Dead Man's Party

"It's a dead man's party, who could ask for more, everybody's coming leave your body at the door, leave your body and soul at the door." - some of the lyrics to Oingo Boingo's song Dead Man's Party

Its Halloween today, one of my son's favorite days (he is Sherlock Holmes today), so I had to look up the origin of the day and it turns out as usual there is much debate on this topic.  What is agreed upon is that it initiates the triduum of Allhallowtide which is the time in the liturgical year dedicated to remembering the dead.  As spooky and scary is the theme of most Halloween parties I find it amusing that the scariest game in town right now are the global markets and by markets I am not just referring to the stock market I am including the commodity markets as well.

As of this moment the S&P 500 is breaking to new all-time highs, gold and silver are down 5.7% and 8.0% respectively in three days, oil has fallen more than 20% this year (a bear market) as have corn and soybeans, housing after an initial rally has seen its luster fade; all this while interest rates hover at multi-year lows.  Fortunately I am completely agnostic to market movements so while I continue to prosper I can feel the workings of something larger than what appears on the surface lurking around.

Certainly with the price of oil and the grains falling it should relieve some of the stress on the consumer.  I have to say that I am rather enjoying gasoline at $3.40 a gallon down from almost $5.00 a gallon a year or so ago.  Business also seems to be picking up in most of the sectors that I am invested and overall 2014 is turning out to be a fairly good year for me so I am not complaining in the least.  The Federal Reserve ended its quantitative easing this month and the stock market, rather than implode, is making new highs.  Conventional wisdom it seems is out of the window as $4 trillion of stimulus has not produced inflation (in fact there is even talk of global deflation), the dollar continues to strengthen daily and interest rates are still exceedingly low.  How is this even possible or are we at a dead man's party?

Never in the history of the globe has such a large amount of financial stimulus been tried and I am certain that the Federal Reserve officials are patting themselves on their backs right now.  History seems to have been defeated and a new era of economic prosperity is upon us, or so they would have us all believe.  What I will say is that for now it does seem to be working but while they have said that quantitative easing is over they are still stimulating the economy to the tune of $40 billion a month (roughly) in that they are not letting their balance sheet shrink.  As they have a $4 trillion investment portfolio of debt roughly $40 billion is maturing each and every month and for now this is being reinvested.

With Europe still extremely weak, Japan in trouble and China slowing down it is no wonder that the dollar is charging.  This is more a factor of external global weakness than a celebration of the economic policies of the Federal Reserve.  It once again appears that there is time to reduce their $4 trillion portfolio and to me they should take this opportunity.  The reason that they will not is that the labor market is still weak and there are fears that the rest of the world will export deflation.  While I can understand these concerns I believe that it is more important to take the opportunity to put some powder back in the barrel for another time as it will come and then it would be nice to have something to fall back on.  For now though let the dead man's party roll on, what do you say my dear Watson?

Paradise

"He that does good for good's sake seeks neither paradise not reward, but he is sure of both in the end." - William Penn

It is another perfect day in paradise here in San Diego.  We have not had a day with temperature below 70F since May 27 and today is no exception.  It will be total shock to the system when we have a day that breaks this streak and last night I had to actually pull a very light blanket on the bed around 3 am as it was a touch chilly!  While this is all happening there is a growing problem - lack of water.  Starting in November water restrictions will be in full force and this will impact many everyone from farmers to people watering their yards.  As I look outside my window I can see massive digging equipment and trucks that are laying the pipeline for San Diego's desalinization plant water pipe so something is being done to alleviate the stress of the low water table but there are plenty opposed to the idea.

As these thoughts wander through my brain I am drawn to conclude that the stock market is much the same.  On the surface everything seems absolutely perfect.  The pesky volatility of last week has been replaced with "business as usual" as the market recovered most of the losses this week.  In a meeting I had last night I was informed by the lieutenants leading the investment sales charge for some large institutions that all was good and that 18,000 on the Dow Jones Industrial Average was only a matter of time and could even happen by year end!  That would be roughly 1,300 points higher from here or roughly 8% rally in two months.  Reasons given for the rally to continue were that the economy is out of the woods, unemployment is falling, businesses are making a lot of money AND don't forget that it is the only game in town!  With most individuals ignorant to the risks and believing this pitch is in no wonder so many lose their shirts in the market.

