Archive for the ‘U.S. Economy’ Category

In October of 2009, I wrote in my blog about the economic and capital market bubbles we’ve struggled through, what caused them and the outcomes. While economic and capital market bubbles are continuously forming, I see strong evidence of specific bubble formation, not particularly good news following the short recovery from the 2008 global meltdown.

Artificially low interest rates.  The current policy of keeping interest rates below 1% in much of the developed world was intended to encourage consumers and small businesses to borrow. In reality, this has not been occurring since there has been very little lending by financial institutions, the exact same beneficiaries of the trillions of dollars of bail out money. These institutions, whose capital structure is now guaranteed by  government, are starting to resume making risky investments. They are looking to participate in the next wave of structured investment vehicles (SIVs) and ‘high-yielding, lower risk’ opportunities that always draw waves of unsuspecting buyers. This behavior is driven by the egregious fee income earned by their investment banking departments, the outsized profits earned by their proprietary trading desk as they take advantage of investors’ inexperience with such securities and the extreme commissions earned by their brokerage departments, who will peddle these securities just long enough to take the lion’s share of the profits. After nearly two years, the failure by Congress to implement regulatory reform over U.S. financial institutions is by default, contributing to another capital market meltdown.

Emerging Markets and U.S. Debt. It doesn’t matter whether you buy equity or fixed income, emerging markets are being promoted as the next no brainer, free lunch investment opportunity. There is tremendous optimism being sold to investors on the growth potential of these new economies. Thanks to their increasing exports and having largely withstood the ravages of the 2008 capital markets meltdown, these economies have played a major role in funding U.S. deficits. Before long, these countries will shift their investments away from buying U.S. debt and reinvest in their own growing economies.  As evidenced in the past, a bubble bursts when the buyers turn and run.

Price-Earnings Ratio and Market Valuation. This often misused stock valuation measure looks at a company’s, an industry’s or a stock index’s current price in relationship to future earnings expectations. This single measure is often used to promote equity investments and assess their current investment attractiveness.  Given this ratio is based on “future earnings per share”, it becomes obvious that this measure is subjective, easily manipulated and often misinterpreted. The sad result is people are lured into investments that may not be as fairly priced or attractive, as the P/E ratio would suggest. For example, the MSCI World Trade Index (an index of global stocks) is trading on a multiple of 14 based on projected earnings for 2010. If you instead look at the cyclically adjusted price-earnings ratio, which averages corporate earnings over the previous 10 years, the multiple jumps up to 20, a nearly 50% higher market valuation than the widely quoted P/E of 14.

There is increased lobbying in Washington D.C. consisting of about 160 U.S.-based subsidiaries of foreign-owned or controlled corporations. These foreign-controlled interests want to prevent Congress from enacting limits on their spending for U.S. political campaigns. This is driven entirely by the U.S. Supreme Court’s recent decision on Citizens United v. Federal Elections Commission (FEC). In this close decision, a 5-4 majority of the Supreme Court overturned a 103 year old law that barred corporations from using their financial profits to spend on federal elections. As a result of this decision, American corporations, including those owned in whole or in part by foreign companies and foreign governments, are no longer restricted from spending money to influence the outcome of federal elections. This ruling also struck down a portion of the McCain-Feingold Bipartisan Campaign Finance Act prohibiting corporations and unions from running ‘issue ads’ in the final days of a campaign.

Already, several congressmen are preparing legislation aimed at blunting the court’s ruling generally and the influence of foreigners specifically. Current Federal Election Commission (FEC) rules are inadequate protection for the free election process, and the FEC’s enforcement is ineffective.  New legislation would include specific rules for lobbyist’s to disclose their affiliations. This includes domestic corporations which are owned or controlled by foreign principals. Specifically, the definition of a foreign principal would be expanded to include corporations that:

-are subsidiaries of foreign companies,
-have one or more foreign members on their board of directors,
-are owned in part by foreign principals,
-or have debt or other obligations held against them by foreign principals.

