By Ron Paul,

In my last column, I joked that with public spending out of control and the piling on of the international bailout bill, economic collapse seems to be the goal of Congress.  It is getting harder to joke about such a thing however, as the non-partisan General Accounting Office (GAO) has estimated that the administration’s health care plan would actually cost over a trillion dollars.  This reality check may have given us a temporary reprieve on this particular disastrous policy, however an equally disastrous energy policy reared its ugly head on Capitol Hill last week.

The Cap and Trade Bill HR 2454 was voted on last Friday.  Proponents claim this bill will help the environment, but what it really does is put another nail in the economy’s coffin.  The idea is to establish a national level of carbon dioxide emissions, and sell pollution permits to industry as the Catholic Church used to sell indulgences to sinners.  HR 2454 also gives federal bureaucrats new power to regulate a wide variety of household appliances, such as light bulbs and refrigerators, and further distorts the market by providing more of your tax money to auto companies.

The administration has pointed to Spain as a shining example of this type of progressive energy policy.  Spain has been massively diverting capital from the private sector into politically favored environmental projects for the better part of a decade, and many in Washington apparently like what they see.  However, under no circumstances should anyone serious about economic recovery emulate an economy that is now approaching 20 percent unemployment, where every green job created, eliminated 2.2 real jobs and cost around $800,000 each!

The real inconvenient truth is that the cost of government regulations, taxes, fees, red tape and bureaucracy is a considerable expense that has to be considered when companies decide where to do business and how many people they can afford to hire.  Increasing governmental burden directly causes capital flight and job losses, as Spain has learned.  In this global economy its easy enough for businesses to relocate to countries that are more politically friendly to economic growth.  If our government continues to kick the economy while its down, it will be a long time before it gets back up.  In fact, jobs are much more likely to go overseas, compounding our problems.

And for what?  Contrary to claims repeated over and over, there is no consensus in the scientific community that global warming is getting worse or that it is man made.  In fact over 30,000 scientists signed a petition recently directly disputing the claims on which this policy is based.  Legitimate environmental claims should instead be directed towards the public sector.  The government, especially the military, is the most serious polluter in the country, and is exempt from most EPA regulations.  Meanwhile Washington bureaucrats have classified the very air we exhale as a pollutant and have gone unchallenged in this incredible assertion.  The logical consequence is that there will come a time when we will have to buy a government permit just to emit carbon dioxide into the atmosphere from our own lungs!

The events on Capitol Hill last week just demonstrate Washington’s audacity in manufacturing problems just so they can expand government power to solve them.

Writes Bill Anderson over at Lew’s blog about my favourite straitjacket candidate’s latest rant:

By VeriteFX

When I sat down to write my commentary on this week’s trading all I could think was, “this should be a wild week”. What’s facing the markets are a number of calendar events and central bank events that are all culminating over the next five trading days, so the key theme I want traders to keep in the forefront of their minds and trading decisions — risk management.

High risk alert–

Over the next 48-hours the price action of the Forex market, equities, commodities, and fixed income will all be under the direct influence of a major calendar event that I like to refer to as “end of quarter book squaring”. Monday and Tuesday are the final two trade days of Q2 and that will be the very last opportunity for market participants like hedge funds, money managers, brokers, institutional traders, and participants in banking/finance to show some kind of a profit or to mitigate an unrealized loss.

Historical price action patterns and historical price behaviors show a repeated pattern of heightened volatility and extended periods of strong price swings the final 48-hours of each quarter. This is not a random coincidence but due to the process for how market participants close out positions, for profit or loss. The end of quarter price swings also repeatedly reoccur due to the continuous and varying degrees of money-flows and levels of liquidity that are moving in and out of all the financial markets as participants are squaring up, repositioning, or pre-positioning.

The strong correlation between currencies, crude oil, gold, the S&P 500, Dow Jones, and Treasuries dictates the high probability for intensified price action across the board as each of those individual markets affect each other as a whole. At least for the next 48-hours forget the charts, forget the multi-colored dissecting lines, all that junk is meaningless because the markets will be driven by fear and greed… just follow the money trail…

The end of quarter window dressing that goes on is driven purely by fear and greed — fear that a money manager or hedge fund won’t show a profit for Q2 or greed that a money manager or hedge fund can potentially show a bigger profit than expected in order to pad their fees and commissions. Many market participants are under intense pressure to show a profitable performance in order to make their quarterly statements look good and this means some of those participants will either take profit off the table, be forced to cover an unrealized loss, or to do some revenge trading to make that bonus or commission and to keep the phone calls from angry clients to a minimum.

I love the end of quarter madness because it shows how human emotions really control markets and drive price action. I recommend to most retail Forex traders to sit on the sidelines while the markets go through this process, especially for those traders who are too under capitalized to be in the FX market in the first place.

End of quarter trade plan–

Other than reducing the amount of margin I use for each trade position I won’t be doing a whole lot different over the next 48-hours in terms of how I pick my entries and exits. That being said, I am starting the week with an anti-dollar bias until we at least get through the end of quarter book squaring event. In my trading career I’ve been through ten end of quarter events and based on what my experience shows me and on what historical price action shows, the dollar historically has a higher probability of weakening against the euro.

With the Forex market’s tendency to repeat price patterns over and over again, I’m choosing not to fight against history or human behavior. Of course if crude oil, gold, and the S&P 500 make gains over the next 48-hours the dollar should be under downside pressure just from those factors alone.

After we get past this calendar event I may reevaluate my anti-dollar bias because we will be coming up on the 1-year anniversary of the market’s monumental meltdown. It was just two weeks into Q3 last year that the Forex, commodities, and equity markets plunged from their historical highs… the EUR/USD, crude oil, and the S&P 500 all made their historical highs in tandem (not a coincidence) and as crude oil was the first to crack and sell-off from the $147 level, the S&P 500 tanked which took the EUR/USD from the 1.6000 level all the way to the 1.2300 level between last July and October.

I’m not predicting or expecting an exact repeat performance of last summer but after we get past this week’s calendar events which include an ECB monetary policy meeting and NFP, there’s really no way to predict what the markets will decide to do next. History will always repeat itself but at this point I am not seeing the market’s sentiment move closer to the side of risk aversion as opposed to where participants have been in terms of maintaining a higher risk appetite.

Keep things as simple as possible, don’t fight against the market correlations even if they appear disjointed at times but to just go with the flow, follow the money and when you do not have a clear view on where you think the market will go, sit out and protect your capital. The great Jesse Livermore once said:

“The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor.”

Fundamental events moving markets this week:

The end of month/end of quarter/start of new quarter are not the only calender events that will move markets this week. There are a number of fundamental factors that will come into play as traders attempt to determine the short-term fate of the euro, dollar, pound sterling, and yen. Underlying fundamental factors like inflation, deflation, monetary policy, employment, manufacturing, and the health of the consumer will all come into view by the markets.

