Sense on Cents

GM: A Question of Trust

Posted by Larry Doyle on June 2nd, 2009 8:00 AM |

“Trust me.”

Have you ever walked away from a discussion with a person–be it a boss, a business associate, a prospective partner–in which you wondered why they felt the need to make that statement?

In regard to trust, I feel much more comfortable when others assert, “you can trust him” rather than an individual asserting, “trust me.” Why? Very simply, trust is a virtue. As such, it is not given like a cheap bauble. Trust is earned. The foundation of our capitalist system is trust. When a basic trust is violated, regulators are compelled to act to rectify that violation.

Let’s enter the Brave New World of the Uncle Sam economy and address the credibility of this virtue known as trust.

CNBC recently aired a fabulous roundtable discussion, “The Future of Capitalism,” which touched on many of the economic issues currently debated. In the midst of the discussion, Mohamed El-Erian of Pimco strongly asserted that capitalism is ultimately a system based upon trust. Without trust, investors will not willingly commit capital to drive future economic growth.

As with any virtue, trust is not a one way street. While trust is earned, it needs to be rewarded so as to promote even greater trust. In so doing, the model of trust is displayed as the shining beacon for personal and professional relationships, whether between two people or amongst three hundred million.

Let’s get more specific. Investors who committed capital to General Motors in the form of equity took the greatest risk. In so doing, they positioned themselves to reap the greatest reward were the company to prosper. The company entered bankruptcy; the shareholders got wiped out. That is the way capitalism works. Or does it?

Investors who committed capital to General Motors in the form of senior debt took lesser risk. In so doing, they positioned themselves to receive a lower fixed return knowing if the company failed they would be first in line. They made this investment based upon trust in longstanding rules of bankruptcy proceedings. These investors include large institutions and thousands of individuals. Their trust was violated in the GM bankruptcy proceedings. They were not first in line. Junior creditors, specifically the UAW, received substantially better treatment. What happened? Uncle Sam rationalized this “violation of trust” as being in the common good of our country. Regrettably, this violation received no real debate in our court system and limited debate within our general media.

Uncle Sam, in the persons of Barack Obama and Tim Geithner, have put forth that the automotive situation is a special case; standard bankruptcy proceedings will continue to be practiced elsewhere. I would counter that we have a responsibility to future generations of investors to challenge Obama and team on this point. The future of capitalism itself rests on this debate.

The true costs of this violation will be borne by future iterations of unionized companies that can not easily access the capital markets. I personally would only commit capital to such an entity at a much higher rate of return knowing full well the risks I am taking are now greater given the precedent set via the Chrysler and GM bankruptcies.

Analysts, government officials, and others will continue to rationalize this violation of trust. In my opinion, this rationalization is akin to “the ends justifying the means.” That is a dangerous weapon.

This “question of trust” will certainly be an ongoing theme as we venture further into the Brave New World of the Uncle Sam economy. In the process of making investment decisions, we now need to more aggressively question just how much we trust our counterparties, especially Uncle Sam.

Please share your insights and thoughts so we can collectively be more diligent in navigating the economic landscape.

Comments (1)

The Future of America is Now

Posted by Larry Doyle on June 1st, 2009 3:29 PM |

Last week I wrote The Future of America to highlight a treatise put forth by Clinton administration Secretary of Labor Robert Reich. In that post, Reich put forth – and I totally concur – that our future economy will be known as the Technology Revolution. In order to participate and prosper in that revolution, one needs to be increasingly well educated.

Reich wastes no time in writing further on this topic and I am pleased to access his work at the highly regarded financial site, Wall Street Pit. Reich writes, The Future of Manufacturing, GM, and American Workers (Part II). In this piece, Reich reiterates the critically important need for education beyond the secondary level. I concur. Reich touches on the shortcomings and failures within the educational experience for lower-middle income and poorer families. He asserts:

America’s biggest challenge is to educate more of our people sufficiently to excel at such tasks. We do remarkably well with the children from relatively affluent families. Our universities are the envy of the world, and no other nation surpasses us in providing intellectual and creative experience within entire regions specializing in one or another kind of symbolic analytic work (LA for music and film, Silicon Valley for software and the Internet, greater Boston for bio-med engineering, and so on).

But we’re in danger of losing ground because too many of our kids, especially those from lower-middle class and poor families, can’t get the foundational education they need. The consequence is a yawning gap in income and wealth which continues to widen. More and more of our working people finds themselves in the local service economy — in hotels, hospitals, restaurant chains, and big-box retailers — earning low wages with little or no benefits. Unions could help raise their wages by giving them more bargaining leverage. A higher minimum wage and larger Earned Income Tax Credit could help as well.

