A Dash of Insight

The Definitive Investors' Guide to the Mid-Term Elections

Regular readers of "A Dash" know that I spent the early part of my career teaching public policy to a wide range of students -- undergraduates, PhD candidates, and career professionals seeking the MPA degree.  The effect of elections on future policy direction was a staple of these courses.

When I became a consultant to trading firms, and later an investment manager, the analysis of changes in policy helped give us an edge in finding the best stock sectors.  The key to being a good consultant and advisor is easy to state and very difficult to follow:

1. Put your personal opinions aside;
2. Analyze what will happen -- at least in terms of probabilities;
3. Analyze the likely consequences; and finally
4. Look for stocks that will benefit.

Many of the popular investment sources are so focused on their own opinions that the investment angle is lost.  Here at "A Dash" we urge political agnosticism -- you should seek to profit in your investments no matter who is in power.

With that in mind, here is how we see the election.

The Prognosis

I watch the regular sources, but also some that do not get much play in financial media.  There is a general agreement that the GOP will take control of the House and make major gains in the Senate, falling short of a majority.  There are plenty of pollsters.  Some are retained by news organizations and some by each party.  In my own forecasting, here are the sources I rate most highly:

• University of Virginia Prof Larry J. Sabato.  His "Crystal Ball" site has been the most accurate source of forecasts for many years.  For some reason, it has not gotten the visibility in the investment community.  I love the "bottoms-up" approach, emphasizing careful analysis of each race.  Sabato was the first to predict a big GOP result.  His forecast has not changed very much.  It is close to the consensus, but he was there first.  You can see the details here.  He sees a GOP pickup of 55 House votes and 8 in the Senate.
• The Hill.  They did a special poll focusing on the key districts.  This eliminates a lot of what is basically irrelevant.  You can see there results here.
• FiveThirtyEight does a great job.  I like this site because it proves that a disciplined approach to research methods leads to good results.  If you can do it with baseball, you can do it with elections.  The methods are the same.  Are there other issues?  Probably, but it is an open field on interpretation.  Here is the final projection.
• The Intrade markets are especially interesting.  This site represents a "wisdom of crowds" synthesis of all of the other information.  The questions reflect the number of seats to switch in the House as well as control of the Senate.  Take a look. The prediction markets predict a slightly better picture for the GOP in the Senate.

Anyone who follows these sources will have a significant information advantage over the average investor.  

What to Watch

Drawing upon the various sources, what should investors be looking for tomorrow night?  The crucial question is whether the GOP can gain control of the Senate.  The sources all see the GOP coming up a vote or two short.  Could the GOP result be better?  Professor Sabato tells you which races to follow:

We believe the GOP will hold all its open seats (FL, KY, MO, NH, OH). This is quite an accomplishment in itself, since the early assumption was that at least a couple would switch sides. In addition, Republicans will probably pick up most of the following: AR, CO, IL, IN, NV, ND, PA, and WI. The closest appear to be CO, IL, NV, and PA. These races, especially the first three, are so tight that a strong breeze could change the result, so the GOP may well come up one or two short in this category. By the way, if Republicans do win the +8 we have projected, then they only have to unexpectedly pick off two of the following states to take control: CA, CT, WA, or WV. CT seems least likely, WA most likely–but any of the foursome would be an upset.

The Perception

There have been many stories suggesting that "Gridlock is good" or "Gridlock is less profitable than control."  Many of these prey upon a general anti-politican feeling.  Let us hope to immobilize Washington!

In fact, the situation is quite different.  The country needs some cooperation so that the Bush era tax cuts do not expire, and the inheritance tax is re-established at a reasonable level.  Gridlock would not be good for the economy or the budget deficit.

The general perception is simplistic and incorrect.

The Reality

Here are the key elements of reality.

There will be no major legislative changes, especially no repeal of health care reform.  This is really pretty simple.  The US political process has a huge status quo bias.  With Obama Care now a matter of political reality, the provisions are not easily changed.  The President can veto any effort at repeal.

We can expect a GOP House to pass repeal measures, but that will simply be a political gesture without effect.

The real consequences of GOP control are important, but more subtle.

First, there is the power to control House committees.  This means that the GOP will control committee staff, be able to launch investigations, and be able to issue subpeonas.  This is really important, since it can keep Administration appointees on the defensive.  Here is a list of the Obama officials most worried about a GOP takeover of the House.

The Effect

The most important effect will be two years of negotiation and compromise.  I would like to be more specific, but this is a story that will play out over time.  There are many variables, including how the GOP will react to the new "tea party" representaion.

I will make two "fearless forecasts."

First, I predict significant legislative compromise.

There is bipartisan interest in fixing the tax problems.  The Bush-era cuts will be extended and the inheritance tax modified.

Most people do not realize how GOP opposition shaped the Obama legislation.  Sixty votes were needed in the Senate, and compromise weighed heavily on getting the last two votes.  This is still in play.