Taking a look at a chart of the market and it certainly looks like it could move that high in that short amount of time, so who am I to argue?  The reason that I am not in the stock market is because I have always felt and do so now even more strongly that the current policies that have ignited the massive run in the market are the same policies that will be the undoing of the market.  While I agree that some headway has been made, the amount of headway (or lack there of) is minimal for the amount of money that was thrown at the problem.  The reason for the lack of headway is the same reason that is undermining the market's future and that is every dollar used to support the market is a wasted dollar and the impact of that dollar on driving the market higher becomes less and less with every new dollar printed.  At some point the market will wake up to the fact that the whole thing is a fictitious game and will implode.  Does this happen tomorrow or in a decade, I cannot tell you but what I do know is that there are alternatives in which to invest (which is what I have done) that are outside of the risk of the stock market and that should benefit from a market correction while continuing to produce great returns in the interim.  Unfortunately the arm of sales people continue to promote only stocks and bonds and so most will be impacted by the unwinding of the great Federal Reserve experiment.

So to me the market is akin to San Diego's weather, on the surface it seems perfect (a direct line to infinity) but rain (volatility and a decent correction) is needed badly to right the situation.  The problem is that investors are being sold on the idea that it will never rain and if it does that they will not get wet (they will either get out in time or the Federal Reserve will save them).  Unless you are 8 years old and still believe that you can dodge rain I am here to say that if you are exposed to the stock market your chances of not getting wet are slim to none and once again you are being sold down the river as there is no magic here and the reality will hurt.  Take the time to turn to alternatives, you will be glad that you did.

Volatility - Good or Bad?

"Well you see Norm, it's like this. A herd of buffalo can only move as fast as the slowest buffalo.  And when the herd is hunted, it's the slowest and eakest ones at te back that are killed first.  This natural selection is good for the herd as a whole, because the general speed and health of the whole group keeps improving by the regular killing of the weakest members.  In much the same way, the human brain can only operate as fast as the slowest brain cells.  Now, as we know, excessive intake of alcohol kills brain cells.  But naturally, it attacks the slowest and weakest brain cells first.  In this way, regular consumption of beer eliminates the weaker brain cells, making the brain a faster and more efficient machine.  And that, Norm is why you always feel smarter after a few beers." - Buffalo Theory as explain by Cliff Clavin of the television show Cheers.

As we have all noticed the volatility in the stock market has increased dramatically in October.  At one point the market had fallen more than 8% in less than a month and yet today it appears that the rally is still intact.  With one day down the next up and most days with moves of more than 1% it is enough to scare anyone, the question then is what is this volatility telling us and is it good or bad?

Life is full of volatility; the daily ups and downs not to mention illnesses from which you recover or challenges that cause stress all normally result in a stronger individual both physically and mentally.  Some time the volatility is so intense that the person never recovers but these cases are relatively rare.  In general the human race has evolved by taking on the challenges of volatility, learning from these challenges and becoming stronger.  As 21st century humans our bodies are immune to many diseases that killed many people in the early 1900's simply because nature passes along the antibodies from previous generations.  Furthermore the volatility caused by new diseases has resulted in many medical breakthroughs along with significant improvements in cleanliness and treatment processes so for all intents and purposes volatility in nature is a good thing.

Turning to the economy it is human nature to try to smooth out volatility.  The Federal Reserve is hell bent on giving businesses a smooth ride and making sure that everyone has jobs all the time.  This goal unfortunately has the side effect of increasing the volatility.  Certainly there are periods when volatility remains under control but this provides a false sense of security.  During these periods businesses and individuals assume that the smooth ride will continue forever and invest accordingly.  Risk is perceived to be insignificant so ever larger bets are made based on the false perception.  For this reason when the dam wall breaks there is an increased level of volatility for which hardly anyone seems to be prepared.  The lack of preparation creates significantly more volatility as companies and individuals are forced to exit investments en mass creating a route that is far larger than it would have been had the market been left to its own devices in the first place.

