January 23, 2004

Let's Buy Two...

Other than sucking risky first time buyers at no interest down to buy a first home, there's always existing home buyers buying a second home as this article shows. Two chickens in every pot...two cars in every three car garage, and two homes for every family. Why limit yourself to one consumption-driven lifestyle when you can have two? After all...interest rates are low.... BEND, Ore. (CNN/Money) – Are two houses better than one? A growing number of second-home owners seems to think so. "The hottest segment of an already hot real estate market is bubbling up in coastal towns, mountain towns and other vacation spots. "Things have really picked up in 2004," said Lynda Traverso, a real estate agent on Sanibel Island, near Fort Myers, Fla. where home prices have risen noticeably over the past couple of years. Most buyers, she said, are from the Midwest or the East Coast. "I see a lot of people in their 40s and 50s who are taking money they would have invested in the stock market and buying vacation homes." Property values on the Jersey Shore, meanwhile, have been bid up by buyers in New York, Philadelphia and Washington D.C.

The American Dream at Zero Down

Hat tip to an alert reader in Miami for point this out to me: "First-time home buyers could take out government-insured loans without making down payments under a Bush administration proposal. The Housing and Urban Development Department on Wednesday estimated that the 'zero down payment' mortgage initiative, if approved, could help 150,000 families buy their own homes. The proposal is to be included in President Bush's 2005 budget request, which will be released next month. The proposal covers loans made by government-approved lenders and insured by the Federal Housing Administration, which is part of HUD. These FHA loans typically go to first-time buyers or people with riskier credit backgrounds." Well...it's definitely ONE way to keep housing demand rising...by extending credit to new homebuyers at NO MONEY DOWN. Ladies and gentleman, the mother of all credit bubbles is brewing in the U.S. Housing market. Duck.

Happy Year of the Monkey

Technically, it's an orangutan (courtesy of orangutan.com), but impressive nonetheless.

Chart of the Day: Ten Year Rates

You may recognize this chart. It's the CBOE Ten year-yield index. As you might guess, it tracks the interest rate on ten year government bonds. This chart goes back ten years, using weekly closes, with a 52-week moving average, which is currently flat, and on which TNX currently sits, poised to move either higher or lower. The chart shows you, (1) ten year rates are still in a long-term downward price channel, and (2) within the shorter term price channel since '99, rates have failed to move up and out of the channel toward 5%. Does this mean rates are more likely to head lower than higher in the next few months? Strange as it sounds if you're as big a dollar bear as I am, the answer is yes. Dollar weakness is bad for stocks, but good for bonds. Of course the chart itself doesn't "say" all that. But what it DOES indicate is that there is no real upward pressure on interest rates right now. Consumer price inflation--which the Fed has its eye on--is sufficiently tame to be worth ignoring. The only real inflation is going on in the housing and financial asset markets (some people calls this 'inflation.' I call it a bubble). This kind of inflation is a direct result of low interest rates...and furthermore...the Fed and everyone else seems to support it. In other words, no one really wants rates to go higher. And so the dollar has decoupled from the bond market. The dollar may fall, but bond prices won't. In fact, they may go up, and yields may fall even further....Japan here we come...

The European Experiment Stumbles

The dollar-standard is beginning to resemble Fidel Castro's Cuba--a regime whose best days are behind it ...but that refuses to gently into that goodnight. It shambles on, week after week, one foot seemingly in the grave, not quite dead yet. One obvious reason why the dollar is falling but no one is yet bailing on U.S. bonds is that...there aren't many better alternatives...other than gold. Certainly not the euro. The euro, for all its strength, represents an economic zone that has profound problems of its own. Wednesday's FT reported that: "Europe's apparently doomed attempt to overtake the US as the world's leading economy by 2010 will today be laid bare in a strongly worded critique by the European Commission. "The Commission's spring report, the focal point of the March European Union economic summit, sets out in stark terms the reasons for the widening economic gap between Europe and the US. "It cites Europe's low investment, low productivity, weak public finances and low employment rates as among the many reasons for its sluggish performance. And it today's Atlanta Journal-Constitution we find the following: "The EU's executive agency said Europe is falling further behind the United States after a standstill year in which European job growth evaporated, public finances deteriorated and the average unemployment rate rose to 8.1 percent. "In an annual survey of how the 15 EU nations fare in trying to become economically more dynamic, European Commission President Romano Prodi said governments lack political will to overhaul the continent's economies. "His report lamented a ``substantial gap'' between Europe and the United States in the ability to rally risk capital and money for research and development, quickly process patent applications and spend generously on information technologies." Europe shares many of the same demographic problems with the U.S. ...an aging population that's been promised an easy retirement. In both economies, fulfilling social welfare promises is already causing substantial and recurring government deficits. Governments don't have the will to raise taxes or cut spending. And so they keep spending....borrowing from the future. This diverts the economy's available savings from real capital investment, the kind that would create jobs and income. Instead, governments merely redistribute income and transfer money, not creating any new wealth. This strategy of wealth confiscation and redistribution is as home in Brussels as it is in Washington. And you can imagine the glee Eurocrats must have felt ten years ago...thinking about wielding the political power to bend whole nation states to their dream vision of a pan-European welfare state. But politics and reality have gotten in the way. Europe is not quite centralized economically...nor is it Federal politically. It's somewhere in between...and struggling. And the economic solution is probably harder than the political solution. Politically, Europe can agree to disagree, saying goodbye to Jacques Chirac's vision of a European counterweight to the U.S. Economically, though, much of Europe (except the U.K.) has hitched its wagon to the euro. What is the chief weakness of the euro (other than the structural failings of Europe listed above)? The EU has 15 different fiscal policies and a one-size-fits-all monetary policy. Fifteen different governments deal with fifteen different sets of labor, budget, and economic issues...and ONE central banks aims to chart a monetary course to suit all needs. Since the birth of the Federal Reserve and essentially a common currency for the United States, we've seen exactly what centralized monetary policy leads to...unrestrained money creation and chronic government budget deficits. Moral buck passing abetted by the printing press. There's no reason to think the fate of the euro will be any different than the fate of the dollar. The euro's time of death will be later, and its cause of death will be different. But in the end, it will be just as dead.

