Friday, August 26, 2011

The Need for Additional Fiscal Stimulus

As Fed Chairman Ben Bernanke made clear today in his Jackson Hole speech, policy makers beyond the Fed need to actively participate in stimulating aggregate demand in the economy (i.e., Congress and the White House need to do their fair share with respect to fiscal policy stimulus.)  Nobel Prize-winning economist Peter Diamond comments on the need for additional fiscal stimulus, especially in the form of infrastructure investment, to help grow the US economy and reduce unemployment. 

Ben Bernanake and Hurricane Irene

Between Fed Chairman Bernanke's upcoming comments this morning and the approach of Hurricane Irene this weekend, I think I'll just stay hundered down for the next few days.  I liquidated all equity positions yesterday and find little reason to take any new investment risk until the BB speech and Irene damage can be assessed.

Thursday, August 25, 2011

Approaching Bernanke’s Jackson Hole Speech – 2011 Version

For the past couple of weeks I’ve been engaged in short-term momentum/volatility equity trading (including leveraged ETFs) on a limited basis.  This has worked very well as I’ve bought when I thought the market has over-reacted on the downside and sold when the market has recouped the over-reaction on the upside.

However, as we approach Fed Chairman Ben Bernanke’s speech tomorrow in Jackson Hole, I’m preparing to liquidate at the open of the market today my current equity positions.  I’m concerned that the equity markets are expecting BB to say something to further buoy stock prices --- and I’m not sure what he can say to meet those expectations.

It seems to me there is more downside risk than upside potential attaching to the BB speech.  There are many who believe the Fed has exhausted the tools in its toolbox and won’t be able to do much more to promote more employment in the economy.  It appears fiscal policy will be the best way to create jobs --- and we all know how dysfunctional Congress is at the moment for this to be a realistic short-term result.  (For an example of this monetary- vs. fiscal-policy discussion, see

If this is a correct assessment, the markets could again fall to their lows of the past month --- and if not correct, what’s the loss of a few upside points by comparison?

Getting ready to fasten my seatbelt for the bumpy ride ahead.

Tuesday, August 23, 2011

Why Is The Eurozone So Important?

Here's a lead-in paragraph to a Brookings Institution article by Douglas Elliott that is a good summation as to why we need to be concerned about the Eurozone economy and its effect on the US economy.

"The Euro Crisis has struck again, hammering not just European markets, but doing real damage to U.S. markets and to economic prospects around the world. The U.S. could easily be pushed into another recession if the eurozone collapsed. We export well over $300 billion a year to those 17 countries; virtually all of the rest of our exports go to nations that also export to the eurozone and would feel ripple effects; roughly two-fifths of our overseas assets are invested in the eurozone; and our major financial institutions have large credit exposures to eurozone banks and other businesses."

source:, Why Can’t Europe Get it Right the First Time… or the Second… or the Third?

Hope You Weren't Looking For A Cheerful Beginning To The Day

Let’s Be Honest: We’re in a Depression, Not a Recession, And There’s No End In Sight

Richard A. Posner

Saturday, August 20, 2011

Euro Debt Crisis: No Solution in Sight

@CNNMoney August 19, 2011: 10:24 AM ET
european stocks
NEW YORK (CNNMoney) -- European leaders are under intense pressure to come up with a long-term solution to the debt problems straining the European Union to its breaking point.  But given the enormous challenges involved and the unpalatable options available to them, few analysts expect EU policymakers to announce any meaningful changes soon.

"There is no solution to the Euroland's sovereign debt crisis in sight," said Carl Weinberg, an economist at High Frequency Economics. "Markets will continue to be fundamentally unstable and volatile as long as we can think."

French President Nicolas Sarkozy and German Chancellor Angela Merkel gave it their best shot on Tuesday.  The leaders of Europe's largest economies announced proposals they said will encourage fiscal discipline and increase economic competitiveness across the euro zone.

Investors were not impressed.  Stock markets across Europe fell Friday, extending Thursday's big sell-off. Shares in Frankfurt fell 3%, while the main market indexes in London and Paris were down about 1.5%.

"The market gave Merkel and Sarkozy their chance to stop the Euro crisis," said Clem Chambers, chief executive of European financial market website ADVFN. "Today it is responding to their inaction."

Shares of European banks have been hit particularly hard. Concerns about the banking sector flared Thursday following reports that an unnamed institution borrowed $500 million from one of the European Central Bank's emergency lending facilities.

Will Europe come tumbling down?

Investors were hoping for more concrete measures to stabilize shaky government finances. They want to see a big increase in the size of the EU stability fund and many are calling for the creation of a so-called euro bond.

