recession

All posts tagged recession

If you believe the government or the popular press, the economy is out of recession and everything is business as usual again. Last month there was an increase in jobs by 162,000, home sales jumped 8.2%, the Dow is now almost at 11,000 and interest rates are inching upwards  in recognition of the economic recovery. It’s all peaches and cream isn’t it!

Unfortunately, I don’t believe the government or the popular press. I like to look at the facts and draw my own conclusions. First of all, the 162,000 new jobs includes 48,000 temporary census jobs. What happens when these jobs go away? And compared to the millions of jobs lost, 162,000 jobs doesn’t feel like anything to celebrate in the first place.

According the Associated press, in February the pending home sales number jumped 8.2%. This is not year-over-year but rather from January to February. Don’t know if anyone remembers but it was awfully cold in January. Historically home sales slow down during winter, especially when you have pretty bad snowstorms. An 8% increase doesn’t sound like newsworthy at all.  Additionally, the government has been offering a ton of incentives to home buyers, which is probably just cannibalization of future home buying. From the California Association of Realtors:

Californians have a brief window of opportunity to receive up to $18,000 in combined federal and state home buyer tax credits.  To take advantage of both tax credits, a first-time home buyer must enter into a purchase contract for a principal residence before May 1, 2010, and close escrow between May 1, 2010 and June 30, 2010, inclusive.  Buyers who are not first-time home buyers may use the same time frames to receive up to $16,500 in combined tax credits if they are long-time residents of their existing homes as permitted under federal law, and they purchase properties that have never been previously occupied as provided under California law.

And why is the DOW on the verge of breaking 11,000? Is it the fact that the government spent around a trillion dollars propping up the economy or could it be that consumer spending is back? May be its consumer spending. After all, the malls seem full around here. But did you hear that 25% of homes in the US are underwater on the mortgage on 14% of all houses are in some state of default? Being in default means that the monthly mortgage payments are not being made. Doing some back of the envelope calculations, TraderMark was able to put a figure on these numbers. By not paying their mortgage, Americans have an extra $160 billion per year to spend on clothes, cars, vacations and other random stuff.  To see the numbers, check out this post on the hidden stimulus package. No wonder the retailers have been doing well!

And are the interest rates trending higher because the market expects a recovery? Or is it because it expects inflation? If you look at the number of people clamoring for TIPS (Treasury Inflation Protected Securities), the number is trending higher as well. Seems like people aren’t big believers of the US Government’s ability to curb long term inflation.

So what is it – peaches and cream or doom and gloom? The truth is somewhere in the middle. With the government willing to spend money (it doesn’t have) to keep stimulating the economy, it looks like the economy is recovering pretty well. But it cannot come without consequence. At some point someone will have to pay the price of all these bailouts and packages. It might be us, our children or foreign bond holders, but that day will come. Just make sure you invest accordingly.

WSJ had an interesting article on New Zealand Prime Minister, John Key. A former foreign-exchange trader, he takes supply-side approach to the global recession.

“We don’t tell New Zealanders we can stop the global recession, because we can’t,” says Prime Minister John Key, leaning forward in his armchair at his office in the Beehive, the executive wing of New Zealand’s parliament. “What we do tell them is we can use this time to transform the economy to make us stronger so that when the world starts growing again we can be running faster than other countries we compete with.”

That idea — growing a nation out of recession by improving productivity — puts Mr. Key and his conservative National Party at odds with Washington, Tokyo and Canberra. Those capitals are rolling out billions of dollars in stimulus packages — with taxpayers’ money — to try to prop up growth. That’s “risky,” Mr. Key says. “You’ve saddled future generations with an enormous amount of debt that then they have to repay,” he explains. “There is actually a limit to what governments can do.”

In the 1980s, New Zealand’s government implemented a wide-ranging program of economic liberalization, including deep reductions in tariffs and subsidies, and privatization of state-run industries. The plan, nicknamed “Rogernomics” after then-Finance Minister (now Sir) Roger Douglas, was akin to Reaganomics, and the island nation grew smartly.

But while the U.S. and Australia broadly continued their economic liberalization programs under both right- and left-wing governments, New Zealand didn’t — until now. Over the past nine years, Helen Clark’s left-wing Labour government rode the global economic expansion and used the revenue surge to expand government welfare programs, renationalize industries, and embrace causes like global warming. As a result, the economy stagnated while Australia took off.

