Financial topics

[mannfm11]

It ever seem absurd that McDonalds has sales of $20 billion while the normal value of wheat harvested in the US on 46 million acres of land in 2006 was $7.7 billion? That is about 70,000 square miles of land. By comparison, the state of NY is 49,000 square miles, so the amount of land plowed, seeded, harvested and plowed again is like plowing NY almost one and a half times. There are hospitals in the US that cost $1 billion a year to run. I believe the annual budget for Parkland in Dallas is in excess of $1 billion. I can assure you that we can live a lot longer without hospitals than without farms.
There have been some interesting points brought up out of what I brought up. I don't believe that the cost of medical care and education in the US can be totally blamed on the diminishing of productive enterprises. But, I do believe this is a big part of it. The cost of education in the US stated in USD's is probably close to the cost of industrial production out of China, yet we constantly hear about how their schools put out so many more scientists and other people. Ditto hospitals. I doubt the medical system in Cuba could be bought for what the rest of their economy would generate in GDP in the US. Is the reason socialism or is it that the Cuban economy in general is engaged in productive pursuits instead of luxuries?
I am not proposing socialism, as I believe that the cost of medicine and the low price of agricultural commodities are both due to government intervention. In fact, I have read where there are fewer slots in US medical schools today than there were in 1900. I believe that the problem in medicine is actually due to the government and not in spite of the government. Basic medical care was something that most people could get before the government got so involved. Though I believe access should be provided, there is clearly no right to live forever, which seems to be the implication of public policy and the acts of politicians. In fact, a person gets old enough and I would imagine most are not so caught up in staying alive.
There are plenty of explanations, but no answers about why health care and education have gone up so much in cost. One explanation is lawyers, but can over $100 billion a year be attributed to this cost? What about the other $900 billion or so that it appears the health care system costs? I don't believe it is waste. I believe it is systematic theft and it will continue on an even faster pace if the government takes over. One only look at the public education system to see that is true.
My point isn't to point the finger for these costs, but to bring up the fact that the costs are rising relatively to the economy because the real value of the rest of the economy is shrinking. I read that financials made up 40% of the earnings of the SPX last year. Can anyone but question the real value of credit creation to the economy? My speculation is the real value is somewhere near zero and I am a financial man. In fact, the value of this industry to the domestic economy is probably negative, as it has served to build economies overseas by consuming collateral in the US. Yet these are the people that have been accorded the highest purchasing power. The truth that is revealed by compound interest and other compound figures reveals this side of the economy can't go on for much longer. Thus any cost structure that might underlie the medical and education fields is quite likely to collapse.

[mannfm11]

I have read where in recent years that financial statements have allowed for the write up in value of assets of corporations. Kind of amazing they are wanting to get rid of mark to market just when it might devastate the balance sheets of corporations that have been pumped up by the writing up in value. How many trillions of dollars of shrinking real estate asset values are on these balance sheets? What about pension liabilities? How many more hundreds of billions or even trilions of bad loans does the banking industry have to write off? If it was 4.5 times in 2000, then the book value of the SPX was about 360. That was about what I felt the value of the SPX was based on historical dividend yields. What is missing though is the trillion of goodwill that was on balance sheets back then and the real price to book was probably closer to 6.

Best guess is book value increased about 30% since 2003, if you don't take the losses that haven't been recognized yet. One has to remember that the financial areas alone have lost about $1 trillion, which at 2.5 to 1 would accoount for about 300 SPX points. That leaves about another 330 points of losses not related directly to the financials. Remember, LEH, BS, WB, AIG (a Dow component), CFC and Wamu have pretty much gone to zero. Also, counted in this mess are FNM and FRE. By any measure I would imagine there was $300 billion or more book value in these stocks 18 months ago. It is highly doubtful there was 2 cents left on the positive side today.

