"I get asked a lot why Apple's customers are so loyal. It's not because they belong to the Church of Mac! That's ridiculous." - Steve Jobs
Clearly Apple is a phenomenon. For those of you with short memories, Steve Jobs grew Apple into a massive market force in the 80's only to be ousted in 1985 and watch the company head almost into bankruptcy. He rejoined the company in 1997 as the interim CEO which he joked made him the iCEO and with his return came the "i" products. These products revolutionized not just Apple but turned the market on its head and created a huge opportunity that the marketing brilliance that was Steve Jobs exploited. Since his death the company has continued its meteoric rise and currently is ranked as the largest company by market capitalization in the world. With a market cap of almost $600 billion it has a huge influence on the movement of the market. In fact over 15% of the market's move this year is accounted for by Apple stock and it makes up over 4.5% of the S&P 500. Over a third of all hedge funds own the stock and of the 39 analysts that follow the stock, 34 rate it as a strong buy.
With almost $100 billion in cash and at a price to earnings ratio of 22 it does not appear by any metric that the stock is expensive. Making billions of dollars a quarter in profit it can afford to pay and has declared a dividend. This along with the news that the company will repurchase $10 billion of stock drove the shares over $600 a piece. So the question that I ask is not whether the stock is worth $600 as fundamentally there are many reasons to answer yes, but rather can the company continue into the future carrying the stock market on its back?
I would answer unequivocally no. Apple's position at the top to me is temporary. A multimedia electronics company has to innovate to remain on top. With Jobs around this appeared to be possible but now that he is gone I would argue their time is limited. The cult that is Apple buyers will not stand by if Apple cannot develop new exciting cutting edge products. As long as the company can roll out these types of products the company can maintain its margins but once they lose their edge all is lost. Already the discerning consumer can purchase products that perform as well as an Apple product for 30% less. To me it is only a matter of time before the company loses its way and thus its generous margins.
Think of Research in Motion as a modern example of a company whose innovations could not keep up with consumer desire. The stock has fallen from well over $100 a share to $13 today. Never in the history of the market has a technology company built on innovative products held the top spot for an extended period for one simple reason, they cannot stay ahead of consumer desire forever. At some point they lose their edge and a competitor comes out with a new product (just as Apple did) and takes market share and erodes the stock value. With the loss of Jobs I feel that this innovative edge is eroded and a time bomb is ticking.
So why my concern about Apple stock? I do not own any and do not own any Apple products so what do I care? I care because so many people's net worth is tied either directly or indirectly to a company that cannot maintain its trajectory for much longer. I doubt it will not fall tomorrow or next week or probably not even next month and maybe not even this year, but at some point it will lose its edge and it will drag the whole market with it. Looking at the share ownership and seeing a lot of hedge funds owning the stock is scary enough. These are fickle folk (I should know as I am one) who are prone to run at the first sign of trouble and this could not only have a large impact on the stock price but I feel it will have a ripple effect on the market.
Keep an eye on Apple as even if you are not an owner of the stock it is and has and will drive the returns of your stock portfolio. This is a fickle market with a fickle leader (Apple). This is not a market built on solid economic fundamentals which is my concern and is another reason that I remain skeptical of the market in general. Think about it, the company at the top of the food chain is a company that relies on consumers to buy products that they do not need, at a massive price multiple above their competitors at a time when consumers around the globe are strapped financially. I expect that as in the past, this will not end well.
Friday, March 30, 2012
Friday, March 23, 2012
How Long Will It Take To Recover?
"The only function of economic forecasting is to make astrology look respectable." - John Kenneth Galbraith
The tongue in cheek quote was from one of the world's most prominent economists, but certainly there is a large dose of reality to it. Trying to predict the future is all but impossible and many a trader longs to be just one minute ahead of the market as untold billions would be made in a very short time. That is what makes forecasting so enticing - when you get it right the world is your oyster and a fortune can be made. More often than not you get it wrong so the bet is hedged with the obvious result of watering down your returns. This is why you so often see a young buck make spectacular returns and then loose it all in a matter of a few years. One big bet on the correct horse and the financial rewards are mouth watering. With all this said I will make my best estimate for the recovery of the economy. The reason that I want to lay this out is that this is (or should be) the basis for investing your portfolio and is the reason why I remain skeptical in the current stock market run.
The first part of the equation is to look at where we have come from and place it in a frame of reference. The economic shock that the world has experienced and continues to work through was on the scale of the Great Depression. It has been labelled the Great Recession as the unemployment and other metrics were not as dire as during the Great Depression due in large part to the massive rounds of quantitative easing performed by the central governments around the world. In fact this quantitative easing is still continuing and looks set to continue for the foreseeable future as without it the global economy would slump back into a recession in fairly short order.
This size of the government stimulant packages have never before been seen. Globally it is crossing more than $5 trillion (by my back of the envelope estimate). Governments around the world are awash with debt that has either been recently created or has been shouldered to rescue banks and other companies from default. This massive shift of debt to governments has caused a unique situation whereby there is a crowding out effect on a global basis. This crowding out (as I mentioned in a previous blog) will dampen global growth by at least 1% per year for years to come. This drag will slow the global economic recovery and will make it seem as if the world is in recession for an extended period.
