Investing through the summer fog of 2012

The economy continued to throw off mixed signals for the month of July, whipsawing traders and making investors even more squeamish and paranoid about where to tuck their wealth.

Added to this seesaw of economic data from everything from July's consumer confidence of 65.9, up from a revised 62.7; the July Chicago PMI of 53.7 up from 52.9.

The May S&P Case-Shiller HPI 20-city M/M rose 0.9%, however, the Yr/Yr fell 0.7%. The June New Home Sales figure fell to 350k from a revised up 382,000. The M/M Pending Home Sales Index for June dropped -1.4% from a revised downward 5.4% increase.

The Richmond Fed Manufacturing Index for July fell from -3 to -17. Conversely, the Empire State Manufacturing Survey, Kansas City Fed Manufacturing Index, Philadelphia Fed Survey all improved from the previous month.

The Dallas Fed Manufacturing Survey, consisting of a Business Activity Index and Production Index, found both indexes falling.

The knowledge that short-term markets are driven first by news headlines and central bank policies rather than primarily macro and macroeconomic data forces a perverse reaction onto the market in this unfamiliar climate we find our capital in.

Deteriorating economic statistics brings hope, by some, of additional stimulus measures from the Feds. Today, August 1, the Feds may shed some light onto their contingency plans, if there are any plans, for supporting a decaying economy between now and the November elections.

If Quantitative Easing III (QE III) or some variation of yield repression doesn't materialize from the Feds, markets will have an excuse to move lower, decaying as well.

Secondly, European Central Bank President, Mario Draghi, kicked off last Thursday's stock market rally by stating that he will do whatever it takes to save the Euro. A quick recap; in theory, generally, saving the Euro and the EU requires capping rising Spanish and Italian debt yields by the ECB agreeing to purchase their sovereign debt.

Because of inflationary fears, many German politicians, including Chancellor Angela Merkel's coalition government, vigorously oppose this action and similar bailout schemes. Two days ago, Monday, Treasury Secretary Timothy Geithner met with German Finance Minister Wolfgang Schaeuble and Mario Draghi, reaffirming their commitment in solving this crisis.

On Thursday, the European Central Bank will hold another policy meeting to find common ground. If the meeting fails to produce the proper response in the eyes of the market, this too will reverse last week's rally and send the market lower.

A third item that will send stocks lower in August, extending the S&P 500 incarceration in the current trading range between 1,099 and 1,419, if the realization sinks in of the draconian effects of federal budget automatic sequestration.

When austerity begins appearing in budgeting decisions in government, and workers begin preparing for possible layoffs and downsizing by reducing personal spending, and when businesses relying on government contracts to purchase their goods and services recalculate their cash flow and revenue, GDP will decline.

The May 2012, G.19 Federal Reserve Statistical Release, dated July 9th, shows "consumer credit increased at an annual rate of 8 percent in May. Revolving credit increased at an annual rate of 11-1/4 percent, while non-revolving credit increased at an annual rate of 6-1/2 percent." It's hard to imagine this type of credit activity continuing in the third and fourth quarters of 2012.

Our anemic economy grew 1.5% in the second quarter, down from 2.0% in the first quarter, with major help from consumer credit. Subtracting significant credit in the third and fourth quarters will exacerbate any weakness.

Individual savings rates were reported up 4.3%, annualized, in the first three months of this year, starving an already malnourished economy of vital disposable income. The minuscule interest currently being paid on savings is also problematic for an economy in need of greater money supply velocity.

An economically weakened Europe and a weakening China will inadvertently push the US economy over the edge unless smaller emerging markets can somehow re-accelerate the global economy while avoiding the developed nations' debt contagion.

The final culprit with the motive and opportunity to assassinate the economy is stagflation. As 2012 futures' prices on corn, oats, soy beans, and wheat reached multiyear highs, 1,300 counties spread over 29 Midwest states have been declared natural disaster areas by the USDA.

In the 1970's, President Richard M. Nixon imposed wage and price controls in an attempt to snuff out stagflation and inflation. President Gerald Ford attempted to talk down inflation with a Whip Inflation Now (WIN) campaign, complete with WIN buttons. Inflation ran rampant throughout the 1970's until a new Sheriff rode into town in 1979.

