Monday, December 18, 2006

Where was I?

Life intervenes and the blog goes begging for attention. Birthday, kids starting to arrive for the holidays. The stuff that, if I had more of, would cure this blogmania.

Anyway, the following truncated items were noted over the last few days and are probably stale already. This may be the standard until the new year. Bare with me.

HONEST ABE: Abe says sorry and forfeits pay after helping to rig meetings This story got my attention as Baby Bat and fiance flew in from Japan, and because, well, could you imagine this even being controversial in Australia or the US?? Taking responsibility? Oh,please - ministerial responsibility is soooo yesterday.
The Prime Minister of Japan has apologised to the nation and agreed to work for three months without pay after admitting that he helped to rig dozens of town meetings to give the impression that voters were overwhelmingly sympathetic to official policy.

Promising to forfeit about £22,000, Shinzo Abe said that it was “very regrettable that these kinds of goings-on occurred”. Four senior members of his Cabinet also agreed to forfeit months of pay.

The town meetings were supposed to inject grassroots democracy into a political system driven by backroom deals and an old guard ruling party that has held power for decades.

But yesterday it emerged that most of the 174 meetings were staged, with officials posing as ordinary citizens to put simple questions to their paymasters.

An investigation, triggered by media claims that the meetings were rigged, found that “citizens” were paid Y5,000 (£20) to ask questions intended to help to forge government policy on education.

Government stooges were instructed to make sure that they did not start off by saying “I was told to say . . . ” Their comments strongly backed Mr Abe’s plan to overhaul education law to promote patriotism and civic virtue.

The town meetings were introduced in 2001, long before Mr Abe became Prime Minister. However, he was seen as instrumental in organising them in his previous role as Chief Cabinet Secretary.

Yesterday Yasuhisa Shiozaki, the current Chief Cabinet Secretary, who is also giving up three months’ pay, said: “We began [these town meetings] to carry out candid reciprocal dialogue with the public. In consideration of the gravity of the situation with discoveries of staged questions to the sloppy use of taxes, I think this is the proper way to take responsibility.”

TWILIGHT TIME: Stardust may be basis of life on Earth
The first analysis of samples that Nasa's Stardust mission brought back to Earth from a comet earlier this year has revealed that comets contain a richer range of ingredients than previously thought, including the complex molecules needed to kick-start biology.

The findings will force a re-evaluation of the traditional thinking on comet formation. "We think we know what these things are made of and then suddenly we find that, no, we don't," said Monica Grady, an astronomer at the Open University who worked on the Stardust samples.

Nasa launched Stardust to test the standard concept that comets are just dirty balls of snow left over from the early solar system. It was sent to examine the comet Wild 2 in February 1999.

The probe flew through the tail of dust and debris the comet had emitted and, after travelling 2.88bn miles, returned to Earth earlier this year with a payload of thousands of tiny particles from the comet.

The results of the first investigations of the trapped dust were presented yesterday at the American Geophysical Union's autumn meeting in San Francisco and simultaneously published in the journal Science.

To their surprise, scientists found a huge range of minerals in Wild 2. In particular, the samples showed evidence of aluminium- and calcium-rich minerals that could only have.

OF SEA CHANGES AND BEACH FRONT PROPERTIES: Oceans may rise up to 140 cms by 2100 due to warming
The world's oceans may rise up to 140 cms (4 ft 7 in) by 2100 due to global warming, a faster than expected increase that could threaten low-lying coasts from Florida to Bangladesh, a researcher said on Thursday.

"The possibility of a faster sea level rise needs to be considered when planning adaptation measures such as coastal defences," Stefan Rahmstorf of the Potsdam Institute for Climate Impact Research wrote in the journal Science.

His study, based on air temperatures and past sea level changes rather than computer models, suggested seas could rise by 50-140 cms by 2100, well above the 9-88 cms projected by the scientific panel that advises the United Nations.

A rise of one metre might swamp low-lying Pacific islands such as Tuvalu, flood large areas of Bangladesh or Florida and threaten cities from New York to Buenos Aires.

"The computer models underestimate the sea level rise that has already occurred," Rahmstorf told Reuters of a rise of about 20 cms since 1900. "There are aspects of the physics we don't understand very well."

