Time To Shut Down The US Federal Reserve?

¹²Time To Shut Down The US Federal Reserve?

By Ambrose Evans-Pritchard, Telegraph.Co.Uk | 29 June 2010

Like a mad aunt, the Fed is slowly losing its marbles. Kartik Athreya, senior economist for the Richmond Fed, has written a paper condemning economic bloggers as chronically stupid and a threat to public order. Matters of economic policy should be reserved to a priesthood with the correct "post-doctoral credentials", which would of course have excluded David Hume, Adam Smith, and arguably John Maynard Keynes (a mathematics graduate, with a tripos foray in moral sciences).

Adam Smith Didn't Have An Economics Phd

"Writers who have not taken a year of PhD coursework in a decent economics department (and passed their PhD qualifying exams), cannot meaningfully advance the discussion on economic policy." Don't you just love that throw-away line "decent"? Dr Athreya hails from the University of Iowa [[ranked 66th in the US by IDEAS: normxxx]].

"The response of the untrained to the crisis has been startling. The real issue is that there is an extremely low likelihood that the speculations of the untrained, on a topic almost pathologically riddled by dynamic considerations and feedback effects, will offer anything new. Moreover, there is a substantial likelihood that it will instead offer something incoherent or misleading."

You Couldn't Make It Up, Could You?

"Economics is hard. Really hard. You just won't believe how vastly hugely mind-boggingly hard it is. I mean you may think doing the Sunday Times crossword is difficult, but that's just peanuts to economics. And because it is so hard, people shouldn't blithely go shooting their mouths off about it, and pretending like it's so easy. In fact, we would all be better off if we just ignored these clowns."

I hold my hand up Dr Athreya and plead guilty. I am grateful to Bruce Krasting's blog for bringing this stinging rebuke to my attention. However, Dr Athreya's assertions cannot be allowed to pass. The current generation of economists have led the world into a catastrophic cul de sac. And if they think we are safely on the road to recovery, they still fail to understand what they did.

Central banks were the ultimate authors of the credit crisis since it is they who set the price of credit too low, throwing the whole incentive structure of the capitalist system out of kilter [[repeating the script of the 1920's disaster as if on cue: normxxx]], and more or less forcing banks to chase yield and engage in destructive behaviour [[ultimately, self-destructive: normxxx]]. They ran ever-lower real interest rates with each cycle, allowed asset bubbles to run unchecked (Ben Bernanke was the cheerleader of that particular folly [[although it was Alan G. who famously opined that "a housing bubble is not possible": normxxx]]), blamed Anglo-Saxon over-consumption on "excess" Asian savings (half true, but still the silliest cop-out of all time), and believed in the neanderthal doctrine of "inflation targeting". Have they all forgotten Keynes's cautionary words on the "tyranny of the general price level" in the early 1930s? Yes they have.

They allowed the M3 money supply to surge at double-digit rates (16% in the US and 11% in euroland), and are now allowing it to collapse (minus 5.5% in the US over the last year). Have they all forgotten the Friedman-Schwartz lessons on the quantity theory of money? Yes, they have. Have they forgotten Irving Fisher's "Debt Deflation causes of Great Depressions"? Yes, most of them have. And of course, they completely failed to see the 2007-2009 crisis coming, or to respond to it fast enough when it occurred [[BB was famously still "holding back" in Autumn of 2007 and was still pretty sanguine about things in the summer of 2008— just before the international credit system completely froze up!: normxxx]].

The Fed has since made a hash of 'quantitative easing', largely due to Bernanke's ideological infatuation with "creditism". QE has been large enough to horrify everybody (especially the Chinese) by its sheer size— lifting the balance sheet to $2.4 trillion— but it has been carried out in such a way that it does not gain full traction. This is the worst of both worlds. So much geo-political capital wasted to such modest and distorting effect.

The error was for the Fed to buy the bonds from the banking system (and we all hate the banks, don't we) rather than going straight to the non-bank private sector. How about purchasing a herd of Texas Longhorn cattle? That would do it. The inevitable result of this is a collapse of money velocity as banks allow their useless reserves to swell.

And now the Fed tells us all to shut up[!?!] Fie to you sir!

The 20th Century was a horrible litany of absurd experiments and atrocities committed by 'intellectuals', or by elite groupings that claimed a 'higher' knowledge. Simple folk usually have enough common sense to avoid the worst errors. Sometimes they need to take very stern action to stop intellectuals leading us to ruin.

The root error of the modern academy is to pretend (and perhaps believe, which is even less forgiveable), that economics is a science[!?!] and answers to Newtonian laws. In any case, Newton was wrong [[actually, as is most scientific theory, even today, merely incomplete: normxxx]]. He neglected the fourth dimension of time, as Einstein called it. And that is exactly what the new 'classical' school of economics has done by failing to take into account the intertemporal effects of debt— now 360% of GDP across the OECD bloc, if properly counted [[I should add that economists regularly ignore the effects of time— an inconvenience to many an economic equation: normxxx]].

There has been a cosy self-delusion that rising debt is largely benign because it is merely money that 'society owes to itself'. This is a bad error of judgement, one that the intuitive man in the street can see through immediately. Debt 'draws forward' prosperity, which leads to powerful overhang effects that are not properly incorporated into Fed models. That is the key reason why Ben Bernanke's Fed was caught flat-footed when the crisis hit, and kept misjudging it until the events started to spin out of control.

Economics should never be treated as a 'hard' science. Its claims are not falsifiable, which is why economists can disagree so violently among themselves: a relatively rare spectacle in hard science, where disputes are usually [[eventually: normxxx]] resolved, one way or another, by hard data. It is a branch of anthropology and psychology, a moral discipline if you like. Anybody who loses sight of this is a public nuisance, starting with Dr Athreya.

As for the Fed, I venture to say that a common jury of 12 American men and women placed on the Federal Open Market Committee would have done a better job of setting monetary policy over the last 20 years than Doctors Bernanke and Greenspan. Actually, Greenspan never earned a Phd. His honourary doctorate was awarded later for political reasons. (He had been a Nixon speech-writer). But never mind.

Depression (Economics)

¹²Depression (Economics)

By From Wikipedia, The Free Encyclopedia | 30 June 2010

In economics, a depression is a sustained, 'long-term' downturn in economic activity in one or more economies. It is a more severe downturn than a recession, which is seen by economists as part of a normal business cycle. Considered a rare and extreme form of recession, a depression is characterized by its length, and by abnormal increases in unemployment, falls in the availability of credit [[eg, as the result of a banking or similar financial crisis: normxxx]], shrinking output and investment, numerous bankruptcies [[including sovereign debt defaults: normxxx]], reduced amounts of trade and commerce [[especially international, see Baltic Exchange Dry Index: normxxx]], as well as highly volatile relative currency value fluctuations, mostly devaluations. Price deflation, financial crises and an unusually large number of bank and other financial institution failures are also common elements of a depression.