Quote of the Day

``Everyone knows what needs to be done. But unless Europe acts now, there won't be much of an economy left to reform.'' --Paul Hofheinz, President of the Lisbon Council, commenting on an EU report about the state of the European economy.

LRM on Iowa

Lord Rees-Mogg thinks a Kerry vs. Bush general election will hinge on the economy...and that whoever wins will have to lower spending and raise taxes to deal with the twin deficits. Today, he gives his take on the U.S. political scene. Presidential Looks by William Rees-Mogg Every columnist is entitled to a moment of joy when he gets something right. I had this experience of self-satisfaction on the day of the Iowa caucuses. Writing from about 4,000 miles away, in my column for the London Times, I had correctly forecast that the two Senators, John Kerry and John Edwards, would do well, that the Congressman, Richard Gephardt, and the Governor, Howard Dean, would do badly, and that the Democrats were now looking for a candidate to beat President Bush, not for a candidate who would merely express their frustrations. In fact, my family have been following American politics for at least a hundred and fifty years, since my mother’s grandparents arrived at Ellis Island from Ireland. When she was six months old, my mother was held up to be kissed by President Glover Cleveland in the election of 1892; she later sold war bonds on the same platform as Teddy Roosevelt, and voted for his cousin Franklin as Vice President in the unsuccessful Democrat ticket of 1920. That was the first election in which American women had the vote. I have myself been visiting the United States for more than fifty years, and I have friends and cousins spread across the Continent, including a couple who live in Ames, Iowa. Four thousand miles is a shorter distance than one might think. I believe that Howard Dean’s disaster has a lesson for all the other candidates both for the nomination and for the election itself. Howard Dean fought an angry campaign, and anger is an ugly emotion. It may arouse enthusiasm in partisans, but it puts off the more dispassionate independent voter. For the Democrats, anger was last year’s emotion. Dean had been very successful in representing the frustrations that active Democrats felt in 2003, but once they reached the early weeks of 2004, the Democrats had a different agenda. They wanted to win. Most of the historic precedents suggest that a Democrat victory is impossible. The U.S. economy is still expanding, if somewhat more slowly than in the second half of last year. George W. Bush is the President, with all the authority and prestige of his office. He has raised far larger sums of campaign money than are conceivable for any Democrat. Iowa showed that the war in Iraq is no longer the central issue – only 13 per cent of Iowa voters put Iraq ahead of domestic issues, such as health care and the economy. Yet, Iraq has been a victory and the majority of the nation supports the President’s decisions. If President Bush does win in November, we shall all be saying that it was always inevitable. But it is not. Presidents do not always have a second term – three of the last five re-election campaigns have been a failure. President Bush’s own father was a one term President. Yet most elections are decided by the economy and by economic expectation even more than by the current state of the economy Many economic forecasters would share the view that 2004 is the year of prosperity, but that 2005 is likely to be a year when the bills will have to be paid. Whoever wins the Presidential election will have to address the problems of the budget deficit, the trade deficit and possibly of a return to inflation in some sectors of the economy. A prudent President of any party will not be cutting taxes in 2005; he will be trying to restore the balance sheet of the United States to something more like health. This is a difficult argument for the Democrats to make. In the words of the Noel Coward song: “There are bad times just around the corner.” How can one run a Presidential campaign by promising balanced Budgets, that is higher taxes and lower spending. That is why the Democrats need a candidate who looks and talks like a traditional President. There have been Presidents, starting with George Washington and including Ike Eisenhower, who have been long on warnings and short on promises. George W. Bush is such a President when dealing with international threats, but not when it comes to taxes. In John Kerry, the Democrats have a potential candidate who looks like a President. Perhaps he could just succeed in making the warnings about the economy in 2005 weigh against the optimism that is still widely felt in 2004. I still think the odds favour President Bush; he may walk it. But a Kerry campaign would raise some really interesting economic issues.