Sea level changes hinge on poorly understood factors such as the pace of the melt of glaciers and of ice sheets in Greenland and Antarctica. Water also expands as it gets warmer but the rate of penetration of heat to the depths is uncertain.

"My main conclusion is not that my forecast is better but that the uncertainty is much larger because of the different results you get with reasonable methods," he said.

BANKING ON AUSSIE BANK STOCKS: Days of big bank profits 'over'
Dwindling mortgage growth and increased pressure on margins may well force bank profits down, said ANZ chief executive John McFarlane.

"There was some years we had mortgage growth well over 20 per cent. We're now seeing mortgage growth in the low teens and still heading downwards," Mr McFarlane said after the bank's annual general meeting in Sydney today.

"They're still pretty good circumstances.

"But given that environment and given that margin pressure has been pretty constant across that period, all other things being equal, you must see an attenuation of the underlying profits in the industry."

: Housing, Auto Slumps May Defy Usual Role as Recession Harbingers By GREG IP and CHRISTOPHER CONKEY (need a ticket to read)
New home construction is plummeting. Car sales are weakening. Investors have driven long-term interest rates well below the short-term rates set by the Federal Reserve. All these factors are present today, and all have been precursors of past recessions.

But the U.S. central bank and much of Wall Street are now betting that the old rules don't apply, and that a recession next year, while possible, is unlikely.

"This time will be different," Ed Leamer, who heads the forecasting center at the University of California at Los Angeles's Anderson School of Management, predicts in a report. "This time the problems in housing will stay in housing." It's a prediction, he admits, that "keeps us up at night."

To be sure, the economy has slowed. Economists expect it to grow at an annual rate of 2% to 3% over the second half of 2006 and all of 2007, after averaging 3.8% for the prior three years.

Moreover, both the Fed and Wall Street have a dismal record on predicting recessions. Ed Hyman, chief economist at New York investment dealer ISI Group, said, "I don't buy the view that because the housing correction hasn't done much to the economy so far, we've seen the worst." He said both the Fed's rate increases over the past two years and last year's rise in oil prices are hitting the economy with a lag. He expects a slowdown, not a recession, but sees more downside than upside risks to that forecast.

BUT MAYBE NOT SO DIFFERENT THAN 1999: Party Like It's 1999
"So where," I asked Phillipa, "is all the strength in retail sales coming from?" The short answer is, because we are partying like it's 1999.

Bullish analysts would correctly point out that incomes are rising. Disposable income was up 6% in the third quarter, partly from rising incomes and partly from reduced tax payments. The third quarter was the first time in two years that income growth exceeded spending growth.

But income growth does not come close to explaining how we can see huge drops in Mortgage Equity Withdrawals, yet no apparent effect on sales. So where are we getting the cash? From savings. Phillipa writes:

"Our tax contacts in states prone to heavy exercise of stock options report a big upsurge this year. Individuals have been sellers of stocks forever, but the levels in the Q3 Flow of Funds report are at record highs. The first 3Qs of 2006 average $770B at an annualized rate; in 2000 it was $630B, and no other year comes even close. It's currently 11% of DPI; previous peak was 9% in 2000.

"(Net financial investments, basically savings less borrowing, has been positive since 1952 when the series started. In the 1950s it was about 5% of DPI rose to its peak of 11% in 1982, went negative in 1999 and now is -9.7% of DPI. This is another way of saying the savings rate is negative, but the levels are stunning to us.)

"In Q3 households sold $166B in treasuries, $139B in corporate bonds, and $757B in stocks, totaling about $1.1 trillion, and net purchases of financial assets was an unusually low $250B.

"Putting it all together, we have decent income growth, but households are still doing a lot of dissaving to keep up their spending. We keep looking to credit card debt to cover loss of mortgage equity, but perhaps people are also selling assets to finance spending. Eek."

But what does it matter if we sell assets to finance spending if the total value of the assets in our portfolio keeps rising? We are back to 1999. It really does look like Goldilocks this time.

Oh, there are some rumblings here and there, but overall, Mr. and Mrs. Consumer Investor are quite happy to party on. Equity markets are going for new highs. Credit spreads are tighter than ever (except for sub-prime debt). Mergers, buyouts, and new debt issuance are at all-time highs. What's not to like?

