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

Wow, that is some mad feedback on such a short post. Insane!

Quite a few takeaways from all the responses:

• The people have spoken: Full RSS Feeds stay!

• Open threads/linkfests are worth doing more regularly, just so as to give all of the off topic ideas a safe home of their own;

• I don’t know if there is a way to make the market posture clearer, and not run afoul of the lawyers, our clients, and everything else. (Any suggestions? I am all ears);

•Alas, comments have to be log in based — it has freed up an enormous amount of time I would rather use researching and writing.  Pick a simple password, turn cookies on, and use Firefox, which always remembers passwords for log ins;

• I am adding category and calendar archives to the sidebar. I will ask about adding a date to each sidebar update;

• The outpouring of comments and affection is very touching; My gratitude goes to everyone who commented or emailed kind words of support. Thanks!

Now, on a personal note: Its very difficult to understand how people see you, and some of the comments surprised me — I think some are based on bad assumptions or inaccurate assessments.

For the record:

Money: I make a decent living, but I am by no stretch of the imagination rich. I have clients who are billionaires, a friend whose firm went IPO (his stock sale netted $950m), a few colleagues worth $100m, and a few buds, grad school friends, etc. in the 8 figure crowd.

They get excellent advice and I get nice outstanding Xmas presents from them.

I live in an upper middle class neighborhood, drive nice — not crazy — cars, and have a few toys. I do well by U.S. standards, but nothing great vis a vis Wall Street contemporaries. If I were more motivated by money, I’d trade more and blog less.

Being A Contrarian: Sometimes what I write is Contrarian and way out of the mainstream; Eventually, the mainstream catches up to the outlier perspective. But the content cannot ALWAYS be away from the crowd (That’s “Naive Contrarianism”), because most of the time — about 75-80% of the time — the crowd is right, and they are what drives the market. Its the 10% or so on either end that is so problematic.

Arrogance: I consider myself a down to earth person (I just spent half an hour cleaning up dog poop in the backyard). I am not coy, I know what I am accomplished in, and where I need work. I have some skills, and I don’t play aw-shucks about. On the other hand, I know many people smarter, more learned, and more accomplished than me. Mr. Market makes you humble — he treats arrogance brutally

Besides, my wife would kick my head in if I ever became that kind of a jackass.

No BS: I call ‘em as I see ‘em. I don’t try to be controversial, I don’t flame bait, click whore, or use SEO tricks. The site is primarily my views, what I think is interesting, plus those people whose work I respect that aren’t usually seen by the public. Everything here is either written for here, or reprinted with permission,. I don’t take othber people’s content.

Ever wonder why Goldman execs don’t speak to mere mortals? The answer was hidden in a tongue-in-cheek Michael Lewis Bloomberg column, which he slipped this by everyone late night Friday.

Its an internal memo to Lloyd Bankfein, chock full of suggestions to improve GS’ public image.

This one was my favorite:

Each year, for example, Goldman Sachs might announce a grand national competition, much like “American Idol.” Finalists will appear before a national television audience to be judged by a panel of three rather ordinary looking Goldman executives. On stage they will perform various Wall Street tricks: negotiating with Tim Geithner, lobbying the Senate Banking Committee, designing securities that blow up, selling bonds to Germans, etc.

The winner receives a job at Goldman Sachs.

I suspect the show would not get great ratings, but the demographics would be incredible.

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Source:
Goldman Trader Shares Three Big Ideas With Lloyd
Michael Lewis
Bloomberg, Jan. 29 2010
http://www.bloomberg.com/apps/news?pid=20601039&sid=aWwht2XAEt84

Big editorial by Paul Volcker in today’s NYT:

“The phrase “too big to fail” has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks.

As things stand, the consequence will be to enhance incentives to risk-taking and leverage, with the implication of an even more fragile financial system. We need to find more effective fail-safe arrangements.

In approaching that challenge, we need to recognize that the basic operations of commercial banks are integral to a well-functioning private financial system. It is those institutions, after all, that manage and protect the basic payments systems upon which we all depend. More broadly, they provide the essential intermediating function of matching the need for safe and readily available depositories for liquid funds with the need for reliable sources of credit for businesses, individuals and governments.

Combining those essential functions unavoidably entails risk, sometimes substantial risk. That is why Adam Smith more than 200 years ago advocated keeping banks small. Then an individual failure would not be so destructive for the economy. That approach does not really seem feasible in today’s world, not given the size of businesses, the substantial investment required in technology and the national and international reach required.”