January 22, 2004

We the Living and the Moral Mugging of the Unborn

On the Eurostar back to Paris this afternoon. But in the meantime, I've liberally excerpted from a fantastic article by Murray Rothbard that ran in a 1992 issue of Chronicles magazine. You can find the entire piece by clicking here or going to http://www.mises.org/fullarticle.asp?control=1423&id=64 . Hat tip to the folks at prudentbear.com for linking to it. I won't try to compete with Murray Rothbard by adding my own comments on the problem of debt, except to add that there's a moral element to the whole conversation as well. That is, debt is not, per se, morally repugnant. You can borrow money and pay it back. Lenders do a service making capital available for new projects. But the public debt in America, and the culture of private debt it had encouraged, are disgraceful and shameful. It's not just that spending money borrowed from the future is irresponsible. It's just plain wrong to live above your means and pass the bill on to people who must live under the burden of paying off. But enough moralizing...on to Rothbard. "Any melding of public debt into a private transaction must rest on the common but absurd notion that taxation is really "voluntary," and that whenever the government does anything, "we" are willingly doing it. This convenient myth was wittily and trenchantly disposed of by the great economist Joseph Schumpeter: "The theory which construes taxes on the analogy of club dues or of the purchases of, say, a doctor only proves how far removed this part of the social sciences is from scientific habits of mind." Morality and economic utility generally go hand in hand. Contrary to Alexander Hamilton, who spoke for a small but powerful clique of New York and Philadelphia public creditors, the national debt is not a "national blessing." The annual government deficit, plus the annual interest payment that keeps rising as the total debt accumulates, increasingly channels scarce and precious private savings into wasteful government boondoggles, which "crowd out" productive investments. "Establishment economists, including Reaganomists, cleverly fudge the issue by arbitrarily labeling virtually all government spending as "investments," making it sound as if everything is fine and dandy because savings are being productively "invested." In reality, however, government spending only qualifies as "investment" in an Orwellian sense; government actually spends on behalf of the "consumer goods" and desires of bureaucrats, politicians, and their dependent client groups. Government spending, therefore, rather than being "investment," is consumer spending of a peculiarly wasteful and unproductive sort, since it is indulged not by producers but by a parasitic class that is living off, and increasingly weakening, the productive private sector. Thus, we see that statistics are not in the least "scientific" or "valuefree"; how data are classifiedÃ;whether, for example, government spending is "consumption" or "investment";depends upon the political philosophy and insights of the classifier. "Deficits and a mounting debt, therefore, are a growing and intolerable burden on the society and economy, both because they raise the tax burden and increasingly drain resources from the productive to the parasitic, counterproductive, "public" sector. Moreover, whenever deficits are financed by expanding bank credit; in other words, by creating new money; matters become still worse, since credit inflation creates permanent and rising price inflation as well as waves of boombust "business cycles." "It is for all these reasons that the Jeffersonians and Jacksonians (who, contrary to the myths of historians, were extraordinarily knowledgeable in economic and monetary theory) hated and reviled the public debt. Indeed, the national debt was paid off twice in American history, the first time by Thomas Jefferson and the second, and undoubtedly the last time, by Andrew Jackson. "Unfortunately, paying off a national debt that will soon reach $4 trillion would quickly bankrupt the entire country. Think about the consequences of imposing new taxes of $4 trillion in the United States next year! Another way, and almost as devastating, a way to pay off the public debt would be to print $4 trillion of new money—either in paper dollars or by creating new bank credit. This method would be extraordinarily inflationary, and prices would quickly skyrocket, ruining all groups whose earnings did not increase to the same extent, and destroying the value of the dollar. But in essence this is what happens in countries that hyper-inflate, as Germany did in 1923, and in countless countries since, particularly the Third World. If a country inflates the currency to pay off its debt, prices will rise so that the dollars or marks or pesos the creditor receives are worth a lot less than the dollars or pesos they originally lent out. When an American purchased a 10,000 mark German bond in 1914, it was worth several thousand dollars; those 10,000 marks by late 1923 would not have been worth more than a stick of bubble gum. Inflation, then, is an underhanded and terribly destructive way of indirectly repudiating the "public debt"; destructive because it ruins the currency unit, which individuals and businesses depend upon for calculating all their economic decisions. "I propose, then, a seemingly drastic but actually far less destructive way of paying off the public debt at a single blow: out-right debt repudiation. Consider this question: why should the poor, battered citizens of Russia or Poland or the other ex-Communist countries be bound by the debts contracted by their former Communist masters? In the Communist situation, the injustice is clear: that citizens struggling for freedom and for a free-market economy should be taxed to pay for debts contracted by the monstrous former ruling class. But this injustice only differs by degree from "normal" public debt. For, conversely, why should the Communist government of the Soviet Union have been bound by debts contracted by the Czarist government they hated and overthrew? And why should we, struggling American citizens of today, be bound by debts created by a past ruling elite who contracted these debts at our expense? One of the cogent arguments against paying blacks "reparations" for past slavery is that we, the living, were not slaveholders. Similarly, we the living did not contract for either the past or the present debts incurred by the politicians and bureaucrats in Washington.

Housing Booms

Well, it looks like I got totally wrong on housing....or did I? First the numbers. The Census Bureau reported that in 2003, housing starts increased 8.4% over 2002. This marks a 25-year high of 1.85 million. The record was set in 1972 with 2.36 million. This, on the face of it, is confirmation that the housing boom is alive and well, right? According to the Mortgage Bankers Association of America, the 30-year fixed mortgage rate is 5.56%, still historically low. We have to very bullish positive numbers. Both at "historical" levels. The question I've been asking all along is, "How long can something stay historically high or low before it goes back to historically average?" The answer, apparently, is, "Much longer than you think." I won't belabor this point much since I've written about it a lot this week. But just one simple reiteration: housing activity is a function of affordability. As home prices rise, homes become less affordable to marginally qualified buyers entering into the market for the first time with generous borrowing terms. The other pressure on affordability is stagnant or declining consumer incomes...and higher unemployment. The housing market today reminds me of the tech market in '99. If you raised even a hint of a doubt, you were laughed out of the room, humored, or patted on the head sympathetically, like a wayward child. No one can imagine that what we're really seeing is the hyperbolic phase of a credit-induced bubble in the American housing market, and that it's going to have disastrous consequences for nearly everyone involved. Instead, the capacity build out goes on...under the assumption that the supply/demand dynamic in housing will support ever higher home prices and new home starts....rates after all, are going to stay low for a long time..... As you'd expect, homebuilding stocks did well yesterday. But take a look at their charts and tell me you if you think, on the back of the strongest housing starts in 25-years, any of these stocks are about to make new highs. First, Ryland Homes (RYL). Here's a two-year chart with a 200-day moving average. Ryalnd was up 6.6% yesterday to close at $79.43. It's still well below its 52-week high of $94.30 Then there's Centex (CTX). Centex was up 6.75% yesterday to close at $106.53. Its 52-week high is $113.08. And finally, Beazer Homes (BZH). BZH was up 4.78% to close at $96.40--well off its 52-week high of $109.60. This is EXACTLY the time to be short the home-builders...as they enjoy one more giddy bullish run on the back of a building boom that can only last at lower interest rates. AND, what didn't make a lot of news yesterday is a regulatory move that may limit the ability of the GSEs to expand their balance sheets. In layman's terms, the GSEs current regulator suggested putting a cap on the size of Freddie Mac's mortgage portfolio and requiring to hold more real capital. This would effectively limit the amount of mortgages FRE could buy or back on the open market. It would slow down the easy money freight train, at least until Freddie Mac comes clean and shows the public its books...something it hasn't done since last year, and doesn't plan on doing until late this year... From CBS.Marketwatch... Regulator mulls limits on Freddie Mac's portfolio (FRE) By Matt Andrejczak WASHINGTON (CBS.MW) -- Freddie Mac (FRE) may be required to restrict the growth of its mortgage portfolio and hold more regulatory capital until it produces consistent financial results, its regulator testified to a House panel. Armando Falcon, director of the Office of Federal Housing Enterprise Oversight, said his agency could make its decision by the end of next week. Freddie Mac, a big player on the secondary mortgage market, is not expected to produce regular quarterly financial statements until late this year. The possible requirement stems from Freddie Mac's $5 billion earnings restatement last year. It is part of 16 recommendations that OFHEO's staff made to Falcon in a 185-report released last month.