Second, I see a new emphasis on Congressional oversight.  Policies that are already a matter of law, like health care, still require specific regulatory language.  Most people do not realize this, but it is an important part of the process.

Investment Implications

This is not a story requiring an immediate reaction on election night, partly because it has been anticipated by the market.  If it plays out as I suggest here, there is plenty of time to profit.

My initial ideas relate to health care (less restrictive in regulations, more profitablity for health sector firms), financials (less aggressive regulatory treatment), and drillers (easier rules).

Since the implications are not obvious to most, there is still plenty of time to buy.

[Full disclosure:  We own GS, NE, and WLP.  We are shopping for other names in these sectors.]

How President Obama Can Help Housing -- Right Now!

The two biggest economic challenges are employment and housing.  Furthermore, they are related.  Weak employment increases foreclosures.  Weak housing decreases aggregate demand and reduces net employment.

There is a cycle here -- an interaction between these two problems.

Obama Policies Miss the Target

Here at "A Dash" we try to remain objective about public poicy and the outcomes.  Not everything works as expected.  It is best not to be doctrinatire in your evaluation.

Briefly put, I am not a critic that will find error in anything and everything President Obama does -- just as I was not such a critic of President Bush.  My concerns are specific and well-grounded.

Mistakes

As the President changes his economic team, here are some key points to keep in mind:

1. There have been too many voices.  The original team lacked direction.  Even if Obama is expert at identifying and drawing out viewpoints (as Warren Buffett maintains), that was not the task here.  This was not a "single-issue" problem like the Cuban Missile Crisis.  There are many dimensions.
2. It is not just a matter of political or economic philosophy.  Even if a Keyensian stimulation was correct, that is a temporary solution.
3. There has been a disconnect between political types, trying to identify jobs saved or created on a website, and real economists.  The most important job effects can only be identified through macro-economic modeling.  This is not the way to win elections.
4. The transition delay -- the wrong people, questionable credentials, and a delay in everything that needed to be done.
5. Excessive emphasis on "macro" solutions.

 

No one won a Nobel Prize for analyzing the 2008 economic problems.

The people opining on this topic supported various theories that were not on point for the specific problems of the day. (I am not interested in a vaguely political/philosophical position about overall debt).

What Now?

The President has -- so far -- missed an opportunity for cheap, non-political policies that would have a big effect.  Here are two key facts:

• The role of government should be to facilitate the effective operation of private markets.

• There is a huge current appetite for securities with a good yield and moderate risk.

 

What Could We Do?  Restore Mortgage Securitization

Securitizing mortgages is a great idea that was poorly implemented.  Investors are reaching for yield in the current low-rate environment.  Meanwhile, the CDO market in mortgages has evaporated because of the crisis.

If we wish to move away from government as the backer of all mortgage debt-- and who doesn't -- it is time to restore this market.

The steps are simple:

• Make sure that CDO's meet specific criteria -- no complexity of tranches.  They should be plain vanilla.  Risk is OK, if the product reflects this.  The market will determine the right price.
• Mortgage originators need some "skin in the game."  This is the only way to keep the process honest.
• Ratings agencies need to be strong and appropriate.  This cannot be a "rubber stamp" process.
• Ideally, the securities would be traded on a public exchange.

Providing a regulatory environment that would facilitate securitization would unleash the private market to connect borrowers and lenders.  Unfortunately, none of the alphabet soup of temporary programs addresses these issues.

Meanwhile, should we be surprised at a decline in housing prices?  There is no market for jumbo mortgages.  The high end of the market has no liquidity.  People cannot move from job to job, from city to city.  The inability to borrow forces the market lower, generating more foreclosures.

Conclusion

Until we have a solid mortgage securitization process, we are stuck with government.  That means there will be no real solution.

It is ironic that the solutions I suggest cost very little.  There are no subsidies.  It is a role for government -- providing the right environment for free markets to work -- that has widespread philosophical support.

Apparently the solution is too "micro" or too "technical" for the big thinkers.  They are all engaged in a political debate, with an election at stake.

We have a moderate economic reobound that could be really exciting of we could address the housing problem effectively.

 

 

 

As I noted in my regular market preview, this week would see a focus on housing.  I regard building permits as important.

Wall Street Myths and Truthiness

Our newest addition to the list of  pages on the side panel deals with the myths and "truthiness" commonly propagated on financial TV and in the blogosphere. The page is posted in full below:

In an effort to promote more empirical thinking in the blogosphere, one of the main themes here at A Dash is to expose Wall Street myths and “truthiness.” I laid out my major objectives when I began a series on this subject in December 2, 2008.

1. Identify a widely-held belief or conclusion where supporting evidence is sketchy;
2. Raise this topic for further discussion and analysis;
3. Consider what facts, if any, might prove the conclusion to be incorrect.

In A Search for Catalysts (December 3, 2008), I considered a number of widely held beliefs that had the potential to set the market in motion.

