Courageous Kareem Contradicts Racial Correctness

USA Today called it a “racist e-mail.”

CNN called it a “racially charged e-mail”

In three separate articles, The New York Times called it “a racially charged memo,” “racially insensitive views,” and evidence of “deeply rooted racism.”

Sports Illustrated said it contained “a series of ignorant, racially insensitive remarks.”

Those are the types of statements basketball great Kareem Abdul-Jabbar was referring to when he wrote:

“Well, the pitchforks are already sharpened and the torches lit anyway, so rather than let them go to waste, why not drag another so-called racist before the court of public opinion and see how much ratings-bragging, head-shaking and race-shaming we can squeeze out of it? After all, the media got so much gleeful, hand-wringing mileage out of Don Sterling and Michael Brown.”

I applaud Mr. Abdul-Jabbar for courageously denouncing the paternalistic forces of racial correctness, who attacked Atlanta Hawks co-owner Bruce Levenson for writing a memo to business partners that, in fact, reveals no racist views. Quite the opposite. I refer you to Abdul-Jabbar’s incisive article in Time Magazine, where he argues Levenson’s e-mail was an “entirely reasonable” discussion of how the Atlanta Hawks franchise could increase revenue by attracting more white fans to the arena. (Google “abdul-jabbar bruce levenson email.”)

Lessons to be Learned

In the over-wrought world of political and racial correctness, actual words – what someone actually said or wrote – does not really matter. If someone “takes offense,” then the remarks are “racially charged,” ”racially insensitive” and even “racist.” Off with his head.

By no means is this always about blacks taking offense from the remarks of whites. Juan Williams (did I mention he’s black?!) lost his job at NPR because he said he got nervous when Arabs got on an airplane. Forget the 9/11 attacks, the Fort Hood massacre, the Boston Marathon bombing and dozens of other attacks by Islamic terrorists on innocents of all faiths; in NPR-land Williams’ remarks reeked of “Islamophobia.” He had to go.

What Levenson Actually Said—the Opposite of Racism

As a business historian who has read thousands of business letters (mostly by 18th century merchants), I find Levenson’s memo interesting reading. Operating in the real world of making a buck in the Atlanta entertainment market, he was simply trying to figure out how to attract more fans to Atlanta Hawks games. If you actually read what he said, as Abdul-Jabbar did and most reporters apparently did not, you can easily see he was not racist. He merely made the error of recognizing cultural and economic “facts on the ground.”

Levenson starts by observing that “from day one I have been impressed with the friendliness and professionalism of the arena staff—food vendors, ushers, ticket takers, etc.” Because the Phillips arena is in a neighborhood with a large black population, I am pretty certain many of these employees whom Levenson praised are black. No sign of racism there.

Then he considers “why our season ticket base is so small.” Speaking as a money-grubbing stock market investor, I would note that Levenson is talking here about the “Holy Grail” of running a business—recurring revenue. Every business craves it. Rain or shine, heat wave or snowstorm, winning season or cellar dwelling, the revenue of season ticket-holders rolls in.

So Levenson wonders, why does the Hawks’ season ticket revenue suck, compared to other basketball teams? “I was told it was because we can’t get 35-55 white males and corporations to buy season tickets and they are the primary demo for season tickets around the league. When I pushed further, folks generally shrugged their shoulders. Then I start looking around our arena during games and notice the following:

–it’s 70 pct black

–the cheerleaders are black

–the music is hop hop

–at the bars it’s 90 pct black

–there are few fathers and sons at the games

–we are doing after game concerts that attract more fans and the concerns are either hip hop or gospel”

Levenson goes on, “My theory is that the black crowd scared away the whites and there are simply not enough affluent black fans to build a significant season ticket base. Please don’t get me wrong. There was nothing threatening going on in the arena back then. I never felt uncomfortable. But I think southern whites simply were not comfortable being in an arena or at a bar where they were in the minority. On fan sites I would read comments about how dangerous it is around Phillips [the Hawks’ arena] yet in our 9 years I don’t know of a mugging or even a pick pocket incident. This was just racist garbage. When I hear some people saying the arena is in the wrong place I think it is code for there are too many blacks at the game.”

He concludes, “This is obviously a sensitive topic, but sadly I think it is far and away the number one reason our season ticket base is so low.”

It is obvious that Levenson is not racist or even racially insensitive:

  • He is trying to attract more whites to Hawks games, which would increase the racial diversity of the audience. So he is promoting desegregation, a primary goal of the civil rights movement. No racism there; quite the opposite.
  • He denounces as “racist garbage” the suggestion that crime is high at the arena. No racism there.
  • He dismisses as “code for there being too many blacks at the game” the fact that “some people [say] the arena is in the wrong place.” No racism there; quite the opposite.
  • He observes that “southern whites” were uncomfortable going to games where a majority of the crowd was black, and entertainment extras such as the music and cheerleaders were oriented toward black tastes. Recognizing southern whites’ aversion to being a racial minority at the arena definitely does not reveal racism on Levenson’s part.
  • He acknowledges all this is a “sensitive topic” and it is sad that affluent whites are not keen to go to games where the majority of spectators are black. No racism there; quite the opposite.

So, as Abdul-Jabbar observed, there is no evidence of racist sentiments in Levenson’s e-mail. He is just recognizing on-the-ground-in-Atlanta economic and cultural realities that are depressing season ticket revenue.

What We Really Have Here is Fear of Racial Equality

The media’s rush to brand Levenson’s comments as racist actually reveals their own racial paternalism. They cannot conceive of Atlanta’s black population being treated as just another demographic segment of the market that can be discussed by a down-to-earth, real-world entrepreneur person as he or she would discuss any other market segment – fashion-conscious women, middle class homeowners, college grads in their 20s, working class Hispanics, wealthy golfers, whatever.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Wall Street Strategists Are Disturbingly Bullish

Barron’s is out with its always interesting “back to school” early September survey of Wall Street strategists, hailing from both the buy side and sell side. Though the samples size of nine is a bit small (where are Deutsche, U BS, Credit Suisse & JPM?) it is a useful compendium of apples-to-apples figures on what strategists are telling clients.

