Politics Uber Economics: Europe’s “War Between the States”

Today’s Wall Street Journal carries an article by Princeton economist Alan S. Blinder titled “Enough With European Austerity, Bring on the Stimulus.” The Financial Times carries similar columns every day of the week and two or three times in the weekend edition.  Come to think of it, I have written a few such articles myself.

Back to the Future

In reality, we are all missing the point. To get the proper perspective, forget about Europe for a moment and think back to the founding of the United States in the 18th and early 19th century. The nation was created by the Constitution ratified in 1788, but that document papered over the divisive issue of slavery with the “three fifths clause,” which apportioned Congressional representation based on 60% of a state’s slave population and 100% of its free population.

But as the U.S. expanded westward the slavery issue—the fundamental question of whether the U.S. would be a “free labor” nation or one that actively tolerated slavery—kept flaring up, threatening national unity. It was deftly finessed by politicians in the Missouri Compromise of 1820 (which admitted Maine as a free state and Missouri as a slave state) and the complex Compromise of 1850, but the “popular sovereignty” solution in the Kansas Nebraska Act of 1854 led to open warfare in those states. The Civil War finally settled the issue, making the U.S. “one nation, indivisible” that was free of slavery, but still extremely racist.

Nation Building in Europe

Europe is going through a similarly tortuous and torturous process of nation building that may continue for decades. Although its economic benefits have been touted over the years, the European Union was created primarily for two political reasons:

  • Avoid World War III by getting Germany and France to embrace;
  • A united Europe would be a Great Power, coequal with the U.S., China and (once upon a time) the Soviet Union.

The goal is unity and national greatness—but on whose terms? The terms of Germany (orderly, efficient, disciplined, rational, ever on guard against inflation) or France and Italy (far less so on all counts). Germany believed the strict rules requiring balanced budgets would force France and Italy to pursue economic policies consistent with German values; there would be gradual economic, political and social convergence.

But Germany’s expectations of national convergence turned out to be incorrect. Erasing profound national differences that developed over many centuries cannot be erased in a few years. And it doesn’t help that the E.U.’s structural design—one currency, one central bank, multiple fiscal policies, distinct labor markets—is simply dysfunctional, because it prevents weak national economies from having an accommodative monetary policy and weak currency.

The great divide between Europe’s North and South was revealed to me when we were vacationing in Florence a few years ago and hired a driver to take us out to Villa Gamberaia, a beautiful garden in the suburbs that overlooks the city. The driver was bitterly criticizing the corrupt politicians in the Italian legislature, who get big salaries and lots of perks for not much work. I asked the driver, “Is there a split between Italy’s hardworking businesslike North, centered on Milan, and the more easy going mores in the South, centered around Naples?” He replied that there really was not much difference between North and South—except, of course, that the South was substantially controlled by the mafia.

Oops. That’s what Germany is worried about. It does not want to let its balance sheet be used to subsidize organized crime in Italy and socialism in France.

The Germans are not dumb. They understand perfectly well the Keynesian arguments made by Alan Blinder, Paul Krugman, the FT’s Martin Wolf, etc. But they are playing for higher stakes than next year’s GDP print. When we see Germany demand that France and Italy balance their budgets and carry out “structural reforms” such as cutting taxes, allowing firms to fire workers without going to court, and getting rid of France’s 35-hour work week, we are not just witnessing an argument over economic policy. We are witnessing a political struggle about the character of Europe, similar to the standoff between America’s North and the South prior to the Civil War.

The problem for Europe is that while this political stand-off goes on the European economy stagnates, unemployment hangs around 10% and much higher for the young, and extremist political parties gather strength. Average voters won’t put up with decades of misrule by a well-compensated, ineffectual elite. I have no idea how this ends, but it won’t be pretty. Hopefully Europe can build a united nation more amicably than the United States managed to do in the nineteenth century.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Cuomo and de Blasio Must Be Reading My Blog

A couple of days ago I suggested the Obama administration should provide some positive incentives for doctors and nurses to help out in West Africa, in order to get beyond the ideological stalemate over quarantines.  I recommended they be paid $15,000 when they completed their quarantines.

Comrades Cuomo and de Blasio have followed my advice. The New York Post reports, “The state and city will ensure that workers who travel to Ebola-afflicted areas will not lose their jobs or benefits while abroad, according to the plan. The state also will reimburse returning workers who are quarantined and their employers.” It’s nice to see that someone in government has the imagination to take some constructive actions to fight Ebola in West Africa, instead of merely engaging in arid posturing about what “the science” does or does not dictate. The Obama Administration should take note.

Copyright Thomas Doerflinger 2014.  All Rights Reserved.



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Outbreak! – Lessons from London (1665) & Philadelphia (1793)

We are not hearing much about the horrific tribulations of the folks in West Africa, but we can start to appreciate their suffering by considering Philadelphia’s yellow fever epidemic of 1793. With a population of about 45,000, it was America’s political, economic, financial and cultural capital. When the fever struck, nearly everyone who could leave town did so; those who stayed in town used all manner of strategies and substances to ward off the fever.

