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The QE2 leaving Southhampton

The QE2 leaving Southampton

Today the Federal Reserve launched the highly anticipated QE2, announcing that it will buy $600 million of Treasuries in 2011 ($75 million per month). It will also continue to reinvest payments on its securities holdings which could bring the total capital injection closer to $1 trillion dollars.

I’m still waiting to see any evidence of  “Change You Can Believe In” and for the $8.5 trillion bailout to kick in and create jobs. But since Bernanke seems that it hasn’t been working too well, we’re going to do exactly the same thing that got us in to this mess – keep interest rates low and turn on the liquidity spigots!

One point of interest is these policies seem to benefit banks the most. Here’s an excerpt from an article on Yahoo! News:

Meanwhile, market watchers noted the Fed’s plan is to focus its QE2 purchasing power on the middle of the Treasury curve, i.e. securities from 2.5 years to 10 years. As a result, prices of shorter-term bonds rose while the price of the 30-year bond tumbled, sending its yield sharply higher.

So the real result of the Fed’s action today is a steepening of the yield curve, which most benefits (wait for it)…the banks. The ability to borrow from the Fed at effectively zero and then reinvest in “risk-free” Treasury securities at a higher yield is a huge reason why bank profits rebounded so quickly from the depths of the 2008-09 crisis.

Despite loads of evidence to the contrary (and very little lending) the Fed is effectively doubling down on its bet that boosting the banks’ balance sheets is the best way to revive the economy.

I can’t believe that this is the best policy to revive the economy. However, it definitely makes sense to align yourself with the Federal Reserve’s determined course of action. Seems like there are 2 things you should do:

  1. If you’re currently unemployed, find a job at a bank. Most banks are hiring like crazy. Bank of America has thousands of job postings (I’m not making this up)
  2. If you’re looking to invest, look for companies that benefit by borrowing at zero interest and reinvesting in risk-free Treasury or Treasury-like products.

There are several companies that fall in this category. Not only do they benefit from the current scenario, but they also pay high dividends and enjoy REIT status (meaning there’s no double taxation of profits) without actually investing directly in real estate.

Any guesses? I’ll talk about them in my next post.

Here’s a round up of some terrific articles I’ve read in the past week:

  • Why spend $1.7 million on lunch with Warren Buffett when you already know what he’s going to say? Well if you don’t then you better read the link.
  • Is Goldman Sachs the equivalent of a Wall Street Mafia? Read this great piece and you’ll be convinced and maybe flabbergasted as well.
  • Thinking of joining a startup firm? Guy Kawaski offers great career advice that I wish I had received 8 years ago!
  • The specter of the subprime is still lurking! (use firefox plugin “refspoof” to read the WSJ for free)
  • A little bit of personal finance with everyday luxuries you definitely can do without
  • And finally, a link to the Christian Science Monitor’s new economic blog who discusses whether or not you should buy real estate at this time. Of course, with a link back to my site, how could I not include them!

Enjoy!

Stanford professor John Taylor had an alarming op-ed piece in the Financial Times on the Trillion Dollar deficits

“I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO [congressional Budget Office] to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

“Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.

A large tax increase would significantly hamper the economy growth and prolong the recession. So that’s probably not the path that the government will follow. On the flip side, 100% inflation over a 10 year period which causes the dollar to devalue significantly may not be an optimal solution either. (But if it is, you should be buying gold!)

May be a middle path which favors taxing the rich and a Europe-style Value-Added-Tax on certain items will be chosen. Whatever they chose, I hope they know what they’re doing.

I just read this interesting article in the Financial Times. Seems like China has tired of US dollars and is looking to get rid of them.

Beijing Bets on Bullion

 By Patti Waldmeir in Shanghai , Financial Times, 6 May 2009

China is expected to keep buying gold to diversify its vast foreign reserves after it recently revealed it had been secretively buying bullion.

Beijing and Shanghai-based gold industry analysts said the country had almost doubled its bullion holdings. But they said China was likely to make as many purchases as possible within its borders, rather than turn to international markets where it could push up gold prices.

Beijing’s exact gold purchasing intentions are a state secret, but industry analysts are betting on more purchases as Beijing has been clear about its desire to diversify its foreign reserves away from the US dollar. Although gold is quoted in dollars, its price usually rises when the dollar weakens.

The analysts base their bet, at least in part, on the history of another buyer: Russia. After Moscow announced it was buying bullion, it regularly disclosed information revealing almost monthly increases in its gold assets.

“I’m absolutely sure that they will continue buying because China’s gold holdings are very small in terms of the size of its economy and the growing significance of its currency,” says Paul Atherley, managing director of Leyshon Resources in China. “But we will find out about it only after they have done it.”

China’s current gold reserves represent only about 1.6 per cent of total foreign reserves, a vastly smaller percentage than the world’s average of 10.5 per cent. Nevertheless, its percentage is similar to the 2.2 per cent in Japan, the world’s seventh-largest holder. The challenge for Beijing is to attain a similar diversification, requiring large amounts of gold, without disturbing the market.