Sarkozy and Merkel dashed those hopes, saying the 440 billion euro stability fund is sufficient and a bond backed by the euro zone as a group would not solve all the region's debt problems.

The proposals the leaders did put forth -- requiring all 17 euro zone nations to commit to balanced budgets, giving the EU bureaucracy more fiscal authority and imposing some sort of transaction tax -- were widely seen as inadequate.

Analysts said serious questions remain about how effective the proposals would be and whether member nations will agree to them.  Jennifer McKeown, an economist at Capital Economics in London, said "decisive steps" towards a more uniform fiscal policy are necessary "if the currency union is going to hold together in its current form."

EU leaders have pledged to do what is necessary to protect the euro. And the latest rhetoric has been about fiscal "integration" and economic "convergence."

So far, the EU has responded to the debt problems in Greece, Portugal and Ireland by throwing billions of bailout euros at them in the hope that harsh austerity measures would do the rest.

As the crisis intensified over the last few weeks, the European Central Bank started buying Spanish and Italian bonds in a bid to prevent a broader debt contagion.  But the aggressive moves that investors are looking for would require fundamental changes in the business model, such as it is, of the European Union.

Europe's debt crisis: Expect more trouble

In essence, the larger EU economies will be required to shoulder more of the burden stemming from the fiscal indiscretions of their smaller neighbors.  That presents a difficult political problem for Germany and France, where voters must approve such measures.

"In the end," said McKeown, "the euro zone's strongest economies might decide that the potential costs of allowing the euro zone to fail, perhaps in the form of a banking crisis, are even greater than those of supporting it." To top of page

Friday, August 19, 2011

Sitting on the Sidelines

For the most part, I've been sitting on the sidelines for the past month with cash reserves in all the investment accounts I manage.  The debt ceiling debacle together with the do-nothing-but-stymie-our-economy debt ceiling legislation together with weak US and Eurozone economic numbers together with the Eurozone debt problems together with weak (or non-existent) economic leadership on both sides of the Atlantic have only added to my resolve to wait until there is some light at the end of the global economy tunnel before committing to non-cash investment alternatives.

On the other hand, with 30-year US Treasury yields sitting at 50-year lows, is there an opportunity (albeit longer term) to short the US Treasury market and ride the yield curve up as yields inevitably rise over the next few years?  I'm considering this possibility, but there's no rush since the Fed has effectively said they will maintain a low-interest-rate policy for the next two years.

But, for the moment, still sitting on the sidelines ---

Thursday, August 18, 2011

Will This Roller Coaster Go Up Anytime Soon?

Last week I thought the market bottom was about 1120 on the S&P 500 (the intraday market low last week was actually 1101) --- now, I'm not so sure.  The latest economic numbers for the US and Eurozone economies show more weakness than the forecasters expected.  In addition, neither the US nor the Eurozone is getting any of the bold leadership that will be required to achieve global economic growth and avoid global recession.

Buckle up and let's hope some in Washington and Europe find the courage to be bold.

This Path Leads Us To Global Recession

What is most bothersome about the blah-blah-blah we are now hearing from the Republican Presidential candidates and from President Obama is that none of the blah-blah-blah contains any solutions to the economic malaise we are experiencing in the US.  And the same is true of European leaders with respect to the Eurozone's economic problems.

The US economy remains the largest in the world, while the aggregate of the Eurozone country economies is second largest.  If these economies falter any further, we are almost certain to be on a path toward global recession.

We need bold leadership on both sides of the Atlantic to move the global economy toward growth and away from recession --- and we aren't getting any kind of leadership at the moment.

Tuesday, August 16, 2011

What We Need --- Aggregate Demand

There is lots of talk in Washington (or Iowa or New Hampshire or wherever the presidential wanna-bees are campaigning) about "jobs programs."  Unfortunately, many of these ideas are on-the-margin concepts which will not do very much to stimulate massive aggregate demand.  And aggregate demand is the best way to turn our economy around and to create jobs and lower the unemployment rate.

Further, private enterprise will not add jobs until there is either demand for their goods and services to warrant creating more jobs, or incentives are legislated that encourage self-interest decisions on their part to create more jobs.

My own view is "infrastructure, infrastructure, infrastructure."  (See my prior post on infrastructure investment ---

Bruce Barlett opined on "aggregate demand" today.  Here is his view --

August 16, 2011, 6:00 am 

It’s the Aggregate Demand, Stupid
By BRUCE BARTLETT  (Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.) 