So should we be concerned? Why even think of comparing today to 1999 or 2000? Perhaps because of the half-dozen forward-looking indicators which typically (and up to now reliably) forecast recessions, like the inverted yield curve and slowing housing. I have written about them for the past few months. New readers can read those letters in the archives section at Now comes Dr. John Hussman to give us yet another reason: valuations may not be as low as you think. (

I quote at length because this is so good:

"Charles H. Dow, who edited the Wall Street Journal a century ago, once observed 'It is impossible to tell in advance the length of any primary movement, but the further it goes, the greater the reaction when it comes, hence the more certainty of being able to trade successfully on that reaction... The best way of reading the market is from the standpoint of values. To know values is to comprehend the meaning of movements in the market.'

"Dow's successor at the Wall Street Journal was William P. Hamilton, who was also a brilliant observer of the market. Hamilton observed that bull markets generally occur in three phases. As Richard Russell summarizes: 'Phase one is the rebound from the depressed conditions of the previous bear market. Here stocks return to known values. In the second and longest phase, shares advance in recognition of improving business and a rising economy. During the third phase they spurt skyward on the hopes and expectations of a continuing rosy future... The low-priced 'cats and dogs' historically make great moves in this third phase...'

"As another follower of Dow, Robert Rhea, once wrote: 'the final stage is sometimes recognizable because people then buy stocks simply because they go up, and because other people are buying them.'

"With the S&P 500 currently trading at nearly 18 times fresh record earnings, on record profit margins, it seems clear that the current bull market is well into its third phase. To anyone who examines more than one or two decades of market history, even a multiple of 18 is very rich by historical measures, and can't be reconciled simply by reference to interest rates or inflation.

"On closer inspection, of course, valuations are even more hostile. Over the past three years, profit margins have widened to record levels, which has detached P/E ratios from other fundamental measures - such as price/revenue, price/dividend, and price/book ratios. The S&P 500 is currently about double its historical norms on those metrics. That isn't a forecast that stocks have to eliminate that valuation gap, but it certainly does suggest that stocks are priced to deliver unsatisfactory long-term returns from these prices.

"It bears repeating that if profit margins were at normal levels - even on the basis of profit margins that prevailed during the 1990's (indeed, anytime prior to the past 3 years) - the price/earnings ratio of the S&P 500 would currently be nearly 25. Unless investors want to speculate on the notion of a 'permanently high plateau' in profit margins, the stock market is strenuously overvalued at present. Neither current earnings nor 'forward' earnings should be considered - in themselves - as anything close to robust or reliable metrics of value here."

Hussman's reference to a "permanently high plateau" is from that famous quote:

"Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months." - Irving Fisher, Ph.D. in economics, Oct. 17, 1929, a few days before the big crash and the beginning of the Depression.

Maybe I just don't get it. Scratch that. I clearly don't get it. I simply don't see the risk versus reward of the broad stock market at these levels, with all the warning signs we can see today. To argue for higher market levels, as almost every economist is (Barron's in their recent roundtable forecast had not even one bearish participant), is to believe that this time it's different. It almost never is.

I admit to the possibility. But I find it hard to risk capital in long-only stock investments, my own or clients', in what looks and feels like1999. Party on, Garth!


Blogger Eric Bergen said...

In 1996, authors Estrella and Mishkin released a famous Fed study that developed a probability table about how likely a recession would be 4 quarters later, given a particular level of the yield curve spread. Their study accurately predicted the stock market crash in 2001 when the yield curve was inverted one year earlier.

The last few months, the spread between the 3-month & 10-year bonds has been -0.40% indicating a ~40% chance of a recession.

Every time a bearish set of economic data was released in late 2006, the stock market shrugged it off since it heightened expectations of a Fed rate cut in 2007 (which stimulates growth). On the other hand, when positive data was released, the market still rallied. Thus, the stock market was going to rally no matter what the news!!!

This year should be different due to (a dirty word for investors) STAGFLATION. Yesterday’s Fed minutes indicated the presence of this double whammy: slowing growth AND rising inflation. These 2 phenomena rarely work in opposition. What this means is that the economy is slowing, but the Fed is unlikely to cut rates as long as inflation is an issue. This is very bad for the stock market and, to a lesser extent, the bond market.

6 January 2007 at 7:12:00 am GMT+10  
Blogger Guambat Stew said...

Thanks for the comment. Good to see people are dropping in on the old posts.


7 January 2007 at 1:38:00 pm GMT+10  

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