By removing the normal levels of market volatility there is increased stress on the system and hence there are major market collapses.  Given the mantra of central bankers across the globe to erase volatility and given the large amounts of money being pumped daily into the globe by central bankers in an effort to calm volatility it is clear from the recent market gyrations that not all is healthy and that we may be in for a long period of turmoil.  One thing that you can bet on is that the authorities are not going to stand aside and let volatility rear its ugly head without trying another futile round of quantitative easing.  They will return with a "new" quick fix program, one that will create a bigger explosion at the end of the line.

For now however enjoy the fact that the United States markets are (at least for the moment) being left to their own devices and as you can see lower may be the order of the day.  That said I would not be surprised to see the Federal Reserve step in once more if we enter a proper correction which is a mere 5% lower from here.  The problem is that this support is futile and does not provide jobs but will create an even larger problem in the years ahead.

Yeee Ha!

"If you think bull riding isn't intense, come sit on his back and try on my saddle.  This ain't for tenderfoots." - Clancy Jean Driscoll

With volatility picking up this week it is like riding a bull in the rodeo.  With 3 days of the past four (today has yet to really begin) and 6 of the past 8 having more than a 1% up or down day things are really rocking.  Volatility of this sort has not been seen in a while and shows a struggle between the bulls and the bears to establish domination.  The bulls are not going to give up without a fight and the bears expect a correction as the Federal Reserve's safety net has been removed.

Who will win is anyone's guess but if the past is any indication each time the Federal Reserve has removed the safety net the market has corrected at least 10%.  Each time this has happened they have stepped back into the arena to print more money and support the market.  The question is will they do it again and I have to believe that if there is a correction of that magnitude that they will.  Housing is still in the doldrums and although unemployment has fallen below 6% (according to the Federal Reserve) most Americans still feel like they are in a recession.  So the only metric that is working in the Feds favor is the meteoric rise of the stock market and I believe that barring any unforeseen circumstances that they will try to prop that up one more time.

The question is then how do they ever exit the quantitative easing strategy without there being any pain?  The answer of course is that there is no way out without causing some if not a large amount of pain.  The problem is that the American people vote with their wallets and so any pain will result in a change at the top and with an election year coming right up it will be interesting to see just how independent the Federal Reserve is.  Once again, if the past is any indication they will bend to the politicians but at some point this lunacy of printing money has to stop and as in all cases the sooner the better.

Its All About the Jobs

"Its a recession when your neighbor losses his job; its a depression when you lose your own."- Harry S. Truman

Today the market is recovering some of its previous week's losses on the back of some heady employment numbers.  The headline unemployment number fell to 5.9% finally breaking the 6% barrier and the underemployed number fell to just below 12%.  Both of these numbers are encouraging as more people employed means more wages and therefore more spending power for the demographic that makes up roughly 70% of United States GDP.

Increased employment numbers however do not necessarily lead to more consumer spending.  If the hours worked per employee fall or if wage rates fall then this can offset the growth in labor but fortunately both of these metrics improved.  Average number of hours worked per week increased to 34.6 from 34.5 and aggregate earnings increased 0.5%.  These are hardly numbers to get too excited about but at least it does point to increased consumer spending in the coming months.

The only fly in the ointment (and it is quite a big one) was that of the 236,000 jobs gained in the private sector 97,000 came from a decline in the labor force.  What this means is that more people gave up looking for work and non of the discouraged workers (those who have given up looking) came back into the labor force.  Had this number remained the same the unemployment number would not have moved.

So once again while the market celebrates the gains in unemployment the underlying current is continued slow growth.  Fortunately the United States is growing (unlike Europe) but I doubt that these numbers will affect the Federal Reserve's policies and I would be surprised to see any movement in interest rates in the near term, something that the stock market may continue to celebrate for the rest of the year.

Japan in Jeopardy

"Ingwa wa, kuruma no wa." (Cause and effect is like a wheel) - Japanese Buddhist Proverb

Japan was once the marvel of the globe.  Their efficiency and manufacturing prowess was revered and Japanese companies morphed from obscurity into global power houses.  Japanese executives were seen trolling the globe armed with fists full of Yen and the desire to snap up buildings and companies around the globe.  The Japanese stock exchange reached an all time high of 38,915 in December of 1989 and it seemed as if the Japanese were invincible.

