The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).

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December 23, 2009

Abstract: Sovereign debt is likely to be the big headline issue for 2010. This commentary will look at some debt-related issues of Greece and California in their two respective currency zones and then discuss our view of sovereign debt markets for 2010, particularly with respect to the US dollar and euro currency zones. Some strategy guidance for portfolio management of debt will wrap things up.

“Whatever it is, I fear the Greeks even when they bring gifts.” This is one of the English translations of Virgil’s Aeneid. It refers to the Trojan horse that Greece used to deceive Troy and gain entry into the city.

“During the Depression about half the population of Oklahoma moved to California and the intelligence level in both states went up.” Will Rogers, the great American commentator from Oklahoma, hatched this quip decades ago in his analysis of California’s governmental policies and its finances.

If we were writing a play on the theme of sovereign debt, we might use the following characterization. The US and the EU are the setting: two currency zones. The Fed and the ECB are the dominant members of the cast: two central banks responsible for the two currencies. Greece and California are in leading roles: two states within the two currency zones.

In the United States, California constitutes about 13% of America’s GDP. If CA were a standalone economy, it would be about the seventh largest in the world. The currency in use in California is the US dollar. The CA government determines its own budget, has its own constitution, operates an internal legal system, and decides its own state tax structure. It is also one of the 50 sovereign members of the USA and has legally bound itself to the rules promulgated in Washington, while attempting to preserve some state rights within our highly federalized legal system. CA and most other states have a requirement to balance an annual budget. There are provisions for emergencies in many of these states, and in the coming year we expect the concept of a financial emergency to be deployed and tested in various state courts. CA recently issued “script” during a short-lived budget crisis when it ran out of cash and until its legislature passed a revised budget. That was not the first time script has been used. We do not expect it will be the last.

In the euro zone, Greece is about 3% of the GDP. It is a sovereign state (country), one of the 16 members of the euro monetary system, and one of the 27 members of the European Union. GR maintains its own budget, although it has pledged to adhere to EU budget rules, which it is currently violating along with most other members of the EU. Under present agreements, penalties will occur if GR is not making a sufficient effort to improve its fiscal situation within a year. We do not expect those penalties to be imposed on GR nor on the other EU states in difficulty. Greece has its own tax structure, constitution, and internal legal system. GR is also covered by the newly developed EU Lisbon Treaty and, like other EU member states, is gradually moving into a Europe-wide economic structure.

California and Greece are both lowly rated by the agencies that appraise the creditworthiness of sovereign debt. CA and GR are also on the top of the list of possible default candidates in their respective currency zones. That list is prepared by CMA DataVision, a service that scrutinizes credit default swap pricing in order to determine market-based assessments of default probability over the next five years. CA and GR are both poorly rated, and their scores (default probabilities) are about the same

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President Obama met with a dozen small banks yesterday, urging them to keep lending.

He did not have to tell that to this group — about 6500 mostly AAA rated, regional and community banks — who have been happily lending away. Its how they earn their money.

The larger banks, on the other hand, are the ones who have cut back lending dramatically. This is especially true of the 10 biggest banks.

Why?

Its the rational thing to do.

These banks STILL have to much debt, too little capital. They books are festooned with bad loans, which, thanks to our corrupt Congress, they no longer have to disclose appropriately. Thanks to Mark-to-Make-Believe, they can pretend these assets are worth near what they paid for them. In reality, they cannot sell them even at 50% off.

Lending money is a risky business; there is the possibility of loss. Under-capitalized banks cannot take that chance. By not lending, their capital base goes up. IT is the rational thing to do from their perspective.

Rather than engage in traditional money lending, these banks have decided to simply borrow from the Fed at 0%, and make risk free loans to the Treasury at 3%.

And, these banks are not lending because the way the Fed/Treasury bailouts were structured, they are encouraged NOT TO LEND.

Why? They need to rebuild their capital levels after 30 years of declining safeguards and capital ratios.

This is yet another unintended consequence of bailing out reckless bankers from their own folly. Their place in the economy has become so distorted as to become nearly economically meaningless . . .

The response to Sundays snowbound shopping list was (surprisingly) encouraging; Many of of you commented or emailed with even more gift ideas; Quite a few of you made specific suggestions in comments. A few of you even asked for more ideas.

In the spirit of (last minute) gift giving, consider this list — many of which can be had or emailed in time for Christmas delivery.

Most of these are personal favorites, or items from my own wish list:

• Californication – Season One and Season Two. Amongst the original HBO programming, I enjoy Entourage and Curb Your Enthusiasm. I also discovered Weeds via DVD; Anyone who travels for work as much as I do finds these discs make for great airplane companions.