Definition

There is no widely agreed definition for a depression, though some have been proposed. In the United States the National Bureau of Economic Research determines contractions and expansions in the business cycle, but does not declare depressions.[1] Generally, periods labeled depressions are marked by a substantial and sustained shortfall of the ability to purchase goods relative to the amount that could be produced using current resources and technology (potential output).[2] Another proposed definition of depression includes two general rules: 1) a decline in real GDP exceeding 10%, or 2) a recession lasting 2 or more years.[3][4]

Terminology

Use of the term "depression" to refer to an economic downturn dates to the 19th century, when it was used by various American and British politicians and economists. The term has connotations both of "a depressed (below usual) level of economic output", and psychological depression (unhappiness). While in the technical sense it refers to a deep and/or prolonged reduction in economic activity, it is popularly used to suggest a crisis of confidence; compare malaise. Alternative terms for extended periods of poor economic performance include "lost decade" and "L-shaped recession".

Today the term "depression" is most often associated with the Great Depression of the 1930s, but the term had been used long before then. Indeed, the first major American economic crisis, the Panic of 1819, was described by then-president James Monroe as "a depression",[5] and the economic crisis immediately preceding the Great Depression, the Depression of 1920–21, had been referred to as a "depression" by president Calvin Coolidge. However, [[in the 19th and early 20th centuries: normxxx]], financial crises were traditionally referred to as "panics", eg, the 'major Panic' of 1907, and the 'minor Panic' of 1910–1911, though the 1929 crisis was most commonly referred to as "The Crash", and the term "panic" has since fallen out of use. At the time of the 1930's Great Depression, the term "The Great Depression" had already been used to refer to the period 1873–96 (in the United Kingdom) or, more narrowly, 1873–79 (in the United States), which has since been retroactively renamed the "Long Depression".

Use of the phrase "The Great Depression" for the 1930s crisis is most frequently attributed to British economist Lionel Robbins, whose 1934 book The Great Depression is credited with 'formalizing' the phrase.[5] However, US president Herbert Hoover is widely credited with having 'popularized' the term/phrase—[5][6] informally referring to the downturn as a depression, with such uses as "Economic depression cannot be cured by legislative action or executive pronouncement", (December 1930, Message to Congress) and "I need not recount to you that the world is passing through a great depression", (1931).

Occurrence

Due to the lack of an agreed definition, and the strong negative associations, the characterization of any recent period as a "depression" is contentious. The term was frequently used for regional crises from the early 19th century until the 1930s, and for the more widespread crises of the 1870s and 1930s, but economic crises since 1945 have generally been referred to as "recessions", with the 1970s global crisis referred to as "stagflation", but not a depression. At this time, the only eras of the past two centuries commonly referred to as "depressions" are the 1870s and 1930s.[7]

To some degree this is simply a stylistic change, similar to the decline in the use of "panic" to refer to financial crises, but it does also reflect that the economic cycle— both in the United States and in most OECD countries— though not in all— has generally been more moderate since 1945. There have been many periods of prolonged economic underperformance in countries/regions since 1945, detailed below, but terming these "depressions" is controversial. The most recent recession, ie, that of December, 2007 onwards, which has been the most significant global crisis since the Great Depression, has at times been termed a depression,[7] but this terminology is not widely used, with the episode instead being referred to by other terms, such as the punning "Great Recession".

Recession Warning

¹²Recession Warning

By John P. Hussman, Ph.D. | 29 June 2010
All rights reserved and actively enforced.

Based on evidence that has always and only been observed during or immediately prior to U.S. recessions, the U.S. economy appears headed into a second leg of an unusually challenging downturn. A few weeks ago, I noted that our recession warning composite was on the brink of a signal that has always and only occurred during or immediately prior to U.S. recessions. The last signal being the warning I reported in the November 12, 2007 weekly comment Expecting A Recession (the instance before that was the recession warning I reported in October 2000).

While the set of criteria I outlined in 2007 would still require a decline in the ISM Purchasing Managers Index to 54 or less to complete a recession warning, what prompts my immediate concern is that the growth rate of the ECRI Weekly Leading Index has now declined to -6.9%. The WLI growth rate has historically demonstrated a strong correlation with the ISM Purchasing Managers Index, with the correlation being highest at a lead time of 13 weeks [[for the ECRI WLI: normxxx]]. Taking the growth rate of the WLI as a single indicator, the only instance when a level of -6.9% was not associated with an actual recession was a single observation in 1988.


Click Here, or on the image, to see a larger, undistorted image.

But as I've long noted, recession evidence is best taken as a syndrome of multiple conditions, including the behavior of the yield curve, credit spreads, stock prices, and employment growth. Given that the WLI growth rate leads the PMI by about 13 weeks, I substituted the WLI growth rate for the PMI criterion in condition 4 of our recession warning composite. As you can see, the results are nearly identical, and not surprisingly, are slightly more timely than using the PMI. The blue line indicates recession warning signals from the composite of indicators, while the red blocks indicate official U.S. recessions as identified by the National Bureau of Economic Research.

The blue spike at the right of the graph indicates that the U.S. economy is most probably either in, or immediately entering a second phase of contraction. Of course, the evidence could be incorrect in this instance, but the broader economic context provides no strong basis for ignoring the present warning in the hope of a contrary outcome. Indeed, if anything, credit conditions suggest that we should allow for outcomes that are more challenging than we have typically observed in the post-war period.

Unthinkability Is Not Evidence

One of the greatest risks to investors here is the temptation to form investment expectations based on the behavior of the U.S. stock market and economy over the past three or four decades. The credit strains and deleveraging risks we currently observe are, from that context, wildly "out of sample". To form valid expectations of how the economic and financial situation is likely to resolve, it's necessary to consider data sets that share similar characteristics. Fortunately, the U.S. has not observed a systemic banking crisis of the recent magnitude since the Great Depression. Unfortunately, that also means that we have to broaden our data set in ways that investors currently don't seem to be contemplating.

On this front, perhaps the best single reference is a somewhat academic book on economic history with the intentionally sardonic title, This Time Is Different, by economists Kenneth Rogoff (Harvard) and Carmen Reinhart (University of Maryland). The book presents lessons from a massive analysis of world economic history, including recent data from industrialized nations, as well as evidence dating to twelfth-century China and medieval Europe. Reinhart and Rogoff observe that the outcomes of systemic credit crises have shown an astonishing similarity both across different countries and across different centuries. These lessons are not available to investors who restrict their attention to the past three or four decades of U.S. data.

Reinhart and Rogoff observe that following systemic banking crises, the duration of housing price declines has averaged roughly six years, while the downturn in equity prices has averaged about 3.4 years. On average, unemployment rises for almost 5 years. If we mark the beginning of this crisis in early 2008 with the collapse of Bear Stearns, it seems rather hopeful to view the March 2009 market low as a durable "V" bottom for the stock market, and to expect a sustained economic expansion to happily pick up where last year's massive dose of "stimulus" spending now trails off. But the average adjustment periods following major credit strains would place a stock market low closer to mid-2011, a peak in unemployment near the end of 2012 and a trough in housing perhaps by 2014. Given currently elevated equity valuations, widening credit spreads, deteriorating market internals, and the rapidly increasing risk of fresh economic weakness, there is little in the current data to rule out these extended time frames.

In recent months, I have finessed this issue by encouraging investors to carefully examine their risk exposures. I'm not sure that finesse is helpful any longer. The probabilities are becoming too high to use gentle wording. Though I usually confine my views to statements about probability and "average" behavior, this becomes fruitless when every outcome associated with the data is negative, with no counterexamples.