There is nothing wrong with looking at the market in this fashion, but it would be advisable to look at other components to see if what is being used as valuation is reasonable. I have looked up trailing dividends on the SPX after much pain of finding the right page. Trailing through the June quarter according to S&P figures is 28.71 and divided by the closing price on Friday gives a yield of 2.966%. If you go back to the beginning of 1982, the SPX paid a dividend of 6.63 per share on a value of 122 for a yield of 5.41%. As you can see, we have 2 pictures here, as the return from holding stocks (holding for return is different than speculation) today is barely over half what it was in 1982. Prior to the quarter ending June 30, 1992, there had been 4 quarters ending with dividend yields under the current yield, 3 of them in 1987. There have been none since and June 1992 can pretty much be considered the start of the GSE induced bubble.

It would be a mistake to use only dividends in this context, but they are much more important than book value. In fact, I believe it would be highly unlikely the assets of these companies could be sold for anything close to what they are valued on the books at. I could be wrong and I know that the corporate takeover game is all predicated on selling assets to retire debt and keeping what is left. That works in a bubble, but not in a post bubble atmosphere. This can be taken farther, as what else is in bubbles quite possibly is the treasury bond yields that are pointed toward as reasoning for stock dividends being so low. But, if one is going to use history to present a bullish picture, then they must also accept the bearish side as well. The bearish side is that stock dividends and earnings have grown less than 1% above inflation for history. The only times that this figure has exceeded this figure was during a bubble. The bulls can't put something out that disputes this and the base year, 1926 they like to use had a 4.8% dividend payout. In order to get that payout, the current price needs to be reduced to below 600.

The other point is that we aren't in a normal monetary economy, but a generational bubble economy. This favored stocks as long was we were on the front side of the peak. But we aren't on the front side of the peak. http://biz.yahoo.com/ap/081102/election ... arket.htmlThis article talks about stocks recovering regardless of who is President. There isn't anyone that has taken this decline or the shift in finances seriously save a very few of us. It doesn't seem to register what deleveraging means. It doesn't seem to register that capital is not borrowed money or injected by the Federal reserve or government. It doesn't seem to register that collapsing bubbles take with them the stated value of assests and the value of using leverage to earn more profits. In fact, the capacity to earn a return off borrowed money is diminished to the point that on a broad base, it is impossible. This, in itself turns the multiple of book value on its head.

The solution being employed right now was the same that was employed several times in the past, patching a leaking bubble. This time is different because the entire structure that built the bubble has collapsed. FNM and FRE were fully intact in 1990 and 2000. There was trillions of free home equity in 1990 and 2000 to borrow. Long term interest rates were 9% in 1990 and 6.5% in 2000 on 10 year treasuries, not 5% or less as they have been recently. It is highly probable that everything that accounts for the valuation of stocks rolls backwards from here.

[mannfm11]

John wrote: [This discussion of short-term market indicators is mind-numbingly
moronic.

Perhaps the MACD might provide useful information during "normal"
times, but none of these short-term indicators is useful today.

Playing the stock market today is the equivalent of playing a
roulette wheel. For the last several weeks, the major characteristic
of the stock market is a huge movement at the end of the day, often
several hundreds points one way or the other on the Dow within a few
minutes. This huge movement is caused by panic buying, but more often
by panic selling by hedge funds and mutual funds to meet margin calls
and collateral calls.

In this environment, all short-term indicators are totally
meaningless. I'm not exaggerating in the least when I say that no
one knows what's going to happen in the last half hour of the trading
day, since it appears to be completely random.

I have traded the SPX futures market before, spending an entire year doing nothing else back in the 1990's. I don't know of any trade other than maybe timing some interday options plays that doesn't promise anything short of total financial destruction. The declines and advances going into the close aren't about huge orders on either side, but instead I believe about huge speads between bid and ask being put into the system by the market makers, plus a premium being charged on either side to be in or out of the market over night. I counted the fade into the close when the market bottomed on October 10th and I believe the last 23 minutes lost 438 points. It had just rallied about 800 on a straight line in the prior 50 minutes. The idea that anyone has the skills to get on either side of a move like this is absurd. We are talking about a market full of air. The close Friday bottomed out with 13 minutes left then rallied about 150 points. There have been some hot trading days in the past where a 150 point move would be considered huge, yet we are seeing it in 10 minutes time over and over again. This is more than oversold or overbought as the moves go in both directions. This is about a lot of stock needing to move with no one on the other side.