Hou Huimin of the China Gold Association, forecast that China’s gold reserves could rise in the long term to as much as 5,000 tonnes. “It won’t be a leapfrog achievement but a gradual increase along with the country’s economic status.”

One potential source of gold for China is the International Monetary Fund’s expected sale of about 400 tonnes of bullion. Analysts said Beijing could try to purchase a block of that sale in an off-market agreement.

China last year overtook South Africa as the world’s largest gold producer and is estimated to have produced 282 tonnes of gold. Some gold from state-owned producers goes directly into Beijing’s gold stockpile every year. Gold purchases from state-owned producers can be made secretly and at below-market prices, making them more attractive than international purchases.

In addition, turnover at the Shanghai gold exchange rose nearly threefold between 2007 and 2008 but it is impossible to know how much of that, if any, may have been reserve buying, analysts said.

I wonder if they’re buying any American Buffalo Gold coins 😉 The US mint considers it a bullion coin.

The state of California, the 9th largest economy in the world, is having liquidity issues of its own. Faced with a shortfall in taxes, it under-budgeted by nearly $42 billion. The government said it will have to delay issuing tax refunds. In fact, according to Governator Arnold Schwarzenegger, the state could run out of cash by February.

According to the AP News:

California’s controller says he will begin a 30-day delay on tax refunds and other payments starting Feb. 1 because the state is running out of money.

Controller John Chiang said Friday he must delay $3.7 billion in payments next month because lawmakers have failed to address California’s growing deficit.

With a $41.6 billion shortfall over the next year-and-a-half, the state is on the brink of issuing IOUs.

Chiang says his office must continue education and debt payments but will defer money for tax refunds, student aid, social services and mental health programs.

A severe drop in revenue has left the state’s main bank account depleted. The state had been relying on borrowing from special funds and Wall Street investors; those options are no longer available.

Today’s guest post is by Brian McMorris of Get Wealth-Ed.

This morning (Wednesday, August 6) I was stunned by comments from Dennis Gartman as I watched Squawkbox on CNBC. Dennis Gartman is one of the most vocal commodity bulls of our time. He has been on the long side of commodities, especially energy and gold, since 2000 or before. Yet today, he came on and unequivocally said the bull market in commodities is over! Now, he is a trader, and he did not frame that comment with a period of time. Later he suggested that it was over for the near term (which might be 6 months to two years for all I know). During the show, Gartman suggested that oil would not top $145 a barrel anytime soon and might break below $70.

The lower price range aside (I don’t take that suggestion by Gartman seriously), this is not so different from my thinking. I have been watching the commodity charts and they all look the same, and what I see is not good for commodities near term. BHP Billiton does a nice job of representing the general natural resource trend, as it has a little of everything, including coal, gold, copper and iron. Using the Investools.com website ($50 a month subscription), a trend can be observed with specific triggers on the metrics of Moving Average, MACD and Stochastics.

Notice that the stock price broke below the Moving Average about July 1. About the same time, red (sell) flags occurred on the MACD and Stochastic trends. Investools analysis suggests that three red flags are a strong sell signal. Other technical analysis theory suggests that when previous support (the moving average) becomes resistance, it is a further indication the trend has changed (see the bounces off the MA on July 14 and again on about July 21). Because all the commodity charts show this pattern, it may indeed be over, as intuitively we may feel that way (notice gas prices have dropped the past 2 weeks).

The second MA test is interesting for its timing. It was on July 23 that the financials broke out to the upside after Fannie and Freddie were rescued by the Feds. We have also looked in the recent past at how Commodities and Financials are countertrend of each other right now. So, the breakdown in commodities in July has supported the surge in Financials and the broader stock market (aided by Fed support for the banks, of course). No surprise here, because commodities are a surrogate for a weak dollar, and anything that helps the dollar hurts commodity prices denominated in US dollars.
So the big question: “How long will this bear trend in Commodities last?” Yesterday on my Blog I suggested that the Chinese Olympics may be the signal of the top for the near/intermediate term for natural resource and material stocks (for the next several months). So much talk has been about the huge infrastructure buildout in China, and how China was rushing to get ready for the Olympics. As the Olympics begin, everyone will take a collective breath and know that the big buildout is done. Traders will respond accordingly using this as a signal.
Probably more important than this symbolism is the fact that the European and Asian economies are cooling off, most likely in response to decreased consumer demand in North America. Because much of consumer demand has been financed by loose credit in our banking system, it may not reignite until housing and banks have bottomed. Again, it is likely that won’t happen before mid-2009. That time frame also coincides with the post American election period and getting the majority of regulatory and tax uncertainty behind us.
What is a reasonable strategy until that time? I would suggest it is similar to the strategy followed until now, which is to invest in high dividend stocks and funds. This play has hurt me some the past year, as Value stocks really were out of favor. Some of that was due to the focus on international and commodity stocks, which don’t issue dividends. The rest was the fact that much of the high dividend stock world comes from out-of-favor sectors, like banks, insurance, REITs and consumer products.
But, eventually this high dividend strategy will prove correct. All dogs have their day. So, it is best to stick with the strategy knowing it will eventually pay off. As long as we stay diversified with our high dividend investments, we won’t be hurt by individual company failures (ala Bear Stearns). Dreman Value Income Edge Fund (DHG) is my favorite high dividend stock fund right now. Not because of recent performance, which like most high dividend funds is poor, but because it has a solid long-short hedging strategy and continues to make its dividend payments without reduction.
DHG has become much more of a commodity / natural resource play the past 6 months. When it first was introduced in late 2006, there was quite a bit of financial exposure to the high dividend bank stocks which proved disastrous from June through year end 2007. But the management team moved away from financials late last year and avoided most of the carnage early this year. To demonstrate the degree to which DHG now reflects the trend in commodities, see the attached chart comparing DHG (red line) to BHP (blue line) over the past 6 months. So, if commodities d o bounce back, DHG will go with that trend. But if commodities continue to lag the market, DHG will be able to offer high dividends to help offset the decline in commodity stocks.
Biran McMorris graduated Cum Laude in 1982 from ASU with a BSBA International Marketing and studies in Nuclear Engineering. He is the North American Industry Manager for Electronics/Solar, Robotics and Life Science Markets for SICK, Inc., a $1B global automation and instrumentation company based out of Waldkirch, Germany.