But I think the greatest surprise has been how much I fell in love with Californication. The writing is outstanding, the characters and acting are top notch, and the plot twists are fascinating. I totally relate to the flawed David Duchovny, and his complex relationships with his wife/girlfriends/daughter.

Of all the premium cable channel shows out there, this one has evolved into my favorite — and I cannot wait for Season 3 on DVD.

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• Skip Barber Performance Driving School: On Sunday,  I mentioned the BMW driving school, and quite a few people suggested Lime Rock. It is my personal favorite track;  I took two of the Skip Barber classes there — everyone should, then go back for a refresher every 5 years.

The nice thing about giving this as a gift, is 1) It is very memorable; 2) Its not 25% off (up to $1000); 3) You can still give it in time for Xmas 2009.

I highly recommend it!

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• Get Yer Ya-Ya’s Out! The Rolling Stones In Concert [40th Anniversary Deluxe Box Set] [3 CDs + 1 DVD]

This is pretty much a collectible best suited for Rolling Stones junkies, hard core rock fans, and those especially enamored with the 1960s/70s rock era.

The raw power of the Stones music, the showmanship of Jagger, the guitar virtuosity of Keith Richards and Mick Taylor, all shine brightly here. Not only does this disc capture the Rolling Stones at their swaggering prime, it is also one of the greatest live albums of all time.

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• Phil writes in: “The Padron Annivarsario is a fine cigar, if you like them mild — but I figured you for a Cubano man.”

Sorry, Phil, but that would be unlawful; I would never smoke, um, I don’t know, let’s say Romeo and Juliet Churchills, especially the 2006 Robusto, nor could I cut them with this nor light them with this. Just because I travel in the Caribbean where Cubanos are plentiful and reasonably priced and there is no damned good reason for that embargo anymore — just because of all that is no reason to encourage anyone breaking the law. No sir, that just wouldn’t be right . . .

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• Drew Friedman :: Frank Sinatra: I love the art work of Drew Friedman, and he captures the Chairman of the Board during the 1950s, when his persona defined sophisticated swinging. “Frank knew how to hold a note, his liquor, and a dame. In button-down mainstream America, Sinatra oozed free ‘n easy; on the opposite side of the cultural divide, Ol’ Blue Eyes didn’t have to behave like a beatnik to convey cool.”

If you have a serious music fan on your gift giving list, I would consider one of these prints. The portrait of Frank Sinatra is hangs in the den near my audio pile.

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• Charitable Contributions: In the spirit of the season, perhaps many of us should be considering making charitable donations rather than accumulating useless baubles.

When you make such a gift, you can make sure your money actually gets put to good use by using Charity Navigator — which rates charities on their financial health. Their ratings show givers how efficiently a charity uses their money i.e., what percentage of money goes to the intended charity, and how much is burned up on administrative costs.

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• A Genius for Deception: How Cunning Helped the British Win Two World Wars: This simply looks like a fascinating slice of military history.

I have a date with this book and my hammock come the spring!

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• Saeco S-TG-ST Talea Giro Super Automatic Espresso Machine: Longtime readers know I am a coffee buff/Caffeine junkie. (If you haven’t read Your Coffee Sucks, go forth immediately). Lately, my caffeinated beverage of choice seems to be some variation of expresso. This machine seems to have all the bells and whistles I want for a lot but not insane amount of money. (The difference between “Super” automatic and “Fully” automatic being about $2000)

And, you can find several really reasonable coffee roasters online: My local NY favorite is Porto Rico Importing, but some friends swear by The Roasterie in Chicago and Intelligentsia in L.A. and Fonte coffee in Seattle.  (Anyone have any other favorite local roasters?)

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• I’ve used the Bose Noise Canceling Headphone for years (I like them) but some reviewers prefer the Sony MDR-NC500D Digital Noise Canceling Headphone: (List price, $400, sale price $279)

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• George Carlin: All My Stuff: George Carlin: Movies & TV: The entire George Carlin Collection, on DVD. Its the sort of thing that you tend to not buy yourself, but love getting as a gift. 14 Discs, ($189, on sale for $89).
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• Googled: The End of the World As We Know It. Ken Auletta’s book is one of the few business tomes I am interested in that has nothing whatsoever to do with the recent crisis. Chronicling the rise of Google from its auspicious origins within the labs of Stanford University, to its current position as perhaps the most influential technology company in the world today. Auletta has covered media and technology industries for decades, and is very plugged into Silicon Valley. This one looks like fun.

