Total Carnage

Do tighter lending requirements in China translate to 500 pts on the Dow?

Well, apparently it does in today’s markets.

Despite the implementation of the circuit breaker and other stop-gaps introduced after Black Monday in 1987, the market seemed to get away from market-makers (namely NYSE specialists) as orders bypassed the post on the floor and were being executed electronically elsewhere, precipitating a 200 point intraday move in the matter of minutes that sent the Dow Industrials hurdling below 12100. Prior to the introduction of hybrid trading on the floor this would have never have happened—so obviously the safeguards may need to be tinkered with to avoid the type of volatility we saw yesterday.

Market malfunctions aside, stocks wanted to go lower as bears finally overtook bulls. The CBOE Market Volatility Gauge (VXO) registered a close up 70%, the Put-Call ratio stayed around the 1.5 mark all day and the Market Breath/TRIN were a total disaster. Ladies and gentleman, this was total carnage.

In addition to the China news, an unexpected Durable Goods contraction (-7%) and an attempt on the life of Vice President Cheney by the Taliban didn’t help things; both overshadowed some positive news out of the real estate market.

I am not sure where we go from here, but I would be skeptical of any big move higher in the immediate near term. A blood letting like we just had requires some basing and cooler heads to prevail in the market place before resuming the rally—if this is just a correction. Conversely, if there is a change in the Macro picture— which there may be—it may be time to get out of the way until things resettle themselves and become clearer.

CLICK TO ENLARGE

Sub-Prime is Sublime

If one agrees with the basic premise that “there is no such thing as a free lunch,” arriving that a free house would be equally out of the question. But during the real estate boom that was (and is no longer), competition was hot and companies did stupid things—i.e. giving away homes.

Now the sub prime lenders didn’t exactly give away homes, what they did was allow many “unqualified” buyers get into digs that were well above their means, all the while postponing the stake holding of debt. This was done in two fashions: no money down and deferred mortgages. Many of these debt/mortgage type instruments have also been conveniently re-bundled and re-sold several times over since the origination of such loans, adding to the several trillion dollar derivative behemoth that nobody knows how to value or assess risk to, but that’s a different story.

So here is the deal: many of these free homes need equity. Many homeowners don’t have the money. Herein lies their problem, soon to become everybody’s problem. A cursory glance of the performance of two names in the sector, NFI and NEW, tells the story: down roughly 70% and 60% respectively. Ouch.

Check today’s Wall Street Journal for more info.

CLICK TO ENLARGE

Safety First

Happy Valentines Day to our men and women serving in the armed forces, who are without their loved ones not only today, but everyday they put their lives on the line for our safety. Your sacrifices and contributions do not go unnoticed and we are forever in your debt. Thank you for your service to our great country and God Bless America.

Safety First

This online publication of ours, here at E1, seems to stray from the topics of financial markets and economies; seemingly always winding up examining our foreign policy and/or national security. This is no accident. The United States and its allies are at war. Our economy, while clearly being driven by technological advances and productivity—is a “wartime economy.”

The need for materials—base metals, precious metals, timber, plastic, rubber and energy sources is significant. Look at commodities prices in the wake of 9-11, compare and contrast with our postmodern military engagements (mainly WWII, Vietnam and Gulf War I) and you will detect a fairly reliable trend—wars require natural resources and finished goods derived from them. Think tanks, hum-vees, aircraft carriers, battleships, aircraft, drones, guns, ammunition, construction (Navy Seabees), etc.

The Iraq War will continue for sometime, most likely through the end of the decade—despite the ridiculous campaign promises of many presidential hopefuls—although the participation of our soldiers beyond the Bush administration is in question, especially the amount. Military, the future is cloudy; while politically and economically will remain bound, as Iraq is not only our toehold in the region—it is the best chance for (dare I say) a true democracy to flower, one with capitalist underpinnings and not necessarily hogtied to the price of a barrel of oil.

I firmly believe today’s announcement by ISF (Iraqi Security Forces) in conjunction with the al Malicki government to close the border crossings with Syria and Iran should be fruitful. The evidence submitted by the US government detailing Iranian supplied armor-piercing IED’s (to Shiite militias and insurgents) that have led to death of over170 soldiers proves Iranian involvement beyond the shadow of a doubt.

While many believe that Iran and Syria hold the key to peace in the region, I would respond in kind that Iran and Syria are promulgating civil unrest, turmoil and sectarian violence—not only in Iraq—but throughout the entire Middle East.

