Showing posts with label analyst. Show all posts
Showing posts with label analyst. Show all posts

Tuesday, May 9, 2017

Bubba’s Proprietary "Anchor Spread Trade"

Every time you lose money in the market, someone on the other side of the trade is grinning their fool head off because they won and you let them do it. Discover how savvy insiders make sure every trade is won before it’s even placed. And you can do it too!

Todd “Bubba” Horwitz is a renowned floor trader, market maker and senior analyst who is frequently interviewed by FOX News, CNBC, Bloomberg Networks and other media giants. Horwitz just released a power packed special report no trader should be without. And today, you can download it here for FREE

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  *  Find out if you’re overlooking any of Bubba’s 4 “Cornerstones” because each one can make a world of difference to your profitability

  *  Use Bubba’s sophisticated, yet easy to follow, Endowment Model to create vast wealth during the next market collapse

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See you in the markets,
The Stock Market Club

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Option and stock investing involves risk and is not suitable for all investors. Only invest money you can afford to lose in stocks and options. Past performance does not guarantee future results. The trade entry and exit prices represent the price of the security at the time the recommendation was made. The trade record does not represent actual investment results. Trade examples are simulated and have certain limitations. Simulated results do not represent actual trading. Since the trades have not been executed, the results may have under or over compensated for the impact, if any, of certain market factors such as lack of liquidity. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown.



Stock & ETF Trading Signals

Sunday, July 5, 2015

Xi’s Anti-Corruption Campaign Is Key to China’s Prospects

By John Mauldin


George Magnus is one of the most influential economists in the world today. From his position as chief economist at UBS for a number of years, he enjoyed a front-row seat to growth miracles, credit booms, and financial crises in major economies around the world and is widely credited with identifying the trigger points that eventually led to the global financial crisis in 2008.

Today, he works as an associate at Oxford University’s China Center, a senior economic adviser at UBS, and an independent economic consultant to governments and private investors who can afford his limited time.

George is the author of two of my favorite books: The Age of Aging (published in 2008), which explores the consequences of deteriorating demographic trends; and Uprising: Will Emerging Markets Shape or Shake the World Economy? (published in 2010), which takes an in-depth look at the new and more sober prospects for emerging markets going forward.

In the following chapter from our recently published e-book on China, A Great Leap Forward?, George explains that moving forward on “more substantive and politically sensitive economic reforms” depends on Xi Jinping’s ability to consolidate power and break through the disruptive vested interests that threaten the Chinese Communist Party’s legitimacy and stand in the way of true economic rebalancing.

While Beijing has made some progress on its stated reform agenda since the Party’s Third Plenum in November 2013, it remains to be seen whether President Xi and his allies have not only the stomach for more difficult reforms and deleveraging but also the political capital needed to move forward without a revolt within the Party.

As George explains, China’s ruling elite find themselves at a do-or-die moment for the ruling Communist Party. Their ability to follow through on tough reforms is one of the biggest points of uncertainty in assessing whether the Middle Kingdom will rise above the muck to escape the middle income trap or fall victim to the same fate that beset the former Soviet Union.

By the way, China is a tad more important than Greece. For starters, there are 20 cities in China whose economies are bigger than Greece’s. Etc. etc. Greece is more dramatic – more hot news – and thus the mainstream media loves it, but the rebalancing act going on in China that we write about in our book is one of the most important economic events of this century so far.

For those of you interested in more of what George writes about China, and the other 16 contributors in A Great Leap Forward?, you can get it as an e-book on Amazon Kindle, iTunes iBook, or Barnes & Noble Nook. It’s a very reasonable $8.99 and has been getting great reviews. China matters and coauthor Worth Wray and I did this book to give you the background and current information to truly understand what is happening. If you don't understand China, it’s like trying to build a house without all the right tools.

You can still build one, but it won't be as good.

I’m on a train from Princeton back to NYC, where I will have dinner with Art Cashin, Barry Ritholtz, Rich Yamarone, and a few of the other usual suspects. One of the fun things about dinner with these guys is that you never know who else might show and how the conversation might unfold. Last night I spent a few hours at Nouriel Roubini's apartment, sitting outside and discussing one thing after another. You gotta love New York.

I am about halfway through my rather unusual new training, where I sit for an hour a day, wired in, trying to control a computer with my mind. I know, it sounds like I’ve gone off the deep end, but there is serious science at work. The idea is to help me to learn to focus better and think more clearly. At times, I feel like a young Luke Skywalker being coaxed by Yoda: “There is no try. Just do.” The conversations that surround this research and practice truly open your eyes to the amazing discoveries being made in a hundred different fields by a variety of geniuses focused on particular new ideas or the solutions to thorny problems. What an amazing world. (The training I’m taking is not ready for commercial application yet, so no use even asking. But in a few years? Oh, yeah; it will be everywhere.

I will get to spend July 4 in NYC. I assume we will find some fireworks somewhere. I tried some BBQ last night, which was guaranteed to be world-class. That would be the case only for people who have never had Texas BBQ. Or BBQ almost anywhere in the South. There is some great food here, but it is NOT BBQ. And now, let's turn to George Magnus.

Your seeing Chinese in my dining future analyst,
John Mauldin, Editor

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Xi’s Anti-Corruption Campaign Is Key to China’s Prospects

By George Magnus
President Xi Jinping’s anti-corruption campaign has been underway now for almost three years and shows no sign of relenting. One major bank has estimated that the cost of the campaign in terms of lower luxury goods purchases and less ostentatious consumption may have been about 1.5% of GDP in 2014, but even if this were really measurable, it would only skim the surface of significance. For it is now undeniable that China’s economic prospects are inextricably bound up with the substance and consequences of the anti-corruption campaign. Any short-term effects on consumption pale into insignificance against the weightier matter of whether the campaign serves to stimulate or stifle the entire economic reform agenda. China’s economic performance in coming years, its chances of avoiding the middle income trap into which most emerging countries have lapsed over the last 60 years, the fate of President Xi and perhaps even of the Communist Party, itself, depend on nothing less.

Party purity as major weapon of governance

Anti-corruption measures are not new in China, but in the past they were short-lived and their principle purpose was to punish or remove foes. The current campaign is different. It is both a traditional purge and a major weapon of governance, designed to bolster the power and legitimacy of the Communist Party at a time of change that is considered threatening. It is probably no exaggeration to say that the current leadership sees the campaign as a sort of do-or-die moment for the Party, specifically to save it from the fate of that of the former Soviet Union. The prevailing narrative is that China must not succumb to the Soviet Communist Party’s failure to stick with Leninist discipline, which allowed political rot, ideological heresy and military disloyalty to undermine and destroy it.

The campaign actually started before Xi came to power. At the Party school in Beijing in March 2012, Vice-President Xi spoke at length on the very familiar Leninist topic of ‘party purity’, which is about the integrity, reputation and effectiveness of Party members at all levels. Cadres were told to take their Marxism seriously and to implement the programmes, regulations and policies of the Party, and shun all interest in personal gain and influence.

This was no run-of-the-mill political speech. Xi insisted then and since that ‘party purity’ was essential if China was to succeed in building a prosperous society, implementing reform, and changing the development model. This could only happen if members opposed and struggled against all forms of corruption, and defended the health of the Party.

Two weeks after the speech, Bo Xilai, governor of Chongqing who was also vying for the job of President, was removed from office. Over time, as is now known, he was stripped of all his Party posts, expelled from the Party, found guilty of corruption, bribery and abuse of power, and sentenced to life imprisonment. This was the curtain-raiser to an unrelenting and comprehensive anti-corruption campaign that shows no sign of winding down.

Implemented by the extra-legal Central Commission for Discipline Inspection (CCDI), the campaign has targeted over 200,000 ‘tigers and flies’, that is high and lower level officials in the Party, People’s Liberation Army (PLA), and state enterprise system. In 2014 alone, 68 top officials and over 70,000 lower level officials were investigated for violations of anti-graft rules. Roughly 36 tigers have been brought down, including Zhou Yongkang, former Minister of Public Security and member of the Politburo Standing Committee, and Xu Caihou, former general in the PLA, who died from illness in March.

Also being investigated for corruption is Zhang Dongsheng, a former director of the finance department in China’s powerful National Development Reform Commission, China’s top macroeconomic management agency. In December 2014, Ling Jihua, once Political Secretary to former President Hu Jintao and Director of the Party’s General Office was put under investigation for disciplinary violations. This move showed that Xi had no inhibitions about going after close associates of both Hu and former Party General Secretary Jiang Zemin, who, at 88, continues to wield influence, and actually supported Xi for the job of President.