Not all of our young people can or should receive a four-year college degree, but we can do far better for them than we’re doing now. At the least, every young person should have access to a year or two beyond high school, in order to gain a certificate attesting to their expertise in a particular area of technical competence. Technicians who install, upgrade, and service automated and computerized machinery — office technicians, auto technicians, computer technicians, environmental technicians — will be in ever-greater demand.

I totally agree with Reich’s assessment of our situation, but I think he otherwise falls woefully short in his analysis. Reich points toward the effects and outcomes of the educational output for the lower-middle income and poorer groups in our social construct. However, Reich immediately points toward the necessity for public intervention and public obligation in providing access to education beyond the secondary level.

I strongly believe the ultimate success – or the continued failure – for those involved in the education for our lower middle-income and poor has to start at home and with the family structure. Reich regrettably does not take this issue on and plays to his strong liberal base in the process.

I have attempted to highlight the horrendous urban graduation rates (50%) and excessively high rates of single parent families (currently 40% nationwide, with rates as high as 70% within the African American population) in my post from last Fall, Give a Man a Fish, Feed Him for a Day. I have also attempted to highlight a program supported by both private and public funding that addresses the academic, community, and family structure needed to promote success for lower income people. On the heels of Secretary of Education Arne Duncan visiting the inner city of Detroit to take the pulse of “the worst school system in the country” (a graduation rate of 25%!!!), I wrote Arne Duncan Visits Detroit; He Should Visit Domus.

I am in total agreement with Reich’s assessment of our global economy entering into a Technological Revolution. I am in total agreement with him on the need to focus on education. I think he falls woefully short in his analysis of the glaring holes in our urban settings, and the costs these holes are incurring on our social fabric and nation as a whole. Regrettably, not unlike the Obama administration remaining beholden to the UAW in the ongoing developments within the automotive industry, Reich is also beholden to the strong, liberal base within the teachers’ unions. As such, he lacks the courage to prescribe the necessary medication to address our national urban education plight. Our nation deserves better.

Comments (3)

Inflation, Deflation, or Stagflation?

Posted by Larry Doyle on June 1st, 2009 11:06 AM |

I am an eternal optimist and, as such, I never want to see people’s spirits waver. I encourage people not to allow the current economy to “deflate” their hopes for better days. By the same token, I am a pragmatist and caution people not to view the recent bounce in our equity markets as reason for an overly “inflated” sense of optimism. In this same spirit, though, we need sufficient optimism along with practical analysis to avoid the perils of “stagflation.” Let me expound.

The debate between analysts touting prospects for inflation versus deflation is ongoing. Those concerned with deflation highlight increasing levels of unemployment pressuring wages, falling asset valuations, and slack consumer demand. Those concerned with inflation point toward the unprecedented levels of liquidity injected into our system via all of the government programs. The inflation hawks maintain the economy merely needs a small spark and inflation will spread in an uncontrollable arson-like fashion.

I actually believe there is a very real chance we get developments from both camps leading to the scourge known as stagflation. How may this play out?

Many respected analysts are promoting the concept of a new “normal” economy. This scenario entails an economy operating with enormous government deficits, an elevated level of unemployment, and little to no shadow banking system (securitization of loans and other assets).

In this new “normal” economy, GDP may only eke out small positive growth given these heightened pressures. Pimco’s Mohamed El-Erian writes of A New Normal:

This reflects a growing realization that some of the recent abrupt changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years. Global growth will be subdued for a while and unemployment high; a heavy hand of government will be evident in several sectors; the core of the global system will be less cohesive and, with the magnet of the Anglo-Saxon model in retreat, finance will no longer be accorded a preeminent role in post-industrial economies. Moreover, the balance of risk will tilt over time toward higher sovereign risk, growing inflationary expectations and stagflation.

Even as we come out of this recession, our economy will run increased risks of slipping into another recession given the lack of cushion provided by a strong consumer, the burdens of heavy government debts, and inability to easily access credit.

El-Erian adds:

For the next 3–5 years, we expect a world of muted growth, in the context of a continuing shift away from the G-3 and toward the systemically important emerging economies, led by China. It is a world where the public sector overstays as a provider of goods that belong in the private sector. (As one of our speakers put it, we have transitioned from a world where the private sector provided public goods to one where the public sector provides private goods.) It is also a world in which central banks and treasuries will find it difficult to undo smoothly some of the recent emergency steps. This is particularly consequential in countries, such as the U.K. and U.S., where many short-term policy imperatives materially conflict with medium-term ones.

