Archive for October, 2011

September Institute for Supply Management

Thursday, October 20th, 2011

The Institute for Supply Management splits our economy into two general groups, manufacturing and services.  They publish monthly reports covering each.  While the service sector is the largest piece of the employment pie, manufacturing moves in line with the business cycle so it bears watching.  Being the attentive group that we are, Atlas tracks them both.  Each continued to expand in September but the real story may lie beneath the headlines.

The overall figure for manufacturing came in at 51.6, up one point from August.  While it may have gotten better as things like employment and output improved, after parsing the numbers the outlook may not be so optimistic.  New orders fell below the 50 mark which in this type of indicator is the line between growth and contraction.  At the same time, inventories continued to climb; suggesting manufacturers are restocking more of their production as sales decline.  This is also evident as order backlogs fell, illustrating manufacturers are having an easier time keeping up with the needs of their customers.  If sales of manufactured goods are waning, it will impact company earnings and cause companies to put off hiring, or worse.

The non-manufacturing counterpart also provided a mixed survey.  The headline advanced 0.1 points to 53.0 as orders, production, backlogs, and inventories increased.  On the other hand, sentiment figures suggest companies are now sensing their inventories are too high.  This may explain why the employment component contracted and may continue to put pressure on jobs if employers remain concerned that their capacity is above the market’s current demand.

With the service sector being the highest employer in the country, it is discouraging to see employment contract while unemployment is already so high.  Also, if the manufacturing side is not able to correct the inventory overstock, it will need to cut its output.  Atlas has mentioned our concern about a degradation of the business cycle in a few our recent postings, and we are noting it here again.

Positive Stinking

Wednesday, October 19th, 2011

We recently took a survey of major brokerages to discern just how much of a client’s money they felt should be allocated between stocks, bonds, and cash.  Almost all of them would have you place over 60% of your portfolio into stocks.  These are all smart institutions with well-funded research staffs.  They all look at the same information we see, but our conservative viewpoint and indicators somehow lead us to a quite dissimilar conclusion.  Currently we have under-emphasized this area.  Why the difference?

Both the modern financial press and modern retail brokerage seem to feel a measure of positive thinking is a requirement when discussing investments.  This is some sense to their argument; after all, if you didn’t think stocks were going to appreciate, why would you buy them?  If you can’t produce articles discovering new opportunities or research justifying old ones, it may be difficult to keep the doors open.  Paraphrasing Coolidge, the business of the financial press and establishment is their business and a bullish spin keeps everyone at the table.  Greed sells and, if it becomes the sole motive for doing business, that stinks.

Fortunately for us here at Atlas we have discovered a group of investors who feel like we do.  They do not need an exposé to keep them interested in current events.  They don’t want a stock-of-the-month plan.  They do want a sensible, informed opinion which places current events in a context which directs their wealth into channels which hopefully can first preserve it, then make it grow when opportunities arise.  Nobody needs to be told times are tough, that the old way of doing business hasn’t worked for over ten years now, yet too many established institutions act like it is business as usual.  For them it is because that is their business.  We prefer to use our indicators and apply what they suggest until trends change.  Currently what we are seeing both here and abroad suggests a much more cautious approach must be applied.

Go Your Own Way

Tuesday, October 18th, 2011

When Fleetwood Mac released their hit Go Your Own Way back in 1976, it ran up the charts, becoming their first top ten single.  Subsequently they included it on the Rumours album, a big hit in its own right.  It is now enshrined in both the Rock and Roll Hall of Fame and Rolling Stone as one of the top 500 seminal/greatest songs ever, illustrating that Baby Boomers apparently feel all life began with them.  The song essentially commemorates the breakup which two of the band’s members were enduring at that time.

