from recent government reports.
Job Creation
If we could increase job creation by 10% -- just 10% -- we would make rapid progress on employment. Payroll employment growth has been just 500K over the last four months, or about 125K per month. This is only about what is needed to absorb new entrants to the labor force. What if employment growth was 350K instead? That is a level that many cite as meaningful for improvement.
An increase to a monthly gain of 350K requires only a 10% growth in job creation because the economy is already generating 2.3 million new jobs every month. By incorrectly focusing on the net change in jobs, the impression is wrongly created that we have an impossible task. This is a silly and common mistake, as is the persistence in basing percentage changes on the net change figure. The monthly change is a very volatile figure and it is small compared to the labor force. Try this comparison. If you were talking about a move in GDP from 2% to 3% you would not say that it was a 50% increase. This is the same thing. Percentages based upon changes are misleading.
The impression is that there are no jobs. Wrong! There are about 2.8 million job openings right now. That number has been pretty constant for months. Some pundits incorrectly infer that the constant number of openings means that the same jobs are standing empty, perhaps because skills are not matched to the job needs.
This is completely wrong. While there may be some structural unemployment, you cannot find evidence in the Job Openings and Labor Turnover Report. (JOLTS). In fact, the report emphasizes the dynamic nature of changing job openings. The mistake is that many observers look just at the total of job openings. The real value of this report is what it shows about the underlying change.
I'll bet you did not know that more people quit their jobs than are fired or laid off. Almost 2 million people quit last month.
Mostly we hear stories about long-term unemployment. To keep perspective, note that as of last month 57% of the unemployed were finding jobs within 26 weeks. 41% within 15 weeks.
These are still poor numbers by historical standards, but not as bad as the general impression.
I write a monthly employment preview on the Wednesday before each month's payroll employment report. I have been among the most bearish of the forecasters, but I try to keep a sense of reality.
My fellow analysts need to join me in looking more deeply into the various employment reports. The jobs picture has been very poor, but not as bad as widely thought.
Most importantly -- the key takeaway:
It would only take a modest 10% increase in job creation to improve all of the data.
Beware the bond pundits. They seem to have an agenda. It does not include profits for the average investor.
I am trying hard not to go into rant mode. Mrs. OldProf sternly instructed that I could not say "ignorant, clueless bozos." In this redacted version you get a milder story. Many widely-esteemed bond market pundits have a viewpoint that we regard as misguided, and costly to equity investors. Here is why.
The Background
Japanese investors -- government and individuals -- are major holders of US debt. The tragedy of the earthquake and tsunami will require cash for rebuilding. Some observers are highlighting this consideration and the implications for US debt. The conclusion of much of the punditry is that this will cause a collapse of the US bond market, followed by a collapse of equity markets.
The erroneous analysis of the bond market is the most blatant example of a major problem for investors. Even if you are intelligent, attentive, and focused, you will be led astray by what you see online.
Some issues require actual skill to analyze, and the Japan situation is a good example. Let us take a closer look.
The Typical Argument
Most of the talking heads on TV and the big-time blog writers cite the possible selling of US treasuries by the Japanese government and citizens as a major threat. I do not want to pick on any specific source -- there are so many candidates. The general argument is that the Japanese will be selling, China is no longer buying, and -- Woe is me! -- what will happen next? Since no one will be left to buy, the US bond market will collapse and equities will follow.
The general appeal of this argument comes from the "everyman" approach favored by most economic bloggers. This approach depends upon oversimplifying economics, transactions, and relationships.
Here are some simple facts:
The leading economic bloggers are not economists. Seeking Alpha (a great source where I am happy to contribute) ranks the top 20 in the economics category by popularity. Only two of these authors have genuine economic credentials (I am not including myself).
A typical pop economics article tells readers what they already "know." It does not educate nor inform. It treats economics as something everyone already knows from practical experience in reading the news or doing the family budget. There is nothing that needs to be learned. This serves to reinforce existing misinformation.
The pop economists treat every economic relationship as a bargain between two unitary actors. "Japan is selling. Who will buy?"
Most of the real economists do not write on the topics of greatest importance to investors.
This is a sad situation. I wish that universities would reward economists who ventured into the field of finance and investments, helping to highlight truth seeking. The upcoming Kauffman Foundation conference for economic bloggers may provide a forum for this topic.
How does this apply to Japan and the current bond market?
The Reality
The right way to analyze this problem would be to analyze the market microstructure to get a handle on demand. Supply is probably easier, since the normal trading is known and so are the Treasury auctions. The main point is that a serious analyst would use microeconomic principles to derive a demand curve. If the Japanese demand is reduced, that would shift the entire curve. Demand and supply curves would intersect at a somewhat different point, suggesting a different clearing price for US Treasuries. To do this properly requires some data and assumptions about the underlying demand and supply curves.