As our global economy transitions to this new “normal,” I believe the likelihood of stagflation is quite high. For those who recall the perils of our economy in the early 1980s, stagflation is not a pretty picture. How does one manage investments and personal finances in an environment of stagflation?

Let’s deal with the component parts. Given sluggish growth, limited credit, and lessened opportunities, it is of paramount importance to cut expenses and minimize debt as much as possible. Servicing debt will be an ongoing challenge and increasingly problematic. Be proactive at this point in time in adjusting your finances to this reality.

Where will the inflation come from and how does one address it? In my opinion, the inflation “train” will arrive sooner than we think. Some of the savviest investors, including Financial Pacific Advisors’ Bob Rodriguez and noted Black Swan author Nassim Nicholas Taleb, are already positioning themselves for it. (The WSJ reports, Black Swan Fund Makes a Big Bet on Inflation).

How can people protect themselves from the inflation monster? Increase exposure to the following:

– precious metals and commodities

– critical infrastructure (power plants, agriculture, water, transportation)

– necessary life items (drugs, medicines, food)

– stronger and more fiscally prudent foreign markets

Decrease exposure if not get outright short

– longer maturity (5yr and and longer) Treasury bonds

This stagflation story will have many chapters and I will be writing extensively on it. Please share your thoughts, opinions, and recollections of the early 80s economy so we can all move forward most effectively in navigating the economic landscape.

Comments (4)

“Reflections and Outrage” by Robert Rodriguez: Strongly Recommended Reading

Posted by Larry Doyle on June 1st, 2009 5:00 AM |

Bob Rodriguez, Partner and Chief Executive Officer of First Pacific Advisors, delivered the keynote address the end of last week at the Morningstar Investment Management Conference.

Mr. Rodriguez is a 35 year veteran in the financial industry and a Morningstar Manager of the Year three times. In my humble opinion, there are none better in the industry today. As I referenced on NQR’s Sense on Cents with Larry Doyle last evening, I totally concur and feel strongly about Mr. Rodriguez’s powerful pearls of wisdom. I beseech you to read this address, save it, read it again, and share it with your colleagues!

Allow me to comment and highlight Mr. Rodriguez’s major focal points. Mr. Rodriguez addresses every major issue in our financial world today. He layers those issues on top of the potential social impact our country faces. Mr. Rodriguez is not bashful in highlighting that our day of reckoning is upon us. I have read this piece three different times. I am more impressed and in greater agreement with his assertions after each reading.

Rodriguez addresses the following:

1. the need for personal and professional discipline and integrity

2. he recounts an experience in which he was solicited to “pay to play” by his biggest account . . . he passed and never regretted it

3. he castigates the financial industry for its performance over the last few years (be mindful he delivered this speech to an audience of financial managers!!)

4. he talks about how and why he has made a major shift into energy stocks within his fund!!

5. the changing nature of the markets and the global economies.

6. he rails on Alan Greenspan

7. Rodriguez offers, “my trust has been severely shaken in the Federal Reserve, the Treasury, the Congress, and the Executive Branch of government…”

8. “the regulatory agencies and federal government were complicit in laying the groundwork that allowed many of these credit excesses to develop prior to this economic crisis.”

9. he addresses the horrendous business practices being promoted by GMAC.

10. the positive economic impact of the Stimulus will be offset by ongoing reduction in consumer spending.

11. “we have to be careful about what is meant by sacrifice . . . a democratic government is the only one in which those who vote for a tax can escape the obligation to pay for it.”

12. Rodriguez’s outlook on the market:

— we are currently experiencing a bear market rally

— corporate earnings will disappoint

— the stock market overall will be price constrained for TEN YEARS

— “I view the Treasury market as being in a bubble territory with foolish leaders at the helm.”

— the bulk of the economy’s credit problems are still to come as charge-offs on trillions of dollars in loans remain to be recognized.

Reflections and Outrage
by Mr. Robert Rodriguez
Partner and Chief Executive Officer First Pacific Advisors

MUST READ!!

Comments (5)

Join Me Tonight at 8PM for NoQuarter Radio’s Sense on Cents with Larry Doyle

Posted by Larry Doyle on May 31st, 2009 10:37 PM |

UPDATE: The show has concluded, but you can listen to a recording in its entirety by clicking the Play button on the audio player below. Once the playback has started, you can fast forward or rewind to any portion of the show by clicking at any point along the play bar.

