Uncertainty Keeps Markets Rangebound

Charles Schwab: On the Market

Posted: 10/31/2016 4:15 PM ET

Uncertainty Keeps Markets Rangebound

U.S. equities finished modestly lower and near the unchanged mark, as investors look ahead to monetary policy meetings out of the U.S., the U.K. and Japan, as well as Friday's domestic jobs report, to gain more clarity. M&A activity dominated the equity front, headlined by Dow member General Electric's oil and gas combination with Baker Hughes and CenturyLink's tie-up with Level 3 Communications. Treasuries were modestly higher, following mixed economic data, while crude oil prices continued to selloff, exacerbated by disappointing OPEC talks over the weekend. Gold was higher, while the U.S. dollar was nearly flat.

The Dow Jones Industrial Average (DJIA) declined 19 points (0.1%) to 18,142, the S&P 500 Index was nearly unchanged at 2,126 and the Nasdaq Composite ticked nearly 1 point lower to 5,189. In heavy volume, 1.0 billion shares were traded on the NYSE and 1.7 billion shares changed hands on the Nasdaq. WTI crude oil tumbled $1.84 to $46.86 per barrel, wholesale gasoline ticked $0.03 lower to $1.42 per gallon and the Bloomberg gold spot price rose $2.58 to $1,278.05 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was nearly unchanged at 98.35.

Dow member General Electric Co. (GE $29) announced that it will combine its oil and gas business with Baker Hughes Inc. (BHI $55). Under the terms of the deal, Baker Hughes shareholders will receive a special one-time cash dividend of $17.50 per share and 37.5% of the new company. GE will own 62.5% of the company and the transaction is expected to close in mid-2017. Both GE and BHI finished lower.

CenturyLink Inc. (CTL $27) announced an agreement to acquire Level 3 Communications Inc. (LVLT $56) for $66.50 per share in cash and stock, in a transaction valued at about $34.0 billion, including the assumption of debt. Under the terms of the deal, LVLT shareholders will receive $26.50 per share in cash and a fixed exchange ratio of 1.4286 shares of CTL for each share they own. Shares of CTL were lower, while LVLT gained solid ground. Both companies separately reported 3Q earnings results, with CenturyLink topping profit forecasts and matching revenue expectations, while Level 3 missed estimates.

Cardinal Health Inc. (CAH $69) reported fiscal 1Q earnings-per-share (EPS) ex-items of $1.24, above the $1.21 FactSet estimate, with revenues rising 14.0% year-over-year (y/y) to $32.0 billion, north of the expected $31.1 billion. Shares were nicely higher despite the company lowering its full-year EPS guidance, as its pharmaceutical segment profit is expected to be down y/y, due to generic pharmaceutical pricing and reduced levels of branded inflation.

Personal income and spending rise

Personal income (chart) was 0.3% higher month-over-month (m/m) in September, below the Bloomberg forecast of a 0.4% rise, and compared to August's unrevised 0.2% increase. Personal spending gained 0.5% last month, north of the expected 0.4% increase and versus August's downwardly revised 0.1% dip. The September savings rate as a percentage of disposable income was 5.7%. The PCE Deflator was up 0.2%, matching expectations. Compared to last year, the deflator was 1.2% higher, in line with estimates. Excluding food and energy, the PCE Core Index moved 0.1% higher m/m, matching expectations, and the index was up 1.7% y/y, in line with estimates.

For more on the consumer, see Schwab's Chief Investment Strategist Liz Ann Sonders' latest article, Vertigo: Effect of Spiking Healthcare Costs on Consumers, at www.schwab.com/marketinsight and follow Liz Ann on Twitter: @lizannsonders.

The Chicago Purchasing Managers Index (chart) fell but clung to expansion territory (above 50), after dropping to 50.6 in October from 54.2 in September and versus expectations of a dip to 54.0. New orders, production and inventories declined, while order backlogs and employment rose.