Quote of the Day

From the Daily Reckoning message board: "The day of the paragraph is over, diatribe is here too stay, move out of the way. the truth is coming out and nothing can stop it blah blah blah blah."

January 21, 2004

Quote of the Day

Then again, maybe I've got this whole housing thing wrong.... "Housing remains totally, completely and absolutely awesome, baby." Joel Naroff, president of Naroff Economic Advisers.

Chart of the Day: Ten Year Yields

So...the great debate over the bond market rages on...with the question....will interest rates rise if no one wants them to? Europe probably does want them to, at least a little bit, to take the pressure off European exporters. How strange though. I guess this is the world of mobile capital. You'd expect slightly higher interest rates in Europe to attract capital...but the bigger worry here is losing manufacturing market share because the strong currency makes European goods more expensive. The dollar recommenced its slide against the euro yesterday. And as you can see from the chart...ten year rates are certainly low, historically speaking. Yesterday, IEF, Lehman's 7-10 year Treasury index, fell slightly, down 0.17%. And IEF hasn't quite been able to get up and over the 86.59 level from late September. Still, no decisive momentum in bond prices right now. You'd have to think that the Federal government expanding spending by 36%--under a Republican president--would concern foreign lenders. But then again, you'd have to think.

Buy versus Build

The money center banks rolled in with good numbers yesterday (although Washington Mutual is having trouble in the mortgage market.) Here's a question though...exactly which businesses have succeeded in growing through acquisition in the last five years? I'm sure there are some. But think of the one's who haven't....Tyco for example. And think of the conglomerates that have been spinning off businesses in order to raise cash for losses in other parts of the business (GM, GE etc.) Yet yesterday, listening to CNBC while I ironed my shirt, two analysts basically reaffirmed the strategy of growing earnings through mergers and acquisitions. One said, "Everyone knows it's better to buy than to build." The other said, and I'm paraphrasing, "Only the largest of the financial institutions have the staying power to compete in a global environment...and acquistion does that." (Does what?) You may be able to grow earnings this way for a few quarters. But integrating two separate businesses and taking advantage of all the alleged "synergies" is much harder. Just ask AOL and Time Warner. Some companies do make it work. For example, the Compaq/HP merger seems to have actually increased shareholder value (although I haven't done an extensive review of this...it's just that there haven't been any catastrophes for Carly Fiorina...yet.) And what about the J.P. Morgan BankOne merger? My colleague Dan Ferris sent me a note basically expressing how terrified we all should be. I tend to agree. Bad consumer credit and commercial credit risks are being concentrated in a smaller and smaller number of businesses. Ironically, this is exactly the opposite of what Greenspan thinks is happening with the derivatives market. Greenspan calls derivatives "intermediaries." He seems to think that by packaging risk up and selling it out to thousands of different parties....by securitizing it (like a mortgage backed security for instance), the total risk is diffused through out the economy. A lot of people own a little piece of it...and therefore...the risk is diminished. No one suffers hugely if the creditors don't pay up. However, and this is a big however, in order to manage big consumer credit risk, money center banks are heavy into derivatives...and that is a risk all its own. And ultimately, the entire paradigm is debt-centered...counting on consumers taking on more debt, and servicing it regularly...without defaulting. Not a good risk to take, if you ask me, in an economy undergoing a structural earthquake in the labor market. Here's an excerpt from a CBS marketwatch article on yesterday's announcements. M&A minded Also Tuesday, Citigroup executives stressed that the company, overshadowed in recent months by a pair of huge banking industry mergers, continues to aggressively seek growth through acquisitions. "We made a targeted acquisition in consumer finance from Washington Mutual," CEO Charles Prince said on the conference call, adding that any future deals will be designed to "extend the franchise," especially internationally. See full story. Citigroup's global consumer business profits grew 14 percent to $2.66 billion, rising 6 percent versus the third quarter. Revenue from its global consumer operation rose 11 percent from year-ago levels. "Cards income increased 23 percent to $1.14 billion, a record quarter, and now serves over 145 million accounts with $163 billion in receivables globally," Citigroup said in a press release. The consumer business growth from gains in credit-card operations reflected the acquisition of Sears Roebuck's card business during the quarter.

Trade Wars

From today's New York Post: The growing trade unease has ignited new blasts against the U.S. on two fronts in Europe. The EU took formal steps to slap penalties on numerous U.S. goods because of a controversial U.S. law that lets American companies get the duties Uncle Sam collects on foreign products sold here at artificially low prices. The so-called Byrd Amendment, now in its fourth year, allows the duties to be turned over to private industries hurt by the cheap goods, instead of flowing into the U.S. Treasury. The EU calls it an illegal government subsidy of industries. The EU said about $700 million in duties collected on imported candles, ball-bearings, pasta and steel under the Byrd law went into corporate pockets. Ohio ball-bearing maker Timken says it's awaiting a $70 million check from the Byrd law and defended it as "leveling the playing field against dumping cheap goods" here. Hmm. No one ever complains about the dumping of cheap electronic goods, or textiles, or any of the goods that are cheaper in the United States because they can be made cheaper elsewhere. The Byrd amendment, which I did a little digging into last week, is absolutely ridiculous...and is precisely the kind of thing that undermines the credibility of the government when it goes around spouting off about free trade. Notice they've taken to saying "fair trade" rather than "free trade," as if it was only fair when it didn't cost you jobs. And the idea of laying duty on a foreign product, collecting it, and then paying it directly to a competing firm is, for lack of a better word, criminal. The American taxpayer and consumer is the one who ultimately loses, paying higher prices than he would have to for goods. Way to go Congress. Way to go Bush.