• The SEC report on mark-to-market accounting, due on January 2nd.  This might recommend reporting transparency, but some relief on the official asset calculation.  Or it might not.
• Housing initiatives.  The Treasury is hinting at a new plan to reduce mortgage rates.  The Fed has already acted.  We expect the market to be skeptical of both, so it may take some real evidence to change opinions.
• Corporate earnings.  No one will believe anything from Q4, so if there is positive news, we are waiting until April -- at least.
  

I have been fighting these myths on Wall Street – especially those related to the BLS and the Birth-Death Adjustment (August 6, 2009) – literally for years. This is just another illustration of how “truthiness” has its way of permeating conventional wisdom.

“As always, our motives are to make the best use of available data.  The multi-year criticism of the BLS and the methodology used has been shown to be incorrect.  Despite this, the myth prevails.  This is due partly to the lack of any mainstream media coverage of the BLS viewpoint.”

Back in April of 2009 I took issue with pundits who felt that the Financial Accounting Standards Board was caving to political pressure on its mark-to-market decision. It was a common case of bureaucracy being drastically oversimplified. As I wrote then:

“Various opponents of change claim that FASB caved in to political pressure.  This is an easy story for journalists to write and for pundits to criticize.  None of them exhibit any understanding of how the American political system works.  They are writing to a receptive audience, which shares their pre-conceptions about how government should work.”

Much of the time mainstream media is largely responsible for spreading these rumors and myths in a misleading fashion. In Popular and Critical Acclaim (June 8, 2009) I quoted an article by Barry Ritholtz in which he suggested a number of ways to improve financial television. He writes:

“Fact Check: An awful lot of things on air get stated with authority and confidence. Much of them are little more than junk or pop myths. Why is it that the more dubious a proposition is, the greater the confidence the speaker seems to muster? Consider fact checking as much of the statements that are made on air as possible, and making frequent corrections.”

At the end of the day, the independent investor simply cannot expect to be successful by following the conventional ‘wisdom.’ Turning a profit means careful analysis from empirical data.

Light Switch Thinking

We have added another page to the right side panel. It deals with the gradual nature by which issues are solved by different policies and institutions. A failure to recognize these increments is a logical fallacy that Jeff calls "Light Switch Thinking." The page is posted at length below:

I emphasize careful data analysis in all cases, regardless of my own preconceptions or feelings on a given issue (see Politics). In doing this analysis, my fundamental principle is to avoid thinking in black and white. Qualifying data in different shades of gray provides far greater opportunities for insight.

One major post where I discuss my careful analytic method is Thinking Like an Economist: When Does it Pay Off?  (April 8, 2010). A small excerpt:

“I was recently asked to participate in a poll of bloggers that had a number of dubious questions.  Typical was whether the Las Vegas City Center complex would add new traffic or would cannibalize the existing base.

This was an awful question -- typical "light switch" thinking.  It is what you see on financial TV and opinion blogs.  It encourages a terrible habit for investors -- thinking that something is black or white, instead of a distribution of results.  The honest answer (a little of both) does not make for an exciting story.”

 

I further explore the impact sensationalist journalism has had on how we view the economy in The Economy: Problems and Solutions (January 14, 2008):

 

“Most market pundits see this as a black-and-white, light switch kind of problem.  There is an economic problem.  It is up to the Fed to act.  They should cut rates aggressively.  The Fed does not see what we do, therefore they are slow in acting.”

 

I support my  ideas with an insightful comment by Maria Bartiromo in the post How to Win a Recession-Predicting Contest (April 2, 2008):

 

“’[T]he truth is, [‘Today’ co-anchor] Meredith [Vieira], it doesn't matter if we’re in a recession,’ Bartiromo said. ‘We can talk ourselves into a recession, and that seems to be what we’re doing right now and that certainly begets more weakness.’”

 

I was once interviewed (June 3, 2010) by Charles Kirk of The Kirk Report. Amongst other things, I discussed the issues with light switch thinking when it relates to criticizing economic models.

 

“It is fine to be skeptical, to look for bias, and to challenge information. Nearly everyone goes too far in this direction --- way too far. It is what I call “light switch” thinking. It is far wiser and more profitable to get the best information from each source.

I am particularly troubled by the reaction to formal models. The criticism of models comes mostly from those who know nothing about them.”

What Apple Should Learn from Intel

As a top business story, the problems with Apple's iPhone 4 has almost all of the key ingredients:

• It features a top company and a leading personality, Steve Jobs;
• It is easy to understand;
• There is a clear problem including an identifiable mistake; and
• There are loyal defenders and vigorous attackers.

(If only the antenna problem were the result of a sex scandal of some sort, the issue would be perfect). 

These ingredients open the field to everyone.  In our office we watched the CNBC "box of six" where all participants were describing what Apple had done wrong, how Steve Jobs was mis-handling the situation, and what he should do now.  No matter that none of the critics has any of his experience, imagination, entrepreneurship, leadership, or communication skills.  On this day, and on this particular subject, the door to Monday morning quarterbacking is wide open for us all.

