WORLD MARKETS CONTINUE TO RALLY!
This was a good week for the stock markets throughout the world. The Dow and NASDAQ and S&P index are all close or above new all-time highs. The DAX index is about 12,000 and the Nikkei is close to breaking into new high ground. The Federal Reserve is clearly on board on its policy to diminish the fears of deflation. Its recent comment to eliminate “patients” from its policy is not clear or transparent. Sure, we’re all patient, like mental patients. Wall Street seems to like the ambiguity and it appears that interest rates may not start up in June as earlier expected. It has been seven years since the Fed raised rates and they seem in no hurry now. There is an old saying on Wall Street “Don’t fight the tape.” So, for the time being, enjoy the rally.
How can I still be bearish? Well, there is a long list. I still feel that deflation and not inflation is the problem. This can be seen in recent reports that have been issued lately that Wall Street seems to be ignoring. Retail sales for instance fell by 0.6% in February. That’s a drop for three months in a row. Housing starts for February were 897,000 on an annualized basis to levels not seen this low since September 2013. Industrial production edged up a negligible 0.1% in February carried almost entirely by gains in utilities because of colder weather. The producer price index, for final demand, in February fell 0.5% , after plummeting 0.8% in January. The bulk of those declines “70%” occurred in the service industry as opposed to goods, which had been weighed down by falling oil prices in recent months.
DEFLATION OR INFLATION DANGEROUS FOR THE BOND MARKET I continue to worry about the bond market. Both deflation, which is what I suspect will happen or inflation, which is what the Fed is trying to accomplish, could be very dangerous for bondholders. Dollar borrowing has grown everywhere, but the biggest growth has been in emerging markets. Between 2009 and $2004 denominated debts of developing countries (in the form of both the bank loans and bonds) more than doubled from around $2 trillion to some $4.5 trillion according to the Bank of the International Settlements. Countries like Brazil, South Africa and Turkey, whose exports fall far short of imports, finance their current account gap’s by building up debts to foreigners. State own energy giants like Russia’s Gazprom from Brazil’s Petrobras, and been issuing dollar bonds via subsidiaries based in Luxembourg and the Cayman Islands. Taking on debt just before a shift in exchange rates, as has now happened with the US dollar rising, can be very painful. For instance in 2010 a Turkish firm borrowed $10 million via a 10 year bond with a 5% coupon. Because of the rise of the dollar, the payments over the 10 year period can now amount to some $25 million. Asian firms foreign-currency debt tripled from $700,000,000 to $2.1 trillion between 2008 and 2014. That’s going from 7.9% of regional GDP to 12.3% according to Morgan Stanley Bank. China holds $1.2 trillion in US treasury bills, most of which are sitting in its sovereign wealth fund. When the dollar rises, the fund gets richer, but even in a dollar rich country there can be pockets of pain. Almost 25% of corporate debt is dollar denominated, but only 8.5% of corporate earnings are. Worse, according to Morgan Stanley is that debt is concentrated with 5% of the firms holding 50% of it. As mentioned market letter number 624, Chinese property developers are vulnerable.
NEGATIVE BOND YIELDS Negative bond yields are very modern phenomena. Strategies that are used to protect one’s investment with negative interest rates have been described as “picking up nickels in front of a steamroller”. Whereas, investors may make a series of small gains, they can be wiped out by a sudden large loss. Most of the time the market will not fall and the seller of put options pockets the premium. However, in times like October 1987 the full bill will come due. Government bonds have typically been used as “shock absorbers” with portfolios when activities of commodities are plummeting, government bonds tend to do very well. Even when bonds do badly, the pain is not that great. Since 1925 the biggest annual loss in real terms was 15.5% in 2009. In contrast, the biggest real loss in equities was 38.9% in 1930. When yields are zero or negative, government bonds clearly do not give investors income. The problem is they may also not function as shock absorbers. Since prices move in opposite direction of yields, it is thus difficult to imagine investors buying bonds at current yields, making much of a capital gain. It is easy however, to imagine them making a big loss. If inflation returns nominal yields would rise sharply and prices could plummet. If government bonds in the rest of the developing world start to behave like Japanese bonds with a negative skew, some investors may doubt whether they are worth holding at all. Many investors, pension funds, insurance companies are forced to hold government bonds for accounting or regulatory reasons. Such requirements are all very well, but in a declining bond market, could have severe negative implications.
SO FAR SO GOOD A deflationary scenario could lead to bond defaults, whereas, an inflationary scenario could lead to gigantic losses in bond portfolios. Wall Street is obviously hoping for a ‘Goldilocks Scenario’ of, not too hot and not to cold. So far, so good. However, like the man who jumped out of 100 story building said at the 50th floor “so far so good”, his long-term outlook appears to be in doubt.
INCOME INEQUALITY. COMMENTS: on The New Yorker Magazine March 16, 2015 entitled RICHER AND POORER
Economic inequality has been measured on a scale, from 0 to 1 with an index known as the Gini index. If all the income in the world are earned by one person and everyone else earn nothing, the world will have a Gini index of one. If everyone in the world earned exactly the same income, the world would have a Gini index of zero. In 1928 the Gini index was at a high of .476, just before the stock market collapsed, with the top 1% earning 24% of all income. In 1944 the top 1% earned 11% and now in 2013, the top 1% once again earned 24% of all income and the Gini index is back to .476. Is there a correlation between the Gini index in 1928 before the stock market collapsed and the current situation? Income inequality in the United States is greater than any other democracy in the developed world.
