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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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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