May 23, 2005
Whoops
In a comment on the Benjamin Franklin piece I posted last week, Al Rosen pointed out that I had given the Great Depression credit for making Mussolini Prime minister of Italy in 1922!
Rather than resorting to explanations involving worm holes and singularities reversing the direction of the arrow of time, I will reveal the truth. My fingers went faster than my brain.
Al's truth is much more interesting than my fiction. In Italy, the collapse of the economy after World War I left 2 million unemployed and 50% inflation between 1918 and 1920. This led to food riots in 1920, the occupation of the factories by 500,000 workers in September 1920, and the March on Rome by fascist squadristi in October 1922, making 39 year old (former Socialist) newspaper editor, Benito Mussolini Italy's youngest Prime Minister.
JR
Posted by John Rutledge at 11:33 AM
10 Year Budget Deficit Projections are Nonsense
Thought you would like to see this chart prepared by the Congressional Budget Office. It shows the accuracy of their previous budget deficit projections in the form of a confidence interval around the forecast. Note that they only show the confidence interval up to four years out.
In the document, they show that the confidence interval increases by about one percent of GDP ($120 billion) each time they add another year to their forecast horizon. In year 4, the confidence interval is about 5% of GDP ($600B) for that year's projection alone. The detail shows that errors are also autocorrelated, a fancy term that means that initial errors tend to build up and get worse over time. Not good news for cumulative forecasts--exactly the ones CBO has to make for their Congressional masters to use on C-SPAN.
I have taken their numbers and estimated the error band around the 10 year projection. According to the CBO, the cumulative budget deficit over the next ten years is going to be about $2 trillion, plus or minus $13 trillion!
I'm not whining about the CBO; they certainly do the job better than I could. My point is that cumulative budget projection is a bad number. We should not use then to decide anything.
JR
Posted by John Rutledge at 11:14 AM
May 22, 2005
Kudlow & Company Appearance Tomorrow (Monday May 23)
FYI, I will be on CNBC's Kudlow & Company tomorrow, May 22, between 5:00PM and 5:30PM EST doing a segment about the investment markets. I hope to be able to talk about the forces driving small company growth--the reason I own a big position in small cap stocks today.
Will also be a guest host on CNBC Squawk Box on Wednesday, June 8. More on that later.
JR
Posted by John Rutledge at 11:20 PM
May 10, 2005
Hedge Fund Collapse Rumors
Stocks are being kicked around today by rumors of a possible hedge fund collapse. Given what I have seen lately in credit management, I don't think it is out of the question.
But to repeat what I wrote last week, the more you worry this will happen, the more you should buy small cap stocks when prices retreat.
There is nothing like a good financial panic event for unclenching the buttocks of the Federal Reserve.
JR
Posted by John Rutledge at 1:01 PM
May 8, 2005
Benjamin Franklin
I mentioned a Benjamin Franklin quote a few days ago in a story discussing the damage that has been done in history by ordinarily decent people who have become frightened by a chaotic event which has penetrated the patina of our illusion of order.
They that give up essential liberty to obtain a little temporary safety deserve neither liberty nor security. Benjamin FranklinFranklin's experience in both the American and French revolutions gave him a full palette of atrocities as examples of frightened man's inhumanity to man.
These events always appear to be non sequiturs when observed from the comfort of our living rooms. The Turk threatening Venice in Othello; Plague in Spain and war with the Moors led Isabella to expel the Jews from Spain in 1492; Plague in Italy burned Savonorolla in Florence; in Italy, 2 million unemployed and 50% inflation led to food riots in 1920, the occupation of the factories by 500,000 workers in September 1920, and the March on Rome by fascist squadristi in October 1922, made 39 year old (former Socialist) newspaper editor, Benito Mussolini Italy's youngest Prime Minister; the Great Depression triggered the election of Hitler and the Holocaust that followed. But they are not random acts; they are the inhumane acts of frightened people. Unfortunately, people will do almost anything to restore our imaginary sense of order.