The newly appointed Federal Reserve Board Chairman, "Tall" Paul Volcker, ended inflation by jacking up short-term interest rates to 22%. Although, lifting interest rates to nosebleed levels induced at the time the deepest recession since the Great Depression, inflation did not return.

Another smart decision made by the government at the time was issuing callable long-dated treasury bonds and zero coupon bonds to minimize interest expense. This morning, Treasury announced it is investigating issuing floating rate notes; while interest rates are lower than they have been in the past 100 years. I'm puzzled by such a decision.

This earnings' season, restaurants such as McDonalds (MCD), Chipotle (CMG), Buffalo Wild Wings (BWLD), have admitted to struggles with cost inputs, missing earnings estimates, and are now lowering guidance for upcoming quarters. Food suppliers like Hormel Foods Corporation (HRL), Tyson Foods, Inc. (TSN), and Smithfield Foods, Inc. (SFD) are experiencing these headwinds, as well.

Brent Crude oil is priced north of $100 dollars a barrel. Members of OPEC require the price of oil to stay north on $80 dollars a barrel to maintain political stability at home. That price level is in conflict with jump-starting the global economy that is continuing to deleverage from the previous decade.

Regardless, if the price of oil should rise or fall short-term, the global economy will be petroleum-based for decades to come. Therefore, an essential building block for any inflation defensive portfolio requires an integrated oil company such as Exxon Mobile (XOM) or Chevron (CVX).

One final thought; although, we have experienced deflation in many things since 2008, technology, of course, real estate and virtually any asset requiring financing, and the cost of capital itself, this economic period will end, too. And once more, we will again face and fight inflation.

Unappreciated is the two-stage intermediate step between deflation and inflation – stagflation. Ben Bernanke has spent years and trillions of dollars attempting to re-inflate asset prices. One day he will succeed. At that point, Stage One, the rising cost of living, or cost-push inflation kicks in, whereby, too few dollars are available for rising prices.

Stage two of the stagflation equation is flat wages and personal income. Whether one draws a paycheck from a job or clip coupons from investments, purchasing power begins contracting, not growing.

This reality of less disposable income relative to prices, combined with an aging population and extended life expectancy is a recipe for structural economic arrested development until we surrender to full-blown inflation in future years.

Politicians will feel obligated to rectify the former condition and then, the more radical and dangerous phase of inflation occurs, demand-pull, leading to too many cheapened dollars chasing too few goods.

Confidence or the lack thereof, in a nation's currency, is the thin line straddling inflation and hyperinflation.

And, it is here, that your portfolio of hard assets such as gold and silver, agricultural commodities providing food security, natural resources such as land, timber, water, energy, selective adjustable rate debt, and very selective stocks, will pay off for the patient, long-term, investor during inflationary times.

The Market Is Just Not Into Main Street Anymore

August Commentary: The Market is Just Not into Us, Anymore

I’m reminded of the story about the recently deceased arriving at the gates of Heaven and being told that he has freedom of choice he may visit both Heaven and Hell before making his eternal decision. After visiting Heaven for the day he journeys down to Hell.

The most incredible party witnessed in history is going on. The most beautiful people he had ever seen were there. The finest food and drink from the four corners of the planet was being served. The greatest band he had ever heard played every one of his favorite songs and sounding never better, from each stage of his life.

The next morning he returned to Heaven, rendered his decision and apologized for choosing Hell, along with conveying his thanks for the heavenly hospitality.

Upon returning below, the music was gone; so too were the beautiful people and the fabulous food and drink. All that remained in the dark cave was coal, fire, shovels, and heat. When he demanded to know where everyone and everything went; Lucifer winked and replied:

“Yesterday, you were a prospect. Today, sir, you are my client.”

Throughout 2010, and for the last decade, equity returns have produced practically nothing for all its troubles. Then, why do investors continue tolerating an insane amount volatility and risk of principal, for punk rewards - we are holding on to a once profitable relationship that no longer exists.

There; it had to be said.

This 30-year affair between the American middle class and financial markets has been counterproductive over the previous decade. Analysts and money managers are like your mate’s best friend who looks straight into your eyes and lie to your face. “The relationship is fine.” “You are imagining things.” “Every relationship has its highs and lows; you two are experiencing a temporary low period, that’s all.” “You think you could do better without her?”