The Dallas Fed Manufacturing Index improved to -1.5 for October, from September's unrevised -3.7 level, with economists forecasting an increase to 2.0. A reading below zero denotes contraction in activity.

Treasuries were higher, as the yield on the 2-year note lost 1 basis point (bp) to 0.85%, while the yields on the 10-year note and the 30-year bond dipped by 3 bps to 1.83% and 2.59%, respectively. Bond yields have given back some of a recent rally that has come from some relatively upbeat economic data and elevated Fed rate hike expectations and Schwab's Chief Fixed Income Strategist, Kathy Jones notes in her article, Are Bond Yields About to Rise?, the shift to higher yields is likely to be slow, in our view, but markets don’t appear to be prepared for the change. We suggest investors prepare for a potential rise in bond yields by trimming exposure to bonds with either long durations or high credit risk. Read more at www.schwab.com/onbonds and follow Kathy on Twitter: @kathyjones.

A heavy week of data will continue tomorrow, with key reads on October manufacturing activity, courtesy of the ISM Manufacturing Index and the final Markit Manufacturing PMI Index (economic calendar). ISM's index is projected to tick higher to 51.7 from 51.5 in September, while Markit's index is estimated to be unrevised at 53.2, and up from September's 51.5 level. Readings above 50 denote expansion. As well, construction spending will be reported, forecasted to have risen 0.5% m/m during September, following the 0.7% decline seen in August.

However, Wednesday's monetary policy decision from the Federal Open Market Committee (FOMC) and Friday's October nonfarm payroll report are poised to command most of the attention, with traders looking to clear up uncertainty regarding a December rate hike.

As noted in the recent Schwab Market Perspective: Looking Past the Election, economic data continues to support a sluggish growth narrative, although there are glimmers of hope that we could see at least a modest acceleration in 2017. Barring a surprise move on Wednesday, which could jolt the market as odds of a hike at that meeting remain low, the focus on the Fed will move back to the forefront following the election, with all eyes on the December meeting. Fed members have been preparing the market and investors for a hike, and we believe, after several false starts, it will actually follow through this time around. Perhaps equally as important will be the message the Fed sends around the next two meetings regarding what it may be looking to do into 2017. Read more at www.schwab.com/marketinsight. Be sure to follow Schwab on Twitter: @schwabresearch.

Finally, with U.S. political risk hamstringing the global markets Schwab's Vice President of Legislative and Regulatory Affairs, Michael T. Townsend offers his latest article, Final Clinton-Trump Debate Sets Up a Sprint to the Finish Line, as part of our election 2016 commentary at www.schwab.com/insights/category/election-2016, where you can also find timely analysis of The Stock Market and Election Cycles.

Europe sees red, Asia mixed amid lingering uncertainty

European equities finished lower, with oil & gas issues seeing pressure after talks over the weekend between the Organization of the Petroleum Exporting Countries (OPEC) yielded no new developments regarding a production cut. Also, global sentiment was stymied by flared-up U.S. Presidential uncertainty as the November election looms, while Italian banking concerns resurfaced. In economic news, preliminary eurozone 3Q GDP rose at a 0.3% quarter-over-quarter (q/q) pace, matching forecasts and 2Q's expansion, while output grew 1.6% year-over-year, in line with estimates and the prior quarter's gain. However, German retail sales unexpectedly dropped in September. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, offers timely analysis of the global economic picture in his article, World Tour: An Around The World Look At the Economic Landscape, at www.schwab.com/oninternational, and follow Jeff on Twitter: @jeffreykleintop. The euro was lower versus the U.S. dollar and British pound reversed to the upside in late-day action, while bond yields in the region dipped.

