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If Rip Van Winkle Ran Wall Street

Rip van Winkle woke up to a completely different world

One of the insightful bits of investment wisdom is that you don’t have to recoup a loss by stubbornly holding onto the same investment that caused the loss and hoping it will “come back.” In other words, it’s okay to sell a loser and redeploy the money in another opportunity that may have better odds of going up in value. That seems to be what Greece and Italy are doing with their leadership change. These countries just dumped their political leaders and are betting that new leadership will calm the financial markets and drive important structural reform.

Greece is now counting on Lucas Papademos and Italy is counting on Mario Monti to lead their countries out of their debt mess.  If these guys take swift action and gain credibility, it could help the markets. As Barron’s pointed out this past weekend, “In the absence of new and nasty headlines or evidence of acute market stress, the default mode of stocks – at least for now – is to hang firm or to climb a bit.”

As of last Friday, the S&P 500 index turned positive on a year-to-date basis. We’ll have to wait and see if political change in Europe is enough to kick start the tired markets toward a climb out of the doldrums.

Rip van winkle slept for 20 years and awoke to discover that his world had changed dramatically. The U.S. stock market has been “asleep” for about 13 years now and in another seven, we may find our world is much different, too.
In the nearly 13 years between January 11, 1999 and last Friday, the S&P 500 index rose as high as 1,565 and dropped as low as 676. During that volatile period, we witnessed numerous impactful events including the following:
• The bursting of the dot-com bubble
• The rise of the euro
• 9/11
• The war on terrorism
• The rise and fall of the real estate bubble
• The spectacular rise of the price of gold
• The Southeast Asia tsunami and the Japan tsunami
• The rise of social media
• The Great Recession
• The sovereign debt crisis

Yet, with all those world events and the tremendous moves in the S&P 500 – both up and down – during those nearly 13 years, guess how much the S&P 500 price changed between January 11, 1999 and last Friday?
Exactly zero!
That’s right. The S&P 500 closed at 1,263 on January 11, 1999 and at 1,263 last Friday, according to data from Yahoo! Finance.
Does this mean you should never invest in the stock market because it’s been flat for so long? No. Here are five things to understand from this long market malaise:
1. Dividends matter. While there was no price change between these two time periods, reinvesting dividends or owning investments that pay dividends may have generated a positive return.
2. Diversification matters. The S&P 500 was flat, but some other asset classes did fine over the past 13 years, so it’s important to search far and wide for investment opportunities.
3. Perspective matters. It’s easy to get caught up in the large day-to-day swings in the market, but understanding the broader trend or context of the market is important to help prevent day-to-day volatility from causing you to make bad investment decisions.
4. Patience matters. As long-term investors, we’re more like the tortoise than the hare. Short-term, rapid traders create a lot of noise and may lead the pack from time-to-time, but we’re focused on winning at the end, not at each checkpoint.
5. Valuation matters. The bubble-like values placed on some companies in the late 1990s were so out of whack with normalcy that it’s taken the market many years to work off those excesses. So, while patience is important, it’s also necessary to understand that valuation at the time you make your investment could have a major impact on how long it takes to get a return on your investment.

Nobody knows if the market will remain “asleep” for another seven years to match Mr. Van Winkle. Regardless, the world will be different and our challenge is to figure out how to reach our destination without the nightmares.

When Expertise Gets Hijacked

When looking at the future, remember there was no iPhone before June 2007

The New York Times published a story from Financial Advisor Carl Richards this weekend with the attention getting title: “How a Financial Pro Lost His House”. Even though I like the humility of Carl Richards’ exposé and the ongoing questions he has, even now that life seems to be getting back onto the tracks, just a relative short couple of years later, I do have some serious footnotes and potential repercussions to add to his story, especially since it is presented in a “feel good coming of age story” type scenario that is not likely going to be your typical outcome for many other victims of the housing boom debacle.

First of all Mr. Richards’ trajectory to become a certified financial advisor seems a bit thin and the product of typical high speed low quality output of this country’s educational system. If you want to know why I make that statement, than check out the training involved here.
By his own admission Mr. Richards had no clue about securities in 1995 and the shear fact that he accepted a job as a call center sales person for Fidelity Investments later that year, turned him into a financial adviser and certified financial planner with Merryll Lynch, less than four years later. In my humble opinion, a certified financial advisor needs the basis of the profession and its constant updates PLUS a little life experience under the belt, and at least have consciously gone through a couple of economic cycles to understand how the world works and the vulnerabilities that come with human nature.

Before anyone should be allowed to call themselves “certified financial planners” they should have a much deeper understanding” of  Alternative Realities and how they play havoc with people’s emotional and financial lives. We humans have a unique tendency to create alternative realities. I would even go as far as to  state that there are now more than 7 billion different realities on this planet, all of which operate within the cycle of such perceived entitlements as: I have – I need – I want – Nice but not necessary. Many of these realities include possible future outcomes that people feel the need to prepare for (family planning, college education, retirement planning,etc.), though few are as predictable and repetitive as for example the arrival of winter or yet another Holiday Season. It’s easy to prepare for those with Hard Realities.

Many realities are of no real consequence to daily life – for instance, if the color blue is your “lucky color”, it may cause an unnoticeable blip in the color of shirts sold by your favorite retailer, but there is no life altering consequence attached.
If however a large part of the population can be convinced that this winter is going to be the coldest in 100 years or that only blue clothing will protect you from the cold, alternative realities may have huge consequences.

Let me at least try to explain .

Back in the days, when tribes coalescing into small nomadic villages were the primary organizing structures for the human race as it developed, I suspect the number of human realities were quite a bit more limited than they are today. For instance, in addition to the certain knowledge that winter was coming, the villagers understood certain basics required to live off the land. For example, the best methods for bringing down game, the optimal times to plant and harvest, when the growing and flooding would come and so forth.

But, side by side with those hard realities, there were other commonly accepted realities – for instance, that angry gods periodically took aim at earth with lightning bolts and thunder (Thor, Zeus, Perun, Indra) or furiously whirling winds (Juracan, Huracan). And if enough authority around the campfire decreed that by jiggling dressed in animal furs, the tribe could command or even ensure a more successful hunt or growing season, an alternative reality based on no other fact than power of persuasion, would become “true” realities. Human sacrifices of witches and virgins became hard reality based on these superstitions.
Over time, as humanity reproduced and morphed into an almost endless number of cultures, the hard realities of life on earth remained essentially unchanged – but the number of alternative realities exploded exponentially.

Today the alternative realities extend well beyond the obvious. We look for and welcome the evidence that fits our favored theories and we ignore or question the evidence that contradicts it. We all do this all the time. It’s not, as we often assume, something that only our opponents indulge in. I do it, you do it, it takes a superhuman effort not to do it.  That is what keeps myths alive, sustains conspiracy theories and keeps whole populations in thrall to strange superstitions.