Breaking Up Is Hard to Do (Neil Sedaka, 1972).  Apparently more so for big banks than any Teenager in Love (Dion & the Belmonts, 1967).  The struggles we are witnessing as the global banking system tries to deal with the ultimate results of an unprecedented lending binge coupled with virtual blank checks underwritten by governments guaranteeing the whole kit and caboodle (no song yet to my knowledge) produce volatile price moves that seem to make little sense.  It does seem natural to us that the equity, precious metals, and bond markets are reacting to such events as they unfold, even while politicians, economists, CEOs, and talking heads all attempt to influence the outcome.  The market will go its own way however, disregarding other opinions and even legislation.

The Economic Cycle Research Institute is one of our favorite indicators.  They use a proprietary methodology which has a record of accuracy unmatched by any other service of which we are aware, a record reaching back into the 1930s.  Recently they said the U.S. is “indeed tipping into a new recession.  And there’s nothing that policymakers can do to head it off.”  They feel many indicators are “now collectively behaving as they did on the cusp of full-blown recessions, not ‘soft landings,’” concluding “If you think this is a bad economy, you haven’t seen anything yet.”  This suggests to us that interest rates have a high probability of continuing their downward trend, something the Federal Reserve states will be policy for some time yet.  We’ll take them at their word and overweight portfolios with high-quality, interest-bearing bonds for the time being, giving us a chance to enjoy both income and possible appreciation.

The Greater Good

Monday, October 17th, 2011

The Chief Investment Officer of a London firm recently called the Euro quagmire “a bad crisis.”  Good call, Sherlock.  I suppose that was to distinguish it from just an ordinary, perhaps even good, crisis.  He felt the cure would require that “Politicians need to move ahead pretty quickly,” thereby unwittingly outlining two additional bad crises.  First, getting politicians from all the countries involved in the European Union to act in concert quickly almost seems to violate one of Newton’s laws.  Second, the solution will be primarily political, not strictly economic.

As the situation deteriorates, American money market funds have been pulling their U.S. dollars away from European banks.  This has led to yet another crisis where systemic liquidity is being threatened.  Riding to the rescue is our own Federal Reserve which needs no political permission to promise an unlimited supply to European, particularly French, banks in an effort to relieve their stress.

Should you ask why American taxpayers are on the hook for Greek profligacy when prudent domestic investment firms shun the same, I would point to Utilitarianism, the idea that more people will benefit than will be hurt.  Interestingly, a recent study found those who tend to this viewpoint also have strong psychopathic, misanthropic and Machiavellian tendencies.  Amazing.  Who would have listed any of those traits on Ben Bernanke’s resume?

So take this test:  You’re standing on a bridge next to a really big guy when a bus goes out of control beneath you, careening toward a large group of school children.  The only way to prevent their imminent death is to place an object in its path heavy enough to alter the fatal trajectory.  You don’t weigh enough, but big boy does.  Do you throw the fat fellow under the bus?  If so, there may just be a job for you at the Fed.

Against the Wind

Friday, October 14th, 2011

Recently I reviewed a report by Jose Ursua, an economist at Goldman Sachs, wherein he analyzed 93 periods of economic stagnation which he identified as occurring in different places over the past 150 years.  They were marked by “high and sticky” unemployment, slow GDP growth, and disappointing stock markets. Avoiding “a Great Stagnation by a pick-up in the recovery is likely to depend on policy,” he states.  Thus central bankers like our own Federal Reserve may consider “truly unconventional ‘unconventional'” methods in an attempt “to jolt economic growth upwards.”

His conclusions mirror those of Reinhart and Rogoff who wrote a tome titled This Time is Different: Eight Centuries of Financial Folly.  Their conclusion suggests the current slow period in which world economies are mired is due in a large extent to the huge amounts of debt accumulated over the past few decades and the subsequent collapse of that trend.  They feel it is probable we have entered a period of reliquification which could last for quite a while yet.

Ursua cautions such circumstances could result in “demand pullbacks that may be difficult to correct if they persist.”  This produces income levels in a country which experiences a decade or more of stagnation which could be substantially lower than average. Will this impact those who are in the middle years of their wealth building?  What about the younger cohort just coming on board?