With the debt limit debate temporarily set aside, the Obama administration is talking about finding some way to create jobs and stimulate growth. But the truth is that there really isn’t much it can do and it knows it. There may be some small-bore things it can do without Congressional action that may help a little, but the operative word is “little.” The only policy that will really help is an increase in aggregate demand.
Aggregate demand simply means spending — spending by households, businesses and governments for consumption goods and services or investments in structures, machinery and equipment. At the moment, businesses don’t need to invest because their biggest problem is a lack of consumer demand, as a July 21 study by the Federal Reserve Bank of New York documented.
The federal government could increase aggregate spending by directly employing workers or undertaking public works projects. But there is no possibility of that given the political gridlock in Congress and President’s Obama’s desire to appear moderate and fiscally responsible going into next year’s election.
That really leaves just consumers as a potential avenue for increasing spending. But that will be difficult as long as unemployment remains high, thus reducing aggregate income, and households are still saving heavily to rebuild wealth, which was decimated by the collapse in housing prices. Saving is, in a sense, negative spending.

Changes in wealth affect spending because people will spend a percentage of their increased wealth. And they are more likely to raise their spending when the wealth increase is perceived to be permanent rather than transitory.
Historically, people have viewed increases in home equity as more permanent than increases in stock market wealth because they know the latter is more volatile. A recent Federal Reserve Board working paper estimated that the long-run increase in spending from an increase in housing wealth may be as high as 9.1 percent per year.
As home prices increased, many people came to believe they had no real reason to save since they could always tap their home equity — which banks were more than happy to help them do — in the event that they needed funds. Thus the personal saving rate fell from 3.5 percent in the early 2000s to just 1.4 percent in 2005 at the peak of the housing bubble.
Home prices roughly doubled between 2000 and 2006, according to the Case-Shiller index, and many homeowners talked themselves into believing they would continue rising indefinitely. Thus they increased their spending and reduced their saving based not only on actual price increases, but also on expectations of future increases.
A prescient 2007 Congressional Budget Office study explained how this would affect spending and growth in the economy. It said that if people were expecting a 10 percent rise in home prices and instead they fell 10 percent, the impact on spending would be equivalent to a 20 percent fall in prices. The budget office estimated that this might reduce growth of gross domestic product by 2.2 percent per year. Since actual home prices have fallen by about a third, this suggests that G.D.P. may be $500 billion less this year than it would be if home prices had simply remained flat since 2006.
One way that the rise and fall of spending can be visualized is by looking at the velocity of money. This is the speed at which money turns over in the economy. When velocity rises, more G.D.P. is produced per dollar of the money supply. When velocity falls, the economic impact is exactly the same as if the money supply shrank by the same percentage.
The chart below comes from the Federal Reserve Bank of St. Louis and shows velocity as the ratio of the money supply (M2) to nominal G.D.P. It rose from 1.85 in 2003 to 1.96 in 2006. It has since fallen to a current level of 1.66. Thus one can say that each $1 increase in the money supply produced almost $2 of G.D.P. in 2006 and only $1.66 today.
Velocity of M2 money supply, expressed as the ratio of quarterly nominal G.D.P. to the quarterly average of M2 money stock. (Shaded areas indicate United States recessions.)
This suggests that the Federal Reserve could have offset the decline in spending and velocity resulting from the fall in home prices with a sufficient increase in the money supply. And it tried. Since 2006, money supply has increased by about $2 trillion. But velocity fell faster than the money supply increased as households reduced spending and increased saving — the saving rate is now over 5 percent — and banks and businesses hoarded cash.
Nonfinancial businesses are now sitting on close to $2 trillion in liquid assets that could be invested immediately if there was an increase in sales, and banks have $1.5 trillion of excess reserves that could be lent as well.
Fiscal policy could raise velocity and growth by getting money moving throughout the economy. But since that is not feasible, the Fed is the only game in town. Joseph Gagnon, a former Fed economist, says that it should immediately increase the money supply by $2 trillion and promise to keep increasing it until the economy has turned around.
But the Fed is already under pressure to tighten monetary policy from its regional bank presidents, three of whom dissented from last week’s Fed decision to keep policy steady. They fear that inflation is right around the corner. But as the Harvard economist Kenneth Rogoff has argued, a short burst of inflation would do more to fix the economy’s problems than any other thing. One reason is that inflation raises spending by encouraging consumers and businesses to buy things they need immediately because prices will be higher in the future.
The right policy can be debated, but the important thing is for policy makers to stop obsessing about debt and focus instead on raising aggregate demand. As Bill Gross of the investment firm Pimco put it recently: “While our debt crisis is real and promises to grow to Frankenstein proportions in future years, debt is not the disease — it is a symptom. Lack of aggregate demand or, to put it simply, insufficient consumption and investment is the disease.”