I can give you thousands of examples to underline this human behavior, from believing that crop circles are extra terrestrial long after it’s proven not, to scientific heresy or the reality behind the frantically growing number of vampire like horror flicks these days, but since we’re talking about political economics in the case of financial advisor Carl Richards, I’ll stick to hard reality versus alternative reality.

It never fails to amaze me how two people for example can receive the exact same input and come to diametrically different or even opposing interpretations. While much of this can be harmless, the crust on planet Earth is stacked high with the dried skeletons of broken relationships, ruined mega-bands, shattered marriages, collapsed business partnerships and more – all without exception due to alternative realities derived from viewing the same events through different lenses.

Interactive Tug of War

Carl Richards story reminds me a little of my favorite Cable TV program “International House Hunters”, in which couples for various reasons such as a vacation home outside the US, a job transfer or a true life changing experience, have a realtor select 3 possible homes for them, based on family and business needs and financial means. It is alarming how many times the couples in the end select the home priced substantially beyond their stated budget and it is a bit chilling to witness how many times the man, at first with a strong opposition to going beyond the budget, will in the end bow to his partner’s desires. Now I’m not saying that women are the culprits here. What I’m saying is that there are alternative realities that play a major role in the decision making process, dealing with children’s wishes, family needs, visitors, commute costs etc. etc.

Carl Richards, certified financial planner, in a way also committed the sin of letting society’s status appeal and circumstances dictate his obligations and responsibilities, rather than choosing for the hard realities of his life and family. He selected for example a pick-a-payment loan, the ultimate creation of alternative reality during the housing boom. He rode the wave of credit cards, equity loans and living the high life until the sky came down as the only hard reality that exists.

What is a moral obligation?

Although it has been argued that banks were at fault for pushing excessively available cheap money to boost homeownership, it still does not free the buying individual from the moral obligation to pay for what they wanted.  At least not from where I stand because it would imply that we actually people that need to be protected against themselves, hence more government. If that is the case we need to seriously start discussing the hard reality of secession

But then during the breakdown phase in the aftermath of the financial crisis, banks actually made it mandatory for people to be at least 3 months in arrears before any action of short sale, loan adjustment or foreclosure could even be scheduled on the discussion board. That action has delayed a housing market restart by more than 2 years now, adding excessive home inventories to new construction stagnation, to stagnated employment opportunities. Talk about confusing hard realities with alternative realities!

I do now know people that have been living in their underwater homes, without any type of payment (including property taxes) for almost 4 years! And that’s absurd. The hard reality is, if you can’t pay for what you ordered, you won’t get to enjoy it. Many people couldn’t pay for what they had ordered, but still got to enjoy many aspects of the ownership, often for extended periods of time. When banks and credit card companies, two major culprits in this sordid scenario, started pushing homeowners and credit card owners even more into the corner with higher rates and penalties, while at the same time accepting or even demanding bailout monies from tax payers inputs, morality became an academic reality, a new creation that now hangs between hard fact and alternative options.

Rationalizing Wants into Needs

Life, more often than not, won’t let us make a clear distinction between hard and alternative realities anymore. The choice of options provided by alternative realities are simply too numerous, while magnified even more by the fact that in the end we are social beings who, for the sake of children, the family, the neighborhood, the numerous social, cultural, economic, political and religious affiliations etc. can rationalize almost any WANT into a NEED and thus justify almost any form of acquisition – purchase, layaway, theft, beg or borrow. We have entered a world where we have to decide whether certain Hard Realities can be softened and at what cost.
If you don’t understand, than it’s time you realize that much in today’s society is laid down in judicial spreadsheets. A burglary gets you 6 month, with 2 months for good behavior and 2 years probation. Armed robbery gets you 2 years with 6 months for good behavior and 3 year probation etc etc. The lines between nature’s hard realities and human alternative realities are getting vague, not because nature has changed, but because humans are increasingly accepting virtual reality as truth.

Carl Richards even at the end of his confessionary tends to justify his behavior by stating that his ordeal has taught him that ‘we’ are a nation of risk takers and that some of us were were just overoptimistic; some were ignorant; some were deluded; some were greedy; some just had bad timing.
And even though I think Carl Richards may have learned some value lesson from his ordeal that may help him as a certified financial planner, I still feel that his education in Hard Realities versus the Creation of Alternative Realities, has not been completed yet. He still is struggling with the acceptance that the unscrupulous, which among others includes mass media, rent-seekers and power grabbers alike, magnificently understand the buttons on human emotions and push those buttons relentlessly in the pursuit of their self-interest.

If you really want to avoid certain future misery you have to accept the hard realities that are time proven and were already very obvious to the old tribes around the campfires:
• If something sounds too good to be true, it probably is. Check the facts before you get emotionally or financially invested in it;
• Be skeptical of dire predictions for the future. Carl Richards is right, we are a country of risk takers and especially when someone plays the threat of the end of the world card in order for us to open up our wallets, we tend to jump into the chaos quite readily.
• Don’t believe anything a politician tells you. It’s in their interest to tell you what you want to hear, and that can be a wide margin away from reality and most likely is. With apologies to Herman Cain fans (I too was hopeful about him) –  but if a woman is willing to step into the docket of public opinion by saying that Cain offered her help getting a job in exchange for sex, and there are four others saying pretty much the same thing, it’s probably true. Did you actually expect him to ‘fess up any more than Clinton did when confronted with his Lewinsky moment? And no I don’t take his wife’s stand as any proof that he’s not smelling a bit different these days.
• Don’t fall in love with bloggers (including me). Anyone who can write reasonably well can now make a rather popular stand into the public discourse. People who can actually think, however, are another thing altogether. Learn to tell the difference.
• Follow the money. If a pharmaceutical company funds a survey that benefits the sale of their product, then you need an extra dose of salt in your diet.
• Find trusted sources, but even then keep your skeptic’s checklist close at hand.

Arbitrage Reality when it comes to your life.

Be aware that given the open-ended nature of government these days, no corner of society is off limits and no expense is too great for them. These days there are few greater fictions prevailing than that the government has a cure for all that ails, even though they will go to great lengths to make you think they do.
If we all agree, and many do, that we’re definitely living in a tough time right now, we should realize that this is the inevitable result of trying to manage far too many alternative realities instead of focusing on the hard realities of how things actually are. It’s kind of fundamental in a sense.

BUT….we also need to realize how far we have come most people will muddle on through, and in no time at all, in the historical context, things will be smoothly humming along, better than ever. And if you need a vision to get a sense of how quickly things change and will continue to change, answer this question: When was the first Apple iPhone offered for sale? Barely 4 years ago in June 2007. Take it from me: The world is going to change for the better, even faster than you can imagine it will.
Carl Richards’ closing sentence in the New York Times article somewhat confirms that statement in the fact that his ordeal had “only” a two year time frame: two years he actually needed to finish his financial planner education taken from the books into the streets: “All I have to do to remind myself is to remember what it felt like to stand outside the kitchen window only TWO YEARS ago, looking in on my life t the dinner table, and fearfully thinking I might not get it back.”