Studies have shown that a typical time frame to recover from a financial crisis is between 6 and 10 years. Suppose that we take this a starting point and add this to the beginning of the crisis which began in 2008 then we would expect that a "normal" economic environment would start to be felt somewhere between 2014 and 2018. As it is now only 2012 we still have some time to go however it is my expectation that as this crisis is on a scale far larger than most that this recovery will take longer than "normal". Also it is my contention that during this recovery period recessions will be more common place and that recovery periods will be short lived and will feel like we are still in a recession.
Based on my analysis and the studies that I have performed I believe that the stock market while it is still aloft is flying with one wing and that the next economic shock will cost investors dearly. Furthermore I believe that the economy has at least another 5 years to go before we will be able to see quantifiable solid economic data. In the interim the market will wobble along with wild swings in both directions but will always be more susceptible to downside surprises than upside moves.
Look to your portfolio in terms of its risk profile and keep it in low risk ventures or risk taking another beating on your stock investments. Certainly looking at the market it looks like 1987 or 2007 all over again and for those of you that have been around for a while you will know that neither of those years ended very well. As Kevin Flynn of Seeking Alpha noted this week "the market may be escaping, but the economy isn't".
The tongue in cheek quote was from one of the world's most prominent economists, but certainly there is a large dose of reality to it. Trying to predict the future is all but impossible and many a trader longs to be just one minute ahead of the market as untold billions would be made in a very short time. That is what makes forecasting so enticing - when you get it right the world is your oyster and a fortune can be made. More often than not you get it wrong so the bet is hedged with the obvious result of watering down your returns. This is why you so often see a young buck make spectacular returns and then loose it all in a matter of a few years. One big bet on the correct horse and the financial rewards are mouth watering. With all this said I will make my best estimate for the recovery of the economy. The reason that I want to lay this out is that this is (or should be) the basis for investing your portfolio and is the reason why I remain skeptical in the current stock market run.
The first part of the equation is to look at where we have come from and place it in a frame of reference. The economic shock that the world has experienced and continues to work through was on the scale of the Great Depression. It has been labelled the Great Recession as the unemployment and other metrics were not as dire as during the Great Depression due in large part to the massive rounds of quantitative easing performed by the central governments around the world. In fact this quantitative easing is still continuing and looks set to continue for the foreseeable future as without it the global economy would slump back into a recession in fairly short order.
This size of the government stimulant packages have never before been seen. Globally it is crossing more than $5 trillion (by my back of the envelope estimate). Governments around the world are awash with debt that has either been recently created or has been shouldered to rescue banks and other companies from default. This massive shift of debt to governments has caused a unique situation whereby there is a crowding out effect on a global basis. This crowding out (as I mentioned in a previous blog) will dampen global growth by at least 1% per year for years to come. This drag will slow the global economic recovery and will make it seem as if the world is in recession for an extended period.
Studies have shown that a typical time frame to recover from a financial crisis is between 6 and 10 years. Suppose that we take this a starting point and add this to the beginning of the crisis which began in 2008 then we would expect that a "normal" economic environment would start to be felt somewhere between 2014 and 2018. As it is now only 2012 we still have some time to go however it is my expectation that as this crisis is on a scale far larger than most that this recovery will take longer than "normal". Also it is my contention that during this recovery period recessions will be more common place and that recovery periods will be short lived and will feel like we are still in a recession.
Based on my analysis and the studies that I have performed I believe that the stock market while it is still aloft is flying with one wing and that the next economic shock will cost investors dearly. Furthermore I believe that the economy has at least another 5 years to go before we will be able to see quantifiable solid economic data. In the interim the market will wobble along with wild swings in both directions but will always be more susceptible to downside surprises than upside moves.
Look to your portfolio in terms of its risk profile and keep it in low risk ventures or risk taking another beating on your stock investments. Certainly looking at the market it looks like 1987 or 2007 all over again and for those of you that have been around for a while you will know that neither of those years ended very well. As Kevin Flynn of Seeking Alpha noted this week "the market may be escaping, but the economy isn't".
Friday, March 16, 2012
Another Great Week For The Market
"To infinity and beyond!" - Buzz Lightyear
The market continued its state of euphoria this week and seems to be on a straight line to infinity. There certainly is good news out there and the news anchors and market pundits continue to blast every little positive aspect while continuing to downplay the negatives. Apparently Greece is sorted (even though the bond holders took what appears to be a 90% haircut, the biggest sovereign default in history) and now that this has been contained we are all good to go. The US property market seems to be approaching a bottom and unemployment data continues to strengthen. The printing and low interest rates are finally taking hold and things are good to go from here.