History also provides examples of leaders great enough to stand up against reactionary pressures to restore both order and humanity. Thomas Jefferson, for example, acted the moment he bacame President to rescind the Alien and Sedition Acts, which had been passed by a fearful Congress and signed by John Adams in 1798.
There is an opportunity today to provide the same leadership Thomas Jefferson showed 200 years ago. But it will require courage to stand up to the mob, tell them it's time to calm down, that we're OK now, that it's time to go back to work. And it will require selfless dedication to forego the popularity and easy political gains to be had by fannibng the flames of people's fears. We badly need that leadership today.
The American public was so frightened by the attacks on 2001 that we stand up and cheer whenever a political leader promises the return of our sense of security. This has fostered reactionary policies we have not seen since the days of Joe McCarthy. End-runs around due process and right to trial (Guantanamo), end runs around restrictions on search and seizure in the Patriot Act, the bloated Homeland Security and TSA programs, restrictions on visas of all kinds, the financial terrorism of Sarbanes-Oxley, and the rampages of Elliott Spitzer are the practical manifestations of our fears.
We have allowed our fears to compromise our lives and our principles in ways Benjamin Franklin would have found dangerous and destructive of ourselves. Fear is by far more destructive than terrorists. Our sense of security lives in our minds, not in our airports. That is where it will ultimately be restored. It couldn't be soon enough.
JR
Posted by John Rutledge at 3:12 PM | Comments (1)
May 6, 2005
GM/Ford Downgrade, Fed, Rates
A very astute journalist from a European paper emailed me this morning asking if my piece last night on the GM/Ford downgrade being good for the markets meant that we could have a pause in interest rate increases and asked me to elaborate. The following is a brief version of my reply, FYI:
Yes, that is exactly what I mean. Also, the Fed will react to any upward pressure on interest rates by adding reserves when necessary. Together with today's huge 274K job number and large upward revisions for both February and March imply the economy, and the stock market, will do better this year that economists expect.The reason is that both bank and non-bank lenders (hedge funds and mutual funds) have been aggressively lending to private business borrowers since the mortgage refinancing boom ended last June. Hedge funds and mutual funds are buying the loans in order to offer more yield to yield-starved investors who often mistake them as safe money-market funds.
These business borrowers had been systematically starved of credit for 4 years--loans declined from $1.1 trillion in December, 2000 to $870 billion last May. In the past 12 months they are up more than $70B. This turnaround is fueling the expansion of small companies.
When economists look at the economy, they tend to focus too much on large public companies, because the data is available and their stories are so visible. But small private companies make up more than 50% of GDP and three quarters of jobs in the US.
We should not measure monetary policy by looking at the Fed funds rate alone. Credit availability to small companies is much more important. And by that yardstick, monetary policy is extraordinarily loose today. That implies more growth, more jobs, and better profit growth (especially among small cap companies) that Wall Street expects. And a much better stock market.
I am long small-cap stocks today.
JR
Posted by John Rutledge at 12:35 PM | Comments (1)
Mike Norman Show, BizRadio. Book to Read
I had a very enjoyable interview on Mike Norman's show on BizRadio this morning. Very solid thinker. During the show, Mike suggested that his listeners take a look at the How We Think section of our Rutledge Capital website, where I describe the thermodynamic foundations of our economics and the Weather Map format of our investing approach.
Then Mike mentioned that he is a physics geek, just like I am, and I suggested a book to read that will change your brain. The title is The End of Certainty. It is written by Ilya Prigogine. I wrote the following paragraph about the book in the JR's Bookshelf section of our site. It had a major impact on my thinking.
The End of Certainty by Isabelle Stengers, Ilya Prigogine This book was an eye-opener for me. Ilya Prigogine won a Nobel Prize in Chemistry for establishing the equivalence between the physics of far-from-equilibrium systems and irreversible thermodynamic processes, and for showing that distance from equilibrium is an essential parameter of nature. His work provided the foundation upon which chaos theory, complexity, complex adaptive systems, and self-organizing systems were built. This book will help you see the importance of looking at the world as non-equilibrium events, and understand why life is only possible in a non-equilibrium universe.
