Which Gate is This?

Will Plame-gate turn out to be a garden-variety Clintonesque-style violation, or something far more serious along the lines of Watergate? That is one of the many questions weighing on the minds of traders this week, along with the selection of Dr. Bernanke for the top banking post, interest rates and quarterly earnings.

I see three possible scenarios:

1. Rove and Libby are indicted for any combination (or all) of the following: perjury, making false statements to investigators, conspiracy and obstruction of justice.

2. An extension is taken (Special Prosecutor Fitzgerald has until Friday) to continue to investigate this matter up the chain of command. Most likely this would happen in regards to the involvement Vice President.

3. Rove and Libby are indicted for intentionally disclosing the name of an undercover agent (in violation of the 1982 Statute).

The first is clearly the most plausible, based on the posturing of Washington and the talking points making the media rounds. The second and third would obviously be far more serious and for the most part are not very likely.

What is important from an economic and market standpoint is a quick resolution. The longer this drags on, the more it hangs over the consumer’s head and national morale. Consequently, I firmly believe if the first scenario plays out, we will be out of the woods, as this is already discounted in equity prices.

As far as earnings go, most have been tracking in-line with analyst’s expectations. Guidance has also been within historical means, as the effects of oil, higher rates and supply disruptions (from Hurricanes) have begun to show up in bottom lines.

Rates are another matter. The fact that the media seems to be portraying Bernanke as “helicopter-money-man” may force him to go above and beyond to disavow the public of such notions.

Lastly, it just came across my desk that NBC is reporting that Mier’s nomination has been withdrawn.

Monetary Mechanics 101

The Fed Chair-in-waiting once likened monetary policy to working on a car while the engine is running. Very true. The Federal Reserve does not have the luxury of viewing data in a vacuum and every decision they make may carry the unfortunate repercussion of crashing the engine of the global economy.

Fortunately for us, Dr. Bernanke possesses the academic background and has real world experience—a rarity among economists.

First off, a splendid selection by the President. Many on Wall Street (including myself) began to experience serious doubts after the dubious pick in Ms. Miers to be Associate Justice of SCOTUS. Since the relentless gleaning of anything she put her John Hancock on in public life by the media (and other interested parties) it had become apparent that the President had made a choice based more on personal preference and loyalty, as opposed to merit and scholarship.

Every Fed Chair has faced his own challenge. For Paul Volcker it was inflation. For Alan Greenspan it has been economic output and market stability (Greenspan had the luxury of overseeing two massive market crashes in 1987 and 2000). Both succeeded admirably.

Volcker’s rate campaign broke the back of inflation. He reigned in the CPI from an astounding double digit level when he took office, handing over a mere 4% to his successor. Greenspan was faced with Black Monday in his “honeymoon” as the newly appointed head in October 1987. Back then the Dow stood at about 2000. 18 years later it is up roughly five fold despite a formidable series of interruptions over his tenure.

At this point it is not entirely clear what lies ahead for Bernanke. While the news headlines sew the seeds of doom and gloom—we are in a fairly buoyant economy with inflation still in check. Of course at any time the risks could shift overwhelmingly to one side, for the most part that seems unlikely.

Under Greenspan, our economy has become as resilient as one could imagine. We have absorbed international monetary crises (Asia, Russia, Japan), terror attacks, stock market bubbles, large bankruptcies/defaults (Worldcom, Enron, Long Term Capital) and war. While at times these events have generated temporary weakness—the damage was seldom structural and never led to the chain of events doomsayers predicted would unfold.

Many insiders and former colleagues of Dr. Bernanke have been suggesting he will push for a policy stance on the part of the central bank—“inflation targeting” if you will.

I sincerely doubt that. Part of the reason the economy was able to absorb such shocks was the dynamism which it was handled by Greenspan. A neutral stance in 1995 was completely different from a neutral stance today. The threat of inflation from a tight labor pool in 2000 is clearly dissimilar to the commodities related threat today. In essence, Greenspan changed with the times and it would be very difficult for Bernanke to break precedent set by the banker whom presided over the largest economic expansion in global history.

