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

David R. Kotok
Chairman and Chief Investment Officer
P. T. F. S. D.
September 19, 2010

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For the last two years, American investors have experienced the evolution of Post-Traumatic Financial Stress Disorder (PTFSD). Many others throughout the world had the same type of shock. It was triggered by the failure of Lehman Brothers and AIG. It grew worse through the 5-week waterfall decline in stock prices in October and November of 2008, and healing did not begin until the bleeding stopped in March 2009.

We have argued for two years that the bear market had two phases. The first was a vicious but normal bear market that started with the peak in stock market values in 2007. That declining phase was discounting the decline in housing values, the financial crisis that was evolving at the time, the failure of Fannie and Freddie, and all the other elements we know. Phase 1 was severe, as bear markets go.

The second damaging phase was equal to the first in monetary size. It occurred after Lehman. It was the second phase, which came as an unexpected shock that caused PTFSD. Phase 2 happened fast. Moreover, merciless in its sweep, it featured worldwide correlation. The combination of phases one and two took the aggregate global stock market value from a peak of $63 trillion in October 2007 to a trough of $28 trillion in March 2009. It also resulted in the demise of the American financial system, as we knew it. Lehman was a primary dealer with the Federal Reserve, and the failure of the firm was unimaginable in the market’s eyes. AIG was the world’s largest insurer; it had subsidiaries in 125 countries. In phase two, the US broadcast its regulatory ineptitude and policy failure to the world. We caused the crisis. It was made in the USA.

PTFSD resulted from the second phase and changed the investment game. It scarred a generation. Only recently are we starting to measure the results. They are very instructive.

The Conference Board publishes consumer-confidence surveys by age cohort. They have been doing it for 30 years. In some brilliant research, Howard Simons of the Bianco Research firm compared confidence deterioration and rebound by age cohort. He then compared changes in confidence by cohort with activity on the US stock market and the US Treasury bond market. Howard’s work explains the results we see in the mutual fund-flow statistics.

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With Obama’s town hall talk today and the FOMC meeting Tues, we will hear again that from both a fiscal and monetary policy view, the Gov’t will continue to ‘do something’ to recharge economic activity. After seeing the Fed’s Q2 flow of funds statement on Friday, the endemic problem plaguing growth still exists and that is too much debt. Household debt is down only 3.4% from its record high, corporate debt is at an all time record high (the liability side of all that cash on the balance sheet that we hear about) and federal Gov’t debt is of course at a record high. The only sector that has deleveraged to any discernible degree is the financial area whose total debt is down 14% from its peak. So, instead of letting a recession cleanse the economy of its previous excess of too much debt, the Gov’t is still trying to put humpty dumpty back together again, that of borrowing and spending to generate growth as opposed to saving and investing.

I wanted to share an interesting email exchange from this weekend. “R” writes:

“You occasionally shred an argument with more than a hint of animus. I don’t want to say its ad hominem, but it comes damn close.  Some people get viciously disemboweled, while others are more gently corrected. Why?”

That’s a fair question. You have identified a pattern, and it is not a coincidence. There are some commentators, analysts, economists, fund managers and strategists I respect. There are others who do not warrant that respect, and I actively dislike their approach.

Why? In a word, Process.

There are those folks who have an approach based on a defendable methodology. There approach to evaluating markets or the economy could be based on fundamentals, it might be derived from quantitative metrics, it could be valuation, balance sheet, macro, momentum, GARP, trend following, technicals, long/short, psychology, sentiment, contrarian analysis.

Call it plug & chug: It doesn’t really matter what the methodology is, so long as it begins with some objective input, runs through a process of sorts, and determines an output.

There are folks in this camp who I am happy to occasionally disagree with. They force me to sharpen my own analysis, be more specific, consider alternatives. These include the likes of Doug Kass or David Rosenberg or Lakshman Achuthan or James Bianco.