White Collar Goes Blue Collar

If the division of labor is really going global, there aren't too many jobs that are safe. Now, instead of competing with someone on the other side of town, you're competing with someone on the other side of the globe. Sure, SOME jobs will always stay in America...selling pit beef at Boog's Barbecue in Camden Yards....shopping cart wrangler at one of the hundreds of Wal-Marts across the country...and (like I did in college) selling cigarettes, lottery tickets, and potato chips at a gas station (contrary to popular belief...retail gas outlets only make between maybe 3-5 cents per gallon...the big margins come on bandannas, key chains, sweatshirts, and the like.) But other than very-high end services (medical, legal, professional), and very low-end services (gas, grocery, shopping), a lot of jobs could disappear in the coming years. Here's more confirmation... Researchers say the cost of hiring an engineer in India is one-fifth the amount of hiring his U.S. counterpart. Some U.S. engineers say they are having a tough time finding work because the U.S. government has let 900,000 foreign engineers work in this country since 2000. The number of visas issued is down sharply, especially since 9-11, but McClure says foreign hiring has taken its toll. He says foreign-born engineers who have worked in the U.S. are being lured back home, where U.S. companies are now hiring. "You can't retrain an engineer for a job that's moved offshore. Those jobs are gone forever," he said. The National Science Board and the Computer Systems Policy Project have voiced concerns about the increased reliance on foreign workers and jobs moving offshore. But they are more concerned other countries are doing more to educate their work force, making them more competitive with the U.S. Indeed, Carly Fiorina, CEO of Hewlett-Packard, and Craig Barrett, CEO of Intel, defended their use of offshore labor when the CSPP unveiled its report, "Choose to Compete," on Jan. 7. It's a natural evolution of business, they said.

January 20, 2004

Coffee Rising, Margins Falling, Counter Intuition in Action

Three different men, three different coffee bulls. Greg Weldon (chart below), Hugh Hendry (dinner last night), and Marc Faber (last month's issue). Plus a question from a subscriber and a coffee stock. I'd do more research into coffee stocks right now...but I'm trying to put the finishing touches on the print issue of SI for February before my publisher sends over some enforcers. Hi Dan, Anything you can suggest on how to take part in a long-term bull market in coffee prices? Not being a real fan (at the moment anyway) of futures, it would be great to find some companies whose stock would move with coffee prices, somewhat at least. Any tips on where to look would be greatly appreciated. Thanks Well first, take a look at the long term bottom in coffee prices Weldon mentions. Having noted that, I would say that the trend of the last 100 years has been for all commodities to get cheaper. Prices rise during inflations. But inflation, as it has been famously said, is always and everywhere a monetary phenomenon. "Things" get cheaper because producing them gets cheaper as technology improves. Prices also come down as more people get in the production game. Falling prices are the norm. Then again....a multi-decade bear market is a long time for prices to be THAT low.... Second, I would not constitute the chart below as a tip, but a start, and an observation. Green Mountain Coffee (GMCR) trades at 18 times forward earnings and just over 1 times sales. It's not conventionally cheap. But if coffee prices do rise...this is a nice looking chart to go along with them. Note, this chart uses weekly closes with a 52-week moving average. You can't see the MA for the last few months because it's right on the trend line I've added to the chart. And it's also moving up. You also see that GMCR started moving up in 1999, well before coffee prices (apparently) bottomed. This makes sense. Green Mountain was paying less at the wholesale level and probably jacking up the prices on double espressos at the retail level...its margins getting ever wider. And in fact, if you look at GMCR's net margins for the last six years, they confirm this exaclty. In '98, the net profit margin was 0.5%. In '99, it rocketed up to 3.4% as coffee prices made new lows in the fall. The recovery in coffee prices in early 2000 ate into net profit growth, but the company still posted a 5% net margin. And when 2001 coffee prices resumed their slump, the net margin topped out at 6.1%. In the last two years however, margins have fallen. In 2002, the net margin was slightly lower at 6%. And through the first nine months of 2003, the net margin is 5.4%. In fact, the more you look at it, coffee stocks are probably good shorts right now. The cost of their raw material is increasing. And the desire of people to pay top dollar for coffee has probably already peaked. Designer coffee is a luxury unemployed Americans will indulge in. The most direct way to profit from rising coffee prices? Obviously the futures markets. Barring that, look for a country fund from a coffee producing country....more on that tomorrow.

Fed Funds and the Financial Economy: Chart of the Day

The chart below is a nice compliment to the chart earlier this week showing the S&P's growth since the end of '73-'74 bear market. Notice that once the U.S. was off the gold standard, the Fed began lowering the funds rate right away. Only after hyper-inflation and the Arab oil embargo did they hike rates back up. About the time the Great Bull Market got under way, the funds rate began a steady overall decline to today's historically low levels. And so there you have it...the correlation between cheap money and rising stock prices, the "financialization" of the American economy, courtesy of your un-elected central bankers and the politicians who slobber at their feet. UPDATE: one further comment on this chart. Note that the rate cutting since 2000 has failed to produce the same kind of zip in stock prices you're accustomed to seeing after previous eases. Why would that be? One reason is that the real beneficiaries of lower rates today are the GSEs, Fannie Mae and Freddie Mac. The new money isn't finding its way into stock prices. It's finding its way into housing...and the huge bond issues of the last five years from the GSEs. This is an even more acute "financialization." When you buy a stock, you're buying the present discounted value of future earnings. Those earnings may be more or less than what you're expecting. But unless you're buying a real dog of a business, or one with lying accountants, you're always buying real earnings. Not so with the mortgage-bond market. Buying mortgage bonds is buying some else's promise to pay....Namely a homeowner. Buyers of FRE and FNM bonds are banking on American homeowners making their mortgage payments.