Monday, August 15, 2011

Shared Sacrifice and the "Super Committee"

In an op-ed piece investor Warren Buffett discusses the concept of shared sacrifice, which should be at the forefront of the dialogue when the "Super Committee" begins its discussions about the ways in which deficit-reduction should occur.  We can only hope ---

August 14, 2011
Stop Coddling the Super-Rich

Our leaders have asked for “shared sacrifice.” But when they did the asking, they spared me. I checked with my mega-rich friends to learn what pain they were expecting. They, too, were left untouched.
While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks. Some of us are investment managers who earn billions from our daily labors but are allowed to classify our income as “carried interest,” thereby getting a bargain 15 percent tax rate. Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.
These and other blessings are showered upon us by legislators in Washington who feel compelled to protect us, much as if we were spotted owls or some other endangered species. It’s nice to have friends in high places.
Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.
If you make money with money, as some of my super-rich friends do, your percentage may be a bit lower than mine. But if you earn money from a job, your percentage will surely exceed mine — most likely by a lot.
To understand why, you need to examine the sources of government revenue. Last year about 80 percent of these revenues came from personal income taxes and payroll taxes. The mega-rich pay income taxes at a rate of 15 percent on most of their earnings but pay practically nothing in payroll taxes. It’s a different story for the middle class: typically, they fall into the 15 percent and 25 percent income tax brackets, and then are hit with heavy payroll taxes to boot.
Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.
I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.
Since 1992, the I.R.S. has compiled data from the returns of the 400 Americans reporting the largest income. In 1992, the top 400 had aggregate taxable income of $16.9 billion and paid federal taxes of 29.2 percent on that sum. In 2008, the aggregate income of the highest 400 had soared to $90.9 billion — a staggering $227.4 million on average — but the rate paid had fallen to 21.5 percent.
The taxes I refer to here include only federal income tax, but you can be sure that any payroll tax for the 400 was inconsequential compared to income. In fact, 88 of the 400 in 2008 reported no wages at all, though every one of them reported capital gains. Some of my brethren may shun work but they all like to invest. (I can relate to that.)
I know well many of the mega-rich and, by and large, they are very decent people. They love America and appreciate the opportunity this country has given them. Many have joined the Giving Pledge, promising to give most of their wealth to philanthropy. Most wouldn’t mind being told to pay more in taxes as well, particularly when so many of their fellow citizens are truly suffering.
Twelve members of Congress will soon take on the crucial job of rearranging our country’s finances. They’ve been instructed to devise a plan that reduces the 10-year deficit by at least $1.5 trillion. It’s vital, however, that they achieve far more than that. Americans are rapidly losing faith in the ability of Congress to deal with our country’s fiscal problems. Only action that is immediate, real and very substantial will prevent that doubt from morphing into hopelessness. That feeling can create its own reality.
Job one for the 12 is to pare down some future promises that even a rich America can’t fulfill. Big money must be saved here. The 12 should then turn to the issue of revenues. I would leave rates for 99.7 percent of taxpayers unchanged and continue the current 2-percentage-point reduction in the employee contribution to the payroll tax. This cut helps the poor and the middle class, who need every break they can get.
But for those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate.
My friends and I have been coddled long enough by a billionaire-friendly Congress. It’s time for our government to get serious about shared sacrifice.
Warren E. Buffett is the chairman and chief executive of Berkshire Hathaway.

Thursday, August 11, 2011

Some Thoughts About the “Super Committee” Approach to Deficit Reduction

As the Congressional “super committee” selections are finalized (at the moment only Minority Leader Pelosi remains to name her three House of Representatives Ds to the committee), we can only hope that partisan ideological viewpoints are temporarily set aside and the “super committee” members recognize the need to move beyond the dysfunctional nature of our political system which has existed for much too long.

There are now at least three deficit-reduction frameworks that could be used as the committee’s starting point in its deliberations, which need to be concluded by Thanksgiving under the enacted debt-ceiling legislation. 

The first of these was the report of the Presidentially-created bi-partisan Simpson-Bowles deficit-reduction commission which was published in December 2010 (you can find it at

The second was an outline proposal by the Senate’s bi-partisan “Gang of Six”, which was issued in July 2011 during the negotiations preceding the enactment of the debt-ceiling legislation.  The executive summary of this proposal can be found at 

The third deficit-reduction framework is one advanced by the Comeback America Initiative in July 2011 (you can find it at  The CAI was founded by David Walker (former Comptroller General of the United States), a former Democrat (until 1976) and now moderate Republican --- so Walker either is schizophrenic or, as I prefer to think, holds bi-partisan credentials. 

The bottom line is that the “super committee” doesn’t need to reinvent the wheel --- all it needs to do is choose between the best features of the three wheels that have already been invented and put the better-designed wheel on a bi-partisan vehicle that moves our Country forward toward prudent fiscal policy and economic growth.