In the first three months of 2015, the chief of military intelligence Xing Yunming was removed from office, scores of PLA officials, including up to 16 generals, were placed under investigation, and senior commanders in the PLA were in the process of being reshuffled. The CCDI announcement that it would target state-owned enterprises (SOEs) in a new intensification of the campaign resulted in the removal or investigation of senior personnel, including Song Lin, the Chairman of China Resources, and Xu Jianyi, the Chairman of the FAW automotive group.

The anti-corruption campaign, therefore, is certainly designed to fight foes, and favour friends. Indeed, one of the objectives is to sideline past leaders and others who continue to wield power in the Party so that the current leadership gets a clear run in getting its nominated members on to the elite Politburo Standing Committee at the 19th Party Congress 2017. Five of seven will stand down having reached the age of 68. The other two members are Xi, himself, and Premier Li Keqiang, both of whom will serve until 2022.

But the campaign is also designed as a weapon of governance to make the Party and the state sector more responsive and efficient, as leaders try to guide China through a very important, and potentially unstable economic transition. To this end, they have raised an enormous flag of economic reform. The broad goals were laid out at the Party’s Third Plenum at the end of 2013, and subsequently, including at the Fourth Plenum in October 2014, which focused on the ‘rule of law’, which is better referred as rule by law, or rule according to law. There is no possibility of the re-ordering Chinese society to make the state and party subservient to an independent judiciary.

It is undeniable that changes are occurring. Progress has been most marked in areas that less politically contentious, for example, financial and capital account liberalisation, and the environment. The government has been reducing some of the red tape required for the approval of public projects, it has introduced important, if partial, reforms affecting the pension system and the household registration system in small and medium-sized cities, and more recently, it proposed fiscal reforms affecting local governments and measures to streamline SOEs.

The key issue, though, is whether the anti-corruption campaign succeed in facilitating the implementation of more substantive and politically sensitive economic reforms. These are widely acknowledged to be essential to rebalancing China’s economy away from an excessive reliance on investment and credit, sustaining a new phase of high economic growth based on service industries, productivity and greater efficiency, and to avoiding the fabled middle-income trap.

Anti-corruption, the paradox of reform, and the economy

Optimists argue that even if anti-corruption measures are dampening down ostentatious consumption now, they will ultimately have strong, positive effects on economic growth. The argument goes that the purge of corrupt Party officials and business managers should lead to more efficient business enterprises. And by making the Party structure more effective, and members more compliant, the implementation of multi-purpose economic reforms and of greater ‘marketisation’ of the economy should lead to better resource allocation, and rising productivity and prosperity. But this is political rhetoric, not judgement.

To be sure, President Xi is using the anti-corruption campaign to amass and centralise power around himself in order to strengthen the Party’s control and primacy. To further this process, Xi has expanded his existing authority over the State Council, the military and the Party by establishing 4 additional ‘leading groups’, which he heads, on national defence and the military, state security, cybersecurity and information, and ‘deepening reform comprehensively’. These secretive groups are key to policy implementation, and the last of those listed is perhaps the most significant because it has a comprehensive portfolio, and unprecedented scope of power and responsibility.

Yet this strategy is also throwing up an intriguing paradox. On the one hand, the centralisation of power and cleansing of the Party are necessary to serve the prospects of successful reform. On the other hand, the same concentration of power raises significantly the danger that the political structure being created will stifle and suppress real reform. How so?

First, a major anti-corruption campaign isn’t an engineering challenge with a neat beginning and end. It is likely to spawn consequences, and could be dangerous. Without an open, transparent and legally accountable campaign, picking off a few rotten apples may still leave an essentially diseased tree intact. It is simply impossible for the government to call an entire ruling class to account.

Second, it risks spreading conservatism throughout the Party and system, so that cadres fear stepping out of line, using initiative or experiment by being disruptive and innovative. Worse, it threatens vested interests that may dilute or stall significant reforms, even if they don’t (yet) come out in open opposition. The latter, though, remains a distinct possibility, perhaps at a point when economic growth slows down more significantly or if and when Xi’s corruption and economic plans should go awry in other ways.

The behaviour of vested interests is already evident in key reform areas, such as capital account liberalisation, where SAFE — the State Administration for Foreign Exchange rules the roost, SOE’s that fall under SASAC — State-owned Assets Supervision and Administration Commission, and local and provincial governments.

Capital account liberalisation has been a Party goal for about 20 years but there is still strong resistance to giving citizens free rein to import and export capital. The capital account is actually more porous than one would imagine, but most of the changes that have occurred have been designed to facilitate capital inflows into China rather than out. Free trade zones have been created in Shanghai, Tianjin and Guandong and it is proposed to create a further 18, but Shanghai — a bellwether — has been criticised by some experts as unworkable because of spillover effects to the rest of the country, which would not be welcome. Businesses generally have expressed disappointment over the incremental and limited scope of liberalisation, and few foreign firms have set up in the zone.

SOE reform is also a key slogan, and the new broom in the country is certainly making waves in getting SOEs to tow the line on outsized executive compensation and perks. SOEs are also being encouraged to become more efficient, pay higher dividends to the government, and merge. But the prime motive of reform isn’t to transfer ownership to the private sector, put SOEs on an equal financial footing with private companies, or increase productivity and other growth-oriented outcomes. Rather it is to strengthen the Party in the iron triangle of Party-State-Business.

Local and provincial governments, which account for the bulk of public revenues and spending, were encouraged to raise copious amounts of debt after the financial crisis. They are now being brought into line a bit as the financing platforms they created are banned from new borrowing. They are being encouraged to refinance expensive and in some cases unserviceable debt through the fledgling municipal bond market though the degree to which they will save debt service costs is probably quite limited. In any event, the incentive system in local governments, in which there’s a strong tendency to push for growth and compete with one another, isn’t really being changed, and there remains a strong resistance to the kind of fiscal and financial reforms that might make them legally accountable and subservient to a central fiscal authority.

Third, the drive for Party purity can already be seen to be leading to a dictatorial style based around the prestige and personality of the leader. While this enhances his authority and increases the ‘fear factor’ among opponents and underlings, it also runs the risk of alienating the urban middle class, on which so much of China’s future success depends. With an on-line population of over 600 million people, a throughput of over 7 million college graduates a year, and a more significant exposure to foreign influence than ever before because of travel, trade and cultural exchanges, it would be rash to assume that the Party will command unswerving support under all or any circumstances.

Increasingly uncertain prospects

There is little doubt that China will continue to introduce economic and governance reforms in its attempts to bolster efficiency and achieve an orderly rebalancing of the Chinese economy. Equally, there is little doubt that these reforms will not seriously ‘marketise’ the economy (other than to serve the iron triangle better), effect a meaningful transfer in structure from the public to the private sector, or introduce rule of law based on an independent legal system and neutral contract enforcement. The question then arises as to what the implications of this juxtaposition might be for the economy over the next several years?

For the time being, the government is likely to struggle to sustain economic growth at the new target of ‘about 7%’ while the economy is rebalancing or after. The downturn in investment growth, especially of real estate and construction, is a secular phenomenon. The government will have to acknowledge this sooner or later because it must also address the challenge of unwinding the economy’s reliance on credit creation and debt accumulation, sooner or later. That will doubtless affect economic growth.

The major problem is that in spite of the rhetoric about managing debt, there is little political appetite at the moment to do so. Credit growth has slowed down from over 30% a few years ago to about 14.5%, but so has the growth rate of money GDP, from 15% to about 7.5-8%. So there will be no let-up in the increase in the ratio of debt to GDP, which is on course to double again by around 2020 or just after, having done so already since 2004. Debt has to be paid for via losses and write-offs, losses have to be assigned and recognised in the balance sheets of private and public enterprises, and the state. Reform, as such, cannot resolve this, only proper de-leveraging can.

Reform, though, is in some ways exacerbating the problem of indebtedness. While financial, fiscal and capital account liberalisation policies are all in principle desirable, they tend to stimulate the demand for and supply of credit, which is precisely what the authorities are supposed to be trying to tame. Deleveraging, meanwhile, is still at a very early stage and it will probably entail several quarters of declining transactions volumes in real estate, defaults, falls in the investment rate, and declining credit to GDP. These trends, though, would add to deflationary pressures, put employment creation at risk, and pose a significant political and economic challenge to the government.