I can't publish it because it would violate copyright laws...but take a look at the picture at the link below. And then tell me you don't think fascism in America could come from the left. http://apnews.myway.com/image/20040119/DEMOCRATS_DEAN.sff_PCS110_20040119233102.html?date=20040120&docid=D806B5DG By the way, notice how quickly the media turned on Dean, taking and publishing pictures like this? I wonder why...maybe the media began to worry that Dean couldn't beat Bush...and did their best to alter the race in favor or a more temperate Democrat. Or maybe Dean just got everyone's nerves a little too often with this kind of angry hulk routine. In either case, Gephardt's out, Dean's on the ropes...and John Kerry....Johh Kerry....is the front runner. Go figure. Kerry was somehow for the idea of war, but not the war itself. He's for eliminating parts of the Department of Agriculture, but not farm subsidies. He possesses that unique political talent for decisive-seeming waffling. He's as vapid as Bush and probably a bigger spender (although Bush has established his bona fides as a big spender.) The whole shameful spectacle of pandering to voters with financial promises is only going to get worse as we gear up to November. Gag. All of the candidates remind of a quote from John Flynn about Giovannia Giolitti. Giolitti won four consecutive elections to stay in power in Italy right up until the start of the Great War. Of him, Flynn says: He was a master politician. He little understood the dark forces that were undermining his world. He was one of those ministers whose first aim is to remain in power. His business was not to solve problems but settle disputes and to win the votes of deputies. This he did by avoiding fixed principles and relying on an ever-shifting opportunism. He spent and borrowed freely without scruples. He promised with liberality. He was all things to all men, took no firm stand against any school, compromised, soothed, and wheedled.

Unemployment versus Low Mortgage Rates: The Housing Cage Match

HGX, the Philly listed index of homebuilders, was up 0.25% yesterday, coming within kissing distance of 360. And the National Association of Home Builders came out with a forecast for a “healthy” housing market in 2004. This from today’s WSJ: David Seiders, chief economist for the Washington-based builders group, forecast 1.45 million single-family housing starts this year, a drop of about 3% from last year's 1.5 million but still a historically high number. However, Mr. Seiders said his estimate may well prove conservative because continued weakness in job growth and other factors are putting pressure on mortgage rates to stay low. Housing has boomed in recent years even as other portions of the economy have faltered. The boom was driven in part by low interest rates, which set mortgage rates and helped bring them down to their lowest levels in decades. Mr. Seiders, presenting his forecast at the International Builders' Show in Las Vegas, expects low interest rates to continue. He forecasts that the surprisingly weak December employment data reported earlier this month and the continued low inflation rate will make gains in the short-term rates controlled by the Federal Reserve less likely this year. And so the lines of argument are now drawn out clearly. Historically low-mortgage rates will stay historically low, feeding historically high housing starts historically longer. History in the constant making. The key is mortgage rates. As long as they stay low, new buyers can brought in to the market to buy up the new capacity. Three points here, though, as ride my housing hobbyhorse this grey London morning. First, home buying comes down to affordability of the monthly mortgage payment. And the affordability of the monthly mortgage payment is a function of two things: interest rates, and income. Interest rates are low. They have been low. And they may even stay low for a while. But if the best hopes of the bulls come true and economic activity takes off this year, Fed complicity or not, it would raise rates. Let’s assume, for a moment, that rates stay low. This makes housing “affordable” to borrowers who couldn’t make monthly payments at a higher interest rate. “Affordable,” that is, as long as incomes keep rising. And so the labor market and long-term income growth are ALSO crucial to the sustainability of the housing boom. In the quote above, David Seiders says a weak labor market is an excuse to keep rates low. True. But a weak labor market also eats into the number of potential new buyers who don’t have the jobs or the income to support buying a home. That’s the downside. If you wanted to go really far out in time (and perhaps on a limb), you could say, as I’ve been saying, that incomes are disinflating in America…against a backdrop of a huge structural migration of high-income manufacturing and service jobs OUT of America and TO Asia. If I’m right about this…it won’t be the end of the world for everyone…but it will certainly be bad news for precisely that calibre of buyer homebuilders are counting on to come into the market and purchase a new home for the first time. Even low rates will not compensate for a diminishing pool of buyers with incomes sufficient to afford a new house. For now, though, we’re still in the capacity over-build stage of the boom. Homebuilders are acting as if there’s an infinite demand for their product, and that prices will always rise. This is also a sign that homes are being treated as financial assets…not as the durable goods they actually are (or not so durable with some of the newer homes.) Bottom line….the low-rate environment may be supportive to homebuilders in the first half of 2004…but the income portion of the affordability equation will start to eat into new home sales at some point. Higher mortgage rates or higher unemployment. Take your pick. Neither is good for housing.

Eurotrashing the Dollar

A lot of dollar bashing went on at Brown’s Restaurant last night. Your editor participated, of course, setting aside my patriotism for common sense. But I asked the mostly U.K. dinner party what made the Euro any “sexier” than the dollar, or at the very least, less ugly. “The euro isn’t ‘sexy’ at all, and that’s just the point. It’s a much more prudently managed currency. Just because the ECB doesn’t follow the daft nonsense of Sir Alan Greenspan doesn’t mean the currency is inferior.” But every paper currency is ugly in its own way. And every paper currency is inferior to gold, in the long run. The long run is a very long time, however. And in the meantime, central bankers and traders are sounding like they just wish the whole business would settle down to something predictable. Here’s a question that came in the e-mail today: Dear Daniel, As you can imagine I was surprised to see last weeks USD "resurgence". While I did anticipate to see regular mild corrections in the value of the USD, the speed and range of the retracement has surprised me, considering that the fundamentals haven't changed. The whole thing seems to have been triggered by comments from several ECB officials. I would greatly appreciate it, if you would be kind enough to give me your view on this subject. The comments that struck me as most absurd in the last week were those by ECB president Jean-Claude Trichet. He said he was "concerned" by "excess volatility and brutal moves in the euro.” Tut-tutting even more, he said these moves were "not welcome and not appropriate." Not welcome, maybe. But not appropriate? This is the problem with tying to manage a currency. It’s not an “orderly” process. The market identifies a level where it thinks the currency is fairly valued and it shoots directly to it. The adjustments are happening quickly now, in a matter of days not weeks. Intervention by central banks, as in Japan, can slow this down a little. But it can’t stop it. And so short-term, the dollar was probably over-sold, the ECB mouthed off about it, and traders took some profits. The dollar trade, after all, isn’t exactly a secret anymore. It fact, it’s almost conventional wisdom now that the dollar is overvalued, interest rates will rise, and bonds will be crushed. The truth is, this could take a very, very, very long time. Interest rates may not rise at all this year, and certainly not until after the election. The Fed doesn’t have to defend the dollar if nobody is selling it. And nobody seems that interested in selling the dollar. Nobody at all. As long as purchasing power doesn’t decline noticeably, American consumers don’t care. Goods from China are still cheap. If energy prices rise…they might start to care. But right now, not a worry. Europe doesn’t want to sell the dollar. It wants to buy it, to support the dollar so the euro doesn’t rise to damaging new highs that hurt the competitiveness of Eurozone exporters. Last week's kvetching caused the euro to finally weaken from its all-time high of nearly $1.29 on Jan. 12. It’s lost about 4% since then. Japan doesn’t want to sell the dollar. It wants to buy it too…and has been to the tune of about 30 billion yet last week. Nobody wants to sell the dollar. And so the dollar rallied for a spell. But at the open this morning here in London, the euro jumped a full one percent from yesterday’s close of $1.2349 to $1.2486. This, after EU finance ministers passed on a chance to trash their currency and instead said they had “no view.” Well of course they have a view. And even now they’re probably regretting not saying something banal and vaguely menacing about the U.S. twin deficits. And THAT, of course, is the root of all dollar evil. The currency may have periodic bouts of strength. But this is illusory strength. Or better, only relative strength. It’s strength only in the sense that other central banks want to have more competitive currencies and do so by making those currencies “weaker” relative to the dollar. Check out the chart below. It tells the story of the last two years between the euro and the dollar. The price channel is down. The recent dollar strength moved the trend line back towards the middle of the channel. Conceivably, the dollar could rally all the way back to $1.20 and still be in the downward channel. Or, it could simply hit the halfway point and move back down…testing new lows this spring. How long will this last? Will something snap and put the dollar in free fall? These are questions I’ll be taking on all winter….