Stocks in Asia finished mixed, as the global markets remain uncertain regarding the presidential race in the U.S., while the world monetary policy landscape continues to garner attention, with decisions looming in the U.S. and U.K. this week, and the Bank of Japan expected to announce its policy stance tomorrow. For our latest analysis of Japan's monetary policy, see Schwab's Jeffrey Kleintop's, CFA, article, Going Godzilla: What has the Bank of Japan Unleashed?, at www.schwab.com/oninternational. The persistent pressure on crude oil prices also bogged down the energy sector, exacerbated by no production cut agreement following weekend talks between OPEC. Stocks in Japan dipped on the heels of a disappointing September industrial production report, which may have overshadowed some weakness in the yen and the announcement that the nation's three largest shipping companies agreed to combine their container operations. Mainland Chinese equities and those traded in Hong Kong also dipped, while South Korean listings declined markedly, even as a report showed the country's industrial production unexpectedly rose in September. Strength in Australian mining issues gave that nation's markets a boost, as China strengthened its currency, more than offsetting sluggishness in oil & gas stocks and a drop in the tech sector. Finally, markets in India were closed for a holiday.

Tomorrow, the economic calendar overseas will focus primarily on the Asia/Pacific region, with South Korea set to release CPI and the trade balance, as well as China's trade balance and manufacturing and non-manufacturing PMIs, and Japan's manufacturing PMI. In addition to the aforementioned monetary policy meeting of the Bank of Japan, the Reserve Bank of Australia will also meet to discuss policy, with no change to its benchmark rate expected.

Financial Review

Fluctuating Between Ugly and Ugly

Sinclair Noe — August 20, 2015

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DOW – 358 = 16,990
SPX – 43 = 2035
NAS – 141 = 4877
10 YR YLD – .05 = 2.08%
OIL + .34 = 41.14
GOLD + 19.00 = 1154.10
SILV + .27 = 15.68

Well, it was just ugly.

Yesterday, the Federal Reserve released the minutes of the July FOMC meeting. Many investors and traders interpreted the policymakers’ discussions as dovish, with the probability of a rate boost next month sliding to 36 percent from about 50 percent earlier in the day. The matter is still open to debate, and the bottom line is that we have to wait about 4 weeks to find out what the Fed will do.

Today, stocks closed near session lows, off about 2%; and it smacks of a rate tantrum, traders expressing their dis-satisfaction to let the Fed know they are opposed to rate hikes. The other reading is that a dovish Fed might mean that the global economy really is weak; the drop in commodities is hurting emerging markets; the strength of the dollar is hurting US exporters; we are now facing currency wars; and global growth (or the lack thereof) will weigh on the US economy. If the Fed doesn’t raise rates, it’s because the market is too fragile.

The S&P 500 fell into negative territory for the year, with consumer discretionary the greatest decliner on the day. Energy is the greatest laggard for the year, down 17 percent. The Dow Industrial Average is now down about 4.5% for the year, and down 7.2% from its peak. After today’s stock market selloff: Russell 2000 off 9.5% from peak; Nasdaq off 6.5%; S&P 500 -4.5%.

Bearish sentiment toward stocks is getting worse, at least according to the options market. Based on the number of puts trading compared with calls on single stocks, pessimism is higher now than any time since 2012. It’s mostly the result of a decrease in bullish calls, whose volume has declined 36 percent since January. Investor skepticism is growing as the Standard & Poor’s 500 Index meanders in its tightest range in nine decades. In August, speculators have neglected calls, which give holders the right to buy shares at a certain price. They’ve instead focused more on puts, which convey the right to sell shares at a specific level.

Of course markets tend to fluctuate; that is the only thing we can say with certainty. Mohammed El-Erian described it as “a classic overshoot that starts in the emerging markets world and it starts spreading. What that causes is heightened risk aversion.”  The outflows of funds hits emerging markets the hardest first, with the capacity to send shock waves to other markets “and at the end is the equity market in the U.S.” The fundamentals of the economy are a bit weak, but risk assets have not adjusted to reflect that weakness, and the difference is central banks boosting the financial markets. If the central banks, or specifically the Fed, steps away from supporting the markets, the valuations could come down to fundamentals. Makes sense.

China’s stocks slumped to a two-week low. The Shanghai Composite Index dropped 3.4 percent, the lowest level since Aug. 6. About 17 percent of mainland-listed shares remain halted. The Hang Seng China Enterprises Index sank 2.3 percent to a 10-month low.

