Friday, May 18, 2012
This is going to be a long post. I am going to cover a lot of territory. There is a lot of bad information circulating out there and I am going to do my best to correct as much of it as I can. Allow me to start with an examination of mutual fund flows. Since the first of the year stock mutual funds have seen a net outflow of $15 billion. That outflow represents 0.3% of total stock fund assets so, obviously, most stock fund investors are sticking with their holdings. However, stock mutual funds have almost always seen net inflows of cash. The fact that stock mutual funds are experiencing net outflows means investors are making different investment decisions in regards to their current investable funds. Sadly, yet predictably, investors are putting their new money into bond mutual funds.
Since the first of the year investors have put $135 billion into bond funds. This represents a huge 4.4% increase in total bond fund assets. Bond fund assets have historically trailed stock fund assets by a large margin. As of today there are $5.9 trillion in stock mutual fund assets and $3.1 trillion in bond mutual fund assets. (Money market mutual funds have $2.6 trillion in assets.) This flight to bonds has been going on for several years and it is going to end badly for those who have decided to favor bonds over stocks. Bond mutual funds will experience significant principal losses when interest rates rise. Interest rates have been artificially depressed by the Federal Reserve for several years. That artificial depression will have to eventually end. When it does interest rates will shoot upward and bond fund values will collapse. Bond fund investors are likely to realize losses on a scale they thought could only be realized in the stock market. Most bond fund investors are aware of the inverse relationship between bond prices and interest rates. Why have they still made the foolish decision to invest in bond funds rather than stock funds? The answer most frequently given is "fears about Europe". The mantra about fear in regards to Europe has been plaguing the stock market for two years.
I mentioned earlier that fears about Europe have driven the US stock market to lows not seen since 2008. The Price/Earnings ratio for the S & P 500 sits at 12.4 as I write this. The earnings yield of the S & P 500 is 8.1%. The dividend yield on the S & P 500 is 2.1% while the 10 year Treasury is 1.7%. The stock market is 23% cheaper than its historic average. Today a stock fund investor can obtain a dividend payment from his stock fund that is higher than the interest paid on a 10 year Treasury note. Yet, money continues to pour into bond funds. This is insanity. What has created this mass delusion? Fears about Europe.
Last night CNN had a headline scroll that read "Is Greece the Lehman of 2012?" The obvious point is that somebody believes that a Greek default is the financial equivalent of the demise of Lehman Brothers in 2008. The collapse of Lehman, you may recall, sparked the stock market sell off and initiated what is now known as the "great recession". Many otherwise intelligent people believe that Europe faces the same future. That belief is utter nonsense. Allow me to prove my point.
We are constantly told that the level of government debt being carried by various countries in the Eurozone is so large it is inevitable that many European countries will have to default and then experience economic collapse. We have been told this so many times most people believe it is true. Please note the following chart. It contains information about the ten most economically powerful countries in Europe. The country name is first. The world ranking for that country in terms of GDP is second. The current GDP (in billions of $) of the country is next. The debt of the country as a percentage of GDP is in the fourth column. The fifth column shows the total amount of debt from Greece held by that country (in billions of Euros). The last column shows the amount of Greek debt held by that country as a percentage of its GDP: (Not all countries shown are European Union members.)(My apologies for the sloppiness of the columns in this posting. The columns are straight in my draft but somehow get changed in the transfer to the blog. Attempts to fix them only made it worse.)
Country World GDP Rank GDP Debt as % GDP Greek Debt Greek Debt % GDP
Germany 4th $3,600 82% 15 0.4%
France 5th $2,800 87% 15 0.6%
UK 7th $2,400 86% 2 0.1%
Italy 8th $2,200 121% 5 0.2%
Spain 12th $1,500 69% 0 0
Netherlands 17th $840 66% 2 0.2%
Switzerland 19th $640 39% 0 0
Sweden 21st $540 38% 0 0
Poland 22nd $510 56% 0 0
Belgium 23rd $510 98% 2 0.4%
Greece 35th $300 165% 140 47.0%
(United States 1st $15,000 103% 0 0)
There are many things of importance to be derived from the above chart. I have provided the same information for the United States for comparison purposes. I have also provided the same information about Greece, also for comparison purposes.
