Friday, July 11, 2008

End Of An Era

Up And Down Wall Street: End Of An Era

By Alan Abelson, Barron's | 7 July 2008

Prepare for meaner slumps and less exuberant recoveries. The jobs report tells only half the bad news.

It was, as Dubya might put it, a heck of a month. But that doesn't quite convey how very distinctive and how awfully bloody it was. Great for ghouls, vampires and short sellers. Bad for just about anyone else with a pulse who happened to own as much as one solitary share of stock. Of course, if you had invested your dough in a nice little oil well somewhere you probably feel like a million bucks and your net worth must feel even better. Or, if you were one of those dastardly speculators who, sneering all the while at the world's hungry millions, took a flier on wheat, while steering clear of zinc, June was a positively lovely month.

But if you're the diehard equity type, as so many of us innocents are, you suffered the agonies of poor old Job. For the sad truth is, to find an equal to how bad June's stock market was. you need to go all the way back to 1930, when the fall-out from the Great Crash was wrenchingly evident and the bodies were still hitting the pavement on Wall Street. If it's any consolation, the elite billionaires as well as we poor investment peasants have been roughed up by this year's cruel and vicious market. We can offer you that solace, thanks to the efforts of crack researcher Teresa Vozzo, who secured the data from an interesting Website dubbed

As its fairly repellent name may give you a hint, GuruFocus tracks the stock picking performance of 55 mostly famous (and usually rich) investors including the likes of Warren Buffett, George Soros, Dave Williams, Glenn Greenberg, Carl Icahn, Ron Baron, David Dreman, Edward Lampert, Bill Miller, Marty Whitman and Seth Klarman. We know a number of these fine gents and even like a few of them. According to GuruFocus, in the first half of this year, only four of the 55 bought stocks that collectively scored a gain.

This lucky quartet was headed by T. Boone Pickens, the oil maven, whose stock purchases in the first half of the year were up a nifty 23%; Ken Heebner, whose equity buys averaged a 14.5% rise; Steve Mandel, who enjoyed a 10.1% average gain on the shares he bought in the opening six months, and David Winters, who posted a 3.8% appreciation. The worst losers were Marty Whitman, whose first-half picks were down 43.9%; Mohnish Pabrai, whose buys were down an average of 41.9%; and Bill Miller, whose purchases, on average, lost 38.5%. No need, we hazard, to pass the collection plate.

The bank for international settlements— BIS, for short, and blessedly less of a mouthful than the official moniker— has been around four score years and thus seen it all: panics and booms, recession, depression and bountiful prosperity, inflation, disinflation and that particularly ugly hybrid, stagflation. The bank, in the not unlikely case its existence has eluded your ken, is the central banks' central bank, a kind of global nanny keeping an eye cocked on the world's banking system and trying, regrettably not always with success, to persuade its charges to act with some semblance of prudence and reason.

For an institution coping with no fewer than 55 central banks, it somehow has contrived to retain its sanity and, perhaps even more surprisingly, its equilibrium. Indeed, for the most part, it manages to eschew those endearing qualities that conspire to make "smart banker" an oxymoron. Unlike so many vaguely official entities with "international" in their title, the BIS renders its analyses and opinions as guided by facts on the ground rather than revelations from on high.

We're grateful to our friends, Philippa Dunne and Doug Henwood at the Liscio Report, whose latest commentary on the economy prompted this little riff on the BIS. Like the diligent scholars they are, they plowed through the 260 pages of the bank's annual report and distilled some of the salient material it contains. Less scholarly and for sure less diligent, we, in turn, are distilling their distillate.

The BIS, incidentally, is based in Basel (forgive us our alliterations), which, we suppose, doesn't surprise you, for where else would the central bank of the world's central banks be based but in Switzerland? More to the point, its Swiss locale provides a suitably neutral perch from which to survey the global economic and financial scenes. What we found gratifying is that so much of the BIS' view of the way things are and what lies ahead of us is very much akin to what we've been scribbling here for months on end (vanity, thank heavens, is not a mortal sin).