We are seeing waves of currency devaluations. Kazakhstan’s currency plunged a record 23% at the start of trading today, following a surprise announcement the government would allow the currency to float freely. Kazakhstan is central Asia’s biggest oil exporter. The move continues a currency war being fought in the emerging markets. Vietnam devalued its currency on Wednesday for the third time this year after a similar move in China, while Russia is allowing the ruble to track the drop in crude, which has tumbled 58% over the past year.

Perfect timing. Greece has made a €3.2 billion-euro payment to the ECB, shortly after receiving the initial disbursement of funds from its new bailout. The first tranche amounts to €13 billion-euro, of which about €12 billion-euro will be used to pay down debt. Meanwhile, Greek PM Alexis Tsipras has called for the European Parliament to join the so-called quartet of creditor institutions overseeing the country’s new rescue. Now, if you look at the numbers you see that the bailout is not so much for the Greek government or even the Greek people; the creditors offer the bailout with one hand and then take the money right back with the other hand. And so this afternoon, Tsipras, faced with a revolt in his party over his acceptance of unpopular bailout measures, said he will resign and call early elections in September. Tsipras said on national television that his ruling mandate has “exhausted its limit and now people must decide anew.”

And just to add a little violence into the mix, North and South Korea exchanged fire today across the demilitarized zone between the two countries. The incident started when North Korea fired a rocket at a South Korean border area, prompting Seoul’s forces to reply with an artillery barrage. So far, no reports of casualties. Tensions have flared in recent weeks across the DMZ that bisects the Korean peninsula.

Two South Korean soldiers were maimed on Aug. 4 by land mines that the Seoul government says were recently laid by North Korea. Relations deteriorated further when South Korea started blaring propaganda at the North through loudspeakers along the DMZ. After today’s exchange, North Korea threatened to “start a military action” unless South Korea stops all propaganda broadcasts and withdraws the loudspeakers within 48 hours.

Purchases of previously owned homes unexpectedly rose in July to the highest level since February 2007. The National Association of Realtors reports contract closings increased 2 percent to a 5.59 million annualized rate from the prior month’s revised 5.48 million pace. The median price of an existing home climbed 5.6 percent from July 2014 to reach $234,000.

The number of Americans filing for unemployment benefits last week remained historically low. Jobless claims increased by 4,000 to 277,000 in the week ended Aug. 15. Applications have been lower than 300,000, a level typically associated with an improving job market, since early March.

The leading economic index fell 0.2% in July after four straight strong gains, largely because of a decline in permits to build new homes. The Conference Board says the LEI is still pointing to moderate economic growth through the remainder of the year.

The Philadelphia Fed’s index of business conditions increased to a reading of 8.3 in August, above the 5.7 reading in July.

Valeant Pharmaceuticals is nearing a deal to pay $1 billion for Sprout Pharmaceuticals, just a day after the company won approval to sell the first drug which boosts libido in women. Under the terms, Valeant would pay all cash, one $500M installment upfront and one next year, for privately-held Sprout and its pink pills that will be sold under the brand name Addyi.

McDonald’s has announced plans to launch all-day breakfast nationwide as soon as October. According to an internal corporate estimate, McDonald’s could see a 2.5% lift in sales at stores that introduce all-day Egg McMuffins. Breakfast is a hot commodity not only at McDonald’s but also at many restaurants nationwide. Breakfast sales rose over 5% to $27.4 billion in 2013 at quick-service and fast casual restaurants.

Yesterday was the 11th anniversary since Google’s initial public offering, and there’s no doubt the company has had a remarkable run (Class A shares +1,277%). Although the online advertising giant has given a massive return to investors, there are still 13 stocks that outperformed Google since 8/19/2004: Alexion Pharmaceuticals; Amazon; Apple; Celgene; Gilead Sciences; Intuitive Surgical; Keurig Green Mountain; Monster Beverage; Netflix; Priceline; Regeneron Pharmaceuticals; salesforce.com; Vertex Pharmaceuticals. Or, if you want to keep it simple, you could limit it to the FANGs: Facebook, Apple, Netflix, and Google – by the way, they were some of the biggest losers today.