Wednesday, August 10, 2011

Prediction: Deficit Reduction "Super Committee" Will Fail to Reach Compromise

Nine of the 12 members of the deficit reduction "super committee" have now been named.  All six Rs have staunchly opposed tax revenue increases/tax expenditure reductions (Senators Kyl, Portman and Toomey; Representatives Camp, Hensarling and Upton).  On the other hand, the Ds named by Sen Reid (Sens Kerry, Murray and Baucus) suggest that the Senate Ds on the "super committee" may be more willing to advocate a “balanced” approach to deficit reduction that pairs spending cuts with new tax revenue.  (Minority Leader Pelosi has yet to name the three Ds from the House of Representatives who will serve on the committee.)

Apparently Sen. McConnell and Speaker Boehner didn't get the message from the S&P downgrade of the US debt rating that now is the time to start moving away from a dysfunctional political environment.  Looks to me like the Rs are doubling down on their ideological posturing.

Bottom line --- gridlock continues.

The Market Giveth and Taketh Away

Fasten your seat belts --- this roller coaster ride isn't over yet.

Monday --- DJIA down 600+ points
Tuesday --- DJIA up 400+ points
Today (as of 10:45 a.m.) --- DJIA down 300+ points

The New Yorker Commentary on Who's Suffering in This Economy

August 15 & 22, 2011

Monday, August 8, 2011

Ouch - Equity Markets Way Down Again Today

Doesn't look like the market bottom is in place just yet.  Market continued to decline after President Obama made public comments at about 1:45 p.m. today.  He didn't add any new ideas to the dialogue as to how to get our Country's fiscal house in order, other than to say he would present his ideas in the next weeks ahead.  Maybe a little late to the party?  Where was he from December 2010 (when the Simpson-Bowles Deficit Commission recommendations were published) until now?

Also, the President said he wants Congress to address economic issues upon their return to Washington in September.  In my view, this is such an important issue he should have demanded that Congress immediately return from their idyllic vacations and start working in a bipartisan manner for the American people.  Would they have listened to him and cut their vacations short? --- probably not, but it would have been the bold leadership thing for Obama to do.

Sunday, August 7, 2011

Wish It Were True

I'm not buying this, but I really want to sign up for what these strategists are smoking.  However, if there is another big decline in the equity markets this week, I may be inclined to get back in because the market may be oversold --- but this is certainly not a strategy for the faint of heart.

Strategists Sticking With 17% S&P 500 Rally by Year-End on Rising Profits
Wall Street has never been more sure that the Standard & Poor’s 500 Index will rally in 2011, even after speculation the U.S. economy is heading for a recession prompted the biggest plunge since the bull market began.

Chief strategists at 13 banks from Barclays Plc (BARC) to UBS AG (UBSN)see the benchmark measure of American equity surging 17 percent through Dec. 31, the average estimate in a Bloomberg survey. Their projection that the index will reach 1,401 hasn’t budged in four weeks, while mounting concern U.S. growth is slowing drove the S&P 500 down 11 percent since July 22, including yesterday’s 4.8 percent tumble.

About $1.8 trillion has been erased from American equities as reports on manufacturing and consumer spending showed the world’s largest economy is slowing. Forecasters at UBS andDeutsche Bank AG (DBK) say rising profits mean the S&P 500 deserves a higher price-earnings ratio than the 28-month low reached yesterday. A year ago, strategists also remained bullish after a 14 percent drop, and proved prescient as the S&P 500 rallied 20 percent from its August low.

“I’m reluctant to overreact to some shorter-term weakness, no matter how real it is, because the market has proven to be unbelievably resilient,” Jonathan Golub, the chief U.S. market strategist at UBS in New York, said in an Aug. 3 phone interview. “If you would have been acting that way for the last two years, you would have gotten killed by this market. Companies have done an absurdly good job of managing through this environment.”

Most Since 2009

Golub says the S&P 500 will end the year at 1,425. It fell yesterday to an eight-month low of 1,200.07 amid a global rout, extending a nine-day retreat to 11 percent. That was the biggest loss over the same amount of time since March 9, 2009, when the gauge ended a 17-month bear market. The MSCI All-Country World Index slid 4.1 percent yesterday, the most since March 2009. The Stoxx Europe 600 Index fell to the lowest level since July 2010, while Brazil’s index sank the most since 2008, as commodities producers dropped.

The S&P 500 fell 0.1 percent to 1,199.38 at 4 p.m. in New York, bringing its weekly loss to 7.2 percent, the most since November 2008. Treasuries and the dollar fell today.