If you believe all of that then you have not been reading this blog for long. In all of my years of market trading I have never seen a market that is so manipulated as this one. First off, while the Greek issues may now have been dissolved to a small scale problem, Europe’s problems are not even close to being over. No-one has mentioned Ireland or Portugal for a while (they are being swept under the rug for now) and there is definitely no talk of the giant elephant in the room. While most believed that the elephant in the room was Greece it turns out that it is in fact Spain. While Greece was a problem, with an economy of roughly $305 billion, Spain is a problem of elephant proportions as its economy dwarfs Greece’s at $1.4 trillion. This problem is not going away any time soon but is rapidly bubbling to the surface and if and when it busts it will effectively derail any kind of global recovery.
Looking at the market closer I went to my old friend the options market. Options are a great way to see what money managers think rather than what they are doing. If the good times are rolling and the market truly believes that we are headed higher on a strong economic footing, the calls (options that give the buyer the opportunity to benefit from a rising market) are priced higher than the puts (options that give protection against a falling market). If the reverse occurs then money managers are more eager to protect their downside or believe that the market has a higher probability of falling than it does of rising. At present the December 2014 call options on the S&P 500 with a strike price of 185 are priced around $2.75 apiece. As the market is trading at roughly 140 today that means that the market has to rise almost 30% in almost three years to make the buyer a profit. On the other side of the equation we go to the puts. An equivalent move to the downside is priced at $8.60 apiece. This is more than a 300 percent premium. In other words the market participants believe at present that there is three times more chance of a 30% draw down than there is a 30% appreciation.
Now options prices can change as things improve, but it is clear that while the market continues to steam forward it is not truly supported by the market participants who are spending a lot of money protecting their positions as they believe (just like I do) that a sell off is inevitable and that it may happen in the very near future. What with the excellent move upwards, the presidential election around the corner (will the Republicans ever manage to elect a person to run?) and the global printing presses running at full steam (an experiment that has no precedent and is being implemented by the same folk that gave us the 2000 crash and the 2007 housing bubble), the market has nowhere to go but up. However when the exit doors are opened there will be a stampede.
Friday, March 9, 2012
The Wall Of Worry
"Worrying often gives a small thing a big shadow." - Swedish proverb
Since my last blog I have had the pleasure to do some back and forth emailing with a few money managers and some of my investors over my market stance. Essentially the arguments were that I am either for the market or against the market and at this stage I am paralyzed by a wall of worry and unable to share in the market's current prosperity. People who cannot stay in the market during the bad times are not rewarded when the market runs and miss out on the upside thereby capping any benefit. Furthermore market timing does not work and a buy and hold strategy based on a diversified portfolio is the best option.
Certainly a lot to talk about and all good points so let's get started. On the first point of the wall of worry I am not concerned. There is a lot of worry out there right now; worry about Greece, the Euro imploding, worry about the massive and increasing levels of debt and worry about the unemployment level and potential inflation rates. A lot to worry about however while I agree that there is a lot to be concerned about, there always is a lot to be concerned about so what makes this any different? My answer is that with the large and ever increasing levels of debt that there is a crowding out effect which will slow GDP growth for the foreseeable future. This will result in lower company profits and will result in a lower market. Also we have seen what happens when the government puts its foot into the equation in 2000 and again in 2007. The NASDAQ bubble and the housing bubble (in my view) were both caused by excessive government intervention. This time around to "fix" the problem the same practitioners that gave us 2000 and 2007 are now printing quantities of money that were only dreamed about years ago. If this does not work (and I believe that the odds are skewed against a success) then we will really be in trouble so going into the market right now is not the best option.
On the buy and hold and diversified portfolio argument I would say that investing in the stock market should be part of MOST people's portfolio but does not have to be looked upon as a necessity. If you rewind the clock 20 years the S&P500 stood at 442 and now stands at roughly 1,350. This is a 908 point move and is up over 200 percent. Impressive number to be sure, but when you factor in that this occurred over 20 years the compound annual rate of return is around 5.5% per year. Not so good! Now when you consider that this does not take into account the massive market swings and assumes that you invested in 1992 and held until today factoring in the market volatility as risk and the risk adjusted return is minimal and no better than bonds. Furthermore, when you look and see that the market accelerated to 1,530 by November 2000 and still has to recover to that level but has dipped down to 667 in March 2008 the chance of you holding right through that without taking something off the table is a long shot. If you had to sell at the bottom in 2003 like many people did your return for the period would be less than 3% per year.
My view is to try to seek places where the odds are in your favor and invest accordingly. As such with the market closing on all time highs, GDP growth up less than 65% during the same period and a poor outlook, it is time to look elsewhere for returns. I traded the market very successfully in 2009 after the meltdown, struggled in 2010 and looking forward saw more of the same so I decided it better to exit. Looking back it was one of the best decisions that I have ever made. In the interim property prices have collapsed and I believe that if you want to start to invest anywhere that you should look at this as an opportunity rather than blindly placing money into a stock investment that really has not produced the returns promised.
In addition I do not think that the majority of people's stock portfolio keeps up with the index return. Remember that not only does the index re balance regularly at which time the shoddy companies are jettisoned for better companies thereby creating upside bias to the returns, but with the cost of trading and investing mixed into this virtually every investor will not keep up with the market. This typically knocks off more than 1% a year off returns meaning that stocks have performed poorly for an extended period. In hindsight it would have been far better to pay off your credit cards or the mortgage on your house which provides a guaranteed return far higher than that of the market rather than taking the extra cash and blindly plowing it into the market.