Anyone who has an objective approach to evaluating the ever changing mix of inputs to the markets or economy or stocks. These folks are often intellectually curious, have flexible minds, and a high degree of integrity. Whether I agree with their conclusions or not, I respect their process.

Then there is that other group.  They are all conclusion, zero input. Process is irrelevant to them, Outcome is all.

They work backwards. They start with a conclusion, and sift through all the data to justify that conclusion. They do not change their minds. They do not care about facts or data or input. They never admit mistakes. “Truth,” as we have discussed in the past, is an irrelevant inconvenience.

They are ideological jihadists.

This group contains a mix of bad fund managers, perma-xxxxs, political ideologues, corrupted journalists, partisan hacks. They are prisoners of the cognitive biases that are so fatal to good investors.

Its called “reaching a conclusion” for a reason;  its how you end, not how you begin. We do not say “reaching for a conclusion” but that is how member of this group seem to operates

Once upon a time, I used to respectfully disagree with these folks. That has faded over time, as I have concluded (from various input) that these folks are simply not worthy of that respect. They are not honest brokers of intellectual debate, they merely seek to further their own agendas.

In the process, they make the jobs of those trying to assess the world in terms of risk and reward, opportunity and chance more difficult. To investors seeking truth, clarity, and understanding, these folks are the enemy.

That is why I give them no quarter.

“In some ways Herbert Hoover got a bad rap,” says David Stockman in an interview with WSJ’s Alan Murray. The Former Reagan Administration budget director lays out a plan for economic recovery by cutting spending, raising taxes, and allowing for years of austerity.

WSJ, 9/17/2010 9:29:03 AM

Congratulations to the 6 newest members of the FDIC class of 2010 bank closings!

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Charts courtesy of Ron Griess of The Chart Store

I want to bring two pieces of Federal Reserve Bank of Cleveland research to your attention this weekend. These are almost-not-quite-contradictory papers, in that the headlines appear opposed to each other. As so often is the case, the reality is more nuanced.

The first piece, Not Your Father’s Recovery?, challenges the conventional assumptions that the current recovery is aberrational and disappointing. Using real GDP growth, unemployment, inflation, and the federal funds rate suggests to this Cleveland Fed researcher that the recovery looks consistent with past recoveries — if we use just the data from 1983 onward:

“If all goes according to the usual business-cycle dating procedures, a committee at the National Bureau of Economic Research (NBER) will soon convene to declare that what has come to be known as the “Great Recession” came to an end in June 2009. As we all know, it was a doosie. Beginning in December of 2007, it will have lasted 19 months—the longest downturn since the Great Depression. It will also go down as the deepest as the United States shed 4.1 percent of gross domestic product (GDP) from peak to trough. The unemployment rate more than doubled, rising from 5.0 percent in December 2007 to a peak of 10.1 percent in October 2009.

Now that we are a year into the recovery, and the annual July “benchmark” revisions to the National Income and Product Accounts are complete, the time is ripe for an assessment of the recovery so far. Popular opinion strongly suggests that it has been “substandard.” But what is the standard by which the strength of a recovery can be measured? Some point to a historical tendency for deep recessions to be followed by rapid recoveries and vice versa . . .

There has been much talk about a disappointing recovery in the wake of the Great Recession—that this time it is much slower . . . Real GDP growth is not so different than we might have reasonably expected a year ago. The relationship between output growth and the unemployment rate looks somewhat anomalous, with an unemployment rate remaining higher than history alone would suggest, but not resoundingly so. Core PCE inflation turned out roughly as anticipated over the previous year, as has the Federal Reserve policy of a near-zero federal funds rate.”

The charts here show the impact of only using modern data.

The second research piece looks at employment, and surmises that post crash/post crisis, the “natural rate of unemployment” is now higher, but not nearly as much as many economists have surmised:

“The past recession has hit the labor market especially hard, and economists are wondering whether some fundamentals of the market have changed because of that blow. Many are suggesting that the natural rate of long-term unemployment  — the level of unemployment an economy can’t go below — has shifted permanently higher. We use a new measure that is based on the rates at which workers are finding and losing jobs and which provides a more accurate assessment of the natural rate. We find that the natural rate of unemployment has indeed shifted higher — but much less so than has been suggested. Surprising trends in both the job-finding and job-separation rates explain much about the current state of the unemployment rate.”