Put bluntly, I believe that the economy is again turning lower, and that there is a reasonable likelihood that the U.S. stock market will ultimately violate its March 2009 lows before the current adjustment cycle is complete. At present, the best argument against this outcome is that it is unthinkable. Unfortunately, once policy makers have squandered public confidence, the market does not care whether the outcomes it produces are unthinkable. Unthinkability is not evidence.

Moreover, from a valuation standpoint, a further market trough would not even be "out of sample" in post-war data. Based on our standard valuation methods, the S&P 500 Index would have to drop to about 500 to match historical post-war points of secular undervaluation, such as June 1950, September 1974, and July 1982. We do not have to contemplate outcomes such as April 1932 (when the S&P 500 dropped to just 2.8 times its pre-Depression earnings peak) to allow for the possibility of further market difficulty in the coming years.

Even strictly post-war data is sufficient to establish that the lows we observed in March 2009 did not represent anything close to generational undervaluation. We face real, structural economic problems that will not go away easily, and it is important to avoid the delusion that the average valuations typical of the recent bubble period represent sustainable norms. Our policy makers have spent their ammunition in the attempt to bail out bondholders and to create an entirely deficit-financed appearance of economic strength.

It would [have been] better to allow insolvent, non-sovereign debt to default (including long-term Fannie and Freddie obligations, and obligations to bank bondholders), and instead to use public funds to take receivership of failing institutions and to defend customers and depositors from the effects. Restructuring is probably a more useful word, but in any case, the key element is that those who actually made the loans, not the public, should absorb the loss. Restructuring means simply that the payment terms are rewritten to reflect the lower amount that will delivered over time.

I can't emphasize this point often enough— "failure" of a financial institution means only that the bondholders don't receive 100 cents on the dollar plus interest. Failure is only a problem when it requires piecemeal liquidation, as occurred in the case of Lehman. This is not necessary when appropriate regulators can take receivership of insolvent bank and non-bank institutions (as the new financial regulatory bill now provides).

My greatest concern is that these new receivership powers will not be implemented because the Fed and the Treasury are both in bed with major Wall Street and banking institutions. Yet there is no effective alternative. Having squandered trillions in an empty confidence-building exercise, it will be nearly impossible for those same policies to build confidence again in the increasingly likely event that the economy turns lower and defaults pick up again.

The best approach will still be to allow bad debt to go bad, let the bondholders lose, and defend the customers by taking whole-bank receivership (as the FDIC does seamlessly nearly every week with failing institutions). Almost undoubtedly, however, our policy makers will choose to defend bondholders again, pushing our government debt to a level that is so untenably high that little recourse will remain but to suppress the real obligation through long-term inflation (though as noted below, the near-term effects of credit crises are almost invariably deflationary at first). Though Reinhart and Rogoff published This Time is Different in early 2009, extending the analysis they provided in a January 2008 NBER working paper (13761), the book accurately foreshadowed the recent debt crisis in European countries.

[They] noted "As of this writing, it remains to be seen whether the global surge in financial sector turbulence will lead to a similar outcome in the sovereign default cycle. The precedent, however, appears discouraging on that score. A sharp rise in sovereign defaults in the current global financial environment would hardly be surprising."

It is interesting that despite the apparent stabilization of the Euro in recent weeks, the stabilization more reflects sudden concerns about the U.S. dollar than improvement of European debt conditions. Notice that relative to the Swiss Franc, for example, the Euro continues to plunge to fresh lows.


Click Here, or on the image, to see a larger, undistorted image.

Deflation, Inflation

Reinhart and Rogoff observe that

" …the aftermath of systemic banking crises involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources. Banking crises almost invariably lead to sharp declines in tax revenues as well as significant increases in government spending. On average, government debt rises by 86 percent during the three years following a banking crisis. "Banking crises in advanced economies significantly drag down world growth. The slowing, or outright contraction, of economic activity tends to hit exports especially hard. Weakening global growth has historically been associated with declining world commodity prices. These reduce the export earnings of primary commodity producers and, accordingly, their ability to service debt."

From an inflation standpoint, is important to recognize the distinction between what occurs during a credit crisis and what occurs afterward. Credit strains typically create a nearly frantic demand for government liabilities that are considered default-free (even if they are subject to inflation risk). This raises the marginal utility of government liabilities relative to the marginal utility of goods and services. That's an economist's way of saying that interest rates drop and deflation pressures take hold.

Commodity price declines are also common, which is a word of caution to investors accumulating gold here, who may experience a roller-coaster shortly. Over the short-term, very large quantities of money and government debt can be created with seemingly no ill effects. It's typically several years after the crisis that those liabilities lose value, ultimately at a very rapid pace.

Reinhart and Rogoff continue,

"Episodes of treacherously high inflation are another recurrent theme. Indeed, there is a very strong parallel between our proposition that few countries have avoided serial default on external debt and the proposition that few countries have avoided serial bouts of high inflation. Even the United States has a checkered history. Governments can default on domestic debt through high and unanticipated inflation, as the United States and many European countries famously did in the 1970's. "Early on across the world, the main device for defaulting on government obligations was that of debasing the content of the coinage. Modern currency presses are just a technologically advanced and more efficient approach to achieving the same end. In many important episodes, domestic debt has been a major factor in a government's incentive to allow inflation, if not indeed the dominant one. If a global surge in banking crises indicates a likely rise in sovereign defaults, it may also signal a potential rise in the share of countries experiencing high inflation. Inflation has long been the weapon of choice in sovereign defaults on domestic debt and, where possible, on international debt."

Commenting on why last year's massive interventions may not have addressed global problems, economist David Rosenberg of Gluskin-Sheff aptly observes—

"It's about bad short-term decisions over good long-term solutions, which is burying the world. While U.S. banks have recapitalized themselves and written off debt, this cycle has been dominated by governments socializing the losses and taking the bad debts from the private sector and transferring the liabilities to the public sector balance sheets. We now have a global debt problem and in order to deal with it we must understand the magnitude. "Even with low interest rates, the massive debt bulge in the U.S. has become so large that interest charges on the public debt are within a decade of absorbing over 30% of the revenue base, which then makes it that much tougher to reverse course. When you add up the entitlement programs, what we have is 65% of total government spending that can't be touched. In the next few years, under status quo policies, this 'mandatory' share of the spending pie goes to 72%."

In short, my concerns about the economy and financial markets are escalating quickly. Given the already vulnerable condition of the U.S. economy, a second phase of weakness would most likely contribute to already troubling levels of mortgage delinquency and foreclosure, and could be expected to push the unemployment rate toward 12%. It is not useful to rule out [such] unfavorable outcomes simply because they seem unpleasant or unthinkable.

It is also not useful to place superstitious hope in the [ability of the]? Fed and the Treasury to fix the consequences of irresponsible lending without any ill effect. In the coming quarters, remember that every time you hear an incomprehensibly large bailout commitment from government, it will equate to an unconscionably large extraction of public resources, possibly through overt taxation, but more likely through the long-term destruction of purchasing power.