The take of Barron’s writers on the results is that strategists are bullish, and I don’t disagree. However, if we actually scrutinize their numbers, the strategists are saying we won’t get further stock price gains this year—even though the fourth quarters of mid-term election years tend to be strong. Their average year-end 2014 price target for the S&P 500 is 2011, virtually even with the current level. Only two of the nine houses look for material gains from here (in both cases, up 5% to 2100).

Here are the raw numbers. (I use averages for the nine strategists; median figures are virtually the same.)

2014 year-end price target for S&P 500          2011

2014 S&P 500 EPS                                               117.5

2015 S&P 500 EPS                                              126.8

2014 year-end trailing PE                                 17.1

2014 year-end forward PE                                15.9

2015 S&P 500 EPS growth                                7.9%


The “Fair PE” Rises 20% in Two Years(?!)

The strategists’ idea of what is a “reasonable PE ratio” has increased a lot in two years. In early September 2012, their 2012 year-end target implied a trailing PE of 13.8x (versus 17.1x now) and a forward PE of 13.2x (versus 15.0x now). So, the strategists are using PE targets that are 20% higher than two years ago.

This is not at all surprising to me. I pointed out two years ago that “Wall Street’s strategists are using PE assumptions that are very conservative by historical standards, particularly considering that we are in a low-inflation, low-interest rate environment.” (Emphasis in original.) I argued that “Muted Expectations Could Set the Stage for a Positive Stock Market Surprise,” which was the title of my September 2012 post. (Admittedly, I was right partly for the wrong reason; I suggested a Romney Ryan victory would trigger an upward “re-rating” of equities.)

S&P 500 at 2170 Sixteen Months from Now?

If we apply the strategists’ now rather lofty PE assumptions to their 2015 EPS figures, they are looking for a 2015 year-end price target of 2170 (17.1*126.8).

Their earnings forecasts look reasonable. The 117.5 for 2014 looks a little low, but the 7.9% growth expected for next year is fairly bullish, given elevated profit margins, mounting wage pressure in some industries, higher stock prices that mute the benefit of buy-backs, a recessionary Europe and a strong dollar that creates currency translation headwinds and reduces energy prices. (Lower oil prices are negative for profits, because revenue is transferred from oil companies to consumers.)

Bullish Consensus Creates Potential for Negative Surprise

What I see in these numbers is a disturbingly bullish consensus, based on high PE assumptions and upbeat earnings expectations. I don’t disagree with the strategists’ assumptions; I have been saying for quite a while that stock prices would “grind higher.”

Nevertheless, in terms of “positioning” and investor psychology, we are vulnerable to negative news. In contrast to two years ago, when PE ratios were much lower, stock prices could fall pretty sharply on a nasty surprise—perhaps a terrorist attack or a political / financial spasm in Europe. When investors are bullish and valuations are high, stock prices don’t necessarily need a good reason to tumble. Investors have big profits to protect. In the first half of 1962 stocks dropped more than 23%, even though earnings rose 15% that year and the U.S. was in the midst of one of the most prosperous five-year periods in its history, comparable to the early 1830s, the late 1860s, 1898-1903 or the late 1990s. The catalyst for that drop was a confrontation between President Kennedy and U.S. Steel over steel price increases.

Investment implication: This is not the time to be particularly aggressive in the stock market. Unlike two years ago, lots of good news is priced in, and there is a decent chance the next big surprise is negative.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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New York State Needs a War on Poverty

A few months ago Arthur Levitt–Bloomberg groupie, former SEC Chairman, and quintessential Wall Street liberal—interviewed Grover Norquist, anti-tax activist and bête noire of Wall Street liberals. At the end of the interview Levitt asked “Grover, do you think it is ever appropriate for government to help poor people?” Norquist archly reminded Levitt that Obama-style liberalism had been a disaster for poor people, although government workers had made out just fine. (I can’t quote exactly because for some strange reason this part of the conversation disappeared from the podcast.)

Levitt typifies the earnest liberal for whom good intentions outweigh dismal results. Exhibit A is upstate New York, which for decades has been pauperized by Democratic politicians pandering to rich New York City liberals and Public Employee Unions. High taxes, oppressive regulation and political corruption have deindustrialized a region that once upon a time was an economic powerhouse. The Erie Canal, the most successful infrastructure project in American history, created a string of prosperous cities stretching westward from Albany—Schenectady, Utica, Rome, Syracuse, Rochester, Buffalo. For decades now, these cities have ranked near the top of lists of the fastest-shrinking cities in the U.S. Buffalo has shriveled from 580,000 in 1950 to 261,000 in 2010.

Inequality, New York Style

When liberals ponder the scourge of inequality in earnest convocations at the 92nd Street Y, they need only glance up the Hudson to find an egregious example. The five richest counties in the state, all in the New York City area, have median household incomes of $82,181, on average. That’s twice as high as the average median household income of the 18 poorest counties in the state. Where’s Thomas Piketty when we need him?

Driving this pauperization is rank corruption in Albany—so rank that Andrew Cuomo had to shut down his own anti-corruption commission when it began snooping too close to home. Where else but Albany can a politician serve in the Legislature while pulling down a six-figure salary from a law firm whose main business is–lobbying the Legislature!

Frack That

The apotheosis of New York liberals’ pauperizing pandering is Andrew Cuomo’s opposition to fracking. Albany regulators are “studying” it to death simply because it is opposed by rich liberals like “river keeper” Robert Kennedy Jr. Done properly, fracking is not risky. Tens of thousands of wells have been drilled in the U.S., and fracking has had no discernible ill effects in neighboring Pennsylvania. It would create thousands of the “good paying middle class jobs” that liberals claim to crave while reducing carbon emissions by helping to substitute clean gas for dirty coal. And it has a far more benign environmental footprint than bird-slicing windmills or solar fields blighting thousands of acres.