Mr. Key’s program focuses first on personal income tax cuts, which — given that the new top rate, as of April 1, will be 38% — are still high, especially when compared to Hong Kong and Singapore. “We just think it’s good tax policy to lower and flatten your tax curve,” he says. “People will move in labor markets and they look at their after-tax incomes.”

Cutting the corporate tax rate — which is now 30% — isn’t as crucial just now as keeping liquidity flowing, Mr. Key argues. “A lot of [companies] won’t pay tax if they don’t make money,” he reasons. “So they might be slightly less focused on corporate tax in the immediate future. Longer-term, they will be.” Why? Corporate money is “mobile.” “If you really are out of whack with the prevailing corporate tax rates, and there’s been a global shift toward countries lowering their corporate tax rate, then you’re not likely to attract capital, or you’re likely to lose capital.” Mr. Key and his coalition partner, the ACT Party — Mr. Douglas’s party — want to eventually align personal, trust and company tax rates at 30%.

But ultimately, Mr. Key says his biggest fear is rising inflation on the back of rising money supplies. “Economic theory will tell you that inflation is going to rise — and that inflation will be exported around the world. . . . In the short term, I’m not criticizing U.S. policy: I think inflation is probably the thing that’s going to be necessary to get them out of the current issue. [Federal Reserve Chairman Ben] Bernanke sort of signaled that. But longer term, inflation is cancerous to your economy.”

Another person who agree that spending doesn’t help bring us out of the recession is Peter Schiff. He thinks that reducing the size of the government is what will do that job. He also think that letting the big financial firms fail would actually help the economy!

About 4 months ago, I protest against the government bail-out of the auto industry. I said they were inefficient operations that were being driven out of business by the Auto Workers Union and they’d be back asking for more money pretty soon.

Well, it looks like the time to ask for more money has arrived! GM just announced it would need another $16.6 Billion if economic conditions continued to worsen, in addition to the $13.4 Billion it has already recieved.  Of course economic conditions are going to worsen. GM’s statement that it may achieve profitability in 2 years and might be able to pay off its loans by 2017 sounds completely bogus to me.

GM claims it will be out of money by March. That means it spent the $13.4 Billion it recieved in December in just 3 months, or nearly $4.5 Billion every month! The company claimed that if it had to file Chapter 11, the cost to the government could reach $100 Billion, so in fact, pay them $16.6 Billion is actually a good deal.

When are we going to pull the plug on this loser?

Many people say that the economy can’t withstand the shock from the loss of nearly 1,000,000 jobs that the auto-industry provides. But the US lost nearly 600,000 jobs in January. Why aren’t we bailing out all those people too? Who decides which jobs get preferential treatment and which ones get axed? Does it help if the CEOs have friends in Congress? Or the Federal Reserve?  (We know Ben Bernanke bailed out his old friends at Goldman Sachs while letting Lehman fail).

With the government spending all this money on things that don’t affect me, I can only think of one thing.

Where’s my bail out?

In the last post I speculated that the bailouts would end up costing the taxpayers upto $1 Trillion. It looks like that has become reality. Here’s an email I recieved from Asif Suria, of SINLetter:

In an unprecedented move, the current administration unveiled a simple three page plan on Saturday that will provide the treasury with $700 billion to buy toxic assets off the balance sheets of financial institutions. Combining this bailout plan with the $85 billion loan to AIG and the $200 billion to rescue Fannie and Freddie, we the taxpayers are eventually likely to incur a bill of $1,000,000,000,000. In case you did not have the time to count all those zeros and calculate what you might be liable for, that is $1 trillion and works out to a little over $3,250 for every man, woman and child living in the United States.

We have come a long way in this crisis that has devoured most of the independent mortgage lenders and left just 3 out of the 6 investment banks that started this year. Almost every weekend there is news of yet another small bank going under and real estate shows no signs of turning around. Nearly 47% of all homes sold in the state  of California last month were foreclosures and the median home price in the San Francisco bay area fell from $655,000 in August 2007 to $447,000 last month.