Fannie, Freddie, And The Delusion Of Uniform Quality

While the Treasury's quiet extension of 3-year bailout funding for the GSEs was not part of Congressional intent, the word I've received is that representatives believe it was legal, but only because of a loophole that would have required explicit Congressional approval had the Treasury made the same announcement a week later. Fannie Mae and Freddie Mac remain responsible for about 3 out of 4 outstanding U.S. mortgages. The way the bailout money is being used is that, for example, Fannie Mae is purchasing all mortgage loans in its MBS pools that are delinquent by more than four months. It effectively pays off the full mortgage balance on those homes, retires a portion of outstanding mortgage backed securities, and takes ownership of the collateral.

Of course, none of those homes can be liquidated at anything close to their outstanding mortgage balances, but that's the deal that Fannie and Freddie made in return for a negligible insurance premium (G-fee), and that Tim Geithner graciously stands behind on behalf of the public. Accordingly, Fannie and Freddie are already sitting on 160,000 foreclosed homes, with losses escalating at public expense. Edward DeMarco, who oversees the government's conservation of Fannie and Freddie, observes "we cannot do this indefinitely."

While our Treasury's magnanimous generosity ensures that Fannie and Freddie obligations maturing through 2012 will be paid in full, if at public expense, it is clear that longer-term GSE obligations should not be viewed as sovereign debt. GSE obligations with maturities beyond 2012 are the obligations of insolvent institutions, not of the U.S. government. As such, the collateral behind these obligations should emphatically not be considered of uniform credit quality. It follows that many of Fannie and Freddie's long-term securities should carry junk status.

The disastrously misleading rating of subprime debt pales in comparison to the current practice of rating longer-term GSE debt as investment grade. In my opinion, Congress should make this distinction clear sooner rather than later, and let the market price this debt accordingly. The problem, of course, is that the Fed also owns $1.5 trillion of these obligations, which is a travesty of judgment and an abuse of public trust.

Regardless, to the extent that the Fed takes losses, it will provide useful discipline on the Fed itself, which it profoundly lacks. At this point, the public will take a loss on Fed-held GSE debt in any event, either through direct default or equivalent bailout cost to the Treasury. Actual losses in market value would be more transparent, and might even prompt the appropriate resignation of Ben Bernanke.

If the public has an interest in promoting home ownership, it should not be by slapping cheap insurance on wildly heterogeneous credit risks, with no residual risk to the mortgage originator. It certainly should not be through Fannie Mae and Freddie Mac, both of which have been disastrously managed. This is not a surprise— it has been clear for nearly a decade that these institutions have operated with far too much risk and far too generous assumptions about the impossibility of default and risk mismatches.

Even in 2002, the GSEs were producing large duration mismatches that threatened their solvency to a much greater extent than investors understood, which is one of the reasons I noted in January of that year "I don't even understand why Fannie Mae trades at all". Except for a note or two suggesting that my view was preposterous, nobody cared. But one can only play balance sheet roulette for so long. Fannie and Freddie became penny stocks about a week ago as it was announced that they would be delisted.

It may grease the skids of capitalism for investors to treat all GSE securities as homogeneous, and all credit risk as being perfectly described by a letter of the alphabet. The wheels of Wall Street are constantly churning to create credit default swaps and payment guarantees to make investors believe that no thought is required of them other than to hand over their money. But this belief in uniform quality is a delusion.

The institutions that provided these guarantees were at far more risk than investors understood, which is why AIG, Fannie Mae and Freddie Mac were the first to go down, and why the U.S. public is paying hundreds of billions to make sure that bondholders get a good deal despite the failure of the underlying collateral. As Bill Hester notes in his latest research piece The Great Divergence, it is also a mistake to view international debt and equity to be of uniform quality. Distinctions and selectivity among investments will most probably be increasingly important as we move through the coming years.

Market Climate

As of last week, the Market Climate for stocks remained characterized by unfavorable valuations and unfavorable market action— a combination that has been unfortunately frequent over the past decade, but has historically occurred only about 25% of the time. A natural consequence of the frequency of this particular Climate over the past decade is that the S&P 500 has delivered a negative total return over this period. This outcome underscores the fact that market outcomes on average do vary with valuations and market action.

But it also reflects an economy that has constantly misallocated resources because we have embraced quick fixes, bailouts, speculation, cheap money, and quarterly operating earnings, rather than careful risk assessment and a focus on long-term solvency and properly discounted cash flows. Frankly, if one good thing comes out of the recent (and likely continuing) trouble, it will be revulsion toward "playing" the market as if it is some sort of carnival. The Strategic Growth Fund is fully hedged here. In this position, the primary source of day-to-day fluctuations in Fund value is the difference between the stocks owned by the Fund and the indices we use to hedge.

In bonds, the Market Climate last week was characterized by moderately unfavorable yield levels and favorable yield pressures. Credit spreads continue to widen, and we've observed a flattening of the yield curve due to a flight-to-safety in default free instruments. This may seem like an odd outcome, given that the growing issuance of Treasury and Fed liabilities is gradually setting us up for a difficult inflationary period beginning in the second half of this decade, but it is a strong regularity that "default-free" beats "inflation prone" during periods of crisis. For that same reason, we have to be careful about concluding that the growth of government liabilities will quickly translate into continued appreciation in precious metals and other commodities.

Again, the historical regularity is for commodities to decline, though with a lag, once credit difficulties emerge. My weekly comments on this front might be less redundant if there were more subtlety to the issue. But it is subtle enough to recognize that the long-term inflationary implications of current monetary and fiscal policies will not necessarily translate into negative short-term outcomes for the Treasury market, nor persistently positive short-term outcomes for commodities.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Investment Strategy

Investment Strategy: “Getting, Keeping, Losing!”

By Jeffrey Saut | 28 June 2010

"… great fortunes are not insulated from risk: The same tides of economic change and progress that were creating these new fortunes were also destroying old ones. Since 1982 the economic and technological progress unleashed by 'supply-side' policies has ousted some 60% of the incumbent tycoons from the Forbes Four Hundred. There are, basically, two kinds of wealth: tangible and financial. Tangible assets already exist: real estate, buildings, mineral deposits, farmland, works of art, stockpiles of commodities, wares of the past. Financial assets consisting of stocks, bonds, and other securities represent not so much tangible wealth as a pledge of future production. The cycles between these two forms of wealth respond to public policy. Times of inflation and high taxes favor existing wealth over new wealth, tangible assets over financial assets, collectible capital over productive capital. Tangibles tend to yield a relative untaxable flow of benefits; housing, jewelry, art and leisure result in mostly untaxable returns. Securities tend to yield a taxable and inflatable flow of income on a principal that dissolves with the decline of currency. Put it this way: Financial assets do best in times of low inflationary growth. Hard assets do best in times of high inflation and high taxes." — "The Slippery Slope of Wealth", Wealth and Poverty by George Gilder

"Getting, Keeping, Losing" is the title of the aforementioned quote and it is certainly consistent with one of my New Year's resolutions, for as we entered 2010 one of my main mantras has been to try and "keep the profits accrued since the March 2009 bottom." As touched on in last week's letter, there are currently two major questions raging on Wall Street— is this a new bull market; or, is what we have experienced over the last 15 months just a rally in an ongoing secular bear market? Fortunately, [downward sloping] secular bear markets are rather uncommon.