The analysis would include the following facts (some from a 2008 Fed paper on market microstructure):
Overall federal debt is about $14 trillion. The Japanese government holds about $700 billion and might need to liquidate about $100 billion or so. This would not occur all at once.
Daily trading volume was over $500 billion in 2007 and this did not include futures trading.
The Fed QE II program was for $600 billion over eight months. The pundits are still arguing about whether this buying reduced interest rates. Those who want to claim it was ineffective point out that rates moved higher. Many of these same people now say that the Japanese selling will cause a market meltdown.
A Simple Rule for Reading Economic Articles
Does the author understand that economics involves a distribution of demand and supply? That prices are determined at the margin? That small changes in price may imply great changes in quantity (or vice versa)?
To illustrate with the current example, the Japanese government, should it choose to sell bonds, cannot be treated like the owner of a piece of real estate -- all or nothing at a single price. The Japanese government (or citizens) will be willing to sell more bonds at a higher price, and might not sell any at a low price (choosing to raise funds in another way). The decision is a distribution, not a single, all-in transaction. It certainly does not happen at one point in time.
If you are reading an economic pundit who does not understand marginal pricing, just turn the page.
The market for US debt is deep and liquid. Small price changes draw many more bids from those using yield-based asset allocation models, a large part of the market.
I can't believe that so many clueless bozos mistaken analysts are so eagerly embraced by the media and readers. I guess nothing beats a good story.
An Afterthought
Here is a little mind game that you might enjoy. As you watch the NCAA basketball tournament, switch to an NBA game. Ask yourself if you could tell the difference between college and pros without announcers or uniforms. If you are a real fan, you would find it easy. Similarly, you could tell the difference between pro and college football by the plays and the speed of the players.
Now try it on economics articles or TV appearances. See if you can spot the real economists. If you cannot, you are probably making many poor inferences about economics.
When the stories are frightening and the news flow is fast and furious, what do you do?
Many who are traders act immediately when a headline hits the tape. Check out this daily chart from Clusterstock.
You can and should check out the news "events" that caused these moves. There were actually a few other items as well. None were placed in context, and some statements were simply wrong.
The speed of news dissemination may not be helpful. Everyone -- bloggers and major media alike -- is posting first and checking later. Tweeters make sure that the information goes viral.
The week had many twists and turns, with plenty of chances to lose for those who took "news" at face value. In this article I will correct some inaccurate information, as well as suggest a better investing context. But first, let me do the regular review of last week's news.
Background on "Weighing the Week Ahead"
There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.
In most of my articles I build a careful case for each point. My purpose here is different. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but some will disagree. That is what makes a market!
Last Week's Data
The economic news was pretty good, but the standard data seem less important when compared to the compelling human stories in Japan and Libya.
The Good
To keep perspective, we should note that most major economic indicators remain in positive territory. There is growing recognition that the economic rally now has a self-sustaining character.
Economic growth is still improving. The ECRI Weekly Leading Index fell slightly, to 130.4. The growth index reached yet another fresh peak, 7.1%, the highest since May, 2010.
Risk as measured by the St. Louis Fed Stress Index, remains very low. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to +.006, about the same as last week's +.002. These are completely normal readings. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now. The scale is in standard deviations, so anything short of 1.0 or so is neutral territory. I am doing more extensive research on this indicator.
Initial jobless claims moved lower, to 385K, consistent with the gradual trend.
The Philly Fed Index hit a multi-decade high of 43.4. I do not place a lot of emphasis on the regional indicators, but it is wise to note that every manufacturing measure has been very strong.
Coordinated currency intervention was effective, as noted by Econbrowser. Many traders continue to underestimate the power of government.
Equity markets outside of Japan held up pretty well, considering the challenges. As we noted last week, there are multiple support levels.
NB: The ECRI and SLFSI are actually readings from week-old data.
The Bad
The bad news centered on housing and Japan.
CoreLogic issued another negative report, this time on home prices, down 5.7% from a year ago.
Building permits were down over 8% from January and over 20% from a year ago. I regard the permit series as a good leading indicator, but for those who prefer housing starts, the numbers were similar.
The Japan tsunami aftermath and nuclear threat is a continuing story of human tragedy as well as economic loss. At the time of writing, the worst case outcome-- a complete core meltdown at one or more of the reactor sites-- seems to have been avoided, although information is not yet complete.
The Military Uncertainty
There is a tension in US foreign policy as it relates to revolts against dictators. On the one hand, we applaud the outbreak of democracy around the world. On the other, we note that this movement has the potential to topple both friends and foes. While I have my own opinions about foreign policy, my mission at "A Dash" is to discern the investment implications.