A new report from NASA shows California is sinking; specifically the Central Valley. The prolonged drought means domestic wells have run dry and growers are drawing down portions of the valley’s vast aquifer to historic lows. As the aquifers shrink the land drops. Some areas have seen the land sink by 10 to 14 inches since the start of the year. The sinking is so subtle that it is imperceptible on the ground, save for the effect on infrastructure. Aqueducts and irrigation canals buckle. Roads crack, causing millions of dollars in damage.

Another month, another record high for global temperatures. The National Oceanic and Atmospheric Administration reports that July was the hottest month since meteorologists began keeping track way back in 1880. Earth’s average surface temperature for the month of July was 61.86 degrees Fahrenheit (or 16.61 degrees Celsius). July’s average temperature was 1.46 degrees F higher than the average for the 20th century and 0.14 degrees F above the previously hottest month, which occurred in 1998.

The new record was fueled by the oceans. Across the globe, the average sea surface temperature in July was 62.85 degrees F, 0.13 degrees higher than the previous monthly record (set in July 2014) and 1.35 degrees higher than the average for the 20th century. All 10 of the hottest months for sea surface temperatures have occurred since April 2014. Temperatures on land contributed too, coming in 1.73 degrees F above the 20th century average. The report bolstered predictions from NOAA’s Climate Prediction Center that an El Niño is likely later this year.

Financial Review

Maybe GM Is Too Damn Stupid To Exist

Sinclair Noe — March 12, 2015

 

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DOW + 259 = 17,895
SPX + 25 = 2065
NAS + 43 = 4893
10 YR YLD – .01 = 2.10%
OIL – 1.14 = 47.03
GOLD + 1.60 = 1153.50
SILV + .05 = 15.57

Tuesday was one of the worst days for Wall Street in months; today we saw the biggest rally in a month. Go figure. The Dow and the S&P were up nearly 1.5%; the Nasdaq less of a gain as Intel warned that first-quarter sales would be below its previous outlook, given weaker-than-expected demand for business desktop PCs and lower inventory levels in the PC supply chain.

Another day, another central bank jumps on the easing bandwagon.  South Korea joined twenty four countries across the globe by easing monetary policy in 2015. Taking advantage of low inflation, the Bank of Korea cut its base rate by 25 basis points to a record low of 1.75%. South Korea also previously cut its forecast for this year’s economic growth to 3.4% in January from 3.9%, and they are widely expected to lower it again next month as China’s growth continues to slow and much of Europe flounders.

The IMF has approved a bigger bailout for Ukraine, giving Kiev immediate access to $5 billion of the $17.5 billion in emergency funding to keep the country afloat. Kiev’s conflict with pro-Russian separatists has put the country’s economy into a tailspin with a plunging currency, the highest interest rates in 15 years and central bank reserves of just $6 billion.

The euro fell to less than $1.05 before pulling back to trade higher on the day. The European Central Bank’s launch of a 1.1 trillion euro bond-buying program this week has dented the euro’s appeal by driving yields of many euro zone bonds to all-time lows. Light buying in core European bonds pushed Germany’s 10-year yield to less than 19 basis points and France’s to less than 45 basis points. Meanwhile, aggressive buying of peripheral bonds has both Italy (1.04%) and Spain’s (1.05%) 10-year yield flirting with sub-1.00% prints for the first time ever.

After spiking to a 10-month high last month, the number of people applying for unemployment benefits sank below the key 300,000 mark in early March. Initial jobless claims fell by 36,000 to 289,000 in the seven days extending from March 1 to March 7, reversing a sharp uptick last month that was likely triggered by bad weather.