Bob Seger wrote a song which defines the generation of which he is a part as follows: “I was living to run and running to live. Never worried about paying or even how much I owed.”  I fear he may also have described a subsequent generation as the song ends: “See the young man run. Watch the young man run.  Watch the young man runnin.’  He’ll be runnin’ against the wind.”

Hopi Drums

Thursday, October 13th, 2011

Take a section out of a tree, maybe cottonwood, but it should be two or three feet in diameter and hollow it out,.  Cut a couple of large patches from the skin of an elk or maybe some buckskin if you have it handy and stitch them tight over both ends using sinew you cut from the same critter, and you have yourself a mighty fine drum.  Some drums made this way have endured for decades, possibly even longer than a century.  You’ll be a big hit at the powwow that’s for sure.

Hollowing out a log is very important when constructing a drum.  If an important segment of a country’s consumer population gets hollowed out by time, the results are much less desirable.  How does such a thing happen?  When any region of the world stops having enough children for a long enough time, a multi-year shrinkage in that population’s demographics manifests.  Evidence suggests that the combined consumption by individuals from around 40 to just over 50 years old contributes significantly to a nation’s Gross Domestic Product.  As they age beyond that and their needs diminish, GDP tends to decline if there isn’t a large enough group aging right behind them.  Here in the U.S. this phenomenon is referred to as the Baby Boom.  In China it is happening due to Mao’s one-child policy.  It is happening in Japan and throughout a large segment of Europe as well.

Economists and politicians seem to hate simple answers, especially those which suggest little can be done to prevent an inevitable outcome.  A Goldman Sachs economist, Jose Ursua, recently wrote “a pick-up in the recovery (of the major developed economies) is likely to depend on policy being able to restore confidence and putting in place reforms that can decisively jolt growth.”  We think it’s impossible to legislate either confidence or consumption.  Look, it appears that Greece will have to default.  China saw manufacturing decline in September for the third month.  Unemployment in the U.S. remains high and wages declined in August.  Retail sales in Germany just fell the most in four years.  Japan is struggling to overcome a devastating earthquake and tsunami.  Anyone who suggests “the government ought to do something” is beating the wrong drum.  Only time will heal these wounds and federal intervention has a history of only exacerbating such slowdowns.

Cream in Your Coffee?

Wednesday, October 12th, 2011

Not often must we endure a period of market uncertainty with a duration lasting so long as has the current one.  The volatility which has accompanying this uncertainty is virtually unparalleled with major indexes swinging up and down by hundreds of points on a daily basis.  This is not normal.  Typically it takes place when the economy is in a period of transition.  That this is such a period of change cannot be debated.  My point is that it is taking an inordinately long time for the economy to find its footing, to embark on a consistent path regardless of direction.  This has a strong impact upon your portfolio.

Let’s say you’re enjoying the Grand Slam at Denny’s while watching a friend who has just been served a hot cup of coffee add way too much cream.  We know the coffee starts out dark black but will end up some shade of mocha.  In between those two steady states the coffee and cream swirl in a chaotic pattern which, while fascinating, delays the drinking of that beverage.  The normal thing to do would be to stir it up, accelerate the process to get to a point where your friend can proceed with the rest of his breakfast.  We would consider such an end point to be just as normal as that of the original cup when it was still black.  The change is where we find all the turbulence.

Here at Atlas we use a system of relative strength to determine how your funds should be allocated amongst investment classes.  You could almost consider coffee and cream to be two such classes.  What we need to see is a consistent relationship between them which allows us to position portfolios in those which are rising while avoiding the decliners.  Unfortunately there is no big spoon which can stir things up to accelerate this current economic transition.  Countervailing trends are still mixing; none have yet been able to assert dominance.

From month to month, especially in times such as these when trends are mixing much like coffee and cream, your statement may not show significant total growth.  Obviously it can even show declines as turbulence holds sway.  We do believe, however, that this system is the best way to discover long-lasting patterns when they do emerge from this chaos, allowing us to be positioned for the next long-lived investment trend.  Then we may even decide to look over the desert menu.