As you've probably noticed I haven't been writing. I took the month of January to recharge my batteries a bit and read, read and yes, read some more. My head hurt. My hair hurt. Hell, at one point I thought I felt my fingernails growing.
By the end of the month, I decided that I needed a bit more time to recover from that exercise and organize my thoughts. All the while wondering what the thrust of this post would be. Believe me, there is more then enough subject matter to choose from. Finally, I had to return to my simple mission statement: Create order out of chaos. That may seem like a tall order in this economic climate. But hey, I'm a pretty tall guy! Let's get to it. Shall we?
My First Car
I've listened to the news and I've read more then I care to regarding the stimulus package. All the while I keep thinking about my old Ford Maverick. It was a great car with a straight six motor and a single barrel carburetor. It was the first and sadly, the last car that I could really work on.
By the end of the month, I decided that I needed a bit more time to recover from that exercise and organize my thoughts. All the while wondering what the thrust of this post would be. Believe me, there is more then enough subject matter to choose from. Finally, I had to return to my simple mission statement: Create order out of chaos. That may seem like a tall order in this economic climate. But hey, I'm a pretty tall guy! Let's get to it. Shall we?
My First Car
I've listened to the news and I've read more then I care to regarding the stimulus package. All the while I keep thinking about my old Ford Maverick. It was a great car with a straight six motor and a single barrel carburetor. It was the first and sadly, the last car that I could really work on.
That car ran like a top except for one vexing problem. Whenever it got cold, that old Ford just wouldn't start. I could crank it and crank it but all I did was flood the engine and kill the battery. Oh, I changed every part I could think of - distributor cap, points, rotor, and wires all with no luck. I even learned a thing or two like how to see if I was getting spark to the plugs. Finally, out of sheer frustration, I bought a can of starter fluid. A couple of quick sprays and presto, that baby turned right over.
The stimulus plan is really just like that can of starter fluid. I mean, we've tried everything else, right? Capital injections to the banks, bailing out Fannie Mae and Freddie Mac, the Treasury and Federal Reserve buying up bad assets. In a situation like this no one really knows what's going to make the engine catch.
There are a lot of moving parts out there. It began with assets that were priced artificially high and took a wicked fall. That caused a ripple effect that wreaked havoc on the financial statements of many - if not all - the major banks. As those ripples fanned out they've effected retail sales, jobs... Well, you know the rest.
A certain amount of what's happening here is just a cleansing of the system. Just as I would have to wait for that flooded carburetor to purge itself, all that can be done here is to wait for the system to reset.
The rest of it is a troubleshooting exercise to see what works. I know, it seems like a lame explanation although I'm not sure why. Let's keep in mind that money is a tool and it is traded in various markets for things of value. Think of it from a personal standpoint. At some point in time each of us have overpaid for something we bought: a home, a car, maybe some stocks. All because we believed that they were worth it. When this behavior happens on a large scale market behavior hits a fever pitch.
When an economy begins to tank, we start to think in terms of what "they" did. Government is always one of the culprits. This time around CEOs and bankers have been added to the list of the "they" we refer to. But we should not lose sight of the fact that we are they. We overpaid for the stocks and homes that are now among the troubled assets. This is a great place to be; accepting the fact that we are a part of the problems also means that we have the ability to overcome them.
In his first inaugural address President Roosevelt referenced the money changers of the day when he said, "True they have tried, but their efforts have been cast in the pattern of an outworn tradition. Faced by failure of credit they have proposed only the lending of more money. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence. They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish." Those words seem as prescient today as they were at the time.
Which leads to Theme #1: while not necessarily a carbon copy of current events, history often rhymes with current events. The ending of each event sets the stage for a new beginning. 2009 should prove to be such a beginning.
The President
We have put a lot of faith into this President. Haven't we? This man is under tremendous pressure to produce a plan that sets this country on a solid footing back to prosperity. By my estimates he has eighteen months to do it and Congress will make it difficult.
Why eighteen months? Because the economy will be the focus of the mid-term elections. If the economy shows signs of a comeback everybody can take a bow and Congress could pick up a larger majority of seats. If however, the economy continues to languish, you can expect voters to display their wrath at the voting booth.
I haven't seen any numbers on the seats that will be up for grabs but if the Democrats lose seats in the mid-term elections, President Obama's agenda for the second half of his first term would lose traction.
There's another history lesson here: Congress controls the purse strings. Let me harken you back to December of 2008. Then President-elect Obama requested that President Bush ask Congress to release the other half of the TARP funds. The thinking being that by the time Congress acted, the funds would be available to President Obama and his economic team to act swiftly.
Even last week, President Obama was making various speeches around the country. Each time he spoke about the need for Congress to act swiftly to pass the Stimulus package so that he could sign it and get the country moving again.
Theme #2: While the President sets the tone, the Congress sets the pace.