We are constantly told that European countries are in deep debt trouble. Yet, the three most powerful economies in Europe (Germany, France, and the UK) all have levels of debt that are lower than the US. In fact, the average debt as a percentage of GDP for the top five countries is 85%, a full 18 percentage points lower than the US level. The average debt for the top ten countries is 71%, a full 32 percentage points lower than the US level. If the major players in Europe are in severe financial trouble, we are in an even worse condition. Yet nobody seems to be very concerned about out level of debt. Nobody is refusing to buy stock funds because of an impending debt collapse in the United States. How strange.
The combined GDP of the ten largest countries in Europe is $12.8 trillion. That would be about the equivalent of 10 trillion euros. The total Greek debt held by those ten countries is 41 billion euros. That Greek debt represents less than one half of one percent of the GDP of those countries. Why should that be a problem? Still, we are constantly told that Greek sovereign debt is a contagion that is going to bring about the collapse of other European nations. Look at the facts. It is not possible. A debt that makes up less than one half of one percent of the wealth of the area cannot, I repeat, cannot cause an economic collapse!
Yes, Greece is in trouble. But that is as far as it goes. There is no reason why what is happening in Greece should spread to any other European nation. Spain, a favorite whipping boy for the doomsayers, has a total sovereign debt that is only 69% of its GDP and no exposure to Greek debt whatsoever. We should not even be talking about Spain, unless you are planning a summer vacation. At 121% of GDP, the Italian debt is the greatest of the top ten. However, Italian exposure to Greek debt is only 0.2% of Italian GDP. That is not going to cause a problem. Italy needs to reduce its overall amount of debt but so does the United States. The Italian debt is not a whole lot more significant that our debt it. And yet, we are incessantly told how the Italians are in trouble. This is utter nonsense.
Greek citizens, in anticipation of a switch from the Euro to a new Drachma, are pulling money out of savings and either sending it to other Eurozone countries or stuffing it in the mattress. This is an entirely reasonable thing to do. A run on Greek banks is healthy. A run on Greek banks forces Greek politicians to deal with the austerity measures they need to implement. Greek citizens are smart enough to know that if the politicians decided to remove themselves from the European Union and revert to their own national currency, that national currency will be rapidly inflated and lose value when compared to the Euro. So, citizens are hiding their Euros. If the Greek government does eventually decide to reissue the Drachma, it will be forced to compete with the Euro on the black market. That is a good thing for Greek citizens. It will apply some restraint to the Greek politicians who have their hands on the government printing press.
I began this post writing about Facebook. It seems everybody wants to own a share of that company. At the same time it seems as if very few want to own shares of any other US corporation. I am going to go out on a limb and predict that any share of any well managed domestic stock mutual fund will do better over the next ten years than Facebook stock. If investors showed the same enthusiasm for domestic stocks in general that they show for Facebook in particular I would not be writing this blog posting. The only thing holding the US stock market down is an irrational pessimism based upon faulty reasoning and false economic data. The only thing propping Facebook up is an unbridled optimism. That optimism needs to be bridled and it needs to be transferred to the US stock market in general. Only then will stocks return to reasonable valuations.
Everyone knows to buy low. Almost nobody is ever able to buy low. Bonds are overpriced. People are buying bonds. Stocks are ridiculously under priced. People are not buying stocks. Go figure.
Thursday, May 17, 2012
There are four main impediments to economic growth and all of them are creations of government. In no particular order, here they are:
1. Inflation - Inflation is not an increase in prices due to an economy "heating up", as the government would have you believe. Inflation is not caused by businessmen in the pursuit of profit, as the government would have you believe. Inflation is a general increase (or slower rate of decrease) in prices as a direct result of the creation of money by the Federal Reserve Board and the US Treasury. In the absence of a central bank there will be fluctuations in prices as the forces of supply and demand operate in the economy. That is not inflation. What distinguishes the normal changes in prices in response to supply and demand from the inflationary increase in prices caused by monetary policy is the fact that inflationary increases occur across the entire economy whereas normal fluctuations are restricted to particular goods and services. Politicians are seemingly incapable of understanding that simply adding money to the economy does not increase wealth. Adding money to the economy does nothing but distort economic signals and cause inflation. Inflation is a huge impediment to economic growth.