Having quashed fracking, Cuomo needed some economic development fig leafs to appease upstate voters ahead of the election. To create the misimpression he is “doing something” about jobs, he created a tax abatement plan called “Startup New York” with a huge in-state ad budget. And as a pathetic substitute for fracking, Cuomo is expanding casino gambling in upstate New York. He claims three or four new casinos will “serve as attractions to bring visitors to the region through tie-ins with the local tourism industry, business community and entertainment venues.”

Cuomo’s casino timing could not be worse. This is 2014, not 1980. There are already several hundred casinos in the U.S. including dozens in the Northeast. The glut is so bad that three casinos will close in Atlantic City this month. If they are ever built, Cuomo’s casinos can hire experienced employees recently laid off in AC.  Only a political aristocrat with zero private economy experience—apart from pressuring Fannie and Freddie to buy more sub-prime mortgages, when Cuomo ran HUD in the 1990s—could come up with such a dumb “job creation” plan.

A New War on Poverty?

There is a solution to Cuomo’s venal incompetence—a new “war on poverty” led by free-market conservatives from Sunbelt states. In the 1960s condescending northern liberals, many funded by elite outfits such as the Ford Foundation, descended on southern states such as Mississippi, Alabama and the Carolinas to “fight poverty.” To the extent they were fighting racial discrimination, they did much good. When it came to actually “fighting poverty” they were of little or negative value, because they were all about income redistribution, not economic growth and job creation.

Anyhow, it is time for the Sunbelt to return the favor. Capitalistic activists from Texas, Oklahoma, Arizon, Louisiana and Florida should invade the “Empire State” and stage a “freedom from poverty summer” to fight remorseless pauperization by King Cuomo and New York City liberals. Rick Perry should lead the fight; the Koch Brothers should fund it. The campaign should push for lower taxes, public employee pension reform, and a pro fracking energy policy that would create jobs and cut carbon emissions.

At the end of the campaign, Arthur Levitt could invite Rick Perry onto his radio show to explain how he saved average hard-working New Yorkers from the depredations of Albany and New York City.  Hopefully NPR’s “Brian Lehrer Show”—which has an abiding interest in inequality and anti-poverty programs—will also host Governor Perry. NPR listeners would learn a lot, if they didn’t faint first.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Fed Survey: Obamacare Impedes Hiring, Curbs Wage Gains

Although Chair Yellen is still mum on the topic, Federal Reserve economists have belatedly started to study the impact of Obamacare on employment and wages. Economists in three regions (San Francisco, Philadelphia, New York) used identical questions to survey employers in the manufacturing sector. Results for all six questions were negative for full-time employment and wage increases. Here are the average responses, across the three regions, for the six questions:

  • Effect of Obamacare on number of workers you employ: 22% said fewer workers employed, just 3% said more workers.
  • Percent of your workers that are part-time or temporary: 4% said fewer workers would be part-time, 18% said more workers would be part-time.
  • Amount of work outsourced to other firms: 3% said less work would be outsourced, 17% said more work would be outsourced.
  • Wage and salary compensation per worker: 19% said the ACA would lead to lower wages, 14% said it would lead to higher compensation.
  • Effect of ACA on “other benefits, including retirement:” 20% said the ACA would reduce other benefits, just 3% said it would increase other benefits.
  • Effect of ACA on prices you charge customers: 20% said they would raise prices, only 3% said they would cut prices.

The bad news is that these results prove what common sense would suggest: The ACA is undermining the traditional employer-employee relationship, where workers get a full-time job and wages rise over time. As Chair Yellen noted at Jackson Hole, part-time employment has surged. This is a disaster for low-skilled workers entering the workforce, who need to work two jobs to get a full weekly pay-check.

More bad news: these results would be even worse if the Fed had surveyed service firms rather than manufacturing firms. Wages are higher in manufacturing because productivity per worker is much higher than in services, partly because capital investment per worker is higher. For example, the 11.8 million people in “food preparation and serving related occupations” had an average hourly wage of $10.38 in 2013, versus $16.79 for the 8.8 million people in “production occupations.” Therefore, the added costs from Obamacare are a lower percentage of wages for manufacturing firms than service firms.


Social: Obamacare makes it even harder for low-skilled workers to get a foothold in the labor market. Thanks to the ACA, hundreds of thousands of young, able-bodied Americans will have lavish health plans they don’t need, but no job.

Economic:   To the extent it retards employment growth Obamacare slows economic growth, which makes it harder to fund Social Security, Medicare, etc.

Political:  Republicans should be the optimistic party of growth and opportunity—not the anti-Obama party. Obama is old news, damaged goods. Because the ACA has been a social and economic disaster—particularly for poor people and middle class entrepreneurs –repealing and replacing it should be a top priority of the GOP.