There is an absolute delusion out there that people are waiting to get back in this market. They didn't get out. I doubt $150 billion of public money got out of this market before the decline, about 2 or 3 days trading volume at best. The biggest problem facing the market are almost zero bonds being issued right now worldwide. A few investment grades and that is it. So, we are going to get this market going again without any bond money? Money can't go in both directions and it is clear the problem is a lack of capital in the system, which portends toward more selling to reduce leverage instead of a plunge back into stocks. We are looking at 3% dividends and lower for the entire market while high grade bonds in the top echelon of companies are returning around 7% or higher from what I can deduce. We are a long way from a final bottom in this market. If john is correct, we still have a generational crash ahead of us or better yet, we have a group that just might go down with the ship.

[John]

Dear Barry,

> I have traded the SPX futures market before, spending an entire
> year doing nothing else back in the 1990's. I don't know of any
> trade other than maybe timing some interday options plays that
> doesn't promise anything short of total financial destruction.
> The declines and advances going into the close aren't about huge
> orders on either side, but instead I believe about huge speads
> between bid and ask being put into the system by the market
> makers, plus a premium being charged on either side to be in or
> out of the market over night. I counted the fade into the close
> when the market bottomed on October 10th and I believe the last
> 23 minutes lost 438 points. It had just rallied about 800 on a
> straight line in the prior 50 minutes. The idea that anyone has
> the skills to get on either side of a move like this is absurd.
> We are talking about a market full of air. The close Friday
> bottomed out with 13 minutes left then rallied about 150 points.
> There have been some hot trading days in the past where a 150
> point move would be considered huge, yet we are seeing it in 10
> minutes time over and over again. This is more than oversold or
> overbought as the moves go in both directions. This is about a
> lot of stock needing to move with no one on the other side.

Do I understand you correctly?

Are you saying that brokers are making these huge buy/sell orders
simply to make commissions, with no regard to whether the the orders
themselves make sense?

If so, that's incredibly damning.

Sincerely,

John

[Gordo]

... the "Peter Drucker thesis" which went something like (round numbers): agriculture used to be 50% or our economy and now it is 3%, then manufacturing was 50% and it is on its way to 3%, and we get and will get more out of the 3% that is agriculture (and will be manufacturing) than we got out of them when they were 50%.

Nice to see more quotes from somebody that actually gets it.

[Gordo]

...Schiff wrote a book back in the 1970's called, "How the government is fleecing you". In it, he brought up the steady cost of health and education against the economy and it is he that described this as evidence that the rest of the economy was faltering.

So let me get this straight, healthcare and education costs were going up in the 70's and that's evidence that economy was faltering, and they are up now 3 decades later, and you are still buying the story? How did that pan out? Standards of living have been steadily increasing every decade. Now yes, a severe economic downturn can disrupt this trend temporarily, but longer term, the trend will never end. Everyone who has ever predicted otherwise has looked foolish over time. This all despite the fact that real hourly earnings haven't changed much in 4 decades - how can this be?? I know you think this is all some credit driven illusion, but its not. This is what technology does for us. No, everybody is NOT working for McDonalds. And yes, a service based economy is to be EXPECTED as a result of massive productivity gains (see the Drucker comments).

I do think medical costs and education costs are too high, I also believe they will fall over the coming decades as technology makes it easier to tear down the walls that have been built to keep costs high. If you want to go to a foreign country for healthcare, no one is stopping you, if enough people did it, maybe costs would come down here.

[Gordo]

There is an absolute delusion out there that people are waiting to get back in this market. They didn't get out.

So the 40% decline was caused by people NOT getting out of the market?
The MASSIVE treasury buying over the last year was people NOT getting out of stocks?