The following fundamental factors hold the highest potential to move the EUR/USD and its correlated markets this week:

• Eurozone Consumer Confidence (Monday 0500 EST)
• Eurozone M3 Money Supply (Tuesday 0400 EST)
• Eurozone Flash CPI (Tuesday 0500 EST)
• US Consumer Confidence (Tuesday 1000 EST)
• German Retail Sales (Wednesday 0200 EST)
• ISM Manufacturing and ISM Prices (Wednesday 1000 EST)
• Pending Home Sales and Construction Spending (Wednesday 1000 EST)
• Crude Oil Inventories (Wednesday 1030 EST)
• ECB Trichet monetary policy press conference (Thursday 0830 EST)
• Non-Farm Payrolls and Unemployment Rate (Thursday 830 EST)
• Eurozone Retail Sales (Friday 0500 EST)
• US bank holiday (Friday)

There will also be plenty of central bankers from the Fed, ECB, BOE, BOJ, and SNB speaking this week. The markets are still ripe for market-moving verbal manipulation, do not get caught off guard because the central bankers may want to use the market conditions to their advantage this week to move their respective currencies one direction or the other.

The ECB and monetary policy:

At 0745 EST on Thursday the ECB will release their latest decision on their monetary policy for the key lending rate. At this point I see a no-change in their interest rate policy. The main reason I believe the ECB rate will leave rates at 1.00% is because Trichet has repeatedly said he’s not cutting rates this month. Trichet could just be messing with the market’s minds but his pattern of behavior in the past shows a much higher tendency for his rhetoric on interest rates to match actual monetary policy.

Remember what the ECB did to the dollar last Tuesday? In case you forget you can re-read it here. It only took a few comments on interest rates from the ECB to send the euro flying against the dollar last week. If Trichet wants to boost the euro again he can do it at his monetary policy press conference on Thursday.

For the past few weeks the Fed and ECB have worked well together to keep the EUR/USD in a relatively tight range. The purpose for this isn’t anything I know but it doesn’t matter, the evidence is clear based on all the verbal rhetoric and monetary policy actions by both central banks. The latest FOMC monetary policy event did not reveal a strong pro-dollar bias. I think their statement left the door open for market participants to continue selling the dollar when the opportunity presents itself.

The ECB has maintained a fairly consistent pro-euro stance recently. Could this change suddenly? Of course, but for now I’m adding the central bank and monetary policy factors as another reason for my anti-dollar bias because the recent trend between the Fed and ECB has been anti-dollar, pro-euro. Until the central banks change their bias, I’m not changing mine.

Trichet is pretty reliable when it comes to telling the market what to do with the euro. If Trichet wants the euro to keep gaining on the dollar he will paint a good picture of the Eurozone’s economic, fundamental, and banking sectors. If Trichet tells the markets that deflation is not an issue and that ECB interest rates have reached their lowest threshold, that’s his way of telling the markets to appreciate the euro and to buy it against the dollar.

If Trichet wants the euro to depreciate he will tell the market’s the ECB is concerned about deflation, that interest rates can go lower in the future, that the ECB is going to monetize sovereign debt, that the Eurozone economy is going to contract further than previously expected, and that the European banking system is fractured.

I can’t predict which message we will hear from Trichet but it won’t be hard to figure out at his press conference. It should not be a mystery, Trichet uses less double-speak than Bernanke and it is very easy to read between the lines to decipher what he wants the market to do with the EUR/USD.

Treasury bonds and the US dollar:

The past couple of months there’s been a lot of focus put on Treasuries and the US debt market, and ever since the Fed announced it would buy up to $300 billion worth of debt, the Treasury/Dollar connection has received the full attention of market participants. When I see something on Bloomberg or CNBC about Treasuries and the US dollar I never see the commentator or analyst explain the relationship between the two.

I think it is important for Forex traders to get a grasp on the Treasury/Dollar connection because their relationship affects both the debt and currency markets in very specific ways. The currency market is not a single entity unto itself and one of the correlated markets which helps determine currency valuations is the US debt market.

Next to the currency market, the US Treasury market is the most liquid in the world. This means the Treasury market can easily handle multi-billion dollar transactions, they can absorb selling pressures while preventing wild price swings, Treasuries are easily converted and there has never been a default on US debt, to date. US Treasuries are considered to be the safest and least riskiest asset class used for investment purposes.

One of the big reasons Treasuries have a strong affect on not just the Forex markets but all financial markets is because they are made up of the two biggest components that drive risk appetites — price and yield (rate of return). All tradeable financial market are just a space for speculators to seek a rate of return on their money. Some speculators want to get that rate of return as safely as possible while others want that astronomical rate of return. But the way it works is, the lower the risk, the lower the yield, the higher the risk, the higher the yield.

In order for market participants to trade in the US Treasury market they need to use the US dollar and in order for the Treasury to meet its obligation to its creditors they need to use the US dollar. The use of the dollar comes full circle from the moment the investor hands the US government his money for a predetermined amount of time back to the moment when the federal government pays their creditor interest and then principle when the debt obligation comes to full maturity. That factor alone is just enough to affect the dollar’s valuations against currencies like the euro, pound sterling, Swiss franc, and yen.

The other key factor which causes the valuation of the dollar to change is also directly related to the yield of each respective US debt obligation. Earlier this year the 10-year note was yielding just 6bps above the 2.00% level and now the 10-year is yielding over the 3.60% level. That means the US government is getting a lower price for their debt and that it will cost the government more money to pay its debts. Right now the US government has a major deficit problem, public debt has skyrocketed and those factors are bad for the US dollar and are a strike against it.

Then when the Treasury prints money to give to the Fed to return it back to the Treasury in exchange for its own debt, the dollar gets a really big strike against it. In a normal world this process of monetizing sovereign debt would be impossible but when you have the Fed and Treasury working so closely together with powers that are not even constitutional, they are like the Super Friends of the financial markets, they can just do whatever they want and nobody can stop them.

All Treasuries have a minimum denomination of $1000 and there will always be more supply than demand and that’s another reason the Treasury market is so liquid and how multi-billions of dollars can move in and out of the market on a daily basis. This factor also has a direct affect on the valuation of the US dollar at any given moment of the trade day.

The other factor with the connection between Treasuries and the dollar is debt repayments… lets suppose you bought a $1000 debt obligation on the 10-year note at a yield of 4.00%. That means the government would pay you $20 every 6-months and then at the date of maturity they would return your $1000 in principle. The more debt that is supplied and purchased means the government has more debt to pay back which is bad for the dollar. Plus, the more debt that is supplied means the yield is higher and the government has to pay more to get less.