In crafting the new legislation, lawmakers have focused on the possibility that investment funds controlled by foreign governments, known as sovereign wealth funds, could end up influencing the outcome of U.S. elections.  Take for example, CITGO Petroleum Company, purchased in 1990 by the Venezuelan government-owned Petróleos de Venezuela S.A. from the American-owned, Cities Services Company.  The Supreme Court’s ruling conceivably allows someone like Venezuelan President Hugo Chavez to spend his government’s money on defeating an American political candidate by funneling money to CITGO to buy U.S. TV commercials.

Arguments that the Citizens United ruling will not increase foreign influence have been raised. The four dissenting Supreme Court Justices disagreed.  The dissenting opinion, authored by Justice Stevens, specifically states that the majority opinion opens the door to foreign influence, as did the lawyer for Citizens United.

Others argue that the Citizens United decision will make no difference since U.S. subsidiaries of foreign companies already spend millions here. The law that was struck down restricted corporate advertising from naming candidates for office, in the 60 days before a general election and the 30 days before a primary election. Now corporations can spend freely during the most critical periods of any election and their message to vote for or against a named candidate. This allows unchecked and undue influence by foreign special interests on the outcome of U.S. elections.

Should we rely on existing law to protect against foreign influence in our elections?  Although the Federal Election Commission (FEC) restricts foreign nationals from spending or directing spending on U.S. elections, it does not prohibit corporations in which foreign nationals are shareholders or officers from making such expenditures.  Prior to this Supreme Court ruling, this issue did not exist at the federal election level because corporations were limited in what they could spend, regardless of whose money or special interest was being peddled.

Over the last century, it was legal to treat corporate contributors differently from individual contributors to election campaigns. The Supreme Court’s decision changes this legal principle. As Justice Stevens wrote in dissent, “Congress has placed special limitations on campaign spending by corporations ever since the passage of the Tillman Act in 1907… The Court today rejects a century of history [and conventional wisdom] when it treats the distinction between corporate and individual campaign spending as an invidious novelty born of [more recent Court decisions].”

The American people have a compelling interest in preventing foreign interests from influencing our domestic political process. In this period of financial vulnerability, with most U.S. debt controlled by foreign governments, we should not begin to allow greater foreign corporate influence on our election process.  An immediate, unified Congressional response is required to protect America’s sovereignty and our citizens’ exclusive right to determine who shall represent us. The ‘access door’ to Capitol Hill is now open wider and the lobbyist queue is growing.

George Vitta, President of Asset Strategies Portfolio Services, Auburn Hills, MI.

For more information, visit our web site www.assetstrategie.com

Asset Strategies Portfolio Services, Inc.

2635 Lapeer Rd, Auburn Hills, Michigan 48326 | Phone: (248) 373-9900

Each New Year begins with a look back and a toast to the future. I suspect the look back on 2009 was more brief than usual given all that transpired in the global capital markets in the past year. Further, the toast to 2010 may be longer than normal, given all that must be accomplished to eliminate the causes of the global capital market meltdown which began in December 2007.

Never one to complain, but often one to contemplate and take action, following are pragmatic solutions for regulators and policy makers to act on today:

1.   There’s been a lot of talk (mainly politicians) about regulating the amount of compensation paid by financial institutions. A practical and effective way to curtail the ‘excessive risk-taking mindset’, for which they are paid oversized awards, is to change the timeline over which they get paid. Forget about quarterly or annual awards; focus on long-term measures of contribution to profitability, measures of customer satisfaction, worker job satisfaction, amount paid out to shareholders and above all, the consistency of achievement of all these goals. The concept of ‘out earning the previous quarter’ is counter-productive and destructive of wealth (well, for many, but clearly not the short-sighted managers making their short-term bets). The short-sightedness of too many financial institutions results from their ‘trader mentality’ and loss of ‘investor mentality’. There must be claw backs for failure to achieve stated goals and lack of consistency. There must be a direct link between shareholder payouts and wealth accumulation, over time, and managers’ compensation – after all, who owns the company, and who do the employees ultimately work for – customers first, then the owners; management should come last, by default. Novel concepts like long-term financial stability and consistency of profitability come to mind as appropriate priorities. Longevity of the board and management’s career risk should be secondary concerns, and would in fact become secondary concerns if they were held accountable for long-term accomplishments and not quarter-over-quarter minutiae. Put a far greater share of the annual compensation at ‘risk-of-return’ if results beyond one year don’t meet objectives. Put more compensation at risk for mistakes, fraud, incompetence, malfeasance, etc. The no brainer among these suggestions is to extend the payout period, including ‘golden parachutes’ and ‘buyout bonuses’ and the sort. Provide less cash payout and in forms (i.e. – stock) which accrue value as the value to the shareholders grows, over time.