The Printing Press and The Fear Factor
"But," you ask, "why is Congress spending all this money?" Because they are the only ones with the printing press! Again, I go back to my earlier statement, nobody really knows what's going to work. What is going to make the engine catch. What we do know is that you have to get money moving. At some point that movement will create friction, which creates energy in the form of heat. Pay attention, this analogy will come up again :)
As Congress debates where to spend the money pundits and politicians of every stripe have emerged from the woodwork all clamoring with the same mantra: today's stimulus spending will be a bill passed on to our children and grandchildren to pay. It's a message we have heard before and it has many advocates. I'm not suggesting that it is wrong per se but I do believe that it is short-sighted. It suggests that our current situation will not change. In fact, a similar viewpoint was prevalent before the downturn. Then people thought that asset values would never go down!
The thing is, right now nobody knows what catalyst is going to prompt the change. Maybe it'll be a new gizmo; the Internet was a new gizmo that introduced a new twist to commerce. Maybe some external event will prompt a brand new wave of immigration similar to that of the early 20th century. Many of those folks would pay taxes that could pay down the debt. My only point is that there are too many variables and unknowns.
Theme #3: To be successful investors do not become paralyzed by fear. Keep an open mind and a keen eye. Opportunities will be found in the least likely places.
Of Government Bonds and Yields
I am a long time student of the yield curve. I track it very carefully. A 1996 summary article by Arturo Estrella and Frederic Mishkin outlined how this spread forecasts the future direction of the economy some four to six quarters out. This time 'round the yield curve is quite revealing.
Initially the yield curve turned positive in June 2007 but it wasn't until February 2008 that the rolling three month average was out of "recession" mode. By March 2008 the yield curve spread began to show a growth track. That tells me that we should start to see some signs of a "turn around" by September or October of 2009.
That positive spread continued to increase to a peak of 3.05% in November 2008. Indicating a healthy growth track well into May of 2010. What d'ya know, that's about eighteen months into the President's term. Isn't it?
As I studied the data, something else struck me: interest rates (yields) as a whole have been declining every month. Revisiting June 2007, the monthly average interest rates for a 90-day T-bill and a 10 Yr. T-bond were 4.59% and 5.10% respectively. By February 2008 those rates were down to 2.10% and 3.73%. Fast forward to December 2008 and those rates were down even further to .36% and 2.41%. Here are snapshots of the yield curve at those various points:
The stimulus plan is really just like that can of starter fluid. I mean, we've tried everything else, right? Capital injections to the banks, bailing out Fannie Mae and Freddie Mac, the Treasury and Federal Reserve buying up bad assets. In a situation like this no one really knows what's going to make the engine catch.
There are a lot of moving parts out there. It began with assets that were priced artificially high and took a wicked fall. That caused a ripple effect that wreaked havoc on the financial statements of many - if not all - the major banks. As those ripples fanned out they've effected retail sales, jobs... Well, you know the rest.
A certain amount of what's happening here is just a cleansing of the system. Just as I would have to wait for that flooded carburetor to purge itself, all that can be done here is to wait for the system to reset.
The rest of it is a troubleshooting exercise to see what works. I know, it seems like a lame explanation although I'm not sure why. Let's keep in mind that money is a tool and it is traded in various markets for things of value. Think of it from a personal standpoint. At some point in time each of us have overpaid for something we bought: a home, a car, maybe some stocks. All because we believed that they were worth it. When this behavior happens on a large scale market behavior hits a fever pitch.
When an economy begins to tank, we start to think in terms of what "they" did. Government is always one of the culprits. This time around CEOs and bankers have been added to the list of the "they" we refer to. But we should not lose sight of the fact that we are they. We overpaid for the stocks and homes that are now among the troubled assets. This is a great place to be; accepting the fact that we are a part of the problems also means that we have the ability to overcome them.
In his first inaugural address President Roosevelt referenced the money changers of the day when he said, "True they have tried, but their efforts have been cast in the pattern of an outworn tradition. Faced by failure of credit they have proposed only the lending of more money. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence. They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish." Those words seem as prescient today as they were at the time.
Which leads to Theme #1: while not necessarily a carbon copy of current events, history often rhymes with current events. The ending of each event sets the stage for a new beginning. 2009 should prove to be such a beginning.
The President
We have put a lot of faith into this President. Haven't we? This man is under tremendous pressure to produce a plan that sets this country on a solid footing back to prosperity. By my estimates he has eighteen months to do it and Congress will make it difficult.
Why eighteen months? Because the economy will be the focus of the mid-term elections. If the economy shows signs of a comeback everybody can take a bow and Congress could pick up a larger majority of seats. If however, the economy continues to languish, you can expect voters to display their wrath at the voting booth.
I haven't seen any numbers on the seats that will be up for grabs but if the Democrats lose seats in the mid-term elections, President Obama's agenda for the second half of his first term would lose traction.