January 19, 2004

Link for History Buffs

I don't have the bandwidth or patience to check it out now, but over 5-million aerial reconnaissance photographs from World War Two go on line Monday at www.evidenceincamera.co.uk . I tried looking this morning but the server was under siege. There was some irony to even finding the link. The apartment next to mine is a monthly rental, so the guests from all over the world roll in and out regularly....Spain, Japan, and last night Germany. The Germans were having a good time last night...and all night, which is why I woke up to do some work and find the Reuters story referring to the new photos. Nearly sixty years later...it's hard to imagine Europe so totally at war. Today...you're as likely to hear German in Paris as you are any other language....yet there's no 1,000 year Reich to speak of.

Why Homebuilders Don't Want the Treasury to Regulate the GSEs

Homebuilders say GSE regulation belongs either with HUD or with some new offshoot agency of the Treasury Department. The Treasury Department, they say, isn't sufficiently concerned with encouraging homeownership. That's probably true. What the Treasury Department IS concerned with is what the heck is going with the GSEs balance sheets and derivatives books. Fannie and Freddie's lobby is powerful, though. And Congress hasn't had much luck getting the GSEs to be more forthcoming. And you can see why the homebuilders would be concerned. If Fannie and Freddie slow down their mortgage buying...it takes out support for rising home prices...which, by extension, hurts the stocks of homebuilders. The chart below shows the Philly Housing Index of homebuilders with a 50-day simple moving average. You can see that the last time the index was flat and its MA was sideways was in July, where the index briefly traded under the MA. This was during the wild summer in which the GSEs disclosed several multi-billion dollar accounting errors. Now, it's looking again like a double top with a sideways MA and some trouble in GSE land. Where do we go form here? Lower rates and another bullish run? Or a sell off? I'm looking for the latter...and buying puts (as recommended in the housing report.)

Gee, Ya Don't Say

Mortgage rates are under 6% again and who knows...it could spawn another wave of home-buying/refinancing....but the incredible story here is how two semi-public companies are stone-walling the public about the risks being taken at the GSEs. Fannie and Freddie's use of derivatives is not something I covered in my recent report. But it's a legitimate issue. The companies have tremendous risk in terms of commitments to bond holders and guarantees made on mortgage-backed securities. They've tried to manage that risk in the derivatives market. Only they're not telling anyone how they've done it, except to disclose now and again that they haven't done it well. Bloomberg.com: U.S.: "Jan. 17 (Bloomberg) -- Fannie Mae, the largest buyer of U.S. home mortgages, isn't providing enough information about its use of derivatives, including how the value of those derivatives fluctuates from quarter to quarter, said Senator Chuck Hagel, a Nebraska Republican. Hagel, a member of the Senate Banking Committee that oversees government-chartered Fannie Mae and Freddie Mac, the second-biggest mortgage buyer, said Fannie Mae's answers about use of the financial instruments are incomplete. In particular, it hasn't satisfactorily explained how hedging with derivatives resulted in a $16.09 billion loss in its equity account during the third quarter. "

Just what the Fed didn't want to hear...oil for gold

And so now the line of thought is emerging...the weak dollar may not hurt the purchasing power of American consumers...but it causes pain for everyone who gets paid for oil in dollars. This will either lead to rising energy costs...which hurt everyone regardless of currency. Or...it could force the Fed to "defend the dollar." Of course, if "defending the dollar" means raising interest rates...the Fed won't want to do that...it would prick the mortgage-lending bubble, knock the legs out of the financial economy, and kick away a huge crutch for consumer spending (home equity withdrawls.) Mahatir is a bit of a crank, but his idea isn't altogether stupid. What's more likely, however, is that OPEC countries will want oil priced in some basket of currencies, and not just the dollar. Sell oil for gold, Mahathir tells Saudi Arabia: "JEDDAH, Saudi Arabia, Jan 18 (Reuters) - Former Malaysian Prime Minister Mahathir Mohamad said on Sunday that Saudi Arabia should sell oil for gold, not dollars, to avoid being 'short-changed' by a decline in the U.S. currency. 'The price of oil is $33, but the U.S. dollar has declined by 40 percent against the euro so you're effectively getting $20,' Mahathir told an economic conference in Saudi Arabia's Red Sea city of Jeddah. 'So you're being short-changed.'"