Following in the footsteps of our neighbors across the pond, the SEC temporarily banned short selling in the stocks of 799 financial institutions in an orchestrated effort to shore up markets. While I felt that the SEC’s move to ban naked short selling was a good move, I think a ban on short selling of any kind makes no sense. Essentially we can only buy stocks to go long or sell our existing positions but cannot hedge our portfolios by selling stocks that may be overvalued?

[Cartoon of Wall Street Bailout]

Short selling is an activity that even noted British economist John Maynard Keynes indulged in as far back as 1919 and is not the evil activity it is being painted out to be in the media. Try telling fund managed Ken Heebner who graced the cover of Fortune magazine just a few months ago that he has to change the structure of his 130/30 fund (130% of assets are invested in long positions and 30% are invested in short positions) because he can no longer sell short even if he identifies overvalued or mismanaged companies in the financial sector.

In its press release regarding the short selling ban the SEC admits, “Under normal market conditions, short selling contributes to price efficiency and adds liquidity to the markets.”. Clearly this action is targeted towards institutions that were aggressively short selling financial stocks and unless extended, it should end on Oct 2, 2008. Thankfully naked put options and the ultrashort ETFs, our instruments of choice to hedge the SINLetter model portfolio, were not included in the ban.

We are already beginning to see the dollar weaken against other currencies and the best way to play this (besides shorting the dollar) could be to take long positions in other currencies through ETFs like Currency Shares Australian Dollar Trust  (FXA), Currency Shares British Pound Sterling Trust  (FXB), Currency Shares Canadian Dollar Trust  (FXC) or Currency Shares Swiss Franc Trust (FXF). If picking a specific currency is too daunting a task (it is for me), then the “carry trade” ETF PowerShares DB G10 Currency Harvest Fund (DBV) could provide a useful alternative. The simple premise of this ETF is that higher yielding currencies tend to outperform lower yielding ones and hence this ETF goes long the highest yielding currencies while simultaneously shorting the lowest yielding currencies. You can learn more about the carry trade and DBV from this BusinessWeek article titled Trade Currencies Like A Hedge Fund.

Bond prices have also dropped in anticipation of the U.S government issuing more debt to finance this bailout. Most homeowners tend to either move or refinance their homes within a 10 year period. Hence 30 year mortgages are closely correlated to the 10 year Treasury note and have already jumped last week in response to this bailout plan. Not only are financial institutions being given a “get out of jail free” card but responsible first time home buyers who waited out the real estate bubble are going to pay the price immediately through increased financing costs.

About 5 weeks ago I suggested that both Fannie Mae and Freddie Mac were going bankrupt and their shares were going to hit single digits in 12 months. Well it looks like the market believed that too and their shares were punished. Instead of having to wait a year, the stocks dropped like bricks within the month!

According to Nouriel Roubini, renowned Professor of Economics & International Business at NYU’s Stern Business school, this is the worst financial crisis since the Great Depression and the worst U.S. Recession in the last few decades.

The FDIC that has already depleted 10% of its funds in the rescue of IndyMac alone will run out of funds and will have to be recapitalized by Congress as its insurance premia were woefully insufficient to cover the hole from the biggest banking crisis since the Great Depression

Fannie and Freddie are insolvent and the Treasury bailout plan (the mother of all moral hazard bailout) is socialism for the rich, the well connected and Wall Street; it is the continuation of a corrupt system where profits are privatized and losses are socialized. Instead of wiping out shareholders of the two GSEs, replacing corrupt and incompetent managers and forcing a haircut on the claims of the creditors/bondholders such a plan bails out shareholders, managers and creditors at a massive cost to U.S. taxpayers.

Wow, those are strong words! Practically every stock in the financial sector has jumped today, probably due of extreme oversold conditions and not because of any underlying change in the fundamental scenario.

Sadly, my beloved Oil & Gas stocks are down. It may be a sector rotation out of energy stocks and into the financials. But so long as my Canadian Income Trusts continue to provide me with dividends and passive income, I’ll continue to hold them.

But I might enter new short positions in the financials if the stocks rally significantly above these levels. Fed Chairman, Ben Bernanke announced today that FNM & FRE were “in no danger of failing”. I don’t know if I believe him – sounds just like a few months ago when the government telling us there’s no recession. Meanwhile everything (except housing) is getting more expensive and unemployment is rising. And as Jim Rogers says that “the only people Bernanke cares about are his buddies on Wall Street”!

There's Still No Recession!