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THE BLUE MONEY REPORT.
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The Blue Money Report
"History suggests that capitalism is a necessary condition for political freedom. Clearly it is not a sufficient condition."
~ Milton Friedman
Welcome to the Blue Money Report
Today's Commentary: 08.09.02 No matter what you call it, ebb and flow, give and take, push and pull, you scratch mine, i'll scratch yours, it still remains an issue of balance. That mystical equilibrium that is needed and often taken for granted like air, until you require it to remain upright.
The economy has been studied by everyone, including those that do not have any idea how it works the way it does. And no, I am not taking a cheap shot at the administration's view on the problem. I'm talking about the learned students of the science who seemed to miss some obvious points.
Let's start with the Federal Reserve Board. Thomas Jefferson once wrote, "If the American people ever allow private banks to control the issue of their currency, the banks and the corporations that will grow around them will deprive the people of all their property, first by inflation and then by deflation, until their children wake up homeless on the continent their fathers conquered". What exactly has Fed done to make sure that none of those things happen? Their attempt at control of interest rates to stimulate the economy will create a bigger problem than currently exists. That could, as a result, enhance the problem they are attempting to solve.
I do realize that it would be easier to drag the Japanese effect of rate cuts into the picture. You will hear enough about that if they decide to ease further on August 13th. Japan, whose economy and people are wholly different than the US are not the best example, but they will be trotted out nonetheless, as an economy whose markets and monetary policy lack the very balance their culture always sought to achieve.
Lower interest rates all you want, the issue of creditworthiness will still be the greatest hindrance to the generating stimulus. If the stock lacks value, lowering the capital worth of the company, and the issuance of bonds does not produce an attractive rating and status, the only solution will be to borrow the money. Banks are looking at the outstanding bad loans currently on the books, the secondary market that sometimes buys these risky debts, and are coming to the conclusion that in the current environment, the risk has no reward.
Companies are also faced with the "need" for the money in the first place. Inventories have reached acceptable levels based on the business they are running. What is the incentive to start up the production process if the market lacks customers? Unless of course you bought into the steady growth numbers pushed so lovingly forward at the beginning of the year. When growth fell 4% points shorter than estimated for the second quarter, many were left with sales expectations and additional inventory that no amount of rate cutting will help. Without the ability to raise prices, inventories will not generate additional profits. Discounting creates deflationary pressure. The customer may be waiting for the competition to lower theirs also. And if they do, they negatively impact their profits. And there is no proof that customers are willing to spend at lower prices, if they believe that the prices have a chance at going even lower.
I should also mention, that banks tend to lag in any kind of recovery. With the recovery on hold, the amount of money that banks are willing to risk on poor credit risks has also been severely curtailed. This not only takes big customers out of the picture, but the higher risk mortgage buyer at the bottom of the ladder will be turned away as well.
This so-called bubble bursting effect that the administration is taking credit for as a natural rebalancing of the economy through the market actions is open to much discussion. The value of something was always determined by the price that someone who wanted it would pay for it. So if I can convince you that something worthless has value, then is it worth the price that the market will bear? No, it would still be worth nothing. So with that in mind, can this market correction be a re-evaluation or a correction? It is the former. Correction come when the realization of value is realigned to its proper worth. Reevaluation comes when you realize that you have been duped out of several trillion dollars of otherwise investable money that the economy, hence the GDP, will not have the chance to account for. This money was put into a mutual dream that markets would go ever higher. This money was then used to create investments by companies whose value should have always been in question.
The market has not corrected. It has tried to rebalance. It is still trying and no one can take any credit for this action.
Unemployment and welfare are not providing the additional spending that they have in the past during these types of downturns. Believed to be a drag on the economy, these programs are actually the helpful hand of the government stepping in to keep things going while solutions can be sought. But even as unemployment continues, despite modest gains in jobs, there are not as many people unemployed as there were in previous downturns. Welfare reform has put a cap on any increases that might appear on their doorstep as new cases as a result of this economic slide. And while forcing folks back to work seems like a good idea, the workplace isn't offering enough money to get things going again.