More common are broad 'trading-range' markets punctuated by numerous 'tactical' bull and 'tactical' bear markets. For example, in 1966 the D-J Industrial Average (DJIA) first approached 1000. By 1982 the DJIA was still hovering near 1000. Yet, over that 16-year time period there were 13 rallies/declines of more than 20% (see chart).


Click Here, or on the image, to see a larger, undistorted image.

As often stated, since the Dow Theory "sell signal" of September 1999 I have suggested the equity markets were likely going to be in a trading range pattern similar to the 1966 - 1982 affair. Clearly, that is what has occurred over the last 10 years. Most recently, the 54% slide from The Dow's October 2007 peak into its March 2009 low has been followed by a 70%+ rally that ended in April of this year. Subsequently, the senior index experienced its first double-digit decline since the March 2009 bottom, ushering in cries of "the bear market rally is over!"

To me, however, all that's transpired is another decline within the context of the broad trading range the Dow has been in since the turn of the century. Nevertheless, I must admit I am concerned because a Dow Theory "sell signal" was registered during the recent decline. Accordingly, I am back in a cautious mode, which is why investment accounts should have some cash, while trading accounts should be relatively "flat."

I also have to admit I am worried about the weakening economic reports. To be sure, the number of economic indicators surprising to the downside is about equal to those surprising on the upside. According to the astute Bespoke Investment Group, "Of the eleven economic indicators released last week, only six came in ahead of expectations, while five surprised to the downside."

One of those downside surprises was the recent shockingly weak New Home Sales, which inked the weakest reading since the statistics began in 1963. That said, I don't think housing is going to spin the economy into another recession, because going from 1.5 million housing starts to 400,000 is plainly impactful. But, going from 400,000 to 300,000, well who cares?

To me participants should be much more nervous about the sharp decline in the Economic Cycle Research Institute's (ECRI) weekly leading economic index (see chart). Readers of these missives should recall I often referenced this index as 'proof' of the economic recovery when the index was ramping at its sharpest rate in history. Regrettably, it is now declining at one of its sharpest rates.


Click Here, or on the image, to see a larger, undistorted image.

I am indeed concerned about the ECRI's weekly index of leading indicators, but it should be noted that while the ECRI Index has been an excellent predictor of the economy, it has NOT been very accurate in predicting the stock market's direction. Still, given the Dow Theory "sell signal," the intermediate "sell signal" registered by my proprietary trading indicator, and the "hook down" in the monthly stochastic indicator (all of which can be seen in last week's letter), I have no choice but to be cautious until circumstances change. I am also watching the interrelationship between the S&P 500's 50-DMA (@1128) and its 200-day moving average (@1112). If the 50-DMA crosses below the 200-DMA, it would be a further cautionary signal.

Because of the envisioned broad trading range, since 1999 I have advised participants to divide equity portfolios such that 80% of the portfolio is for investment stocks. The remaining 20% of the portfolio should be used in an attempt to take advantage of the various mini-bull/bear markets. Currently, that 20% portion of the portfolio, aka the trading account, should be relatively "flat."

Investment accounts, however, should always be on the prowl for decent risk/reward situations. To that point, the Bespoke Group penned a study titled "Bespoke's Custom Portfolio Trading Range Screen". The report highlights a number of stocks that are oversold as measured by the distance (in standard deviations) each stock is below its 50-DMA. Of the 30 stocks mentioned, 12 are part of the Raymond James research universe.

Of particular interest were: Chevron (CVX); Home Depot (HD); and Wal-Mart (WMT). Wal-Mart, under $50 per share, is pretty compelling given the fundamental metrics expressed by our analyst Budd Bugatch. And on a completely separate note, I was intrigued by Peabody Energy's (BTU) article regarding the "Supercycle for Coal," which can be viewed on the company's website. You can also read Raymond James' opinion on the subject in the most recent report by our coal analyst Jim Rollyson, dated 6/21/10.

The call for this week: I continue to attempt to "keep" the profits accrued since the March 2009 bottom. Accordingly, I remain cautious in the short-run for the aforementioned reasons. Longer-term I continue to think the equity markets are okay into the mid-term elections which, as stated, should be a referendum between the 'progressives' and their more fiscally 'conservative' counterparts.

If the progressives "win," I think it puts a HUGE headwind into the economy and the markets. The quid pro quo would suggest easier "sailing" going forward. Until then, the yield-curve is still relatively steep, credit spreads have not leaped, the Advance/Decline Line appears steady, and earnings comparisons should remain favorable; so unless it really is different this time, the recent correction in the equity markets should resolve itself with higher prices.

The call from last week: The current debate de jour centers on whether what we have experienced since the March 2009 "bottom" is just a rally in an ongoing bear market or the beginning of a new secular bull market. Plainly, this is not an unimportant question, for the difference is whether you become more invested on weakness or less invested on strength. As for me, since the initial Dow Theory "sell signal" of September 1999, I have opined that the equity markets were likely going to be in a trading range characterized by numerous 'tactical' bull and bear markets.

My strategy, therefore, has been to attempt to determine where there is a [current] secular bull market and tilt the investment account (80% of the portfolio) accordingly. Since the 4Q01, I have been adamant that there is a secular bull market in "stuff stocks" (energy, agriculture, metals, water, electricity, cement, etc.), preferably "stuff stocks" with a yield, as well as a bull market in emerging and frontier markets. I still feel that way despite my near-term caution.

For the other 20% of the portfolio (the trading account), I have recommended a more dynamic approach in an attempt to take advantage of the various mini-bull/bear market "swings". The most recent example of this strategy was the recommendation to layer downside hedges, and "bets" on increased volatility, into portfolios during the entire month of April as protection for the "long" positions in the investment account. Currently, those hedges have been shed, leaving the trading account flat. And, this morning that looks to be at least partially correct given the Chinese news, albeit still half wrong since the trading account is indeed flat. Nevertheless, I'm back and hopefully can get back in step with the various markets.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Investment Strategy

Investment Strategy: “Getting, Keeping, Losing!”

By Jeffrey Saut | 28 June 2010

"… great fortunes are not insulated from risk: The same tides of economic change and progress that were creating these new fortunes were also destroying old ones. Since 1982 the economic and technological progress unleashed by 'supply-side' policies has ousted some 60% of the incumbent tycoons from the Forbes Four Hundred. There are, basically, two kinds of wealth: tangible and financial. Tangible assets already exist: real estate, buildings, mineral deposits, farmland, works of art, stockpiles of commodities, wares of the past. Financial assets consisting of stocks, bonds, and other securities represent not so much tangible wealth as a pledge of future production. The cycles between these two forms of wealth respond to public policy. Times of inflation and high taxes favor existing wealth over new wealth, tangible assets over financial assets, collectible capital over productive capital. Tangibles tend to yield a relative untaxable flow of benefits; housing, jewelry, art and leisure result in mostly untaxable returns. Securities tend to yield a taxable and inflatable flow of income on a principal that dissolves with the decline of currency. Put it this way: Financial assets do best in times of low inflationary growth. Hard assets do best in times of high inflation and high taxes." — "The Slippery Slope of Wealth", Wealth and Poverty by George Gilder

"Getting, Keeping, Losing" is the title of the aforementioned quote and it is certainly consistent with one of my New Year's resolutions, for as we entered 2010 one of my main mantras has been to try and "keep the profits accrued since the March 2009 bottom." As touched on in last week's letter, there are currently two major questions raging on Wall Street— is this a new bull market; or, is what we have experienced over the last 15 months just a rally in an ongoing secular bear market? Fortunately, [downward sloping] secular bear markets are rather uncommon.