JR
Posted by John Rutledge at 11:10 AM | Comments (4)
May 5, 2005
GM/Ford Downgrade
The stock market got it wrong today. The stock market fell sharply when S&P announced their downgrade of GM and Ford bonds to junk status. Should have gone the other way. I have been through enough of these crises to know that any event of this size which threatens to impair liquidity will make the Fed significantly more accomodative. (Bank Herstatt or LTCM) A benign Fed and the huge profit growth being posted for Q1 are very positive for the stock market.
JR
Posted by John Rutledge at 9:54 PM
May 3, 2005
The Fed is Still Fueling Growth
The Fed is Still Fueling Growth
The Fed raised the Fed funds rate target 1/4% today to 3%; that's 8 increases in a row since last June.
While everyone picks through the press release to try to divine what they really meant, let's not forget one thing. Monetary policy is not the Fed funds rate, it is the availability of credit. And monetary policy is still aggressively expansionary today.
There are two U.S. economies, not one. The economy we read about made up of big public companies like GE, AIG, GM, and Microsoft. And the one we don't read about made up of small private companies with names we don't recognize. It is the one we don't read about that matters. It comprises more than half of GDP and 3/4 of jobs.
Monetary policy impacts the 2 economies in different ways. It hits the PUBLIC economy by changing short-term interest rates, just like the textbooks, and by moving mortgage rates, which are priced against T-bills in the capital markets. Big companies don't borrow money from banks. They get their money in the capital markets which are usually more or less open for business. For them it is the price that matters.
But monetary policy impacts the PRIVATE economy differently. Small companies can't tap stock and bond markets; they get their money from banks and modern-day loan sharks. And banks are not always open for business. Monetary policy impacts the PRIVATE economy by causing temporary blackouts in lending, like the one we had from November, 2000 until May, 2004. Or by creating a gusher of bank lending, like we have today.
Make no mistake about it, bank and non-bank lenders today are cramming loans to business borrowers, then selling them to hedge funds and mutual funds, who in turn sell them to yield-starved savers and investors who can't live on 1% money market yields.
As long as that remains true, monetary policy will be expansive, regardless of the Fed funds rate. That expansion is leading to very strong profits for business, and for strong growth among small companies. this is good for the economy, for jobs, for profits, and for stock prices.
JR
Posted by John Rutledge at 4:01 PM | Comments (1)
May 1, 2005
Investor Beware: Bank-Loan Funds are not Money Market Funds
Investor Beware: Bank-Loan Funds are not Money Market Funds
The WSJ referred to bank loan funds as a safe haven that investors are buying to protect themselves from rising rates. Bad idea.
Yield-starved investors have stuffed about $4 billion this year into bank-loan mutual funds, also called senior-loan funds or loan-participation funds, in which funds buy short-term loans that banks and other lenders make to companies. That's a nearly 10-fold increase from a year ago.
Many investors are even using bank-loan funds, which distribute payments monthly and are currently yielding as much as 7%, as a stand-in for sedate money-market accounts...The risk with bank-loan funds: They are generally noninvestment-grade debt, meaning they have ratings of double-B or lower on the Standard & Poor's credit-rating scale. That is in the junk-bond neighborhood. While not terribly troubling in an improving economy, low-rated debt is more likely to default in a weak economy.
Based on recent conversations with friends of mine--the guys who are actually making these loans--there is less diligence being applied to leverage lending today that during the last drunken brawl we had in the late 1990s, and certainly less than is applied when issuing a junk bond. I see serious default risk down the road.
Moral of the story: If you have money that you want to keep as cash, rather than invest for long'term income and gains, keep it in a money market fund--a real one--collect the 2-3%, and relax. Funds that pay you 5, 6, or 7% are paying you for the risk you will lose some or all of your money.
JR
Posted by John Rutledge at 5:18 PM
Babelonian Broadband
Babelonian Broadband
There is so much mis-information and propoganda flying around about the Middle East that I thought you might like to read something that is actually sound. Bernard Lewis is the smartest man I know on Middle East history. I got to know Bernard when we were both sitting in a meeting organized by the White House 2 years ago, briefing the young team on their way to Iraq. He has travelled the Gulf region since the mid-1930's. Bernard is not a Bushie. He is not an anti-Bushie. He just thinks.