The full piece though long, is worth the time to read.

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Source:
How to Reform Our Financial System
PAUL VOLCKER
NYT, January 30, 2010

http://www.nytimes.com/2010/01/31/opinion/31volcker.html

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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Goya, Velazquez and El Greco provide an excellent distraction from world economics as we walk in the Prado with some NBEIC colleagues. We are here for the quarterly meeting of the National Business Economics Issues Council.

Madrid is cold but the skies are clear. The moon is full. Lovely young women in short skirts with great legs wrapped in black tights and black boots on three-inch heels, strut with their arms entwined with young men with short-cropped hair and close beards. The squares are full of life. The tapes bar/restaurant scene is robust, crowded, and vibrant.

Six of us enjoyed the cuisine and the scene. Some Rioja added warmth. Recession aside, Madrid is alive and tourists are evident. A few mostly older gray-haired or balding economists provide contrast.

NBEIC meetings are closed to the press and operate under the Chatham House Rule. This makes for a lively and fruitful exchange of views and data. It also allows us to compute what a beneficial value-added proposition NBEIC is. Cumberland now has two of the 40 members: Bob Eisenbeis, who established his NBEIC role while with the Fed, is one. The other is me.

Our gathering in Cordoba starts Monday night. The agenda includes an extensive session on the financial markets and the issues surrounding currencies and sovereign debt, and exit policies. We are looking forward to the presentations and discussion.

Tonight at the end of dinner four of us talked about Bernanke and Geithner. We speculated about the forthcoming Fed-Treasury accord and wondered if we need to go and reread the story of the last one, which followed the end of World War II. Elements on the table for conversation include the fact that Bernanke has a bias because of his study of the Great Depression. He does not want to be the Fed Chairman who presides over a repeat of the history of 1937, when the Fed tightened too soon and sent a fragile recovery into a downturn.

But we all agreed that Bernanke has character and is untainted by ethical lapses. The risk may be lack of symmetry in his views, but that is not in the area of ethical standards. We contrasted this with Treasury Secretary Geithner. He is neither respected nor trusted. It started with his various behaviors at the New York Fed and continues with the onslaught of questions about his policy making. One colleague asked if I feared retribution because I was willing to be outspoken in my criticism of Geithner. I answered that I still be believe that our great country protects editorial freedom. I hope I am right.

We will probe the issue of sovereign debt burdens at the meeting here in Cordoba. They are rising. And there is ample evidence in the research literature that a rising debt/GDP ratio causes a rise in the real interest rate. That may not show in the nominal rate, but it is estimable in real terms. Rising debt burdens do act in a deflationary way. Studies show that each increase of 1% in this debt/GDP ratio can add 3 to 4 basis points to the ongoing equilibrium real rate. At Cumberland we pay very close attention to this work when we apply strategies to our fixed-income accounts.

There is great history here in Spain. It is reflected in the art, where the great painters were courtesans, and in the culture, which has modernized but stayed intact in many ways right through today. And now it is being written anew in the way Spain deals with its position in the Euro zone and with its economic downturn. My sense here is that comparisons between Spain and Greece are very wide of the mark. Frankly, it is hard for me to see a default by either country, notwithstanding Greece’s very public budget pressure. But I must say that it is hard for me to see a default by New Jersey or California, as well. Sovereigns have little incentive to default and have many and varied reasons to restructure and pay their debts and bring their budgets into alignment. The penalties are very high if they fail.

We leave for Cordoba early on Monday. The weather report says it will be cold but no snow is expected, so travel delays are not anticipated. Now jet lag is catching up. Adios.

David R. Kotok, Chairman and Chief Investment Officer

Pres. Obama spoke to House Republicans at their two-day retreat in Baltimore, MD. He repeated his State of the Union address plea for bipartisanship on health care and other economic issues. GOP leaders commented later, following shortly after a question-and-answer session with the President.

Hat tip Richard

Here is an interesting thing I noticed:

RSS feeds have exploded — we went from 20k to an astounding 138,000. But as they happened, the blog traffics and comments have slipped. Unless its a provocative topic, comments are int he 20-40 range (as opposed to 80-100 from last year).

Does this matter much?

Right now, I do full RSS posts. Should I reduce those feeds (can you do 50% of a post?) to bring people to the site, and generate more discussions?