The same weapons used to kill nearly 200 of our troops in Iraq somehow wound up in the hands of Hezbollah and were used against the IDF (Israeli Defense Force) tanks and armored vehicles in Lebanon last year.

The United States under the Clinton administration treated terrorist acts both on our soil (WTC 1993 bombing) and abroad (Khobar Towers, African Embassies, U.S.S. Cole) as criminal acts, as opposed to what they were. One poignant example of this failure is the Khobar Towers bombing. While it is still yet to be proven, U.S. intelligence is quite positive that the bombs used in the attack that killed 19 servicemen were smuggled through Lebanon (Hezbollah’s backyard) and carried out by Saudi Hezbollah. Hezbollah is literally but an extension of Iranian Intelligence—as it is actively financed, supported and coordinated through Teheran.

Getting back on track, it is important that this administration keep Iran from meddling in the affairs of their neighbors, namely Iraq which is uniquely susceptible to foreign interference. By creating an internal sectarian-style “war of attrition,” everybody loses sans Iran. They need to be isolated further (as we have preliminary indications that sanctions are working) and marginalized in the international community—so they will not be able to afford additional interference in the region.

A safer, successful Iraq is in everyone’s interest minus Iran. This has to be the goalpost for our policy, not merely maintaining dignity while leaving the job unfinished. We owe this much to the Iraqi people, international community and our citizens. In the immediate vacuum following the cold war, when America realized it had no discernible, formidable enemies (among nation-states) other than the usual pests—the market built in a “peace premium,” though theoretical, carried a value of up to 10% by some speculators. While peacetime may be a ways off, it is important for us as a country to do the heavy lifting now, rather than handing it off to another generation.

DOW JONES TRANSPORT CHART

Dow Jones Transportation Average looks to break out to another all time high as energy prices ease and railroads lead the trudge higher.

Newsflash: The French Economy Could Get Worse

Like many who read the above, I find it difficult to believe that things could get worse in France economically—but as I have rediscovered time and time again in my short time on this planet—ANYTHING IS POSSIBLE.

In this particular case, not only is anything possible, but this is actually looking more and more probable.

For those not in touch with France’s electoral politics (guilty as charged), Ségolène Royal, the Socialist Party candidate for President (who is currently second in the polls behind Interior Minister Nicolas Sarkozy) just unveiled a “100 point” economic plan in an effort to halt her recent slide in favorability among voters.

Being a socialist, here are a few of the more substantive “reforms” Royal supports to spur growth and stave off growing unemployment (and a general feeling of malaise among the populace):

-Build more subsidized housing for the underprivileged
-Raise the level of pension contributions from the Government
-Raise the minimum wage by about 1500 Euros ($2000 USD)
-Government policy would be monitored by “randomly” selected juries
-Delinquents would be forced to attend educational camps run by the military
-Raise taxes
-All young people would have access to an interest-free 10,000 Euro loan
-Expansion of socialized health-care (including free contraceptives for women)

Despite her far-left policies, the Wall Street Journal ran a profile of her today which basically described her as somewhat unorthodox in her views of government and governing—despite a methodology that is right out of the playbook of Karl Marx and Friedrich Engels.

This is a textbook example of leftist pedagogy—throwing money at problems, instead of a careful analysis and targeted solution. If you recall last summer, you will note that the financial underclass in the city of light didn’t show the desire for more subsidize housing. They simply burned their homes, cars and local police stations down. Giving people free money will not teach them the value of a euro, nor will it provide them with the skill set they need to compete in the global economy.

In addition, small businesses are not only the growth engine of the US economy; they are the driving force behind every capitalist society. Most of Royal’s policies create no incentives for your companies with a handful of employees to: a. innovate b. invest in new technologies c. take on new employees or d. earn more money

I know this may sound patronizing or even rudimentary, but why take risk when there is no quantifiable reward?

French law, AS IT STANDS, punishes companies that turn a profit! I believe it is fiscally more rewarding for a CEO (Partner or Proprietor) to hire a hundred people and run the business into the ground, thereby burning shareholders and forcing the French government to orchestrate a bailout.

The barriers to expansion are clear, as the level of taxation is egregious, while literally punishing employers for hiring new employees via health care, wages and retirement costs. There is little room for market forces to intervene as literally both supply and demand are overrun by fraught government agencies and all powerful unions. Bureaucracy runs amok to the point where the work week is limited—hypothetically, some manufacturers would be unable to meet skyrocketing demand for a product via artificially placed quotas on supply (human capital).