Stocks Still a Good Bet for the Long Run

Investing is laced with personal preferences.

One of the core beliefs of modern investing may turn out to be not so true. Investors have long believed in “stocks for the long run” and many a financial advisor has reminded clients that stocks outperform bonds over a long period of time, as long as we “stay the course.” Perhaps it is time to re-evaluate that old truism.

New data shows that for the 30 years ending September 30, 2011, long-term government bonds outperformed stocks. During that period, bonds rose by 11.5 percent a year on average, beating the 10.8 percent increase in the S&P 500, according to Jim Bianco, president of Bianco Research in Chicago, as reported by Bloomberg. That’s the first time bonds beat stocks over a 30-year period since the Civil War!

Here’s some long-term historical data on how stocks and bonds have performed relative to each other:

Stocks versus Bonds over time.

Is this an argument for dumping stocks and just owning bonds? Not exactly.  Have you taken a good look at bond yields lately? The recent outperformance of bonds over stocks was partially a function of the starting point and the “lost decade” for stocks. Specifically, in 1981, long-term government bonds yielded in the 13 to 15 percent range while, last Friday, the yield was down to 3.1 percent, according to data from Yahoo! Finance. As the yield drops, the price of the bond rises, thus, giving investors a capital gain on top of the interest return.

With yields so low now, you won’t get the same capital gain boost from bonds that we experienced over the past 30 years. In fact, Professor Jeremy Siegel, author of Stocks for the Long Run, says, “It’s absolutely mathematically impossible for bonds to get any kind of returns like this going forward.”

Bonds also benefited from the “lost decade” in stocks as stocks experienced two bear markets in the past 11 years.

These historical data do two things for us:

1.    They suggest that there are no “absolutes” when it comes to investing, except, perhaps, that there are no absolutes. Key takeaway – be flexible.
2.   They suggest that there is a time and a place for each asset class and placing each asset class within historical context is important. Key takeaway – know history.

Oh, we should add a third key takeaway from this data – be a continuous learner and a student of financial markets in particular.  Never be afraid to question the “truisms” we so often take for granted.

The Fall of Jefferson County Alabama

The first of a long line of community bankruptcies?

The massive bankruptcy of Jefferson County, Alabama and Nancy Pelosi’s appearance on Jon Stewart’s Daily Show  last night has once again confirmed that the safest and best jobs in America are being a lawyer or a lobbyist and if you can manage to be both, you’re absolutely set for life. Of course this should not come as a surprise considering Washington’s relentless contribution to a never ending introduction of laws and regulations, objected or supported by a lot of lobbying cash.

I watched Nancy Pelosi squirming on Jon Stewart’s Daily Show last night, as she deviously tried to come up with an adequate explanation of why Paul Volcker’s original 3 page letter to Obama about Banks Too Big To Fail in 2009, became a 10 page inclusion in the Dodd-Frank Wall Street Reform and Consumer Protection Act when it went to Congress last year and is now a 298 page DRAFT, that includes more than 1,300 questions on some 400 different topics. She essentially said: We, (America), would not understand! “When a document like that goes through congress,” she said, “the language changes.” It’s all about legal interpretations.
I have no idea where the whole Reform Act will go from here now that banks and even Paul Volcker are calling the proposal too complicated and too costly, but I can guarantee that more lawyers and lobbyists will be involved in this essentially useless effort of trying to reign in an industry that has long gone global, far beyond the reach of Congress.

Another eye-opener in the our world of lawyers and lobbyists was the announcement yesterday that Alabama’s largest county, the one that includes the capital city of Birmingham, voted to declare a $4.1 billion dollar bankruptcy. Court proceedings started this morning at 10am local time, just to make sure that this was a serious move.

It started all back in the mid 1990s when a federal court forced Jefferson County to begin a huge upgrade of its outdated and overwhelmed sewer system in order to meet federal clean-water standards. County officials used bonds to finance the improvements. Outside legal advisers and lobbyists  suggested a series of complex deals with variable-rate interest that were later shown to be laced with bribes and influence-peddling. (who would have ever thought…?) and the upgrade became a fact.

But every time global credit markets started to struggle, increasing (adjustable!) interest rates caused loan payments to rise quickly and the county could no longer meet its payments. Since 2008 Jefferson County has been trying to avoid filing bankruptcy over the growing debt, as it faced an additional annual shortfall of as much as $50 million in its operating budget because Alabama’s State Supreme Court struck down a major local tax as unconstitutional. No problem said Wall Street investment banks including JP Morgan and arranged complex financial deals using swaps. But the fees, penalties and bribes increased a project that was worth about $1.2 to $1.5 billion to $3.2 billion. Too big of a nut to crack according to the latest batch of local leadership, claiming that elected officials close to the deal had encouraged repayment scheduling with very low early payments so long as peak payments occurred after they left office. Not an uncommon practice in politics, also called kicking the can (of worms) down the road.

Between Washington and America’s Heartland, the legal profession in this country has taken over daily life on both end of the spectrum. Jefferson County is just the latest “victim” of being played against both ends: a Federal court forces a community to upgrade its sewer system at a considerable expense and a State Court declares it unconstitutional to raise the taxes required to pay for it.
From a 1995 Lawsuit on behalf of the Cahaba River Society against Jefferson County, the course of action in this sordid affair has been initiated, manipulated and encapsulated by lawyers and lobbyists, from writing the initial plan to representing the bankruptcy in court.

There is no doubt that lawyers and lobbyists are sitting royally on the throne in the Republic called America.

How Too Big To Fail Changed the American Dream

Many Ideas, but no patience for bureaucratic roadblocks

At the heart of all opportunity lies the ability to solve problems. We used to do that here in America with creative and innovative solutions and a keen sense of what would work and what not. For example when we “ran out of oil in 1973” we invented the fuel injector and a bunch of other oil/gas saving concoctions and look, 40 years later the discussion of diminishing resources is still ongoing, yet we keep on consuming more and finding more oil. Recent discoveries in Argentina, Brazil and Venezuela count for a whopping 360 billion barrels, more than Saudi Arabia. A lot of these reserves were inaccessible 30 years ago, but we introduced technologies that made it financially feasible and technically possible to exploit these reserves. There are many problems in this world that can be solved through creative entrepreneurship, but it requires that entrepreneurs are allowed to be creative. After all it is that freedom that turned America into the world’s economic powerhouse in the last 100 years.

How things have changed

I had this conversation a couple of days ago when asked which was more important in a small business: a good accountant or a good sales person? I really had to look my counterpart in the eyes to see if this was a joke, but it seemed a completely earnest question. My answer: “Without a good sales person, there is no need for an accountant?”