Retail sales fell 0.6% last month, following even larger declines in January and December. Part of the problem was bad weather, but that doesn’t tell the whole story. Sales at gasoline stations jumped 1.5% — the first increase since last May, but that increase was offset by weaker sales of autos – down 2.6% on the month. Unadjusted retail sales were up just 1.7% over the past 12 months.

Combine the lower retail sales number with today’s report from the Commerce Department showing business inventories are at the highest level in almost 6 years, and it would take 1.35 months to clear the shelves at the current pace. That’s bad news because inventories tie up cash. Cash is supposed to be used to make more cash. Cash on the shelf is cash that isn’t working. Maybe we can blame the slow sales on bad weather. If sales pick up, problem solved; but it doesn’t look like American consumers are in a buying mood. If sales don’t pick up, businesses will need to cut back on purchases while they clear their stock. If enough businesses cut back, the supply chain grinds to a halt and all sorts off bad things result. Here’s how it could play out. We wait a month to see if sales pick up; if not we wait another month for the sales promotions and liquidations; if that doesn’t result in sales, then we could see cost cutting (which is another way of saying job cuts), and that puts us right about June, when the Fed might be looking to raise interest rates.

The prices paid for imported goods rose in February for the first time in nine months, largely because oil is no longer in a freefall. The import price index increased a seasonally adjusted 0.4% last month; that follows a 3.1% drop in January. Export prices dipped 0.1 percent in February after falling 1.9 percent in January.

General Motors’ approval this week of a new $5 billion buyback plan will likely delay one of its important goals: achieving a top-tier credit rating. Standard & Poor’s and Moody’s analysts say the carmaker’s next upgrade could be delayed due to its new capital allocation plan. The buyback scheme was pushed by an activist investor, Harry Wilson, and even if it doesn’t make the company stronger, it might make the shareholders more money, or not.

The intentions of a share repurchase plan are simple: to “return capital to shareholders” by spending money in a way that makes the stock go up and shareholders wealthier as a result. The primary idea is that buying back existing shares decreases the supply of outstanding stock, and gives existing shareholders a bigger piece of the company. Each dollar of earnings is spread among fewer shares, meaning that each share should be more valuable. But stock buybacks aren’t all they’re cracked up to be.

For example, ExxonMobil bought back more than $13 billion of its own shares last year. The price of oil went down and ExxonMobil share price dropped about 9% in 2014. Another example is IBM; they bought back more than $13 billion of its own shares last year and the share price underperformed the broader S&P 500 index by about 25%. Not much of an advantage. The problem with IBM is that the one-time tech giant isn’t doing anything very innovative, and a buyback scheme can’t cover that flaw.

General Motors announced today that, beginning with the 2016 model year, they will cut the warranties coverage on Chevrolet and GMC vehicles. The new warranties will be five years or 60,000-miles on the powertrains, including courtesy transportation and roadside assistance, down from five years or 100,000 miles. Free maintenance will drop to two visits within 24 months, from four.

GM issued a statement that said: “We talked to our customers and learned that free scheduled maintenance and warranty coverage do not rank high as a reason to purchase a vehicle among buyers of non-luxury brands. We will reinvest the savings we will realize into other retail programs that our customers have told us they value more than these.”

We don’t know what retail programs they intend to reinvest in, but we do know they plan to invest $5 billion into a stock buyback plan. And that goes against the published research on warranty coverage. According to a study published in the Journal of Business Research curtailing warranties is bad for business. The study found that: “Warranty improvements signal improved vehicle quality and lower maintenance costs. Warranty curtailments signal the opposite.” The authors note that “Korean manufacturers’ share of the U.S. market quintupled from 1% in 1996 to 5% in 2006. Much of the credit for this increase has been attributed to restyling, lengthened warranty, and improved quality.” And cutting warranties results in a 24% decline in market share growth.

The study finds that if you want to sell more cars, restyling gives you the biggest bang for the buck. In other words, build a better car, give it a strong warranty so people know you are confident that it is indeed a better car, and people are more likely to buy it. Sounds like common sense.