Add in the chance for a permanent tax cut, which I am still finding difficult to believe has any legs left. Dreamt during a era of budgetary surpluses and bullish markets, these tax cuts are counterproductive to creating wealth in a lagging economic situation. If you make more, you pay additional taxes. Those moneys are used to pay for the high cost of keeping the economy going through rough times. Which is why you need surpluses. Cutting taxes for those that are under no obligation to reinvest is counter to anything even close to fiscally responsible. Making them permanent is economic suicide.
And all of this equals a very low tide for quite some time. The equity market is being jerked around by individuals not institutions. The bond markets are showing signs of weakness. Housing is finding demand still strong, but the surpluses are climbing and econ 101 tells you supply must be lower than demand to keep the price high. Refinancing will take place as expected this year, but the money will not be spent on anything short of lowering the long term debt payment of the average consumer. In the last few years, equity has spurred spending. Now it will reduce debt.
I am not even going to mention the dollar and the international effect of it's worth.
What I will tell you though is that we may not have what would quantify as a recession in the future. The last recession barely made the benchmark. So double dipping isn't really the issue. There will be some very lean months ahead if things stay on the current course. The ebb though, is greater than the flow.
Today's Commentary: 08.07.02 Two days ago, I wrote this column with the market taking a nosedive. Two days later, the market has moved north again, recovering a good deal of lost ground and adding some in the process. Is this a reason to become excited?
Not really. There are some underlying movements that are effecting this market and none of them are particularly strong.
The announcement of a company buyback of stock once led investors to believe that the company's management knew something about the fundamentals of the stock that the public didn't know. The public often reacted with great enthusiasm, helping the company by purchasing shares of the stock hoping that an equity with less shares available would ultimately be a plus. This re-cutting of the pie would have been considered a good move from every angle, but in the current environment of full disclosure, the notion that the company somehow knows something that the public doesn't can't be a good thing.
These plans are usually announced with a targeted repurchase. Less stock on the open market should create a greater demand on the shares left outstanding, and that, in theory should drive up the price. This is not the kind of thing that makes a company look any better. It doesn't increase profits. It doesn't increase the fundamentals that help the company's success. It is merely illusory and should be questioned rather than applauded. In a side not, the company is under no obligation to complete the buy back and once they feel the stock has reached acceptable levels, the repurchasing usually dies a slow and quiet death.
Insider trading of any kind is usually put on hold while the stock is reinforced by the repurchase.
Another problem that is currently causing these small starts north of the bottom, which in my opinion has not fully formed yet, is a pension fund rebalancing that is was bound to happen. Pensions need to keep their money invested and the bond market has gotten quite expensive of late. The price of bonds move in the opposite direction of yields. So as the yield drops, the price of short term maturities has become much less attractive. Stocks on the other hand are beginning to look as though they are cheap, even if they are not.
Either way, there is still another problem that is lying in wait. Credit.
Companies are in dire need of money and are finding it increasingly difficult to get off the ground with any operating capital. Without stock that can be used as currency or at least an asset, many major companies are forced to either buoy up their share price through a buyback or to issue bonds. With bond prices rising and the issuance of bonds by companies whose stature may be in question receiving junk status, the only place left to turn are the banks.
Even with rates as low as they are, the chances of another rate cut in the near future becomes more likely as the months progress. It remains to be seen, though, whether it will have the desired effects in the long term. Short term it may very well fight off deflation. But this was supposed to be a time of vibrant recovery, rising short term rates, and not to say I-told-you-so, but a growth factor in excess of 5%.
Today's Commentary: 08.05.02 Note from the Editor From the front page of the New York Times on Sunday, we saw a picture of our President and his father golfing, starting his vacation in Maine and then heading off to Texas. What he does on his vacation should be little of our concern, but I am sure we will following his "working" respite as it progresses. Congress is also off on a month long hiatus that will allow those up for re-election to do some campaigning and/or damage control. If you get an opportunity to see your representative during this month, don't pass on the moment.
Vacations, if they are run correctly, allow the vacationer an opportunity to reflect on how hard they have worked, or at least, what they have done. I know that preparation for the last two weeks, I have probably worked harder than usual just to make sure that everything was a least in decent shape when I returned. President Bush should be reflecting on what he missed.