In the longer-term, economic reforms have to go much further now that China’s potential to derive growth from the deployment of physical labour, or from limitless capital accumulation is diminishing quickly. A different sort of economic growth is required for China to grow its per capita GDP strongly as well as its nominal GDP. This would be based much less on the dominance of state institutions, and more on innovation, higher educational attainment standards, stronger productivity, and entrepreneurship. This is all the more relevant because China’s working age population share of the population is declining, and rising wage costs and digital technologies are encouraging foreign companies to go home or to cheaper manufacturing nations in Asia, such as Vietnam, Cambodia, Bangladesh, and now perhaps Modi’s India.

China’s leaders are well aware that the growth and development model has to change. The anti-corruption campaign is essential to securing the reforms that would lead to that change. But, as argued, the campaign has weaknesses and shortcomings. Reforms, especially to create robust and inclusive institutions that would really put China on course to become a high income country are most likely incompatible with the central philosophy of Party, which is to rule unchallenged. A purified Party is no substitute for political reforms in which the Party has no interest.

We can understand the resulting insecurity that seems to pervade the behaviour of the leadership, which has manifested itself in fear, distrust, and a major crackdown on opponents, critics, liberals, and most recently, Western values and influences. The government has forbidden universities from teaching or discussing universal values, press freedom, civil society, civil rights, historical errors of the Party, capitalism and an independent judiciary — collectively known as the ‘seven don’ts’. Ironically, allowing these don’ts would go much further in purging the country of corruption than an extra-legal campaign of going after tigers and flies that by comparison, seems quite limited.

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Sunday, June 14, 2015

Time to Move Capital into Next Bull Market – Part I

Our trading partner Chris Vermeulen just shared with us his take on what most traders are missing when it comes to market rotation. It's a great reminder of what so many of us did so wrong not to long ago. Let's play this different this time.

If you remember the dot com bubble as clearly as I do and are a technical analyst then you will recall the month which the NASDAQ broke down and confirmed a new bear market has started. The date was November of 2000.

You may be wondering why I bring this up. What do tech stocks have to do with commodities?

Good question because they have nothing in common. But the key here is that when a bull market ends in one asset class that money is shifted into another. That money moved into commodities and resource stocks and in a big way. Precious metals and miners exploded, surging an average of 1000% return (10 times ROI) over the next six years, topping out in 2008. In fact, these resource stocks bottom the exact month which the NASDAQ confirmed it was in a bear market on Nov 2000.

Compare Dot-Com Bubble & Burst to Precious Metals Stocks 

Over the next couple of weeks, I will be sharing some of my top stock picks in the metals sector (gold, silver, nickel, and copper). If you missed the 2001 and 2008 metals bull market then you best pay attention and be sure you don’t miss what is about to happen.

Read Chris' entire post and chart work here > Time to Move Capital into Next Bull Market – Part I



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Thursday, November 20, 2014

Cut Trading Risk and Increase Reward with a Strategy I Know You're not Using

"Amazing insights...THANKS!"

"Whoa, completely changed my mindset on ETFs"

Those are two quotes from people who watched John Carter's latest video on trading options on ETFs: John's Favorite Ways to Trade Options On ETFs

He shows you how his strategy allows you to cut risk, increase rewards, and grow your account [of any size we might add] using options on ETFs.

Don't worry...it's VERY clear and easy to apply (Watch Video)

John also shows you....

   *  Why trading options on ETFs cuts your risk so you can sleep at night

   *  How you can profit with ETFs from the unexpected move in the dollar

   *  Why you avoid the games high frequency traders play by trading ETFs

   *  Why most analysts have the next move in the dollar wrong and how to protect your investments

   *  What are some of the markets that will be impacted by the dollars next move

This is crucial information that I highly recommend you take the time to review...it's FREE after all.

Stream the video HERE

See you in the markets putting this to work,
The Stock Market Club


Get our latest FREE eBook "Understanding Options"....Just Click Here!


Wednesday, July 23, 2014

When All You Have Left Is the Cost of Breakfast at McDonald’s

By Dennis Miller

When I was 20 years old, I sat through my first day of a business law course at Northwestern University. The professor began by writing two words on the blackboard (in the prehistoric days of blackboards and chalk): Caveat emptor. He raised his voice and said, “Let the buyer beware!” I’m here to echo his warning, but this time it’s about annuities.


Annuities are at the top of the list of complicated products that often profit insurance companies without adequately compensating the buyer in return. Put plainly, sometimes you don’t get what you thought you paid for.

And, while annuities are often described as a “transfer of risk,” which is basically correct, owning an annuity will not transfer the risk of one of the greatest hazard’s to a retiree’s financial security: inflation. Inflation isn’t the only risk to worry about—lack of liquidity and insurance company default should also top your list of concerns—but it can be the most treacherous for someone with an annuity heavy portfolio.

Will an annuity protect your lifestyle? In the short term, it might. If you believe the Federal Reserve when it says it will keep inflation at 2% or less, perhaps it will for a period of time. Even then, inflation will eat away at the buying power of your annuity payout fairly quickly. You are contractually guaranteed income; however, that does not guarantee your lifestyle.

To see the effect, my analysts and I charted the purchasing power of a single premium immediate lifetime annuity with installment refund, which pays $583.33 per month. We’ve compared several inflation scenarios: the currently tame 2% inflation rate; the long run average of about 3%; and the possibility of things getting considerably worse at 7% inflation. We’re not even talking about hyperinflation—just reasonable estimates.


Even at the low 2% inflation rate, your $583.33 benefit would only have the purchasing power of $392.56 after 20 years. In the 7% inflation scenario, the purchasing power would be down to $150.74. Let’s put this into context.

The average U.S. electricity bill is around $103.67. The average cellphone bill is $111. According to the USDA, an elderly household of two that’s being extremely thrifty could get its monthly grocery bill down to as low as $357.30 per month. In total, that’s $571.97 – leaving just enough for a McDonald’s breakfast.

Right off the bat, that isn’t so bad. The annuity takes care of the cellphones, the electricity, the groceries, and leaves a little extra. However, after 20 years at 2% inflation and a purchasing power of $392.56, the benefit would only be enough to pay for the thrifty grocery budget, leaving only $35.26 left over. Though your annuity benefits are the same, prices have risen, so now you have less purchasing power.

After 20 years of 3% inflation, it gets even worse. With $219.85 in purchasing power, you’ll have to weigh either purchasing 2/3 of your usual groceries against paying the electricity and phones. You won’t be able to do it all. By the third year, you will need to add funds to your annuity payment to cover those expenses.

And under the 7% scenario, you’ll only be able to pay for the electricity bill with less than $50 in purchasing power left over. That’s hardly the lifetime income most annuity buyers had in mind.

Furthermore, consider that our assumptions are a little optimistic. In all likelihood, your electricity and grocery bills will probably rise faster than the rate of inflation. If that’s the case, then you’d be in real trouble.
So, while annuities promise guaranteed income, they certainly do not guarantee what that income will afford you in the future.

Annuity policies can be structured with inflation protection, but those options are expensive in terms of the lower initial payments. With benefits starting so much lower, you would have to live an exceptionally long time to make them work out.

Depending on your circumstances, an annuity might play a useful role in your long-term financial plans. There is much to be said for transferring some risk to a quality insurance company. However, transfering one risk without planning for another could be catastrophic. Even something like a 5% inflation rider might not protect you if higher inflation rates become a reality. If a considerable portion of your portfolio is in annuities, then another portion needs to be balanced to fight inflation, with holdings such as precious metals.

While it’s impossible to make the risk of inflation go away, there are a few simple things you can do to minimize it:
  • Never hold a very large portion of your portfolio in annuities. If high inflation picks up you could be entirely cleaned out.
  • If you’re holding annuities, make sure that another part of your portfolio is geared to hedge against inflation.
Now, I’m not shouting caveat emptor just for the heck of it. As a retirement advocate and senior editor at Miller’s Money Forever my mandate is transparent financial education for seniors, conservative investors and anyone serious about building a rich retirement. That’s why my team of analysts and I have put together a free, comprehensive special report called Annuities De-Mystified—Three Simple Tools for Choosing the Right Annuity.

Get the full truth on annuities by downloading your complimentary copy of Annuities De-Mystified today.


Another must read from Adam J. Crawford....The Rise of Africa… and How To Play It
 

Monday, July 21, 2014

Beware of Flashy Stock Repurchases When The Market Is on The Rise

By Andrey Dashkov

Retail giant Bed Bath & Beyond just announced plans to buy back another $2 billion in shares, which the company will start doing after it completes its current share repurchase program. You’ve seen it before: Press releases emphasize that buybacks return value to shareholders, analysts sometimes rely on repurchases to spot a stock to write up next, and management likes to tout their focus on shareholder returns. But what’s the real story? Why would a company buy its own shares?