Now, keep in mind that GM is still dealing with claims of defective ignition switches that resulted in crashes that killed 64 people and 1571 other claims are in for injuries. The executives at GM knew for 13 years that their cars had a defective ignition switch that would, well, kill people. But they did a “cost-benefit analysis” and concluded that paying off the deceased’s relatives was going to be cheaper than having to install a $10 part per car. They then covered up their findings and continued to let millions drive around with the defective part in their cars.

So, in the real world, GM must now deal with the death and injury claims; they could repair all the defective switches so nobody else dies; they could make sure there are no additional killer design flaws; they could invest in R&D to build a better car, a car that looks great, runs more efficiently, is safer for the drivers, and is so reliable that they could increase the warranty with confidence – or – they can kowtow to one activist corporate raider and gamble $5 billion on a stock buyback scheme that may or may not pay off; and in the process, they are destroying their own credit rating and hamstringing liquidity.

About 7 years ago GM was on the verge of collapse. Back then we had high oil prices and the Big Three US automakers were stuck making big trucks and SUVs and when oil prices jumped, buyers developed an aversion to gas guzzlers. GM was slow to respond and soon they were bleeding cash. They turned to Uncle Sugar for a bailout, to the tune of $49 billion. GM was essentially nationalized. In December 2013, Treasury sold its last GM shares. According to a tally by the US Treasury, taxpayers lost $9 billion on the U.S. government’s automotive industry rescue program. According to another study by the Center for Automotive Research, a couple of million jobs were saved and the government “saved or avoided the loss of” $105 billion in lost taxes and social service expenses, such as food stamps, unemployment benefits and medical care. Of course there were some vendors that got stiffed by GM in bankruptcy. And it might have been cheaper to just give every GM worker a check for $250,000 and tell them to make the most of it.

We could debate whether the bailout was good or bad, but the bottom line is that GM is still around and now they are profitable, at least for Harry Wilson. The bad thing is that they didn’t learn from their struggles. They aren’t setting aside money as a cushion for a rainy day; they aren’t taking the $5 billion for stock buybacks and investing in R&D and innovation and better, safer cars. They didn’t learn any lessons about how to serve their customers, how to treat their employees and vendors, or how to show gratitude for the country that saved their bacon. And so, if GM ever finds itself in the same situation as they were in just 6 short years ago, the debate should not be about whether there should be government intervention or not, we could just look back on their decisions of the past week and we could all agree that GM was too damn stupid to exist.

Should the Feds Create Inflation? This Time It Is Different

Through the bombs bursting in the Korean Peninsula’s air, minutes of the FOMC meeting were released Wednesday. The division over Quantitative Easing II (QE II) wasn't as intense as the 58 year old NoKo/SoKo conflict. However, I have reservations with this logic in 2010 of affirmative voting Fed members’ confidence behind QE II theory of inflating asset prices will put a halt to deflation. 

That QE II will create a wealth effect and stimulate consumer spending, the easy stuff like the dubious weekly Jobless Claims dropped to 407,000 from a previous week upward revision to 441,000, from 439,000 is showing a positive trend. 

Also, The Reuter's/University of Michigan's Consumer sentiment index rose for November to 71.6 and third quarter GDP growth was revised up to a 2.5% annual growth from an estimate of 2.4%. The hard stuff, physical things like durable goods and housing (found below) tell a different story. Durables orders in October fell 3.3 percent, a figure below the median market forecast decline of 0.1%.  

Unfortunately, the Fed’s beautifully elegant thesis isn’t growing inside a sealed petri dish with exact ingredients from the 1930’s or 1970’s. Therefore, past performances do not guarantee future results.  

For those of us old enough to remember the 1970’s it was a far different world. During that period, current dollars had greater purchasing power than holding them until tomorrow, so it was logical for consumers to spend money immediately. However, the basic financial infrastructure for consumers was the opposite of what it is today. 