I don't put a whole lot of weight on anecdotes - but here's my collection so far. A very good friend of mine decided, after taking what he considered to be unbearable losses to his retirement, to move ALL (100%) of the stock funds in his 401k to money market funds on Oct 10. He managed to time this to the EXACT DAY that the DOW hit its low point for the year. This was with hundreds of thousands of dollars. Is he waiting to get back in? YOU BET. Is he pissed off about his terrible timing and now worried that he may have missed the bottom and he is sitting on the sidelines as we go back up? YES, of course.

Story 2 - a coworker NOT ONLY sold his stocks a couple of weeks ago, but he actually started stockpiling cash at his house (maybe he reads John's blog? Hahah). This guy is young and fit, but things got so worrisome for him that he ended up in the hospital - he thought he was having a heart attack! The hospital kept him for a little while, but could find nothing wrong with him. Personally I think it was a panic attack related to his anxiety about the markets/economy/investments. Is he worried now that he might have panicked a little? Gotten out at the wrong time? You tell me.

Does any of this sound like bottoming type activity to you?

How about this?



From the Forbes article: "Why small investors are stupid"

[zev]

Why will the government win? China is a country where the government (the CCP or Chinese Communist Party) has almost complete control of the government. The CCP has been trying for years to cool down the country's bubble economy, with no success whatsoever.
Until this year, when they're finally getting what they wished for, except that the Chinese economy is crashing, as the economic bubble collapse, and now the Chinese are desperately trying measures to blow the bubble up again, which will surely fail.

The problem I have with this statement (in an otherwise good posting!) is "where the government ... has almost complete control of the government"? Huh?
Did you mean to say that the government has almost complete control of the economy? Or did you mean that one party (the CPP) has almost complete control of the government? I'll assume both, as both are true-ish.
However, you omit one key parameter - that the CPP is not a united front most of the time: lots of fractions, geographical divisions, and political jockeying. This may be a reason why this non-democratic government has been so resilient, as it allows a fair measure of debate and dissent within the otherwise autocratic regime. The point is, stating that "the CPP has been trying for years to cool down the ... economy, with no success whatsoever" is a bit misleading. Yes, official pronouncements have said so, and some factions have been genuinely worried about the bubble. But, other factions had strong incentives to stay the course, as the bubble provided desperately needed jobs, raised China's technological prowess, provided foreign currency, filled the government's coffers - allowing military build-up, and drove economic development generally. Others may have simply believed that it wasn't a bubble, and so was sustainable.
What this meant is that the Chinese government's actions to cool the economy were rather half-hearted and ineffectual. Not because they couldn't have done it, but because they (like most other governments around the world) found too many things to like about the bubble, while it lasted.
So China does not provide a good example of government powerlessness before market forces. But, it does provide a good example of the phenomenon of governments becoming party to keeping the bubble going, rather than doing their job to prevent them or contain them. This, by the way, ties nicely with the generational dynamic, as governments wills' to resist bubbles weaken as time passes since the last big bubble/generational crisis.

[John]

> The problem I have with this statement (in an otherwise good
> posting!) is "where the government ... has almost complete control
> of the government"? Huh?

This is a typo. I'll correct the web log this evening. Thanks for
pointing it out.

> However, you omit one key parameter - that the CPP is not a united
> front most of the time: lots of fractions, geographical divisions,
> and political jockeying. This may be a reason why this
> non-democratic government has been so resilient, as it allows a
> fair measure of debate and dissent within the otherwise autocratic
> regime. The point is, stating that "the CPP has been trying for
> years to cool down the ... economy, with no success whatsoever" is
> a bit misleading. Yes, official pronouncements have said so, and
> some factions have been genuinely worried about the bubble. But,
> other factions had strong incentives to stay the course, as the
> bubble provided desperately needed jobs, raised China's
> technological prowess, provided foreign currency, filled the
> government's coffers - allowing military build-up, and drove
> economic development generally. Others may have simply believed
> that it wasn't a bubble, and so was sustainable.

> What this meant is that the Chinese government's actions to cool
> the economy were rather half-hearted and ineffectual. Not because
> they couldn't have done it, but because they (like most other
> governments around the world) found too many things to like about
> the bubble, while it lasted.