There are but a few situations when returning cash to shareholders instead of paying dividends or investing in new projects is prudent:
  • The company has largely exhausted investment opportunities that would generate a positive net present value (NPV).
  • The stock is trading below its intrinsic value; or
  • The tax on dividends is so high compared to the capital gains tax that it makes sense to boost the share price and let shareholders enjoy the extra return instead of receiving heavily taxed dividends.
When these situations happen we support repurchases. In the reality, however, managers often have their own reasons to buy back shares; let’s look at the more popular ones.

First, management’s compensation is often based on share price performance or earnings based metrics like earnings per share (EPS), which buybacks are designed to boost.

Second, higher share price increases the value of a company’s options. Managers are often shareholders, too, but unlike you and me, they have direct access to the Treasury. When managers own a lot of their own company’s stock, they may have too much skin in the game. This may skew their preferences toward increasing the share price at the expense of long term business growth.

Third, share buybacks became a standard (and often abused) signal to the market that: a) the company’s stock is undervalued, and b) that management takes care of the shareholders. Both of these statements may be correct in isolation, based on the company’s fundamentals and management practices. Nonetheless, a buyback should not convince you that either is true.

One additional reason is often overlooked. Many a CEO has been fired for an acquisition that did not work out. When the decision is made to dump the acquisition, it is accompanied by a write off against earnings, sometimes worth billions of dollars. Wall Street armchair quarterbacks are quick to point out how much better off shareholders would have been if they had just paid out what they lost in dividends. Buying back company shares, with all the accompanied hoopla, is less likely to be a career threatening move.

Linking the two subjects together makes for nice copy; however, keep it in perspective. For example, a technology company that realizes their product line is becoming obsolete will often make acquisitions to increase their product line market share, or move them into a new business with long term potential. Buying back company stock, then having to go into the market and borrow at high interest rates, might be the exact wrong move. The key is making the right acquisitions for the company to continue to grow and pay dividends for the next generation.

In fact, managers have proven to be pretty bad stock pickers even when they have only one stock to pick. As my colleague Chris Wood showed in A Look at Stock Buybacks, managements have bought shares of their own companies at pretty bad times in the past. Moreover, the expectations of higher valuation based on higher EPS did not always materialize. Even though a lot of investors use P/E as their main gauge of value (which they shouldn’t), there is no convincing evidence that buybacks can support high valuation multiples in the long term.

Your Bottom Line

 

History has shown that the only value-creating buybacks were the ones carried out when stocks were deeply undervalued. In those instances, the repurchases helped companies outperform the market. But overall the optimism and confidence inducing press releases that accompany buybacks should be taken with a huge grain of salt.

As a rule of thumb, beware of increased buybacks when the market is on the rise (everybody is an investment guru when everything is going up) or when management compensation is closely tied to the share price performance or earnings based metrics. Companies with better corporate governance may fare better when it comes to managing conflicts of interest, but there is a significant vested interest there that investors should be aware of. Don’t mistake noise for a sign is all.

When it comes to returning value to shareholders, we appreciate companies that invest in long term projects—or pay dividends. Despite the potential tax implications, the yield strapped investors may be better served with a special dividend these days than with a promise of a better price in the future.

Learn more ways to cut through press rhetoric by signing up for our free weekly e-letter, Miller’s Money Weekly, where my colleagues and I share timely financial insight tailored for seniors and conservative investors alike.

Sign up here, and we’ll send a complimentary copy straight to your inbox every Thursday



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Wednesday, July 2, 2014

5 Simple Rules to Evolve Past the Hot Stock List

By Andrey Dashkov

If you’re a typical small time investor, chances are you prefer to let a team of analysts fuss about such irksome things as correlation and beta. Maybe you’ve bought a stock because your brother in law gave you a hot tip, maybe you heard something about it on a financial news show, or maybe you just loved the company’s product.


Friends often ask me for “hot stock tips”—which is like walking up to someone at the craps table and asking what number to bet on. An accomplished craps player will have position limits, stop losses, income targets, and an overall strategy that does not hinge on one roll of the dice. You need an overall strategy long before you put money down.

So, what do I tell those friends asking for hot stock tips? Well, that they can retire rich with a 50-20-30 portfolio:
  • Stocks. 50% in solid, diversified stocks providing healthy dividends and appreciation.
  • High Yield. 20% in high yield, dividend paying investments coupled with appropriate safety measures. These holdings are bought for yield; any appreciation is a nice bonus.
  • Stable Income. 30% in conservative, stable income vehicles.
Unless you’re starting entirely from scratch, you should review your current portfolio allocations, identify where you’re over or underallocated, and then look for investments to fill those holes. In our portfolio here at Miller's Money Forever, we separate our recommendations into StocksHigh Yield, and Stable Income to help you do just that.

The Art of the Pick

 

By the time an investment lands in our portfolio, we’ve already run it through our Five Point Balancing Test. When your boasting brother in law tempts you with a “can’t-miss opportunity” or some pundit touts a hot tech company on television, you can come back to these five points, again and again.
  1. Is it a solid company or investment vehicle? Investing your retirement money safely is a must. How do you know if a company is solid? Take the time to validate essential company information, particularly when the recommendation comes from a source with questionable motivation.
  2. Does it provide good income? A good stock combines a robust dividend and appreciation potential.
  3. Is there a good chance for appreciation? There are two types of appreciating stocks: those that rise because of general market conditions and those that rise further because of the way management runs the business. We want both.
  4. Does it protect against inflation? High inflation is one of the biggest enemies of a retirement portfolio.
  5. Is it easily reversible? Ask yourself, “Can I quickly and easily reverse this investment if something unexpected occurs?” The ability to liquidate inexpensively is critical to correcting errors.

Marking the Bull’s Eye So You Can Hit It

 

It’s worthwhile to write down your goal—including an income target and the price at which you’ll sell if things head south—with every investment. After all, if you can’t see the bull’s eye, how will you know if you’ve hit it? Buying any investment because a trusted adviser, newsletter, or pundit recommended it is not a good enough reason. Buying because your portfolio has a hole, you understand the company, the investment vehicle, the risks, and the potential is.

Remember, retiring rich means having enough money to enjoy your lifestyle without money worries. Do your homework on every investment and you’ll make that pleasant thought your life’s reality. Every week, the Miller’s Money team provides no nonsense, practical advice about the best ways to invest for your retirement in  Miller’s Money Weekly Sign up here to receive it every Thursday.

The article 5 Simple Rules to Evolve Past the Hot-Stock List was originally published at Millers Money


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Tuesday, June 3, 2014

Investing in China....Looking at the Middle Kingdom with Fresh Eyes

By John Mauldin

I am writing this introductory note from London during a layover on my way to Rome, and I’ll append a personal ending tonight after I finally make my way back from dinner to the hotel.

One of the few consensus ideas that I took away from the Strategic Investment Conference is that China has the potential to become a real problem. It seemed to me that almost everyone who addressed the topic was either seriously alarmed at the extent of China’s troubles or merely very worried. Perhaps it was the particular group of speakers we had, but no one was sanguine. If you recall, a few weeks back I introduced my young colleague and protégé Worth Wray to you; and his inaugural Thoughts from the Frontline focused on China, a topic on which he is well versed, having lived and studied there. Our conversations often center on China and emerging markets (and we tend to talk and write to each other a lot). While I’m on the road, Worth is once again visiting China in this week’s letter, summing up our research and contributing his own unique style and passion. I think regular TFTF readers are going to enjoy Worth’s occasional missives and will want to see more of them over time. Now, let’s turn it over to my able young Cajun friend.

Editors’ note: With John up to his eyeballs in prosecco and peaches there on the patio in Trequanda this morning and with Worth just getting the sleep out of his eyes in Houston, we are hereby making an executive decision to split this 22 page beast masterpiece right up its middle and bring you the second half next week … which will give both these guys some well earned rest!  – Charley & Lisa Sweet

Looking at the Middle Kingdom with Fresh Eyes

By Worth Wray (Houston, TX)
In my Thoughts from the Frontline debut this past March (“China’s Minsky Moment?”), I highlighted the massive bubble in Chinese private sector debt and explored the near term prospects for either (1) a reform induced slowdown or (2) a crisis induced recession. Unfortunately, it was not an easy or straightforward analysis, considering the glaring inconsistencies between “official” state compiled data and more concrete measures of real economic activity.

