A Dash of Insight

Candidates and Fuel Prices

Sophisticated market observers and economists joined today in objecting to Presidential candidate positions on energy issues.

The Statements

Sen. McCain was first with a proposal for a "gas tax holiday" this summer.  Sen. Clinton joined in, leaving Sen. Obama as the only holdout for maintaining federal gasoline taxes.

Sen. Clinton has been even more aggressive about high profits for oil companies.  This afternoon, as spotted by Colin Barr, her campaign complained about the decline in ExxonMobil stock, in spite of excellent earnings. 

There is something seriously wrong with our economy when Exxon’s record $11 billion in quarterly profits are seen as a disappointment by Wall Street,” Clinton said. She went on to use the company’s latest gains to reiterate her call for a gas tax holiday — a proposal has been criticized by economists who say it won’t result in lower prices for consumers. “I believe we should impose a windfall profits tax on big oil companies and use that money to suspend the gas tax and give families relief at the pump.

The Reaction

Not surprisingly, these proposals generated near-universal dissent from the economic community.  The complaints about profits and the ExxonMobil stock decline of 3.6% created similar objections among sophisticated market observers, like the panel on Kudlow and Company.

Barry Ritholtz is ready to give a good lesson to the candidates.  Check out his article about how the candidates fail Econ 101 (a course frequently cited at The Big Picture!).

We are delighted to find ourselves in agreement with Barry, the economists, and the savvy market observers on Kudlow's excellent program.

But here is the question:  Do the candidates really not understand how economics and markets work, even at the level of Econ 101?  Or is their motive a different one?

Is This Credible?

Well -- McCain admitted that he was soft on economics and was reading Greenspan's book to bone up!!  In spite of this, we think his team has enough economic horsepower to "speak truth to power" as we say in the public policy business.

Senator Clinton's case is even more clearcut.  She turned $1000 into $100,000 in only ten months of cattle futures trading, a record that none of us can claim.  She did it by "following the market closely" and "making her own decisions".

So she understands markets.  Her campaign also knows the proper role of experts, according to the Wall Street Journal.

Clinton’s position on the gas tax runs counter to that of economists across the political spectrum who argue that a temporary tax reprieve would do little to lower gas prices this summer.

“There are times a president will take a position that a group of quote-unquote experts will agree with and there are times when a president will take a position that a group of quote-unquote experts won’t agree with it,” campaign spokesman Howard Wolfson told reporters today, “Sen. Clinton believes this is the right policy.”

An Alternative Explanation

Instead of assuming that people intelligent and successful enough to be Presidential candidates are stupid, let us instead assume that they are smart.  As time winds down in a life-or-death struggle, the candidate looks for anything that might work.

It is natural to look at the issues of the day and gauge the public reaction.  Everyone is worried about high fuel prices.  Whom do they blame?

Here are data from a 2007 poll.  We follow such polling questions constantly and the numbers do not change that much.  The data show that the average person blames big oil or government for high fuel prices.  They do not understand much about market forces.  They go for conspiracies and simple-minded answers.  It is a winning tactic, at least in the short run.

If you were a candidate, would you try to educate the 2/3 of the people who are wrong-headed, or would you "go with the flow?"

Here is the poll question:

Who do you blame the most for the recent increase in gasoline prices - oil producing countries, oil companies, President Bush, Americans who drive vehicles that use a lot of gasoline or normal supply and demand pressures.

Oil companies	43%
President Bush	20%
Supply and demand	13%
Oil countries	11%
American drivers	4%
Not sure	9%

Pandering?

Barry calls the candidate efforts "pandering" and the term seems to fit.  Let us take careful note of the circumstances:

• An issue where nearly all of the top experts -- people who have relevant credentials and have reflected carefully -- draw a conclusion different from many average  people.
• Many consumers of the information believe in conspiracies and simple, common-man explanations.
• The candidate, someone in a position of leadership, chooses to exploit the public mis-perception rather than to educate and to lead.
• The resulting pandering helps the candidate, but might well hurt the average voter -- the person consuming the candidate's message.

This all has an eerily familiar pattern.  It is something to think about.

And by the way, we do not think any of the energy proposals have a ghost of a chance of passage.

Weekly Sector Update

The apparent shift in Fed policy was partly anticipated by the markets.  As a result, the expectations concerning the dollar changed.  The TCA-ETF portfolio from last week had a number of "weak dollar" plays, foreign markets, energy, and basic materials.  The data for this week (as of Wednesday's close) show a shift in the rankings, with more emphasis on technology.  (This is evolving rapidly).

The table below shows this week's rankings.  Vince has adjusted the strength scale to aid in the interpretation.  The underlying method has not changed.  A reading of zero indicates the average expected performance of a sector over a one-month time frame, the general time horizon for the model.  A reading of 50 indicates an expected return that is one standard deviation above the average, roughly the top third of returns.  A reading of 100 indicates an expected return of two standard deviations above the average.

While we update the model daily, we have introduced a program for average investors that does weekly trades unless emergency adjustments are required.  A report on this program is available upon request.

(Click to see the chart)

Bailing Out Bond Insurers: It's Big, Really Big

Today's dramatic market turnaround was due largely to the leaks, rumors, and eventual news stories about a meeting convened by New York Insurance Department Superintendent Eric Dinallo.  Wisconsin, which has a very active insurance industry, was also represented by Commissioner Sean Dilweg.