I see an ad hoc policy, lacking a consistent guiding principle. How else can one explain intervention in Libya and a sideline stance in Bahrain?
The turmoil has created a premium in oil prices of $15/barrel or so. Depending upon events in the region, that premium might move either way, but the bias seems higher.
Our Own Forecast
We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned much more cautious. Several weeks ago we said it was a close call, and switched to neutral. Six weeks ago it was still close, but we shifted back to bullish in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We remained marginally bullish last week, but we have now moved to a neutral posture. This is based on the near-zero ratings for the various index ETFs, which do not suggest at time for selling short. Here is what we see:
Only 45% of our 56 ETF's have a positive rating, down from 70% last week, a continuing trend.
86% of our 56 sectors are in our "penalty box," up dramatically from 43% last week. This is an indication of very high short-term risk.
Our universe has a median strength of -11, down from +9 last week, also a negative trend.
The overall picture deteriorated dramatically last week. We reduced positions in trading accounts to 40%, holding only the strongest sectors. This has been a very close call for several weeks.
[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
There is little of importance on the economic data front. The routine numbers will be overwhelmed by news from Japan and the Middle East.
Interpreting this news will be a continuing challenge for traders.
Investment Implications
Investors with a longer time frame should be far less interested in the specifics of the news flow. I'll stand by what I wrote last week:
The ongoing theme is how investors should deal with worries. In general, there is a tendency to overreact. World events are difficult to quantify. Translating worry about Europe into the effect on, for example, tech company earnings, is quite a challenge. Many people react to the story without stopping to gauge the specific effects.
During the week I explained exactly how to deal with a crisis: Plan ahead, follow your system, measure risk (as opposed to wild speculation), and analyze each holding. Following a quantitative risk measure like the SLFSI is an important advantage: You don't need to speculate about the importance of world events.
Meanwhile, most others follow the anecdotal approach. Many prefer this because is permits maximum spinning of events.
For the next several weeks we can expect everyone who wants to ignore the obvious economic improvement to claim that every new piece of economic data is irrelevant, since it does not reflect the incipient post-Japan weakness. Meanwhile, the economic evidence suggests that the Japanese impact on world and US GDP will be minimal and might even be positive.
The nuclear fear also requires context, especially when projecting world-wide effects. Except for those in the immediate vicinity of the site, the radiation levels should be compared to those from a variety of other sources. I strongly recommend the careful analysis cited at The Big Picture, a valuable tool for interpreting news about radiation exposure. Here is another good piece from Scientific American with a brief and accurate summary.
For long-term investors we followed the cautious buying strategy at mid-week, and we will be more aggressive if support levels are holding.
Everyone is focused on the human tragedy in Japan. Hopes and prayers of all go out to those stricken. In such an environment it can be difficult to think about business and what the effects will be. Nonetheless, that is the job of the investment manager. We need to put emotion aside and think clearly about the issues.
Everyone needs a strategy for dealing with risk. It must be planned in advance. As he does so often, Barry Ritholtz has the colorful quote on the subject:
The time to look for the emergency aisles and where the exits are located is before takeoff, not after the wings fall off the plane. You must have a plan in place to deal with unanticipated events, a just-in-case things head south scenario.
Exactly. We all need to plan ahead.
Rejected Ideas
I am going to explain my own approach. Feel free to agree with whatever portion you find useful.
Let us start with what not to do. I do not approach investment with a single "fund" that is either in the market or out. I have several different programs, blended to individual needs.
In particular, I reject the idea that you should reduce stock exposure because of some rhetorical or political arguments about the market. It is better to rely on a data-based system (described here). (I also offered readers my recent report, Limiting Risk. Just write to falin at newarc dot com). Most investors, and even many pros, are overwhelmed by emotion. Bad move. The alternative?
Try to measure the impact of the crisis. Thinking about quantification forces objective reasoning and displaces emotion.
If you have a plan, developed in advance, you will be prepared for a crisis. Otherwise, emotions will prevail.
Our Approach
The most important element of our approach is to maintain confidence by limiting risk. For an investor to stay the course is a tricky problem. Everyone would like to have a system that had a short-term, top-calling orientation in market rallies. Does anyone really get this right? Most of the top-callers have been out of the market since September. And those are the good ones!
We have three elements of risk control.
We have a dynamic asset allocation(DAA) program that relies strictly upon the data. This program treats the first 10% or so as noise, but it is always on the right side of major moves. It goes short in a 2008-style situation.
We use the St. Louis Fed Stress Indicator. Instead of listing worries, we measure them. The SLFSI gave a great warning in 2008. This warning is not anticipatory, but reactive.
We use professional analysis. I watch all of the news all of the time. If there is something specific that is not reflected in our quantitative methods, I can act independently.