Dollars have to be printed to facilitate these processes and of course that is a big strike against the dollar. A market situation where Treasury yields are rising can be dollar positive but the cause for the higher yields is the key. If Treasury yields are rising because the Treasury is over supplying the market with debt, that is bad for Treasuries and bad for the dollar. Printing money is the purest form of inflation and when inflation rises the value of Treasuries falls.

Foreign debt holders like the Chinese see their investment in Treasuries erode when the value of their investment falls and the dollar weakens. Whenever inflationary price pressures pick up again in the future any foreign investment in Treasuries will devalue accordingly. Add the combination of inflationary price pressures and a depreciated US dollar and US debt looks pretty unattractive.

I don’t want to over complicate this stuff but hopefully this sheds some light on why the Treasury market is so closely correlated to the Forex market and why movements in the Treasury market lead to movements on pairs like the EUR/USD, USD/CHF, GPB/USD, and USD/JPY. Even though I’m purely a currency trader I keep close tabs on the Treasury market because I think bond traders are very smart and well adjusted to the fundamental, monetary policy, and geo-political factors which move the markets.

Swiss National Bank interventions:

Between March and as recent as last week, the SNB has gone on a quest to manipulate and devalue the Swiss franc. In the past three months there’s been at least six open-market operations by the SNB and BIS to depreciate the franc versus the euro. The secondary affect of their open-market operations results in the dollar gaining against the franc and because the USD/CHF and EUR/USD maintain mostly an inverse correlation, the EUR/USD routinely moves lower during these interventions just for the fact the USD/CHF and EUR/CHF move higher.

Why the SNB is depreciating the franc–

The SNB and BIS are most concerned with the valuation of the EUR/CHF and their main objective is to sharply weaken the franc against the euro. The SNB’s motivation to devalue their own currency is about as simple as it gets… debt holders in Europe, especially in Eastern Europe owe Swiss banks money and they want to get paid, bottomline. The Swiss are good financiers and so they are using monetary policy to make it easier for European debtors to pay their Swiss creditors. The secondary factor is to help support the Swiss exporting industry.

The SNB dumps francs and buys euros right on the open market and that’s why those 150-point spikes occur on pairs like the EUR/CHF and USD/CHF. I do not trade either of those pairs but if I did I would be watching the SNB and BIS like a hawk and I’d never attempt to trade against them. Traders who are purely technical and who do not pay attention to the central banks have been steamrolled by these interventions and those traders who understand how the central banks affect the Forex market have been on the right side of these moves.

I personally think the interventions can continue in the near-term until the SNB has achieved its objectives. As long as Eastern Europe remains on the brink, the Swiss will likely see to it the CHF remains depreciated against the EUR. Do not fight the SNB on this stuff, it’s not worth it. Central banks love using the element of surprise to hit the markets when they least expect it and this week could easily present more opportunities to see a repeat performance.
Correlated markets:

Beside all the monetary policy, fundamental and calendar events that will be moving the markets we need to keep up with the price action of crude oil, gold, the S&P 500, Dow, and Treasuries. If the higher-risk, higher-yielding correlated markets make upside moves the dollar and USD Index will come under renewed selling pressure this week. Beside all the underlying fundamental factors, crude and gold will be the two linchpins which can make or break the markets and I will be watching both closely and using both as trade indicators.

Support and resistance levels–

In preparing for the trade week I spent some time studying the most recent price action and price behavior patterns of the markets and these are some of the overall key price levels on the upside and downside I’ll be monitoring…

Spot crude — the market has shown a pattern of buying crude when it dips below both the $69 and $67 levels. Below there is more support sitting around the $65 level. I’m not expecting any big downside moves with crude this week unless there are heavy rounds of profit-taking or geo-political factors that might come into play. On the upside strong resistance is seen just above the $73 level with minor resistance seen around the $72/$71 level.

Spot gold — gold spent most of the month of June in a downward directional move but the same exact day the six ECB’s came out to talk the euro up against the dollar, spot gold hit a bottom and has since moved up decisively (not a coincidence). Currently there is some resistance between the $943 and $945 levels while support is sitting at the $923 and $913 levels. Strong resistance for spot gold sits around $988 while strong support is currently around $888. A strong move up in gold this week should carry the euro and pound sterling up with it.

S&P 500 futures — this correlated market has had a wild ride in recent weeks… the S&P 500 futures made three solid attempts to sustain a break of the 952 level on the topside and failed. On the downside, the market made several runs at the 888 level but also failed to break below there. Near-term support is sitting around 901-900 while near-term resistance is around the 920-925 levels. If the S&P 500 puts in a strong showing it should carry the higher-yielding currencies right along with it or vice versa.

EUR/USD — price action patterns show the first line of support is strong at the 1.3982 level and then at the 1.3828 level, and then further strong support sits at the 1.3753 level. On the upside, there will be some resistance around 1.4088, then at 1.4178, and then at the 1.4226 and 1.4340 levels. Any of these upside/downside levels can easily be broken this week and the probability remains high for a EUR/USD range break in the days ahead, especially with all the fundamental, monetary policy, and geo-political events going down.

That should about cover things for the week ahead. Like I said at the start, good risk management should be at the forefront of your trading decisions at least over the next 48-hours and especially on Thursday. If you find yourself on the wrong side of the market it’s always easier to recover from a small loss than it is to make up when you let a position run away from you.

Finally one last quote from Jesse Livermore:

“All through time, people have basically acted the same way in the market as a result of greed, fear, ignorance, and hope. This is why the numerical formations and patterns recur on a constant basis.”

–David

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Embrace Deflation – It’s The Cure, Not The Problem

by Michael Shedlock

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Concern over Japanese deflation is increasing. Please consider Japan Succumbs to Deflation as Consumer Prices Fall Record 1.1%.

Japan’s consumer prices fell at a record pace in May, adding to the risk that deflation will become entrenched and hamper a rebound from the nation’s worst postwar recession.

Prices excluding fresh food slid 1.1 percent from a year earlier after dropping 0.1 percent in the preceding two months, the statistics bureau said today in Tokyo. It was the sharpest decrease since comparable figures were first compiled in 1971.

Bank of Japan Governor Masaaki Shirakawa said last week that price declines will accelerate through the middle of the fiscal year as demand slackens and crude oil continues to trade lower than last year’s record. Retailers including Aeon Co. are cutting prices to attract customers as falling wages and the worsening job outlook damp spending.

“Profits fall, then wages come down, then consumers stop shopping,” said Junko Nishioka, chief Japan economist at RBS Securities Japan Ltd. in Tokyo. “And because people aren’t shopping, companies lower prices. That’s the process that we’re starting to see. It isn’t easy to break out of.”