Intel and the Floating Point Processor Problem

When I recounted the Intel story today at lunch I did not have the exact year in mind, although I remembered the facts, where I was, and what I did.  Intel had a regular and very profitable cycle introducing new chips -- the original PC processor, the 286, the 386, the 486, and by 1994, the Pentium.  Each cycle moved Intel a step ahead of competition and enabled new and more powerful software.  The Pentium had been released and was shipping in new computers.

In late November of 1994 there was a story about a "bug" in the new floating point processor.  The problem had been identified weeks before.  It was known in some scientific circles, but the story was not widespread. It appeared on some Internet "newsgroups" which were relatively small, specialized forums for discussion. (These days the story would have moved much more quickly).  The "bug" only affected a small minority of users who had software where the floating point processor was invoked and needed accuracy to many decimal places.  For those of us doing routine work, we would never know the difference.

Intel's initial response was to downplay the problem, explaining that it was not important and they would do a fix for anyone who could demonstrate they needed a replacement.  They held this position for weeks.

Can you guess the reaction?  The stock tanked to the tune of billions of dollars in market cap.  I found a nice reference for the entire story at Vince Emery's site.  Here are some jokes demonstrating how a great company can be an easy target:

• At Intel, quality is job 0.999999998.
• Q: Know how the Republicans can cut taxes and pay the deficit at the same time? A: Their spreadsheet runs on a Pentium computer.
• We are Pentium of Borg. Resistance is futile. You will be approximated.
• The Intel version of Casablanca: "Round off the usual suspects."
• Q: How many Pentium designers does it take to screw in a light bulb? A: .99995827903, but that's close enough for nontechnical people.

Investment Reaction - 1994

When the story broke on TV I was at the health club.  I grabbed something from the sign-in desk and did an actual back-of-the-envelope calculation.  Knowing a few relevant facts, I determined that Intel could completely replace all of the suspect processors for less than 40 cents/share.  I guessed that they would figure this out.  I made some calls to my clients and we all did some buying.

It took a few days, but the company finally announced the program.  They set aside about $400 million to cover a complete replacement program.  As I recall, very few people actually took them up on the offer, since part of the program was a careful explanation of the problem.  Most did not want to take the trouble, but were reassured that they could do the exchange if they wanted to.  I think they only used a small fraction of the reserve, so my estimate was actually too high!

It was a very profitable trade and carried a good lesson.  Most investors, and even most analysts, do not really try to estimate losses.  When there is "headline risk" they simply sell.  Readers can easily think of a few other companies in the current news where there has been massive selling because the risks were difficult to quantify.

The Lesson for Apple

Let us assume that the Apple executives are confident of their position -- they really believe that they are right.  Here is the lesson Vince Emery derives (emphasis added):

...when you see hundreds of email messages and newsgroup postings which all say you have a problem, and you don't think you have a problem, think twice: you really do have a problem. You might not have a technical problem, but you have a PR problem. Intel said, "Pentium chips have a flaw, but it doesn't matter." Intel's customers said, "It does too matter." Intel responded "No, it doesn't," and even though Intel meant well, thousands of its customers on the Internet swore they saw Intel stick its virtual tongue out at them. In retrospect, it seems like a no-brainer, but Intel had the facts on its side and thought that the facts mattered. They didn't. When you are absolutely sure you are right, you increase your likelihood of making a mistake. Ask any prosecuting attorney. The facts have very little to do with the outcome of a case--it's how the facts are couched and presented that sways your jury.

Investment Reaction -- 2010

I do not know how long it will take Apple to reach the same conclusion as Intel, but they will get there eventually.  There is an inexpensive fix (free "bumper" cases for all customers) that would only cost a few million dollars.

Disclosure:  Long Apple (AAPL) and adding to positions.  Also long Intel (INTC).

Art Laffer and the Triumph of Politics

Presentation is everything.

An excellent idea, poorly presented, is a failure.  A simple concept may sizzle, even if there are flaws.

Take the Laffer Curve.  Famously drawn on a napkin, Laffer suggested that a tax rate of zero raised no revenue, a tax rate of 100% raised no revenue, and there must be something in between that was ideal and appropriate.  This simple concept became the foundation for a series of books and articles and the idea of supply-side economics.

There was a real-life experiment for this theory during the Reagan Administration.  This was a time when we thought we could have low taxes, high defense spending, and make up the difference by  cutting waste, fraud, and abuse out of the Federal budget.

Why should we care about this?

If you want to understand about deficits, taxation, and spending, you need to know history.

and

Don't Confuse Your Politics with Your Investments

The Current Issue

The debate about supply-side economics could be left to history but for the current implications.  Seizing upon recent stock market weakness, Laffer launched a political assault.  In a Wall Street Journal op-ed he argues that the market is already starting to reflect the end of the Bush tax cuts.  Larry Kudlow highlights the Laffer piece in a confrontation between Laffer and James Altucher.  Regular readers of "A Dash" know that we are long-time fans of the Kudlow program, mostly because the host brought together differing viewpoints and brought out their best through impartial questioning.