As a first-read, I suggest Bernard Lewis's beautiful book "From Babel to Dragoman" (2004), a collection of short pieces written over six decades. While reading it today I could not help thinking of a G.B. Shaw line, "he writes so well he makes me want to put my quill back in my goose."
(Note: Unless explicitly stated you can assume that everything that I write has been stolen from somebody. And my citations, although rare, are frequently to the wrong person. When interrogated I intend to take the Alzheimer's defense, incognito, ergo sum. Yes, that was stolen too.)
You will learn a lot about the legacy of learning we inherited from the Arabs and Persians. The early Persians, for example, invented the stirrup (the one on the horse, not the one in the doctor's office), which both revolutionized warfare and allowed them to develop the first postal system, complete with couriers and relay stations, just like our pony express. The Greeks later referred to the Persian postman's horse as a paraveredo, which later became the German word Pferd. This created the world's first high-speed communications network, the broadband of its day. (Note: The Chinese created a similar system in the 14th century AD, including a set of paved roadways that enabled them to send information from the capital to the south in only 5 days. This was the firt G2 broadband.)
JR
Posted by John Rutledge at 4:28 PM
Stock Market Up 1651% Since 1980, More Than Half Dividends.
Stock Market Up 1651% Since 1980, More Than Half Dividends.
We spend so much time whining about what the market did yesterday that I thought it would be helpful to remind you about the longer-term numbers.
During the nearly 25 years (97 quarters) between January, 1980 and March this year, the S&P 500 index delivered a total return of 1651% (12.5% annually) to investors who re-invested dividends. Of that, just under half (46.6%) was in the form of capital gains; 53.4% was in re-invested dividends.
The S&P 500 Index (SPX) was 135.8 on 12/31/80, when Larry Kudlow, Jerry St. Dennis, and I were scrambling to put together President Reagan's economic plan. It hit a low of 109.6 in June, 1982, when Dr. Doom and Mr. Gloom were whining about the twin deficits. It is 1158.5 today.
Many investors today bought their first stock in 1999 when you couldn't lose money buying tech stocks. They are sitting in cash today earning 2% per year. (3% if you are willing to lock your money up for 6 months in CDs or T-bills).
Stocks are up 26.3% just in the past 2 years since the dividend tax cut. I remember doing a press conference with John Snow in March, 2003 when the S&P was 7500, saying the dividend tax cut would boost values by 10-20% and change corporate payout policies. Since then the market has added $3 trillion in value.
There is no better place for long-term investors than the stock market. That is as true today as it was in 1980.
JR
Posted by John Rutledge at 3:05 PM
Q1 Earnings Up 18.7%, 2.5x January Estimates!
Q1 Earnings Up 18.7%, 2.5x January Estimates!
As of today, 382 out of the 500 companies in the S%P 500 index have reported their Q1 earnings. Weighted by market cap, the average company reported earnings 18.7% higher than in the in the same quarter last year. (Share-weighted, +17.4%, Non-weighted, +20.7%)
These are blowout numbers, folks, up 2.5x the 7.6% expected for the quarter by analysts in January. Two-thirds of the companies (255/382 so far) beat estimates. Of course, we can thank Mr. Sarbanes and Mr. Oxley for that--in a world where optimistic CEOs, CFOs, and analysts get to go to jail and be a bad man's girl friend, estimates have become rather subdued.
Here is how the share-weighted numbers break out by sector:
-18.9% Consumer Discretionary
+ 6.4% Consumer Staples
+42.0% Energy
+18.6% Financials
+11.8% Health Care
+25.1% Industrials
+18.4% Information Technology
+66.0% Materials
+ 5.4% Telecom
+ 7.3% Utilities
+17.4% Total for S&P 500
In some cases the big increases represent higher energy and commodity prices and, as such, are somewhat dependent on continued growth in China and India. But revenues were up more than 9% overall. And behind all the sectors you can find the driving force of rising productivity. The catch: continued productivity gains depend on huge impending investments in high-speed communications networks, yet Telecom sector earnings (+5.4%) are not growing fast enough to attract the capital to fund them. Mergers in the sector will help. Congress's intent to reform telecom law this year is badly needed.