Or is this just the natural evolution of the web?

Great piece in Friday’s Times by Floyd Norris on an earlier boom and bust in securitized mortgages: The 1920s and 30s!

“Real estate securitization was one of the great innovations in finance in the last quarter-century. In an unprecedented way, it allowed vast sums of money to go into the real estate market from people who traditionally did not take part in it. But the people making the loans did not need to worry if they would be repaid, and in the end the entire edifice collapsed.

Now, with the securitization market nearly dead, getting that market going again is vital to providing Americans with mortgage loans. Securitization may need to be reformed a little, but it remains critically important to a well-functioning economy.

That is the conventional wisdom now, at least among many bankers and economists.

Most of it is right, except that “unprecedented” part. Although few people now remember it, another wave of private securitizations once altered the real estate landscape, particularly in New York but also in Chicago and some other American cities.

That wave ended pretty much like this one did. . .

The original wave of securitizations took place in the 1920s, when the United States went on the greatest building boom ever. Many investors saw how rapidly real estate prices were rising and wanted in on the action. The builders and brokers were only too happy to oblige.” (emphasis added)

Fascinating stuff!

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Source:
In the Packaging of Loans, a Bust With Precedent
FLOYD NORRIS
NYT, January 28, 2010
http://www.nytimes.com/2010/01/29/business/29norris.html

Hat tip boingboing

Barron’s Review Column asks various people “Is the plan to curtail banking activities and rein in risk-taking a good idea?”

Here are a few of their answers:

“These new ideas are all good stuff…and entirely justified. Everyone…knows banks trading their own capital like a hedge fund is a conflict of interest….[It] was indeed the rot at the heart of our financial problems.”
-Jeremy Grantham
Co-founder, Chief Investment Strategist, GMO, in a recent client letter

“Trading did not lead to the financial crisis. While we await details of the plan, our initial observation is that rather than arbitrarily banning certain activities, or setting arbitrary size limits, [we] should focus on improving risk management, internal controls, corporate governance and supervisory oversight, and creating the authority to wind down large financial institutions.”
-Rob Nichols
President, COO, Financial Services Forum

“Nearly a year ago, we investors recommended enhanced bank regulation to avoid a repeat of the financial crisis, that OTC derivatives markets be eliminated, and that proprietary trading [not] be permitted to jeopardize banking operations. Industry’s reaction to the Volcker rule makes it look like it has amnesia.”
-Kurt Schacht
Managing director, CFA Institute Centre for Financial Market Integrity

Interesting perspectives . . . My own view is nuanced:

-Risk-taking is fine; excessive risk taking is a problem. And ANY Risk-taking without the ability to pay off your bad sepculative bets is totally unacceptable. That is a form of “Heads I win, tails you lose” that is a recipe for taxpayer financed disasters;

-Prop trading did not cause the crisis, but it presents a future risk. If Banks want access to cheap Fed money, taxpayer backed guarantees, and FDIC insurance, than no prop trading.

You get to choose what type of financial institution you want to be: Hedge fund? Insured Commercial Bank? Leveraged Investment House? Sure! However, if you choose the FDIC/taxpayer backing, you have to forgo the other two choices.

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Source:
They Said What? The Volcker Rule
ROBIN GOLDWYN BLUMENTHAL
Barron’s FEBRUARY 1, 2010
http://online.barrons.com/article/SB126481011371437491.html

The Statistical Recovery has Arrived
This Time Is Different
A Crisis of Confidence
Greeks Bearing Gifts
Biotech, Conversations and Babies

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“Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that ‘this time is different.’ That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy.”

- This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)

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When does a potential crisis become an actual crisis, and how and why does it happen? Why did most everyone believe there were no problems in the US (or Japanese or European or British) economies in 2006? Yet now we are mired in a very difficult situation. “The subprime problem will be contained,” said now controversially confirmed Fed Chairman Bernanke, just months before the implosion and significant Fed intervention. I have just returned from Europe, and the discussion often turned to the potential of a crisis in the Eurozone if Greece defaults. Plus, we take a look at the very positive US GDP numbers released this morning. Are we finally back to the Old Normal? There’s just so much to talk about.

But first, I want to give you a chance to register for my 6th (where do the years go?!) annual Strategic Investment Conference, cosponsored with my friends at Altegris Investments. The conference will be held April 22-24 and, as always, in La Jolla, California. The speaker lineup is powerful. Already committed are Dr. Gary Shilling, David Rosenberg, Dr. Lacy Hunt, Dr. Niall Ferguson, and George Friedman, as well as your humble analyst. We are talking with several other equally exciting speakers and expect those to firm up shortly.