Bank of America (BAC) recently announced it would be buying Countrywide (CFC) for $4.1 Billion putting an end to rumors that CFC was considering bankrupcy.

Apart from gaining access to CFC’s technology, banking business and god-only knows what it has thats of any worth, Bank of America will also inherit it’s losses. According to tax guru Robert Willens, the tax break could total about $500 Billion dollars over the first five years and may even be worth considerably more from the sixth year, depending on how big Countrywide’s losses are when Bank of America formally acquires it.

This isn’t the first time this has happened. In 1988, Bank of America purchased the failed FirstRepublic Bank of Dallas in auction. Using a complex tax strategy allowed Bank of America to save $1 Billion in taxes.

Willens estimates that Bank of America will be able to deduct $270 million of Countrywide’s losses annually for the first five years it owns the firm, which would total $1.35 Billion! If Countrywide’s losses turn out to bigger, Bank of America gets to write off even more of its profits.

CFC’s CEO Mazillo will get a going-away present of $115 million, including company jet time and country club fees. Its not enough that he had been pumping the stock on CNBC for the past 18 months while simultaneously dumping $100 million worth of stock. He should be investigated by the SEC for painting a rosy picture of his company’s business when he must have known the stock was going to drop like a rock. If not illegal, it was definitely unethical.

On the other hand, Bank of America which currently owns 9.7% of US deposits will be breaking the law when it acquires CFC. Countrywide’s Bank has savings deposits which will push Bank of America over the federally regulated limit preventing individual banks from possessing more than 10% of all deposits. I guess they’ll just have to give the depositors some of their money back! It’ll be like a reverse bank-run.

Today’s guest post is from Mark at Investment Quest.

Mutual funds are a great way to get exposure to stocks. They are diversified, meaning there a lot of stocks in the portfolio so if one tanks the downside is limited. The same happens with a winning stock and gains to though. If you are in for the long haul, which you should be when in mutual funds there are some basic things to pay attention to. A fund that is hot for only one year might not be the next year. Was it a real-estate fund that had a great couple years that will probably pass? Past performance is no indication of the future but you will want to see how the fund has performed against the index it tracks.

Here are some of the most important things. Pay attention to how much it costs! They can really get you with commissions and fees. Stay away from 12b-1 fees. Expense ratios to assets above 2% are not necessary. Remember you will have to pay taxes on top of any sales commissions and fees. Buy a no load (commission free) fund. Vanguard and Fidelity are good no load fund companies.

The only time I would pay for commissions is if they have been beating the S&P 500 or the Wilshire 5000 and their index they track for years and I mean killing it. Sometimes its ok to pay up but if they barely beat the averages pass. You may have been better off buying the index.

Fidelity’s Latin America Fund (FLATX)has been a good performer, up 49% this year. The investing climate in Latin American countries is more favorable in some instances than in the U.S. Argentina is growing three times faster than the U.S. and has no debt and a sound financial industry.

Remember to watch out for commissions when you purchase and also when you sell. So, don’t forget your opportunity cost or the next best investment that you could be missing. Don’t expect history to repeat in cyclical like industry funds and take advantage of dollar cost averaging when necessary. You can’t buy ETF’s without commissions. Also, if your interested join The American Association of Individual Investors (aaii.com). They mail out a paper back book of the best mutual funds every year and are a great resource on mutual funds and ETF’s via their monthly newsletters.

Having finished off with Thailand, I’m now in India on the second leg of my vacation. Right now I’m attending a cousin’s wedding. Unlike western weddings, an Indian wedding is a 3-4 day production with various ceremonies, parties and gatherings before the actual wedding. It typically includes lunch and dinner for close family and friends for those 3-4 days.

Right after the wedding’s over, I’ll be in a rush to get my MBA applications in for the January 9th deadline so I may not be able to post for a few weeks. When I get the time I’ll post about my travels and also about the investment environment in both countries.

But it is the holidays, so enjoy your time with the family. Merry Christmas everyone!