A year ago, stocks also fell as investors speculated theU.S. economy would contract. Equities plunged until Federal Reserve Chairman Ben S. Bernanke foreshadowed $600 billion in bond purchases meant to prevent deflation and stimulate growth at a Aug. 27, 2010, meeting in Jackson Hole, Wyoming.

Pimco’s Gross

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., told Bloomberg Television on Aug. 2 that another asset-purchase program may be announced by the Fed, even after President Barack Obama signed a deficit reduction plan that demands less government spending.

Should a plan materialize, it won’t have the same impact as last year, said Mark Luschini of Janney Montgomery Scott LLC, which manages about $54 billion.

“The macroeconomic issues are trumping the good earnings picture,” Luschini, the chief investment strategist at the Philadelphia-based firm, said in a phone interview on Aug. 3. For valuations to rise, “we’d have to have better economic conditions than we do at the moment, and that’s not evident,”he said.

Expecting Growth

Strategists say earnings growth will fuel gains. S&P 500 profit will rise 18 percent in 2011 and 14 percent in 2012, according to the average per-share analyst estimates in a Bloomberg survey. More than 75 percent of corporations in the index have exceeded earnings estimates for the second quarter, with total income topping projections by 5.2 percent.

Credit Suisse Group AG (CSGN) and HSBC Holdings Plc (HSBA) advised investors to buy equities today. Andrew Garthwaite, a London-based strategist at Credit Suisse, reiterated an “overweight”recommendation on stocks even as he cut his year-end forecast for the S&P 500 to 1,350.
“Our economists are not forecasting a recession and, indeed, are looking for U.S. growth to accelerate in the second half,” Garry Evans, global head of equity strategy at HSBC in Hong Kong, wrote in a note today. “Investors should look to raise equity risk gradually over the summer.”

Even as companies from Ford Motor Co. (F) to Boeing Co. beat forecasts, the S&P 500 has plunged as investors turned their attention to reports showing slower economic growth. Consumer spending fell 0.2 percent in June, personal incomes grew at the slowest pace since November and an index of American manufacturing sank to a two-year low.

Not ‘Well-Reasoned’

“It’s unlikely I will change my view because we had a bad week or get really excited because we had a good week,” Tobias Levkovich, Citigroup Inc. (C)’s chief U.S. equity strategist in New York, said in an Aug. 3 phone interview. “That’s not a well-reasoned market outlook,” said Levkovich, who forecasts the S&P 500 will end the year at 1,400. “That’s a reactive trader mindset, but that’s not what I’m supposed to be doing.”

The combination of falling prices and rising profits has driven the S&P 500’s price-earnings ratio down 17 percent since Feb. 18, data compiled by Bloomberg show. At 13.2 times profit, the valuation is 20 percent below the average since 1954.

Following the drop in valuations, “our view is growth picks up, and like last summer/fall as the data turn up, they will take the equity market up with it,” Binky Chadha, Deutsche Bank’s chief U.S. equity strategist in New York, said in an Aug. 2 e-mail. He said the index will reach 1,550, the highest projection in the Bloomberg survey.

Last Year’s Rebound

The S&P 500 bottomed in 2010 at 1,022.58 on July 2. Gross domestic product expanded at an annual rate of 2.5 percent and 2.3 percent in the third and fourth quarters. The stock indexrallied 10 percent to 1,127.79 through Aug. 9, before slipping 7.1 percent to 1,047.22 by Aug. 26.

At the time, strategists said the index would rise to 1,234 through the end of 2010, according to the average estimate. Three days later, Bernanke said the central bank would “do all that it can” to sustain growth, foreshadowing the bond-purchase program revealed two months later. The August announcement helped catapult the S&P 500 to 1,257.64 as of Dec. 31 and 1,343.01 by Feb. 18, a 28 percent advance.

Laszlo Birinyi, one of the first investors to recommend buying stocks when the bull market began in March 2009, said this week that stocks shouldn’t be abandoned.

More Scotch

“It’s like all these times when you second-guess yourself, and you probably wake up a little earlier than you’re used to, and maybe you put an extra finger of scotch in the glass,”Birinyi said in an Aug. 2 telephone interview. “It’s probably a good idea to have a gut check once in a while, because it makes you review and rethink your process. Our view is that this is still a market of some duration.”

The S&P 500 had the second-best performance in 2011 among the world’s 10 biggest stock markets through yesterday, even after the 12 percent slump since April 29 brought the year-to-date decline to 4.6 percent. China’s Shanghai Stock Exchange Composite Index did best with a 4.4 percent drop. Japan’s Topix lost 8.1 percent, while the FTSE 100 Index (UKX) of U.K. stocks dropped 8.6 percent.