These examples mirrors a few mindless talking points investors hear bantered about each day on business channels, describing investors’ net worth reduction and why any concern, on your part, is totally unnecessary. Let’s recall how this relationship started by returning to the beginning of this latest chapter.

Wall Street was a rich man’s playground - until the inflationary 1970‘s. At that point, the rich stop buying stocks. P/Es on stocks fell to hat size levels. Prior to the stagflation and inflationary 1970’s, it mattered little that commissions were fixed and burley. The last secular bill market ran from 1950 to 1965. Potential brokers were invited and groomed, by white shoe firms, to introduce themselves to and to form relationships, with the affluent.

In 1962, self-employed individuals or unincorporated businesses became eligible to self-direct retirement accounts through Congressional legislation with the establishment of (Eugene) Keogh or HR (10) plans. Twenty years later, employers asked the same question, differently: Why shouldn’t employees have the same freedom to self-direct their retirement account (thereby, removing corporate responsibility for employees’ retirement).

The private sector, as late as the early 1980’s, offered new workers employer-sponsored defined benefit (DB) retirement plans. Investment risk and portfolio management are entirely controlled by the company. Payouts are calculated on factors such as salary and duration of employment. If there is a short-fall on investment returns, companies are obligated to dip into earnings to cover the difference.

Luckily, for corporations, bottom line margins and much of today’s $1.6 trillion in cash, sitting on the balance sheets of corporations, is safe from being encumbered by DB plans and their retirees.

DB plans are still owned by many public sector workers. Currently, these plans are routinely vilified in the press as parasitic in nature. Defined Contribution (DC) retirement plans, enthusiastically launched in the 1980’s as DB plan’s chief competitive product, and were sold primarily by ridiculing DB plans as being inferior to self-directed accounts. DC plans’ major weakness, an unknown future payout to retirees, became its major marketing strength.

Men with ambition, real men, theoretically, could make untold millions playing the stock market. Accepting a DB plan’s corset over unlimited retirement income potential was the providence of the dull-witted or the lazy, lacking in motivation, vision and imagination.

The tiny requirements for raking in bushels of filthy lucre, for your golden years, as the pitch went, were reading Peter Lynch books and by faithfully watching Louis Rukeyser’s Wall Street Week; “as you know, over time, all stocks increase in value.”

Because of the internal logic of DC plans’ supposition from 1980’s Wall Street, it was antithetical for Human Resource departments and mutual fund companies to argue, at the beginning of a secular bull market, in favor of capping pedestrian, formulaic, DB plan payouts. Unrestricted, free market-based, DC plans were vastly superior on every count.

Beside, where did DB plans’ returns really come from? They came from the stock market! Eliminate the middle man; keep for yourself all the returns your hard earned dollars generate in the stock market. Mr. Hare, meet Mr. Tortoise.

The accelerants fomenting this new mindset, when stocks such as Boeing, Walt Disney, Mattel, and many others, sold for $5 dollars a share or less, were de-regulated commissions, Merrill Lynch’s new Money Market Account, and Sears acquisition of Dean, Witter, Reynolds (now Morgan Stanley). Additionally, declining inflation and interest rates, tax cuts, and deficit spending, helped deliver to Wall Street the middle class aspiration of champagne wishes and caviar dreams.

Over the next 20 years it was a world wind affair with unbridled infatuation. Mutual fund sales loads were cut from 8.5% to 4.5%. Exchange privileges inside mutual fund complexes were established. Letters of Intent, reducing sales fees further, became standard. Investors began choosing stock investment over precious metals, over real estate, over all other asset classes.

Stock market DC plans, became the preferred method of saving for retirement. Dividend Reinvestment Plans (DRIP) and stock purchase plans, compounding returns, also became more popular, adding fuel to the roaring stock market fire. Owning equities were touted by every financial services company. Consequently, more workers chose DB plans, year after year, playing at the big boys table.

Fictional character Gordon Gecko became the Pontiff of American financial idolatry and fictional prosperity. In the late 1980’s, banks begin selling mutual funds and insurance; and vice versa. Charles Schwab introduce the no load mutual funds Fund companies created A, B, C, and D shares, offering various sales load configurations.