Let me take a closer look at that last point, the human part of management.
What I Do
When I am dealing with a crisis situation I approach the problem on three levels -- worst case, macro, and stock specific. In the current situation I have spent many hours on the research, following stories as they have appeared around the clock.beginning in the early hours of the morning. When markets are moving, the investment manager must attend to clients rather than write. Having said this, here are a few thoughts.
Worst case. We are all trying to get a read on this. When there was a sense that there might be a nuclear meltdown, the market was at the low point. As Josh Brown notes, the tendency is to overreact. The reason was that there was no good way of quantifying the impact. Various sources noted that there was no precedent, no model, for a meltdown in a populated area. When the news changed for the better, the market rallied sharply.
My conclusion: As long as the nuclear consequences avoid a meltdown (more Three Mile Island than Chernobyl) we can analyze the crisis with "normal" methods. Reaction by floor traders seemed to support this conclusion.
Macro. Everyone was trying to determine the economic effects and the global economy. While these were just educated guesses, there were some good articles.
My conclusion: The immediate GDP effect on Japan and on the world economy is likely to be minimal. This pieceat Econbrowser was typical of several that seemed to be the most authoritative. The mixture of pluses and minuses in the actual GDP tally seems counter-intutive to some, so I urge you to read the article. The long-term debt consequences could be different. Here is another good example.
Stock Specific. Careful thinking each of your individual holdings is important. Some of our stocks have done quite well (construction, health care, some energy) while others have been under pressure. One question relates to Japan's role in the supply chain. This may be especially important for some technology companies.
My conclusion: I am reviewing stocks like Apple, where products include parts from many companies. A single component in short supply could hurt sales. I am looking more favorably on companies that will be part of any reconstruction effort (CAT).
The result of the various conclusions has been moderate buying after the Fed announcement on Tuesday. The macro risk indicators have not triggered.
The Real Test for Investors
This type of crisis provides a good test for the individual investor. The actual market reaction has -- so far -- not been very significant. It is not really a test of courage or risk tolerance. If it seems so to you, I recommend one of the following steps
Reduce stock exposure and add bonds to lower portfolio drawdowns. It is important to invest at a level that is comfortable. Drawdowns of 10-15% are an expected part of the trading year for stocks. Accepting this level of risk is part of gaining superior performance.
Don't watch the news! Or at least don't think about stocks while watching. Leave the worry to someone else if you want to get personally involved.
The famous investment gurus always advise being fearful when others are greedy and vice versa. This attitude is easier to talk about than to implement in practice, especially with a constant flow of scary images on TV.
The secret sauce in our risk control measures is not what they save in down markets. It comes from the confidence to stay involved in up markets.
Are you still invested in the market, but with one foot out the door?
Viewed another way, how can you join in the rally while keeping a close eye on risk?
There is a popular sense that the market is overdue for a correction. Many others feel that a collection of "headwinds" means that stock investors face an inflection point. This is a story that has been told for two years, with poor results. I maintain that you need some objective, data-based indicators to stay on the right side of the market. I wrote about the importance of system last week. (Upon request, we will also send my recent investor report on how I limit portfolio risk).
My weekly review of the market will look at some differing perspectives on this theme, but let us first do our regular review of last week's news.
Background on "Weighing the Week Ahead"
There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.
In most of my articles I build a careful case for each point. My purpose here is different. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but some will disagree. That is what makes a market!
Last Week's Data
Last week the economic news was pretty good. This week we saw the opposite. The non-economic stories were even worse.
The Good
To keep perspective, we should note that most major economic indicators remain in positive territory. There is growing recognition that the economic rally now has a self-sustaining character.
Economic growth is still improving. The ECRI Weekly Leading Index moved higher, to 130.8. The growth index reached another fresh peak, 6.7%. Both figures were the highest since May, 2010.
Risk as measured by the St. Louis Fed Stress Index, remains very low. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to +.004, about the same as +.03 from last week. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now. The scale is in standard deviations, so anything short of 1.0 or so is neutral territory. I am doing more extensive research on this indicator.
Federal Budget Compromise. There is still no federal spending agreement, and all signs are that there will be another extension. I realize that most people interpret this as "Congress is not doing its job." The problem comes in criticizing an institution, rather than the participants. Depending upon your viewpoint, you might think that either Democrats or Republicans should be caving in. If you really want to understand something about this aspect of policymaking, check out my article on "strategic postponement"and thanks to aerospace engineer reader "KK" for the terminology suggestion.
Energy prices, still high with threats intact, moved a touch lower on the week.
