Tuesday, May 31, 2011

Sovereign Debt

THE OLD ADAGE OF “SELL in May and go away” would appear to apply so far in May, though we don’t suggest that as a strategy. By the numbers, for the four weeks ended Friday, May 27, 2011, the Dow Jones Industrial Average closed at 12,441, down 369 points, or 2.9%. The Standard & Poor’s 500 closed at 1331, down 32 points, or 2.3%, and the NASDAQ Composite closed at 2797, down 76 points, or 2.6%.

Commodities and metals have been especially hard hit the last few weeks, after peaking on Friday April 29th. In fact, during the first week of May, silver was off 27% from its high. While this sector has recovered some, professional opinions are all over the board as to the future of commodities and metals prices.

Much of this opinion divergence comes from the uncertainty and unknowns associated with sovereign debt. Around the world, including the U.S., nations are drowning in debt. In addition, the legacy or entitlement promises made by elected officials are completely unsustainable. Some politicians, including a few in the states, are finally realizing this. Most of us have known this for years, since we must balance our personal and business budgets on a regular basis.

The challenge is that no one knows how the debt issue will be resolved, or what the fallout will be. What does it look like when a country goes bankrupt? Their currency is effectively worthless, but what other negative results are there? These are the issues that economists and other macro thinkers are dealing with. There is little in modern history to give us guidance. Modeling 10,000 scenarios gives some input. Until we can accurately forecast human behaviour, in large groups and in worst case scenarios, it will remain difficult to forecast with any accuracy. Our estimates, in the meantime, are a combination of quantitative analysis, and the subjective, or qualitative, which is heavily influenced by our worldview.

GM and Ford both posted double digit percentage gains in April. Industry wide, deliveries rose 17.9% from April 2010, with GM posting a 26% gain, overtaking Ford as the leading car seller in the U.S. Brett Arends of MarketWatch is suggesting that Apple will be the first company with a $1 trillion market cap.

Zillow, the real estate information company, shows housing prices down 8% from a year ago. It appears that housing prices are dropping about 1% per month. We have said it before, and it bears repeating. Home prices should be two to two and a half times annual household income. With annual household income in the $52,000 range, average home prices should settle at something less than $130,000. Depending on whether you are evaluating new or existing stock, average home prices are still in the $170,000 to $185,000 range. For the sake of our many friends in the residential real estate world, we hope we are wrong on this one.

Microsoft announced that it is buying Skype for $8.5 billion in cash. LinkedIn, the business networking site, saw its shares more than double on its first trading day, closing at $94.25. This from an initial offering price of $45. Liberty Media has made a $1 billion bid for Barnes and Noble.

Dominique Strauss-Kahn, head of the International Monetary Fund and one time French presidential contender, was arrested and charged with assaulting a hotel maid. His wife, Ann Sinclair, is funding his journey through the courts. Her wealth comes from the art trading of her grandfather.

The G-8 summit ended with a pledge by the member nations to cut debt. This pledge reminds me of a favorite quote, attributed to Molier. “All men are alike in what they dream, and all men are alike in what they say. It’s what they do that makes the difference.” We’ll see what these politicians actually do about the debt they have incurred.

On the economic front, signals continue mixed. Initial jobless claims have been running just over 400,000 each week. Home construction and prices remain soft. The Producer Price Index is up 6.8% over the last 12 months, while the Consumer Price Index, ex food and energy, is up 3.2%.

There is always information to review, absorb, and evaluate. Often, we can allow it to have a negative or depressing impact on our outlook. If we step back and attempt to look objectively, however, life is good. This past long weekend gave us the opportunity to reflect on that. Millions of young men and women, serving through our armed forces, have worked to keep us free. Many have paid the ultimate sacrifice, giving their lives so that we can enjoy the freedoms that we enjoy.

There will always be problems to solve, things that don’t fit with our plans, and outcomes that we don’t prefer. In spite of that, all of us reading this commentary live wonderful lives. I have found that gratefulness and depression can’t exist at the same time in the same person.

Quote of the week:

“In everything give thanks, for this is God’s will concerning you.”
                                                                                                            St. Paul

Thursday, May 5, 2011

PT Barnum

THE LAST THREE WEEKS HAVE BEEN KIND TO stocks, with all three major equity indices up nicely. By the numbers, for the three weeks ended Friday, April 29, 2011, the Dow Jones Industrial Average closed at 12,810, up 430 points, or 3%. The Standard & Poor’s 500 closed at 1363, up 35 points, or 2.3%, and the NASDAQ Composite closed at 2873, up 93 points, or 3.1%.