Last year Thomas Pickety’s book, Capital In the 21st Century, became a bestseller. Basically the book explained that income inequality and economic growth could not go hand in hand after reaching a critical point. This book was followed by a book entitled The Unstable American State and a world version of this argument, entitled Inequality Matters in a report by the United Nations and a book by economists Joseph Stiglitz called The Price of Inequality, all of which indicated that income inequality is not good for economic growth on a worldwide basis. Last year, Pew research Center conducted a survey about which of the five dangers people in 45 countries considered to be the greatest threat in the world. Most countries polled had religious extremism and ethnic hatred at the top of their list. But most Americans and Europeans chose inequality as the number one problem. Capitalism may be the best system in the world, but it creates winners and losers by its very nature. And capitalism as Karl Marx pointed out; can choke on its own success, as capital dominates the workers, causing wages to shrink beyond the ability to keep all boats afloat.
As stated in the Lone Bear Letter: In the US all income growth in the last 15 years has gone to the top 1% of the economic ladder, whereas wages, adjusted for inflation, are down 4.3%. It is estimated by Oxfam America that the top 1% in the world own 99% of total world wealth and most of that belongs to the 0.01%, as worldwide only 80 billionaires control 50% of the global wealth (they own more than 3.5 billion people in the bottom half). There is nothing wrong with accumulating wealth; however, the excessiveness of wealth accumulation could have a stifling effect on the US and world consumer based economies and could make future economic growth unsustainable. The cause of this great wage slowdown and shifting of assets to the very rich has several main causes: 1) Globalization has forced many American and Developed Country’s workers to compete with worldwide poorer workers, who are willing to accept lower wages. 2) Computers and modern machines are replacing human labor in numerous ways. 3) The rest of the world has become more educated and more highly skilled than the US, which ranks 39th in basic education, according to the latest Social Progress Index. 4) Economic and political power (through political contributions) has been switched away from workers and toward billionaire entrepreneurs, corporations and high paid executives. 5) The very nature of the Internet makes pricing extremely competitive and thereby squeezes profit margins, causing companies to trim work force expenses in order to maintain competiveness. The proposals that the President made at his State of the Union Address on 1/20/15, for ‘Middle Class Economics’ have in my opinion, no chance of passage in the Republican Congress. Because of these factors, instead of all boats rising, this scenario isn’t good for anybody and it is possible that as in the 1930s depression, all boats will sink. After all, how many bars of soap and how many cars can each of the wealthy people buy? These excessive conditions, in my opinion, are taking the breath out of the economy, are shaking its base and have yet to be seen in the metrics.
In another book written by Robert Putnam entitled Our Kids The American Dream in Crisis an attempt to set statistics aside and instead tell a story. Our Kids, is a heartfelt portrait of four generations of Putnam’s fellow 1959 graduates and their children in the town of Port Clinton on Lake Erie. The world obviously changed and Port Clinton changed with it. Putnam states that most of the downtown shops of his youth now stand empty and derelict. In the 1970s the town’s manufacturing base collapsed. Between 1999 and 2013 the percentage of children in Port Clinton living in poverty rose from 10% to 40%. Wealthy newcomers began arriving in Port Clinton in the 1990s and built their mansions and golf courses and gated communities next to the trailer parks. A comment of one of the higher income residents to Putnam was, “If my kids are going to be successful, I don’t think they should have to pay other people who are sitting around and doing nothing for their success.” As income inequality expands, kids from the more privileged backgrounds start and probably finish further and further ahead of their less privileged peers. Putnam sees the American dream in crisis. He states, “Americans used to care about other people’s kids and now they only care about their own kids.” The situation is even getting worse. In states where Republican governors have cut taxes, they find they also have to cut educational expenditures.
The latest Social Progress Index has just been announced. The US ranks 16th overall, ranks 70th in health, 69th and in echo systems sustainability, 39th in basic education, 34th in access to water and sanitation and 31st and personal safety. Even access to cell phones and the Internet ranks us at a disappointing 23rd, partially because one of Americans in five lacks Internet access. The winners are New Zealand number one, followed by Switzerland, Iceland, the Netherlands and Canada. All are somewhat poorer than America per capita, yet they appear to do a better job of meeting the needs of their people, including free healthcare and reasonably priced colleges. Some politicians who propose cuts in Medicare and ending Obama Care and reducing food stamps and public services believe that such trends could boost America’s competitiveness. However, looking at this report, it seems that the opposite is true. In America, capitalism spiritual home, a survey conducted in 2013 found that just 54% had a positive view of the term. This seems to be the case because the benefits of capitalism have recently only gone to the top 1%. There seems to be a crisis in confidence as the Supreme Court has a ranking of only 30% public schools 26%, the criminal justice system 23% and Congress 7%. The recent election showed just how unsatisfied people are. They voted for change, but change is unlikely to come. Since Citizens United, that declared corporations are people, most changes in government is dictated by donors and election contributions. A recent Princeton study has shown that public opinion has no effect on the outcome of an issue in Congress, whether there is 0% approval or 100% approval, the line of accomplishment is flatlined. Donor power has taken over the rights of ‘we the people’. The current illusion that voters are being heard and are connected will soon diminish in my opinion. The risk now is that voters of both parties may pursue policies which damage the common good.
What’s new about the chasm between the rich and the poor in the United States is that American politicians are now all climbing on the bandwagon and talking about it. In a recent January forum sponsored by Freedom Partners (the Koch brothers), GOP presidential candidates Ted Cruz, RAM Paul, and Mark Rubio battled over which one of them disliked inequality more. At the end of Pres. Obama’s State of the Union address he said “let’s close the loopholes that lead to inequality by allowing the top 1% to avoid paying taxes on their accumulated wealth.” Speaker of the House John Bayner countered that with “the president’s policies have made income inequality worse.” The causes of income equality are much disputed. What is no longer in disputed, is that income inequality is bad for the economy and could eventually lead to its stagnation and the sinking of all boats.