The city’s esteemed medical community was clueless about how to fight the disease, though some doctors were more clueless than others. Aggressive treatment involved bleeding patients with leeches, inducing vomiting, and feeding them mercury. The fever was thought by many to be contagious and caused by the “miasma” emanating from decaying organic matter; a prime suspect was a pile of coffee rotting on the Arch Street wharf. Actually, yellow fever is spread by mosquitoes; the fever finally ended with the onset of frost. A splendid 1949 book, Bring Out Your Dead, by J.M. Powell, conveys the horror and mayhem caused by the disease, which killed a tenth of the city’s population. A few excerpts:

“Some cases began with violent chills and temperatures, others with languor and nausea. Stupor, delirium, vomit, slow pulse, bloodshot eyes, yellowness regularly succeeded. Sometimes patients remained sensible and conscious to the last. One man shaved himself just before he died.” [A common symptom was black vomit.]

“At once the very appearance of the street changed. People stayed indoors scouring, whitewashing, ‘purifying’ their houses, burning gunpowder, tobacco, and nitre, sprinkling vinegar. Those who had to walk abroad carried their tarred ropes or camphor bags and chewed garlic constantly, doused themselves with vinegar…” [Another supposed remedy was shooting guns and cannons.]

“Children were wandering in the streets, their parents dead at home. A laborer with the improbable name of Sebastian Ale hired out as a gravedigger. An old man, he had long since lost the sense of smell. He opened a grave to bury a wife with her husband who had died a few days before. His shovel struck and broke the husband’s coffin, from which emitted such an ‘intolerable and deadly stench’ that Sebastian Ale sickened immediately and in a day or two died.”

“Calamities multiplied beyond number. A man named Collins buried his wife, two daughters, a son, his son’s wife and child; he married again, buried his new wife, and died himself….” [Dolly Todd lost her husband, an up-and-coming Quaker lawyer, to the fever and later married Congressman James Madison of Virginia.]

The city’s government and social services broke down when they were needed most. They had to be reconstituted by exceptionally courageous citizens, one of whom was a one-eyed French merchant named Stephen Girard, who reorganized and operated the city’s makeshift fever hospital, a mansion called Bush Hill. Girard went on to become one of America’s richest capitalist, with a fortune of well over $3 million when he died in 1831.

Residential Quarantine in London

 The White House and CDC could learn a lot from A Journal of the Plague Year by Daniel Defoe, the prolific author who wrote Robinson Crusoe. It’s an unusual book. It’s a first person, you-are-there account of the rat-and-flea borne plague that ravaged London in 1665. Only Defoe was not there; he published the book in 1722 by piecing together contemporary accounts from newspapers, memoirs, etc.

A big issue for London then, as for the U.S. now, was quarantines and how to enforce them. The Lord Mayor and Aldermen of the City of London decreed that:

“No Person to be conveyed out of any infected House.” So if you, a family member, or one of your servants got sick with the plague, you were a prisoner in your own house, even if you were not ill. This could be a death sentence; as Defoe wrote, “This shutting up of houses was at first counted a very cruel and Unchristian Method, and the poor People so confin’d made bitter Lamentations.”

“Every visited House to be marked” with a big red cross on the front door.

“Every visited House to be Watched” by two government-appointed watchmen, one for the day and one for the night. These watchmen would run errands such as fetching food, fuel, etc.

Here was an extraordinary situation—the government making ordinary citizens prisoners in their own houses, even if just one member of the household came down with plague. The citizens did not cooperate. They sent the watchmen off on errands to buy food, and then broke the lock, or used a second key to open the lock, or broke through the wall to the next house, or bribed the watchman. On one occasion the watchmen heard violent shrieking and wailing in a shut house. They pounded on the door to learn what was the matter. No answer. At length they used a ladder to peer into the second floor bedroom; there they saw a woman dead on the floor. They opened the front door and discovered that the rest of the household had stolen away in the night.

Beyond “Science:” a Proactive and Rational Quarantine

 Contrary to the condescending “scientific” assurance of Federal officials, Ebola is not that difficult to get. Many well-trained western doctors have contracted the disease in Africa, as have two nurses in Texas. And it turns out that self-quarantines don’t work; we have three cases of people who had (or might have had) the disease traveling widely in America—the nurse who flew round trip from Dallas to Cleveland, the reporter back from Africa who got take-out from a Princeton eatery, and the doctor who spent an action-packed day jogging, bowling, dining and subway-riding in Manhattan right before (we hope) he became symptomatic. Basically, Americans today do not like to be “shut up” in their houses any more than Londoners did in 1665.

Clearly, then, it makes sense to quarantine anyone entering the U.S. from West Africa who potentially came in contact with Ebola. The Feds claim this will “isolate” West Africa by dissuading healthcare workers from traveling there. A simple solution is to enforce a stay-in-your house quarantine for all returning travelers, but to pay returning healthcare workers $15,000 for enduring the 21-day quarantine. The government could provide luxury quarters for those who did not wish to be quarantined in their house. This tells the health workers, “We love you, and we want you to help out in West Africa, but we won’t let you put millions of Americans at risk.”

Once again Obama has “led from behind” with disjointed, incoherent, indecisive half measures, instead of aggressively and proactively addressing a crisis. His ineptitude forced Governors Christie and Cuomo to improvise a policy that will inconvenience a handful of people but cut the risk that Ebola spreads in the U.S.

Copyright Thomas Doerflinger 2014. All Rights Reserved.


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FT: Obamanomics Failed, but Don’t Blame Obama

In a Financial Times column titled “The riddle of black America’s rising woes,” Edward Luce spins a convoluted alibi to absolve Barack Obama of his egregious policy failures. He may have been President for the past six years, and Democrats may have controlled Congress for two of them, but it’s all the fault of the racist Tea Party, don’t you know.