But what if you have paid off your credit cards and have a decent positive net worth? My view is that you should sit down with your portfolio manager and review your portfolio on a true risk adjusted basis to ensure that the returns expected meet your desired risk. I would be surprised if you do not adjust your portfolio after this review. In addition I would look to alternative investments rather than just the stock market for return. For those of you trading and speculating I wish you luck and keep the downside protected. As for me? I am born to trade so I will be back but for now I plan to sit on my fingers rather than watch them get burned in the fire.
Since my last blog I have had the pleasure to do some back and forth emailing with a few money managers and some of my investors over my market stance. Essentially the arguments were that I am either for the market or against the market and at this stage I am paralyzed by a wall of worry and unable to share in the market's current prosperity. People who cannot stay in the market during the bad times are not rewarded when the market runs and miss out on the upside thereby capping any benefit. Furthermore market timing does not work and a buy and hold strategy based on a diversified portfolio is the best option.
Certainly a lot to talk about and all good points so let's get started. On the first point of the wall of worry I am not concerned. There is a lot of worry out there right now; worry about Greece, the Euro imploding, worry about the massive and increasing levels of debt and worry about the unemployment level and potential inflation rates. A lot to worry about however while I agree that there is a lot to be concerned about, there always is a lot to be concerned about so what makes this any different? My answer is that with the large and ever increasing levels of debt that there is a crowding out effect which will slow GDP growth for the foreseeable future. This will result in lower company profits and will result in a lower market. Also we have seen what happens when the government puts its foot into the equation in 2000 and again in 2007. The NASDAQ bubble and the housing bubble (in my view) were both caused by excessive government intervention. This time around to "fix" the problem the same practitioners that gave us 2000 and 2007 are now printing quantities of money that were only dreamed about years ago. If this does not work (and I believe that the odds are skewed against a success) then we will really be in trouble so going into the market right now is not the best option.
On the buy and hold and diversified portfolio argument I would say that investing in the stock market should be part of MOST people's portfolio but does not have to be looked upon as a necessity. If you rewind the clock 20 years the S&P500 stood at 442 and now stands at roughly 1,350. This is a 908 point move and is up over 200 percent. Impressive number to be sure, but when you factor in that this occurred over 20 years the compound annual rate of return is around 5.5% per year. Not so good! Now when you consider that this does not take into account the massive market swings and assumes that you invested in 1992 and held until today factoring in the market volatility as risk and the risk adjusted return is minimal and no better than bonds. Furthermore, when you look and see that the market accelerated to 1,530 by November 2000 and still has to recover to that level but has dipped down to 667 in March 2008 the chance of you holding right through that without taking something off the table is a long shot. If you had to sell at the bottom in 2003 like many people did your return for the period would be less than 3% per year.
My view is to try to seek places where the odds are in your favor and invest accordingly. As such with the market closing on all time highs, GDP growth up less than 65% during the same period and a poor outlook, it is time to look elsewhere for returns. I traded the market very successfully in 2009 after the meltdown, struggled in 2010 and looking forward saw more of the same so I decided it better to exit. Looking back it was one of the best decisions that I have ever made. In the interim property prices have collapsed and I believe that if you want to start to invest anywhere that you should look at this as an opportunity rather than blindly placing money into a stock investment that really has not produced the returns promised.
In addition I do not think that the majority of people's stock portfolio keeps up with the index return. Remember that not only does the index re balance regularly at which time the shoddy companies are jettisoned for better companies thereby creating upside bias to the returns, but with the cost of trading and investing mixed into this virtually every investor will not keep up with the market. This typically knocks off more than 1% a year off returns meaning that stocks have performed poorly for an extended period. In hindsight it would have been far better to pay off your credit cards or the mortgage on your house which provides a guaranteed return far higher than that of the market rather than taking the extra cash and blindly plowing it into the market.
But what if you have paid off your credit cards and have a decent positive net worth? My view is that you should sit down with your portfolio manager and review your portfolio on a true risk adjusted basis to ensure that the returns expected meet your desired risk. I would be surprised if you do not adjust your portfolio after this review. In addition I would look to alternative investments rather than just the stock market for return. For those of you trading and speculating I wish you luck and keep the downside protected. As for me? I am born to trade so I will be back but for now I plan to sit on my fingers rather than watch them get burned in the fire.
Friday, March 2, 2012
The Stock Market Conundrum
"Don't be afraid of a little opposition. Remember that the "Kite" of Success generally rises against the wind of adversity - not with it." - Napoleon Hill
The stock market is causing many investors a conundrum as to whether to jump on the band wagon and potentially get beaten up in a draw down or whether to take the pain of watching "everyone else" make money while they sit on the sideline. It is one of the hardest lessons to learn and even seasoned traders can get sucked into the market at just the wrong time.