This seems to be at an end.  The show is becoming overtly political, which makes it less valuable for thinking investors.  In the Laffer/Altucher matchup, one of the participants has a napkin and the other provides a quiet review of data -- earnings, interest rates, and other factors that are different from 1981.  If you watch this as a debate, and I urge you to do so, it is pretty one-sided.   Laffer does not respond to the specific Altucher points.  Despite this, Kudlow awards his "prize" to Laffer.  Take a look for yourself.

Altucher also cites an argument that nearly everyone misses -- the importance of the slack demand for labor.  This helps to contain inflation, but it also helps new businesses which can draw upon these inexpensive resources.  This is the natural way economies grow, and it is something that most observers miss.

An Avalanche of Criticism

The Laffer initiative generated a well-deserved response.  Here are some of the highlights.

Barry Ritholtz, one of our featured sources, has a first-rate analysis of the Laffer WSJ piece.  Here is a key quotation:

In his OpEd, Mr. Laffer confuses causation with correlation, ignores market history, makes spurious argument, and simply make up crap as he goes along.

Readers would be disappointed if Ritholtz pulled any punches.  I urge you to read the entire, point-by-point analysis.

Another data-rich commentary from Asha Bangalore at Northern Trust may be summarized as follows:

It is not clear yet if the Bush tax cuts will expire in 2010.  Given the fragile state of the economy, it is entirely possible that the tax cuts will be extended into 2011.  Assuming the tax cuts are allowed to expire, the forces that may prevent strong economic growth in 2011 are entirely different from tax increases.  The headwinds from the financial sector, by way of a severe credit crunch, lackluster job growth, and housing market challenges are factors that will influence the near term path of the economy.  The evidence presented here suggests that Mr. Laffer's story is selective and incomplete.  Many factors will play a role in how the U.S. economy performs in the next few years in addition to taxes.

Read the entire article and enjoy the great charts.

And also check out Brian Wesbury's video.  He talks about several concerns including debt levels and the comparisons to Greece, the end of government stimulus, and the Laffer article.  Wesbury sees a continuing strong recovery for stocks, but thoughtful readers will want to watch the entire video.  Like other critics of Laffer cited here, Wesbury uses data.  He looks at the actual interest rates as an indicator of risk.  He also suggests that people look at the assets held by the federal government.  Yosemite anyone?

The Real Story

If you really want to understand the Laffer theory and the Reagan implementation, go to the source.  David Stockman was the Budget Director in the Reagan Administration.  He provided an interview that was pretty frank, and was "taken to the woodshed" by the president.  I taught about this stuff back in the 80's, often to a skeptical audience.  Eventually I was able to use Stockman's book, Triumph of Politcs:  Why the Reagon Revolution Failed, as a piece of evidence.  The book is now added to our recommended readings for serious students.  Stockman argued that the supply-side test failed, but was not fair.  Judge for yourself.

Investment Conclusion

With the mid-term elections a few months away, we are entering the season of intense political debate.  There is no question that the decisions we make as voters will affect our nation's future and our economy.

I intend to exercise my voting rights.  I expect that readers will do the same.

Now how about making money from our investments?

As usual, I recommend paying attention to the prospects for corporate earnings and cash flow.  Look at specific stocks.  There are many choices that are very cheap.

If you cannot see them, perhaps those with a political agenda are blinding your vision.  Get ready for several more months of the same.

Thinking Like an Economist: When Does it Pay Off?

Few people think like economists or policy analysts.  It requires a combination of facts, methodology, and discipline.  Let me start with some background and  a couple of examples.

Policy Impacts

Most people have a simple test.  They merely want to know what worked.  The prevailing standard is some gut feeling about "what is good."  A true policy comparison looks at the "counterfactual,"  what would have happened in the absence of the policy change.  (If you do not understand this vital concept, please check out an article where I provided a nice illustration.)

Let me be perfectly clear about this.  A candidate for office who tries to talk in these terms is known as a loser.  A President who talks in these terms is likely to be known as a "former President."  The average person has absolutely no interest in what might have happened had things been different.

People want results!  Our political system rewards those who deliver results.  There is no "what if?" calculus.  In the long run, this works pretty well.

Examples

I was recently asked to participate in a poll of bloggers that had a number of dubious questions.  Typical was whether the Las Vegas City Center complex would add new traffic or would cannibalize the existing base.

This was an awful question -- typical "light switch" thinking.  It is what you see on financial TV and opinion blogs.  It encourages a terrible habit for investors -- thinking that something is black or white, instead of a distribution of results.  The honest answer (a little of both) does not make for an exciting story.

The Cash for Clunkers program is a similar example.  I did not care much for the policy, which I analyzed here.  A couple of months after the  program conclusion an old Street.com colleague wrote an article on the subject.  He carefully adjusted for seasonal effects in auto sales and demonstrated that there was a "pull forward" effect.  It was a nice piece of data analysis, but he was on a mission when it came to interpreting the results.  It was pretty obvious that the data also showed an extra sales impacdt.  He completely ignored this effect, even after I privately called him on it.  He was intent on proving his point.