Investor sentiment(a contrarian indicator) is lower. The Bespoke Investment Group reports, "At a current level of 35.98%, bullish sentiment based on AAII's poll is at its lowest level since September 2nd, which was more than 200 S&P 500 points ago!" Check out the great chart that we all expect from the BIG team. This is a short-term indicator, but it got a lot of play from the bearish punditry a few weeks ago. My guess is that none of these sources will mention the decline. I don't find this measure of sentiment to be very important. It is much less significant than the attitude of pension fund managers, and it does not take much to get a big change.
These are all interesting indicators, but the ECRI and SLFSI are actually readings from week-old data. There was plenty of bad news last week.
The Bad
The bad news seemed to come every day and from all fronts.
Initial jobless claims. The weekly number barely kept the "three handle" but this noisy series is still not where we need to see it for net job growth.
University of Michigan Sentiment was bad -- very bad. I regard this as an important indicator, since it helps to capture job creation. I have a feeling that the poor numbers were a reflection of the spike in fuel prices. I need to consider a fuel price component for my employment model, I guess. In the absence of further information, I see a fall in Michigan sentiment as negative for employment and for the economy. I like Doug Short's analysis of this indicator, so check out his fine charts.
European debt downgrades. A downgrade of Spain is more worrisome than Greece.
The trade deficit spiked higher by $ 6.1 billion to $46.3 billion. This series is a challenge for most to interpret. Dean Baker, in an excellent interview with Talking Biz News, states the following:
My personal favorite is the identity that net national savings is equal to the current account surplus. This means that a country, like the United States, that is running large trade deficits MUST have negative net national savings. In other words, as long as we have a large trade deficit, we must have either very low private savings, a large budget deficit, or some combination. There is no way around this fact.
Economists can dispute the direction of causation (i.e. does the trade deficit lead to low savings or do low savings lead to the trade deficit), but the relationship is not in dispute. Nor is the mechanism in adjustment. In a system of floating exchange rates, like the one we have, the adjustment for eliminating a trade deficit is through a lower value of the currency (i.e. the dollar).
While no serious economist could dispute this point, my guess is that less than 1 percent of the listeners to NPR or the readers of the New York Times understand this. That speaks to an incredible failure of economic reporting.
The interview has plenty of similar wisdom. If you want to understand why most of the standard news you read is misleading, this is an article for you.
The Ugly
The earthquake and the tsunami, with the most important effects on Japan, were the dominant news for the week. The loss of life is most important, but there is also significant damage to infrastructure and property. Some are citing the stringent Japanese building codes as the reason that damage was not even worse.
While we all share a heartfelt reaction for the Japanese people, when you go back to work you realize that the picture for stocks is more mixed. Some are already looking for stocks to buy. Investors have learned that many natural disasters have led to the need for rebuilding. How bad is the news?
My concern is the continuing nuclear threat. As I write this (on Saturday night) there is news of a partial meltdown in one of the reactors affected by the quake. If this story is seen as a negative for nuclear power, there could be additional pressure on energy prices from fossil fuels. I do not want to put too fine a point on this, since the reactor is an old one and the circumstances very unusual, but dramatic events change political opinion.
This bears careful watching.
In most other weeks the events in Libya would win the "ugly" award and we would be carefully watching the rest of the Middle East. There is plenty to worry about. In Libya we must combine the human and the economic issues.
I have consistently recommended watching Prof. James Hamilton's analysis of oil prices and the economy. This week he notes that we should not expect the Saudi's to step in with more production.
An increase of a million barrels per day in Saudi production relative to reported November levels, some of which may have in fact already been implemented, would put them back up to where they were in July of 2008. If all of Libyan production gets knocked out, we'd need 1.8 mb/d to replace it. If the Saudis weren't able or willing to go above those production levels in 2008 when oil was selling for over $140 a barrel, why would you expect them to do so now with West Texas only at $106?
It is becoming clear that we must adjust to a higher base level of energy prices, with the corresponding impact on stocks and the economy. Read the entire article to get a full analysis with helpful charts.
Our Own Forecast
We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned more cautious. Several weeks ago we said it was a close call, and switched to neutral. Five weeks ago it was still close, but we shifted back to bullish in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We remained bullish this week, but there was some debate among the staff. The indicators are just mildly positive. Here is what we see:
70% of our 56 ETF's have a positive rating, down from 79% last week, a continuing trend.
43% of our 56 sectors are in our "penalty box," about the same as last week (45%). This is still an indication of significant short-term risk.
Our universe has a median strength of only +9, down from +14 last week, also a negative trend.
The overall picture remains slightly bullish. We are fully invested in trading accounts since there are several strong sectors, but we are watching the indicators quite carefully. This has been a very close call for several weeks.
[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
There are a number of minor reports this week, but here is what I will be watching.
Energy prices! Like everyone else. We are now all students of the politics of the Middle East.