Momentum in the equity markets has been driven in part by continuing strong performance in first quarter earnings. Ford Motor posted its best first quarter profit since 1998, and ExxonMobil profit topped $10 billion, with income up more than 50% year over year.

Ben Bernanke held his first ever press conference, his comments suggesting that he is comfortable with current policy positions. He has no plans to make changes in order to address inflation or slower growth. Meanwhile, gold and silver continued their rocket ride, with silver pushing $50, and gold well over $1500.

Research In Motion is having a tough year. Not only has its stock performance been underwhelming, but it isn’t competing well in its core business markets. J.P. Morgan’s profit was up 67%, to $5.6 billion. JPM increased its dividend to $0.25, and plans to buy back $8 billion in stock this year. Apple reported a 95% increase in profit, citing strong sales of iPhones and Macs.

Obama released his long-form birth certificate, and Mr. Trump is making noise about a presidential run. P.T. Barnum at his finest couldn’t orchestrate what is shaping up to be a most interesting election year.

Glencore, Groupon, and Dunkin Donuts are all preparing for IPOs. Glencore is a Switzerland based commodities trading house, Groupon provides online discount coupons and related services. Dunkin sells lots of caffeine and sugar, staples of the American diet.

The quality and viability of municipal and sovereign debt has been the subject of much debate over the last year. In fact, S&P is now questioning the sterling credit rating of U.S. debt. Wall Street’s line is that government debt of developed Western countries is the safest available. The challenge with that thought is that if it weren’t for Germany, then Greece, Ireland, and Portugal would most likely be in major default at this point.

Personal preference, if I’m evaluating sovereign or municipal debt, is to get input from those who stand to lose if the bonds default, rather than those who are often simply looking to move inventory. The insurance companies that offer bond default insurance seem to have lower rates for countries such as Australia, New Zealand, and the Scandinavian countries, than they do for much of the rest of the world, including the U.S.

On the tax front, the budget deal reached recently in Congress to keep the federal government open cut funding for high speed rail and the EPA, and increased the Pentagon’s budget by $5 billion.

In 2010, Congress had the gall to include legislation mandating business to business 1099s, beginning in 2012. This legislation ranked near the top of stupid laws, in terms of the cost/benefit ratio. The good news is that on April 5th, the Senate approved HR 4, which retroactively repeals the expanded 1099 reporting rules. For the moment, we can relax. As a rule though, we must remain vigilant, to protect our freedoms and liberties.

On the economic front, housing starts were up 7.2% in March, to an annualized 549,000. According to economists, a healthy economy should see 1 million new home starts annually. The Commerce Department announced that GDP grew at an annualized rate of 1.8% during the first quarter, substantially less than the 3.1% growth during Q4 2010. In addition, Commerce is officially recognizing the inflation that the rest of us have been experiencing at the gas pump and grocery store for at least the last year.

In 1862, roughly 10% of Americans, mostly affluent Northern citizens, paid income taxes. The income tax at the time was a temporary war time measure. This according to Joseph Thorndike, director of the Tax History Project at Tax Analysts, a Falls Church, VA non-profit.

During the war, citizens would pay no more than 10% of their income in tax, and this only if income was greater than $10,000. For those with incomes at or below $5000, the tax rate was closer to 5%. Income included profits from business or trade, earnings from sale of stock, gold, or real estate, and rents and interest on real estate, bonds, or securities. Income from farming operations or livestock sold was also taxable.

Deductions included a $1000 exemption, losses sustained from fire, shipwreck, or business losses not already recognized. Also deductible were wages paid to hired labor, and the cost of livestock purchased. There was a flat tax on gold watches, gold and silver, billiard tables, and carriages.

The tax law of the time was designed to be a rich man’s burden, as very few could afford a gold watch, billiard table, or carriage. The tax burden was gone in 1872, when the income tax law was repealed. It’s time to repeal it again.

To see how far we’ve come in accepting income taxes as part of the white noise of life, the IRS has announced its “Dirty Dozen” tax avoidance scams. These include hiding income offshore, identity theft, filing false or misleading forms, abuse of charitable giving, abusive retirement plans, and disguised corporate ownership, among a few others.

Quote of the week:

“Taxing oneself into prosperity is like standing in a bucket and lifting yourself up by the handle.”
                                                                                 -Winston Churchill