When TOO BIG TO FAIL became an overriding consideration in the political, economical and financial landscape of the USA a couple of years ago, the country’s previous free market philosophy forever changed the enthusiasm for entrepreneurship. Entrepreneurship starts with an idea that leads to a product or service that people need and want and more than anything else it needs marketing and sales. What made America was young entrepreneurs with a decent idea and a business plan and access to funding. Friends, family or the local bank were often the initial funders and once the entrepreneur(s) had pioneered their idea into a viable small business, they could usually find angel investors, small business loans, bankers or the stockmarket to secure expansion funding. That’s how Apple Computers started in 1977 or Microsoft or HP and so many others. Google and Facebook found angel investors to give them just enough time to bring an idea to the market and from there they’ll take the reins and start moving full speed.

2008 changed all that. Politicians and Wall Street orchestrated the largest bank heist in history and when they received scores of billions of dollars of taxpayer’s money after doing the opposite of what banks are supposed to do (losing money instead of keeping it safe), and then had the audacity to pay themselves bonuses for doing such a ‘good job’, Americans started to give up on dreaming of being entrepreneurs. I’m not sure but I think it was Al Capone who said that one accountant with a pen can steal more than a 1,000 thugs with guns.

Small start-up businesses used to be good for 3-5 million new jobs every year. Granted 50% of them didn’t make it to the first 5 year marker, but guess what? Of those who did make it, 80% of the jobs created were still in place and growing stronger. But that is not the case anymore for 2 major reasons:
1. Middle Class Americans are fed up in growing numbers and are sympathetic to causes like the Tea Party and the OWS (Occupy Wall Street) movement. Many young people are outraged – and they have a right to be, because they have been robbed of their dreams and loaded up with a debt, they won’t be able to repay.
2. People give up on the idea of their own business, because governments on every single level from Federal to Local have made it impossible to focus on selling first. An aggregate of required licenses, compounded  by restrictions, ordinances, massive amounts of paperwork, fees and numerous delays, kills any initiative to start a business, or continue as we have often seen on a local level recently.

On a national level a good measuring stick pertaining to entrepreneurship comes from the Nasdaq Marketplace, where entrepreneur look for opportunities to publicly finance their expansion needs. Well, in spite of Groupon’s successful trading debut last week, the backlog for initial public offerings (IPOs) is actually quite serious, with 215 companies waiting to go public. And that is an important marker for jobs and employment. Just think about it. The whole point of an IPO is to raise additional capital for expansion. With that in mind, it’s easy to calculate how many jobs are being held back here. With banks sitting tight on a mountain of bailout cash, promising companies look at going public to raise the money to expand or try to find grants and industrial incentive loans to accomplish expansion.

The market for initial public offerings is suffering through a drought of Texas proportions.
And a dried-up IPO market matters because stock debuts aren’t just a chance for tech whizzes to become overnight billionaires. Companies use the cash they raise to grow — and that means hiring people. And at a time when 14 million Americans are looking for work and the unemployment rate has been stuck at 9 percent plus for almost 3 years, the last thing the economy needs is for another engine of hiring to stall.

There are 215 companies waiting to go public. They’ve filed the necessary paperwork and lined up bankers, and are just holding out for the right time to unleash their stock. The waiting list is the longest since 2001.
And once again, small and medium sized companies are the true employment generators in this country, yet without financial means to back up expansions beyond the pioneer phase, will ultimate kill the energy and enthusiasm for the entrepreneurship that made America. Entrepreneurship is risky, life and time consuming and requires a pioneer’s log of sacrifices. In today’s America that entrepreneurial fire is replaced by entitlement promises. Greatness and growth only happens at the edges of our comfort zone and increasingly few people feel the need to live there.

Of course, the economy has bigger problems than a barren IPO market. Even if all the promising upstarts in line for an IPO successfully went public, it might not put a dent in the 9.0 percent official unemployment rate.
But then comes along the heartwarming story of a company in Americus, Georgia that found a way to buck the trend and now exports 10 million chopsticks per week from good old Georgia Poplar and Sweet-gum trees to China, soon to be expanded to Japan and the rest of Southeast Asia.

Owners Jae Lee and partner David Hughes recognized the opportunity as China’s billion and a half people use a lot of disposable chopsticks and China is starting to look a little devoid of the right trees for the job. With incentive loans and grants Georgia Chopsticks started production in December last year and now provides in access of 80 jobs for the local economy, which is expected to increase to about 150 by the end of this year.

And just when I was giving up hope, an initiative comes along that proves that the American Dream is still alive for entrepreneurs who can solve problems and add value – all over the world.

European Debt Crisis Will Not Go Away

Italian and Euro Flag still waving together

This sovereign debt problem in Europe is keeping the financial markets on edge and does not appear ready to go away anytime soon.
Despite an October 27 agreement that strengthened the bailout of Greece, the “Greek Tragedy” continues as the country’s government is a mess, Prime Minister George Papandreou is reportedly stepping down and the populace is protesting. And, with each day of delay, Greece is running out of money and European leaders are running out of patience.

Meanwhile, across the Ionian Sea from Greece, Italy is quickly becoming the next problem. Its 10-year government bond yield rose to a euro-era record of 6.4 percent last Friday. The Wall Street Journal says: “The 6% mark on the 10-year bond is seen as crucial because a breach of that level in the past has portended a sharp rise in bond yields of other fiscally frail countries.” When bond yields rise dramatically, it increases a country’s borrowing costs and suggests investors are losing faith in that country’s ability to pay its bills.

Even though Greece is grabbing most of the headlines, Italy is much more crucial to world markets than Greece, because Italy’s government bond market is the third largest in the eurozone behind Germany and France. If Italy goes the way of Greece, that would elevate the European crisis to a whole new level.  Ultimately, there’s just too much debt in the worldwide monetary system. Until it gets cut to a manageable level, expect financial markets to continue behaving erratically.

Good News on the Jobs Front

Last Friday greeted us with some positive jobs news, when the Labor Department announced that payroll jobs rose by 80,000 in October, bringing the jobless rate down a bit from 9.1% to 9.0%. Although the government shed 24,000 jobs last month, the private sector performed much better, creating 104,000 jobs in October.

Thursday brought even more great news with new weekly jobless claims finally breaking the 400,000 barrier by falling 9,000 to 397,000. In the past, whenever jobless claims fall below 400,000, companies begin cranking up new hires for the coming months. With the holiday months contributing additional temporary hires, expect to see more in the way of positive jobs reports.

Despite the expanding European debt crisis and persistent unemployment situation in the U.S., silver linings are out there.  We just have to look harder for them these days.

As the Greek Tragedy is Coming to a Head

the Eurozone in different perspective

A Bird's Eye Perspective of the Eurozone

What’s going on in Europe? is a question I get almost daily. Upon prodding to be a bit more specific it usually turns out to be a question about the situation in Greece, the volatility in the stock market and what will happen here on account of a potential default over there. My initial answer is a question: Do you have a vested interest in the stock market and more precisely the financial institutions? If the answer is no, than just sit back in a comfortable chair and watch the “tragedy” unfold because it’s mostly about politicians trying to initiate the Rise and Fall of Democracy on the backs of some overly greedy bankers. If the answer is yes: Than take a good look at Jon Corzine, former governor of New Jersey (banker turned politician turned banker) and his sordid performance at bankrupt MF Global.