Equity Investment:  Obamacare increases consumption of healthcare at the expense of other products. It is no coincidence that in Q2 2014 the healthcare sector had by far the best earnings and revenue growth. Because the ACA hinders hiring and wage gains, consumer-oriented industries, such as retailers, packaged foods, restaurants, and household products are struggling. (To be sure, there are other factors at work, such as the impact of Amazon, firms’ exposure to Europe, and consumers shopping at auto showrooms rather than malls.) By increasing labor costs the ACA also increases demand for labor-saving capital equipment, particularly in the service sector.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Stock Prices Will Grind Higher

After being long and wrong in 2007 and 2008, I have been correctly bullish on stocks for the last few years, arguing they would scale the proverbial wall of worry. Bonds, on the other hand, have looked to me to be vulnerable to an eventual correction. The stock call still looks correct; the bond call may turn out OK eventually, but not for a while. Here are the key macro headlines:

  • The U.S. economy is strengthening, particularly profit-relevant metrics such as—ISM Manufacturing, Industrial Production, Capacity Utilization.
  • S&P Profits will be around $120 this year, higher than many estimates. (If they fall short of this figure, it will be due to the government shake-down fines on JPM, BAC, etc.—not macro drivers.)
  • As expected, Europe is stagnant, not rebounding as many expected. Socialism, bank deleveraging, EU dysfunction and stagnant populations are tough obstacles to overcome.
  • Emerging markets are weak and won’t improve quickly. China is not a disaster but growth will be ham-strung by persistently weak real estate.
  • Therefore, central banks’ monetary policy will be super-easy, depressing bond yields. The German 10-year yield is well under 1%; Spain and Italy are around 2.5%.
  • Fed policy is “behind the curve”—far too easy for the 6th year of recovery. (See the illuminating analysis by Drew Matus of UBS.) Eventually, as Chair Yellen admits, rapid and “disruptive” rate increases may be needed to address inflation. But not now. With bond yields so low in Europe, even an inflation scare may not push U.S. bond yields to levels that are ruinous for stocks.
  • In this weird environment, as strategist Jason Trennert noted in Barron’s, it’s all about TINA: There Is No Alternative to stocks. Stock prices will grind higher, barring an exogenous shock.
  • Stagnant Europe / improving U.S. = stronger dollar. The strong greenback and unfavorable oil market fundamentals (abundant supply / weak demand) are weighing on oil prices. Both a strong dollar and weak oil are positive for real GDP growth because they restrain inflation. But they are both headwinds for S&P profits, which are measured in nominal not real terms.

The main problem with these views is that they are close to consensus. But there are some bearish misconceptions about the macro picture. Some “Big Picture” thinkers such as Mohammed El-Erian seem to believe investors are recklessly bidding up stocks despite bad fundamentals. Actually, the PE of the market has not increased materially this year. If the S&P 500 is at 1995 by the end of September, the trailing PE on pro forma earnings will be about the same as year-end 2013 (17.1x vs. 16.8x). Another misconception is that stocks are being driven higher by buy-backs; they are only adding 1-2% to S&P 500 earnings growth.

You Heard It Here First

We shamelessly “point with pride” to some prescient observations:

Part-time America:  We have been babbling for years about how Obamacare would increase part-time employment. Now a famous labor economist has highlighted the unusually “elevated number of workers who are employed part time but desire full-time work (those classified as ‘part time for economic reasons’). At nearly 5 percent of the labor force, the number of such workers is notably larger, relative to the unemployment rate, than has been typical historically.” But though she recognizes the part-time America phenomenon (a calamity for many low-income workers who must commute between two jobs every day) Janet Yellen still can’t bring herself to connect it to Obamacare, even though some recent Fed surveys have done so.

Costly CAPE. We explained why Robert Shiller’s widely followed valuation metric is useless, flashing a “red light” to equity investors for all but a few years since 1990, while stock prices sextupled. Much to his credit, Shiller admitted as much in a NYT article. But I see little evidence he understands the accounting and fundamental factors (FAS 142, lower transaction costs, less stock market fraud, better corporate governance since 2002, etc.) that justify a PE well above the average since1871. He points to low bond yields (fair enough; see above) and investor psychology.

Hedge Fund Madness. On July 5, 2013, we observed, “Hedge funds have several serious flaws that are gradually becoming recognized.” Now big pension funds and college endowments are belatedly taking notice. Writes the WSJ: “Public pensions from California to Ohio are backing away from hedge funds because of concerns about high fees and lackluster returns. Those having second thoughts include officials at the largest public pension fund in the U.S., the California Public Employees’ Retirement System, or Calpers. . . . The retreat comes after many pension funds poured money into hedge funds in recent years in hopes of making up huge shortfalls.”  What we are seeing is the unwinding of the “stock avoidance syndrome” I highlighted in December 2012.  Now that they have doubled, stocks seem safer to asset allocation committees.  Go figure.

Krugman belatedly brushes up on bond math. About a month ago he revealed to NYT readers that conservatives hate easy monetary policy because they are greedy. You see, easy money reduces their interest income. As we pointed out, he forgot that declining interest rates boosted bond prices, generating huge capital gains for bond holders, greedy conservatives and enlightened progressives alike. Apparently a colleague took Krugman aside and explained to him that when yields fall, prices rise. Or maybe he read this blog. Anyhow, last Friday Krugman admitted “Yes, low interest rates mean low long-term returns for bondholders (who are generally wealthy), but they also mean short-term capital gains for those same bondholders.” (Emphasis mine.)

French Funk. In the summer of 2012 we highlighted “seven new reasons not to create jobs in France”—specifically, seven tax hikes imposed by President Holland. Since then the over-taxed, over-regulated French economy has slipped from first gear into neutral, even as the conservatively managed economy across the English channel shifted into third gear. Evidently socialism works no better in Paris than Moscow.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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The “Philadelphia Negro,” Then and Now

In 1896 a brilliant scholar who received his PhD from Harvard and went on to study in Europe with such luminaries as Max Weber was engaged by wealthy philanthropists to prepare a sociological study of Philadelphia’s black population. Their motives were suspect; he believed they were operating on the “theory” that “this great, rich, and famous municipality was going to the dogs because of the crime and venality of its Negro citizens, who lived largely centered in the slum at the lower end of the seventh ward” near Lombard and South Streets. Despite his misgivings, W.E.B. DuBois prepared a remarkably detailed analysis of the city’s black population—an exhaustive study with dozens of tables and charts illuminating all aspects of Negro life, including income, occupations, wealth, education, literacy, religion, social classes, crime, rents, amusements and housing. Just the chapter on crime had thirty charts and tables. DuBois ended his study with a prescient meditation on the “Duty of the Negroes” and the “Duty of the Whites.” Concerning the former, he wrote,