More common are broad 'trading-range' markets punctuated by numerous 'tactical' bull and 'tactical' bear markets. For example, in 1966 the D-J Industrial Average (DJIA) first approached 1000. By 1982 the DJIA was still hovering near 1000. Yet, over that 16-year time period there were 13 rallies/declines of more than 20% (see chart).


Click Here, or on the image, to see a larger, undistorted image.

As often stated, since the Dow Theory "sell signal" of September 1999 I have suggested the equity markets were likely going to be in a trading range pattern similar to the 1966 - 1982 affair. Clearly, that is what has occurred over the last 10 years. Most recently, the 54% slide from The Dow's October 2007 peak into its March 2009 low has been followed by a 70%+ rally that ended in April of this year. Subsequently, the senior index experienced its first double-digit decline since the March 2009 bottom, ushering in cries of "the bear market rally is over!"

To me, however, all that's transpired is another decline within the context of the broad trading range the Dow has been in since the turn of the century. Nevertheless, I must admit I am concerned because a Dow Theory "sell signal" was registered during the recent decline. Accordingly, I am back in a cautious mode, which is why investment accounts should have some cash, while trading accounts should be relatively "flat."

I also have to admit I am worried about the weakening economic reports. To be sure, the number of economic indicators surprising to the downside is about equal to those surprising on the upside. According to the astute Bespoke Investment Group, "Of the eleven economic indicators released last week, only six came in ahead of expectations, while five surprised to the downside."

One of those downside surprises was the recent shockingly weak New Home Sales, which inked the weakest reading since the statistics began in 1963. That said, I don't think housing is going to spin the economy into another recession, because going from 1.5 million housing starts to 400,000 is plainly impactful. But, going from 400,000 to 300,000, well who cares?

To me participants should be much more nervous about the sharp decline in the Economic Cycle Research Institute's (ECRI) weekly leading economic index (see chart). Readers of these missives should recall I often referenced this index as 'proof' of the economic recovery when the index was ramping at its sharpest rate in history. Regrettably, it is now declining at one of its sharpest rates.


Click Here, or on the image, to see a larger, undistorted image.

I am indeed concerned about the ECRI's weekly index of leading indicators, but it should be noted that while the ECRI Index has been an excellent predictor of the economy, it has NOT been very accurate in predicting the stock market's direction. Still, given the Dow Theory "sell signal," the intermediate "sell signal" registered by my proprietary trading indicator, and the "hook down" in the monthly stochastic indicator (all of which can be seen in last week's letter), I have no choice but to be cautious until circumstances change. I am also watching the interrelationship between the S&P 500's 50-DMA (@1128) and its 200-day moving average (@1112). If the 50-DMA crosses below the 200-DMA, it would be a further cautionary signal.

Because of the envisioned broad trading range, since 1999 I have advised participants to divide equity portfolios such that 80% of the portfolio is for investment stocks. The remaining 20% of the portfolio should be used in an attempt to take advantage of the various mini-bull/bear markets. Currently, that 20% portion of the portfolio, aka the trading account, should be relatively "flat."

Investment accounts, however, should always be on the prowl for decent risk/reward situations. To that point, the Bespoke Group penned a study titled "Bespoke's Custom Portfolio Trading Range Screen". The report highlights a number of stocks that are oversold as measured by the distance (in standard deviations) each stock is below its 50-DMA. Of the 30 stocks mentioned, 12 are part of the Raymond James research universe.

Of particular interest were: Chevron (CVX); Home Depot (HD); and Wal-Mart (WMT). Wal-Mart, under $50 per share, is pretty compelling given the fundamental metrics expressed by our analyst Budd Bugatch. And on a completely separate note, I was intrigued by Peabody Energy's (BTU) article regarding the "Supercycle for Coal," which can be viewed on the company's website. You can also read Raymond James' opinion on the subject in the most recent report by our coal analyst Jim Rollyson, dated 6/21/10.

The call for this week: I continue to attempt to "keep" the profits accrued since the March 2009 bottom. Accordingly, I remain cautious in the short-run for the aforementioned reasons. Longer-term I continue to think the equity markets are okay into the mid-term elections which, as stated, should be a referendum between the 'progressives' and their more fiscally 'conservative' counterparts.

If the progressives "win," I think it puts a HUGE headwind into the economy and the markets. The quid pro quo would suggest easier "sailing" going forward. Until then, the yield-curve is still relatively steep, credit spreads have not leaped, the Advance/Decline Line appears steady, and earnings comparisons should remain favorable; so unless it really is different this time, the recent correction in the equity markets should resolve itself with higher prices.

The call from last week: The current debate de jour centers on whether what we have experienced since the March 2009 "bottom" is just a rally in an ongoing bear market or the beginning of a new secular bull market. Plainly, this is not an unimportant question, for the difference is whether you become more invested on weakness or less invested on strength. As for me, since the initial Dow Theory "sell signal" of September 1999, I have opined that the equity markets were likely going to be in a trading range characterized by numerous 'tactical' bull and bear markets.

My strategy, therefore, has been to attempt to determine where there is a [current] secular bull market and tilt the investment account (80% of the portfolio) accordingly. Since the 4Q01, I have been adamant that there is a secular bull market in "stuff stocks" (energy, agriculture, metals, water, electricity, cement, etc.), preferably "stuff stocks" with a yield, as well as a bull market in emerging and frontier markets. I still feel that way despite my near-term caution.

For the other 20% of the portfolio (the trading account), I have recommended a more dynamic approach in an attempt to take advantage of the various mini-bull/bear market "swings". The most recent example of this strategy was the recommendation to layer downside hedges, and "bets" on increased volatility, into portfolios during the entire month of April as protection for the "long" positions in the investment account. Currently, those hedges have been shed, leaving the trading account flat. And, this morning that looks to be at least partially correct given the Chinese news, albeit still half wrong since the trading account is indeed flat. Nevertheless, I'm back and hopefully can get back in step with the various markets.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Markets Sense The Plague Is Coming (Back)

Markets Sense The Plague Is Coming (Back)
Order For New Age Of Austerity Takes On The G-20, Attacks Growth

By Nick Godt, Marketwatch | 29 June 2010

NEW YORK (MarketWatch)— In the 1947 classic novel "The Plague" by Albert Camus, a deadly epidemic shuts off the town of Oran in Algeria from the outside world and leads to panic, a near collapse of institutions, order, common sense and humanity. Ultimately, two leading and opposing trends emerge on how to respond with the issue and to sway the course of action. On the one hand, religious and repressive judicial authorities say the plague was a long-coming, well-deserved punishment from God for the sins of the populace and the breakdown of values.