With the market on a one way ticket to infinity it is hard to sit on the sidelines but honestly I believe that is your best alternative. Let's start at the top with JP Morgan. This week's article reiterated their full year projection for the S&P 500 of 1,430. Currently the index stands at around 1,370 so for the rest of the year JP Morgan estimates that the market will rise another 4.40%. Hardly something to get excited about, particularly if you consider all the risks of getting that return especially when you know where to go to get a guaranteed 4% return.
Another article I read this week pointed to the rapid price increase in high yield debt, or junk debt. The investment banks are buying billions of dollars worth of this junk pushing the prices up and the yields down. One banker was quoted as saying that after considering the risk that a 7% return on these investments was warranted. It was not long ago that this debt was yielding north of 30%! This is a big side effect of cheap money and low interest rates. More and more money is starting to be attracted to high risk investments in search of yield. The price of these assets is soaring, increasing the risk further. It appears that we are starting to enter a new bubble that is once again being created by cheap money and this is worrisome.
The stock market is a huge benefactor of cheap money. Margin borrowing costs drop spurring additional investment. The risk trade is put on and this drives valuations higher. Certainly a lot of the expansion of stock prices is based on the assumption that cheap money leads to increased company profits but this argument is starting to lose steam as the market has had the benefit of low interest rates for the past three years.
Another benefactor of cheap money are commodities. In addition to this oil supply contractions and disruptions have caused the price of oil to spike. This in turn has pushed the price at the pump up at an alarming rate. Here in Southern California the cost is rapidly approaching $5 a gallon and this will start to severely crimp consumer spending on discretionary items like entertainment and travel. It will also start to negatively impact profits at airline and transportation companies. Weakness in the transporters and materials have pointed to at least a 5% stock market contraction however based on the poor economic fundamentals I would not be surprised to see a larger contraction.
There is some good news to offset all of this poor news and that is the job market continues to pick up steam. There is plenty of evidence to show that the numbers published by the government are not capturing a large portion of unemployed workers who have given up finding a job. Furthermore the employment number stands at 63% of the population which is a historic low number, but there does seem to be an improvement here. Furthermore this should allow the Federal Reserve to keep interest rates at their historic low for the foreseeable future as the inflation number tracked by them does not include oil and food prices. Therefore the excess capacity of workers will keep wages down for now and that will allow the Fed to continue to stick its head in the sand and pretend that inflation does not exist.
All of this said I would not be a buyer of the market here as I feel that we have come too far too fast on the back of a lot of speculation and little in the way of tangible economic successes. Furthermore the drag on the economy of the massive government debt levels will continue to be felt for years to come so GDP growth does not justify the recent stock market successes. With 4% of upside and the possibility of a large downside I believe that your best option is to move to the sidelines once again and wait to see what happens.
The stock market is causing many investors a conundrum as to whether to jump on the band wagon and potentially get beaten up in a draw down or whether to take the pain of watching "everyone else" make money while they sit on the sideline. It is one of the hardest lessons to learn and even seasoned traders can get sucked into the market at just the wrong time.
With the market on a one way ticket to infinity it is hard to sit on the sidelines but honestly I believe that is your best alternative. Let's start at the top with JP Morgan. This week's article reiterated their full year projection for the S&P 500 of 1,430. Currently the index stands at around 1,370 so for the rest of the year JP Morgan estimates that the market will rise another 4.40%. Hardly something to get excited about, particularly if you consider all the risks of getting that return especially when you know where to go to get a guaranteed 4% return.
Another article I read this week pointed to the rapid price increase in high yield debt, or junk debt. The investment banks are buying billions of dollars worth of this junk pushing the prices up and the yields down. One banker was quoted as saying that after considering the risk that a 7% return on these investments was warranted. It was not long ago that this debt was yielding north of 30%! This is a big side effect of cheap money and low interest rates. More and more money is starting to be attracted to high risk investments in search of yield. The price of these assets is soaring, increasing the risk further. It appears that we are starting to enter a new bubble that is once again being created by cheap money and this is worrisome.
The stock market is a huge benefactor of cheap money. Margin borrowing costs drop spurring additional investment. The risk trade is put on and this drives valuations higher. Certainly a lot of the expansion of stock prices is based on the assumption that cheap money leads to increased company profits but this argument is starting to lose steam as the market has had the benefit of low interest rates for the past three years.
Another benefactor of cheap money are commodities. In addition to this oil supply contractions and disruptions have caused the price of oil to spike. This in turn has pushed the price at the pump up at an alarming rate. Here in Southern California the cost is rapidly approaching $5 a gallon and this will start to severely crimp consumer spending on discretionary items like entertainment and travel. It will also start to negatively impact profits at airline and transportation companies. Weakness in the transporters and materials have pointed to at least a 5% stock market contraction however based on the poor economic fundamentals I would not be surprised to see a larger contraction.