“Doing this 22 years, to me this has to be the type of bottoming that the U.S. needed to just clean the slate,” Brian Belski, the New York-based chief investment strategist at Oppenheimer & Co., said in a telephone interview yesterday. “A year ago, we were only a couple quarters into the rebound, now we’re further in. There was less belief a year ago because nobody really believed forward earnings growth. Now they’ve proven themselves.” He estimates the S&P 500 will reach 1,325.

No Contraction

Barry Knapp, the New York-based chief U.S. equity strategist at Barclays, said that it’s unlikely the economy will contract even though data show a slowdown. The Citigroup Economic Surprise Index has averaged negative 95.05 since sinking on June 3 to negative 117.20, meaning reports were missing the median estimate in Bloomberg surveys by the most since January 2009.

“If you sell stocks at 1,250, that’s a bet we’re going back to a recession, and we don’t buy that,” Knapp said in a telephone interview yesterday. His year-end projection is 1,450.“The probability of the U.S. going back into a recession is low. These things have a way of running their course.”

Saturday, August 6, 2011

AAA to AA+ -- Wakeup call? We can hope.

Standard & Poor’s backed themselves into a corner during the debt ceiling debate, and when the outcome was less than S&P hoped for, they bit the bullet last night and downgraded the Country’s credit rating from AAA to AA+.  However, the other two major credit rating agencies, Moody’s and Fitch, had reaffirmed our AAA rating earlier in the week. 

Reading the text of the S&P downgrade (reproduced below), it’s pretty clear the downgrade was not based upon any expectation that the United States is a less credit-worthy risk now than it was a week ago, or a month ago or a year ago.  Indeed, S&P states rather clearly that the Country’s debt/GDP ratio is now within the relevant range of other AAA-rated countries and, although diverging, is still expected to be within that relevant range by 2015.  See the specific language of their downgrade report: 

“When comparing the U.S. to sovereigns with ‘AAA’ long-term ratings that we view as relevant peers–Canada, France, Germany, and the U.K.–we also observe, based on our base case scenarios for each, that the trajectory of the U.S.’s net public debt is diverging from the others. Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%.” 

What then is the primary basis for the downgrade?  It’s the dysfunctional nature of our partisan political system.  Here are S&P’s words:

"We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade." 

"The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy."

So, what do we think will happen in Washington because of this downgrade?  A coming together of the partisans to compromise and reach a balanced approach to address the fiscal issues our Country faces?  Or, will Congress and the President just continue to play the blame game?

We can only hope that Congress and the President get the message from S&P’s downgrade and together move forward as a force to solve problems for the American people.  Otherwise, Moody’s and Fitch won’t be far behind in downgrading this Country’s credit rating --- and that will be much more significant in undermining our credit-worthiness than this current action by S&P. 

Text of S&P downgrade of U.S. credit rating - August, 5, 2011
"We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.

Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty, consistent with our criteria (see “Sovereign Government Rating Methodology and Assumptions,” June 30, 2011, especially Paragraphs 36-41). Nevertheless, we view the U.S. federal government’s other economic, external, and monetary credit attributes, which form the basis for the sovereign rating, as broadly unchanged.

We have taken the ratings off CreditWatch because the Aug. 2 passage of the Budget Control Act Amendment of 2011 has removed any perceived immediate threat of payment default posed by delays to raising the government’s debt ceiling. In addition, we believe that the act provides sufficient clarity to allow us to evaluate the likely course of U.S. fiscal policy for the next few years.

The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a ‘AAA’ rating and with ‘AAA’ rated sovereign peers (see Sovereign Government Rating Methodology and Assumptions,” June 30, 2011, especially Paragraphs 36-41). In our view, the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging (ibid). A new political consensus might (or might not) emerge after the 2012 elections, but we believe that by then, the government debt burden will likely be higher, the needed medium-term fiscal adjustment potentially greater, and the inflection point on the U.S. population’s demographics and other age-related spending drivers closer at hand (see “Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even More Green, Now,” June 21, 2011).

Standard & Poor’s takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.’s finances on a sustainable footing.

The act calls for as much as $2.4 trillion of reductions in expenditure growth over the 10 years through 2021. These cuts will be implemented in two steps: the $917 billion agreed to initially, followed by an additional $1.5 trillion that the newly formed Congressional Joint Select Committee on Deficit Reduction is supposed to recommend by November 2011. The act contains no measures to raise taxes or otherwise enhance revenues, though the committee could recommend them.

The act further provides that if Congress does not enact the committee’s recommendations, cuts of $1.2 trillion will be implemented over the same time period. The reductions would mainly affect outlays for civilian discretionary spending, defense, and Medicare. We understand that this fall-back mechanism is designed to encourage Congress to embrace a more balanced mix of expenditure savings, as the committee might recommend.