A Room sans Elephant

The old adage about the elephant in the room, once largely regarded as a truism (in matters political and economic) seems to be inapplicable in today’s day and age. For those of you unfamiliar, the elephant in the room is the big unavoidable topic that is extremely obvious, but everyone is being careful not to discuss.

If anyone caught the text of Al Gore’s speech from the Clinton Global Initiative last month, it would be blatantly obvious that the former VP is not only out of touch—he is out of his mind. Alleging that there is some sort of shortage or barrier in the marketplace of ideas, Mr. Gore apparently has not visited his own “creation” (read internet) in the past few years.

Witness the explosion of internet news and weblogs (or “blogs” as they are called). The marketplace of ideas is richer than ever. Weblogs have served as a check on the mainstream media, government and any entity or enterprise in the public realm. They make for rapid dissemination of news, debate, capital and other important resources. Internet news mogul Matt Drudge can count reporters from all the major news organizations among his site’s 3,538,024,605 visitors in the past year.

Washington and Wall Street used to be worlds of backrooms, handshakes, winking and coded speech. Who you know, not what you know. No longer. The individual receives the same information as the institution, more importantly (as a result of Reg FD), at the same time.

Prior to the mid 1990’s the Federal Reserve was an organization shrouded in secrecy. At present, the fed releases the minutes from its FOMC meetings, releases its “beige book” report (which gives everyone access to the same data the Fed uses to formulate its policy decisions) and gives the press access to nearly all of its governor’s speeches. This is a far cry from the Fed tenures of Paul Volcker and his predecessors. What a difference a decade makes.

Prior to the Bush administration’s attempt to modernize and stabilize Social Security, that was the biggest elephant in Washington. Nobody would come near it with a ten foot pole. While clearly the President did not make the headway (or desired changes) to the program, finally a spirited debate ensued. Sure there was scaremongering, but the second a newscaster let a hint of inobjectivity into his coverage the bloggers from the other side emerged in full force. Social Security is still the third-rail of U.S. politics—no question—but it no longer is an eight ton tusk-baring mammal.

The fictitious (amalgamation of a) character Gordon Gekko had one thing right: information is the most important commodity of all. In other words, it is the Vermeer of the High Baroque and the Matt Drudge of breaking news.

No Shortage Here

The one thing we have in abundance at present is negativity. Consumer confidence is distraught at best. Fuel prices are high. The White House is marred in scandal. Inflation is supposedly running rampant. Category 5 hurricanes are as ubiquitous as the common cold. Iraq. Avian Flu. Bankruptcy. Earnings. Valuations. Interest rates. The list goes on and on…

Sounds pretty bad, doesn’t it?

I hate to speak in bromides and platitudes but there is no other alternative here: it is always darkest before the dawn.

Why?

Mostly because it is true. There is little room for things to get worse from a confidence perspective. By the time you have become truly scared the night will never end it is daybreak.

This market exercise underway is 99% psychology and 1% reality in my opinion. The action is remarkably similar to the bottoms we have had since the bear died and those prior to 2000 (think Asian/Russian crises, Long Term Capital, etc.). High in fear, low in expectations. Basically, people thought the end of the financial world was nigh.


That alone is only half of the picture, as technical indicators need to be examined also. So far a few things have lined up since last Wednesday: VIX has been spiking, Put-Call Ratio above 1, NYSE new lows exceeded 300 and Declining-Advancing Volume above 4-1 on NASDAQ and 5-1 on NYSE.

Another thing to look for is lower prices (on the indices) without confirmation of lower lows from market internals and lighter volume. This often signals a shift in psychology is in the works as well.

Focus on the low hanging fruit and don’t get caught up in calling bottoms.

"When the Facts Change…

…I change my mind—what do you do sir?” This is a quote from John Maynard Keynes, famed economist known primarily for his theory involving a prominent role for government spending in stimulating growth.