More Questions Than Answers

Although John and I spend hours every week searching for the truth in a murky stream of official and unofficial reports, we always reach the same conclusion about the People’s Republic: There is really no way to know what is happening in China today, much less what will happen tomorrow, based on widely available data. The primary data is flawed at best and manipulated at worst. Sometimes the most revealing insights lie in the disagreement between the official and unofficial reports… suggesting that official data is useful only to the extent that we think about it as state-sanctioned propaganda. In other words, it tells us what Chinese policymakers want the world to believe.

This shortfall in credible and actionable data from one of the global economy’s largest and most interconnected members leaves us with more questions than answers – especially in the presence of a massive Chinese credit bubble, with clear signs of overinvestment and unsustainably high debt-service ratios. These are troubling signs for all investors, in every asset class, everywhere in the world today… and everyone should be paying close attention.

(I should note that John has access to a massive amount of research from a very wide variety of both traditional and nontraditional sources… and I say that after having extraordinary access myself as the portfolio strategist for an $18B Texas money manager. I am seeing and reading things every day that I could only imagine before, and the information flow is addictive. John’s sources give us a big, if sometimes overwhelming, head start on thinking through all the implications for investing around the constant collisions of macroeconomic forces. While we legally and ethically cannot share some of the best research we see, we can share a lot of the core ideas and do our best to give you a head start, too. That’s what this letter is about.)

Read the Tea Leaves Carefully & Expect Miscues

Most China economists – who do the best they can to read the economic tea leaves by focusing on a handful of economic indicators ranging from gross domestic product (GDP), purchasing managers’ indices (PMI), consumer/producer inflation (CPI/PPI), total social finance, and industrial production – end up expressing a rather bipolar view on Chinese economic activity, with wild swings in their outlooks from quarter to quarter.

On this front, I was particularly impressed by an explosive letter (viewable by Over My Shoulder subscribers only) from our friends at Political Alpha, which remains one of the elite political intelligence/analysis firms on the Street. While China watchers tend to trade reactively around official and unofficial manufacturing PMI releases as monthly proxies for the broader economy, very few investors realize that “not only is manufacturing no longer the bellwether of the [Chinese] economy, more often than not it now performs counter cyclically.”

Although China is the world’s largest producer of value added manufactured goods, it has not been an export led economy for a very long time. As I detailed in last month’s letter, China’s growth has largely relied on extraordinarily high levels of fixed investment, supported by even higher levels of domestic savings and an unsustainable rise in private sector credit.


Source: Wayne M. Morrison, China’s Economic Rise: History, Trends, Challenges, & Implications for the United States. Congressional Research Service, February 3, 2014

Even so, industry experts often fall into the trap of extrapolating flash manufacturing readings into forecasts for the broader economy.

Our friends at Political Alpha describe one such situation where HSBC’s China team (which puts out the unofficial monthly PMI each month in partnership with MarkIt) “was forced to backpedal from its September 23rd announcement that the flash PMI data was ‘further evidence [of] China’s ongoing growth rebound’ to a much more somber conclusion just seven days later: ‘There are still a lot of structural headwinds ahead. This is as good as it gets for the time being…. [D]on’t expect too sharp an acceleration from here."

Feel free to compare the clips yourself:

On a side note, I don’t mean to disparage the China research team at HSBC or question their competency by reprinting the comments above. I’m sure they get up each morning (just like I do) with a genuine intent to understand changing economic conditions as best they can and to help their clients protect and grow their savings. If anything, this example is a broader indictment of investors’ widespread reliance on a handful of flawed or misunderstood data points in the absence of credible Chinese economic data.

I don’t mean to be cute or coy on this issue. The lack of transparency of the Chinese economy is not just a problem for individual and institutional investors who make the choice every day to put their money at risk; it also carries enormous policy implications for central bankers and elected politicians in a highly unstable global system where total debt-to-GDP has risen across the world’s major economies by nearly 35% since 2008… and continues to rise.


Source: Hoisington Investment Management Company, May 2014

As you can see in the table above (which Dr. Lacy Hunt was kind enough to share with us at this year’s Strategic Investment Conference), China has seen its total debt to income ratio jump by more than 100% (another full turn of GDP) in the last five years… more debt growth than any other major economy on the planet, including Japan.

Pulling Back the Bamboo Curtain 

Fortunately, my last letter on China’s debt build up sparked a flurry of introductions and fresh conversations with investors, economists, and policymakers from around the world – in places like London, Spain, South Africa, Singapore, Dubai, Australia, Hong Kong, and Finland. Of course, John has also eagerly introduced me to many of his close friends (who happen to be serious A-list economists and money managers)… so needless to say, it has been an incredibly fun and enlightening couple of months.

But John introduced me to one man, in particular, who was able to pull back the curtain on the Chinese economy in a way I had not imagined… and it feels like I am looking at the Middle Kingdom with fresh eyes.
Meet Leland Miller, President of China Beige Book International. Along with Dr. Craig Charney, who oversees the firm’s vast research efforts, Leland spearheads the effort to supply the world’s elite institutions (from central banks and heads of state to multinationals, mega banks, and hedge funds) with a comprehensive look into China’s economy, by applying the same survey methodology employed by each of the regional U.S. Federal Reserve Banks in preparing their submissions for the national Beige Book. 

Aside from the fact that Leland is an Oxford-educated China historian, a brilliant economist, and a genuinely nice guy, what first caught my attention was his remarkable track record of contrarian calls since the inaugural issue of the China Beige Book in Q1 2012… from the initial slowdown; to unexpected bounces in economic activity; and even the June 2013 cash crunch where interbank interest rates spiked dramatically in a matter of weeks, signaling that a wave of defaults was on the way. (I should note that John has sat on China Beige Book International’s advisory board and has worked closely with Leland for most of the firm’s history.)
Before we proceed, here is a short but important description of the history and methodology behind the China Beige Book. Although survey data has its limits in any economy, this is as good as it gets for a semi-closed economy like China’s.

Beginning in early 2010, our team set out to craft a Chinese analogue of the US Federal Reserve’s Beige Book. Over the next twelve months, we conducted a study of the Beige Book and the methods used to prepare it, including contact with officials at each of the regional Federal Reserve Banks involved in its preparation. We then worked to develop a method that would be similar, but more comprehensive and systematic, in its approach to the world’s second largest economy – a Beige Book “with Chinese characteristics.”

Our approach triangulates three methods, repeated every quarter: a quantitative survey of over 2,000 leading firms from key sectors across the country; qualitative one-on-one in-depth discussions with C-Suite executives in the same industries across every region; and a separate, targeted banker survey of loan officers and branch managers, designed to home in on the complexities of both the official and shadow economies. With the data from this approach, we are able to compare regions and industries within a quarter, as well as track changes over time, both in near and real time.
The result of these efforts is the largest and most comprehensive survey series ever conducted on a closed or semi-closed economy…

I cannot share the report in its entirety or reveal too much of its contents, but Leland did give me permission to share part of the regional overviews and research highlights from the Q1 2014 report. If you are able and willing to pay the six figure annual subscription fee, Leland’s work will blow your mind and dramatically change your perspective. For the rest of us, the following excerpt can at least point us in the right direction… and I am discovering that Leland’s media interviews and tweets (@ChinaBeigeBook) are quite telling, as well. (You can also follow John and me on Twitter at @JohnFMauldin and @WorthWray, respectively.)