2. Taxation - It should go without saying that the more government takes, the less there is left for those who produce. Still, politicians seem incapable of understanding that taxation reduces growth. In fact, politicians are so economically ignorant they actually have attempted to argue that taxing one group to give to another, less a significant amount for government handling, is a stimulus for economic growth. Even if government could operate in the economy with no costs associated with its own operation, it could not stimulate growth. Profit seeking businesses are always, by definition, in a better position to accurately allocate resources and create economic growth. Profit seeking businesses have the price mechanism to tell them what to do and when to do it. Because government has unlimited access to new dollars (through taxation and inflation), the price mechanism is irrelevant. Because price issues are irrelevant, government is incapable of efficiently allocating scarce resources. Taxation always retards economic growth.
3. Government Regulation - Do an Internet search for "cost of government regulations" and feast your eyes upon the hundreds of examples illustrating the huge negative impact of government attempts at regulating the economy. Politicians seem incapable of understanding that all regulations created by government necessarily come associated with a cost for compliance and enforcement. It is impossible for a regulation to be written that would have the net impact of increasing economic growth. Regulations will enrich lawyers and others associated with the business of compliance but, on the whole, more will be lost than will be gained. Still, politicians talk incessantly about how their programs for regulation will create economic growth. They are all economically ignorant. Government regulation always hinders economic growth.
4. Government Spending - Government spends money in order to reward those who support it. Politicians propose spending programs in order to reward those who voted for them. Government spending takes no thought of cost/benefit analysis. Government spending programs are passed without regard to whether the goods/services provided are actually wanted or needed by consumers. Indeed, many, if not most, government spending programs are initiated specifically because the free market would not waste the resources on such foolish endeavors. Government is in the business of providing goods and services nobody, relatively speaking, wants. As a result, all government spending is wasteful and less efficient when compared to spending by the private sector. It is therefore necessarily the case that government spending works to impede economic growth. Politicians seem incapable of understanding this truth. They persist in their belief that they are capable of creating economic growth primarily because they refuse to consider the fact that everything granted by government must first be taken from the private sector. It is impossible for government to create economic growth because government is incapable of creating real wealth.
As this presidential election year progresses you will hear a steady stream of stupid comments from politicians about how they will create economic growth. Everything you hear is untrue. Never forget that government is this country's primary impediment to economic growth. All recessions (contractions in economic growth) are the direct result of government action. All calls for more government control and involvement in the economy is a call for lower rates of growth. The best policy the government could create to encourage economic growth is to allow the free market the freedom to do what it does best....grow. Laissez Faire.
Wednesday, May 16, 2012
- The GDP for Eurozone 17 (what is generally considered the Eurozone) was 0.0% for the first quarter of 2012, quarter over quarter. The GDP for Eurozone 27 (expanded to include other countries) was +0.1% for the first quarter of 2012, quarter over quarter. No growth is not recession. Slow growth is not recession. Why do we keep hearing how Europe is in the middle of a horrible recession when the entire area is either experiencing little or no growth?
- Countries in Europe with a greater commitment to free markets and small government are doing just fine. Estonia, Lithuania, and Latvia were +0.5%, +0.8% and +1.1% in GDP growth for the first quarter of 2012. Although these are admittedly smaller markets than Germany and France, why is the success story of these nations not being told?
- Larger countries in Europe are also not in recession. French GDP growth was 0.0% for the first quarter. No growth is not a recession. German GDP growth was +0.5% for the first quarter. Growth is not recession. Why do we keep hearing about how Germany and France are mired in recession when they are not?
- Italy is in recession. First quarter GDP growth was -0.8%. Spain is in recession. First quarter GDP growth was -0.3%. However, compare those rates of economic contraction with what we experienced in the US during our previous recession in 2008-2009. The fourth quarter of 2008 was -5.4%. The first quarter of 2009 was -6.4%. The second quarter of 2009 was -0.7%. By the third quarter of 2009 we were out of recession and the economy was growing again. By way of reminder, the US did not collapse into a feudalistic barter economy in 2008-2009. Why do we keep on hearing that Spain and Italy are doomed to collapse into a feudalistic barter economy when the present rate of contraction is so small?