On the other hand, there is Interior Minister Nicolas Sarkozy, whom favored dealing with the rioting via policing (imagine that!). He actually wanted to stop the mobs from burning down private and public property. He also favors cutting taxes and allowing market forces to play a greater role in France’s economy.

Maybe we are spoiled as Americans, as we usually have a choice every 4 years (2 if you count congressional elections) of electing a leader that pledges to cut taxes, which usually hails from the Republican side of the aisle; i.e. The Bush Tax Package is credited with creating several million new jobs while experiencing robust growth and historically low inflation. In fact the independent CBO predicted the deficit will be eradicated by 2012, despite funding 2 wars and rebuilding the entire Gulf Coast. While the Capital Gains Tax Rate is at its lowest level in 10 years, in 2006 the IRS reported record tax revenue!

This year on the Democratic ticket (thus far) only one serious candidate, Senator John Edwards, is calling for an increase in taxes. On the Republican side, there is a pledge circulating among those running to extend the Bush tax cuts, which to my knowledge Senator John McCain, Mayor Rudolph Giuliani and Governor Mitt Romney, have all signed.

In France, last Presidential election was between Jacques Chirac (the incumbent), whom represented the status quo style of the capitalist inspired socialism and a wacko right-wing who is emblematic of the current of anti-Semitic, ethno-centrism that is the underbelly of colonial Europe (or “old Europe” if you will). The scary part is that Chirac almost lost, which is only marginally better than the fact if you look at him alone—that he won



Click to Enlarge

Miracle on the Champs Elysees! I don’t know how…but the French CAC Index remains in a steady bullish trend despite economic turmoil. Viva La France!

Happy Birthday, Mr. President

Were he alive today, President Ronald Reagan would have been celebrating his 96^th birthday. A leading figure in the conservative movement and the namesake/founder of the “Reagan Revolution,” President Reagan was truly an inspiration to people all around the globe.

He forced the USSR to try and match our defense spending dollar for dollar, bringing about the dissolution of Soviet Socialism in Europe right after leaving office. In his own words:

So in your discussions of the nuclear freeze proposals, I urge you to beware the temptation of pride -- the temptation blithely to declare yourselves above it all and label both sides equally at fault, to ignore the facts of history and the aggressive impulses of an evil empire, to simply call the arms race a giant misunderstanding and thereby remove yourself from the struggle between right and wrong, good and evil.

And:

From Stettin on the Baltic to Varna on the Black Sea, the regimes planted by totalitarianism have had more than thirty years to establish their legitimacy. But none--not one regime--has yet been able to risk free elections. Regimes planted by bayonets do not take root....If history teaches anything, it teaches self-delusion in the face of unpleasant facts is folly....Our military strength is a prerequisite to peace, but let it be clear we maintain this strength in the hope it will never be used, for the ultimate determinant in the struggle that's now going on in the world will not be bombs and rockets but a test of wills and ideas, a trial of spiritual resolve, the values we hold, the beliefs we cherish, the ideals to which we are dedicated.

He pulled the American economy up by its bootstraps from the despair and malaise of stagflation by cutting taxes, creating incentives for small businesses and reducing the size of government. Here are several different thoughts from the Gipper:

Depression is when you’re out of work. A recession is when your neighbor’s out of work. Recovery is when Carter’s out of work.

The best minds are not in government. If any were, business would hire them away.

The government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.

He restored confidence, faith and decency in the oval office following the Vietnam War, Watergate and Iranian Hostage Crisis.

Double, no triple, our troubles and we'd still be better off than any other people on earth. It is time that we recognized that ours was, in truth, a noble cause.

President Clinton may have been a great talker, but there was (and will be) only one “Great Communicator”:

I won a nickname, "The Great Communicator." But I never thought it was my style or the words I used that made a difference: It was the content. I wasn't a great communicator, but I communicated great things, and they didn't spring full bloom from my brow, they came from the heart of a great nation— from our experience, our wisdom, and our belief in principles that have guided us for two centuries. They called it the Reagan revolution. Well, I'll accept that, but for me it always seemed more like the great rediscovery, a rediscovery of our values and our common sense.

Happy Birthday, Mr. President.