Fast forward to today and Japan is in a world of hurt.  The current administration under Shinzo Abe is fighting deflation and slow growth with.Mr. Abe's economic stimulus plan, Abenomics consisting of three measures: monetary easing, fiscal stimulus and structural reforms.  These measures were expected to repair Japan's economy through quantitative easing strategies similar to the United States, spending to stimulate private investment and structural reforms to make the market more open to new businesses and improve labor policies to reduce the reliance on welfare and make the labor market more flexible.

After a year of actively pursuing the first two strategies the results are anything but stellar.  The effect of quantitative easing has been to devalue the Yen by more than 25%.  While this was the intended effect the results were not as expected as exports have not flourished as they have in the past.  Normally when a currency devalues it promotes exports of local products as they become cheaper on the international markets.  As Japan relies heavily on exports, devaluing the currency has been a quick fix to stimulate the economy however this time around the effect was muted by the fact that a large majority of exporters are building their products off shore.  The result is that Japan government debt has rocketed to more than 220% of GDP and this is creating a new set of problems.

At the present level (and growing) debt service payments are more than 25% of the government's annual budget and this is with interest rates at essentially zero.  Even a small rise in interest rates to say 2% would effectively make the government insolvent as the tax receipts would not cover the debt payments.  In an effort to stem this tide Japan raised its consumption tax from 5% to 8% in April.  The result of this move is that the country's economy declined at an annual rate of 7.1%.  While many believe that this trend will reverse in the current quarter there is another round of consumption tax increases expected in October 2015 so it would not surprise me to see consumption stay down for an extended period.

Another side effect of the weakening Yen has been to hike the cost of base goods like electricity.  With the loss of a large portion of the country's nuclear power and the aftermath of concern following the Tsunami and the radiation leaks Japan has come to rely more and more on natural gas powered plants.  As Japan is not a gas producer this gas is imported but with the price of natural gas tied to the USD the Yen weakness has resulted in a spike in the cost of producing electricity.  These price increases are being pushed on to the Japanese consumer who is now paying 28% more for their electricity than they were four years ago.  Between this squeeze, consumption tax increases and lackluster pay increases it is no wonder that the consumer is closing their wallets.

So the only arrow left in Abe's quiver is to change the country structurally.  The problem with structural reforms is that they do not happen overnight and Japan needs something to happen quickly as time is running out.  Amazingly through all of this the Nikkei is leaping to 6 year highs on the back of some stellar company earnings courtesy of the weak Yen but if the structural problems facing Japan are not sorted out these highs may soon be distant memories much like the high last printed 25 years ago.  While all of this seems to be unrelated to the United States consumer, one need only look at the issues that arose out of Europe's mess to see that any significant problems in the world's third largest economy would be felt around the globe.

China's Ascendancy

"Open sesame!" - Alibaba and the Forty Thieves

Today marked an historic occasion as Alibaba's stock was listed on the New York stock exchange.  It marked the largest IPO ever raising the company more than $21 billion and valuing it at more than $220 billion.  The shares opened up more than 40% making Ma, the founder, China's wealthiest man.  Talk about "Open Sesame"!  To think that he started the company in 1999 in his house while teaching English as a school teacher makes the story even more remarkable and even more like the original story (he was a poor woodcutter who found an entrance to a secret cave where thieves hid their loot; the words Open Sesame unlocked the cave entrance and access to a fortune).

What also interests me is that this Chinese company not only eclipsed the likes of Facebook and Amazon but it shows China;s ascendancy into a technology superpower that more than rivals the United States.  Furthermore it shows just how important a large population and rapidly expanding middle class can be to local companies.  The company boasts more than 220 million active buyers using its platform and it now has plans to expand its services and platform throughout the rest of the world.

He will now use American money to expand internationally taking on Amazon, EBay, Google and others while these companies face massive government intervention in their efforts to expand throughout China.  So the protectionism that China has for its companies has worked in that they are now becoming global players but at what point in the future will the walls blocking free entrance to China be removed so that there can be a level playing?

With the Chinese flag flying in front of the NYSE today it appears that greed trumps everything but to me it also shows that business and economic freedom can supersede political squabbling.  It is now time for the Chinese to allow foreign businesses to operate freely throughout China but in order to achieve this we have to turn to the politicians to hash out an agreement.  While this will take time and will come with a large amount of baggage and distrust, until things can be ironed out I will continue to marvel at the greed that is American investment banking but hopefully Alibaba can use the magic words to open the gates to free competition.