With all this good news you'd think analysts would b e excited about Q2. Not so. Business Week reports current Q2 earnings estimates of just +7.2%. I think the number will be +12-15%. Look for more good surprises.
JR
Posted by John Rutledge at 2:11 PM
Homeland (In)Security
Homeland (In)Security.
It is very important for people to know this. A Washington Post article today, U.S. Sees Drop in Terrorist Threats, cites evidence that terrorist threats have fallen by 25-50% to their lowest level since Sept. 11, 2001.
What's the reason for the improved numbers? In part, improvements at the intelligence agencies which makes it more difficult and expensive to do bad things than it was before.
As you know, I have been urging Americans to unclench their buttocks and get back to business. Wars against 'isms' are a load of crap, designed to pander to people's fears, usually for political purposes. I have travelled enough (15M miles at last count) to know the world is, and always has been, a risky place. We are all going to die one day anyway, so kick butt, take names, and don't waste a single day while you are here.
I'm not saying we should be dumb. We should keep an eye out for anyone trying to hurt anybody. But man-on-man homeland security, where we divide up the country in pairs and watch each other, has been tried before, without success, in the Soviet Union. Rather than hire more shoe-sniffers at the airports we should give them shovels and have TSA'ers help dig the trenches to lay fiber-optics to every school in America. The key to our future safety is educating our children so we can retain our lead in technology and grow.
Benjamin Franklin, not known as a wussie-boy in his time, had it right when he wrote: "Those that would trade liberty for a little temporary security are not worthy of either."Let's get some attitude again. And let's quit whining and get back to work.
JR
Posted by John Rutledge at 1:27 PM
Japanese GDP Data Miscalculated Since 1989
You just can't make this stuff up. The Japanese government admitted today that they have miscalculated every piece of Japanese GDP data for the past 16 years. Whoopsie! It shouldn't be a problem though, as I'm sure the Japanese government will reimburse investors for any losses they suffered during this period as the Nikkei average fell from 42,000 to 11,000 today.
GDP data miscalculated since 1989
Japan's gross domestic product data have been miscalculated since 1989 due to an error in a computing program regrading imported products, according to the Cabinet Office.
The corrections of the GDP data, which are large enough to change the first digit after the decimal point, appear only for the nominal GDP growth rate for 1997, the office said.
But the mistake would affect a wide range of economic data such as consumption expenditures and savings ratios for households. The office revised upward the 1997 nominal GDP growth rate from the initially announced 2.1 percent to 2.2 percent.
The office said the mistake was caused by flaws in the program regarding the consumption tax, which was raised from 3 percent to 5 percent in April 1997, among other things. Data correction work is expected to continue until late this year, it said.
The Japan Times: May 1, 2005
Must be a coincidence they announced the error over the weekend before Golden Week when Japan is shut down.
Who are we to talk? The U.S. GDP number for the 4th quarter was off by about a half a percent when first released because we forgot Canada. It was also distorted by the fact that Microsoft paid a special dividend in December of $32 billion, roughly 4x the market cap of GM. I could understand if we forgot Liechtenstein or Monaco, but Canada is real big and it's right there above the the US. Hope we remembered all the countries this quarter.
There is a moral to this story. First, investors should base broad strategies on ideas, not data points. Second, if you are going to use data to make decisions, use asset price data, not GDP national income accounts; they are more accurate, they are easier to understand, and the asset markets are more than 10x the size of the GDP accounts.
All you needed to know about Japan since 1989 was that land prices fell every year. The spread between Japanese borrowing rates and the annual rate of change of prices for land and other real assets--the right way to measure real interest rates--averaged almost 1000 basis points. You can't run a business and survive with that level of balance sheet drag. They are not falling anymore.
JR
Posted by John Rutledge at 12:15 AM