Let’s begin by giving Mr. Luce credit for noticing something U.S. liberals studiously ignore: Based on median household income, median net worth, labor force participation and other metrics, Obamanomics has been a disaster for black Americans. They fared far better under the heartless George W. Bush. But Mr. Luce assures us that “Obama is not to blame” for his sorry record because “by any yardstick – the share of those with subprime mortgages, for example, or those working in casualized jobs – African Americans were more directly in the line of fire” of the recession. “By no honest reckoning,” Luce avers, “can Mr. Obama be blamed for the decline in black America’s fortunes.”

Sorry. You Can’t Separate Obama from Obamanomics

Where to begin? The Luce narrative makes no sense because if blacks were particularly hard hit by the recession that would set up what Wall Street calls “easy comparisons” that made it all the easier for Obama to lift the incomes of poor blacks during the ensuing economic recovery. That didn’t happen; black median household income was lower in 2013 than the recession year 2009. Furthermore, Mr. Luce is actually insulting President Obama by insisting he was effectively a bystander during his own administration and had no substantive impact on the economy. Would that it were true. In reality Obama and the Democrats are responsible for the worsening plight of poor Americans, black and white (which is why inequality is increasing):

  • Obamacare discourages businesses from having more than 50 full-time workers, so part-time employment is proliferating. The U.S. labor market is starting to resemble that of Italy, where there are strong incentives for firms to have fewer than 15 workers.
  • Obamacare discourages hiring low-wage workers by promoting substitution of cheap capital (thanks to the Fed) for increasingly costly labor.
  • Transfer payments such as Food Stamps and Obamacare have the perverse effect of making it financially irrational for poor people to work more. The CBO estimates the equivalent of 2 million jobs will not be filled due to Obamacare; other estimates are higher. It is impossible for a poor person to “get ahead” if he or she doesn’t work. Result: lower social mobility and greater inequality.
  • Obama excoriated “millionaires and billionaires” (aka job creators) while sharply raising their taxes. Not exactly a confidence builder for entrepreneurs.
  • Dodd Frank cut small business lending by wrapping community banks in red tape.
  • Obama opposes charter schools, school vouchers, and school choice for inner city parents; terrible public schools are good enough for poor kids but not for Obama’s own daughters.
  • Obama attacked fossil fuels, thereby killing jobs and raising the energy costs of the poor.
  • Obama failed to reform America’s dysfunctional corporate tax code, which kept $2 trillion stranded offshore.
  • Obama failed to negotiate new trade agreements that would promote exports.

Mr. Luce attributes the loyalty of blacks to President Obama, despite his economic failures, to the racism of the Tea Party, as evidenced by such “dog whistles” as Newt Gingrich accurately calling Obama “the food stamp President” and a Congressman calling Obama a “liar” during a State of the Union Speech. Luce must have a very low opinion of blacks if he thinks they lay greater emphasis on those trivial ephemera than on substantive economic blunders that consign millions of Americans to poverty.

Here is what the Tea Party (including such blacks as Herman Cain, Dr. Ben Carson, Senator Tim Scott, Thomas Sowell and Lieutenant Colonel Allen West) really think. Obama’s statist policies have been just as harmful to poor Americans as Tea Party folks feared back in 2009. My own prognostications in this regard have been depressingly accurate. What is needed to move poor people off “the liberal plantation” and toward economic independence is a decisive shift from Obama’s paternalistic statism to a dynamic, fast-growing free enterprise economy that fosters strong job growth and rising incomes. That is what we had in the late 1990s under President Clinton and a Republican Congress led by Newt Gingrich, who cut the capital gains tax in 1997. Despite “rising inequality” during the tech bubble, the unemployment rate plunged to 4% and the median household income of black families rose a stunning 18% between 1995 and 2000.

Copyright Thomas Doerflinger 2014.  All Rights Reserved.

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Q3 Earnings: Off to a Strong Start

Based on results so far, I believe investors will conclude in mid November that third quarter profits were fairly good and better than feared. The big exception, which will surprise no one, is the energy sector, which will weigh on overall profit results even as weak energy prices buoy real growth in the U.S. economy (see below for details). Consider the early results:

Industrial looks OK so far. Fastenal, which is a bellwether because it distributes all kinds of industrial fasteners throughout the U.S., had an in-line quarter, with revenue growing 14.3%. Alcoa is a decent indicator of global demand in aerospace, autos and packaging. The CEO (who admittedly is chronically bullish) provided a positive, detailed, segment-by-segment, assessment of global aluminum demand. He continues to expect 7% growth in 2014.

Transportation; Fed-Ex, trucker J.B. Hunt (a leading player in the inter-modal market) and railroad CSX all handily beat estimates. Because these firms haul all sorts of products, from coal to semiconductors, this is positive for GDP.

Big Banks (JPM, WFC, C) all met or beat estimates, despite headwinds from weak mortgage demand and declining net interest margin due to low rates. Loan growth was strong; WFC’s CEO said “we had strong broad-based loan growth with our core loan portfolio up almost $51 billion or 7%.” Strong IPO and M&A activity show that “animal spirits” have improved in corporate America, notwithstanding global growth jitters.

Consumer: Costco, PepsiCo, Kroger and Domino’s Pizza all posted solid quarters, but YUM was more mixed due to continued problems in China.

JNJ reported a solid quarter and raised 2014 guidance (with the top end of the range above current consensus), but the stock traded down due to strength in a product that will be hurt by a new offering from Gilead.