DemoKratia: People of the Community have the Power (Authority) to Decide

Yes the early history of Democracy was initiated in Athens of the ancient Greece. The noble experiment in which all members of a society (country) supposedly have an equal share of formal political power, translated as the right to vote, has in the past week however shown quite clearly, that democracy is no longer a reflection of the will of the people. And to be honest, I don’t think it ever was.
It’s all about politics and politicians pushing their own agendas, often supported in their efforts by funding provided by like minded interests.

Here is what’s happening in Greece. When Greece’s prime minister Papandreou’s announced that he would put the latest Euro bail out plan as a referendum in front of the Greek population last Monday evening, he was essentially pushing his opposition into the corner of “are you with us on this or not?…time is running out, there is no money to pay our bills or government workers unless we agree to the Eurozone bail out plan and if we don’t we’ll be bankrupt by Christmas.

Well, that plan didn’t fly too well as creditors got real angry and world markets went into a conniption. That was last Wednesday and much has changed since Papandreou had to cancel that supposedly democratic move. Under pressure from the prosperous counterparts in the European Union, Greece’s conservative opposition, frankly the ones that produced the falsified financial records that started the whole charade in 2009, are temporarily in the driver’s seat as Papandreou got a narrow confidence vote victory, based only on the pledge that he would be willing to quit and form a caretaker coalition government. It’s almost as good as this week’s episode of the CBS hit series “SURVIVOR”.

The Essence of the Greek Culture

To be fair, my last trip to Greece was in 2003 and at that time the country was gearing up to host the Olympics in 2004, so industrial and construction activity was almost comparable to that of the northern European Countries who originally introduced the idea of a common currency and one trade zone to the rest of Europe.
To understand why the idea was good (and still is), you only have to look at the USA. To understand that the execution of the idea on equal level base was a political pipedream, you have to understand that the average difference between a Dutchman or German and a Portuguese or Greek in matters of work ethics is enormous. Whether it’s climate related or culturally embedded, northern Europeans live to work and souther europeans work to live.
And before you attack me on this position, both live/work relationships work for me, it’s just that assuming that the Eurozone integration would be an easy one, was irresponsibly ignorant, an arrogance you can only expect from hardcore politicians.

It’s like assuming that residents of Seattle Washington and Miami Florida are tooled the same way with the same needs and wants.
Northern Europeans take 2 or 3 vacations per year to escape from the misery of the climate and for the rest of the time they work…and work…and work. Southern Europeans have 2 hour lunches, take a nap, enjoy happy hour and an extended dinner table presence. Weekends are times to party and sleep. I’m not pussyfooting around here just because this may sound offensive.
Even if these profiling standards have marginally changed in recent decades, the essence still explains the difference in the strength of the respective economies.

Germany, Holland, Belgium, Scandinavia, Northern France even Northern Italy are the economic engines behind the Eurozone and only time, and I’m talking a generation or two in terms of time, will bring the Southern European economies marginally up to par with their northern counterparts. It’s like here in the USA. Mississippi was and still is the poorest state in the nation and probably will be until basic economic laws make it attractive enough for companies and industries to invest, educate and build a new future in and for the state.

Don’t Give up on the Eurozone

Since 1992 I have seen an increasing number of northern European companies move business into mediterranean counterparts, a process that will ultimately bring forth the anticipated economic integration. It is not the political force that will make it happen; it’s the force of business and entrepreneurs.

The bailout drama that is currently playing and keeping markets volatile, is instigated by politicians and financial institutions, pretty much in the same way these vultures have managed to almost paralyze the economy here in the States.
With the veiled threat of a referendum Greek Prime Minister Papandreou tried to play the democracy card that could have given him a statue on Syntagma (Constitution) Square in Athens, until The German French Couple of Merkel and Sarkozy put him back down to the bottom of the European Pecking Order. For politicians it’s only about posterity in the current moment.
Pity that investors don’t understand that it’s easy to temporarily turn the clock back culturally and economically if Greece wants to step out of the Euro Currency Zone. They once again will become a very affordable vacation destination with a cheap Drachma, until enough time has passed and enough economic leveling has occurred to give the Euro another shot, ten or fifteen years from now. All the thunder and lightning right now is the fallout from giving democracy to the politicians to interpret as they see fit.

In conclusion for this chapter of the Greek Tragedy, I hope that the Greek Government will fall and Greece will not get the next euro 8 billion ($11 billion) installment of its loans and will foreseeably go bankrupt before Christmas. The true tragedy is then that Papandreou, whose coalition came into office in 2009 with a landslide of the votes, found that much of Greece’s financial reality was the victim of falsified data. He has valiantly fought to restore the credibility of the country, but will likely finish up finding that in the process he destroyed his own credibility.
And that’s just it…another “Greek Tragedy”.

October Markets Ignore European Debt to Celebrate Christmas Early

Pumpkin Pi says 3.14etc may not be what Greece wants

Greece’s Prime Minister George Papandreou’s surprise curve ball announcement to call for a referendum on Greece’s bailout, has German politicians in an uproar and may well have derailed the effort of 14 summits in 21 months, during which European leaders finally thought to have solved their sovereign debt problem. Judging by the U.S. stock market’s reaction in the past weeks, you might think the answer was yes, although the “solution” appears to be mostly another attempt to kick the can a bit further down the road.

In marathon sessions last week, European leaders agreed on a new, three-point deal to stave off a deeper debt crisis. The deal includes:

1)    A commitment by banks and other private bondholders to accept a voluntary 50% write down on Greek government debt.
2)    A boost in the lending power of the euro-zone bailout fund.
3)    A 106 billion euro ($148 billion) recapitalization of European banks.
Source: MarketWatch

Even though details were still a bit sketchy, investors threw caution to the wind and bid up stock prices. U.S. stock prices rose 3.8 percent last week and 14 percent for the month with just one trading day left, according to Bloomberg. After yesterday’s close, the DJIA ended the month of October up over 12%, which is a nice treat in spite of a tricky Halloween trading day.

With Europe’s debt crisis tempered for the moment, attention now turns to the U.S. On the positive side, the U.S. economy grew at a 2.5 percent clip in the third quarter, which was the fastest pace in a year. In addition, third-quarter earnings are still coming in strong as about 75 percent of the companies reporting so far have beaten expectations, according to Bloomberg.

Looming on the horizon, the congressional supercommittee has about one month left before making its recommendations on how to cut at least $1.2 trillion from the federal budget. If the supercommittee fails, then across the board budget cuts of a like amount would ensue.

As of last week, investors were happy to breathe a sigh of relief that Europe seems to have dodged a disaster (at least for now) and the U.S. economy still has some life.  Wall Street appears more confident that growth in the U.S., China, and other emerging markets is resuming.  As a result, commodity prices (crude oil in particular) have surged, boosting energy-related companies. Also, China’s manufacturing component rose to a six-month high of 51.7, up from 50.3 in September. This confirms China’s claim that its economy has resumed growing.