Greece will undoubtedly default on a portion of its sovereign debt. There will be significant changes to the government pensions received by so many Greek citizens. Overall government spending will eventually become smaller. These things must happen. The sooner these changes are made, the better for everyone concerned. The Greeks may end up dropping out of the Eurozone. So what? The United Kingdom is doing just fine outside of the Eurozone.
The panic being generated by day traders and market timers in the US stock markets is not based upon a realistic appraisal of the risks associated with the European Union. European nations are not nearly in the terrible shape we are being told they are. European politicians do nothing to help their cause when they dramatically overestimate the nature of their economic problems in an attempt to exploit the populace for political gain. But, that is what politicians do. For the most part, whatever comes out of the mouth of a politician, whether in Europe or here in the US, should be ignored. Concern about Europe is misplaced concern. Europe is not in trouble.
Meanwhile, here in the good old USA, April housing starts were up 2.6% as home builders are coming back into the market in response to consumer demand. How can housing starts be going up while there are so many foreclosures on the market? Because market demand is high and that is good for the housing market.
Meanwhile, industrial production continues to climb back to the pre-recession high. The Index of Industrial Production is +5.2% in the last year and +1.0% in the last month alone. Things are beginning to hop. The economy is growing.
The recent 6.5% decline in the S & P 500 looks like a great buying opportunity to me. I think I will call my broker.
I climb mountains. I have summited a mountain peak over 700 times in the past 35 years. I have spent literally thousands of days in lion country. I have spent hundreds of nights sleeping outside in lion country. I have never seen a live lion. I have never heard a live lion. The risk associated with coming across a homicidal lion is so infinitesimally small I never consider it while I am wandering through the hills. My appraisal of risk is reasonable. The modern mother's appraisal of risk is wildly out of proportion to reality.
Rich Karlgaard (Forbes. April 9, 2012, pg 34) lists some interesting statistics about risks assumed by our forefathers.
- On a prorated per mile basis and in comparison to the number of air travel deaths actually experienced in 1929, we would have 7000 people killed in airplane accidents this year.
- Six people died building the Empire State building.
- Eleven people died building the Golden Gate bridge.
- Ninety six people died constructing Hoover dam.
- 3,242 people died in mining accidents in 1907.
The modern mantra about risk is that it is worth prohibiting all activity if "only one life is saved". State and federal legislatures routinely pass legislation designed to "make sure this never happens again" and to ensure that "not one person is harmed". Karlgaard points out that the Three Mile Island nuclear accident (1979) was sufficient to shut down the construction of new nuclear power plants. How many people were killed in that accident? Zero. How many people died prematurely as a result of the radiation that was released? Zero. Nevertheless, nuclear power plant construction was immediately deemed to be too risky and was shut down.
There is a phrase for today's parent who will not allow his/her child to assume any risk whatsoever. It is "helicopter parent". I think that is a good phrase. The parent is permanently suspended over the head of the child attempting to ensure that nothing bad will ever happen to the child. According to the helicopter parent, the worst possible thing that could happen to a child is that he might fall and get hurt. What is wrong with us? Have we all lost our minds?
I believe there is some connection between the modern helicopter parent and the modern citizen of the deified state. Helicopter parents believe that no risk, no matter how small, is ever worth taking. The state believes that it is possible, by making a law, to eliminate all of life's risks. Helicopter parents believe that there is nothing worse than a child being injured. The state believes that there is no such thing as an accident and every time somebody is hurt there is a corporation somewhere near that is to blame. Whenever an accident happens, the lawyers are called in and blame is quickly assigned (along with the promise of a hefty cash payment for damages). Helicopter parents believe they can provide cradle to grave security for their children. The state attempts to provide cradle to grave security for its citizens. Just like the state believes it is possible to be like god and provide eternal security for its citizens, so the modern parent believes he is capable of providing eternal protection for his child.