Tech: Intel reported another strong quarter paced by strength in PC’s and servers, though mobile remains unprofitable. Linear Tech slightly missed estimates.

It is way too early for strategists to estimate with confidence what third quarter S&P 500 EPS will actually be, but we know enough to conclude that earnings will be acceptable, though not great. From a stock market perspective, this basically means “more Goldilocks” – gradual profit growth of 5-7%, faster dividend growth of 10-12%, and a super-easy Fed.

There simply is no evidence here of an implosion in global demand. Europe is weak, but what else is new? Yes, France and Italy remain near recession, but the UK is fairly strong and Germany can support growth with much-needed infrastructure spending, if it wants to. China continues to grow. As for the U.S., which still accounts for two thirds of S&P 500 revenue, its economy is decidedly stronger now than over most of the last three years.

As for the impact of weak oil prices on profits, the story is complicated and usually mangled by the financial media and the experts they interview. Especially in the near term (i.e., Q3 and Q4 and probably next year), weak energy prices are a net negative for profits. They clobber the profits of the energy sector (about 10% of S&P earnings) and also hurt industrial suppliers of everything from steel piping to compressors to trucks. This weakness is only partly offset by the positive effects of weak energy prices, namely A) lower costs for energy users such as transports and chemicals, B) stronger revenue for retailers, restaurants, etc. as consumers spend less on fuel for their vehicles and dwellings.

On the other hand, investors will be more impressed by a positive EPS surprise at a Starbucks, Delta Airlines, or Macy’s than by weak results at Exxon or Chevron. Another positive: lower energy costs help to prolong the economic expansion by boosting consumer spending and reducing inflationary pressures, which gives the Fed more leeway to keep rates low.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Seven Stock Picking Themes

I have argued that investors should “create their own conglomerate” of high quality companies, mostly growth companies that pay dividends, and own them for long periods of time. I know this sounds like just another dumb investment platitude. Now we have a practical example of what it means, in terms of real world decision making.

OMG, the Dollar Is Soaring

Wall Street is in a tizzy about the strong dollar, which will hurt the reported earnings of multinationals and depress commodity prices as denominated in dollars, which is bearish for energy stocks, gold stocks, other commodity stocks, and the industrial companies that supply them with capital goods. Analysts, strategists, and economists are busy revising their forecasts to take account of the strong dollar.

What should you do with your portfolio in response to the strong greenback? You should do very little, for a few reasons. For one thing, currencies are not forecastable, so you are wasting your time thinking much about them. (I, like many others, have incorrectly expected the Euro to weaken for the last three years.) For another thing, whatever effect a strong dollar has on companies’ earnings is already priced in; it’s too late. But most importantly, currency is not that important to a multinational firm with operations around the globe. Yes, eventually (like two years from now) the strong dollar may reduce U.S. exports, but it will increase European and Japanese exports, so the underlying impact of a strong dollar on the dividend paying ability of a large company is modest. And, to the extent the strong dollar reduces inflation and interest rates in the U.S., the reduction in earnings is offset—in terms of the stock’s price—by a higher PE ratio, because the discount rate for valuing the stock is lower. (This was apparent in the Fed minutes released yesterday; the strong dollar and weak growth in Europe, which are closely related, gives the Fed more leeway to keep monetary loose.)

As an aside, a recent report from BAC reported that only 20% of fund managers were beating the S&P 500 so far this year. One reason is that—because their performance is evaluated annually—they have to try to react to things like currency swings, even though they cannot do it successfully. They just run up transaction costs and their clients’ tax bills.

Think Thematically

Forget about currency and save your brain power for something more important: Identifying long-term trends in the world economy and high quality companies that stand to benefit from those trends, enabling them to pay a decent dividend and to raise that dividend over the next decade. This is a two-part process:

  1. identify the trend
  2. identify the winners, as well as the losers you should sell or not buy.

Here I only do (1) by suggesting seven specific themes; for (2), talk to your broker or do your own research, in order to find good companies that really are leveraged to the theme. (Some themes are far more “investable” than others; it is hard, for example, to find stocks that are leveraged to the looming global water shortage.) Thinking thematically is not only a good way to identify stocks to buy; it is also a good way to identify stocks to sell and stocks not to buy even though they appear to be “cheap.” I also like thematic thinking because it gets you away from abstract “strategy speak” dualities such as high beta / low beta, cyclical / defensive, large cap /small cap, domestic / foreign; instead you are thinking about the “real world” — real businesses and what they do for a living, and how their prospects are affected by real world trends.

Why the Street Pays Little Attention to Themes

Note that many themes last for years and years. I first started writing about income inequality and the need to avoid the “mediocre middle,” such as department store chains, in the 1980s. The theme is still valid, especially with Obamanomics hurting the poor and middle class. Despite all the brain power on Wall Street, it does a poor job of identifying, and acting upon, themes. The most important clients, hedge funds, want short-term ideas with a “catalyst.” Wall Street thrives on “incremental information” – the “new news” that no one else knows yet, even if it is not particularly important news. A portfolio manager will hang up on a salesman who tells him that Nike is a good long-term play on the fitness craze and the emerging market consumer; that same PM will listen to the salesman if she says, “our analyst was on the road with the Nike CFO, and he seems more bullish on demand in China.” Analysts often ignore obvious themes – such as the fact that Coca-Cola makes you fat, so people will drink less and less as they get older — for a couple of reasons. For one thing, analysts are constantly talking to managements in the industry (who are chronically bullish), and to investors who own millions of shares of the stock. Another reason: analysts almost “have” to recommend something in their industry because they have clients who want to know what is their “best idea in the space” (in this case, beverages).