Comments from those who attend often run along the lines of “This is the best conference we have ever been to.” And each year it seems to get better. This year we are going to focus on “The End Game,” that is, on the paths the various nations are likely to take as they try to solve their various deficit problems, and how that will affect the world and local economies and our investments. We make sure you have access to our speakers and get your questions answered, and you’ll come away with excellent, practical investment ideas.

This conference sells out every year, and you do not want to miss it. There is a physical limit to the space. Every year I have to tell people, including good friends, that there is no more room. Don’t wait to sign up. There is an early-bird discount of $200. And while it pains me to say it, you must be an accredited investor to attend the conference, as there are regulations we must follow in order to offer specific advice and ideas. Click on the link and sign up now. https://hedge-fund-conference.com/2010/invitation.aspx?ref=mauldin

At the end of the letter I am going to comment on my latest Conversations with two of the leading lights in the biotech world and give you a link to my recent Outside the Box on biotech, which has had more response than almost any letter I have posted. If you missed it, you should read it, as I outline why I am actually buying stocks in the biotech space, even as I think we are headed for a double-dip recession and a rather sharp bear market. But now, let’s jump into today’s letter.

The Statistical Recovery has Arrived

Before we get into the main discussion point, let me briefly comment on today’s GDP numbers, which came in at an amazingly strong 5.7% growth rate. While that is stronger than I thought it would be (I said 4-5%), there are reasons to be cautious before we sound the “all clear” bell.

First, over 60% (3.7%) of the growth came from inventory rebuilding, as opposed to just 0.7% in the third quarter. If you examine the numbers, you find that inventories had dropped below sales, so a buildup was needed. Increasing inventories add to GDP, while, counterintuitively, sales from inventory decrease GDP. Businesses are just adjusting to the New Normal level of sales. I expect further inventory build-up in the next two quarters, although not at this level, and then we level off the latter half of the year.

While rebuilding inventories is a very good thing, that growth will only continue if sales grow. Otherwise inventories will find the level of the New Normal and stop growing. And if you look at consumer spending in the data, you find that it actually declined in the 4th quarter, both annually and from the previous quarter. “Domestic demand” declined from 2.3% in the third quarter to only 1.7% in the fourth quarter. Part of that is clearly the absence of “Cash for Clunkers,” but even so that is not a sign of economic strength.

Second, as my friend David Rosenberg pointed out, imports fell over the 4th quarter. Usually in a heavy inventory-rebuilding cycle, imports rise because a portion of the materials businesses need to build their own products comes from foreign sources. Thus the drop in imports is most unusual. Falling imports, which is a sign of economic retrenching, also increases the statistical GDP number.

Third, I have seen no analysis (yet) on the impact of the stimulus spending, but it was 90% of the growth in the third quarter, or a little less than 2%.

Fourth (and quoting David): “… if you believe the GDP data – remember, there are more revisions to come – then you de facto must be of the view that productivity growth is soaring at over a 6% annual rate. No doubt productivity is rising – just look at the never-ending slate of layoff announcements. But we came off a cycle with no technological advance and no capital deepening, so it is hard to believe that productivity at this time is growing at a pace that is four times the historical norm. Sorry, but we’re not buyers of that view. In the fourth quarter, aggregate private hours worked contracted at a 0.5% annual rate and what we can tell you is that such a decline in labor input has never before, scanning over 50 years of data, coincided with a GDP headline this good.

“Normally, GDP growth is 1.7% when hours worked is this weak, and that is exactly the trend that was depicted this week in the release of the Chicago Fed’s National Activity Index, which was widely ignored. On the flip side, when we have in the past seen GDP growth come in at or near a 5.7% annual rate, what is typical is that hours worked grows at a 3.7% rate. No matter how you slice it, the GDP number today represented not just a rare but an unprecedented event, and as such, we are willing to treat the report with an entire saltshaker – a few grains won’t do.”

Finally, remember that third-quarter GDP was revised downward by over 30%, from 3.5% to just 2.2% only 60 days later. (There is the first release, to be followed by revisions over the next two months.) The first release is based on a lot of estimates, otherwise known as guesswork. The fourth-quarter number is likely to be revised down as well.

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