Wall Street was further encouraged as FedEx forecasted a record holiday shipping season. The delivery company expects to ship 17 million packages on their anticipated busiest day of the year, December 12th. FedEx usually ships about half this volume on a typical day. Between Thanksgiving and Christmas, FedEx forecasts it will handle 260 million shipments, fueled heavily by e-commerce.  FedEx also announced plans to hire 20,000 seasonal workers to handle the holiday crush, providing an additional sign of confidence. Last year, they hired 17,000 seasonal employees.

One more factor that excited Wall Street last week was a “merger Monday” that surprised many investors. This resurgence in “merger mania” is being fed by record amounts of cash in company coffers, thanks to record earnings and a healthy corporate bond market where capital is available at extremely attractive interest rates between 2% and 3%.

With Halloween behind us, we are officially entering holiday mode.  Can the markets look forward to an upcoming ‘Santa Claus” rally to end the year on an even higher note?
I guess a little patience to wait for the fall out from the latest Greek Tragedy, would be sound advice before making that prediction.

Understanding Your Employee Stock Options

Not only employee-owned companies work with stock options

Do you have stock options from your employer? Make sure you know the rules before exercising them, or you may be in for some unpleasant surprises.
Even though the boom days of the 1990s have passed, employee stock option programs continue to be popular with both public and private companies.  As long as they take steps to learn the basic rules, employees stand to profit handsomely from these valuable benefits.
In the dot-com “go-go” days of the 1990s and early 2000s, many companies frequently used employee stock option plans as a way to reward and retain valued staff.  Everyone from top level executives to temporary administrative help participated in some companies. Although the modern Great Recession has produced fewer “company stock millionaires” these days, stock option programs are still popular with public and private companies.

What Is a Stock Option?

If your company benefits package includes stock options, you’ve been given the right to purchase shares of your company’s stock at a specific price and under certain conditions set by company management.
Vested options allow you to purchase a specific number of shares only after you’ve satisfied a time-in-service commitment for your employer.
If your options are performance-based, these will vest once you or your company meet specified goals.
If you have immediate options, you can purchase your allotted shares whenever you like.

The two most common types of employee stock option plans are incentive stock option (ISO) and nonqualified stock option (NSO) plans. Typically, ISOs are reserved for key executives, while staff on lower rungs of the corporate ladder may be issued NSOs. The primary difference between the two option types is how they are treated for tax purposes.

An ISO may be taxed as a long-term capital gain, assuming the employee holds the stock for at least two years from the option grant date and one more year from the exercise date. They are also taxed only when the stock is sold, effectively creating a  tax-deferred investment plan. However, ISOs may trigger alternative minimum tax (AMT) liability. Be sure to discuss this with your tax advisor to see exactly how your taxes may be affected.
NSOs are not quite as attractive, since they are taxed as both income and capital gains.  Income tax is owed once the options are exercised (when you purchase the stock). This is an important consideration to anyone who is thinking of exercising options. If you don’t have enough cash available, you may need to sell some of the shares you’ve just purchased in order to pay the tax bill.

Exercising Options

Stock options often have an exercise period of 10 years.  This means you have 10 years from the time your company grants you the options to actually purchase the stock. You are not obligated to buy any shares, particularly if your company’s stock price is trading below the option exercise price. If you choose not to purchase the stock during the exercise period, your options will expire worthless.

Some companies may offer the flexibility to exchange option grants if the market price of their stock has dropped significantly. For example, if your stock options have an exercise price of $50 a share and your company stock has been trading at only $40 a share for a long time, the company may exchange your $50 strike price options for a new set of options with a lower strike price.

If you are participating in an employee stock option plan, consult with a financial and/or tax professional who can help you decide when to exercise your shares and how to deal with the tax consequences.

When Absence of Bad News is Good News

Newspaper waste

Every News medium shows a different mirror of ideology

News has many different scenarios, a bit like the game of tic-tac-toe. Good news, bad news or no news are the leading indicators in any scenario but then there is also lack of good news and lack of bad news, that can be interpreted to fit any purpose. In recent weeks, the relative absence of bad news has pushed markets up as investors are starting to apply the “Cry Wolf” principle.

“Good news is good and bad news is bad, but a lack of bad news can be good, at least for investors,” so wrote Vito Racanelli in the current issue of Barron’s.
Since the recent October 3 low, the S&P 500 index has risen 12.6 percent on the back of “a lack of bad news,” according to data from Yahoo! Finance.

Here’s what we could classify as a lack of bad news in the past few weeks:

•    Corporate earnings are coming in strong so far this quarter as 75 percent of the 118 companies that reported earnings have beaten estimates, according to financial data provider FactSet.  Fund manager Louis Navellier further notes that the S&P 500 is up 15% from its October 4 lows.  Analysts are now projecting third-quarter earnings to be 14.7% above last year’s third quarter, compared with analysts’ October 3 estimate of 13.1%.  This likely explains the strong October market rally we are seeing now.

•    Economic news has generally supported the idea that the economy, while soft, is not collapsing. Historically, stock markets have risen rapidly from October through January, and we are entering a seasonally strong time of the year. Furthermore, stock markets tend to rally during election years.

•    European leaders, after months of tough talk, but little action, may finally be on the verge of taking “comprehensive” action to quell (at least temporarily) the sovereign debt crisis, according to Phil Orlando, chief equity market strategist at Federated Investors.  Then again, the financial markets may simply be “tired” of hearing about European sovereign debt issues, bank recapitalizations, or yet another strike in Greece.

Bad news will always be with us, although recently the stock market continues to shrug off bad news and focus instead on some strong, positive third-quarter corporate earnings. These positive earnings reports have a way of reducing fears about double-dip recessions and provide nervous investors with some solid performance.

Whether this “lack of bad news” turns into good news or bad news in the long run, remains an interesting dilemma for financial analysts and an opportunity for those who embrace the attraction of change.

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What Happened to the Economy ?

Uncertainty is not a bad thing. It’s what creates opportunities in the market.

Are happy days here again? Think more along the lines of Milton Ager and Jack Yellen, instead of Potsie and Fonzie. Less than three weeks ago, it seemed like the U.S. economy was falling off a cliff. Firms like the Economic Cycle Research Institute were saying a new recession was on its way and there’s nothing the government could do to stop it, according to MarketWatch. The stock market was sensing economic weakness, too, as it slumped to its lowest level in a year on October 3.

But, now, just two weeks later, the S&P 500 stock index is up a whopping 11 percent since October 3 and trading at the top end of a range that it’s been stuck in for more than two months, according to Bloomberg.

Has the economy suddenly turned the corner?