“With demand deteriorating, companies are finding it more difficult to sell goods and services and are turning to discounting,” said Azusa Kato, an economist at BNP Paribas in Tokyo.

Some 47 percent of 775 Japanese retailers surveyed by the Nikkei newspaper plan to lower prices in the year ending March 2010 to spur sales, up from 9 percent a year earlier. Aeon, Japan’s second-largest retailer, this week started a discount campaign for confectionary, drinks and mayonnaise.

Consumers, whose spending accounts for more than half of the economy, may delay purchases if they expect goods to get cheaper. That would erode profits and force companies to cut wages, which have already slid for 11 months. Japan only escaped from a decade of deflation in 2005.

Japanese Deflation Deepens

As Japanese deflation deepens, Japanese Bonds Complete 2nd Weekly Gain.

Japan’s bonds gained for a second week as a government report showed consumer prices fell at a record pace, adding to signs deflation will hamper the economic recovery and boost the value of the fixed payments of debt.

Ten-year yields touched the lowest in almost three months after the statistics bureau said yesterday prices excluding fresh food fell 1.1 percent in May from a year ago.

“The drop in consumer prices may accelerate to about 2 percent in the summer,” said Yuichi Kodama, chief economist in Tokyo at Meiji Yasuda Life Insurance Co., Japan’s third-largest life insurer. “The 10-year yield may decline to 1.3 percent or below as the market needs to prepare for deeper deflation.”

An “extreme” slump in demand and production are causing the drop in prices, Finance Minister Kaoru Yosano said yesterday. “We continue to monitor developments in prices and need to carefully manage the economy to avoid a deflationary spiral.”

The Organization for Economic Cooperation and Development this week urged the Bank of Japan to keep pumping cash into the economy “until underlying inflation is firmly positive.” Since it cut the key interest rate to 0.1 percent in December, the central bank has been buying corporate debt and increased government bond purchases from lenders to revive growth.

Japan Fighting Deflation For Decades

Notice the misguided advice by the OECD about pumping cash into the economy. Japan has been doing this for 15 years and all they have to show for it is massive national debt and bridges to nowhere.

Will Deflation Derail A Japanese Recovery?

Jun Saito, a top Japanese economist says Deflation May Derail Japan Recovery.

Deflation “will exert a significant amount of downward pressure on the recovery,” Jun Saito, an adviser to Economic and Fiscal Policy Minister Kaoru Yosano, said in an interview yesterday in Tokyo. “An increase in deflationary expectations will raise real interest rates and that will restrain business investment.”

“Declining prices will mean lower profits, less investment and wage cuts that will weaken consumer spending further,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co.

According to Saito, who quantifies the risk of deflation by using government data and figures from the International Monetary Fund, the risk of persistent price declines climbed to the highest level since 2003 and almost doubled since last year.

“I think there’s a risk we may slip back into deflation,” Saito said, adding that he defines it as a sustained decline in prices.

Japanese companies cut spending at the fastest pace in 54 years in the three months ended March 31. Wages have dropped for 11 months and households reduced spending for a record 14th month in April.

Falling prices are a blow to households who borrow money because it makes it harder to repay debt, Saito said. Consumers will cut back spending if entrenched price declines push up their borrowing costs, he added.

Deflation Misinformation

There is so much misinformation in the above articles it’s hard to know where to begin. For starters, inflation and deflation are monetary measures not price measures. However, let’s talk about prices for a change.

The idea that “Falling prices are a blow to households who borrow money because it makes it harder to repay debt” is preposterous. When prices fall, consumers have more money and they can pay off debts faster, provided of course they have a job. Falling prices reward the fiscally prudent, which is the way it should be.

Falling home prices do encourage more mortgage walk-aways which is another matter. However, home prices must drop to the point of affordability before a recovery in housing can begin, so even falling home prices are desirable. The sooner home prices fall to the point of affordability, the better of everyone will be.

In general, falling prices are good for consumer balance sheets. Imagine the problems we would have if prices were soaring with the unemployment rate approaching 10%.

Profits are falling along with prices because demand is returning to some sense of normalcy that businesses did not plan for. In the meantime, cash strapped consumers spent recklessly for decades and need to save. They are. Proof is easy to find: US Savings Rate Hits 6.9%, Highest In 15 Years.

This saving is not bad for business as Keynesian clowns believe. Savings provides capital for businesses to expand. For more on this as well as a rebuttal to the ridiculous concept callled “Paradox of Thrift”, please see Families Start Saving; Does This Aggravate The Nation’s Woes?.

The only reason it appears that savings is bad is after decades of loose credit and monetary expansion by the Fed the world is awash in overcapacity. Now is payback time for misguided Fed polices and reckless consumer spending.

This recession and a rising savings rate are both necessary ingredients to restore fiscal sanity. Deflation should not be feared; deflation should be embraced. What should be feared is the reckless expansion of consumer and corporate credit made possible by Fed policies under both Greenspan and Bernanke. Deflation is not the problem, it is the cure for those reckless policies.

Ironically both Greenspan and Bernanke encouraged Japan to write off bad debts as the means to return to normalcy. However Bernanke Suffers From Selective Memory Loss and cannot follow his own advice.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
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Mike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

By Wladimir Kraus |

The concepts of socialism and capitalism have definite meanings. Socialism is defined as state ownership of the means of production. The definition has been accepted by the most consistent practitioners of collectivist creed in failed socialist countries. But certain left-libertarian theoreticians (”mutualist” Kevin Carson is prominent among them) deny that state ownership captures the essence of socialism or that it has anything to do with the state or central planning of the Soviet style. To them socialism has a cosmopolitan and innocuous meaning which is really just about voluntary cooperation. Proudhon said so, Benjamin Tucker said so, even Friedrich Engels did say so. Did they not all preach and hoped so sincerely for the withering away of the state? Were they not among the most uncompromising foes of the oppressive state – that great anathema of voluntary association and classless society?

What is going on here? In a sense, left-libertarians have a legitimate point. Upon closer examination, the definition by state ownership is indeed definition by non-essentials. It is too narrow because its focus is merely on the final stage, the practical consummation of the collectivist creed. Initially, state ownership was conceived as a mere mechanism to abolish the hated “wage system”, the “undemocratic” and “oppressive” concentration of economic power in the hands of a few industrialists, bankers, landowners. Socialism has always defined itself by the hatred of the “wage system”, not by any meaningless bromides about “true” freedom and “true” voluntary cooperation. This is the real meaning of socialism. And this is what really unites Proudhon, Marx, Engels, Lenin, Stalin, Trotsky, Mao, Carson, and probably the majority of so-called left-libertarians. Make no mistake about it, Carson and other left-libertarians are open about their desire to abolish the “wage system” and replace it somehow with something but which would be genuinely voluntary and really and finally just (of course, in the sense of labor being paid the “full product” – Carson).