Seven Themes

More and Safer Rail Cars: The fracking boom and irrational government opposition to pipelines have vastly increased demand for rail cars to transport oil, as well as inputs such as sand. But oil-by-rail is dangerous, as shown by a disastrous accident that destroyed the Canadian town of Lac-Mégantic and killed about 45 people (the figure is approximate because some victims were vaporized). Regulators are belatedly demanding better / safer rail cars, both new ones and retrofitted cars. Apart from energy, demand for rail cars is robust due to strength in such areas as agriculture and chemicals (see below) as well as a shortage of drivers for long-haul trucking. This is bullish for certain industrial companies involved in making or rebuilding rail cars, as well as the railroad industry generally.

The Cloud Commoditizes Tech. This is one I don’t know much about. But basically computing power is shifting from individual customers having their own customized hardware and software (provided by companies such IBM, HPQ, ORCL, etc.) to the cloud – i.e., giant server farms. The server farms use huge numbers of cheaper computers, which threaten the margins of incumbents. (This is similar to the shift in the electricity industry in the 19th and early 20th centuries from every building having its own generator to buying power from a utility company such as Commonwealth Edison.) The shift to the cloud is good for some companies, bad for others. One implication is that some apparently cheap stocks will get cheaper and eventually go out of business. A smart hedge fund with access to the best Wall Street analysts could probably put together a nifty long-term long/short trade on winners and losers.

More pork and chicken with that rice. Chinese consumers want to eat better, which means eating more meat. But producing meat, whether chicken, hogs or beef, requires large amounts of feed such as corn and soybeans. That is bullish for the big agribusiness companies. The biggest U.S. export to China is not airplanes but soybeans. As the CEO of Deere recently noted, the profits of ag stocks have been hit by an unforeseen “extreme weather condition” – good growing conditions around the world, which have depressed corn and soybean prices. But strong Asian demand for corn and soybeans as feed for livestock, plus the likelihood that weather conditions will change for the worse, suggest that now is not a bad entry point for long term investors to buy the best global ag companies. They have strong franchises because of big R&D budgets, sprawling dealer networks, and close ties to farmers who are disinclined to take risk a growing season on new and unfamiliar suppliers of seeds, equipment, fertilizer, etc. Performance minded fund managers are scared of weather-dependent stocks, but long-term investors don’t have to worry much about the weather. A smart friend of mine who has worked for some of the best strategists and economists on both the Buy and Sell-side of the Street told me he is buying these names because they look cheap based on normalized earnings.

Spending More on Healthcare. This is a no-brainer, which suggests I don’t have a brain because I only acted on it in the past few months. Obamacare is taking money out of the pockets of tax payers and individuals who had what they considered adequate health insurance (and now have to pay much more for Obama-mandated plans) while funneling it to uninsured people who will spend more on healthcare. (For example, the health bills of 30,000 Wal-Mart workers are going up.) The trend is broadly negative for consumer spending but bullish for healthcare, which is the S&P 500 sector with the strongest earnings trends—both in the recent past and in analysts’ estimate revisions.

The Electronic Fuel-efficient Car. Whether or not they go electric, cars and trucks will contain more and more electronic content which will make them safer and more fuel efficient. It is ridiculous that new cars and trucks still have “blind spots” making it hard to change lanes; nor do they have automatic braking systems so that vehicles don’t plough into stopped traffic, creating catastrophic accidents such as the one on the New Jersey Turnpike that injured Tracy Morgan and killed James McNair. The new technology would pay for itself via lower insurance and litigation expense. As improvements are made, vehicles’ electronic content—the number of chips, connectors, wires, etc.—will increase, and so will demand for things like turbochargers that make them more fuel efficient. A buy-side strategist for a big firm told me he expects Apple to move into the vehicle space, which I had not thought of.

Purity Plays. In a rapidly globalizing world, Ebola is just the latest example of contaminants that governments, companies, and consumers need to monitor in order maintain health and safety. (Other examples: SAARs, AIDs, fake Chinese medicines, tainted meat, tainted fish, lead paint on toys, mercury smokestack emissions.)  Companies that aid in that process, whether by producing lab equipment, sanitizing factories and hospitals, testing food for salmonella and e-coli, measuring / minimizing factory emissions, providing laboratory services, etc. will continue to experience strong secular demand. Around the world, government regulations to maintain purity are becoming ever more stringent.

Reconfiguring the U.S. (and Global) Energy Infrastructure. The fracking boom and rapid drop in oil and especially natural gas prices are making the U.S. energy industry—broadly defined to include oil refining, chemicals, plastics, fertilizers, LNG exports, etc.—extremely competitive globally. Eventually Washington will permit exports of oil and gas, something Tom Friedman recently recommended on economic and strategic grounds (we made the case last March). U.S. firms are building their new plants in Louisiana and Texas rather than Saudi Arabia and Dubai. Foreign firms, including giant German chemical companies facing skyrocketing energy costs at home, are also migrating to the U.S. gulf coast. U.S. industrial firms will continue to benefit from these trends.

Copyright Thomas Doerflinger 2014. All Rights Reserved.