There is some good news to offset all of this poor news and that is the job market continues to pick up steam. There is plenty of evidence to show that the numbers published by the government are not capturing a large portion of unemployed workers who have given up finding a job. Furthermore the employment number stands at 63% of the population which is a historic low number, but there does seem to be an improvement here. Furthermore this should allow the Federal Reserve to keep interest rates at their historic low for the foreseeable future as the inflation number tracked by them does not include oil and food prices. Therefore the excess capacity of workers will keep wages down for now and that will allow the Fed to continue to stick its head in the sand and pretend that inflation does not exist.
All of this said I would not be a buyer of the market here as I feel that we have come too far too fast on the back of a lot of speculation and little in the way of tangible economic successes. Furthermore the drag on the economy of the massive government debt levels will continue to be felt for years to come so GDP growth does not justify the recent stock market successes. With 4% of upside and the possibility of a large downside I believe that your best option is to move to the sidelines once again and wait to see what happens.
Friday, February 24, 2012
Is Immigration A Good Thing?
"America was indebted to immigration for her settlement and prosperity. That part of America which had encouraged them most had advanced most rapidly in population, agriculture and the arts." - James Madison
In order to spark some debate in the United States there are a few hot buttons. One is abortion, another is student loans, another is the state of the economy and still another is immigration. I recently read a very interesting article that sides with allowing more immigration into the world's rich countries. This is contrary to most schools of thought and certainly against the wishes of congress, so I thought I would provide the other side of the argument to tweak your interest as there is definitely some merit to allowing more immigration.
Some of the most successful modern economies of the world are a direct result of immigration. Immigrants either settled or were exported to Australia and America just to mention a few obvious ones. Currently however both of these countries are avid supporters of stiffer immigration requirements in order to protect the jobs of the local worker. This argument goes that by keeping immigrants out, there is more work for the local residents. The merit of this argument is questionable as a lot of the work that immigrants perform locals would not do such as janitorial or construction labor work. Recently there was a Business Week article posted how Americans will not do the dirty work and rely on immigrants to perform these tasks. That aside immigrants have far greater benefit to rich economies than performing just the grunt work. Looking back in history the evidence is clear by looking at the success of those countries which grew into modern successful economies on the back of those original immigrants. So keeping the immigrants out it is very short sighted.
Furthermore when immigrants migrate to a new country they create Diasporas or groups of people that share a common bond on their original country. The Huguenots, Scotts, Jews and British are great examples. These groups provide a good economic base from which to gain a foothold in the new country. Once established they then provide a wonderful link back to the original country as not only do they understand the local customs and language, but they can find gaps in the market that can be filled with exports from their new home. This business expansion provides jobs to locals and helps the economy grow. It has been shown that immigrants are very successful at opening new markets for their new country.
A study shows that more than 3% of the world's total population are immigrants. If this were a nation it would be larger than Brazil in terms of population. With this large a mass of people international trade becomes far easier. Knowledge of local cultures is of critical importance in international trade. Just ask anyone who has tried to break into China or Japan. I remember a relative of mine tried to expand from South Africa to Australia expecting that the cultures were similar. How wrong he was and while the business remained successful and thrived in South Africa it fell flat in Australia. Had he had an Australian immigrant to show him the ropes things may have turned out differently.
Rich economies are constantly training foreigners in their ways. Not only do we spend a fortune educating them we also spend a fortune teaching them our ways of trade and finance. The amazing part of the equation is that once we have trained and educated them we often send them home. A large swath of innovative ideas are thought of by this group of people and these ideas are repatriated to their countries. Keeping them in the country that educated them would help stimulate growth. Think about this, a person that has the capacity and drive to leave their home country and explore the world is far more likely to think outside the box than a local who has never left their county. Rich nations need this edge to remain competitive.
Obviously opening borders to let anyone enter is absurd particularly if you are a rich nation bordered by poor ones. The flood of people would overwhelm the system and bring with it a lot of the dregs of society that no country wishes to house. That said closing the borders and keeping everyone out is a loosing battle that is very short sighted when you consider the benefits of recruiting highly skilled entrepreneurial people from other countries. China is rapidly overtaking the United States in innovation. To me this is a direct result of education being provided in the United States being exported back to China rather than trying to employ these engineers to innovate in the United States and maintaining the benefit long past the school tuition costs. Think of it in terms of sport. Recruiters spend countless hours scouring the world for the next big talent, why not do the same in business? Well it is done in business however many times companies find the talent and then are unable to bring that talent in house as the laws prevent them from doing so.
This is a very politically charged situation. Opening the doors to immigrants while unemployment is high is political suicide, however exporting talent that we created back to their countries is short sighted and gives our competitor nations an edge. Immigration will always be a problem area, but we should consider letting more of the A-team in.
In order to spark some debate in the United States there are a few hot buttons. One is abortion, another is student loans, another is the state of the economy and still another is immigration. I recently read a very interesting article that sides with allowing more immigration into the world's rich countries. This is contrary to most schools of thought and certainly against the wishes of congress, so I thought I would provide the other side of the argument to tweak your interest as there is definitely some merit to allowing more immigration.