Well, economic reports in the last couple weeks have come in better than expected. According to The Wall Street Journal, “Auto sales rebounded to their highest level since April. Chain-store sales posted year-on-year growth of 5.5 percent. The economy added 103,000 jobs, and manufacturing sentiment improved a bit.” On top of that, the Commerce Department said retail sales rose 1.1 percent in September — above the 0.8 percent expected by economists surveyed by MarketWatch.

While the recent positive economic data is encouraging, it would be premature to ring the metaphorical bell for an all-clear signal. As we have seen over the last few days, the European economic crisis continues to ripple across the pond and impact the U.S. market indexes. The economy still has plenty of repairs to make before happy days are here again.

Sometimes A Little Spark Is All You Need

The difference between a Spark and a Jolt defines intensity

At one point last Tuesday, October 4, the S&P 500 index dropped below 1,091, which represented a 20 percent decline from the April 29 closing high, according to MarketWatch. That’s a key number because many investors consider a 20 percent decline to signify a bear market. But, lo and behold, just when it looked like the market might go from bad to worse, the Financial Times (FT) published a story that hit the internet that afternoon and the U.S. stock market staged a massive positive reversal.

The FT story said, “European Union finance ministers are examining ways of coordinating recapitalizations of financial institutions after they agreed that additional measures were urgently needed to shore up the region’s banks.”

That story prompted a huge 3.7 percent rally in the S&P 500 index in the last hour of trading on Tuesday, according to Bespoke Investment Group. Interestingly, the reversal propelled the index well above the key 1,091 level and prevented us from starting a new bear market in the U.S.

The key point about the late day reversal on October 4 is not so much that it saved us from printing a new bear market (although that’s a good thing!).  Rather, the amazing thing is the key reversal was prompted by mere “talk” of another plan to help save the euro-zone from the sovereign debt abyss.

Last week’s market action reinforced the notion that macro issues like the sovereign debt problem – rather than company-specific news – are still a significant driver of the overall stock market.  Until the critical macro issues get resolved, we should be prepared for major market moves – both up and down – based on little more than the latest headlines.

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Wall Street Volatility is Going to the Streets

Take Back Our Country is a Message in itself

I get a couple of hundred emails every day and a good percentage lately is from people who ask why we don’t publish more on the financial markets and frankly the only answer I can give is: I’m getting bored by manufactured “volatility,” so much actually that I’m not even active in the market anymore, not even shorting a bunch of stocks like Kodak or AMR (American Airlines). The same jojo is operating in the foreign exchange markets. It’s just too volatile and in my case it has become a bit boring.

I only look at the market on my Mac Dashboard on Friday afternoons these days and what I see is the same cycle “repeat, rinse, repeat” week after week. A message about a weaker than expected job creation in September and the market crashes a couple of hundred points. Except of course big oil that sees a job lift of 103,000 as a reason to up the barrel price. Some light in the tunnel of the European debt situation, never mind that it still is the headlight of an oncoming train, and the market jumps a couple of hundred points and every analyst is predicting the start of a rally. This morning Yahoo Finance had two contradicting stories about oil prices, listed right next to each other.
As far as I’m concerned the market is full of forecasters in financial and economic fields that have swallowed their predictions a couple of dozen times in recent months. And I think it is rather stupid that some of them try to draw medium or long term implications from single day fluctuations. We’re just living in highly volatile times, fed by alternating fear and greed.

When confusion becomes the daily grind

Europe will remain a big question mark until they run out of road to kick the can down to until it sinks in the Mediterranean. I see it as living on a one way dead end street or if you want Cul-de-Sac. This afternoon the Dow closed at 11,103 and the S&P at 1,155 and everyone is worried. Less than 2 weeks ago there were days the Dow fell way beneath 11000 and Armageddon was reportedly on our doorstep. We are all in the process of learning how to kick our problems into next week, month or year, which accounts for fear in one week and greed in another and that creates a highly volatile environment.

Right about exactly a year ago we were in a similar volatile market at about the same levels. The Piigs in Europe were frontpage news, the budget deficit frightening, none of the stimuli were working, the housing market was dead and the industrial nation governments collectively started kicking cans down the road by essentially pushing new bills into the market place. We’ve seen since then grocery spending almost double with less items in the shopping cart. Oil was $82 a barrel 52 weeks ago and the gas price per gallon was an average $2.80. Today at the same price per barrel, the gallon price remains close to $3.50! The Banks are sitting on $1.5 trillion in untouched cash from government stimuli and for the first time in history mortgage rates have dropped below 4%. Will it increase demand for housing, new or existing? Not a chance. First of all, you will have to give the banks your first born as collateral if you want to qualify based on the outdated credit rating system, and secondly….times are just too volatile for most people to commit to the long term.

It’s the middle class that’s getting hammered and considering the voracious  appetite of still expanding governments on national and local levels, the middle class is looking at getting taxed out of existence. And that puts a damper on the essence of our democratic society. Because frankly there is no democracy if there is not a large middle class. The problem is that too many are still hoping that miraculously the days before the 2008 crash will return, and therefore none of the underlying behaviors that caused the crash nor basic economic fundamentals have been addressed.

So instead of reporting on Wall Street’s volatility dance, I look at the ongoing and widening display of anger and confusion of tens of thousands of protesters who are currently roaming the streets of Downtown New York, with a movement into Washington as was reported today, because even though they seem to not have a clear objective for their actions according to the ridicule of the mainstream media, it only takes one messianic person to bring them together in their effort to Take Back Our Country and market volatility could turn into something much more serious.

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China’s Impact on the World Stage — Part III

Grauman's_Chinese_Theatre,_by_Carol_Highsmith_fixed_&_straightened

Grauman's Chinese Theatre, a different culture

Before China, there was Japan. From the 1960s to the 1980s, Japan was on a roll. They had one of the highest economic growth rates in the world, according to PBS. Their manufacturing prowess grew to be the envy of the world. Their stock market soared 373 percent between 1980 and its peak in 1989, according to Knowledge@Emory.edu. And, like China today, there were predictions that Japan would overtake the United States as the largest economy in the world.

We’re still waiting.

Along with its stock market, Japan’s economic miracle came crashing down in the 1990s. By the end of 2010, the Japanese stock market, as measured by the Nikkei 225 index, was down an astounding 73 percent from its 21-year old 1989 high, according to data from Yahoo! Finance.
As happened in Japan, extrapolating past performance may be hazardous to your wealth. Will China suffer a similar fate? If it does, what will that do to world financial markets? In this final installment of our series on China, we’ll look at three issues facing China that are an outgrowth of their strong economy and how these issues may affect you.

MANAGING THE ECONOMY

China has deftly managed its economy over the past three decades to produce spectacular growth and improved living standards for its people. In fact, economic growth has contributed to more than 500 million Chinese people rising out of poverty since 1981, according to The World Bank.  Growth, however, has its price.
Strong economic growth can lead to problems such as inflation, social and economic inequality, and a growing pile of foreign exchange reserves. Let’s take a closer look at each of those three issues.