The problem is that like the old crop of collectivists, the recent one does not understand that the hated “wage system” is precisely the essence and beauty of capitalism and an indispensable element of civilization and human progress. Economically, the “wage system” is an indispensable precondition for and thus a necessary manifestation of a modern division of labor society, for it is responsible for every increase in productivity of labor and standard living of all members of society, especially the wage earners.

Prior to industrial revolution, division of labor did not go very far beyond a small number of simple tasks. Self-sufficient farming was the predominant mode of economic organisation. In such economies virtually all goods and services, the quantity and quality of which were barely sufficient to provide for mere physical survival, were produced either by families or within narrow confines of a tribe or village. The wealth both in form of directly consumable goods and primitive means of production was typically jointly owned by family or tribe members and exists directly and exclusively for their own benefit; in other words, producer and consumer are almost always one and the same person.

In contrast, as Mises has shown, and which was one of his greatest contributions to economic science, because of the very nature of economic organisation in a market economy, the physical beneficiaries of the means of production owned by capitalists are those who buy consumers’ goods produced with the help of these means of production. As a matter of fact, and contrary to Marxists and other collectivists, the greatest beneficiary of capitalistic ownership and mode of production is the average wage earner in his capacity as buyer of consumers’ goods. Indeed, the actual motivation of producers, who are the owners of the means of production, is to produce commodities not for the satisfaction of their own needs but of the needs of consumers; in short, in a market economy producers and consumers are almost always different persons.

In a self-sufficient economy the extent to which one owns means of production determine directly the amount of consumption one will have. The life and well-being of a family possessing a large fertile plot of land, cultivation tools, large herds of cows and sheep etc. is directly dependent on how much of this wealth it owns. In order to benefit from the wheat, the milk or meat, one, or one’s family or tribe, has to own things that help to produce wheat, milk or meat.

Quite different is the situation in a market economy ruled by the “wage system.” Here in order to benefit from products made with the help of the means of production, one does not have to own these means of production themselves or to own stocks or bonds of the companies employing these capital goods. In order to benefit, say, from Toyota automobiles or Sony TV sets or any other product available for purchase, one does not need to be an owner of stocks or bonds of Toyota Corporation or Sony Corporation or any other company; all one needs is merely to be able to buy these goods. The buyers of these products are overwhelmingly wage and salary earners, not businessmen and capitalists. Capitalism is distinguished by the mass market for the masses of wage earners.

Wage and salary earners benefit not only in their capacity as buyers of products while the means or production used in their production are owned by capitalists, they also benefit when it comes to the monetary demand for labor which is the source of almost all wage payments in the economic system. The necessity to employ labor and to pay wages is dictated by both the unlimited need for human labor as the ultimate source of value and the competitive pressures in the market process. Continuous survival under conditions of economic competition positively requires that businessmen and capitalists plow back into the production process the far greater part of their sales revenues in order to maintain, and if economically feasible under given circumstances, to expand the scale of production. Since labor and capital goods represent the actual, physical means with which the quantity and quality improvements of products can be expanded, each and every capitalist is forced to restrict his consumption down to an absolute minimum and reinvest the far greater portion of his earnings into the maintenance and, if possible, into the enlargement of his business operations.

It is precisely in this way that with the rise of capitalism the demand for labor and capital goods has come into existence and has remained in existence and can be practiced on the presently existing large scale only under institutional arrangements of a market economy with its all pervading elements of economic competition, the profit motive and economic inequality.

As a matter of fact, by far the greatest fraction of aggregate wage payments in a modern market economy originate in business enterprises and are paid out of that portion of sales revenues which are not spent for personal consumption of businessmen and capitalists but saved and productively expended. The average wage earner in developed countries, as far as his economic status is concerned represents the overwhelming majority of population, benefits indirectly from the wealth invested into the means of production. He benefits from this particular category of wealth to a far greater degree as long it remains invested than if it were simply sold and the selling proceeds equally distributed among his fellow workers, as hoped by such “mutualist” theoreticians as Kevin Carson.

It would do no good to the economic condition of the average wage earner if accumulated savings invested in factory buildings, machinery, equipment, inventories and other capital goods were expropriated and distributed to him and his fellow workers. Rather, it would be tantamount to the case of a farmer consuming all his seeds in the present only to discover that he has nothing to plant and consequently to eat in the future.

To conclude. Semantics aside, the ultimate problem that Carson and other left-libertarians have is the hated „wage system.” In this respect, they are no different from Proudhon, Marx and all other collectivists. They have the same mindset when it comes to the analysis of capital, the capitalist “wages system”, the source of profits, the inequalities in wealth and income. Anyone who advances such views and on that basis opposes the “wage system” is a socialist. Anyone who understands the essence of the “wage system” as one of civilization’s most essential and benevolent institutions and upholds it on the basis of that understanding is a defender of capitalism.

US Savings Rate Hits 6.9%, Highest In 15 Years

by Michael Shedlock

Personal incomes are rising reflecting tax cuts and consumer spending is up as well, notably car sales. However, consumers are still struggling to fix their personal balance sheets, currently overloaded in debt.

Please consider Surging U.S. Savings Rate Reduces Dependence on China.

In the recession following a borrowing binge that sent consumer debt to the highest level ever, Americans are shutting their wallets and building their nest eggs at the fastest pace in 14 years.

While the trend will put the country’s finances in better balance and reduce its dependence on Chinese investment, it may also restrain economic growth in 2010 and beyond, said Lyle Gramley, a senior economic adviser with New York-based Soleil Securities Corp. and a former Federal Reserve governor.

“There’s been a fundamental change in people’s behavior,” he said. “It will affect the economy for years.”

Government data today showed that the household savings rate rose to 6.9 percent in May, a 15-year high, as personal spending increased less than incomes. The rate in April 2008 was zero.

Americans’ newfound frugality is pinching airlines such as Chicago-based UAL Corp., which is cutting staff amid dwindling demand for leisure travel. Donations to charities dropped last year for the first time since 1987, and they’re in danger of declining further in 2009.

Banks are benefiting. Deposits grew 1.7 percent in May, the ninth-biggest monthly rise since 1973.

The bigger cash reserves will lessen U.S. dependence on investment by China and other foreign countries to finance economic growth, Gramley said. The current-account deficit, which includes trade in goods, services and income transfers, narrowed in the first quarter to its lowest since 2001 as Americans saved more and brought fewer imports.

Banks are already gaining from American’s thriftiness. Fed data show that deposits at commercial banks stood at $7.5 trillion in the week ended June 10 after recording the biggest monthly increase of this year in May. “They’re getting cheap deposits,” said Allen Sinai, chief economist at Decision Economics in New York. “It’s part of the healing process.”