Poor guy has been an problem for confidence in the markets and has found that silence will help the average shareholder more than his words or involvement. It is plain to the majority of Americans that he will at some point be a private citizen. Historically, that will happen sooner if the economy decides that another swipe at a shallow recession is in the works. More on that later. But his return to business is inevitable and the care with which he is undertaking this transition is becoming evident.
Prescription drugs bills have not been passed. The budget, due in October is still without resolution. Labor unions are up in arms over Mr. Bush's attempt to secure the country while undermining worker's security. And the recession, which was shallow in the first go around, is threatening to resurface as a double dip. We have watched a small parade of executives do a perp walk in front of the media knowing full well that they have the capital to fight the government for excruciatingly long periods of time while they spend the interlude waiting for America to lose its zeal for their heads. We are excellent at forgetting wrong doings due to the fact that old ones are inevitably replaced by new transgressions. As questions arise as to when anyone from Enron does a similar, smirk filled, hand-cuffed parade, you have to wonder what kind of fishermen we are. Catch and release, or into the frying pan?
In an earlier column, I predicted a Dow 7500. The following week, Barron's predicted a Dow 7400. Over the last two weeks, those lows were tested, bounced up from, and are heading, as I write this, back to test lows once again. Now we have to wonder, without adequate volume and the growing feeling of disconnect, does any of this really matter as the market begin to resemble a flopping fish, struggling on the dock, gasping for air, hoping that the angler believes in catch and release?
Or the frying pan.
Here's is how I see this happening in both the long term and the short term. In the short term, we fry the fish. The markets have nothing but bad news ahead of them. The economic numbers will be adequate enough, sometimes bad, sometimes good, but overall tipped to the downside. There will be little if anything that will send the markets into any short term reparations. The Fed will lean towards an easing bias, but will be unable to move either way. There is little inflation, which is bad from a pricing standpoint. Companies cannot raise prices and this creates slimmer profit margins. They will not commit to hiring because they know the pool of labor is still there, declining only slightly in numbers. Unemployment will be a thorn for the rest of the year. The Fed will begin to worry about deflation, which simply stated is the inability of prices to attract buyers. With limited funds, consumers may wait for the "better" price point. If they wait long enough, they will get it, and they know it. Even if they can afford it, they may wait until necessity drives them to spend.
Housing, another short term concern, is continuing to grow. But so are the amount of refinances. New homes are not staying in the hands of new owners very long although, especially in the lower end of the market as predatory lending practices force the foreclosure market into new territory. Refinances will be used to repay exuberant spending of the last two years as owners tapped equity, using it for a variety of reasons without regard to the creation of new debt. With interest rates continuing their slow descent, new money will buy better loans, not bigger ones. This will be a negative for those that assume money will continue to buoy a stagnant economy.
Catch and release. This is the long term outlook for the economy if... Mr. Bush realizes that the economy he inherited at the beginning of his administration resembles little of the one he is left with today. He should abandon his upper end tax cut and do something he has yet to do, admit his error. It would go a long way in helping American investors. He should probably explain what he means when he states, along with Mr. Cheney, what they mean by "fully vetted". The average American has had to learn a slew of new words over the last couple of years, and this phrase has a way of meaning less when uttered by folks whom the public isn't as sure of as they once were.
Economists, the Fed, and the administration needs to drop the cheerleader stance. We have a problem here and giving us a false positive isn't going to stop the bleeding. If you are still in the markets in any way, shape, or form, you either can not move because you have no idea where to go, or you have lost so much, that moving is a greater risk. With mutual fund managers asking for leeway to short positions in their funds, we can hardly find solace. If we release the fish, the chances that recovery from the trauma of being caught will be forgotten and the next time, it will be smarter, if not bigger. And the species continues to move forward.
As the economy lay gasping for air, we are faced with the decision. Throw the prized specimen back, or feed yourself for the effort. Over the last several years, we have chosen the frying pan. Our greed is no better than that of the celebrity CEO. We wanted dinner now, we once said, and we have had a difficult time making decisions otherwise. Let it go.
Now this may not be what the administration wants to hear. Re-election of incumbent presidents tends not to happen in situations such as this. Maybe that's what he is talking to his father about out on the course. Maybe George W. can't read lips.
The release will do us all some good and when the purge is completed, the wealth will still be in the hands of the few, the poor will still be struggling to rise above it, and the rest of us, will simply forget and go fishing again.
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