In keeping with this theme, it is noteworthy to mention that at one point in time, economists were not solely relegated to the academic world of abstractions and theories—they had the duty of actually arriving at solutions for practical problems, hence this quote.

The problem with the world of economics today is the confines in which they operate. Instead of looking at the facts objectively and arriving at a conclusion, many enter the debate with a preconceived notion, looking ardently for data that match their pre-postulated criteria.

The reason I bring this up is to shed some light on the search for Chairman Greenspan’s replacement. President Bush has clearly articulated that he has no “litmus test” in looking for an appointment to SCOTUS; I think it would be fair to expect the President to adhere to the same in terms of finding a new Fed Chair.

Think about it—both the Supreme Court and Fed/FOMC operate democratically—decisions require quorum and a simple majority. Both operate independent of traditional government, Justices and Governors are chosen via appointments (as opposed to elections) and have the ability to serve their capacities for decades.

I think it is fairly safe to say that both entities operate independently of the political process and have the ability to govern without fear or interference from outside forces. This is why it is especially important for the President to search the country for the “John Roberts” of monetarists—someone with unquestioned and impeccable credentials with real world practical experience. Not a supply-side ideologue or someone unlikely to criticize the administration when it feels it is not acting in the best interest of price stability.

We need someone who has the confidence of both Wall Street and the world. We need someone who has espoused a clear record on monetary policy and the central role of the Fed in the global growth engine.

Basically, we need someone who will change their mind when the facts change.

Holidays, Birthdays and Answers

We wish everyone a prayerful Yom Kippur.

Today we also wish Lady Thatcher a very happy 80th birthday. Her mark on politics in Britain is as obvious as it is indelible. Look no farther than the three consecutive terms that Labour has enjoyed in power on the backs of PM Tony Blair and issues traditionally thought of as being “Tory.”

The tone in Washington is not getting worse, rather more evasive. President Bush nominated Harriet Miers, WH Counsel, to fill Justice O’Connor’s seat on SCOTUS. Why? Don’t know. What I do know—if President Clinton had nominated his lawyer to the bench, the GOP would be crying foul. Anyhow, a few long term friends and colleagues of Ms. Miers are throwing her business credibility into question, alleging she is “conservative on social issues, liberal on economic ones.” It is also troubling that she has encountered more trouble from the right side of the aisle than the left. Best case scenario—nominee withdraws from consideration (although it appears that Bush is letting her be taken down by outside forces so this may be unnecessary).

There is also the matter of a Greenspan successor to be dealt with. President Bush would be remiss to nominate his financial advisor to this post, although looking through past appointments I would not rule it out. The best course of action here is to avoid the academics and look at those who are known in the financial world—with private sector experience and Wall Street clout.

Finally, we come to the twin deficits, yet again. As costs from the War, Katrina, Rita and entitlements mount, some decisions need to be made. Former Majority Leader DeLay indicated that all the cuts had been made and there simply was no more room for offsets. First, this is very surprising and disappointing coming from a “fiscal conservative.” Second, I don’t buy it. Not a word of it.

First you need to understand what constitutes a “cut” in Washingtonian—it doesn’t actually mean giving less to an issue, item or group. What it means is the rate of the program’s growth (year-over-year) will increase less. For instance, if drug coverage grows at three times the rate of inflation, most likely a cut would result in maybe two times the rate of inflation. So in reality this is not a “cut”—more of a scale back in expansion.

Think about it this way- if you opened a bank account and initially the bank paid you 5% interest on your balance. 3 months later, rates fell to 4%. You would be making less than when you deposited the principal; however you would still be making money.

Finally, some easy ways to trim some overhead:

1. Eliminate the Pork-laden highway bill. Pass a new version with no riders, covering solely repairing and improving infrastructure.

2. Eliminate corporate welfare subsidies. Most of these antiquated provisions originated in the 1980’s to protect American industry from Japan Inc.

3. Eliminate subsidies to agriculture and energy. Agriculture needs to become more competitive. We need to open our markets. Energy companies shouldn’t be punished or rewarded for the current state of the global economy. Most of the large companies are rapidly expanding outside of oil and should bare the same R&D costs as every other sector.