Rebuilding Balance Sheets

From 1960 until 1990, households socked away an average of about 9 percent of their after-tax income, government figures show. Americans got out of the habit in the 1990s as they saw their wealth build up in other ways, first through surging stock prices and then soaring home values, Gramley said.

Retailers are adjusting their strategies to reflect that new reality of a permanently higher savings rate. Saks Inc., Neiman Marcus Group Inc. of Dallas and other luxury businesses are reducing orders this year to limit supply and boost profitability.

“Across the board you are going to find less of the sizes, less of the availability in almost all of the categories,” Saks Chief Executive Officer Stephen Sadove said in an interview on June 23.

Roubini is concerned the savings rate will rise too quickly.

Nouriel Roubini, an economics professor at New York University and chairman of RGE Monitor, forecasts that the savings rate will ultimately reach 10 percent to 11 percent. What’s critical, he said in a Bloomberg Television interview on June 24, is how quickly it increases.

A rapid rise in the next year because of a collapse in consumption would push the economy, already in its deepest contraction in 50 years, further into recession, he said. If it occurs over a few years, the economy may grow.

Edmund Phelps, winner of the Nobel Prize in economics in 2006 and a professor at Columbia University in New York, said it may take as long as 15 years for households to rebuild what they lost in the recession.

“The only way we’re going to get a healthy, full recovery is over a long period of time, involving households rebuilding their balance sheets,” Phelps said in an interview on June 22 with Bloomberg TV. “There’s no silver bullet that’s going to get us into good shape quickly.”

On this issue I side with Phelps.

The increasing savings rate is a good thing not a bad one. The faster the savings rate rises the better off we will be in the long run.

Fortunately consumer attitudes towards debt have changed and changed for good, something that many have told me would never happen. Retailers are now adjusting for this new reality.

Consumer Spending Stabilizes, Incomes Rise, Wages and Salaries Drop

Bloomberg is reporting U.S. Consumer Spending Rose, Incomes Gained in May.

Consumer spending rose for the first time in three months in May as incomes jumped by the most in a year, a sign that government efforts to revive the economy may be starting to pay off.

The 0.3 percent gain in purchases followed no change in April, the Commerce Department said today in Washington. Incomes surged 1.4 percent, reflecting tax cuts and Social Security payments from the Obama administration’s stimulus and driving up the savings rate to a 15-year high.

Wages and salaries dropped 0.1 percent in May, showing the effects of mounting job losses.

Today’s report also showed inflation moderated. The price gauge tied to spending patterns rose 0.1 percent from May 2008, the smallest gain since records began in 1959. The Federal Reserve’s preferred gauge of prices, which excludes food and fuel, rose 0.1 percent from a month earlier and was up 1.8 percent from a year earlier.

Adjusted for inflation, spending climbed 0.2 percent, following a 0.1 percent drop the prior month.

U.S. auto sales rose to a 9.9 million-unit rate in May from 9.3 million the prior month. Industry estimates for June show the rate may exceed 10 million for the first time this year.

Car sales will rebound, but it’s important to remember how depressed the current level is. Moreover, a significant portion of sales this year will be profit-losing sales as dealers cut prices to clear inventories. These sales will cut into demand for 2010 as will the silly as well as wasteful, cash for clunkers plan.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Mike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Federal bailouts of private companies are a regular occurrence these days. Take a glimpse at one quasi-public company’s track record for a good indication of what’s to come.

In the wake of Penn Central filing for bankruptcy, America’s largest rail company at the time, Congress passed the Rail Passenger Service Act of 1970 and Amtrak was born. The new federal monopoly was expected to be self-sufficient by 1974.

Today, 38 years of federal subsidies and over $33 billion tax dollars later, the company has yet to turn a profit. So what is Congress’s solution?

Throwing the dysfunctional enterprise $13 billion more tax dollars over the next five years, plus another $1.3 billion towards infrastructure and security.

If the bureaucrats’ ongoing experiment with Amtrak is any indication of GM or Chrysler’s future, then American taxpayers are in for a world of hurt.

Growing government intervention and control of the economy is a big trend now in motion with tremendous profit opportunities… if you’re correctly positioned early.

Learn how today’s government meddling will present tomorrow’s big money-making opportunities by clicking here.

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Q: Good Afternoon Doug, anything on your mind this week?

Doug: Yes, actually. I’ve been thinking about interest rates.

Q: What’s your gut feeling? Are they going up? Down? Staying the same?

Doug: Well, let me start out by telling you a joke. Einstein dies and goes to heaven. When he gets there, St. Peter meets him at the pearly gates and tells him that he’s sorry, but because heaven operates on a centrally planned economy, there’s a housing shortage, and Einstein will have to share a cloud with three cloud-mates for a while. Einstein is agreeable and is introduced to his new roomies.

This first fellow says, “Professor Einstein, I’m honored to meet you! I have an IQ of 130 and would love to talk with you.”

Einstein replies: “That’s great. Let me settle in and we’ll have a talk about astrophysics.”

The second fellow says, “Professor Einstein, I only have an IQ of 100, but I’m honored to meet you, too, and would love to get to know you better.”

Einstein answers: “That’s fine. Let’s chat over a game of chess later on.”

The third fellow says, “Professor Einstein, I’m not as smart as those other guys, but I’d like to speak with you as well.”

And Einstein says, “So where do you think interest rates are going?”

It’s a very complex matter, trying to figure out where interest rates are going. It’s not generally something I’m inclined to do, except at times that are clear tops or clear bottoms. Clear in relative terms, of course.

Interest rates reached their last long-term peak in the early 1980s, in the 15% to 20% range, depending on the financial instrument you look at. Since then, they’ve dropped to 2% to 3%. Part of that has been a secular trend. But in recent years, the government has been looking to suppress interest rates artificially, in the belief that that will stimulate the economy.

And of course that’s true. When you have low interest rates, people borrow more and they save less. But in today’s economy, low interest rates are the problem, not the solution. What people should be doing at this point is saving more.

In other words, people should produce more than they consume – but these low interest rates are causing people to consume more than they produce. And that’s the genesis of the problem we have today.

Q: So, with the rates at historic lows, and some economists including our own Bud Conrad saying that the effective rate is practically zero, are you calling a bottom?

Doug: Yes. Within a percentage point or two, I’m comfortable calling a bottom now. People who short interest rates – in other words, people who bet they are going much higher in the coming years – are going to make a fortune. I think interest rates will go back to the levels we saw in the early 1980s, possibly higher.

Now, there are basically three ways you can capitalize on that.

1. The riskiest way is to short interest rates on a futures exchange. That’s not the easiest way to go, for a number of reasons, but it’s the most direct.