In the 1990’s, everyone made money playing the stock market. The beginning of online trading even made it easy to do. The WSJ ran a recurring article featuring a chimp throwing darts, selecting stocks, and comparing his returns with professional money managers. That’s when you know when you are in a secular bull market.

The 14-member investment club from Beardstown, IL, the Beardstown Ladies became national celebrities for reporting earning compound annual average returns of 23.4%, over 10 years, thru 1993 - until they were audited.

Their actual return was 9.1%. By 1997, the Ladies had upped their stock picking skills and annual average returns over 10-years increased to 15.3%, yet, they still lagged the S&P 500’s 10-year return, during this period, of 17.2%.

Yes, we were so in love with each other. Then, dark clouds appeared and forever changed the future – Glass-Steagall was repealed.

Early in the next decade, Wall Street’s wandering eyes caught a glimpse of augmented proprietary trading and underwriting fees. Enhanced leverage, donning smaller and more provocative capital reserves, heretofore, disapproved of among prudent men, became desirable and lusted after by all. Scandalous risk was in vogue.

Investors’ trading commissions and management fees were a competent and faithful, if somewhat, plain way for firms to earn revenue. It was like home cooking five nights a week and backyard grilling on the weekends – safe, predictable, fulfilling, and bland.

Conversely, trading the firm’s capital and collecting securitization fees was the long-legged, redheaded, man-eating, gorgeous knockout, swinging from your arm each night, walking into your favorite hangouts.

Are you still dollar-cost averaging into your funds? Maximizing 401k and IRA contributions? Sporadically purchasing round lots of a few hundred or a few thousand shares of stocks, at discounted prices? This was no longer enough for descendants of the Buttonwood Agreement.

Once Wall Street felt the rush from mainlining mortgage-backed securities, the relationship with John and Jane Q. Public was doomed.

Any hope of salvaging this fraying union ended in 2008. We were unsuccessful in getting American finance off the narcotic of toxic assets; kicking this addiction to fast money, infinite fees and profits, and nympholeptic bonuses. A clean and sober banking system, facing tough new regulations, would function properly, yet again.

Regrettably, the wrong crowd appeared to offer help – Buffett, Paulson, Geithner, Blankfein, Bernanke, and Geithner – peddling TARP, Quantitative Easing, credit facilities, and government guarantees.

Immediately, overnight loan orgies were being held at the Feds’ discount window. The decency of mark-to-market accounting was scoffed at and ignored. Banking hedonism ran amuck on the streets of Manhattan and through the halls of Congress. Someone had shot the sheriff and the deputy, too.

It’s over. In a world of globalization, high frequency trading, melt-ups, flash-crashes, and algorithms, Wall Street doesn’t need the American middle class anymore; Need proof? Here is a snapshot from the internet of an Investment Company Institute chart displaying flows into LT Mutual Funds thru 07/21/2010:

The stock market was up 7% in July despite the fact that equity mutual funds experienced outflows in each of the last 12 weeks.

Wall Street borrows pure, uncut, scratch – at 0% - directly from Mr. Big; Washington DC. Treasury auctions are co-dependent enablers of this bankrupt practice. There is no turning back. Investors will make the wrong choice during a flash crash or flash bounce and will lose.

Somehow, that someone is always John and Jane Q. Public.

The Lazarus Rally in 2010

This week marks the one-year anniversary of the market bottom for stocks following the 2008 collapse of the supply-side themed western financial system. A deceased stock market, the second week in March 2009; the major averages resurrected themselves, like Lazarus, on a holy-water flood of liquidity, more than any other cyclical bull market bounce in history.

The Dow Jones Industrial Average advanced March 9, 2009 to March 9, 2010, from a gut-wrenching 6,547.05 to 10,564.38. Likewise, the Standard & Poor’s 500 Index moved from 676.53 to 1140.45. The NASDAQ 100 climbed from 1043.87 to 1,901.38, over the same 365 days. These returns equal a decade’s worth of historical gains.