2.    Don’t’ fix it if it isn’t broke. Why not re-enable the Glass-Steagall Act? It worked fine for 66 years, enforcement didn’t carry a large price tag and it prevented risk mongers from getting out of control as they did in 2000 – 2009. Do you think the fact the return from investing in the U.S. stock market is – 1 % for this decade may be related to the short-sighted repeal of this Act? This Act was established in 1933 to control speculation and excessive risk-taking by banks. The repeal of this act in 1999 is believed by some to have contributed to the global financial crises of 2000-2002 and 2008-09. The original law created deposit insurance and to limit the risk to the U.S. Treasury, it forbade a bank holding company from owning other financial companies or engaging in certain high-risk financial activities. This firewall between a commercial bank and an investment bank was critical and the repeal spawned reckless lending practices which contributed to the meltdown of the financial markets. Let banks be banks, taking deposits for checking and savings accounts and prudently loaning money. Investment banks should be just as they are named, a place for investment. There is talk on Capitol Hill that Senator John McCain and former Federal Reserve Chairman Paul Volcker will be pushing this idea in 2010.

3.   Again, if it’s not broke, don’t fix it. In the case of Credit Default Swaps (CDS), this insurance concept was never implemented or regulated properly. You know the old saw about ‘out of sight, out of mind’? With a majority of global CDS done off-market (i.e.-unlisted), absolutely nobody had any idea of the total notional value of these liabilities (so-called insurance policies) or the extent of counter-party risk. Pure and simple, CDS should be exchange traded (i.e. – listed) for investors’ protection. Instead of investment banks and others (remember AIG?) playing matchmaker between parties, a public exchange would do this with standardized guidelines for risk management and transparency.

4.   Another simple, easily implementable fix is to set a higher standard for stronger capital structure in the financial industry by increasing equity capital or reserve requirements for depository and lending institutions, regardless of their size. We now know that ‘too big to fail’ means too big to save (Bear, Stearns, Lehman Brothers, Washington Mutual and on and on). The current leverage ratio of 8 percent tangible equity per dollar of assets should be increased to 10 to 12 percent. Why not double the reserves requirement all the way up to 10% from the obviously inadequate 5%? This includes banks, insurance companies and brokers as well as every government sponsored enterprise (GSE). This protects the workers’ job security and the American taxpayer by reducing the risk that the burden of failure among financial institutions will be dropped on our heads, again.

5.   Speaking of GSEs (GNMA, SLMA, FNMA, FHLMC, FHLB), there is absolutely no economic reason to not dismantle and restructure Fannie Mae, Freddie Mac and maybe FHLB. The latter two relinquished their independence on September 7, 2008, when the U.S. Government took control of both Fannie Mae and Freddie Mac and committed up to $1.5 trillion to keep them afloat. Both were once publicly-traded corporations and issued billions of debt on top of the equity. Both government-sponsored entities have over-evolved since inception. Both purchase single-family mortgages, originated by other companies, guarantee the mortgages and pool them to sell to institutional investors or keep them in their respective portfolios. Over the years these two entities have become identical twins and both abandoned their original charter which was to purchase prime mortgages (people who could actually make a monthly payment and had a substantial down payment to begin with). Management of both companies failed as they ignored their charters in hopes of earning outsized compensation. This was done with higher risk Alt-A and Sub-prime mortgages. Restructuring should involve limitations on the amount of guarantees that may be covered, market segmentation and likely geographic separation. Subdividing the portfolios of these two into possibly four or more entities also has merit. This will create jobs and a more vibrant, competitive residential lending environment versus the current monopolistic version.

Each of these ideas will reduce corporate welfare (i.e. – decrease the need for government bailout), reduce the financial burden on today’s taxpayers and give future generations a chance to enjoy the same standard of living that we enjoy today.