2. An easier way is to buy a reverse ETF, which is like an ordinary stock that gives leverage to interest rates.

3. The third thing, and this is something that almost everyone can and should do, since most people own homes, is to take out the largest mortgage you can against it on a fixed, low interest rate. As interest rates go up, the value of your mortgage goes down.

On the third point, I don’t think the bear market in real estate in the U.S. is over, but I do think we’ll see a new bull market in real estate for many years to come. In the meantime, having a significant fixed-interest, long-term mortgage on your house is an excellent way to bet on higher interest rates.

And, of course, you have to do something prudent with the proceeds of that mortgage – you can’t go out and spend it all. With all the risks inherent in different investment classes today, I think the best answer at this point is gold. I can’t think of anything else that, for purposes of security and prudence, is even in the same class with gold.

Q: That’s music to the ears of BIG GOLD and International Speculator subscribers, but what do you say to the people who argue that, for the very reasons you give, the government won’t let interest rates rise?

Doug: I admit it seems like a paradox at times. Like any market, interest rates are set by the numbers of buyers and sellers. So, if the Federal Reserve buys government bonds, they drive the price of those bonds up, which drives interest rates down.

That’s the immediate and direct effect of the Fed buying government debt. And they are going to have to do a lot of that, because the government is issuing so much debt because of its huge deficits. But more important than the immediate and direct effects of the government buying debt to drive down interest rates are the indirect and delayed effects. The primary one is the creation of more money to buy that debt.

If you double the amount of money in circulation, prices double. It’s cause and effect. And when the price level doubles, people who have money will demand to be compensated for the depreciation of that money – so they won’t lend it, except at much higher interest rates.

So it seems paradoxical, but that’s what governments do to economies when they intervene; they create conflicting signals, which leads to economic and financial chaos.

It’s very hard to predict the timing of these things, but in the long run, interest rates are going to go much higher. It’s inevitable.

And as I said before, not only is it inevitable, it’s also the solution to the economy’s problems. It will cause people to borrow less and save more.

As an aside, one other thing we can be certain of is that as new money is created, it will be directed politically, which means it will go to the state and its friends.

Q: Is there anything else people should do, or keep in mind, as interest rates bottom and head back up again?

Doug: The important thing to remember is that the prices of everything revolve around them. So, as weak as real estate is right now, with record-low interest rates, when interest rates go up, it could drive real estate down even further. And as much as the stock market is off from its previous peaks, when interest rates go up, it’s going to drive the stock market down even further. Everything else being equal.

So, even though higher interest rates are the solution, they are going to create even more financial pain in the future. It’s a painful cure.

But even before the economy corrects and people learn to save again, you can do it yourself by making the decision to consume less than you produce – and sticking with it.

Q: That makes sense – thanks Doug!

Doug: My pleasure.

Betting on interest rates going up is one of the favorite investments of 2009 for the editors of The Casey Report. Read this in-depth report by Casey’s Chief Economist Bud Conrad on the sophisticated ways to make money from the blunders of the Fed – click here to learn more.

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Any Casey publication and its content and images, as well as all copyright, trademark and other rights therein, are owned by Casey Research, LLC. No portion of any Casey publication or web site may be extracted or reproduced without permission of Casey Research, LLC. Nothing contained herein shall be construed as conferring any license or right under any copyright, trademark or other right of Casey Research, LLC. Unauthorized use, reproduction or rebroadcast of any content of any Casey publication or web site, including communicating investment recommendations in such publication or web site to non-subscribers in any manner, is prohibited and shall be considered an infringement and/or misappropriation of the proprietary rights of Casey Research, LLC. Casey Research, LLC reserves the right to cancel any subscription at any time, and if it does so it will promptly refund to the subscriber the amount of the subscription payment previously received relating to the remaining subscription period. Cancellation of a subscription may result from any unauthorized use or reproduction or rebroadcast of any Casey publication or website, any infringement or misappropriation of Casey Research, LLC’s proprietary rights, or any other reason determined in the sole discretion of Casey Research, LLC. © 1998-2007 by Casey Research, LLC.

So, how far have the commies/socialists progressed since the inception of the Communist Manifesto? Well, have a look around you while reading the ten planks below and judge for yourself.

Nevertheless, in most advanced countries, the following will be pretty generally applicable.

1. Abolition of property in land and application of all rents of land to public purposes.

2. A heavy progressive or graduated income tax.

3. Abolition of all rights of inheritance.

4. Confiscation of the property of all emigrants and rebels.

5. Centralization of credit in the banks of the state, by means of a national bank (Central Bank) with state capital and an exclusive monopoly.

6. Centralization of the means of communication and transport in the hands of the state.

7. Extension of factories and instruments of production owned by the state; the bringing into cultivation of waste lands, and the improvement of the soil generally in accordance with a common plan.

8. Equal obligation of all to work. Establishment of industrial armies, especially for agriculture.

9. Combination of agriculture with manufacturing industries; gradual abolition of all the distinction between town and country by a more equable distribution of the populace over the country.

10. Free education for all children in public schools. Abolition of children’s factory labor in its present form. Combination of education with industrial production, etc.

Judging from the way people continue to vote across the globe, it shows you how they’ve been duped into believing that socialism is not communism. What they don’t see is that these ideologies only differ in approach, (socialism being soft and gradualist and communism being crude and revolutionary) but the end goal is still the same.

History can attest to it that both ideologies are seriously flawed and have been proven to be a miserable failure, but

like a moth to flame, it keeps drawing people back into its clutches of misery. And if you’ve been suckered into believing that Free Market Capitalism is the cause of this (and previous) financial crisis, then you may just as well believe in the Tooth Fairy. The excerpt from the Communist Manifesto above, proves the opposite.

Socialism/Communism took control of Capitalism very long ago and have been driving economies into the ground in order to destroy Capitalism, and whatever remnants of the Free Market  is left over. Remember this when you wake up one morning, and the only control you’re left with is your bodily functions (that’s if they haven’t yet started taxing you for breathing and flatulence) and all the rest will be controlled by the State.

Sweet dreams…

Long Term Buy And Hold Is Still Bad Advice

By Mike Shedlock

In spite of what you hear from main stream media and self-serving advice from Wall Street, an investment philosophy of long term buy and hold is not what it’s cracked up to be.

Unfortunately, many boomers headed into retirement are finding that out now, at the worst possible time. Moreover, looking ahead, I doubt the next decade is not going to be much better than the last.

Please consider the following analysis from my friend “TC”

Recently a CalPERS spokesman was on CNBC talking about how they’re “managing” through the market downturn and how over the long haul they feel confident they’ll hit their 8% annual target. Also consider The house that Jack built, a MarketWatch article in which Jack Bogle reiterated his “buy and hold” investment recommendation.