Interesting food for thought . . .

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Sources:
Not Your Father’s Recovery?
Kenneth R. Beauchemin
Federal Reserve Bank of Cleveland, 09.09.10
http://www.clevelandfed.org/research/commentary/2010/2010-12.cfm

Unemployment after the Recession: A New Natural Rate?
Murat Tasci and Saeed Zaman
Federal Reserve Bank of Cleveland, 09.08.10
http://www.clevelandfed.org/research/commentary/2010/2010-11.cfm

IF you get the channel EPIX, I suggest you watch Louis C.K.’s Hilarious tonite.

10 Louis C.K. Facts

1. Louis shortened his last name, Szekely, to the letters “C” and “K” to make it easier for people to pronounce. Are you paying attention, Melina Kanakaredes?

2. Smart genes: Louis’ parents met while they were students at Harvard University – not, as you might suspect, at Chuckles Comedy Institute.

3. Louis spent the first five years of his life living in Mexico City, before his parents moved back to Massachusetts. In fact, Spanish was his first language. How do you say “C.K.” en Español?

4. To prepare himself for life as a stand-up comic, Louis trained with renowned Massachusetts boxer Micky Ward. As Louis explained it, he thought it was important to “do the grunt work and the boring, constant training so that you’ll be fit enough to take the beating.”

5. Something about a man in uniform: Louis’ various acting roles have included a security guard, a park ranger, an EMT, and the police officer looking to capture Amy Poehler’s heart on NBC’s Parks and Recreation.

6. Louis took home an Emmy for his writing on The Chris Rock Show. He shared the award with fellow writers Rock, Wanda Sykes and Lance Crouther, who all starred in Louis’ feature film Pootie Tang (which, sadly, won no awards).

7. In addition to his time on The Chris Rock Show, Louis also spent time as a writer on The Late Show with David Letterman, Late Night with Conan O’Brien and The Dana Carvey Show. If you’ve laughed late at night in the last 20 years, thank Louis.

8. Groundbreaker: Louis created, co-wrote and starred in the series Lucky Louie on HBO, the network’s first sitcom to be taped in front of a live studio audience.

9. Groundbreaker, part 2: Louis C.K.: Hilarious premiered at Sundance – the first stand-up comedy film ever accepted into the revered film festival.

10. Louis claims the hardest decision he had to make in directing Hilarious was choosing which of his performances to film – he narrowed the choice down to Minneapolis, Cleveland and Boston before ultimately deciding on Milwaukee. No hard feelings, but 46 other states would have loved to star in your movie too, Lou.

Parody of the Free Credit Report.com “New Car” ad featuring U.S. financial heads Ben Bernanke, Hank Paulson, and Timothy Geithner. Our boys have fallen on hard times, and aren’t the fiduciary studs they might once have been.

Written and Produced at Flinch Studio for Mark Cuban’s “Blog Maverick”

Hat tip Mike Panzner

The NYTimes graphic department has your Sunday morning chart porn regarding the extension of tax cuts. Its an illustration fueled by data from the Tax Policy Center, a nonpartisan research organization.

The graphic shows how much Americans have gotten so far broken down by income groups. And it calculates that extending all of the Bush Tax Cuts for the next decade will cost another $2.7 trillion (through 2020).

Here is a guide to who will get what if the cuts are extended, and who got what from the last seven years of cuts:

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click for larger graphic

Courtesy of the NYT

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Source:
Your Coming Tax Cut (or Not)
BILL MARSH
NYT, September 18, 2010
http://www.nytimes.com/interactive/2010/09/19/weekinreview/19marsh.html

Hat tip Icanhasinternets