George Vitta, President of Asset Strategies Portfolio Services, Auburn Hills, MI.   For more information, visit our web site www.assetstrategie.com

Is there no voice of reason left in the financial media?  The  financial media operates with incentives that are not in the best interests of investors. The financial media – internet, broadcast and print – have an agenda, like any business, to increase their revenue. They do so by running stories that will maximize their audience and, accordingly, their advertising revenues.  Sometimes they have a political agenda as well.

Headlines are created to stimulate our interest, or at the least, our curiosity. These motivate us to keep watching or keep reading with hope we will buy their publication or spin. We must heed the feeling of sensationalism and trust our intuition.

Aside from increasing unemployment, the most talked about economic problem is housing. The forever optimistic National Association of Realtors (NAR) keeps pointing through the media that the worst is over.  But if you look closely at history, the real story is always different.  Except for two spectacular housing booms – the first after World War II and the second starting in 1998 – residential real estate appreciation has been unimpressive after figuring in inflation.  Technology has allowed builders to nail up more houses faster, ensuring that supply never gets too far behind demand (and often gets ahead of it). The combination of increasing foreclosures and unemployment insures an increasing supply today. The reverse wealth effect and economic malaise insure demand is beaten down. In spite of what NAR would have us believe, does anyone believe housing prices are going to stabilize on the downside anytime soon?

Amherst Securities Group LP, the New York-based mortgage-bond analyst said in September of this year that a “huge shadow inventory” which is about five-and-a-half times larger than 2005’s national tally of delinquencies and foreclosures – threatens to further destabilize a housing market that had shown signs of righting itself over the summer.

While housing is only one factor in the US economic recovery, it’s the number two issue. As with any financial media you follow:

1.    Be smart- temper what you read or hear with your knowledge of the markets and economy

2.    Think long-term – don’t get caught up in the “headline of the day”

3.   Talk to someone you trust- someone steeped in the knowledge of the markets and economy that has no self-interest

Asset Strategies Portfolio Services, Inc.

2635 Lapeer Rd, Auburn Hills, Michigan 48326 | Phone: (248) 373-9900

George Vitta, President of Asset Strategies, gives advice on looking at market index performance. “Investors are mislead by the financial press on a daily basis. There is too much focus on the Dow Jones Industrial Average (DJIA) and whether it returns to 10,000 as it recently did, causing us to lose sight of the bigger picture. While the performance of the DJIA continues to be influenced by not only economic and corporate reports, natural disasters, and domestic and foreign political events, this stock index is computed from the daily price change of 30 very select publicly held U.S. companies. Several of the 30 companies are not even part of the U.S. industrial market sector. Further, unlike other stock indexes whose daily performance is based on the change of total market value of each company, the DJIA’s daily performance is based on the change in the price per share of each of the 30 stocks. This means the entire direction and the magnitude of the indexes daily performance can be unduly influenced by one, two, or simply a few stocks.”

A truly meaningful and more accurate approach, which parallels the philosophy of Asset Strategies, is to look at the    S & P 500 or Russell 1000 Indices. “First, we believe that the companies represented in either of these indices is a superior representation of our diverse economy”, says George. “Second, we think the method for calculating these indices’ daily performance is more accurate than the DJIA methodology and thus gives a meaningful indication of the U.S. stock market’s daily results. Finally, we hope this critical, yet rational thinking inspires investors to stop and consider what they just heard or read for the benefit of their investment success.”

“This time it’s different” are often quoted words following a financial calamity, such as the world has been going through for more than one year. Actually, it’s not different this time, it just feels that way. For a healthy dose of 1) why we should not feel anything is different, 2) why in fact, the financial environment may be worse than the past, 3) why we are bound to repeat past mistakes, and 4) a preview of what today’s mistakes could lead to in the near future, read this article that ran in the New York Times on Septemeber 14.  To read the article that George Vitta, President of Asset Strategies Portfolio Services, is referring to please cut and paste the following link to your browser.
www.nytimes.com/2009/09/14/business/economy/14bubble.html?scp=1&sq=same