Its take on inflation, for example, seems quite on the money. It doesn't much hold with the notion, so firmly held in Wall Street and Washington, that the concoction known as "core" inflation, which eliminates such insignificant stuff as the cost of food and energy, is the proper measure of inflation. Instead, the bank is convinced that in the U.S. and the Eurozone, headline inflation— which, of course, much to the chagrin of the no-inflation claque, includes prices of food and energy— has become a much better predictor of inflation.

As to whether the economy is done in by a violent flare-up of inflation in a redux of the 1970s or by the insufferable weight of debt aggravated by the brutal credit crunch, the BIS ventures with admirable impartiality that those on both sides of the argument might in the fullness of time be proved right. Which pretty much echoes our feeling that the current surge of inflation will worsen ponderably and be followed by a painful period of deflation [[something I've been warning about for several years: normxxx]]. The bank warns that resorting to "gimmicks and palliatives" to support asset prices and stymie an impulse among consumers to save will only make things worse.

The BIS lays the blame for the current financial mess we find ourselves in squarely on the vast buildup of debt over the years that has instilled in various global economies a dangerous tendency, fed by easy credit, to magnify booms and busts. From here on, in other words, you might as well kiss those comparatively mild recessions and moderate expansions that we've recently had goodbye. As Philippa and Doug sum up the message in the BIS annual, it increasingly looks "like the evermore freewheeling financial environment that we've taken for granted for the last 25 years is behind us." Or, as the Bank declaims "has run its course."

In sum, better buckle your seat belt; the ride ahead stacks up as pretty darn bumpy.

Another Month, Another Punk Employment Report.

We're always razzing the poor old consensus for its bum forecasts, often so very much off the mark, of monthly employment numbers. So we figure it's only fair to be nice for a change and commend the consensus for being smack on target. And we'll even refrain from pointing out that once in a very great while, the guy or gal with a blindfold on does pin the tail on the donkey. Anyway, the going estimate on the Street for June was a loss of 60,000 or so jobs and, by golly, the actual number was 62,000. All you members of the consensus, stand, please, and take a bow (it may be a long time before you get a chance to do it again).

The unemployment rate, meanwhile, which had taken a huge jump in May, the biggest, in fact, in 22 years, held steady at 5.5%. Revisions to April and May swelled the earlier reported totals of pink slips by a combined 52,000. The private sector lost 91,000 jobs, with, as you might expect, construction and manufacturing the heaviest hit. The good news was on the skimpy side: The biggest gains in hiring were by municipalities and states, and given the increasing financial pinch afflicting city halls and statehouses just about everywhere, that old reliable geyser looks due to dry up in a hurry. Governments of every stripe chipped in 29,000 to the job total. There were some 30,000 fewer temps working at the end of June than at its start, which tells you more about the economy than you'd like to hear. It's also a bit of an evil harbinger for employment.

That insightful pair, Philippa Dunne and Doug Henwood, cited above, are invariably spot-on when it comes to parsing the monthly job numbers and we've passed along their conclusions, many a time and oft. Our only reservation, and a modest one, has been, kindly souls that they are, they were too forgiving of the Bureau of Labor Statistics' birth/death model, which seeks to capture the jobs added and subtracted by, well, the birth and death of 'new' firms [[those not captured by the regular survey: normxxx]]. The device invariably strikes us as a fire alarm that works swell— except when there's a fire. And in the overwhelming majority of months, it perhaps conveniently serves to bloat the total of jobs added.

As it happens, we now have reason to forgive Philippa and Doug for being forgiving. Here's what they say in Friday's review of the latest jobs report: "Although we usually shy away from pointing to mischief coming from the birth/death model, this seems to be one of those moments when we should overcome our shyness: It added 177,000 to June employment." Duly noting that the birth/death calculation is made without seasonal adjustment, they nonetheless observe that save for it, private employment would have been down a formidable 268,000 or so. Other absurdities: The birth/death model miraculously added 29,000 to rapidly vanishing construction employment, 22,000 to professional business and professional services and— get this— a whopping 86,000 to leisure and hospitality. They comment dryly: "Given the weakness of the economy and the crunchiness of credit, we doubt there are enough start-ups around to match these 'imputations'." Exactly.