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Global Plague (Not Ebola – Econo-Imbecility)

Stock market jitters are not surprising. I have been shamelessly straddling the equity fence, saying rising earnings and low rates would enable stocks to “grind higher” but nevertheless the “risk of a correction” is high due to excessive complacency. Investors are spooked by weak global growth, which is driven less by debt-driven “secular stagnation” than by terrible economic policy. You know the world is in trouble when Obama’s economy looks relatively robust. Consider:

Europe: The Eurozone’s single currency and seventeen fiscal policies are an absurdity only a cabal of bureaucrats could dream up. There have been no structural reforms in Italy or in France (which still has a 35 hour work week). Choking on bad debt and cramming for their stress tests, banks are deleveraging rather than lending. Oblivious of deflationary risk, Germany refuses to recognize that A) countries can’t cut their sovereign debt to GDP ratio when GDP is stagnant and B) it is impossible for all countries to run trade surpluses simultaneously. Meanwhile Germany’s high-cost energy program slows growth and strengthens Putin. The ECB is out of bullets; still lower rates would not help much in any event.

United States: Corporate CEOs deserve combat pay because they have to fight Washington every step of the way. Obamacare has created a part-time economy, exacerbating poverty and inequality. Banks’ shake-down fines constrain lending and business confidence. Obama nixes corporate tax reform that could repatriate $2 trillion. We have no immigration reform to attract tech talent. We have not ended the ban on oil exports—a “no brainer” on both economic and geo-political grounds. Obama opposes the Keystone Pipeline, a “shovel ready project” costing taxpayers nothing, even though pipelines are safer than oil-by-rail.

Japan. Abenomics is worth a try, and it has succeeded in depressing the Yen. But exports are still down year / year, because many firms have built capacity outside Japan. And a weak yen increases the cost of imports, including energy, which depresses consumer spending power; so do big hikes in the sales tax needed to manage Japan’s huge debt load. Still no sign of structural reform or immigration reform that would grow the labor force.

Submerging markets:

  • Following a huge credit bubble, growth in China is being dragged down by a real estate slump.
  • Russia is a kleptocracy with a cunning leader but a plunging currency.
  • Brazil has an inflation problem (over 6%), and the economy is in a slump; real GDP will only grow about 0.5% this year.
  • Argentina: don’t ask.
  • Venezuela: don’t ask.
  • In India, Mr. Modi is a big improvement. But will he really reform a corrupt socialist bureaucracy that keeps hundreds of millions of people in poverty? Two tells: Will he reform India’s corrupt food subsidy program (which wastes billions and blocks international trade deals), and will he build enough electricity capacity to end frequent blackouts?
  • The Middle East is in turmoil from Libya to Pakistan; Israel is a lonely island of sanity and stability.
  • Africa is growing but from a very low base. The tragic situation in West Africa highlights the fragility of its civic infrastructure, not to mention the feckless incompetence of the global elite. On August 8 the UN announced that the Ebola outbreak was a PHEIC (“Public Health Emergency of International Concern”). But Obama was about to go on his Martha’s Vineyard vacation and didn’t get around to sending troops to Africa for another 38 days. Pathetic.

The Bright Side

Pervasive econo-imbecility has produced the “secular stagnation” that Larry Summers blames on the global credit cycle rather than on policies he helped to put in place. Aside from the fact that the problem is deflation not inflation, we are actually in a situation similar to the late 1970s: global economic policy is so terrible that there is ample room for improvement. A Republican Senate would ameliorate the U.S. situation; a Republican in the White House could work wonders because the underlying economy is sound (unlike the 1970s). France and Italy may rediscover capitalism. Germany may figure out that it cannot prosper as an exporter when most of its customers are in recession. Stronger global economic growth would not necessarily be extremely bullish for stocks, however, because it would eventually lead to higher interest rates. But that’s a high-class problem we can all learn to live with.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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The Poverty and Inequality Party

Between 2001 and 2008 it was impossible to discuss economic issues with a liberal without getting a stentorious sermon about the evils of the “Bush tax cuts for the rich” and the resulting surge in income inequality. Now the Bush years are looking like the “good old days” because poverty and inequality have surged under Obama, even though we are in the sixth year of economic expansion and high earners were hit in 2013 with two big tax hikes that were supposed to reduce inequality:

  • A tax rate of 39.6% (up from 35%) on incomes above $400,000 for single filers and $450,000 for joint filers.
  • Obamacare imposed an extra 3.8% tax on capital gains and dividend income for filers who have above $200,000 (single) and $250,000 (joint filers) in adjusted gross income.

The Fed and Census Agree: Obamanomics Sucks

Two authoritative studies released earlier this month document the increase in poverty and inequality under Obama. The Federal Reserve’s Survey of Consumer Finances, which examines in minute detail changes in Americans’ finances from 2010 to 2013, discovered a big increase in income inequality. Specifically:

  • “Between 2010 and 2013, mean (overall average) family income rose 4 percent in real terms, but median income fell 5 percent, consistent with increasing income concentration during this period.” (emphasis mine)
  • “Families at the bottom of the income distribution saw continued substantial declines in average real incomes between 2010 and 2013, continuing the trend observed between the 2007 and 2010 surveys.”
  • Only families at the very top of the income distribution saw widespread income gains between 2010 and 2013, although mean and median incomes were still below 2007 levels.” Most of the gains were in the top 3% of the income distribution.
  • As I detailed in a recent post, Main Street small businesses have suffered under Obama, with the exception of businesses owned by rich people.