More time has passed, so we now have more data.  The CEA analysis (HT Brad De Long) is clear enough that we can all see the evidence, even without seasonal adjustments.

The chart does not prove that this was a good program, nor that the expenditure was justified.

It does demonstrate that there was something going on in addition to "pulling forward" some sales.  This is  a completely typical effect, which we will eventually see is true of other government programs for housing, small business, and the like.

Investment Implication

I want to apply this lesson in a way that is relevant for current investors.  There is a clear example of the difference between the thinking of economists and investors -- the concern about inflation.

The broad body of market participants -- investors, bloggers, floor traders -- has one viewpoint about inflation.  They do not agree with official definitions or measurements of inflation.  Some think there is a conspiracy.  Others believe that they see things more clearly.  Some think that "bond vigilantes" will eventually enforces their viewpoint.

On the other side we have the economic community and the Fed.  The Fed does not even follow the CPI, preferring the core PCE deflator.  The Fed is not interested in non-core fluctuations, since these are not viewed as responsive to changes in policy.  A WSJ online poll showed that 83% of responding readers felt that inflation was a concern for the markets.

This is crazy!  As an investor, why fight the Fed, their staff, and the entire economic community?

Even if you choose to diasgree, I urge a pragmatic approach.  Feel free to express your opinion in blogs, in comments, at the ballot box, or anywhere else you want -- just not in your investments.

Meanwhile, if you want to join me in making profits no matter who is in power, you should be a political and philosophical agnostic.

Focus on predicting what will happen, not what you think should happen.

Weighing the Week Ahead: A Decision on Health Legislation

Health care legislation has been a focal point for national debate for more than a year.  One way or another, the fate of legislation supported by President Obama will soon be decided -- probably this week.  The final maneuvering will be the most important story of the week.

Sure, the Fed will meet.  We will also have some economic reports, but the health care story is one that is both less frequent and more important.

I have some comments below about the investment implications.  First, I want to answer a question from reader BK, who seeks advice on sources for health care reading.  BK is willing to do some work, but is frustrated by the black-and-white portrayals from most sources of information.

Health Care Reading List

Here at "A Dash" I avoid positions on elections and partisan issues.  I have my own viewpoints of course, including health care, but this is not my forum for opinion.  I am active in local citizen groups, and I never miss an election.  I urge everyone to think about issues and to get involved.  Meanwhile, the best investors are political agnostics.  It is possible to find a good investment thesis no matter who is in power.

Here are some sources where you can get information that is factual and unbiased.  You can augment this with strident arguments from partisans if you wish.

• The Rand Corporation (at Rand Compare) provides both facts and comparisons, as well as news updates.
• The Kaiser Family Foundation provides a side-by-side comparison of proposals.
• FactCheck pulls no punches and finds fault with partisans from both sides.  I found their discussion of the President's Health Care Summit to be much more helpful than any other news coverage.
• CBS News had a nice piece, a few months old but still relevant, on 10 health care reform myths.  I am avoiding most regular media sources, since nearly everyone imputes bias to them all, but I thought this was a helpful piece.  Decide for yourself.
• Consumer Reports, viewed as an authoritative voice on many topics, has a lot of material devoted to health care.  Since they evaluate health insurance companies, they have an interesting perspective.

Thanks to BK for the suggestion.  I certainly would not have done this without the question.  I will try to address a reader question each week.

Last Week's Action

Here is my take on the key data from last week.  I am not trying to be comprehensive, nor am I taking a viewpoint.  I will highlight what I found significant, trying to be objective.

The Good

There were a few pieces of good news.

• Jobs are important.  The IT market (nice jobs) is heating up.  Most ignored this, but it fits my thesis for 2010, where tech stocks take the lead as businesses catch up.
• The latest JOLTS report from the BLS shows the highest ratio of job openings since February of 2009.  I might have been the first of the economic bloggers to highlight this relatively new release.  The permabear types pounced on it to show the terrible ratio of openings to job seekers.  That ratio is improving.  Many observers focus on the level (still bad) rather than the direction (improving).  I see it as good news.
• Consumer spending -- despite the skepticism of the bearish crowd (consumers spent-up, not pent up  est. 2002) total consumer spending is solid.  The analysis--from Gene Epstein in Barron's?  Total payrolls are only off about -0.8% from a year ago.
• Stocks.  Still strong, somewhat to the surprise of everyone.

The Bad

There was much to dislike last week.