China Beige Book, Regional Overview (Excerpts from the Q1 2014 report)

China Beige Book regions [listed below]
Region 1: Shanghai, Jiangsu, Zhejiang
Growth slowed – retail & real estate gains weakening sharply – despite stability in manufacturing and pickups in services, transport, and agriculture. Borrowing was stable with rates down at banks and up at non-bank lenders. Hiring slowed, as did margin growth. On quarter weakness was modest, but the on-year drop was worrisome.
Region 2: Guangdong, Fujian
Despite the national slowdown, Guangdong’s pickup continued, driven by manufacturing and transport. Growth was steady in retail, off in services and property. Wage growth remained high but costs inflation eased, boosting margins. Borrowing ticked up, with bank rates steady and shadow rates up. The export power-house found an encouraging second wind.
Region 3: Beijing, Tianjin, Shandong, Hebei
The capital region saw Q1’s worst results, due to trouble in services and manufacturing. Property and mining were stable, retail slightly better. Margin growth suffered. Borrowing was stable and moved to banks, on the country’s lowest interest rates. Beijing is leading the national economic slowdown.
Region 4: Heilongjiang, Jilin, Liaoning
The Northeast slowed as mining contracted and manufacturing, property, and farming growth eased. Services was stable and retail saw a pick-up. Hiring and wages strengthened, while pricing weakened, pressuring margins. Borrowing ticked up, rates easing. Rebalancing does not look easy in this old industrial region.
Region 5: Hubei, Henan, Chongqing, Sichuan, Anhui, Jiangxi
Growth slowed sharply, slipping in retail, services, property, farming, and mining, with only manufacturing stable. Hiring was steady but input costs grew faster, narrowing margin gains. Borrowing slid again, with lower interest rates in both formal and shadow finance – not an encouraging trend.
Region 6: Shaanxi, Shanxi, Inner Mongolia, Ningxia
Growth took a hit, gains slowing in this crucial mining sector. Manufacturing, real estate and, especially, retail weakened. Services and transport were the bright spots. Hiring and margin growth both eased. Borrowing was flat as rates went up. The North remains dependent on struggling mining.
Region 7: Guizhou, Guangxi, Yunnan, Hainan, Hunan
Again out of sync with the rest of China, the Southwest sped up. Manufacturing, transport, and mining improved, but retail, services, and real estate saw growth slow. Hiring and input costs picked up, but so did pricing and margins. Borrowing ticked up, as shadow lenders’ rates moved back above banks’ rates.
Region 8: Xinjiang, Tibet, Gansu, Qinghai
The West again boasted China’s best overall growth, though manufacturing, retail, and services slowed. Only property picked up, with mining and transport stable. Hiring and input cost growth were steady, but pricing and margin growth eased. Borrowing remained China’s least frequent as rates jumped.
China Beige Book, Research Highlights (Excerpts from the Q1 2014 report)
Manufacturing is fine, yet the economy is not
The pace of Chinese economic expansion has painfully slowed. Revenue, sales, profit, and wage growth are all weaker than a year ago. The slowdown is particularly steep in the North [region 6] and Northeast [region 4] and also pronounced in Beijing [region 3] and Central China (region 5).
By sector, stable first-quarter growth in manufacturing confirms our long-standing thesis that it is no longer the economy’s bellwether...
A bounce-back later this year is possible
The worst performer according to CBB figures, both on-quarter and on-year, is real estate and construction. While property companies are getting crushed, the sector is also notoriously unstable for both structural and political reasons. It would be no surprise if real estate were to rally before the end of the year.
More immediate reason for optimism: Growth in new domestic orders was solid (save in the Northeast), and domestic orders and export orders were both stronger in powerhouse Guangdong. The results do not indicate a boom later in 2014, but they do suggest that linear forecasts of continued deterioration are overly simplistic.
Financial segmentation is profound
The ongoing debates about monetary policy assume that anticipated loosening or tightening applies across the spectrum of borrowers. CBB data say otherwise, and in multiple ways. First, while the number of firms reporting that they borrowed stabilized in Q1, it did so at a very low level. Shoving more liquidity at the credit market will have limited effects until participation expands. This includes RRR cuts – though of course these may occur for political reasons.

Second, shadow finance may be revving up for a comeback. CBB numbers show a recovery in the sales of wealth management products (WMPs), likely due to competition from online banking. This is cash leaving the traditional banking sector and, while non-bank lending did not pick up in the first quarter, the groundwork is being laid for it to do so.
Online banking may be encouraging riskier behavior
Online lenders are typically viewed as a force for liberalization, as well as a potentially healthier alternative to unregulated shadow finance. Yet our data show their proliferation would impart significant costs as well…
What appears to be happening is the higher returns available in online banking are forcing banks to move more transactions off-balance sheet, in order to avoid the interest rate cap. While this may accommodate policy goals in the short term, an uptick in off-balance sheet funding portends more shadow bank lending down the line.
Interest rate spread between banks & shadow banks highest in a year
Bank loan rates and bond yields eased slightly this quarter, but the cost of capital increased again for those borrowing from non-bank lenders. While the shifts were not dramatic, the spread between bank and non-bank loan rates nationwide is now the largest since Q1 2013. This highlights the still more challenging road for those firms, principally domestic private entities that are pushed outside formal lending channels.

Growth Is Slowing But Not Collapsing (So Far…) 

After reading through the latest report, consulting with friends who are also familiar with the research, and bombarding Leland with a never-ending stream of questions for the last month, John and I still cannot claim to have enough information to make a directional call on the world’s most powerful (and least understood) macro force… but we know more about the inner workings of China’s economy than we did when we wrote to you a couple of months ago.

Great data often has that effect – it’s like shining a light into the shadows (including China’s shadow banks). We can see the nuanced regional contrast in economic activity, the modest (but still insufficient) rebalancing between sectors, and pressure points in the credit markets that suggest last summer’s interbank volatility may return in 2014.

We also see a far more mixed picture of economic activity than a lot of the widely followed headline data suggests. The overall pace of Chinese economic growth is clearly slowing but not collapsing. The credit transmission mechanism is obviously broken, as you can see in the chart below (with government and government-sponsored borrowers in zombie industries consuming the majority of the country’s credit… in turn forcing households to borrow through shadow banks at massive risk premiums); but so far, the credit bubble is not imploding.

On that note, China Beige Book International is the only independent research firm in the world that tracks the non-bank (shadow) lending rates not just nationally, or by region, but for every sector in every region over time. Leland and his team have essentially solved the most difficult China puzzle of all: what is true cost of capital in the Chinese economy, and who is able to actually access it?


Source: Wei Yao, “China: A whiff of debt deflation.” Societe Generale Research, May 9, 2014

Of course – and Leland was emphatic on this point – China’s greatest challenge will lie in deleveraging the economy while also rebalancing toward a consumption-driven growth model for the first time in modern history. That cannot happen as long as households remain repressed by unequal access to credit markets or intentionally suppressed exchange rates, which essentially represent a transfer of household wealth from workers to state-favored firms. But reforming the system will require a greater slowdown than China’s policymakers are letting on. And, Leland warns, Beijing runs the risk of blowing its credibility and instigating capital flight if the divergence between official forecasts and China’s actual economic experience grows too large.

To be continued next week 

Trequanda, Nantucket, New York, and Maine

It is very early Saturday morning here in Rome (still late Friday night in the US) as I finish this letter, or at least my part of it. Worth is still up and reworking this piece (I really can’t keep up with him); then the editors, Charley and Lisa Sweet, will do their final runs; and then a whole team will make sure you get your letter. A far cry from the early days when your humble analyst did everything. And the mistakes I made showed up in print far more often. I am grateful to have a whole group of dedicated people working to keep the machine humming.

In a few hours I will meet George Gilder at the train station. I will buy a few local phones (I already have local sim cards for the iPads from the airport yesterday), find some cash, and have lunch before we hop the train to Chiusi with my daughter Melissa and some friends and then meet Tiffani and Lively, who are already there with the cars. We’ll drive to Sinalunga to shop for groceries and other stuff for the week before going the last short leg to Trequanda.

Other guests will come and go over the next few weeks, using the villa as a base to explore the Tuscan region; but I will probably stay “home,” reading and thinking and working out, doing some preliminary writing on my next book, and trying to take the speed of life down a gear or two. Vacation for me is being in the same place for an extended period. And getting to talk with Gilder in the evenings about our books is such a treat. He is one of the finest philosophical/sociological/economic/technological minds in the world (in my opinion), and having him to talk with in the evening will help me lay the proper intellectual framework for my book, though I have to work on not distracting him too much.

Last night I had dinner arranged here in Rome with my friend Steve Cucchiaro, his daughter (who was celebrating her birthday), and his son. My group was running late, even though our driver from the airport was driving like we were in a Formula One race. That is typical, but it was not long before we realized he was also drunk and half mad, talking and gesturing to himself the entire time. Obviously, we survived. When we got to our hotel, I was busy getting people to get ready ASAP so we would not be too late. I asked the concierge for directions, and he gave them to me but then said, “Signor Mauldin, you cannot wear that to the Imago restaurant. It is a very nice place.” I pointed out that I had not brought a tie, and he offered me one. So I went to the room and called Steve to tell him we would be a little late. He said jackets were required but no ties.

It turned out he had booked one of the finest places in Rome and got the corner window table overlooking the Spanish Steps and St. Peter’s, with a spectacular sunset/nighttime view. Another special night for the memory book.

It is time to hit the send button, as trains will not wait. I will report from Tuscany next week, by which time Worth and I should have China all figured out – not! But we’ll keep after it. Also, I hope to summarize the speech I did in San Diego. Until then have a great week!