> So China does not provide a good example of government
> powerlessness before market forces. But, it does provide a good
> example of the phenomenon of governments becoming party to keeping
> the bubble going, rather than doing their job to prevent them or
> contain them. This, by the way, ties nicely with the generational
> dynamic, as governments wills' to resist bubbles weaken as time
> passes since the last big bubble/generational crisis.

You make a very good and important point here. I have in the past
emphasized that China's government is becoming as paralyzed as
western governments, and for exactly the same reason -- the
generation of crisis war survivors (in China's case, the Communist
Revolution civil war, 1934-49) is rapidly disappearing. Those
survivors, their Artist Generation, are the people who have been
making decisions and making sure that all goes well. Hu Jintao is in
that generation.

But now they're disappearing, being replaced in the leadership by a
post-war Prophet Generation (like our Boomers), as well as a Nomad
Generation (like our Gen-Xers). People in these generations do not
know how to govern, just as they don't know how here. Instead, they
bicker and complain and whine and undercut anyone who tries to
accomplish anything. And their Nomad generation is just as
destructive and nihilistic as ours is.

And so you're exactly right. They're no longer capable of making the
hard decisions, with the results that you describe: "lots of
fractions, geographical divisions, and political jockeying." I think
it's incredibly ironic that, for all the differences people imagine
about China's Communist government and our democracy, in the end they
both fall to the same generational bickering and destructiveness.

However, I purposely chose not to go into all this in the web log
article you're referring to. All I really wanted to say was that if
China's Communists had no power to control its economy, then there's
absolutely no reason to believe that America has any power to control
its economy.

This brings us to another incredible irony: Those who believe that
President Obama and a veto-proof Democratic Congress are going to
solve the country's and the world's problems are in for a very rude
surprise. It's going to be fun to watch, except for the disasters.

Sincerely,

John

[Higgenbotham]

... the "Peter Drucker thesis" which went something like (round numbers): agriculture used to be 50% or our economy and now it is 3%, then manufacturing was 50% and it is on its way to 3%, and we get and will get more out of the 3% that is agriculture (and will be manufacturing) than we got out of them when they were 50%.

Nice to see more quotes from somebody that actually gets it.

Here are some of the notes I took on Peter Drucker's book, Managing in the Next Society, which also covers the above information.

The Industrial Revolution began with the steam engine in 1776. In 1829, the railroad, which was unprecedented and virtually unanticipated, set off a boom that forever changed the economy, society and politics. For the first time in history, human beings had true mobility. The early industries of the Industrial Revolution were boom industries that created millionaires overnight. Typically, the speculative boom precedes the growth in the real businesses by 10 years. The railroad boom in the first half of the 1830s led to the Depression from 1835 to 1842. The industries that emerged after the 1829-1835 boom had 20 years of hard work, struggle, disappointments, failures and thrift ahead of them.

The Information Revolution began with the computer in the mid 1940s. Until recently, the Information Revolution had only routinized existing processes, resulting in time and cost savings. In the 1990s, e-commerce, which was unprecedented and virtually unanticipated, set off a similar boom that will forever change the economy, society and politics. It will result in one economy, one market, and eliminate distance. E-commerce sells and, more importantly, delivers a whole range of products...

Fundamental changes occurred in the 1990s that have resulted in the next society. The Information Revolution was only one factor and perhaps not the most potent one. Demographics were at least as important, especially the rapidly falling birthrates. The Information Revolution was the culmination of a trend whereas the shrinkage of the young population was a total reversal. The steady decline in manufacturing as a creator of wealth and jobs was another total reversal...

In the next 20 or 30 years, social issues will be dominant. The rapidly aging population and the rapidly shrinking younger population means there will be social problems.

He then goes on to discuss the role of information technology, much of which can also be found in...

This article which also summarizes some of the information in the book and discusses the role of the printing press:

http://www.theatlantic.com/doc/199910/i ... revolution

The period from 1835 to 1842 did not occur during a Fourth Turning of the generational cycle which, according to Strauss and Howe, was from 1860 to 1865. The technology and generational cycles appear to be in closer alignment today by this interpretation, although I have seen other (different) interpretations of the technology cycle.