• Concurrent indicators that I like -- initial jobless claims and Michigan sentiment -- both showed a downtick.  I still do not see net job creation, and certainly nothing like what is needed for a solid recovery in employment.
• A new "leading index",  highlighted by Econbrowser and created by a group featuring excellent members, suggests that the recovery is lagging
• The ECRI leading index ticks lower.  This one is humorous.  You can read the story at Reuters, "Weekly Leading Index Rises" or Barron's "Weekly Leading Indicators Weaker."  Same data, two headlines.  The ECRI index is still in solid growth levels, but less solid than before.  Astute readers can compare to the JOLTS report above.  Please submit info from any pundit who uses level for one indicator and change for the other.
• States and local governments are in trouble -- big trouble.  Everyone knew this, but the timing of state budget processes is moving this into the news.  State and local governments are generally required to maintain balanced budgets.  Even though they cheat (a lot) they are still pro-cyclical in their behavior.  There are serious questions about whether federal policy was large and long-lasting enough to offset state issues.

The Week Ahead

Everyone will fixate on the Fed for the early part of the week.  Why bother?  It is easy for people to criticize and get great exposure.  Those who hate the Fed as an institution or who get page views from pounding on Bernanke have another week to enjoy.  These are all cheap shots with little help for your investments.

I expect little in the way of fresh news from the Fed.  Everyone is trying to parse nuances in statements about exit strategies. and new appointments.  It is wasted effort.  The Fed is going to move slowly as long as there is significant risk to the economic recovery.

In the economic releases, I always watch building permits as a clue to housing.  I do not think that CPI or the various regional indexes will be market movers.

Politics and legislation will be important.  With respect to the health legislation, I expect the bill to pass.  I think that the Democrats will do enough horse trading to garner a majority in the House.  The House hates the Senate bill, but the approach will be done in a way(reconciliation) that guarantees some amendments and only requires a simple majority in the Senate.

Regular readers may recall that I have been predicting this outcome for quite some time.  The result is now upon us.

Our Trading Forecast

Our own indicators (see our regular ETF updates for an explanation) are now neutral, and that was our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:

• 27% (up from 18% two weeks ago) of our ETF's have positive ratings.  This is weak, but improving.
• The median strength is -15 (up slightly from -20), very negative, but improving.
• 89%  (down slightly from 93%) of the sectors are in the "penalty box," showing an extremely high level of risk.
• Our Index Package has a slightly negative rating.

Investment Implications

My expectation is that the health legislation will pass.  The market reports see the outcome as in doubt, so it will be something of a surprise.  The market reaction will be negative.  Even though the CBO projects a ten-year cost savings from the bill, it is pretty obvious that most market participants disagree.

I continue to look for opportunities to buy more health stocks, including insurance companies (the current bad guys in Obama speeches) and health information technology.  This week may be the last good chance for those interested in buying these names.

The Bernanke Circus

Fed Chair Ben Bernanke's nomination for a second term was approved by the Senate Banking Committee by a vote of 16-7.  Democrats supported the move 12-1 and the GOP vote was 4-6.

Our focus?  What does it mean for investors?

Analyzing the Opposition

Opponents fall into the following categories:

• Those who do not like the Fed at all, questioning the powers and authority
• Those who believe the Fed should focus on inflation alone, ignoring the legal dual mandate -- full employment and price stability.  Some of these critics also prefer their own inflation measures, typically commodity prices rather than generally accepted gauges of inflation.
• Those with a partisan agenda.  Some GOP negative voters freely admitted that Bernanke was probably the best of those who might be nominated from the Obama Administration.  Put another way, they would not support any likely Obama candidate.

Analyzing Supporters

Most supporters, representing mainstream viewpoints, understand that Dr. Bernanke inherited a very difficult situation.  There is a consensus that the Fed policy staved off the worst effects of the credit crisis and helped to stabilize the economy.  It is a rejection of those who think that having a "cleansing depression" would have been good for us all.

Supporters had criticisms of Bernanke, but tried to assess the balance of his performance.  I suggest that readers consider two important viewpoints:

First, conservative, free-market advocate Bob McTeer who writes in Fed Bashing: Unfair and Costly as follows:

It is taken as given these days that the Fed created the housing bubble. If this is true, then it must follow that the Fed is responsible for the bursting housing bubble, the ensuing financial crisis and subsequent recession. But, as I recall, the Fed did not create the housing bubble. It was the collateralized subprime loans, not a reversal of home prices, that caused the problems. Maybe there were too many loans, but, if so many had not been bad loans, air could have come out of the bubble without devestation.

And further:

I’m beating this dead horse because the casual and careless accusations that “it’s all the Fed’s fault” has caught on with an angry public and thus with Congress. The institution that did the most to save our financial system is about to be punished for it.

And finally, powerfully, but readers should check out his entire article:

Fed bashers who really care about their country should be more cautious lest they get what they pray for.

Second, liberal critic Brad DeLong.  His list of criticisms are mostly the opposite of those cited by the Bernanke opponents!  Read his list, but his realistic conclusion is as follows:

Now I am morally certain that had I been in Bernanke's (or Paulson's, or Geithner's) shoes over the past two years, I would have made more and bigger mistakes, and we would right now be worse off. He has done better as Fed Chair than I would have, or indeed that almost everyone I can think of would have. So I am inclined to judge Bernanke lightly, and say that the Senate should confirm him for a second term in spite of his mistakes: he is, I think, one of the very best we can get for the job right now, and he won't make the same mistakes again.