Japan -- for many reasons.
Initial jobless claims. Let us see where things stabilize.
The FOMC decision will not surprise, nor do I expect anything from the language.
Housing data will include building permits, which I find interesting. Unless the Philly Fed is another big surprise, it will have little impact, and I do not care about the "leading" economic indicators.
College basketball -- especially the resurgent young Wolverines. This is the month when TV's on trading floors switch from (the muted) CNBC feed.
Investment Implications
The ongoing theme is how investors should deal with worries. In general, there is a tendency to overreact. World events are difficult to quantify. Translating worry about Europe into the effect on, for example, tech company earnings, is quite a challenge. Many people react to the story without stopping to gauge the specific effects. Here are some helpful ideas.
Quantifying worries. Cullen Roche has an interesting "wall of worry" measure which uses several major sentiment indicators. He notes that there is still an ample supply of well-known worries. This is the fuel for the market.
Reacting to short-term news is "gambling, not investing" according to Josh Brown. I was also interviewed for this article by Nancy Miller (no relation) who took the refreshing approach of questioning like an intelligent but open-minded investor. She was well aware of current fears, but interested in getting to the right answers. The result of her professional approach is a nice article citing several prominent colleagues who are cool heads in a time of turmoil. I mentioned several areas where we are currently buying.
The technical aspects are the topic for Charles Kirk's weekly chart show. Charles is neutral on the market, and describes carefully what might lead to a breakout in either direction. He sees support at various levels in a correction. Most interestingly, he does not see anything really negative in the individual charts of many companies that he follows. I was reminded of our own market inferences drawn from the analysis of many sectors. Watch the show for yourself to get the entire benefit.
With so many important news stories, the issues and opportunities can change quickly. For the moment, we are marginally bullish for trading accounts and cautiously shopping in several sectors where we see great value.
I was very nervous. Despite earning my PhD at 27, advising high-level government officials, testifying before government committees, and frequent public speaking to large groups, this was a bit different. I was actually spending money -- a lot of it!
Under firm instructions. I said, "Buy two grand Beam at a quarter."
There was a brief pause, since the guy on the other end was hearing a new voice for the first time. After a beat he repeated "two grand Beam at a quarter."
A few minutes later the phone rang. I answered and heard the report, "Filled at a quarter."
That was it. A few words in a few seconds. And that is how I bought almost a quarter of a million dollars worth of stock on my first trade. I did it without knowing the guy on the other end of the line, and he did not know me.
I was a little nervous about all of this, but it was part of the initiation. Everyone in the office had to be able to make stock trades to adjust our option positions. Even the new guy might have to take action. We had a general schedule of position adjustments and some standing orders. The stock desk knew our line, and soon learned my voice. There were no formal introductions.
I remember, in my first few weeks, feeling that it was like piloting a jet plane. When everyone else was gone, and I was alone in the office, sitting in front of the screen, I was the (inexperienced) pilot. What if I had to do something?
After some time, that changed. We were all expected to learn, and to learn quickly.
Translation
The translation of the call? "Beam" was the shorthand for IBM. Everyone knew this. Most of the stocks had shorthand names. The market in IBM (we always thought of markets, not prices) was 119 3/8 - 1/2. That meant that people were bidding 119 3/8 and the stock was offered at 119 1/2. If you wanted to buy "two grand Beam at a quarter" this meant that you were 119 1/4 bid for 2000 shares. You were expected to know the "handle" and no one ever actually said it. If you did, you were a real rookie!
If the boss called in and asked where Beam was trading, the correct answer was something like "119 3/8 - 1/2, 15 by 20" which meant 1500 shares bid and 2000 offered. Pros wanted to know the market, not just the last trade. You had to learn how to give a report.
There were never any mistakes on stock trades. Never. Everyone was a professional, sharing a shorthand language that saved time. Every day the filled trades squared with what we expected, hundreds and hundreds of times.
I don't recommend trying this with your broker at (name deleted).
Epilogue
A year or so after this first order, and after many other exchanges that followed, my group was out for a drink on a Friday night. I thought I heard a familiar voice, and he thought the same. That was how I finally met the clerk on our stock desk.
Tadas Viskanta, ...(Y)ou have to have a system that gets you in and out of the market based upon your own signals and not pay attention to what other people are saying.
I could not agree more! The quotation is from today's screencast at Abnormal Returns, a brief video that I watch and enjoy every day. The cited text comes at the 2:10 mark or so, but you should really watch the whole thing. The links are also informative and fun.
[Regular readers of Abnormal Returns will notice that I have shamelessly ripped off their daily introduction to let Tadas have a turn at being the source of the "quote of the day."]