Ruining America’s Pastime

Despite the Yankees losing in 5 to the Angels, it isn’t any MLB team that has begun to impinge upon our national sport. It is something far more serious (and sinister), a gentleman by the name of Richard Fisher.

You might not know his name, but if you are a market watcher you can probably recall a statement by a non-voting Fed Governor in April that compared the central bank’s tightening cycle to that of a baseball game—averring that we were in the 8th inning (for those of you unfamiliar, a baseball game is 9 innings), with an end in sight.

Granted that was pre- Rita and Katrina; and no one (including a meteorologist) could have predicted the devastating aftermath of these weather anomalies.

Maybe it was because he was a rookie. Rookies make mistakes. Most importantly, rookies are supposed to learn from their mistakes—that’s how they become veterans.

Mr. Fisher apparently has no intention of learning from his blunder. Last week, on several occasions Mr. Fisher addressed groups regarding our economy and Fed policy. He warned of pending inflation doom, sending the bond market into a frenzy and causing a sell off among international equities.

In the spring his words sparked a rally. In the fall they caused a collapse.

The Fed’s role is not to embolden or scare investors—it is to maintain price stability. Since everything is interconnected in the world of finance, much in the way an ecosystem is in nature, statements like his have the ability to alter our course in ways previously thought unimaginable.

Mr. Fisher should undoubtedly take a page from the playbooks of Governors Greenspan, McTeer, Broaddus, Cohn and others…don’t make predictions—weigh the data and react. Don’t sensationalize and don’t speak in platitudes. Resist the urge to see your name in the headlines and do your job.

OIL CHART



Crude oil breaks below neckline of Bearish Head and Shoulders. A rally back to 62.5 before dropping further would be consistent with pattern.

Tough Times Don’t Last (Tough Bankers Do)

Yesterday the market saw a round of fresh selling after reaching the downtrend line (drawn off the August high) and an unfavorable inflation outlook from Fed Governor Fischer despite another strong economic reading from September Factory Orders.

It looks like the battle will continue to be fought between the two lines which will inevitably run their course by year end, although I expect the situation to be resolved much sooner, with a likely break to the upside.

Usually by the time the data shows that we are in a recession or contraction, the market has already bottomed out and began the trudge upward. Examining the syntax surrounding the macro-environment and fiscal issues for financing the reconstruction will be key in gauging exactly how far off we are.

Last but not least, keep an eye on the White House as the selection process for Greenspan’s successor is apparently underway. Hopefully the President will choose a candidate from the Friedman/Laffer/Lindsay/Greenspan school of free trade, lower taxes and governmental nonintervention. Fingers crossed.

Repeat?

Nine months down, three to go. The 4th Quarter was good to us last year and many bulls have already started talking of a similar end to this year. Sure, oil was about $15 dollars cheaper and we had not felt the wrath of back-to-back hurricanes; but all and all, the market (much like the economy) had been muted all year—directionless, if you will.

Last year it was the election result that broke us out.

This year there is no such event in the cards. There is nothing that could be construed as “make or break” for the market or the economy.

There are a few smaller items that may emerge as a confluence of sorts, guiding us higher:

1. Government Spending. President Bush’s program to rebuild and rehabilitate New Orleans would make both FDR and J.M. Keynes proud.
2. Holiday time. Early indications suggest the American consumer has not been devastated by higher gas prices and interest rates—rather adjusting, if you will. This could still translate into another record holiday season as demand for consumer electronics and $300 jeans remain at the height of their popularity.
3. Economic Data. Late last week the Chicago PMI report came in about 10pts higher than what had been expected, confounding economists yet again…
4. China. Still the wild card. WSJ has great article this morning revealing that credit cards issued has doubled this year, bringing more of the population into the mainstream.
5. Corporate profits. Energy’s value and size inside the S&P 500 has ballooned well past historical norms. With rates still low (and rising) and higher commodities prices look for this cash to be reallocated among other industries inside the market.