And finally, you can consider the CNBC debate among Larry Kudlow, Diane Swonk, and Steve Liesman.  Swonk and Liesman highlight the moves to avoid financial catastrophe.  Kudlow emphasizes the need to defend the dollar at all costs.  Swonk also notes the likely impact on financial markets if Bernanke is not re-confirmed.

Check out the video here.  You can and should consider the arguments by all, but it seems to us that Kudlow has an agenda, while Swonk and Liesman have a more balanced viewpoint.

Investment Conclusion

Here at "A Dash" I try to focus on what events mean for investors.  The Bernanke circus is a political distraction.  He is a Bush appointee.  Had McCain won the election and renominated Bernanke, the Senate vote would be a quite different partisan mix.  It is pretty easy for a Senator to posture and assign blame.  There are obvious issues and plenty of room for second-guessing.

It all gets plenty of buzz in the investment blogosphere.  The media bias is negative, as I noted in this article.

Meanwhile, he is still the Fed Chair with unanimous support.  He will get confirmation in the Senate some time in January.

The astute investor looks beyond the political debate and focuses on policy -- what will actually happen.

As investors think ahead to 2010 opportunities, balancing risk and reward, we should all keep our focus.  The  political debate is an interesting sideshow.  Meanwhile, don't fight the Fed.

The Dumbing Down of News

I am working on a concept, and I invite comment.

The basic idea is that recession-induced cutbacks in news organizations have altered the way in which news is interpreted and delivered. There is more emphasis on profitability from each article, so popularity is paramount.

My working hypothesis is that the more educational and intellectual pieces, including those that take balanced viewpoints, draw less interest.  These are the mainstream media authors who have been squeezed out.

A Baseball Lesson

Regular readers know that we love drawing lessons from sports.  I just finished reading  As They See 'Em: A Fan's Travels in the Land of Umpires  by baseball fan and occasional umpire Bruce Weber.  There are many fun facts and problems, plenty of stories, and lots of arcane information about umpiring.

The lesson for us is about the strike zone, something that is in the rule book, but not actually implemented by umpires.  Umpires adopt a shorter and wider strike zone.  Even if they start with the rule book, as they move up the minor leagues, they learn what is expected.  It comes from the reaction of batters, pitchers, managers, and fans.  It is an inevitable socialization of the umpire, and often defies league edicts.  The umpire -- who does an excellent job according to Weber -- gradually adapts to the norm.  The individual strike zone may vary a bit, but it approaches the norm.

This is happening in regular news, and more importantly to investors, in financial news.

The Sources of Bias in Financial News

Financial news sources, in a play for page views and ratings, are succumbing to various influences:

• The political bias.  Most market participants and affluent, educated, and conservative.  More than a few are libertarian and outspoken.  These participants constitute a majority of the audience for financial sites, and an even larger share of outspoken commenters.  It drives ratings.
• The bearish bias.  This overlaps with politics, since market bears are also political critics, but it goes further.  The most popular contributors and commenters on Seeking Alpha, Minyanville, TheStreet.com, and the most highly-rated investment blogs share a bearish viewpoint.  It is not necessarily a bias on the part of the editors of these sites.  They are merely "learning the strike zone."  The readers have hated the market rally and embrace any criticism.
• The controversy bias.  Even efforts to achieve balance do so by bringing in extreme representatives and highlighting conflict.  CNBC helps out by showing boxing gloves clashing over the images of participants!  These brief segments do little for enlightenment.
• Dueling Economists.  The featured sources are left and right, emphasizing conflict.  The mainstream sources get less attention.
• Incestuous Linkage.  If you are a fledgling writer of a mainstream media blog, one who needs to get page views, you need recognition from the established sources.  Since these sources reflect the prevailing biases, the writers offer respect and deference.  This even helps to explain why recognized economists with real credentials engage and link to the pop economists -- those who discuss the economy in terms that merely cater to the biases and understanding of the average reader.

What is Lost

Mainstream media is closing down reference libraries, cutting back staff whose articles are not popular, and de-emphasizing the balanced approach.

It is a reaction to readers, who are teaching them the strike zone.  Most readers want a daily fix of information supporting their current views  -- liberal or conservative, bearish or bullish.

In happier economic times, publications could afford to pay for thoughtful analysis and examination of data.  One of our featured sources, Talking Biz News, has chronicled the major cutbacks.  (They may not share our interpretation of the implications).

Our Conclusions

First, this is a work in progress.  There is room to debate my conclusions, and I invite comment.

Second, there should be a way to profit from these developments.  It is a challenge.  The reader or viewer must have a healthy skepticism, with special attention to the sources.  Eventually, the best investment choices will emerge.

The intelligent consumer should be delighted when it is difficult to find the best information.  That is the source of investment edge.