Inspiration
Like Tadas, I am not a big fan of round numbers or anniversaries, but his screencast inspired me to compare today's market with what we saw two years ago. I have done a few pieces like this in the past, but this was an occasion to be more systematic and to spend a few hours doing additional research.
The table below shows a summary of the method that I use to "have a system" and to ignore the noise. It combines value, future prospects, and risk.
There is room for improvement, but it helps me stay on the right side of the market.
I am going to discuss each of the categories in turn. The result, a doubling in stock prices, is what we seek to explain. Let me explain the other factors.
Value
There is something about discussing market valuation that generates passionate responses. Regular readers of "A Dash" know that I have provided solid evidence that the bottoms up projections by analysts are the best predictor of next year's earnings. I have a continuing invitation to those advocating alternative methods to provide any evidence. [Here is the article where I discussed the misinterpretation of the widely-cited McKinsey study.] So far I have no takers. This is something to keep in mind the next time you read someone assert, without evidence, that analysts are "too bullish."
Everyone who picks stocks looks ahead, starting with what they expect the earnings to be. The sum of this individual analysis of stocks is reflected in the valuation of the market. Who knows? If Ben Graham had lived in the era of sell-side analysts he might have improved his backward-looking method of forecasting earnings. My guess is that he would have employed the best available information, had it been available.
In the table above I have also provided data for those who (mistakenly) prefer to look at past earnings instead of looking ahead. I have also added interest rate comparisons.
The forward P/E for the market is now 13.5 compared to 10.8 in 2009. The trailing P/E comparison is even worse -- 15.8 instead of 10.3.
Many pundits thoughtlessly cite average P/E multiples without regard to interest rates. Since every major pension fund manager has a daily choice between stocks and bonds, the comparison is of obvious necessity.
The table shows two interest rate comparisons -- the rate for investment-grade corporate bonds and the ten-year treasury note. The former provides a comparison for those willing to take the risk of corporate failures and the latter an indicator of perceived risk in the system.
By this measure, stocks are 20% undervalued now and were only 12% undervalued in 2009. Another way of looking at this is that investors in corporate bonds have also done very well in the last two years.
The valuation disparity is quite different when compared to the ten-year note. The stock risk premium is still 100%. This is large by historical standards, but only half of what it was in 2009.
Future Prospects
The stock market is not a futures contract on GDP. Having said this, the prospects for the economy are the biggest single input for expected earnings. There is a real challenge in finding forward looking economic indicators. The Economic Cycle Research Institute has a good record and a widely followed forecast.
In 2009 their Weekly Leading Index was a meager 105.5 and the growth index a negative 23.7. Today the WLI is at 105.5 and the Growth Index a postive 6.5. While the ECRI does not look ahead more than six months or so, the economic prospects look good. This is confirmed by other professional economic surveys.
The economic future looks much better than it did in 2009.
Risk
I evaluate risk using the St. Louis Fed Stress Index. This method is objective and market-based. If a doomsday pundit is telling you to worry, and the concern is not reflected in any of the 18 factors in the SLFSI, I recommend choosing the data over the anecdotes.
In 2009 the SLFSI was at 3.88. This is measured in standard deviations, so it was a true black swan. The chance of this happening is about 0.5%. An intersting comparison is the maximum stress from the prior 90 days, which I show in the change in the level. The prior high was at a 3/1000 percent extreme.
The current readings are quite normal -- very close to the middle of the distribution with a mild decline from the high in the last three months.
The future also looks less risky than it did in 2009.
Investment Conclusion
The overall conclusion from this analysis is pretty clear. This is a better time to invest than it was two years ago. The valuation is a little lower, but the risk is much, much lower. Risk-adjusted return is our goal.
I realize that most readers will disagree with this conclusion, but that is only because they already know what happened to an investment in 2009, and they are skeptical about the future.
Many would also have been skeptical in 2009. This is the challenge of looking ahead. Investors need an objective, data-based method for cutting through the noise.
You might want to consider my Value+Economy+Risk approach. I write about this method nearly every week in my "Weighing the Week Ahead" series. I also have a risk-adjusted program for clients, where I pay special attention to what might go wrong. You can do the same at home by following the indicators I have outlined..
One More Thought
One more factor that I cite is the need for a list of widely publicized worries. Most investors are big losers because they react to market "headwinds" by selling. The gradual meeting of worries has been the story of the last two years. We continue to have a long list of worries, highlighted every day. When this is no longer true, it will be a warning of a market top.
As compelling evidence the Abnormal Returns article provides a link to an entertaining article on Clusterstock, reviewing the bearish punditry of the last two years. As you read through the past predictions, you might well notice that most of those cited are offering the same advice now as they did then. A little research will show that they are often hailed as "early" predictors of the financial crisis, which means they were bearish as early as 2005 or so....