What is lost in this deal? What happens when risk is criminalized? What happens to a child when he is raised to be afraid of everything outside? Let me suggest that several things necessarily follow from the belief that a parent should shield his child from all of life's risks.
1. The child grows up afraid of everything. His life goal is to be physically and emotionally secure. He will never take any risks. Consequently, he will never accomplish anything significant.
2. The child grows up to look to the state for security. He will become politically active in order to get the state to take care of him, and everyone else who is just like him. As a result of his actions the modern welfare state will become even more messianic.
3. The child grows up to never assume responsibility for his own actions. When something bad happens it is always the fault of somebody else. He is always a victim.
4. The child grows up to be an adult with a grossly distorted view of risk. He will see risks where there are none. He will be prime fodder for exploitation by the state which will work to convince him that there are terrorists behind every tree. He will gladly give up his freedom for the security promised by the state. He, and others like him, will constitute a nation of zombies.
5. Just like the children who are imprisoned in their own home, the child who is sheltered from all risk will grow up imbued with a slave mentality that will imprison him, emotionally and intellectually, for all of his life.
Parents, if you love your kids, let them play.
Tuesday, May 15, 2012
I have a water line coming into the basement of my house. Outside the basement the water belongs to Denver Water. The first thing that happens to the water when it enters my home is it passes through a meter. From the point of the meter inward that water belongs to me. I have purchased it. Even though the water belongs to me, Denver Water still controls how I use the water with a series of laws. Here are just some of the laws I have violated in the past month:
1. No lawn watering between 10:00am and 6:00pm. I watered my lawn at 5:00pm last week. I had no idea how immoral I was being. My conscience is so seared I did not even feel guilty for this horrible offense.
2. Do not waste water by allowing it to pool in streets. Every time I water my lawn some of the water runs down the street. I had no idea I was behaving like a criminal.
3. Do not waste water by allowing it to spray on concrete. Every time I water my lawn some of the water ends up on my concrete driveway. I never would have considered making concrete wet to be a sin. How could I have missed something so obvious?
4. Do not water while it is raining or during high winds. A couple of weeks ago I was watering my lawn and some high winds came up. It never occurred to me that I need to sit outside with an anemometer anytime I am watering my lawn to make sure I do not commit the immoral offense of lawn watering during a wind storm.
Something is very wrong with this scenario. The problem is not with me however. There are so many things wrong with Denver Water it is hard to know where to start criticizing. Allow me to start with the fact that Denver Water is a monopoly. Governments at all levels love to talk about how they protect citizens of this country from the deleterious impact of corporate monopolies. The fact of the matter is that there are no free market monopolies anywhere in the world. All monopolies owe their existence to the fact that they are supported by the immoral, yet lawful, coercion of government. Denver Water has a monopoly over water where I live. I am unable to purchase water from any other provider. As a monopoly provider of water they are able to do things to me that a true, free market, provider of water could never do. They are able to sell me water and, at the same time, tell me how to use it.
Once that water runs through the meter in my basement it belongs to me. If I choose to shoot it into the sky on a windy and rainy day, allowing all of it to run down the street and pool in the gutter, that is my business. Denver Water should have no say in how I use the water I purchase. Denver Water does have a tiered pricing scale for water. The more I use, the more I pay. As long as I overlook the fact that Denver Water is an immoral monopoly I can accept the fact that they have a tiered pricing schedule. It makes total economic sense that if Denver Water wants to reduce the amount of water they sell, the more water I use the more I should pay. But once I have paid for that water they should have no control over how I use it. The fact that Denver Water controls the way I use the water I purchase from them is a classic example of government hegemony.
Government in this country is out of control. Law should be simple to understand. Law should be based upon moral principles. Law should be brief and concise. Government law is not simple to understand. It is not based upon moral principles and it is anything but brief and concise. It is truly impossible for a citizen of the United States to even come remotely close to knowing and obeying all of the myriad laws that are on the books. There is nothing wrong with the citizens of the United States. There is a tremendous amount wrong with the lawmakers. We, of course, have nobody to blame but ourselves. We run around saying "there ought to be a law" about anything that personally offends or bothers us. Politicians, ever on the prowl for a vote, are quick to jump up and make a law for us. The more time goes on, the more laws that are made. Before we know it, everything is illegal. Welcome to the Socialist Democracy of America. By the way, did I mention that I ought to be arrested? And, so, probably should you.