Then we have the annual publication from the U.S. Census, Income and Poverty in the United States: 2013. A few highlights:

  • During the Bush years 2001-2008 (which included a slow recovery from the 2001 recession and the start of the 2008 recession), median household income averaged $55,230. In 2013 it was just $51,939, or 6% less. For blacks it declined by 8%, from $37,621 to $34,775.
  • The poverty rate, which averaged 12.45% under Bush, was much higher in 2013 at 14.5%. Six years into an economic expansion, the poverty rate is still at a recessionary level, equal to the recessions of 1980-83 and 1991-93 and above the level in 2001.
  • Inequality has climbed. The ever popular Gini coefficient rose from an average of 467 in the Bush years to 476 in 2013.
  • Another way to measure inequality is to ask “How much more does a rich guy in the 95th percentile of the income distribution earn, compared to the median or 50th percentile?” This metric has also climbed sharply. During the Bush years, it averaged 3.56; now it is 3.78x, meaning if the median guy earns $50,000 the rich guy earns $189,000, up from $178,000 in the Bush years.

Part-time Nation

Bottom line: Obamanomics has been a disaster for the poor and middle class. Tax increases, Obamacare, Dodd Frank, Obama’s anti-business rants, the war on fossil fuels, bank shake-downs, absence of tax reform or foreign trade deals—the litany of economic malpractice is too familiar to dwell on. With one exception: the shift to a part-time labor force was a major driver of the drop in median incomes. In the WSJ, William A. Galston notes “In 2007, 108.6 million Americans were working full time, year round; in 2013 only 105.9 million were doing so….[from 2007 to 2013] the number of Americans working part time who wanted a full-time job jumped to 7.2 million from 4.6 million.” (Note that the 2.7 million decline in the full-time workforce is virtually the same as the 2.6 million rise in the part-time workforce.)

Like other liberals, Galston ignores the obvious role of Obamacare in corrupting the U.S. job market, even though the Congressional Budget Office estimates the law will cut the equivalent of two million jobs as people elect not to work in order to get benefits. Obviously low-income people will remain poor and dependent if they are not working full time.

The Prosperity and Opportunity Party

The challenge for Republicans is obvious but, for them, daunting: Convince voters, in an optimistic, forward-looking, Reaganesque way, that the GOP’s pro-growth policies will dramatically improve economic conditions for poor and middle class voters, men and women alike. More and better jobs. Lower energy costs. Lower taxes. Less burdensome regulation. More opportunity for their kids. Republicans need to be articulate, specific, and persuasive, going beyond stock slogans like “free enterprise” and “job creators” and “where are the jobs?” and “crony capitalism” to a clear and compelling description of steps they will take to improve the economy for the middle class. The emphasis should be on helping workers who have been screwed by rich Democrats.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Gross-Out: End of an Era

The news flash crossed the wires at 8.29 AM. CNBC’s Becky Quick was astounded. Bloomberg’s Tom Keene was stunned. They had to double-check that the William H. Gross joining Janus Funds was indeed THE William H. Gross, bond king, whom they had interviewed many times. The answer was YES—the Two Billion Dollar Man was leaving Pimco, the firm he founded.

Why should we care? That’s a real good question, unless you happen to own shares in Janus or Allianz, owner of Pimco.

Here’s the answer. This Gross-Out signals the end of an era, an era of ever lower bond yields and higher bond prices. Yields have been dropping for a long, long, long, long time. Back in the early 1990s I helped write a bullish report on the bond market (the theme and title were conceived by my co-author, Edward Kerschner). The report’s daring title was “Six in ’96,” and it was followed in due course by “Five at the Turn” (of the century) and then “Fours Before Long.” We never thought to write a report called “One and Not Yet Done,” which is now appropriate for the 10-year German Bund.

Anyhow, the era of ever-rising bond prices, which Mr. Gross brilliantly rode to fortune and fame, is very probably over, at least in the U.S. QE bond buying by the Fed is about to end. The U.S. economy is finally strengthening. Unemployment is fairly low. The Fed will start to tighten next year. Bond prices will stop rising. I admit they may not decline all that much, what with inflation restrained by the strong dollar and foreign bond yields depressed by deflationary pressures in Europe, China and Emerging Markets. So maybe bond yields gradually drift higher from 2.5% to 3.5% over the next year or two. That is still a difficult bond market in which to produce attractive returns for mutual fund investors.

A Parade of Gurus

Historical perspective is useful. Bill Gross is just the latest celebrity fund manager whose brilliant career coincided with a specific phase of the financial markets.

  • In the late 1920s mega-bulls Billy Durant (founder of General Motors) and John Jacob Raskob (who engineered DuPont’s purchase of a large stake in GM) mesmerized the public with investment wisdom, which turbo-charged their speculative positions. A favorite forum was the deck of an ocean liner, where Durant would regale financial reporters before he set sail for Europe. A bullish interview that Raskob gave The Lady’s Home Journal was immortalized in an article titled “Everybody Ought to Be Rich.” Unfortunately it appeared two months before the 1929 crash.
  • In the “go-go” stock market of the late 1960s, the Manhattan Fund of Gerald Tsai (rhymes with “die”) personified the “performance” mutual fund of the era, which beat the market by trading tech stocks and conglomerates.
  • The leading guru of the dismal 1970s was Henry Kaufman, “Dr. Doom.” He kicked off the great bull market in August 1982 when, as Salomon Brothers’ Chief Economist, he became more bullish on bonds.
  • The celebrity fund manager of the 1980s was Peter Lynch, the brilliant stock picker who ran Fidelity’s Magellan Fund. His approach was strictly bottom-up: “If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.”
  • A variety of strategists and fund managers became “household names” during the tech bubble of the 1990s. (Bearish strategists tended to lose their jobs.)
  • During the financial crisis, when bonds soared and stocks soured, it was all about macro insights, not stock selection. Bill Gross was a star commentator on Fed policy, bank balance sheets, the fate of the Euro, the risk of deflation, and the direction of interest rates.