Your thinking I need to get to China analyst,
John Mauldin, 



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Wednesday, April 23, 2014

Hoisington Investment Management Quarterly Review and Outlook, First Quarter 2014

By John Mauldin


In today’s Outside the Box, Lacy Hunt and Van Hoisington of Hoisington Investment have the temerity to point out that since the Great Recession officially ended in 2009, the Federal Open Market Committee (FOMC) has been consistently overoptimistic in its projections of U.S. growth. They simply expected QE to be more stimulative than it has been, to the tune of about 6% over the past four years – a total of about $1 trillion that never materialized.

Given that dismal track record, our authors ask why we should believe the Fed’s prediction of 2.9% real GDP growth for 2014 and 3.4% for 2015 – particularly with QE being tapered into nonexistence. A big part of the reason the Fed has been so steadily wrong, say Lacy and Van, is its overreliance on the so-called “wealth effect,” which posits that an increase in consumer wealth – through higher stock prices or home values, for instance – will lead to increased consumer spending.

The wealth effect has been both a justification for quantitative easing and a root cause of consistent overly optimistic growth expectations by the FOMC. The research cited below suggests that the concept of a wealth effect is in fact deeply flawed. It is unfortunate that the FOMC has relied on this flawed concept to experiment with over $3 trillion in asset purchases and continues to use it as the basis for what we believe are overly optimistic growth expectations.

The effect isn’t completely absent, say the authors, but their research suggests that it may five to ten times weaker than the Fed assumes. Go figure.

Hoisington Investment Management Company (www.Hoisingtonmgt.com) is a registered investment advisor specializing in fixed-income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $5 billion under management and is the sub-adviser of the Wasatch-Hoisington U.S. Treasury Fund (WHOSX).

It is been a busy day for me here in Dallas. Besides nonstop meetings and conversations and my usual reading, I had the privilege of going to the Dallas branch of the Federal Reserve and watching President Richard Fisher make loans to a group of budding entrepreneurs to build lemonade stands. It is part of a fabulous organization called Lemonade Day. The basic concept is to enable young children to learn about entrepreneurship and capitalism by helping them launch a lemonade stand. Youth who register are taught 14 lessons from their entrepreneurial workbook, with either a parent, teacher, youth organization leader, or other adult mentor supervising. At the conclusions of the lessons, they are prepared to open their first business… a lemonade stand. Local businesses and banks volunteer to empower these kids by making them a $50 loan and helping them set up their business. By the time they come to talk with the “banker,” they have a business plan and a set of goals as to what they will do with them profits they make. Watching these kids respond to adults asking them about their plans brings joy to your heart.

On May 4, in some 35 cities across the country, 200,000 young people will be building lemonade stands and trying to turn a profit. If you drive by a lemonade stand, stop and support America’s future entrepreneurs. If you are in one of those 35 cities (click here to find out), make a point to find a few lemonade stands and support America’s future. And if you don’t have a lemonade stand in your city, consider following in the footsteps of local heroes (and my good friends) Reid Walker and Robert Alpert, who decided to launch Lemonade Day here in Dallas. This should be a spring ritual in every city in the country.

Buoyed by the kids and their enthusiasm, I then went to dinner with Richard Fisher and Woody Brock and a few other associates of Ray Hunt, who hosted us for a fabulous and thought-provoking session, talking economics, geopolitics, and even a little politics. There was an interesting mix of pessimism and optimism in the room about the future of our country, but there was not a person who was not concerned with the direction in which we are headed. Gerald Turner, the president of SMU, talked to us about how fiscally conservative and socially liberal his students are. That kind of mirrors my own children. The world is changing faster, both technologically and demographically, than many of us in the Boomer generation are comfortable with. But we’d better get used to it.

It’s been a tumultuous last few days, and tomorrow morning I have to leave early for San Francisco to do a video shoot with my partners at Altegris, before going right back to the airport and flying home to speak to a local group of investment advisers and brokers brought together by Peak Capital Management. It is late and time to hit the send button, because the alarm clock will go off early. Have a great week
Your wondering where all the time goes analyst,

John Mauldin, Editor
Outside the Box

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Hoisington Investment Management – Quarterly Review and Outlook, First Quarter 2014

 

Optimism at the FOMC

 

The Federal Open Market Committee (FOMC) has continuously been overly optimistic regarding its expectations for economic growth in the United States since the last recession ended in 2009. If their annual forecasts had been realized over the past four years, then at the end of 2013 the U.S. economy should have been approximately $1 trillion, or 6%, larger. The preponderance of research suggests that the FOMC has been incorrect in its presumption of the effectiveness of quantitative easing (QE) on boosting economic growth. This faulty track record calls into question their latest prediction of 2.9% real GDP growth for 2014 and 3.4% for 2015.

A major reason for the FOMC’s overly optimistic forecast for economic growth and its incorrect view of the effectiveness of quantitative easing is the reliance on the so-called “wealth effect”, described as a change in consumer wealth which results in a change in consumer spending. In an opinion column for The Washington Post on November 5, 2010, then FOMC chairman Ben Bernanke wrote, “...higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.” Former FOMC chairman Alan Greenspan in a CNBC interview on Feb. 15, 2013 said, “The stock market is the key player in the game of economic growth.” This year, in the January 20 issue of Time Magazine, the current FOMC chair, Janet Yellen said, “And part of the [economic stimulus] comes through higher house and stock prices, which causes people with homes and stocks to spend more, which causes jobs to be created throughout the economy and income to go up throughout the economy.”

FOMC leaders may feel justified in taking such a position based upon the FRB/US, a large- scale econometric model. In part of this model, employed by the FOMC in their decision making, household consumption behavior is expressed as a function of total wealth as well as other variables. The model predicts that an increase in wealth of one dollar will boost consumer spending by five to ten cents (see page 8-9 “Housing Wealth and Consumption” by Matteo Iacoviello, International Finance Discussion Papers, #1027, Board of Governors of the Federal Reserve System, August 2011). Even at the lower end of their model's range this wealth effect, if it were valid, would be a powerful factor in spurring economic growth.

After examining much of the latest scholarly research, and conducting in house research on the link between household wealth and spending, we found the wealth effect to be much weaker than the FOMC presumes. In fact, it is difficult to document any consistent impact with most of the research pointing to a spending increase of only one cent per one dollar rise in wealth at best. Some studies even indicate that the wealth effect is only an interesting theory and cannot be observed in practice.

The wealth effect has been both a justification for quantitative easing and a root cause of consistent overly optimistic growth expectations by the FOMC. The research cited below suggests that the concept of a wealth effect is in fact deeply flawed. It is unfortunate that the FOMC has relied on this flawed concept to experiment with over $3 trillion in asset purchases and continues to use it as the basis for what we believe are overly optimistic growth expectations.

Consumer Wealth and Consumer Spending

 

Many episodes of rising and falling financial and housing asset wealth have occurred throughout history. The question is whether these periods of wealth changes are associated in a consistent and reliable way with changes in consumer spending. We examined, separately, percent changes in real consumption expenditures per capita against percent changes in the real S&P 500 index (financial wealth) and against percent changes in Robert Shiller’s real home price index (housing wealth). If economic relationships are valid they should work for all time periods, regardless of highly different idiosyncratic conditions, as opposed to an isolated subset of historical experience. As such, we conducted our analysis from 1930 through 2013, the entire time period for which all variables were available.

Financial Wealth. Chart 1 is a scatter diagram of current percent changes in both real per capita personal consumption expenditures (PCE), the preferred measure of spending, and the real S&P 500 stock price index. It is made up of 84 dots, which constitutes a robust sample. Over our sample period, as with most extremely long periods, time will tend to link economic variables to each other; population is a key factor that can cause such an association. By expressing consumption in per capita terms, trending has been reduced, and in turn, an artificially overstated degree of correlation has been avoided.



If financial wealth drives consumer spending, an unambiguous positively sloped line should be evident on this scatter diagram. Larger gains in the S&P 500 would be associated with faster increases in spending; conversely, declines in the S&P 500 would be tied to lower spending. If there was a strong positive correlation, the large gains in stock prices would be associated with strong gains in spending, and they would fall in the upper right quadrant of the graph. In addition, sizeable declines in the S&P would be associated with large decreases in consumer spending, and the dots would fall in the lower left quadrant, resulting in an upward sloping line. For the relationship to be stable and dependable the dots should be packed in an around the trend line. This is clearly not the case. The trend line through the dots is positive, but the observations in the upper left quadrant of the graph and those in the lower right exhibit a negative rather than positive correlation. Furthermore, the dots are not clustered close to the trend line. The goodness of fit (coefficient of determination) of 0.27 is statistically significant; however, the slope of the line is minimally positive. This suggests that an approximate one dollar increase in wealth will boost real per capita PCE by less than one cent, far less than even the lower band of the effect in the Fed’s model.