To those investors, who grew feathers, and ran to the sidelines, take heart; in investing, there are lies, damn lies, statistics, and market returns. At the beginning of 2009, the DJIA started at 8,801.72, the S&P 500 Index at 902.99, and NASDAQ at 1,212.24. Only the luckiest of people and your typical liar coolly strolled into the market that second week in March last year, aggressively bought stocks, and are still holding those positions.

Closer to the truth, an experienced bull investor last March probably started taking profits off the table in early summer. Or, they screwed up their courage in April or May and bailed in September, or year end. Anyone capturing these once in a lifetime returns should be running full page ads of their trade confirms announcing the opening of their new hedge fund. And why not, they could afford the advertising rates. Unfortunately, 2009’s trend will be swapped for market fluctuation in 2010.

So, where do we go from here? The answer for the stock market is quite different from the answer about the economy. Let’s first look at the stock market.

Stocks will not repeat the performance of the last 12 months. The last 12 months was fueled on liquidity and promised future growth. The future is here but the growth is not. Wall Street Cardinals assigned to Washington DC, Ben Bernanke and Timothy Geithner, will be less helpful to stocks over the next 12 months.

U.S. Quantitative Easing has an expiration date on its existence. Some central banks have already begun raising rates because their economies are moving forward, unlike ours. The retail customer has yet to return to the market, either through their company’s retirement account (which is hard to do when you no longer work for a company), or taxable investment accounts; when your 1%-2% bearing CDs and T-Bills, and falling home values no longer contributes to your positive cash flow.

Also, investors are going through Post Traumatic Stress Syndrome (PTSD). The dot.com bubble, the Enron era of scandals, the real estate depression, and 2008, has left baby boomers dazed and confused. They are reluctant to hop into the barrel one more time before retirement.

Despite paraphilic dispatches by CNBC anchors, reporters, and guests of an aroused recovery, to the contrary, the U.S. economy is impotent based on low tax receipts, high unemployment, and contracting housing prices and available credit. This is what occurs during a period of deleveraging.

Disposable income from the safest fixed income investments has all but disappeared. That retired couple that spent their 5%-6% interest from their fixed income portfolio to shop, to travel, and to dine has temporality lost over 70% of their purchasing power. Fewer transactions equals fewer sales taxes, in turn, equals less state and federal revenue. Becoming smaller becomes a vicious cycle.

In October and November of 2008, when extraordinary unilateral decisions were made to save the economy, two additional smaller adjustments would have made a huge difference; temporarily change the tax laws for five years, permitting individuals to write off all interest payments for credit cards, automobiles, etc. on their taxes, and to suspend for five years the provision in the Monetary Control Act of 1980 eliminating usury laws. Individuals would have extra cash inside their annual tax return and smaller monthly finance payments. How could banks complain since the Federal Funds target Rate was set December 16, 2008, at 0.00% -0.25%? Their return on borrowed capital is infinity.

Cities and states across the nation will become the biggest drag on the economy in 2010. Dramatic budget cuts to reduce a currently projected $180 billion shortfall are being debated for the 2010-2011 budgets, at this moment, thereby, violently truncating personnel and services.

Banks are still failing. The FEDS feel that they dare not raise interest rates without a very good reason. But, with banks not lending, or reducing credit lines to businesses, and credit cards rates were hiked before new banking credit cards laws were changed, I’m unsure who might be hurt by an increase. Top-down stimulus programs are inefficient and growing more unpopular. Both commercial and residential real estate are not improving And, the November elections will drive sagacity from public conversation.

Internationally, what we can see are sovereign debt problems and a suspect economy in Europe. Tensions growing in the Far East over; military bases, and now Toyota, with Japan; trade disputes and sanctions and political disagreements over Taiwan, Tibet, and Iran, with China. Plus, we have an amorphous exit strategy in Iraq and Afghanistan.

Adding up tapped out consumers, the continuation of deleveraging, near insolvent municipalities, and a gradual reduction of liquidity, what you have is a somber national economy with too few pockets of strength.

Traders relying on volatility and stock pickers that can hunt for appreciation will have several opportunities to feast, however, investors hoping for an expanding economy will soon wish for 2010 to be over with nothing but apples (AAPL) and chips (PEP) and cokes (KO) to snack on in the interim.