On the other side is the scientific and medical community, which tries to relieve human suffering while seeking and ultimately finding a cure. The human toll, however, has been devastating— in large part due to human folly in opposing relief efforts. In the same vein, as leaders of the Group of 20 nations meet in Toronto this weekend, we'll all be reminded why the outlook for jobs and global growth as well as for markets is getting darker by the minute.

Unlike two years ago, when global leaders were united in their will to stimulate economies and avoid the abyss of another Great Depression, this time around, members of the "order for a new age of austerity," it seems, will outnumber the proponents of stimulus, job creation and growth. The order has found new high priests in the leaders of Germany and the United Kingdom, who say that we must accept the painful penance of cost-cutting measures now to appease the gods of market forces. Debt markets must be dealt with 'at all costs', as must the 'guilt' of passing on debt to future generations.

The simple idea that the outlook for long-term deficits magically improves when employment and economies grow, which boosts government revenues via already existing taxes, is apparently lost on anyone whose desire for repentance overwhelms everything else. The real-world result: The growth outlook for Europe has been severely hit, not because of the debt crisis itself, but because of the austerity measures. It could be said that some of the 14% correction in U.S. stocks from late April through early June accounted for part of this. This week, the Federal Reserve did acknowledge that there will be a hit to U.S. growth.

At the same time, the impact of stimulus measures in America— measures that were implemented at levels much less than advocated by many prominent, nonprivate-sector economists— is quickly fading. Huge drops in home sales and a downward revision in first-quarter growth might serve as reminders that, in fact, not enough stimulus was put into the economy. China, which spent 10 times more relative to the size of its economy, is now busily slowing down its growth.

Yet U.S. members of "the order" point to the fading effect of measures that were too small to begin with as proof that the really reasonable thing to do is "inflict pain by cutting spending". Nowhere was this more evident than in the punitive move by Congress not to renew the spending bill to extend the period of unemployment benefits: About 2 million Americans will lose their benefits by the end of July, including 1.3 million by the end of this week.

As Sal Guatieri, senior economist at BMO Capital Markets, said in a note: "This is another body blow to consumer spending, which is already flagging". Legislators' punitive side, meanwhile, didn't seem to impress Wall Street on Friday following what has been called the biggest overhaul of the financial system since the Great Depression. Banks and financial stocks rallied, with Goldman Sachs Group Inc. (GS) shares up 3.5%, J.P. Morgan Chase & Co. (JPM) up 3.7%, Bank of America Corp. (BAC) up 2.7% and Morgan Stanley (MS) up 3%.

But the "order" likely will say that private-sector firms are about to "unleash" a big wad of cash that will "make up for" the lack of consumer and government spending, and spark massive hiring in the face of a darkening global economic outlook. For some reason, however, firms flush with cash after the bursting of the tech bubble didn't really begin spending or hiring until after the housing bubble lifted the economy out of recession (as most reasonable businesses usually do). The "order's" faith in 'market forces' might be strong, but the market itself didn't seem to be holding its breath about growth this past week, which saw stocks slump for the first week in three due to worries about the economy.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Seeing Economic Rebound, Firms Step Up Spending

¹²Seeing Economic Rebound, Firms Step Up Spending

By Justin Lahart and Kris Maher, WSJ | 25 June 2010

Companies are stepping up spending on equipment as the recovery that first took hold in manufacturing broadens to other areas of the economy. Spending on such capital goods fell sharply during the recession, and even now, businesses remain cautious as they eye turbulence in Europe and worry that the recovery could still stumble. But with demand for goods around the world continuing to rise, that uncertainty is being trumped by concern about getting left behind.

"We're seeing global commerce expand and as a result we want to be very aggressive in our international expansion," said Alan Graf, chief financial officer at FedEx Corp. "We're back on the offensive". The Memphis-based shipping giant plans to spend $3.2 billion on equipment and facilities in the fiscal year that began this month, up from $2.8 billion last year. "Two thirds is for growth and only one-third is to maintain our current business, so we're very bullish," said Mr. Graf.

FedEx says it will buy more of Boeing Co.'s 777 airplanes to help serve its busy U.S.-Asia routes. It also is building more sorting facilities for its U.S. ground network, spending on new technology and pulling back into service jets that it had parked in the desert during the downturn. A Commerce Department report Thursday showed that orders for durable goods— items expected to last at least three years— fell 1.1% in May from April, a drop that was driven by a decline in often-choppy aircraft orders. But a key measure that economists watch to gauge capital-spending plans— nondefense capital-equipment orders excluding aircraft— rose 2.1% and was 18.4% above its year-earlier level.

There remain significant clouds on the economic horizon. As the Federal Reserve said earlier this week, business spending on equipment and software "has risen significantly," but it also noted that financial conditions "have become less supportive of economic growth". "Where we go from here is somewhat muddied," said Jim O'Sullivan, an economist at MF Global. "We've seen turmoil in the markets and I think that's going to lead to at least some temporary loss of momentum."

Dean Maki, an economist at Barclays Capital, pointed out that corporate profits in the first quarter were up 30% from a year ago. In the past, whenever profits have risen that much, it has created a competitive dynamic where companies have felt they need to spend and hire to keep pace with rivals. "The only way to increase your market share is through investing and hiring," he said. "You can't do it by sitting around."

3M Corp., which makes things ranging from Post-it Notes to surgical masks, plans capital spending of up to $1.2 billion this year, compared to $900 million last year. Among other things, the St. Paul, Minn., company is building a new plant in Singapore to make films for solar panels. Demand at an existing plant there has grown over 100% for the past several quarters. 3M CEO George Buckley said at an investor conference earlier this month that the company has seen other upside "surprises" in demand, including in abrasives, electronics and the energy industry. "We are up against capacity in some of those areas," he said.

Makers of computer equipment and software have seen business pick up, too. In a conference call Tuesday, Timothy Main, CEO of contract electronics manufacturer Jabil Circuit Inc. in St. Petersburg, Fla., said: "Many companies delayed their procurement of [information technology]-related capital expenditures throughout the recession and there's certainly significant catch-up". Software developer Red Hat Inc., in Raleigh, N.C., saw 11 deals worth approximately $1 million or more in the quarter ended May 31, more than double what it signed a year earlier, said Charlie Peters, chief financial officer, in a conference call Wednesday.

Still, boosting capital spending is a white-knuckle decision for many companies. Europe's debt crisis has hurt financial markets badly over the past two months and threatens to stifle an economic recovery that through May looked like it was gathering steam. JB Brown, president of Bremen Castings Inc. in Bremen, Ind., said his board met earlier this week and gave him the green light to spend $5 million this year, mostly on new equipment, double the amount he spent last year. He said he still has concerns that the economy could turn south, but he has no choice but to invest now.

Bremen's sales fell 24% last year, but they are expected to be up 27% this year. Credit is much more available now than a year ago, Mr. Brown said. The company wants to diversify and automate its processes for making metal castings and machining parts, such as valves used by the military and in industries such as agriculture and heavy-truck manufacturing.