Wanted: A Responsible Media

This is from David Frum’s piece in the National Post, February 3rd, 2007. This article was posted in NRO’s (National Review Online) blog where Mr. Frum is a contributor. He was also a speechwriter for President Bush during his first term and is known for coining the term “axis of evil.” Mr. Frum currently is serving as a Resident Fellow at the American Enterprise Institute.

The politics of bulls and bears
How does the U.S. Media describe the economy? It depends on who's president
David Frum

National Post
Saturday, February 03, 2007

Want to get rich in the American stock market? Here's some advice: Don't watch the news.

I'm not being facetious here. One of the iron laws of U.S. news reporting is that the economy gets positive reviews under Democratic presidents and negative reviews under Republican presidents.

In 2004, the Virginia-based Media Research Center (MRC) produced a stark summary of the disparity.

In 1996, Bill Clinton ran for reelection as president. The U.S. economy was doing well at the time: unemployment down to 5.2%, inflation under control at 3%, and overall growth at 2.2%. And the press reported all this good news: According to the 2004 MRC study, 85% of all major economic stories on the economy in the summer of 1996 were positive.

Eight years later, George W. Bush was running for re-election as president. The U.S. economy in 2004 did much better than in 1996: The economy grew at a 3.9% pace, while unemployment and inflation roughly matched their 1996 levels (5.4% and 2.7% respectively). Yet this time, 77% of all major media economic coverage was negative. (For the full report, see http://www.mediaresearch.org/realitycheck/2004/fax20041020.asp.) And since the 2004 election, the barrage of bad news has continued: reports of housing bubbles, warnings of an imminent collapse in the U.S. dollar, and so on.

The economist John Makin has done some interesting calculations on the consequences of the euphoria of the '90s and the persistent gloom of the '00s. As the economist who most accurately predicted the Japanese stock market crash of the late 1980s, Makin deserves attention when he assesses valuations.

Makin points out that the usual determinants of stock prices are a function of expected corporate profits and interest rates. The more we expect companies to earn, the lower we expect interest rates to be, the more we will pay for a share in a company. Based on this formula, economists calculate a "fair market value" for stocks —a base line around which they expect stocks to trade.

Between 1998 and 2000, the S&P 500 traded at a premium of some 60- 80% above fair market value: Investors, it seems, were making the mistake of believing Bill Clinton's PR — and of course it ended in tears. In the single year 2000, the S&P dropped from almost 1,600 in March to 1,300 by year end. The S&P finally hit bottom at under 800 in the fall of 2002.

Then the recovery began. Investors who disregarded the gloomy Bush-era reports from CBS and The New York Times noticed the rise in corporate profits and the reductions in interest rates. They began to buy and buy and buy — pushing the S&P past 1,400 at year end 2006.

Makin, however, points out that even at 1,400, the S&P remains some 20% below its "fair market value": "If the stocks in the S&P 500 were currently valued as they have been on average over the past 20 years, the index would be at 1,775 instead of 1,420."

Don't take that as a buy signal however. Because now, after the elections of 2006, some very genuine reasons for concern have materialized.

The new Democratic Congress takes office committed to a series of measures intended to attack corporate profits. They have already voted to raise the minimum wage — a measure that affects the entire U.S. labour market, because many union contracts are tied to multiples of the statutory minimum. Leading Democrats talk of changing labour rules to eliminate secret ballots for unionization elections.

Even more ominously, Democrats are proposing higher taxation of energy companies — and making it clear that they will not vote to renew President Bush's cut in taxes on dividends and capital gains. Leading members of the new Congress have expressed strong protectionist views.

Democrats hope to push labour costs up faster than productivity — and to curb corporate profits they regard as inflated. If they succeed, profitability must suffer, and stock prices must decline.

And yet, bizarrely, at this very moment of maximum worry, the press reports — so negative, for so long — are suddenly turning positive again. On Jan. 31, Associated Press reporter Andrew Taylor filed a story from Washington that opened cheerily: "The House passed a [US] $463.5-billion spending bill Wednesday that covers about one-sixth of the federal budget as Democrats cleared away the financial mess they inherited from Republicans."

In this case, "clearing away the financial mess" means adding tens of billions of dollars in new federal spending to the budget — while destroying hundreds of billions of dollars of national financial wealth along with it. The economic results may be dreadful. But count on it: The economic reporting will be glowing!

Link:
http://frum.nationalreview.com/post/?q=MjY5YWJiNzYyNTEwNTY0ODY3OGE1ZTU3YTM0YTI5NWY=



CLICK TO ENLARGE