Some of the most successful modern economies of the world are a direct result of immigration. Immigrants either settled or were exported to Australia and America just to mention a few obvious ones. Currently however both of these countries are avid supporters of stiffer immigration requirements in order to protect the jobs of the local worker. This argument goes that by keeping immigrants out, there is more work for the local residents. The merit of this argument is questionable as a lot of the work that immigrants perform locals would not do such as janitorial or construction labor work. Recently there was a Business Week article posted how Americans will not do the dirty work and rely on immigrants to perform these tasks. That aside immigrants have far greater benefit to rich economies than performing just the grunt work. Looking back in history the evidence is clear by looking at the success of those countries which grew into modern successful economies on the back of those original immigrants. So keeping the immigrants out it is very short sighted.
Furthermore when immigrants migrate to a new country they create Diasporas or groups of people that share a common bond on their original country. The Huguenots, Scotts, Jews and British are great examples. These groups provide a good economic base from which to gain a foothold in the new country. Once established they then provide a wonderful link back to the original country as not only do they understand the local customs and language, but they can find gaps in the market that can be filled with exports from their new home. This business expansion provides jobs to locals and helps the economy grow. It has been shown that immigrants are very successful at opening new markets for their new country.
A study shows that more than 3% of the world's total population are immigrants. If this were a nation it would be larger than Brazil in terms of population. With this large a mass of people international trade becomes far easier. Knowledge of local cultures is of critical importance in international trade. Just ask anyone who has tried to break into China or Japan. I remember a relative of mine tried to expand from South Africa to Australia expecting that the cultures were similar. How wrong he was and while the business remained successful and thrived in South Africa it fell flat in Australia. Had he had an Australian immigrant to show him the ropes things may have turned out differently.
Rich economies are constantly training foreigners in their ways. Not only do we spend a fortune educating them we also spend a fortune teaching them our ways of trade and finance. The amazing part of the equation is that once we have trained and educated them we often send them home. A large swath of innovative ideas are thought of by this group of people and these ideas are repatriated to their countries. Keeping them in the country that educated them would help stimulate growth. Think about this, a person that has the capacity and drive to leave their home country and explore the world is far more likely to think outside the box than a local who has never left their county. Rich nations need this edge to remain competitive.
Obviously opening borders to let anyone enter is absurd particularly if you are a rich nation bordered by poor ones. The flood of people would overwhelm the system and bring with it a lot of the dregs of society that no country wishes to house. That said closing the borders and keeping everyone out is a loosing battle that is very short sighted when you consider the benefits of recruiting highly skilled entrepreneurial people from other countries. China is rapidly overtaking the United States in innovation. To me this is a direct result of education being provided in the United States being exported back to China rather than trying to employ these engineers to innovate in the United States and maintaining the benefit long past the school tuition costs. Think of it in terms of sport. Recruiters spend countless hours scouring the world for the next big talent, why not do the same in business? Well it is done in business however many times companies find the talent and then are unable to bring that talent in house as the laws prevent them from doing so.
This is a very politically charged situation. Opening the doors to immigrants while unemployment is high is political suicide, however exporting talent that we created back to their countries is short sighted and gives our competitor nations an edge. Immigration will always be a problem area, but we should consider letting more of the A-team in.
Friday, February 17, 2012
Fix The House And You Fix The Mess
"I'm living so far beyond my income that we may almost be said to be living apart." - E.E. Cummings
As I have mentioned in many previous blog posts that in order for the economy to turn and get on a solid footing there has to be a recovery in real estate. The real estate market makes up more than 10% of total GDP and when you factor in all the subsidiary businesses that number increases to more than 15%. It is one of the largest employers in the United States and provides most of the world with their nest egg. A continually depreciating housing market points to trouble and unless we can solve this one problem there will be a long period of slow growth ahead.
The problem with falling prices is that they exacerbate the problem. Irving Fisher was a Yale University professor who published a paper in 1933 entitled "The Debt-Deflation Theory of Great Depressions." In this paper he produced the theory that the pressure from excessive debt forces distressed selling by creditors which results in a broad decline in asset values, profit, output and employment. The problem is that while asset values shrink the level of debt remains fixed. As long as prices continue to decline there is a larger and larger incentive to default on the debt and walk away from the asset. The lender takes the asset back but the value of this asset is now less than the balance owed so they rush to offload the asset dragging the price lower thereby setting off more defaults. We are seeing this first hand at present and the cycle has yet to end mainly due to the problem of over-leverage.
Banks at the peak of the market got greedy for fee income and loosened the underwriting standards just at the time that they should have been tightening them. The result is that they are now having to write-off billions in mortgage values. This is crimping their balance sheets and so the Federal Reserve is providing them with capital. Even so the banking industry is still reeling from the mess and and have now been forced to tighten the underwriting criteria making it harder and harder for a strapped consumer to obtain a loan. This reduces the demand for housing resulting in continued prices declines.
This will all come to an end once the price of housing falls to a level where it pays to buy over rent and I believe that we are rapidly approaching that level, however as with most falling markets it does not reach a rational price and stop. It often overshoots the mark before turning around however once the market prices are too low this creates demand from speculators and investors. If we take a look at the current inventory of housing that is underwater (the owners owe more than the house is worth) it will take at least another two or three years to clear out this inventory before pricing stability is achieved.
