Financial topics

[JLak]

Could someone please explain why the fed is buying treasuries, with what money, and what that does to the money supply. Thanks.

[TheCoinCollector]

A news reporter stated that Barack Obama claimed he was going to lower taxes and increase government spending! Now thats a contradiction.

[The Grey Badger]

Did you notice that the Dow dropped 680 points because Wall Street finally admitted what Main Street has known for over a year? I loathe the term "sheeple" when applied to Main Street, but it surely seems to fit Wall Street here. The big boys come clean and they panic? What sort of delusion were they living in before?

[John]

-- Market summary, Tuesday morning, December 2, 2008

Analysts are totally confused about what's going on. Yesterday's 7%
fall in Wall Street indexes was a huge disappointment to many who had
hoped that after five straight gaining sessions, the market would
keep going up.

The market is up 2-3% this morning, but I'm not hearing any rosy
predictions any more. After having their hopes so thoroughly dashed
yesterday, they're all well aware that anything can happen tomorrow.

> Did you notice that the Dow dropped 680 points because Wall Street
> finally admitted what Main Street has known for over a year? I
> loathe the term "sheeple" when applied to Main Street, but it
> surely seems to fit Wall Street here. The big boys come clean and
> they panic? What sort of delusion were they living in before?
>

To say that Wall Street fell yesterday because of the NBER recession
report is attributing way too much intelligence to investors. It
wasn't so long ago that a recession was considered to be good news,
since it meant that the Fed would lower interest rates. Of course in
those days, good news was always good news, and bad news was always
good news. As you point out, everyone has known we were in a
recession for some time, so the NBER report couldn't have made much
difference. It was just another head blow to dazed investors who
barely can figure out which way is up any more.

John

[freddyv]

Make sure you keep reading. John's theories get stronger and make more sense as you learn more and put them into perspective.

The very basis of making predictions based on such long term cycles means that predictions are often too early. IMO, it is this fact that will keep the Generational Dynamics theory from being properly utilized by most people; they will see how much sense it seems to make but then in their impatience and greed will jump on the bandwagon at the last moment fearing they will miss out on the big runup. Not only will this ruin them but you can then expect those people to blame the messenger.

To utilize such information you need to be prepared and patient. And be aware that change does not come overnight in most cases; there is often one event that starts a cascade of other events so if you know the big event is due then you are much more likely to see it coming and be able to take advantage.

As for the high PE ratios, I still hear fools on CNBC using forward earnings estimates and talking about a PE of 10 for the S & P 500...and they expect growth next year! IT'S MINDBOGGLING!!! Do your own research and come to your own conclusions and only use the talking heads as a contrarian indicator.

Go to the Standard & Poors Website to see the stats for yourself:
http://www2.standardandpoors.com/portal ... 0,0,0.html

You can even see the folly of their ways at CNBC:
http://www.cnbc.com/id/15839135
...the estimate was once for growth of 17.3% for Q3 while the reality was -18.7%.

The talking heads believe that since the PE ratio has not been under 17 since 1995 that things really are different now and that since the current PE is 17 we must be at a bottom. It doesn't take a genius to see the error in this thinking, what is amazing is how many people buy into it. Groupthink says that we must be at a bottom, reversion to the mean says we must now correct for the excessive valuations; which do you believe? BTW, this all holds up for book values, dividends and any other valuation you care to try it on. The market is still historically overpriced.

--Fred

From a web site reader:

> Your web site is the most accurate and understandable description
> of the economy I have found anywhere . This has been the most
> enjoyable site. Thank you for all of this. As a Harvard Business
> School graduate and McKinsey alumnus, I still struggle with where
> to safely place my assets. I have nothing in equities and haven't
> since last January. Then I found your site and started reading
> and learning. How is it possible that we are in a once in a
> century crisis, banks have failed, all investment banks are gone,
> and yet the P/E ratio is still above historical average. It is
> mind boggling. I keep asking myself if something has
> fundamentally changed, and I keep concluding no. Anyway, THANKS.

This writer makes a very interesting point: If the economy were in
good shape, then analysts who say that P/E ratios are OK might at
least be making sense.

But after a year of bank failures and other crises, how could ANYONE
possible invest in stocks when P/E ratios are so far above historical
averages?

Sincerely,

John

[malleni]

Could someone please explain why the fed is buying treasuries, with what money, and what that does to the money supply. Thanks.

JLak,
Very wrong question on this forum...

best regards

[The Grey Badger]

They are at least buying the appearance of Doing Something.