Theoretically, lagged changes are preferred because when current or coincidental changes in economic variables are correlated the coefficients may be biased due to some other factor not covered by the empirical estimation. Also, lags give households time to adjust to their change in wealth. As such, we correlated the current percent change in real per capita PCE against current changes as well as one and two year lagged changes (expressed as a three-year moving average) in the S&P 500. The lags did not improve the goodness of fit as the coefficient of determination fell to 0.21. An increased dollar of wealth, however, still resulted in a one cent increase in consumption. We then correlated current percent change in real per capita PCE with only lagged changes in the real S&P 500 for the two prior years (expressed as a two year moving average), and the relationship completely fell apart as the goodness of fit fell to a statistically insignificant 0.06.

Housing Wealth. Chart 2 is a second scatter diagram, relating current percent changes in real home prices to current percent changes in real per capita PCE. Once again, the trend line does have a small positive slope, but there are so many observations in the upper left quadrant that the coefficient of determination does not meet robust tests for statistical significance. The dots are even more dispersed from the trend line than in the prior scatter diagram.



As with the analysis on financial wealth, when current changes in consumption were correlated against the lagged changes in home prices (both the three-year moving average and the two-year moving average), the goodness of fit deteriorated significantly and was not statistically significant in either case.

Correlations, or the lack thereof, indicated by these scatter diagrams do not prove causation. Nevertheless, economic theory offers an explanation for the poor correlation. If a person has an appreciated asset and wishes to increase spending, one option is to sell the asset, capture the gain and buy something else.

However, the funds to make the new purchase comes from the buyer of the asset. Thus, when financial assets are sold, money balances increase for the seller but fall for the buyer. The person with an appreciated asset could choose to borrow against that asset. Since new debt is current spending in lieu of future spending, the debt option may only provide a temporary boost to economic activity. To avoid an accentuated business cycle, debt must generate an income stream to repay principal and interest. Otherwise any increase in debt to convert wealth gains into consumer spending may merely add to cyclical volatility without producing any lasting benefit.

Scholarly Research

 

Scholarly research has debated the impact of financial and housing wealth on consumer spending as well. The academic research on financial wealth is relatively consistent; it has very little impact on consumption. In “Financial Wealth Effect: Evidence from Threshold Estimation” (Applied Economic Letters, 2011), Sherif Khalifa, Ousmane Seck and Elwin Tobing found “a threshold income level of almost $130,000, below which the financial wealth effect is insignificant, and above which the effect is 0.004.” This means a one dollar rise in wealth would, in time, boost consumption by less than one-half of a penny. Similarly, in “Wealth Effects Revisited 1975- 2012,” Karl E. Case, John M. Quigley and Robert J. Shiller (Cowles Foundation Discussion Paper #1884, December 2012) write, “The numerical results vary somewhat with different econometric specifications, and so any numerical conclusion must be tentative. We find at best weak evidence of a link between stock market wealth and consumption.” This team looked at quarterly observations during the 17 year period from 1982 through 1999 and the 37-year period from 1975 through the spring quarter of 2012.

The research on housing wealth is more divided. In the same paper referenced above, Karl E. Case, John M. Quigley and Robert J. Shiller write, “In contrast, we do find strong evidence that variations in housing market wealth have important effects upon consumption.” These findings differ from the findings of various other economists. In “The (Mythical?) Housing Wealth Effect” (NBER Working Paper #15075, June 2009), Charles Calomiris, Stanley D. Longhofer and William Miles write, “Models used to guide policy, as well as some empirical studies, suggest that the effect of housing wealth on consumption is large and greater than the wealth effect on consumption from stock holdings. Recent theoretical work, in contrast, argues that changes in housing wealth are offset by changes in housing consumption, meaning that unexpected shocks in housing wealth should have little effect on non housing consumption.”

Furthermore, R. Glenn Hubbard and Anthony Patrick O’Brien (Macroneconomics, Fourth edition, 2013, page 381) provide a highly cogent summary of the aforementioned research by Charles Calomiris, Stanley D. Longhofer and William Miles. They argue that consumers “own houses primarily so they can consume the housing services a home provides. Only consumers who intend to sell their current house and buy a smaller one – for example, ‘empty nesters’ whose children have left home – will benefit from an increase in housing prices. But taking the population as a whole, the number of empty nesters may be smaller than the number of first time home buyers plus the number of homeowners who want to buy larger houses. These two groups are hurt by rising home prices.”

Amir Sufi, Professor of Finance at the University of Chicago, also indicates that the effect of housing wealth is much smaller than assumed in the policy models and earlier empirical research. Dr. Sufi calculates that an increase of one dollar of housing wealth may yield as little as one cent of extra spending (“Will Housing Save the U.S. Economy?”, April 2013, Chicago Booth Economic Outlook event). This is in line with a 2013 study by Sherif Khalifa, Ousmane Seck and Elwin Tobing (“Housing Wealth Effect: Evidence from Threshold Estimation”, The Journal of Housing Economics). These economists found that a threshold income level of $74,046 had a wealth coefficient that rounded to one cent. Income levels between $74,046 and $501,000 had a two cent coefficient, and incomes above $501,000 had a statistically insignificant coefficient.

In total, the majority of the research is seemingly unequivocal in its conclusion. The wealth effect (financial and housing) is barely operative. As such, it is interesting to note its actual impact in 2013.

Where Was the Wealth Effect in 2013?

 

If the wealth effect was as powerful as the FOMC believes, consumer spending should have turned in a stellar performance last year. In 2013 equities and housing posted strong gains. On a yearly average basis, the real S&P 500 stock market index increase was 17.7%, and the real Case Shiller Home Price Index increase was 9.1%. The combined gain of these wealth proxies was 26.8%, the eighth largest in the 84 years of data. The real per capital PCE gain of just 1.2% ranked 58th of 84. The difference between the two was the fifth largest in the 84 cases. Such a huge discrepancy in relative performance in 2013, occurring as it did in the fourth year of an economic expansion, raises serious doubts about the efficacy of the wealth effect (Chart 3).



In econometrics, theoretical propositions must be empirically verifiable. Researchers using numerous statistical procedures examining various sample periods should be able to identify at least some consistent patterns. This is not the case with the wealth effect. Regardless if examining a simple scatter diagram or something far more sophisticated, the wealth effect is weak and inconsistent. The powerful wealth coefficients imbedded in the FRB/US model have not been supported by independent research. To quote Chris Low, Chief Economist of FTN (FTN Financial, Economic Weekly, March 21, 2014), “There may not be a wealth effect at all. If there is a wealth effect, it is very difficult to pin down ...” Since the FOMC began quantitative easing in 2009, its balance sheet has increased more than $3 trillion. This increase may have boosted wealth, but the U.S. economy received no meaningful benefit. Furthermore, the FOMC has no idea what the ultimate outcome of such an increase will be or what a return to a ‘normal’ balance sheet might entail. Given all of this, we do not see any evidence for economic growth as robust at the FOMC predicts.
Without a wealth effect, the stock market is not the “key player” in the economy, and no “virtuous circle” runs through the stock market. We reiterate our view that nominal GDP will rise just 3% this year, down from 3.4% in 2013. M2 growth in the latest twelve months was 5.8%, but velocity should decline by at least 3% and limit nominal GDP to 3% or less.


 

The Flatter Yield Curve: An Opportunity for Treasury Bond Investors

 

The Fed has indicated that the federal funds rate could begin to rise in the next couple of years, and the Treasury market has moderately anticipated this event. Similar to the 2004-2005 federal funds rate cycle, long before the federal funds rate increased short Treasury rates began their ascent (Chart 4). Interestingly, once the federal funds rate did begin to rise in 2004, long Treasury rates fell over the next two years. From May of 2004 until Feb. 2006 the federal funds rate increased by 350 basis point (bps) and the five-year note increased by 80 bps, yet the 30-year bond fell by 84 bps as inflation expectations fell. If the Fed follows through with its forecast and short rates rise, the dampening effect on inflation expectations should again cause long rates to fall. On the other hand, should economic activity continue to moderate then the downward pressure on inflation will continue. The prospect for lower Treasury yields appears favorable.

Van R. Hoisington
Lacy H. Hunt, Ph.D.



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