“Against prejudice, injustice and wrong the Negro ought to protest energetically and continuously, but he must never forget that he protests because those things hinder his own efforts, and that those efforts are the key to his future. . . . In Philadelphia those efforts should first be directed toward a lessening of Negro crime; . . . . Efforts to stop this crime must commence in the Negro homes; they must cease to be, as they often are, breeders of idleness and extravagance and complaint. Work, continuous and intensive; work, although it be menial and poorly rewarded; work, though done in travail of soul and sweat of brow, must be so impressed upon Negro children as the road to salvation, that a child would feel it a greater disgrace to be idle than to do the humblest labor. . . . “

As for the duty of the whites, DuBois observed:

“There is no doubt that in Philadelphia the centre and kernel of the Negro problem so far as the white people are concerned is the narrow opportunities afforded Negroes for earning a decent living. Such discrimination is morally wrong, politically dangerous, industrially wasteful, and socially silly. It is the duty of the whites to stop it, and to do so primarily for their own sakes. Industrial freedom of opportunity has by long experience been proven to be generally best for all. Moreover the cost of crime and pauperism, the growth of slums, and the pernicious influences of idleness and lewdness, cost the public far more than would the hurt to the feelings of a carpenter to work beside a black man, or a shop girl to stand beside a darker mate.”

Unfortunately, DuBois sound advice was not followed by whites; Philadelphia’s major companies hired very few blacks in the first half of the twentieth century.

On the Run in West Philly

Fast-forward to the present, and we have another fascinating study of Philadelphia blacks, On the Run: Fugitive Life in an American City, by sociologist Alice Goffman. As a student at the University of Pennsylvania and later Princeton, Goffman fell in with a group of West Philadelphians who were involved in drug dealing, robbery, gun play and occasionally murder. While certainly not representative of all low-income black males in the city, they were not exceptional either; 60% of black males who do not finish high school go to prison by their mid-thirties. What stands out in Goffman’s account is the perpetual entanglement of poor crime-prone black families with an expansive criminal-judicial-penal-industrial-complex. While middle class kids, white or black, go to grammar school, middle school, high school and college, these folks graduate from juvenile detention to jail to prison, with innumerable dealings along the way with street cops, detectives, parole officers, warrant officers, judges, etc.

Black males are almost constantly “on the run” because they are seldom “clean.” Perhaps there is a “body warrant” for a crime they allegedly committed, or a “bench warrant” because they missed a court date, failed to pay court fees, or violated their parole. They are ever on the lookout for cops, planning their next escape if a squad car pulls up in front of their row house. When they get shot or beat up, they do not go to a hospital for fear of arrest. They drive cars without a license, because it is too difficult and risky for them to get ID. The same goes for bank accounts. They are, in effect, “undocumented” citizens. Constant legal entanglements make it tough to get a job; frequent trips to court make it tough to keep one. None of the people Goffman hung out with held a job for long, let alone developed a career. (She mentions only one individual who worked in a company owned by his family—not surprising, because fathers were scarce in the community.) Income from short stints working at a fast food joint or a warehouse were supplemented by dealing drugs. Which was dangerous: Most of the men in Goffman’s group were eventually murdered, maimed, committed suicide, or went to prison for long stretches.

Bottom Line: W.E.B. Dubois exhortation to blacks to “Work!” is not operative for many (though not all) poor black males in Philadelphia. This conclusion is confirmed by official data; the employment population ratio for black males in the U.S. is 60.4% versus 68.8% for white males. This is a disaster for all concerned; poor blacks stay poor while tax payers of all races pay immense sums to maintain the criminal-judicial-penal-industrial-complex.

Racial Correctness  Is Part of the Problem

Finding solutions is impeded by liberal race-mongering. When Congressman Paul Ryan correctly observed that many men in inner cities were not connected to the labor market, Paul Krugman accused him of racism. On “Meet the Press” the ever-repulsive David Gregory subtly leveled the same charge at Ryan.   But what do you expect from racially correct white liberals? More troubling to me was the response of Fox News’ Juan Williams to Newt Gingrich’s suggestion that kids in inner city schools should learn about work by getting paid to do janitorial work. This was a constructive suggestion that would save money and introduce teenagers to workplace norms—showing up on time, dealing with a boss, and getting a paycheck. Williams opined that this idea was “insulting to all Americans but particularly black Americans.” Huh? How can it be “insulting” for a teenager, of whatever race, to do work previously done by an adult? (Memo to Juan: As an undergraduate at a fancy college, I did not find it demeaning to perform “janitorial work” such as wiping table tops, sweeping floors, serving food and putting out the garbage.)


What should be Republicans’ approach to the problem? First, go on offense. Blame Democrats for failed policies that inhibit hiring and poverty reduction. Philadelphia is a Democratic city in a Democratic state; taxes are through the roof; only 3 of the 15 biggest employers are private firms. Democrats there, as in other big cities, are more interested in enriching public employees than promoting economic growth. As for specific policy suggestions, here are four: 1) push for school vouchers for inner city parents; 2) Embrace reforms suggested by Rand Paul, such as reducing sentences for having small amounts of marijuana; 3) Reform entitlement programs that phase out with higher incomes; they impose enormous marginal “tax rates”—the more you earn, the less you keep of the incremental dollar, because you lose benefits. 4) Encourage job growth with such reforms as repealing Obamacare, corporate tax reform, and an “all of the above” energy policy that creates jobs and lowers energy costs.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Bloomberg Befuddled by Racial Incorrectness

It’s not often I have money-making advice for Mike Bloomberg, but here’s a suggestion: You could improve the ratings of Bloomberg Radio/TV by finding one or two conservatives to spice up the conversation, as Joe Kernen and Rick Santelli do on CNBC. Some spirited disagreement would elevate both the entertainment value and the intellectual level.  We might even occasionally hear the words “Obamacare” and “structural unemployment” in the same sentence. Right now, Bloomberg TV’s notion of political diversity is to balance a Manhattan liberal from the upper west side with a Manhattan liberal from the lower east side—perhaps leavened with a couple of West Coast liberals.  It gets kind of boring . . . . except when the on-air liberals have to contend with – eeek – a real, live conservative.