Source:
Good Riddance to the ’00s. History Suggests Things Will Be Better Over Next Ten Years
Peter Gorenstein
Yahoo Tech Ticker, Dec 22, 2009 01:00pm EST

http://finance.yahoo.com/tech-ticker/good-riddance-to-the-%2700s.-history-suggests-things-will-be-better-over-next-ten-years-395428.html

An interesting variety of readings today:

• Holiday Cliffhanger: Stores Pin Hopes on Last-Minute Shoppers (WSJ)

• The Equity Culture Loses Its Bloom (Institutional Investor):

‘The equity party is over. After a 25-year bender in which stocks catapulted Wall Street to such dizzying heights that financial firms managed to tip off a worldwide recession, the cult of equities is declining in earnest. The resulting hangover could fundamentally change the game for Wall Street.”

This one has a certain “Death Of Equities” smell to it . . .

• Interview with Dr. Marc Faber: US vs China: Watch the power game play out (FT)

• Lower loan payments = fewer redefaults for homeowners (CNN/Money)

• Accept Defeat: The Neuroscience of Screwing Up (Wired)• Taxpayers Help Goldman Reach Height of Profit in New Skyscraper (Bloomberg)

• Healthcare Reform has More Corporate Sponsors than NASCAR

• Twitter:

-Profitable? (Bloomberg)
-Or Not? (GigaOm)

• Apple TV-Service Proposal Gets Some Nibbles (WSJ)

• My lazy American students (Boston Globe)

• 10 TED Talks to Download for the Holidays

What are you reading?

Interesting graphic showing the world’s most profitable companies.

Its no surprise that 6 of the top 10 firms with the greatest earnings  are Oil companies.

Full list after jump . . .

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“Our results show that political connections play an important role in a firm’s access to capital. The effects of political ties on federal capital investment are strongest for companies with weaker fundamentals, lower liquidity and poorer performance — which suggests that political ties shift capital allocation towards underperforming institutions.”

-Ran Duchin and Denis Sosyura, University of Michigan School of Business

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File this one under “Duh!”

U.S. banks that spent more money on lobbying, were politically connected with the Fed, or had close ties with Pols, were more likely to get government bailout money.

That stunner is according to a new study released this week by two professors at the University of Michigan, Ross School of Business.

Profs Ran Duchin and Denis Sosyura paper also found that  “TARP investment amounts” were positively correlated to banks’ political contributions and lobbying expenditures. Overall, the effect of political influence was strongest for the most poorly performing banks.

Here’s a Reuter’s excerpt:

“U.S. banks that spent more money on lobbying were more likely to get government bailout money, according to a study released on Monday.

Banks whose executives served on Federal Reserve boards were more likely to receive government bailout funds from the Troubled Asset Relief Program, according to the study from Ran Duchin and Denis Sosyura, professors at the University of Michigan’s Ross School of Business.

Banks with headquarters in the district of a U.S. House of Representatives member who serves on a committee or subcommittee relating to TARP also received more funds.

Political influence was most helpful for poorly performing banks, the study found.

Banks with an executive who sat on the board of a Federal Reserve Bank were 31% more likely to get bailouts through TARP’s Capital Purchase Program, the study showed. Banks with ties to a finance committee member were 26% more likely to get capital purchase program funds.”

Is there anyone in this country that finds this data remotely surprising . . . ?

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Sources:
Banks and Bailouts: Playing politics?
Ran Duchin and Denis Sosyura
University of Michigan, 12/21/2009
Ross professors

http://www.bus.umich.edu/NewsRoom/ArticleDisplay.asp?news_id=18270

Banks with political ties got bailouts, study shows
Steve Eder
Reuters, Dec 21 2009

http://www.reuters.com/article/idCNN2124009320091221?rpc=44

Coincident with the selloff in treasuries, MBS are also lower with the 30 yr FNMA coupon today above 4.5% for the first time since Aug 21st. It’s up 10 bps on the day and is up 60 bps this month. So far in ’09, the average 30 yr fixed mortgage rate according to Bankrate.com has averaged about 90 bps above the 30 yr FNMA coupon. As of last night, Bankrate had the average 30 yr fixed rate at 5.11% so there is potential for a jump in mortgage rates if the action in MBS holds into early 2010.

Nice interactive graphic of the last decade from the FT showing various world markets  — stocks, bonds, commodities — in the context of the major global events:

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click through for interactive chart

Chart courtesy of FT

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Hat tip Simon!

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Source:
The decade in markets
Johanna Kassel and Cleve Jones
FT, December 21 2009 17:07 | Last updated: December 21 2009 17:07

http://www.ft.com/cms/s/0/fee44b50-ee52-11de-944c-00144feab49a.html

Art Cashin, head of floor operations at UBS, has the buzz from the NYSE.

Airtime: Tues. Dec. 22 2009 | 8:50 AM ET