*******************************

Please join me Sunday evening from 8-9 p.m. ET for NoQuarter Radio’s Sense on Cents with Larry Doyle. The developments in the markets, economy, global finance, Wall Street, and Washington are occurring at breakneck speed. I will try to slow things down a bit and provide a sense of perspective. What did we learn in the markets over the last week and what does that mean for the weeks and months ahead? We will address a wide range of issues, including economic statistics released this week, the automotive situation, market performance, and the road ahead.

Additionally, I am always happy to address anything on your mind as you navigate your own economic landscape. I will be joined by a special guest this week, as well. John Busacca has been involved in the regulatory and compliance side of the financial industry since the mid 1990s. John has worked as a compliance officer for large wirehouses and NYSE member Clearing Firms. In 2000 he was involved in founding a fixed income firm in Florida. From there he transitioned into a sales role which led him to becoming President of a clearing firm. He grew that firm from a handful of correspondents to over 75.

In 2006 John was elected to the NASD-Business Conduct Committee for District 7 and was also elected to the Florida Securities Dealers Board of Governors. John was involved in the founding of The Securities Industry Professional Association in 2007. The SIPA is an industry advocacy organization. He acquired BDexchange in 2008 and has relationships with nearly every clearing firm and Securities Consultant in the Country. John is an accomplished writer and contributes to many national publications. I look forward to my conversation with him tonight. Read the rest »

Comments (0)

Incoming

Posted by Larry Doyle on May 31st, 2009 11:18 AM |

Comments (0)

May 2009 Market Review

Posted by Larry Doyle on May 29th, 2009 11:23 PM |

Welcome to the Brave New World of the Uncle Sam economy! Let’s review the price action across the market, add some analysis as we look behind the numbers, contrast these returns with developments in the economy, and chart our path forward as we navigate the economic landscape!!

may-2009-market-review2

Market Returns:

Equities: while market analysts continually measure the market from March 6th, unless one purchased the market on that date and at that point, it is much more intellectually rigorous to measure returns on a YTD (year-to-date) basis. Although I will incorporate short term movements, focusing solely on the short term increases the risk that we “miss the forest for the trees.”

The equity markets posted solid returns for the third month in a row. Although the returns in May were positive, they were not as largely positive as the prior two months. Year to date, the DJIA is slightly below unchanged while the S&P 500 is slightly positive. The tech heavy Nasdaq continues to outperform and is solidly positive (+12.5%) on the year. Why? Many tech companies have significnatly less debt burden and refinancing risks.

Bonds: the high yield sector continued to outperform (+9.7% MTD, +24.3% ytd). The mortgage and municipal sectors largely marched in place. The front end (shorter maturities) of the U.S. government bond market held steady as the Federal Reserve indicates they will keep the Fed Funds rate at 0-.25% for an extended period. The long end (intermediate to long maturities) of the government bond market sold off dramatically (+35 basis points on the 10 yr) under the weight of very heavy supply.

Currencies: the U.S. dollar had a very difficult month relative to almost every other major currency. The greenback gave back almost 4% relative to the Japanese yen, although it remains within the trading range for the year. The dollar particularly suffered versus the Euro on concerns of a potential downgrade of U.S. government credit due to the ongoing fiscal deficit.

Commodities: this is where the real action occurred this month. Commodities, in general, posted their largest monthly gain in 34 years. Oil was up 30.1% on the month and 55.6% on the year. Gold rallied 11% on the month and is up a like amount for the year.

Looking Behind the Numbers . . .
As I view the monthly and annual numbers, I am drawn to a comparison of a football pass thrown in a game. That is, when the football is thrown, three things can happen and two of them are not good. The pass can be completed, fall incomplete, or be intercepted.

Similarly, our economy can gradually improve with credit lines opening, housing and employment stabilizing, and markets improving – much like a completed pass.

Our economy can stumble under the weight of a surge in delinquencies and foreclosures in the residential space, a wave of commercial real estate defaults, and a double digit unemployment situation – much like an incomplete pass.

Our economy can stabilize with enough traction to create velocity in the growth of the money supply. Given the trillions of dollars injected both directly and indirectly, a hint of velocity will likely spark a sharp increase in the expectation of inflation even prior to actual signs of inflation. The price action in the commodity and currency space are sending warning signals on this front. This development is akin to an intercepted pass.

Economic Review . . .
As I look back on the wealth of economic data, I am continually struck by the downward revisions to prior months’ numbers. Although consumer confidence has increased, in my opinion, virtually every other statistic both here and abroad shows ongoing caution signs. These numbers include retail sales, housing, employment, and industrial production. Overseas the export data is decidedly weak.