A case in point is “The Hays Advantage” with Kathleen Hays and Vonnie Quinn. Much to their credit, they invited as a guest the WSJ’s Jason Riley, to talk about his new book Please Stop Helping Us. Riley—did I mention he’s black!—argues liberals are doing far more harm than good by “helping” blacks with supposedly well-intentioned measures like affirmative action and raising the minimum wage. These initiatives harm the average black person while empowering paternalistic liberal elites that pretend to be protecting downtrodden blacks from racist conservatives—despite the manifest failure of liberal policies to improve the lot of poor blacks. Because they find this anti-racist posturing so personally satisfying and politically expedient, Riley argued, liberals try to destroy any black opponent of racial paternalism by labeling them an “Uncle Tom.” Which is why Riley was very courageous to write the book.

Riley told Hays and Quinn that what poor blacks need to get ahead is not more “help” from liberal elites but, rather, embracing traditional habits of self-help – finish school, get a job, get married, take care of your kids, save some money. Too many blacks dismiss such behavior, Riley said more than once, as “acting white.”

Alarm bells sounded in the liberal brains of Hays and Quinn. Despite their best efforts to play it cool, you could hear the consternation and confusion in their voices as they probed and challenged this wayward black conservative. “Aren’t the behaviors you describe also characteristic of other poor people?” Quinn wanted to know. Late in the interview, Kathleen Hays asked the standard liberal question: “What should Washington do?” To which Riley answered “Stop! Stop trying to help us.” What blacks need is self-help, not help.

Riley ended with a searing indictment of liberals’ cynical opposition to school choice: “President Obama has never found a public school good enough for his own children, not before he was president, not since he became president. Yet since the day he entered the oval office, he has been trying to shut down school voucher programs right there in Washington DC that would give the black poor the same educational options that his own children have.”

You don’t hear conservative common sense like that on Bloomberg very often.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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How Overvalued Are High Yield Stocks? We Deploy the PETTR Principal

Today’s 30-point sell-off in the S&P 500 is consistent with my warning a few weeks ago that the Fed was “behind the curve.” It made no sense, I argued, for Chair Yellen to still be pursuing an emergency monetary policy, with zero short rates and continued bond buying, five years into an economic expansion that is finally gaining some traction. Fear of rising inflation could hit the bond market hard, particularly because Dodd Frank has dried up capital on the trading desks of those nefarious investment banks.

That warning has been validated by a 4% GDP print for Q2 and a 0.7% jump in the ECI (Employment Cost Index)—figures that obviously are not consistent with a labor market that has plenty of “slack.” Throw in “unrest” in Ukraine and Gaza, stiffer sanctions on Russia that will hurt European “growth,” and incoherent domestic policy with respect to tax policy, the Texas “border,” etc. and you get a 2% sell-off which may get worse.

The stocks most at risk of a bursting bond bubble are “bond surrogates” such as utilities with juicy dividend yields. They have looked expensive to me for quite a while but performed well as investors “reach for yield.” Which got me to wondering—how over-priced are these “bond surrogates,” some of which I own? So, I turned to my oh-so-sophisticated valuation model, the PETTR Principal, which is the equation:

PETTR Ratio = (PE of the stock on consensus 2014 EPS) / (dividend yield + long-term EPS growth rate)

So, for a stock with a PE of 16x, a dividend yield of 2%, and a growth rate of 11% the PETTR ratio . . .

=16 / (2+ 10)

= 1.33

(In this equation, the PE ratio and the dividend yield are established fact; the growth rate you have to estimate based on your knowledge of the company and economy. No database will provide it. And remember this is about the future, not the past; extrapolating the past four years probably won’t work too well.)

Solving for the Growth Rate Consistent with a PETTR Ratio of 1.5

The stocks I own—a broad selection of quality growth stocks—have an average PETTR of 1.5. So, I looked at a group of “bond surrogate” stocks – 8 electric utilities, the 2 big telecoms, 3 consumer staples, and 4 big pharma names—and asked “What growth rate do these names need to have, for their PETTR Ratio to be 1.5?” For example, AEP has a PE of 15.3x and a dividend yield of 3.8%, so it would need to have a growth rate of 6.4% for the PETTR ratio to be 1.5—that is, 15.3/(6.4+3.8)=1.5.   The next step is to look at that 6.4% growth rate and ask “Is this figure look realistic, given analysts’ EPS estimates for the company, and what we know about the state of the industry?”

Before we get to the results, consider a few characteristics of the 17 “bond surrogates” studied:

  • Their average dividend yield is 3.9%, about twice the S&P 500
  • Their average PE is 16.7x, about the same as the S&P 500
  • Their dividend payout ratio averages 64%, about twice the S&P 500—which, by definition, means their retention ratio (1 minus payout ratio) is half the S&P 500.

These facts suggest their growth rate should be less than the S&P 500, because the very high payout ratio and low retention ratio mean they have comparatively little capital to reinvest in their business to generate future earnings growth.