[mannfm11]

For one, it depends on who the Fed is buying treasuries from. They are merely swapping liabilities. If it is from a bank, the treasuries form the backbone of the banking capital reserves and would merely be converting capital to a form of asset that could be redeemed at the Fed. Banking and modern money are only issues on balance sheets, liabilities and assets. The banks still have the liabilities and the cash is in essence owed back to the Fed, as the debt is in the Fed and not on the outside. Thus, unless the bank makes another loan, there isn't any effect. They could go out and buy another Treasury, which in effect could put money in another account if the bond belonged to the public or put the money right back into the Fed. IF you read the Fed balance sheet, you will see that there are a lot of banks that are merely putting their surplus funds back into the Fed, basically transferring their deposit liability to the Fed.

In other news, John is one of the few guys I have met that think about the market like I do. I also call these guys morons and they are more prevalent than you might think. I just recently read an article by MIchael Lewis, who wrote the book Liars Poker, in response to the overpaid morons that were on Wall Street in the 1980's. He included himself in the group, as he said he had no qualifications to get a job on Wall street drawing the kind of salary he drew. The biggest business in the US is selling stock and when you figure how cheaply these guys can manufacture money, you have to be leery they are using so much effort to convince the world they need to be in stocks when these guys already own them all. If we need to be in them, why are they always trying to sell them? I blow a fuse every day watching CNBC when they bring on some guy that looks about 5 years out of high school to repeat something some Parrot told him about market history. This isn't normal times. Bernanke was on TV the other day talking about there is not going to be a depression, yet every time something sneezes now, like the auto makers or the banks, if you don't throw out $25, $50, $100, $300, $500, $700 or $1000 billion, we are going to have a depression. We are already in one when the game is that severe. The $64,000 question (that used to be a lot of money) is, if money is so free, why ever go to work again?

[StilesBC]

The Fed is buying treasuries further out on the yield curve (10 and 30 year) so they can collapse the yield on those treasuries. Their logic is that lower yields on treasuries will discourage people from investing in them and force them to buy riskier assets. They essentially create new electronic money to buy these treasuries. The process is known as Quantitative Easing. See my article on QE here: http://futronomics.blogspot.com/2008/12 ... -work.html

It's not going to work. It won't work because there is nothing for people to buy that makes any sense. Banks know this and therefore won't lend to people. So even though the Fed balance sheet is growing, asset value destruction in other areas will overcompensate for this phenomenon - prolonging deflation. Additionally, the "new" money just sits in accounts and doesn't get used. This means the "velocity" of money is collapsing. "Velocity" is essential to a growing economy - it is a measurement of how many times money changes hands.

People will cry hyperinflation over the exploding Fed balance sheet chart that is posted everywhere. There cannot be hyperinflation in this current situation. Even the last government stimulus cheque went 80% toward saving or paying off debt (equivalent to saving). Even if Bernanke "drops physical notes from helicopters," there is no guarantee that it will have any effect on boosting the velocity in which that money is used.

[mkrogh]

Hi john

you keep talking about the law of mean reversion of p/e ratios. But such a law does not exist. You are not very precise about
how you define it, but I assume you mean something like this.

The average of p/e ratios in the future of a stock, or a basket of stocks, will be equal to the average p/e in the past.

That is simply not true. Besides, there are big issues about how to account for a year with a loss.

There is only one certain law about future stock prices, namely that every stock eventually will go to zero. So, in the long run, it is a disaster to own stocks. Any buy and hold portfolio of stocks will go to zero. It is the exact opposite of what almost everybody believes, namely that in the long run stocks will go up. An index, e.g., DJIA, is always shown to prove this illusion of rising stock prices, but the problem is that an index is qualitatively different from a stock, or a basket of stocks. The difference is that the index has replacement. it sounds like a minor detail, but it is actually a difference so big, that it makes the difference between going to zero or going to infinity in the long run. Of course, infinity is not really infinity, and the long run is not the life of the universe.

An obvious objection is that one can track the index. I will claim that it is impossible to track the index in the long run. The reason is that the replacement requires infinity liquidity which is not present in the market. An index tracking fund will get caught with a declining position at the wrong time without liquidity to get out. The index, on the other hand, will just swap that company with another, using the closing price at the day of replacement.

There are companies going bankrupt every year, but the generational crisis must be a period of exceptionally many stocks going to zero.

If your law of mean reversion applies to an index, it might be true, but it is irrelevant because of the replacement. It doesn't matter to an investor that the p/e in 2030 of company A founded in 2020 will be equal to the p/e of company B in 2008. There is no way for the shareholders of B to get into A. The shares of A will be owned by the founders of A. The shareholders of B will be left with nothing.