Monday, May 14, 2012
As of the time of this writing the S & P 500 is sitting at 1344. That is down 5.3% from the most recent high of 1419 set on April 2, 2012. This most recent stock market correction has been attributed alternatively to the US unemployment report, the $2 billion loss realized by J.P. Morgan last week, and the possibility of a Greek debt default and exit from the Eurozone. I have addressed the first two issues in recent posts. Today I present this bonus blog on the third reason given for the recent stock market drop.
Here are some facts that need to be considered:
- The International Monetary Fund estimates that total world GDP is 63.0 trillion dollars. The largest country in the world economically is the US with a GDP of 15.1 trillion. Italy is #8 with a GDP of $2.2 trillion. Spain is #12 with a GDP of $1.5 trillion. Greece is #35 with a GDP of 0.3 trillion. A total default on all Greek debt, assuming that it would wipe out the entire Greek economy (which it obviously would not), would only result in a decrease in world GDP of 0.5%. Even a total obliteration of the Greek economy would have next to no impact upon the remaining countries of the world. Why should this be an issue?
- National debt expressed as a percentage of GDP (the best way to express this type of debt since it takes into consideration the ability of the country to repay the debt) is presently 103% in the US, 120% in Italy, 68% in Spain, and 161% in Greece. The highest debt this country has ever experienced, as a percentage of GDP, was 130% in 1946. The twenty year period starting in 1946 and ending in 1965 saw annual gains in the S & P 500 of 13.6%. Clearly that level of debt did not have a large negative impact upon our ability to grow. Families routinely take on levels of mortgage debt around 300% and never give a second thought about their ability to repay the money. Mortgage companies, which make their living by being expert analysts on the ability to carry debt, consider a mortgage debt of 300% of family income to be a reasonable risk. Why should the present levels of Eurozone debt be any different? Yes, present debt levels in many countries around the world at at, near, or above record highs. However, they are nowhere near levels that cannot be repaid, provided the governments carrying those debts really want to make the sacrifices required to repay them.
- Ten year bond yields on US Treasuries are at 1.8%. Ten year bond yields in Italy are 5.9%. Ten year bond yields in Spain are 6.3%. Ten year bond yields in Greece are 11.4%. The yield on a ten year US Treasury peaked at 14% in 1981. For the entire 25 year period between 1973 and 1998 the yield on a ten year Treasury was higher than the 6.3% presently found in Spain. The S & P 500 rose at an annual rate of 13.7% for that 25 year period. The S & P 500 rose at an annual rate of 15.8% for the twenty year period following the ten year yield high realized in 1981. Clearly government bond yields in the 6-14% range did not have a huge negative impact upon economic growth. Why should this time be different?
- In 2002 Argentina defaulted on its sovereign debt. At the time of the default an Argentinean 10 year bond was yielding almost 50%. Argentina is presently the 27th economically largest country in the world with an annual GDP of 0.4 trillion dollars. When Argentina repudiated the majority of its national debt in 2002 there was very little economic impact around the world. Besides those who were immediately affected due to the fact that they actually held the debt, there was little to no impact upon economic growth and stock market performance elsewhere in the world. Most Americans do not even remember the Argentinean default. Clearly there is no reason why a default by a country the size of Argentina or Greece should have any significant impact upon the economies of other countries in the world.
Wall Street bank J.P. Morgan announced last week that it had realized a $2 billion loss in the first quarter of 2012. Jamie Dimon, CEO of the company, described the loss realized in the company's proprietary account when he said, "The portfolio has proved to be riskier, more volatile and less effective as an economic hedge than we thought. There were many errors, sloppiness and bad judgment." Aside from the usual battering the stock could be expected to take as the day traders pounced upon the bad news, that should have been the end of the matter. It was not the end of the matter as the government had to get involved.
- When Wall Street banks were making record profits in 2006-2007 these same regulators were screaming for the right to enforce more regulations over the banks to keep them from making "obscene profits". CEO compensation was specifically targeted.