Another fly in the ointment is the Federal Housing Administration (FHA) insured loans. One of the outfalls of the housing crisis was the bankruptcy of private mortgage insurers so the FHA stepped in. To date the FHA has backed more than $1.1 trillion in home loans. Without this backing the housing crisis would have been exacerbated but now it appears that the FHA itself may be severely short of funding to handle this level of burden. Some analysts estimate that the FHA is more than $50 billion in a hole while others estimate that number to be closer to $100 billion. Unless the housing market can stabilize this could be another disaster waiting to happen and one in which the taxpayer will once again be on the line to pay for. Removing the support of the FHA will undermine any recovery in the real estate market as lenders will be even more skittish to lend than they currently are.
On the plus side interest rates are at historic lows. This means that those that can afford to buy a house are paying as little in interest as has ever been recorded. This has always been a catalyst to house price appreciation and I believe that it will once again assist in supporting the market however it is the lack of liquidity that is the current constraint. Tied to that is a high level of unemployment and this nasty combination is causing the drag on the housing recovery. I remember a number of years ago the Economist magazine writing that the world property markets had increased by over $30 trillion. While a lot of that gain has been eliminated the hangover from that party will drag on for a while and cannot be repaired by a few trillion dollars of Federal Reserve input.
Keep a close eye to the data that comes out of this sector as an indication that the market is on a strong footing will point to good times ahead however the economic indicators are pointing to a long period of slow growth ahead of us and one that has plenty of potholes to derail any form of a recovery.
As I have mentioned in many previous blog posts that in order for the economy to turn and get on a solid footing there has to be a recovery in real estate. The real estate market makes up more than 10% of total GDP and when you factor in all the subsidiary businesses that number increases to more than 15%. It is one of the largest employers in the United States and provides most of the world with their nest egg. A continually depreciating housing market points to trouble and unless we can solve this one problem there will be a long period of slow growth ahead.
The problem with falling prices is that they exacerbate the problem. Irving Fisher was a Yale University professor who published a paper in 1933 entitled "The Debt-Deflation Theory of Great Depressions." In this paper he produced the theory that the pressure from excessive debt forces distressed selling by creditors which results in a broad decline in asset values, profit, output and employment. The problem is that while asset values shrink the level of debt remains fixed. As long as prices continue to decline there is a larger and larger incentive to default on the debt and walk away from the asset. The lender takes the asset back but the value of this asset is now less than the balance owed so they rush to offload the asset dragging the price lower thereby setting off more defaults. We are seeing this first hand at present and the cycle has yet to end mainly due to the problem of over-leverage.
Banks at the peak of the market got greedy for fee income and loosened the underwriting standards just at the time that they should have been tightening them. The result is that they are now having to write-off billions in mortgage values. This is crimping their balance sheets and so the Federal Reserve is providing them with capital. Even so the banking industry is still reeling from the mess and and have now been forced to tighten the underwriting criteria making it harder and harder for a strapped consumer to obtain a loan. This reduces the demand for housing resulting in continued prices declines.
This will all come to an end once the price of housing falls to a level where it pays to buy over rent and I believe that we are rapidly approaching that level, however as with most falling markets it does not reach a rational price and stop. It often overshoots the mark before turning around however once the market prices are too low this creates demand from speculators and investors. If we take a look at the current inventory of housing that is underwater (the owners owe more than the house is worth) it will take at least another two or three years to clear out this inventory before pricing stability is achieved.
Another fly in the ointment is the Federal Housing Administration (FHA) insured loans. One of the outfalls of the housing crisis was the bankruptcy of private mortgage insurers so the FHA stepped in. To date the FHA has backed more than $1.1 trillion in home loans. Without this backing the housing crisis would have been exacerbated but now it appears that the FHA itself may be severely short of funding to handle this level of burden. Some analysts estimate that the FHA is more than $50 billion in a hole while others estimate that number to be closer to $100 billion. Unless the housing market can stabilize this could be another disaster waiting to happen and one in which the taxpayer will once again be on the line to pay for. Removing the support of the FHA will undermine any recovery in the real estate market as lenders will be even more skittish to lend than they currently are.
On the plus side interest rates are at historic lows. This means that those that can afford to buy a house are paying as little in interest as has ever been recorded. This has always been a catalyst to house price appreciation and I believe that it will once again assist in supporting the market however it is the lack of liquidity that is the current constraint. Tied to that is a high level of unemployment and this nasty combination is causing the drag on the housing recovery. I remember a number of years ago the Economist magazine writing that the world property markets had increased by over $30 trillion. While a lot of that gain has been eliminated the hangover from that party will drag on for a while and cannot be repaired by a few trillion dollars of Federal Reserve input.
Keep a close eye to the data that comes out of this sector as an indication that the market is on a strong footing will point to good times ahead however the economic indicators are pointing to a long period of slow growth ahead of us and one that has plenty of potholes to derail any form of a recovery.
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