We note that in a letter to Congress on Aug. 1, 2011, the Congressional Budget Office (CBO) estimated total budgetary savings under the act to be at least $2.1 trillion over the next 10 years relative to its baseline assumptions. In updating our own fiscal projections, with certain modifications outlined below, we have relied on the CBO’s latest “Alternate Fiscal Scenario” of June 2011, updated to include the CBO assumptions contained in its Aug. 1 letter to Congress. In general, the CBO’s “Alternate Fiscal Scenario” assumes a continuation of recent Congressional action overriding existing law.

We view the act’s measures as a step toward fiscal consolidation. However, this is within the framework of a legislative mechanism that leaves open the details of what is finally agreed to until the end of 2011, and Congress and the Administration could modify any agreement in the future. Even assuming that at least $2.1 trillion of the spending reductions the act envisages are implemented, we maintain our view that the U.S. net general government debt burden (all levels of government combined, excluding liquid financial assets) will likely continue to grow. Under our revised base case fiscal scenario–which we consider to be consistent with a ‘AA+’ long-term rating and a negative outlook–we now project that net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 79% in 2015 and 85% by 2021. Even the projected 2015 ratio of sovereign indebtedness is high in relation to those of peer credits and, as noted, would continue to rise under the act’s revised policy settings.

Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act. Key macroeconomic assumptions in the base case scenario include trend real GDP growth of 3% and consumer price inflation near 2% annually over the decade.

Our revised upside scenario–which, other things being equal, we view as consistent with the outlook on the ‘AA+’ long-term rating being revised to stable–retains these same macroeconomic assumptions. In addition, it incorporates $950 billion of new revenues on the assumption that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, as the Administration is advocating. In this scenario, we project that the net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 77% in 2015 and to 78% by 2021.

Our revised downside scenario–which, other things being equal, we view as being consistent with a possible further downgrade to a ‘AA’ long-term rating–features less-favorable macroeconomic assumptions, as outlined below and also assumes that the second round of spending cuts (at least $1.2 trillion) that the act calls for does not occur. This scenario also assumes somewhat higher nominal interest rates for U.S. Treasuries. We still believe that the role of the U.S. dollar as the key reserve currency confers a government funding advantage, one that could change only slowly over time, and that Fed policy might lean toward continued loose monetary policy at a time of fiscal tightening. Nonetheless, it is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards. In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021.

Our revised scenarios also take into account the significant negative revisions to historical GDP data that the Bureau of Economic Analysis announced on July 29. From our perspective, the effect of these revisions underscores two related points when evaluating the likely debt trajectory of the U.S. government. First, the revisions show that the recent recession was deeper than previously assumed, so the GDP this year is lower than previously thought in both nominal and real terms. Consequently, the debt burden is slightly higher. Second, the revised data highlight the sub-par path of the current economic recovery when compared with rebounds following previous post-war recessions. We believe the sluggish pace of the current economic recovery could be consistent with the experiences of countries that have had financial crises in which the slow process of debt deleveraging in the private sector leads to a persistent drag on demand. As a result, our downside case scenario assumes relatively modest real trend GDP growth of 2.5% and inflation of near 1.5% annually going forward.

When comparing the U.S. to sovereigns with ‘AAA’ long-term ratings that we view as relevant peers–Canada, France, Germany, and the U.K.–we also observe, based on our base case scenarios for each, that the trajectory of the U.S.’s net public debt is diverging from the others. Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%. However, in contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.

Standard & Poor’s transfer T&C assessment of the U.S. remains ‘AAA’. Our T&C assessment reflects our view of the likelihood of the sovereign restricting other public and private issuers’ access to foreign exchange needed to meet debt service. Although in our view the credit standing of the U.S. government has deteriorated modestly, we see little indication that official interference of this kind is entering onto the policy agenda of either Congress or the Administration. Consequently, we continue to view this risk as being highly remote.

The outlook on the long-term rating is negative. As our downside alternate fiscal scenario illustrates, a higher public debt trajectory than we currently assume could lead us to lower the long-term rating again. On the other hand, as our upside scenario highlights, if the recommendations of the Congressional Joint Select Committee on Deficit Reduction–independently or coupled with other initiatives, such as the lapsing of the 2001 and 2003 tax cuts for high earners–lead to fiscal consolidation measures beyond the minimum mandated, and we believe they are likely to slow the deterioration of the government’s debt dynamics, the long-term rating could stabilize at ‘AA+’.
On Monday, we will issue separate releases concerning affected ratings in the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors.”