No Place To Hide

By Alan Abelson | 23 June 2008

A seasoned pro sees a global shakeout in equity markets.

This isn't the 1970s; ergo, inflation is not a worry.

We find that sentence freighted with interest, and not only because we wrote it. What's intriguing, as well, is that it contains two clauses, one of which is indisputably true, the other as clearly a non sequitur as you could ever hope to come across. What's also striking about the sentence is that it offers a striking example of how economists think (or, at least, make a pretense of doing so) and why their perceptions are often so alien to what's actually going on.

There's no record of the brilliant soul who discovered this isn't the 1970s, so we can't offer our congratulations. Too bad, really, because it matches in perspicuity the venerable observation that when people are out of work, unemployment results [[I believe that was one of 'silent' Cal Coolidge's: normxxx]]. Except for the calendrically challenged or the hopelessly infected with incurable nostalgia, no one would likely take exception to the remarkable insight this is not the '70s. Somehow, though, it doesn't ineluctably follow that because this is 2008 and not, say, 1978, we needn't shiver before the specter of inflation.

In fostering that notion, its numerous proponents, whether leaning left or right philosophically, triumphantly cite as proof labor's present emasculated state compared with the prowess it possessed three decades ago to score huge wage increases that provided tinder for the inflationary flames. No quarrel that globalization in particular has exerted enormous competitive pressure on working stiffs from their counterparts who labor for a pittance in faraway lands, compelling once truculent unions to ask rather than demand at the bargaining table. Nor that, in consequence, paychecks are not, as in the '70s, spiraling wildly upward.

But so what?

Where, except in standard economic texts, is it written that inflation comes in only one flavor? That without exploding wage costs, what naifs like us call inflation doesn't meet the definition of inflation? As it happens, our trusty dictionary, in fact, defines inflation as: "A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of goods and services."

Granted that dictionaries are the handiwork of people who are exacting about words and their meanings and not by professional economists, for whom even their native tongue is always a second language. But that quote perching in the paragraph above is not a bad description of what's happening out there in the real world, in contrast to the fantasy land where denizens of academe, Wall Street and Washington cavort and gambol.

We'll forgo once again listing the various and sundry conjuring tricks used to make inflation officially invisible and content ourselves with brief notice of a few of the more egregious ones. Like, of course, banishing oil prices from the anointed inflation measure— the sacred mythical core— because they're too "volatile." Volatile means wide and frequent changes up and down. The price of crude has risen for six and a half years in a row, from $20 a barrel to $135 barrel, and during this extended span it experienced only one rather brief and relatively modest decline worthy of mention.

That's volatility?

Food prices— which you may have noticed have been on a tear for quite a spell now and, according to the latest consumer-price index, rocketed upward in May alone— are also conveniently excluded by that purposively myopic crew from their pristine reckonings of inflation because of volatility. Add to the more serious sins of the no-inflationiks a tendency to overlook or shrug off the inexorably mounting cost of health care. Analyst Shirla Sum of Goldman Sachs, however, in a commentary released on Friday makes no bones about the painful bite rising health-care costs are taking out of the increasingly pinched consumer.

Last month, medical services were up an unhealthy 4.7% over the same month a year earlier. Moreover, Sum points out, anyone unlucky enough to have to check into a hospital had to fork over as much as 8.3% more than a year ago. And together with prescription drugs, hospital services account for nearly half John and Jane Q.'s medical outlays. But, hey, the consensus among any number of economic wise men who are never in doubt and rarely right is that there is no inflation. And, on reflection, we're forced to concede that maybe there isn't— unless you're one of those silly types who insist on driving, eating or getting sick.