Anyhow, here are the results:

  • For all 17 companies, the average growth rate needed to have a PETTR ratio of 1.5 is 7.3%; the median is 6.2%. These figures are not ridiculously high, but they do look too high for 17 big, mature companies with very high dividend payout ratios. Judging from history and the current weak state of the global economy, the future EPS growth rate of the entire S&P 500 (which includes many fast-growing companies) is probably 6%. These companies will probably grow  only 4-5%, not 6-7%. Bottom line: as a group, they do look overvalued.
  • From a “bottom-up” perspective, when I examine the individual companies and compare the growth rate consistent with a PETTR ratio of 1.5 with my best guess at the “actual” future growth rate (based mainly on analysts’ estimates over the next three years), on average the actual growth rate is 1.2% lower. Again, they look overvalued.
  • Most overvalued are the electric utilities, where the actual growth rates look to be 2.2% (220 bps) less than the growth rates consistent with a PETTR ratio of 1.5. The industry faces slow growth because demand for electricity is slowing, plus the government-subsidized “roof-top solar revolution” will hurt growth as consumers produce their own power. Companies may be obliged to maintain transmission infrastructure while they are starved of revenue from generating power. I would avoid all electric utilities that are not restructuring stories or “special situations.”
  • The two telecoms, VZ and T, look reasonably valued; VZ looks cheaper than T.
  • The three consumer staples (MO, PM, KRFT) also look reasonably valued, though not as cheap as tobacco stocks used to be.
  • The four big pharma names (MRK, PFE, BMY, JNJ) look rather expensive. On average their growth rates look 120 bps lower than the figure consistent with a PETTR ratio of 1.5. I admit the growth rates are idiosyncratic and hard for an amateur like me to assess; they depend on the ability of these companies to develop new drugs. JNJ has been doing this lately, but in general big pharma has a poor track record of drug development over the past decade. Furthermore, Wall Street was treating Pfizer as a “streamlining” story that had shifted from an acquisitive behemoth to a more nimble, focused company—until it tried to acquire Astra Zeneca. This gives me pause. In general, the risk / reward in these names does not look compelling, although, again, it all depends on the specific pipelines.

Investment Conclusion: Avoid electric utilities, treat big pharma with caution.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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The Bianco Golden Ratio vs. Lew’s Inversion Perversion

Deutsche Bank’s ace stock market strategist David Bianco—a friend of mine and formerly a colleague—has devised a nifty new ratio to summarize the health of the U.S. economy. He calls it the Golden Ratio; I call it the Bianco Golden Ratio. It is real GDP growth / the inflation rate. More formally:

Yr/yr percent change in real GDP / Yr/yr percent change in CPI

David reckons that when that ratio is 1.6x or higher—for example, with GDP growth of 3.2% and inflation of 2%—the economy is in good shape. At such times, he writes, “productivity and capex are strong, interest rates are benign while providing decent returns to savers, and risk premiums are low and the job market is vibrant with prosperity gains broadly shared.” In general, PE ratios tend to be higher when these conditions prevail and the Bianco Golden Ratio is high. A few examples:

  • In the wonderful early 1960s (1961-65), GDP grew 5.1%, inflation was 1.3% and the Bianco Golden Ratio was a sky-high 3.92.   In these years, the trailing PE of the S&P 500 averaged 18.8x.
  • In the awful 1970s (1974-79) GDP – boosted by a surge of women and baby boomers into the workforce – grew 3% but inflation was 8.5%, so the Golden Ratio was an abysmal 0.4%. PE’s were very low, averaging 9.4X and just 8.4X if you exclude recessionary periods when PE’s were boosted by depressed earnings.
  • In the late 1990s (1995-99) GDP grew 4.1%, inflation averaged 2.4%, the Bianco Golden Ratio was 1.9x, and PE’s averaged a lofty 21.2x. Obviously a bubble developed late in the decade; before then, in 1995 and 1996, PEs averaged 16.2x.

Crappy Economy, High PEs—Huh?

Against these three earlier periods, the current situation is anomalous—crappy economy, high PE ratios. Since the beginning of 2011, GDP growth has averaged a pathetic 2.1% and inflation is about the same, 2.2%; therefore the Bianco Golden Ratio is about 1x.  Despite this poor performance, PE’s have averaged a fairly high 14.7x since 2011 and—more importantly—over the past year the S&P 500 PE averaged a lofty 16.9x.

So why are PE ratios high despite poor U.S. economic performance? That’s a complicated question with several answers. Better than average corporate management, and share-holder friendly use of cash are important. But the cause I would highlight, and the one conventional economists continue to miss, is: Regulatory mismanagement is restraining economic growth, especially employment growth, which is prompting the Fed to keep rates low, forcing investors to buy stocks to get a decent return. I still see no evidence Chair Yellen has figured this out.

Looking at the litany of regulatory blunders by the Obama Administration, arguably the most egregious is failure to reform corporate and individual taxes, despite bipartisan desire to do so. The Stimulus had some Keynesian logic, even if it became a slush fund for Democratic special interests. Dodd Frank may be a monstrosity, but Wall Street did need reform. Obamacare may be one of the worst laws in American history, but expanding healthcare access is a worthy goal.

On the other hand, refusal to reform America’s antiquated corporate tax code – with its excessive rates and global incidence that force firms to keep trillions of dollars offshore—is pure negligence, born of Obama’s anti-capitalist ideology. The President simply hates the idea that, properly incentivized by a rational tax system, companies can do good (like creating jobs) while doing well. His reform proposals have all centered on taxing the foreign profits of U.S. firms, which is a non-starter in Congress. Result: no reform.

Lew’s Inversion Perversion

Now Obama’s tax reform negligence has turned into a crisis, as one company after another acquires a foreign firm to do a tax inversion that will permanently raise its return on capital—and likely its PE ratio—by lopping about 1000 bps off its tax rate. This is not a new phenomenon; Wall Street nerds, myself included, have been discussing it for about six years. But the trickle has become a flood as more and more companies invert A) because they decided Obama will never reform taxes, B) to remain competitive with industry peers that have already done it, C) to get it done before a punitive preventive measure is passed.