Manufacturing has been a key force in the U.S. recovery, boosted by increased demand from developing markets such as China, Brazil and India and a need to replenish inventories that were slashed during the downturn. Because manufacturing companies account for about a fifth of total U.S. spending on capital equipment, their rebound is creating ample demand. Engine-maker Cummins Inc. plans to boost capital spending to $400 million this year, up nearly 30% from 2009. The Columbus, Ind., company needs to meet increased demand being fueled by rising sales of trucks and off-road engines in India and China, and an expected increase in demand for fuel-injection and emission-control systems that can meet new air-quality and fuel-efficiency standards.

"Over the next five years we see a pretty significant amount of growth," said Mark Land, a Cummins spokesman. Welspun Corp., a Little Rock, Ark., maker of pipe used in the oil-and-gas industry, decided to pump an additional $30 million this year into a new Little Rock plant to increase its welding capabilities and build out its rail yard so it can load 40 rail cars a day, up from 20. With the recovery now rippling into parts of the economy other than manufacturing, other businesses are boosting spending as well.

Greensboro, N.C.-based Moses Cone Health Systems cut its capital spending to $45 million in its fiscal year ended last October, way under the $70 million to $90 million it usually spends, as revenue fell at the five hospitals it runs and the financial crisis made access to credit uncertain. "We delayed a lot of projects," said CEO Tim Rice. "This year we're more into a normal mode". Moses Cone is putting more money into health-care information technology and has also been expanding its emergency-care department.

China: Mounting Local Government Debt A Risk

¹²China's Chief Auditor Warns Mounting Local Government Debt A Risk To Economy

China's chief auditor has warned that high levels of local government debt could derail the country's economy, with some observers suggesting that a number of Chinese provinces are even more fiscally-troubled than Greece.

By Malcolm Moore In Shanghai | 24 June 2010

Visitors discuss Chinese local government debts in front of a model of a real estate development at a property fair in Beijing Photo: Reuters

Liu Jiayi, the head of China's National Audit Office said the financial crisis had left some Chinese provinces with serious debt problems. "The scale is large, and the burden is quite heavy," he said, in an annual report to the Chinese government. Chinese provinces are, in some cases, equivalent in size to major European countries and run with a degree of fiscal autonomy. The southern province of Guangdong, for example, has the same population size as Germany.

However, provincial budgets have been classified as state secrets until now and this is the first time that China has disclosed the level of local government debt. Mr Liu said the ratio of debt to disposable revenues at some local governments was over 100% and in the highest case it was 365%. He said the audited debts of 18 of China's 22 provinces, together with 16 cities and 36 counties amounted to 2.79 trillion yuan (£279bn) in 2009.

Several observers believe the situation is far worse. The China Daily newspaper, which is run by the government, suggested that the total sum could add up to between 6 trillion and 11 trillion yuan (£590bn-£1.08 trillion). Victor Shih, a professor at Northwestern University in the United States, believes the sum in 2009 was 11.4 trillion yuan, equivalent to 71% of China's nominal GDP. (The US debt-to-GDP ratio is close to 90% while Greece's is 130%.)

Mr Shih has warned that local governments have also succeeded in rapidly funnelling large amounts of debt off their balance sheet and into public-private investment vehicles. China's banking regulator said outstanding loans from banks to local government financing vehicles was 7.38 trillion yuan at the end of 2009, rising 70% year-on-year. Mr Shih, who researched more than 8,000 of these "local investment companies", said that orders to ramp up spending on infrastructure after the financial crisis could leave China with widespread debt problems.

"I collected data from thousands of sources, including regulatory filings, bond-rating reports and press releases of government-bank agreements," he said, although he admitted that comprehensive data was difficult to track down. Next year, he is forecasting government debt to hit 96% of gross domestic product as infrastructure projects continue to eat up cash and produce negligible returns. "The worst case is a pretty large-scale financial crisis around 2012," he said. "The slowdown would last two years and maybe longer," he added.

With Europe's debt problems in the spotlight, the Chinese government has moved to try to fix the problems in its own provinces. Earlier this month, the State Council, China's cabinet, ordered local governments to stop borrowing using 'special vehicles' which rely solely on government income for their revenues and to shut down the public-private partnerships as soon as possible. The State Council said local government vehicles had "in many cases illegally guaranteed the debt of those vehicles" and had "experienced some problems that demand urgent attention".

The government ordered a progress report to be completed by local governments by the end of the year.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

'Risk Management'

Risk Management

By Jay Lipeles | 25 June 2010

To the Editor, Mechanical Engineering magazine:

I read with alarm, the cover story in your current issue: "Risk— Informed Decision Making". The basic message that risk can be managed is wrong and extremely dangerous. Mechanical Engineering does a great disservice to its readership and the engineering community at large by promoting such nonsense.

To cite a few examples: In the investigation that followed the Challenger disaster, NASA testified as to its risk assessment made prior to the event. The assessment was wrong. Seven astronauts died, and it cost the nation many hundreds of millions of dollars and several years to recover. To my mind, NASA never has, witness your article. Bad thinking remains.

The error in NASA's assessment (and related risk management theories) is that inherent in the theory (and usually unstated, as in your article) is the assumption that the situation is ergodic. NASA's assessment was based on (among other things) test data taken at room temperature. The probability of failure of the O rings was based on that data and it was incorrect [[because, as is necessarily usually the case in real life, the data was incomplete: normxxx]]. The situation was non-ergodic. The theory was inapplicable. The analysis was wrong and disaster followed.

Long Term Capital Management (LTCM) lost $4.6 billion in 1998 and subsequently failed. Among the reasons for its failure was that it assessed its risk with an analysis similar to the one in your article, which assumed that the situation was ergodic. It was not. When Russia defaulted on its debt, the mistake was revealed and LTCM went down. [[This error was systematically repeated in the models of the market created by the so-called 'quants'— which so famously failed in the summer of 2007. They made the mistake of assuming that a couple of decades of recent market behavior (during a rather anomolous period in the market's history, one might add) was a sufficient sample of market behavior.: normxxx]]

Now we are struggling through the worst recession since the Great Depression. It was initiated by the collapse of the subprime market. It goes without saying, that there were a number of contributing causes. Among them was the bundling of mortgages into securities backed up by 'risk analyses' that predicted the [combined] risk to be very low. [[They committed a common error; like LTCM, they assumed that the various risks were independent of each other— that the probability of any large number of defaults occurring at the same time was close to nil— whereas, in fact, so long as the 'players' are the same (ie, the general public, in the case of MBBs), the system is highly prone to highly correlated excursions (due to 'herding behavior'— group 'panic' buying or selling).: normxxx]] The analyses assumed that the situation was ergodic. Whoops! In all of history, was there ever a more costly mistake?

Inherent in all analyses of this type is the assumption that the situation is ergodic. It almost never is. What the authors would have us believe is that a careful, thorough 'risk analysis' can be helpful in reducing risk. Nonsense! What such an analysis does is provide a sense that risk is being addressed when it is not. It contributes to a false sense of security.

The most important quality an engineer brings to the game is his judgment. Greater reliance on [[so-called 'formal' (mathematical) models of : normxxx]] 'risk management' really implies (and demands) reduced reliance on judgment (engineering, financial or whatever). It is a very bad strategy, based as it is on an assumption known to be wrong! It is an extremely dangerous strategy. We should instead be relying more heavily on, and developing the people, who possess good judgment.