As markets change, financial market celebrities who hitch their wagon to a certain phase inevitably fade into obscurity, though not poverty. Gerald Tsai parted ways with his Manhattan Fund during the bear market year 1973. Henry Kaufman eventually resigned from Salomon to start his own firm. After Peter Lynch left, Magellan Fund struggled under a succession of managers; today, few people on Wall Street are aware of who is managing that portfolio.

Dance of the Money Bees

Step back and contemplate how weird this all is.

After all, investing occurs throughout the economy, not just stocks and bonds. But there is no famous “strip mall king” or publicly celebrated “garden apartment queen” or widely quoted “elevated parking structure guru” even though there are smart people who have made oodles of money investing in those properties. Stocks and bonds are different because they constitute a participatory spectator sport—not unlike fantasy football. With just a few dollars John and Jane Q Public can participate, and the media is constantly commenting, especially these days when there are three business channels on cable TV. The media, in concert with ubiquitous gurus like Bill Gross, whip up excitement in whatever part of the market is glamorous now.

Shrewd New York investor John Train called this process, “the dance of the money bees” (the title of one of his books). By watching the coming and going of celebrity fund managers and financial gurus, we can get some sense of where markets are headed. Today’s fixation on the Gross Out shows the media is behind the times. The next generation of celebrity investors will run stock funds, not bond funds.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Federal Reserve: Main Street Small Business Has Struggled Under Obama

President Obama likes to say the U.S. economy performs best when it grows “from the middle out.”  Unfortunately an exhaustive Federal Reserve study shows middle class entrepreneurs have struggled during this recovery, even as big business thrived. Every three years the Fed conducts a “Survey of Consumer Finances” based on detailed interviews with about 6,500 Americans. A little-noticed topic is ownership of “business equity,”— “small businesses” as distinct from largely companies whose shares are publicly traded. This represents a big chunk of the U.S. economy; about an eighth of families own this type of property, and holdings have an average value of about $1 million (although the median value is much smaller).

The Survey demonstrates that the typical small business fared poorly during the putative “economy recovery” between 2010 and 2013:

  • The percentage of families owning “business equity” plunged to 11.7% in 2013 from 13.3% in 2010. This was the biggest three-year decline on record, and 11.7% is the lowest figure on record, well below the average of 13.4% in the prior eight surveys. (The survey has been done every three years since 1989, so there are data for nine years.)
  • The median value of “Business Equity” plunged 20%, from $84,400 in 2010 to $67,500 in 2013, which was the second lowest level of the nine years—only 1995 was lower, at $45,500. The average figure for 2001, 2004, 2007, and 2010 was $93,000, or a huge 39% above the 2013 level. (All figures are in 2013 dollars.)
  • The median value declined sharply, by more than 30%, in every family income group except the top decile, where the median value rose slightly. Specifically, here is the change in the median value of business equity, from 2010 to 2013, by income group:
    • Lowest 20 percentile of family income: median value of equity fell 34.3%.
    • 20th to 40th percentile: median value fell 31.7%
    • 40th to 60th percentile: median value fell 46%
    • 60th to 80th percentile: median value fell 31%
    • 80th to 90th percentile: median value fell 37.7%
    • Top 10%: median value rose 2.5%
  • The story is different when we look at the mean value of families’ holdings of “business equity.” For all families, between 2010 and 2013 the mean value rebounded 15.3% to $973,900. This was still well below the 2007 level of $1,062,500. The mean figure has recovered while the median did not because rich people are doing quite well under President Obama.
  • Despite the overall rise in the mean value of business equity, it nevertheless declined sharply for low income groups between 2010 and 2013 even as it rose for richer folks:
    • Lowest 20 percentile of family income: mean value of equity fell 11.0%.
    • 20th to 40th percentile of family income: mean value fell 32.6%
    • 40th to 60th percentile: mean value fell 31.9%
    • 60th to 80th percentile: mean value rose 16.5%
    • 80th to 90th percentile: mean value rose 25.6%
    • Top 10%: mean value rose 13%

Note that people who both A) own “business equity” and B) are in the top 10% of the income distribution are quite rich. The median value of their business equity is $500,000 and the average value is $2,576,000. Of course, this represents only a portion of their total assets; they also own real estate, stocks, bonds, bank accounts, vehicles, etc. Clearly they are among the “millionaires and billionaires” Obama used to vilify until that phrase became too tired and trite even for him. It’s ironic that his supposedly equalitarian policies have hurt the middle class while the rich and well-connected continue to prosper. This is a major reason why hiring has been so weak in this economic expansion.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

Note on Sources: Articles on each of the Surveys of Consumer Finance (done for 1989, 1992, 1995, 1998, 2001, 2004, 2007, 2010, 2013) are available on the Web. But the most convenient source is the 2013 SCF Chartbook, which has consistent information in 2013 dollars for all nine years, including charts and data for all survey items.


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