Perhaps the markets are discounting an expectation of improved economic data due to the $780 billion Stimulus Bill starting to kick in later this year. The major money center banks have clearly been stabilized, although it took a fabrication in their accounting (via a relaxation in the mark-to-market) to do so.

The movement in commodities is clearly indicating a sign of improved economic activity and/or heightened inflation, or both. It is not inconceivable that our economy does get inflation sooner than later combined with minimal credit flow due to ongoing writedowns on delinquent or foreclosed loans. Combine these two components and we have a very real chance of stagflation over the next few years.

The Path Forward . . .
The steepening of the yield curve (rates on short term maturities relative to long term maturities) is very positive for our banking industry. The banks can continue to borrow money at extremely low rates and earn significant interest on almost any sort of lending that occurs. That said, new loan demand is not strong while demand for refinancing is quite strong.

My concern currently is not with the major money center banks. I am VERY concerned with the non-bank banks (Freddie Mac, Fannie Mae) and the Federal Home Loan Banks (FHLBs). Given the ongoing surge and expected high levels of residential loan defaults, these institutions will bleed money. The insurance sector, despite some recent improvements in their stock prices, also concerns me given their commercial real estate holdings primarily.

I do believe longer term interest rates will continue to work their way higher under the weight of supply of global government debt, and expected ongoing heavy demand (May was a very heavy issuance of both bonds and stocks) by municipal and corporate issuers. Do not be surprised to see our 10 yr Treasury note get to 4% and 30yr fixed rate mortgages get to 6%.

The deleveraging process will continue as the economy adjusts to life without a vigorous securitization business (remember the securitization business on Wall Street provided 40-45% of total credit to our economy).

Add it all up and I think the following will occur:
   – equity markets will now move sideways in range bound fashion;
   – the bond market will move lower in price, higher in rates;
   – the dollar will gradually decline;
   – our economy will be filled with more stops than starts.

Please share your thoughts and comments!! Thanks.

Comments (8)

The Future of America

Posted by Larry Doyle on May 29th, 2009 2:19 PM |

On this historic day in which the government of the United States of America is on the doorstep of taking a majority equity stake in General Motors, I thought it may be prudent to address manufacturing in America.

To that end, former Clinton administration Secretary of Labor Robert Reich provides highly insightful commentary at Wall Street Pit: The Future of Manufacturing, GM, and American Workers (part I).

As we wonder what the future of our automotive manufacturing industry may look like as well as manufacturing in general, I strongly recommend we take Reich’s words to heart. Let’s take a round trip as we review the dynamics of the Industrial Revolution and the road ahead:

What’s the Administration’s specific aim in bailing out GM? I’ll give you my theory later.

For now, though, some background. First and most broadly, it doesn’t make sense for America to try to maintain or enlarge manufacturing as a portion of the economy. Even if the U.S. were to seal its borders and bar any manufactured goods from coming in from abroad–something I don’t recommend–we’d still be losing manufacturing jobs. That’s mainly because of technology.

When we think of manufacturing jobs, we tend to imagine old-time assembly lines populated by millions of blue-collar workers who had well-paying jobs with good benefits. But that picture no longer describes most manufacturing. I recently toured a U.S. factory containing two employees and 400 computerized robots.
The two live people sat in front of computer screens and instructed the robots. In a few years this factory won’t have a single employee on site, except for an occasional visiting technician who repairs and upgrades the robots.

Factory jobs are vanishing all over the world. Even China is losing them. The Chinese are doing more manufacturing than ever, but they’re also becoming far more efficient at it. They’ve shuttered most of the old state-run factories. Their new factories are chock full of automated and computerized machines. As a result, they don’t need as many manufacturing workers as before.

Economists at Alliance Capital Management took a look at employment trends in twenty large economies and found that between 1995 and 2002–before the asset bubble and subsequent bust–twenty-two million manufacturing jobs disappeared. The United States wasn’t even the biggest loser. We lost about 11% of our manufacturing jobs in that period, but the Japanese lost 16% of theirs. Even developing nations lost factory jobs: Brazil suffered a 20% decline, and China had a 15% drop.

I’m fairly certain this message is not one commonly promoted by our media. I believe we strictly hear how our manufacturing jobs are purely shipped overseas and especially to developing countries. Read the rest »

Comments (10)

A Picture Is Worth A Thousand Words

Posted by Larry Doyle on May 29th, 2009 10:47 AM |

This video clip with graphs provided by the Financial Times addresses the surging rate of delinquencies, foreclosures, mortgage rates, and Treasury rates.

The historical view provided by these graphs gives us reason to pause and question the potential for a near term real economic recovery.