There's another history lesson here: Congress controls the purse strings. Let me harken you back to December of 2008. Then President-elect Obama requested that President Bush ask Congress to release the other half of the TARP funds. The thinking being that by the time Congress acted, the funds would be available to President Obama and his economic team to act swiftly.
Even last week, President Obama was making various speeches around the country. Each time he spoke about the need for Congress to act swiftly to pass the Stimulus package so that he could sign it and get the country moving again.
Theme #2: While the President sets the tone, the Congress sets the pace.
The Printing Press and The Fear Factor
"But," you ask, "why is Congress spending all this money?" Because they are the only ones with the printing press! Again, I go back to my earlier statement, nobody really knows what's going to work. What is going to make the engine catch. What we do know is that you have to get money moving. At some point that movement will create friction, which creates energy in the form of heat. Pay attention, this analogy will come up again :)
As Congress debates where to spend the money pundits and politicians of every stripe have emerged from the woodwork all clamoring with the same mantra: today's stimulus spending will be a bill passed on to our children and grandchildren to pay. It's a message we have heard before and it has many advocates. I'm not suggesting that it is wrong per se but I do believe that it is short-sighted. It suggests that our current situation will not change. In fact, a similar viewpoint was prevalent before the downturn. Then people thought that asset values would never go down!
The thing is, right now nobody knows what catalyst is going to prompt the change. Maybe it'll be a new gizmo; the Internet was a new gizmo that introduced a new twist to commerce. Maybe some external event will prompt a brand new wave of immigration similar to that of the early 20th century. Many of those folks would pay taxes that could pay down the debt. My only point is that there are too many variables and unknowns.
Theme #3: To be successful investors do not become paralyzed by fear. Keep an open mind and a keen eye. Opportunities will be found in the least likely places.
Of Government Bonds and Yields
I am a long time student of the yield curve. I track it very carefully. A 1996 summary article by Arturo Estrella and Frederic Mishkin outlined how this spread forecasts the future direction of the economy some four to six quarters out. This time 'round the yield curve is quite revealing.
Initially the yield curve turned positive in June 2007 but it wasn't until February 2008 that the rolling three month average was out of "recession" mode. By March 2008 the yield curve spread began to show a growth track. That tells me that we should start to see some signs of a "turn around" by September or October of 2009.
That positive spread continued to increase to a peak of 3.05% in November 2008. Indicating a healthy growth track well into May of 2010. What d'ya know, that's about eighteen months into the President's term. Isn't it?
As I studied the data, something else struck me: interest rates (yields) as a whole have been declining every month. Revisiting June 2007, the monthly average interest rates for a 90-day T-bill and a 10 Yr. T-bond were 4.59% and 5.10% respectively. By February 2008 those rates were down to 2.10% and 3.73%. Fast forward to December 2008 and those rates were down even further to .36% and 2.41%. Here are snapshots of the yield curve at those various points:
Click to Enlarge
What does this tell me? Well, as more bonds are purchased, interest rates decline. Imagine that, despite a battered economy, U.S. treasury bonds are in demand. But when an economy starts moving it generates "heat" in the form of inflation. That inflation will prompt bond investors to sell their bonds, and move that money to other instruments - like stocks - which will increase in value at a rate greater than inflation. Of course the action of bond sales means higher interest rates. Translation: expect inflation to accompany the growth we begin to see later this year.
Believe me, the federal government is doing everything it can to pump money into the system with the intent of generating inflation. Once the economy starts to change direction, the next trick will be to get interest rates to just the right level. Too little and the economy could get overheated very quickly; too much and the economy will stall before it gets off the ground.
Theme #4: Keep a close eye on Treasury bond yields. They will be a part of the early warning system this year.
The Stock Market
With all these themes, you're probably asking, "When will it be a good time to get back into the market.
Click to Enlarge
As you can see, closing prices are significantly below the 45 Week Moving Average but I am encouraged by the pricing action. Since November 2008 pricing has appeared to bottom at the 800 level. I believe that the longer those lows hold, the more solid the uptrend will be when it gets under way.
In the meantime our best bet continues to be interest bearing cash accounts. If you can invest in ETFs, the Spider Gold Shares (GLD), will start to gain ground as inflation begins to come into vogue. Once again, I suggest that you watch those interest rates.
Theme #5: Expect the unexpected. Stocks will begin to rise for "inexplicable" reasons. The reason will be insider buying. CEOs, CFOs and corporate directors, with their fingers on the financial pulse of their companies, will be the first to see signs of economic improvement and begin buying their companies stocks.
I've made some pretty bold predictions for the year ahead and, believe me, they run counter to much of what I have been reading. Though recently I came across this story about legendary economist John Maynard Keynes: "When confronted about an apparent change of his opinions he is reported to have said, 'When the facts change, I change my mind. What do you do, sir?'" I suppose I can take some solice in knowing that if I do change my tune, at least I will be in good company!
Thank you for reading my posts. As always, if you have any questions or comments, you can email me at billmazzacca@gmail.com.
Have a wonderful 2009!
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