Denial will get you only so far. That's true for inflation (even Ben Bernanke, of all people, is turning a bit green these days at the mere mention of the word). It's true of the economy at large (even President Bush seems to have vaguely sensed that the economy isn't what he cracked it up to be). And, as last week made emphatically clear, denial— much less delusion— just won't cut it when you're confronted by a big bad bear breathing fire from its flaring nostrils and nary a tree in sight to climb.

As we've been muttering aloud it seems like forever, the recession far from being over hasn't really gotten up a head of steam yet. The credit crunch, crush, crisis— whichever you prefer— is still very much with us and, by whatever name, doesn't give the slightest indication of packing it in. Very much the contrary, as the fresh drubbing administered to the banks, brokers and other assorted and often sordid financial outfits strongly suggests. Credit for at least two decades has been what made our world go 'round, and suddenly somebody pulled the plug and it was gone.

And gone, too, are the fabulous bubbles and booms that it so generously fed, leaving a horrible mess that we're nowhere near mopping up. What the stock market is belatedly waking up to is that the much-heralded and more fervently hoped-for 'second-half recovery' isn't going to happen [[this year, or even, maybe, next: normxxx]]. That housing may have another ugly, maybe longer decline ahead of it before it's close to a bottom. That unemployment, despite all the gimmickry used to disguise the real numbers, will continue its doleful push higher.

And as if all that weren't enough to make you hop the next shuttle to the moon, comes now S. Dewey Keesler to warn that "the global bear market in equities" triggered by our very own subprime credit mess "is now entering its next phase." A phase, he thinks, that will see the emerging markets transformed into submerging markets, an unwelcome change that will encompass the so-called BRIC quartet— Brazil, Russia, India and China— as well a full complement of the smaller fry.

Dee, as his intimates call him, is an extraordinarily bright and low-key chap, who has under his belt about 25 or so enormously successful years as a global investor. He was a founding partner back in 1986 of Oechsle International Advisors, which, as its moniker subtly hints, invested abroad, primarily for big institutions, including the endowment funds of top-notch (read: rich) universities. He eventually left to form his own shop, Boston-based SDK Capital.

Emerging markets are an accident no longer waiting to happen but very much in progress, he says, and while the severity of the further declines vary (Shanghai, for example, already down 50% from its peak, still has a long way down to go), they're all vulnerable. In the months ahead, he warns, "the concept of global economic decoupling will be thoroughly exposed as a naive fantasy." And we say amen to that.

He blames misguided monetary policies that tied the developing countries' currencies to the U.S. dollar and prevented them from controlling their interest rates. Thanks to the Fed's serial rate slashing in its effort to stave off a cataclysmic credit collapse, inflationary pressures were mightily increased in the developing world. Negative real interest rates and burgeoning money supply, Dee cautions, are destined to stoke overheated economies and kite inflation still higher.

To make matters worse— which is what governments universally do when they find themselves in a pickle— efforts to keep the masses calm in the face of rapidly rising food and energy prices have proved costly and counterproductive, yielding shortages in gasoline, diesel fuel and food (so what else is new?). This approach, Dee reports, is being pretty much abandoned, which, in the short run, is sure to mean more inflation. There's no way out for developing nations, he believes, but to adopt more stringent monetary policies, "which means higher interest rates and stronger currencies" and, inevitably, a sharp economic slowdown.

Investors who have been counting on more of the vigorous earnings growth that attracted them to emerging markets in the first place are in for a very big disappointment. Such expectations, Dee declares, "will be crushed." The great unwinding of emerging markets has just begun, he avers, "with much carnage still forthcoming." For financial markets in developing countries the vicious cycle he sees unfolding will bring pain aplenty issuing from lower multiples on lower earnings.

As we intimated, Dee knows foreign markets, and especially the emerging ones, inside out, and he has come up with more than his share of winners to prove it. We haven't the slightest hesitation in urging you to pay close heed to his forebodings. We might add that given the big chunk of U.S. corporate profits that flows in from the rest of the world, the prospect of a global shakeout doesn't exactly dissipate our own, more parochial forebodings about the market back here at home.

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