Inflation
Inflation is a major threat to China’s future success because if it gets out of control, the population may revolt. In August 2011, inflation rose by 6.2 percent from a year earlier – well above the government’s 4.0 percent target. Worse yet, food prices rose 13.4 percent from a year earlier and, for a country that needs to feed 1.3 billion people, that’s a big problem.
Rising food prices are particularly difficult for China to stomach (pardon the pun), because the average Chinese household spends about a third of its disposable income on basic food, according to the Financial Times.
If you want to know why inflation is a threat to national stability, go back to 1989. The Financial Times said, “Inflation of nearly 20 percent is considered a key contributing factor to the 1989 student protests that culminated in the bloody military crackdown in and around Beijing’s Tiananmen Square.”

Social and Economic Inequality
While China’s economy has grown more than 90-fold in the past 30 years, the gains have left a widening gap between the “Haves” and “Have-Nots.” Chinese Premier Wen Jiabao said back in February 2011 that rising inequality is threatening social stability, according to a Bloomberg article.

Can you imagine what would happen if even a small percentage of China’s 1.3 billion people turned against the government?  Civil unrest has been on the rise in recent years. As Bloomberg reported in citing data from Sun Liping, a professor of sociology at Beijing’s Tsinghua University, “‘Mass incidents,’ everything from strikes to riots and demonstrations, doubled from 2006, rising to at least 180,000 cases in 2010.”

So, how do you keep 1.3 billion people calm and restrained? According to Nicholas Bequelin, a China researcher for Human Rights Watch in Hong Kong, China’s been doing it “through a combination of economic growth, social reforms, and political repression.” Time will tell how long that lasts.

Foreign Exchange Reserves
At $3.2 trillion, China has – by far – the largest foreign exchange reserves in the world, according to The Wall Street Journal.
These trillions were built over the years through China’s trade surplus, foreign direct investment, and capital inflows betting on currency appreciation. On the surface, large foreign exchange reserves sound like a good thing, and, in some ways, it is. The downside is that it exacerbates inflationary pressure, according to Bloomberg.

In an ironic twist, the U.S. has been a beneficiary of this massive reserves buildup. China had to park their cash somewhere so where did they turn? To the U.S. treasury market! At the end of June 2011, China was the largest foreign holder of U.S. Treasuries with more than $1.1 trillion filling their balance sheet, according to the Treasury Department.
Viewed another way, China has been a big reason why the U.S. has been able to run up trillion-dollar budget deficits while keeping interest rates low – we have China as a willing buyer of our paper.

With China needing a large liquid market to park its reserves and the U.S. needing a big buyer of its paper, these countries have the ultimate “too big to fail” global relationship, said Andy Rothman, an analyst in Shanghai for the investment bank CLSA as quoted in The New York Times.

Conclusion

China is so large and growing so fast, that it will impact the world in major ways for the foreseeable future. Its success or failure, its twists and turns, will reverberate throughout the financial markets and affect everything from the level of interest rates to the price of soybeans to the volatility of the S&P 500 index.

Will China stumble at some point? Probably. The big question is how will their potential tumble cascade throughout the world and affect each of us personally?  The diligent will continue to research world events and closely monitor their investment choices.  In a globally interconnected world that is getting smaller by the day, who can afford to do otherwise?

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Has the Great Recession Become the Great Stagnation?

Recovery Going Down in Flames?

The word “volatile” has been so overused in the media, but it’s hard to find a better way to describe recent movements in the financial markets. On any given day, the markets can rise or fall based on the latest thinking about euro-zone sovereign debt problems, a possible U.S. or Chinese recession, weak banks, inflation, deflation, or poor job numbers.

In the just completed third quarter, uncertainty (there’s another overused word!) was in full bloom as the three major U.S. stock market indices posted double-digit declines, according to Barron’s. Was the market sniffing out a new recession? Possibly. Last week, the respected Economic Cycle Research Institute was quoted in MarketWatch as saying, “The U.S. economy is headed for another recession that government intervention cannot prevent.”

Along those same lines, Goldman Sachs said we may be moving from the 2007-2009 “Great Recession” to an upcoming “Great Stagnation.” As quoted by Bloomberg, Goldman Sachs said a “Great Stagnation” would be characterized by “‘high and sticky’ unemployment, an average 0.5 percent growth rate in per capita gross domestic product, and stock markets that under perform historical averages.”

But, not everyone agrees with that assessment. Warren Buffett told CNBC last week, “It’s very, very unlikely we’ll go back into a recession.”
So, who are you going to believe? The market’s jumpiness may reflect the fact that smart people have completely different views of the economy.

What to Watch in the Fourth Quarter:

Here are a few things that made the headlines in the third quarter and may affect the markets over the final three months of the year:

•    The S&P 500 index dropped 14.3 percent in the third quarter and is now down 10.0 percent for the year.

What to Watch: Third quarter corporate earnings will start rolling in soon and investors will scour them for any sign of weakness. For the past few quarters, strong earnings helped the market recover from the Great Recession. While some earnings weakness may already be priced in the market, we have to wait for the actual earnings to see how the market reacts.

•    Commodities and precious metals experienced significant price movements during the quarter. Gold prices finished the quarter up 8 percent, while silver dropped 14 percent, according to MarketWatch. Oil prices declined 17 percent for the quarter, while copper dropped a stunning 26 percent. On the agricultural side, corn prices finished the quarter down 25 percent from their June 10 all-time high, according to The Wall Street Journal.

What to Watch: Recent declines in oil and copper prices are particularly noteworthy because they may presage a slowing worldwide economy. If the declines continue, it may not bode well for stock prices.

•    The housing market is still weak and that puts a significant drag on economic growth. According to the most recent S&P/Case-Shiller Home Price Indices, housing prices around the country are back to where they were in the summer of 2003.

What to Watch: Mortgage rates are at a record low yet the housing market is still in the doldrums, according to Bloomberg. Any sign that housing is turning the corner could bode well for the economy and the markets.

•    Interest rates on U.S. government securities dropped significantly in the third quarter as the flight to safety continued. The yield on the 10-year Treasury note recently hit a paltry 1.67 percent — the lowest yield since the 1940s. While low rates are good for businesses and our indebted government, it’s bad for savers who rely on interest income to support their living expenses.

What to Watch: If interest rates keep dropping in the fourth quarter, it may suggest investors are still in a fearful state. Ironically, it could be a good thing to see interest rates rise — as long as it’s due to economic growth and not due to money printing by the Federal Reserve.

•    Sovereign debt woes in Europe and budget wrangling in the U.S. weighed on the financial markets in the third quarter.

What to Watch: Continued bad news here could be very problematic. However, if there’s any concrete resolution to the Euro-zone debt problems or a credible bi-partisan budget solution in Washington — look out. The financial markets could rally strongly on that kind of news.

With the above issues looming, you can see why the markets are a bit nervous. Yet, even if the market swoons in the fourth quarter, it could make valuations so compelling that it sets the stage for the next bull market.

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