What better evidence can there be for the quote of the day?
One of my missions at "A Dash" is to find unpopular themes that have investment significance and value. Often this means challenging the accuracy of the most recent "Wall Street Truthiness."
There is a dangerous idea making the rounds, the notion that delay is inherently bad. Adherents of this viewpoint are winning the sound bite war with "extend and pretend" and "kick the can down the road." (The latter has been barred in our household by Mrs. OldProf because of flagrantly excessive overuse. Since she proofreads this work, you will know what happened if text is replaced with a series of xxxx's). Using these phrases seems to have the effect of trying to end discussion.
To me it seems more like an impatient toddler insisting, "I want this! I want it right now!"
Let me try to explain why delay can be a good thing. I wish that I had a sexier or more alliterative term than the pedantic "constructive postponement," but that is the best I can do right now. Nominations welcome.
Meanwhile, try to focus on the concept and the merits rather than the slogans and terminology.
Delay Can Work for Advocates
A long-established principle in the public policy literature is how to behave when you are losing. Decades ago E.E. Schattschneider endorsed the strategy of expanding the scope of conflict. If you are losing in the current arena, change it! Move to a higher court, involve a higher level of government, or attract more partisans to your side.
There are hundreds of examples of this strategy. Since this is mostly unknown to current market participants, they see this as something unfair or illegitimate. Wrong! It is how groups compete in a pluralistic society. The misunderstanding distorts how people view the policymaking process and it leads to investment mistakes.
Here are two recent examples. I have no allegiance to the advocates in either case. They are just good illustrations of effective advocacy.
ObamaCare. The GOP was about to lose a key vote in the Senate. They engaged in every possible delay and filibuster, hoping against hope that something good would happen to change the odds. The Massachusetts Senate election for Ted Kennedy's seat was the answer. While a version of national health care was still passed, the one-vote shift in the partisan alignment had an important influence on the resulting policy, perhaps dooming the public option.
Wisconsin Senate. The Democrats in Wisconsin were about to lose. The loss would not relate merely to the current budget, but a crippling -- and perhaps permanent -- loss of collective bargaining power for public employee unions. Taking advantage of the quorum rule in the Senate, Democrats have left the state. They basically have nothing to lose. They hope to marshal support for their side and to negotiate a better deal. We are waiting to see the outcome of this one.
Delay Can be Wise for All
Here are some easy examples of when delay is (or might have been) wise.
The surgeon recommends shrinking the tumor before operating.
You decide to make sure of your current job situation before buying a new house.
President Bush delays attacking Iraq to get a little more evidence about weapons of mass destruction.
You negotiate a new repayment schedule of loans to reflect your changed employment status.
You decide to do some graduate study instead of taking a job that you do not really like.
You decide to travel abroad for a year, delaying your college studies.
You delay an investment in a local business, waiting for more clarity about conditions.
You postpone your plan to quit smoking until you are through a period of stress.
In most of these cases an aggressive adovcate for the "other side" could invoke slogans.
Current Applications
Once again, there are many current policy questions where delay is an issue. I'll stick to two cases.
Addressing the federal budget deficit. The consensus is to worry about this more when the economy is stronger. President Obama is compromising on this viewpoint in a reaction to political necessity. Despite this, the real heavy lifting on the deficit issue will be delayed.
Fed interest rate policy and QE II. The Fed is on record concerning the weight of their concerns (the economy), the expectation for inflation (not much), and the plan for future policy (low rates for an extended period). Investors are free to disagree with this viewpoint -- at their peril.
Summary
There is nothing wrong with delaying tough medicine until the time is right. There are many pundits who loudly proclaim what THEY would do if in office. In practice, these people, if actually elected, are soon referred to as the "former" Congressman.
Actually representing people and making important decisions has a galvanizing effect that you do not feel until you are there. I never got around to a review of Hank Paulson's book, On the Brink. I really enjoyed this book and learned several important things. It is now added to our recommended reading, especially for those who want to learn details about policy making during the crisis.
The most important, by far, is that Paulson and Bush were both willing to take actions completely at odds with their ideology when they thought the economic stakes were high enough.
Secondary points include the following:
Paulson scrapped the plan to price toxic assets long before it was revealed to the public. This was important to many of us.
President Bush granted a wide range of authority to Paulson. Even a charitable reading suggests that he made seat-of-the pants decisions about valuing Bear Stearns and the government role on Lehman that vastly exceeded what might be expected for an appointed official.
What is not there -- a discussion of currency values when visiting China.
And some little stuff about interactions with Gov. Palin, Sen. McCain, and the future President.
I recommend reading this book regardless of your political persuasion. It is the perfect counterpoint for today's article. It shows when delay is not feasible.
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