Meanwhile in the same period my parents reiterated their successful and simple retirement strategy – CD laddering. This caused me to set out and look into greater detail about the market’s historical return, analyze buy and hold and see if an 8% annual market return target is even achievable.

My findings about the market from start to finish were of no surprise. The S&P 500 is down 32% over the past 12 months and down 31% over the past 10 years (-3.6%/yr). However, it’s the “long haul” where I’ve been promised and 8% annual return – and sure enough the returns did improve. The S&P 500 is up 100% (+4.7%/yr) over the past 15 years, up 500% (+7.4%/yr) over the past 25 years and up a staggering 5,313% (+6.9%/yr) since inception in 1950.

Although the annual ROI amounts fell short of the 8% target, it seemed reasonable that CalPERS in its infinite “wisdom” could outperform near 60 year market return by 1.1 annual percentage points.

However, the problem with looking at these returns is that they bare no semblance to reality. CalPERS or an individual doesn’t investment all their money on January 1, 1950 and then buy and hold. Rather individuals make regular contributions through their working years and dollar cost average into the market.

And according to CNBC’s clueless happy talker Dennis Kneale this is how individual investors can assure themselves they won’t lose and will make a killing in the market.

Due to different holding periods, the next references will all be related to Internal Rate of Return (IRR).

True to Dennis’ hope over the past 12 months a strategy of dollar cost averaging into the market improves an individuals’ IRR to -8.7% (compared with -32.4%). However, for the next 6 time periods, dollar cost averaging into the market actually hampered performance. Additionally, one has to extend the time period to at least 20 years in order to even show a positive IRR!

For example the 3 year time period resulted in -17.1%/yr (compared with -10.6%/yr) and a 15 year period resulted in -0.6%/yr (compared with +4.7%/yr). Fortunately, when you extend out the window to 38 years or more, dollar cost averaging once again works in your favor. But how many investors have been systematically investing this long?

Keeping my parents in mind, you’re probably wondering how someone did by simply investing in 6 month CDs. The answer is for any holding period of less than 25 years, a stock market investor who made regular and equal contributions has actually underperformed a CD investor! Yes, you read that right for time periods of 1 – 20 years a CD investor outperformed the stock market by 1.6 to 20.1 annual percentage points.

Additionally, if one extends the time window to 50 years (clearly “long term”) CDs again have outperformed the stock market by 0.3 annual percentage points. Even when one extends out the time period to the full 59+ years (the start of the S&P 500 index); the stock market has outperformed short-term CDs by a mere 0.2 annual percentage points – not much of an equity premium.

However, the problem with dollar cost averaging into the market is that over the long term is that uniform dollar cost averaging bares little semblance to reality. Individuals typically invest more each year as the value of their dollars fall due to inflation. In other words if they invested $10,000 annual today – they surely didn’t also invest $10,000 in 1980, rather they invested $4,000 (an inflation equivalent). To account for this, contribution limits on retirement accounts increase annually.

I reran the numbers using the annual 401k contribution limits for the weekly investment and the results surprised me.

Imagine you’re 55 years old, investing for the past 25 years and looking to retire. Assuming you invested $250,000 (roughly the 401k maximum over the time period) you now have about $725,000 – not too bad right? Meanwhile “my parents” experienced none of the volatility and have just over $800,000. Which would you choose?

Now imagine you’re in your early 40s and investing for the past 15 years. Assuming you invested $175,000 (roughly the 401k maximum over the time period) you now have less than $150,000 – a loss of nearly 18% over a 15 year horizon. Meanwhile, “my parents” experienced none of the volatility and have over $300,000 – nearly an 80% gain. It is going to be near impossible for today’s early 40s investor to overcome this 116% divergence. Even if the stock market doubles tomorrow “my parents” are still ahead of the average market investor.

Buy And Hold Vs. CD Laddering

Click on chart for sharper image

To help show this disparity of an IRR of -1.3%/year vs. +3.9%/year over 15 years I included a chart of return per $10,000 invested. Looking at the above chart one should quickly realize they either need to be active investors or stick to simple, unsophisticated CD investing.

TC is ignoring dividends, and stock selection. Then again stock selection would imply some activity as sectors fall in and out of favor.

One simple, active strategy that would have avoided the stock market holocaust in both the recent recessions would be to get out of the market when the yield curve inverts and stay out until the NBER announces the recession has ended.

Treasury Yield Curve 1999 To Present

click on chart for sharper image

Length of US Recessions 1900-Present

The above chart from Chart of the Day as posted in Trader’s Narrative.

Using the above two charts one would have exited the stock Market in Spring of 2000 and reentered in November of 2001. One would have exited the stock market in Summer of 2006 and would still be out.

One could have improved returns by buying long dated treasuries after exiting the stock market. Of course one can improve upon the CD strategy by buying 6 months treasuries, switching to 10 year treasuries when the yield curve inverted and back after into 6 month treasuries when the yield curve gets sufficiently steep.

Regardless of what strategy one uses, it is a horrible idea to hold stocks thought recessions.

Why Is Bad Advice So Common?

Clearly, stay the course is bad advice. So why is it so common? A personal anecdote might help explain things: In January of this year, an investment advisor from Wachovia Securities called me up and stated “Mish, I am sitting on millions because I see nothing I like”. I told the person I did not like much either and that Sitka Pacific was heavily in cash and or hedged. His response was “Well, I do not get paid anything if my clients are sitting in cash”.

I called up a rep at Merrill Lynch and he said the same thing, that reps for Merrill Lynch do not get paid if their clients are sitting in cash.

Massive Conflict of Interest

Notice the massive conflict of interest possibilities. Reps for various broker dealers have a vested interest in keeping clients 100% invested 100% of the time, even if they know it is wrong. And so it is every recession, bad advice permeates the airwaves and internet “Stay The Course”.

A Look Ahead

Clearly stocks are a better buy now than in 2007 or 2008. But that does not mean stocks are cheap. Indeed, by any realistic measure of earnings, stocks are decidedly not cheap. Then again, 6-month treasury yields are yielding a paltry .31%.

Can equities easily beat that? Yes they might, but that does not mean they will! Fundamentally, the S&P 500 can easily fall to 500 or below, a massive crash from this point. Alternatively, stocks might languish for years.

Please consider a chart of the Nikkei.

$NIKK – Nikkei Monthly Chart

The Japanese Stock Market is about 25% of what it was close to 20 years ago! Yes, I know, the US is not Japan, that deflation can’t happen here, etc, etc. Of course deflation did happen here, so the question now is how long it lasts. Even if it does not last long, there are no guarantees the stock market stages a significant recovery.

Buy and hold is no more likely to be a good choice for the next 5 years than it was for the last 20.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Mike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.