Some vague early stories dribbled out from hard news agencies with a stronger Bloomberg story a bit later.  Subscribers to RealMoney Silver could have paid for their subscription by following the Doug Kass commentary, which came out in time to catch about 40 points in the S&P.

Why So Important?

To appreciate the news, one has to realize that many of the media explanations for early selling were wrong.  The talking heads were speculating about the Fed and the meaning of the inter-meeting rate cut.  The real problem was an expanding concern about the companies insuring bonds.  If these companies fail, the credit ratings of many bonds are imperiled, and we get another round of write-downs from financial institutions.

Because this news hit the bulls-eye for market worries, it had an immediate impact.

How to Judge a Bailout

The beauty of the news today is that it requires no government action, and no taxpayer money.  It is reminiscent of the Long Term Capital Management rescue, where the New York Fed provided a meeting room for the financial firms most affected.  After discussion, they went around the table and all of the firms (except Bear Stearns) contributed to the rescue.  The process, described well by Roger Lowenstein in his book, When Genius Failed:  The Rise and Fall of Long-Term Capital Management, did not really save the original investors in the hedge fund, but it rescued the financial system from the falling dominoes that come with counter-party risk in the derivatives market.

Please note the key distinction.  Measures that require legislation take time.  Those that help financial institutions cooperate work much more quickly.

We expected some kind of action to shore up these insurers, because the stakes are so high.  It is a "too big to fail problem."  We are surprised (and delighted) by the speed of insurance regulators in taking action.  It is part of our viewpoint that a solution to current problems is going to take more than just fiscal stimulus or interest rate cuts.  There are several different aspects to the problem, and each requires a solution.  This means that many different agencies of government must act.

It is relatively easy for government to take popular steps like tax cuts to many individuals and businesses.  We expect such a program, and we think it will help.  So will the Fed's interest cutting moves.

But these are not targeted solutions.  The Fed's TAF approach was targeted, and it has worked well.

What is Still Needed

There are two steps remaining that will be more difficult.

First, we need attention to the jumbo loan market.  In many parts of the country housing prices are high enough that average mortgages exceed the $417,000 limit on Fannie and Freddie.  The Administration is holding out for a comprehensive reform of the GSE's before supporting an increase in the limit, something that requires legislation.  The House has passed a bill, but the Senate has been very slow.  The Washington Post editorial on this subject hits the mark:

Last May, the House of Representatives passed a bill that would remedy this situation. The legislation would replace OFHEO with a new, independent Federal Housing Finance Agency, which would regulate not only Fannie and Freddie but also the 12 regional Federal Home Loan Banks. The Senate, however, has done exactly nothing since then. Its inaction has been due in part to differences on other points of the bill between Republicans and Democrats -- and in part to the fact that the Senate Banking Committee chairman, Christopher J. Dodd (D-Conn.), was pursuing his long-shot presidential campaign. In recent weeks, both President Bush and Rep. Barney Frank (D-Mass.), who shepherded the House bill, have called on the Senate to get busy. It's not often that George W. Bush and Barney Frank agree on anything. In this case, they are both right.

Second, we need to get some valid pricing and trading in existing debt obligations (CDO's) which have been marked to market at distressed prices.  This may require some buyer of last resort, either governmentally or privately.  There is a continuing demand for extra yield, but it needs to be correctly priced and rated accurately by agencies.  This was a good idea that was poorly implemented, and it will return.  How long will it take?

These two steps are needed for qualified buyers to have access to mortgages, firming up demand for housing, and helping existing borrowers to work out their loans.  Some think this  process will take several years.  We disagree.  It will happen more quickly, but it will require more innovative actions of the sort we saw today in the bond insurance market.

Implications for Investors and Traders

The news today coincided with various technical interpretations of testing support and a double bottom.  Our own Gong Model finished the day with the hammer cocked -- finally!  This means that the Gong will ring as stocks recover.  The ringing of the Gong is a very unusual and meaningful indicator.  It provides an intermediate-term buy signal, suggesting significantly higher prices within a few months. 

Today's news is good enough that potential buyers may see a combination of technical and fundamental factors supporting action.  Obviously, many did today.  Our view is that this is more than just a "bear market rally" or trading bounce.

Problems remain, but several of the key steps to maintain economic growth have already been taken.

 

Election 2008

Investors and traders alike are becoming interested in next year's elections.  While some are jumping to conclusions about the outcome, we think the story is just beginning to play out.

Things are beginning to heat up, with regular coverage on the networks and the chance that the New Hampshire primary will be moved to December.  This could alter the campaign dynamics dramatically.

Our Election Project monitors the daily news on the campaign front with the investor in mind.  We do not advocate any party or candidate.  Our objective is to examine each candidate's issue positions and prospects.  We then try to identify specific stocks that may gain or lose with that candidate's changing fortunes.  We actively solicit input on candidates, issues, and stocks.  Readers can best do this via comments at the forum.  We will use these to develop specific candidate stock portfolios to be tracked at Stockpickr.com.

Investors following the election should also monitor the insightful commentary of my colleague at TheStreet.com, John Fout.  John not only writes regular articles on the campaign, but he now has a daily feature tracking political blogs.  This search link locates the most recent columns.  This is a great addition to what we do in tracking the regular news sources on a daily basis at Election Stocks.