Why the Fed may not raise rates, part one

The excerpt below from an article here, shouldn't surprise anyone by now. By coincidence, I met a salesmen for Texas Instruments last night at an Irish bar, watching the Colts-Patriots game. When I found out his line of work I asked him a few questions about what TI's plans were. "We're gonna keep going East till we start going West. Singapore and Taiwan and Malaysia were nice. But they just didn't have the labor. In China, you wouldn't believe it. They build these dorms. Folks roll in from the country to work 12-hour days for a few weeks, and then a new group comes in. They're almost like prison camps too, some of them, with barbed wire fences." "We're already looking at the Stans in Central Asia. The governments are willing to make good deals and the labor is just as cheap. The key is skilled. China and India have tons of engineers. Skilled labor at Wal-Mart prices." "It really is Wild West capitalism though. For example, China suddenly decided Wi-Fi was illegal. You couldn't use it unless you had the 'China Standard." "What's the China Standard," I asked? "Money." So...even without the rule of law, regulatory transparency, or clear property rights...it's still worth it for American business and manufacturing to East, on labor cost alone presumably. Ironically, this could help the Fed in its cause to keep rates low. As long as this China dynamic keeps rolling, don't expect to see consumer price inflation....at least in electronic goods...or anything else coming out of the East. If consumer spending can pick up without raising inflation specters...the Fed would love it (although this doesn't exactly help improve the employment picture...and reinforces the fact that the jobs that are leaving American shores....aren't coming back...And neither are the wages that left with them.) This is the great globalization of the division of labor. And it's not going to be kind to Western manufacturers.... My new source of info, three beers into the evening, also said intellectual property was a huge concern. "We don't move our high-end stuff over cuz it gets ripped off. There's just no protecting it. Everything gets knocked off. You'll see a guy in a rickshaw with a basket full of oranges, a basket full of modems, and a basket full of hooded sweatshirts....whatever sells. They've got the fever." By the way, the lack of copyright and IP protection COULD be a barrier to more Western business in China. After all, China is a member of the WTO and is supposed to monitor this sort of thing. But if it's happening with drugs and electronics...it's hard to see what's going to stop it from happening with everything else. U.S. manufacturers will complain and maybe get some tariffs slapped on knock-off imports...but that will only raise prices here....not anywhere else, nor will it change what's happening. From today's WSJ: In a rare look at the numbers and verbal nuances a big U.S. company chews over when moving jobs abroad, internal documents from International Business Machines Corp. show that it expects to save $168 million annually starting in 2006 by shifting several thousand high-paying programming jobs overseas. Among other things, the documents indicate that for internal IBM accounting purposes, a programmer in China with three to five years experience would cost about $12.50 an hour, including salary and benefits. A person familiar with IBM's internal billing rates says that's less than one-fourth of the $56-an-hour cost of a comparable U.S. employee, which also includes salary and benefits. According to the documents, which also provide managers with detailed advice on how to talk about the moves and their effect, IBM plans to shift the jobs from various U.S. locations to China, India and Brazil, where wages for skilled programmers are substantially lower.

Chart of the Day

Headed over to London in a few hours for the first of a monthly roundtable meeting with investors and some money managers over there. I'll let you know how it goes... For now...here's a sneak preview at a chart you'll see in the February issue of SI. It's a 30-year chart of the S&P on a monthly-close basis, with a 40-month moving average. I've done in logarithmic scale rather than linear scale to give a better picture of the slope of the S&P's advance over the last three decades. What does it tell you? I won't give away all my analysis....and truth be told I haven't found a chart than runs back before this to see if the slope of the last 30 years is different than the the 30 years before IT...but...the S&P's rise correlates nicely with the end of the gold-standard and the closing of the gold window...it's probably not by accident that the end of the gold standard launched the era of hyper inflation...both in commodities AND in financial assets....

Why the Fed may not raise rates, part two

If the falling dollar isn't hurting the purchasing power of Americans at home, then why worry? Raising interest rates to "defend" the dollar only makes sense if the weak dollar is causing a sell-off in American financial assets or rampant inflation. And so far, neither of those things is happening. In fact, low-interest rates are the key to credit creation in the American economy. As long as long-term interest rates stay low, mortgage rates stay comparatively low. And as long as they stay low, housing sales will stay strong and so will refinancing activity. And if THAT's the case, then there is a seemingly inexhaustible demand for the bonds and mortgage-backed securities issued by Fanny Mae and Freddie Mac to fund the whole operation. The gases sell bonds to finance the purchase of mortgages from primary lenders. Who buys these bonds and why? Pension funds, banks, life insurance companies, mutual funds...industrial corporations. The bond is just as good as a Treasury, and is, in Greenspan's world, an excellent "intermediary" for hedging interest rate risk. It's also income (even though it only remains so as long as American homeowners make their mortgage payments on time.) The GSEs don't just sell bonds, though. They also pool up the mortgages they own, slap a guarantee on them, and sell a mortgage-backed security (a bond that derives its monthly payments from interest and principal payments on mortgages). Fannie and Freddie have been doing a lot of this bond issuing, mortgage buying, and mortgage-backed security issuing. They have over $3 trillion in assets. Thousands of companies own their bonds and mortgage backed securities. The Fed has little interest in shutting the whole operation down by raising interest rates. That would expose just how many companies are now dependent on the American homeowner for income...or on low interest rates and financing activity for profits. We'd find out who owns those bonds...and how many they own. Of course, to find that out, we'd probably need a regulator forcing Fannie and Freddie to disclose what they're up to. And who knows when that wil happen.... WSJ.com - Fannie Favors Treasury as Regulator: "Moving financial regulation of Fannie and Freddie to Treasury from its current location at the Department of Housing and Urban Development carries big potential benefits for the two government-chartered companies. Notably, it would strengthen investors' perception that the companies enjoy the implicit financial backing of the federal government. The downside for Fannie and Freddie is that the Treasury Department has more political clout than HUD and ultimately could prove to be tougher in reining in the companies' rapid growth, as many critics in and out of government have sought. Fannie's position doesn't remove all obstacles to legislation, however. Fannie and Freddie Mac continue to have concerns about various specifics, such as how their capital and new financial products would be regulated. This year's bill also is likely to be complicated by inclusion of the 12 Federal Home Loan Banks, which borrow money from capital markets to lend to banks for writing mortgages. Fannie and Freddie borrow to buy up the mortgages, injecting still more money into the system."