Take credit cards; this was a relatively new consumer product. Interest rates were fixed, unlike today. Shoppers would hand their credit card to a merchant and the merchant would pick up the phone and call an authorization center for approval. Then, the card would be placed in a manual charge card machine to make an impression on carbon paper for the shopper to sign after approval was granted. 

Holding and servicing fixed debt during “normal” inflationary times is easier to do if incomes are rising, mirroring the change in inflation. Virtually every credit card issued today has a variable rate. Wages have been stagnant in the US for ten years and Ireland just announced an austerity plan which includes cutting minimum wage which could become a harbinger of things to come in America. 

If we experience prolong inflation, the interest rate on consumer debt will be adjusted upward to cover issuers rising costs, accordingly. This will cancel any presumed benefits for creating inflation. 

Mortgages were different then, too. Adjustable rate mortgages did not exist. When you purchased a 30-year fixed mortgage, you could plan for your next 360 mortgage payments. This became problematic during the real estate bubble of 2003-2007. Teaser rates tied to Prime, LIBOR, the 11^th district, T-bills, COSI, etc, that allowed borrowers to qualify disappeared after 12, 24, or 36 months. Real mortgage payments undermined the false real estate prosperity of the day.

In the 1970’s mortgages were also assumable in many instances. The fixed mortgage came with your home. Think what our current housing market would look like if residential real estate came with mortgages. Would housing markets have experienced 30%, 40%, 50% in value or more, with assumable loans attached? Is a house easier or harder to sell with an assumable mortgage? 

Maybe this is an opportunity for the Department of Treasury to self-refinance mortgages directly with borrowers. New Home Sales reported the average price fell 8.0 percent to $248,200 while sales of new homes which fell 8.1 percent to a much lower-than-expected annual unit rate of 283,000. The median price of a new home plunged 13.9 percent in October to $194,900, a seven year low. 

Existing home sales were even worse. Sales fell 2.2 percent in October to a 4.43 million annual unit rate. The year over year change is a staggering 25.9%. Supply on the market has returned to 10.5 months. The median price fell an additional six tenths to $170,500. The average price moved two tenths higher to $218,700. 

Consumers were protected in other ways. In 1980, Congress passed the Depository Institutions Deregulation and Monetary Control Act exempting federally chartered savings banks, installment plan sellers and chartered loan companies from state usury limits. This effectively overrode all state and local usury laws. Heretofore, banks were limited by law as to what interest rate they could charge customers. 

Then, there was collective wage bargaining. The apex of organized labor existed in this time frame. For employees, price inflation was met with multi-year wage contracts, negotiated wage increases, and Cost Of Living Adjustments (COLA). Employers could better plan their labor costs and workers would not fall too far behind, too quickly. In retrospect, these automatic triggers helped exacerbated moderate inflation as it fulfilled structural price increases. 

Manufacturing as well as capital was neither nimble nor mobile in the pre-digital age. Employers were more inclined to sit down with workers and arrive at a schedule of wages and benefits both sides could live with. Relative labor peace in the US resulted from this tack verses a more confrontational civil disobedient approach on the European continent. 

The America I just described no longer exists. Instead of a fairly closed economic system capturing Ben Bernanke’s domestic asset price inflation action, the global economy will absorb our inflation, spilling into overheating emerging economies. This will cause resentment toward our predatory monetary policy. 

At home, stubbornly high unemployment continues as more hiring of temporary and contract workers identify firms that are practicing company before country, and a deteriorating financial system that is biting disproportionately into financially vulnerable consumers’ thinning disposable income. 

Municipalities are moving closer to default, just like Europe, under the weight of this radical redistribution upward of capital since the repeal of Glass-Steagall Act. The probability of a double-dip recession followed by uncapped interest rates and a widening chasm between Tiffany & Co. and Target customers, and rising corporate profits grows. 

The Ben Bernank offers other lesser reasons why QE II is necessary, such as a goal of optimal employment, without any major tax or infrastructure jobs initiatives coordinated with other quarters of government. I think their reasoning and aiming needs more work.