Having belatedly noticed the inversion flood, which could become a tsunami, Treasury Secretary Lew wrote a letter to Democratic Senators on the topic. He starts out by noting that “the President has called for undertaking business tax reform as a way to improve the investment climate.”   Which is true—Obama “called” for reform but did nothing to make it happen, like compromise with Republicans. Then Lew asks for a stop-gap measure to prevent inversions, even though it would become a barrier to comprehensive reform. Echoing the sophomoric rhetoric of his boss, Lew opines, “What we need as a nation is a new sense of economic patriotism, where we all rise or fall together. We know that the American economy grows best when the middle class participates fully and when the economy grows from the middle out.”

Lew knows this proposal will get nowhere. He is simply trying to turn a policy failure into a campaign issue for Democrats. But his letter goes far toward explaining why we have a crappy economy and high PE’s. Companies have managed  to protect themselves from regulatory incompetence with such moves as inversions and low capital investment that limits capacity growth and protects profit margins. This helps shareholders but not average workers, who are hurt by Obamacare, the War on Coal, higher tax rates on entrepreneurs, etc. Consequently profits as a share of GDP are near record highs while the Fed’s zero-rate policy keeps valuations high. Wall Street flourishes while Main Street struggles—not exactly the “hope and change” Obama promised in 2008.

Maybe the Grass Really Is Greener in 2017

The good news is that Obama leaves office in thirty months (but who’s counting?). Hopefully his successor, even if it is Hillary, will adopt policies that promote rather than hinder economic growth. Then the Bianco Golden Ratio will move up, justifying elevated PE ratios even if interest rates are higher than they are now.

Copyright Thomas Doerfligner 2014. All Rights Reserved.

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Skip Piketty; Read Easterly

Here’s all you need to know about the most popular, least read, business book of the year. In his ponderous, repetitive, tedious, tortuous, tendentious, repetitive tome on the evils of inequality, Capital in the Twenty-First Century, Thomas Piketty, in the process of advocating for redistributive policies that—as I predicted two years ago—have failed spectacularly in his native France, unwittingly makes a great case for privatizing Social Security in the United States.

Piketty claims rising inequality is inevitable because investors’ return on capital exceeds the growth rate of GDP and workers’ incomes. If he is right, the best way to reduce inequality is to encourage workers to invest in stocks and bonds. Social Security prevents this by confiscating wages that workers could have saved and invested on their own account, creating middle class wealth that can be passed on to their kids. If you believe Piketty, reforming Social Security to permit this process of middle class fortune building is a no-brainer. In addition to reforming Social Security, Republicans should propose other reforms–such as creating 401K plans for all adults—that encourage workers to invest in stocks and bonds.

Easterly’s The Tyranny of Experts – a Brilliant, Iconoclastic Assault on Econo-Conventional Wisdom

William Easterly, an economics professor at NYU, is an expert on international development who takes a properly jaundiced view of his own profession. Years of seeing pompous, know-it-all development “planners” like Bill Gates and Jeffrey Sachs formulate costly schemes that fail to reduce poverty have given him a fresh perspective on the whole topic of economic growth, in both developed and developing nations. Here are a few insights:

  • The World Bank, IMF, Ford Foundation, etc. practice “authoritarian development.” Planners routinely ignore the rights of individuals in favor of the state. Easterly prefers “spontaneous cooperation” of individuals via markets, as opposed to “conscious design” by out-of-touch experts.
  • Top-down planning fails because planners simply do not have the necessary knowledge of on-the-ground local conditions, nor do they have an incentive to maximize the utility of the local population. For example, Thomas Jefferson thought the Erie Canal, the most successful infrastructure project in American history, was a really, really dumb idea; it had to be planned and financed by local politicians in the State of New York. One thinks immediately of Obamacare, where Ivy League professors and Congressional staffers force small businesses to use insurance policies the planners refuse to use for their own families. (Ivy League health insurance plans all brag about the “choice” and “flexibility” they offer participants; Jane and Joe Doe get no such choice.)
  • Planners place excessive emphasis on the performance of nations, when in fact patterns of development are regional—the countries in Latin America or sub-Saharan Africa tend to share similar problems.
  • Markets are “associations of problem solvers” using the price system to equilibrate the utility of consumers and the income of producers. Bureaucracies (think the Veterans Administration or the IRS) don’t answer to consumers; they answer to other bureaucrats and so have no incentive to maximize the utility of consumers.
  • One of the best ways to reduce poverty is immigration—whether from West Virginia to Ohio, or from Haiti to Florida. Plus, successful immigrants often send money back home to relatives, alleviating poverty in their home country. Liberal pundits (such as Alan Blinder in a recent WSJ column) routinely ignore how rising immigration necessarily increased “inequality” in the U.S. since 1980, even as it alleviated the poverty of immigrants and their relatives in the home country to whom remittances were sent. By the way, measured inequality in the U.S. is lower than it appears precisely because immigrants send money home, making the American residents appear poorer than they actually are.
  • Breakthrough technologies, such as the horse-drawn cart or the railroad, are often constructed from prior technological innovations. (In the case of the railroad, rails were originally used in mines, and steam engines were first used in factories and steamboats.)
  • Clueless development experts often operate with a “blank slate” – they have zero knowledge of the historical circumstances of particular countries. You might find an expert on Asia writing a detailed plan for how Brazil should be developed. We are now seeing the results of “blank slate” thinking in foreign policy; I doubt folks in the Bush Administration understood the significance of the Sunni / Shia schism before they invaded Iraq.
  • Here’s an insight from one of Easterly’s colleagues in the anti “development” fraternity, Dambisa Moyo: Development aid tends to undermine the political and economic power of a nation’s indigenous business community, because corrupt rulers can take a cut of the aid dollars while ignoring the needs of business community. Result: the rulers get rich but the economy remains under-developed. I suspect something similar has happened in the U.S. African-American community, where politicians and “community leaders” spending government money have more influence than black entrepreneurs and professionals.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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