Awash in Liquidity

Again (see last post) I defer to another insightful analysis about the economy and why we might be at an investment inflection point, this time turning to the world’s leading bond manager, Bill Gross at PIMCO. His monthly investment outlook, Midnight Candles, details why the investment “bubble” is a long standing one, that as a nation which once relied on the production of real things, we became focused on “paper asset” appreciation by the 1980’s. Governments have artificially influenced those prices since then. Gross distills this in an interesting observation: “How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down.”

That sets the macro economic scene, which has been compound with the crisis of the last couple years. More recently investors have flocked to riskier assets as the Fed has flooded the markets with liquidity and driven interest rates to nothing. Unless the real economy grows substantially, this has to end badly when the Fed reverses course. For this reason, Gross believes asset prices might be peaking.

Gross is certainly one of the more literate, philosophical money managers around, and his prefatory remarks set the stage in that venue. As one who is about Gross’ age, I identify with his feelings about being “Everyman.” I suspect he has read Philip Roth’s novel of the same title, but that’s another matter.

On a lighter side from my photo archives….

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Einhorn’s Speech and Bubble Du Jour

Sometimes you come across a point of view on our economic crisis that provides such clarity you want to share it. Such is the case with David Einhorn’s recent speech at the Helbrunn Center for Graham & Dodd Investing. Einhorn is President and founder of Greenlight Capital, a money management firm that specializes in long-short value oriented investments, and he is the author of Fooling Some of the People All of the Time, the story of Greenlight’s short sales of Allied Capital and the subsequent controversy that became highly publicized. I learned of this speech from a blogger colleague over at Fund My Mutual Fund but undoubtedly it has been widely circulated by others as well.

I have selected some salient points from the speech and post them here. If you read these, go to the entire speech, as quotes out of context cannot convey the full measure of Einhorn’s well-reasoned arguments. While his value oriented investing style will remain his approach, the current crisis has convinced him to include gold in his portfolio, something most value investors find antithetical.

I wonder what he thinks about the rise of the Dow to more than 10,000, a sixty percent “recovery” from its earlier lows. Late last year I had posted a summary of the Wall Street Journal’s headlines all of which were decidedly negative, the perfect contrarian indicator. Now, the market is being bid up with talk of green shoots and improving earnings. An anecdotal observation regarding the latter is the recently announced “improved” earnings (that is, a positive comparison to expected earnings, not normalized ones) of many of the Dow’s major components seem to be accompanied by a shortfall in revenue, in other words earnings that come as a result of cost cutting, particularly layoffs and hiring freezes. Corporations cannot sustain earnings growth without revenue growth and the latter cannot happen while real unemployment rates stubbornly remain in double digits leaving the consumer on the ropes.

The illogical exuberance of the market lately is in lock step with the dollar’s decline as interest rates have also disappeared into a black hole. Stocks have just become another commodity, with a more limited supply than the government’s ability to manufacture dollars. As the headlines of almost a year ago signaled a bottom, perhaps the recent introduction of the Porsche Panamera, a $133,000 four door sedan with a 500 horsepower twin turbo V8 that can reach 60 mph in a mere 4 seconds – the perfect car for the bailed-out gang on Wall Street in this energy-challenged age – foreshadows a new bubble.

Here are some salient points from David Einhorn’s speech (Value Investing Congress David Einhorn, Greenlight Capital, “Liquor before Beer… In the Clear” October 19, 2009) which should be read in its entirety here:

* As I see it, there are two basic problems in how we have designed our government. The first is that officials favor policies with short-term impact over those in our long-term interest because they need to be popular while they are in office and they want to be reelected. …. Paul Volcker was an unusual public official because he was willing to make unpopular decisions in the early ’80s and was disliked at the time. History, though, judges him kindly for the era of prosperity that followed. Presently, Ben Bernanke and Tim Geithner have become the quintessential short-term decision makers. They explicitly “do whatever it takes” to “solve one problem at a time” and deal with the unintended consequences later.

* The second weakness in our government is “concentrated benefit versus diffuse harm” also known as the problem of special interests. Decision makers help small groups who care about narrow issues and whose “special interests” invest substantial resources to be better heard through lobbying, public relations and campaign support…. [A]t some level, Americans understand that the Washington-Wall Street relationship has rewarded the least deserving people and institutions at the expense of the prudent. They don’t know the particulars or how to argue against the “without banks, we have no economy” demagogues. So, they fight healthcare reform, where they have enough personal experience to equip them to argue with Congressmen at town hall meetings. As I see it, the revolt over healthcare isn’t really about healthcare, but represents a broader upset at Washington.

* The financial reform on the table is analogous to our response to airline terrorism by frisking grandma and taking away everyone’s shampoo, in that it gives the appearance of officially “doing something” and adds to our bureaucracy without really making anything safer. With the ensuing government bailout, we have now institutionalized the idea of too big-to-fail and insulated investors from risk. The proper way to deal with too-big-to-fail, or too inter-connected to fail, is to make sure that no institution is too big or inter-connected to fail. The test ought to be that no institution should ever be of individual importance such that if we were faced with its demise the government would be forced to intervene. The real solution is to break up anything that fails that test.

(As a follow up to this last point, see today’s New York Times article: “Volcker’s Voice Fails to Sell a Bank Strategy: The former Fed chief said the giant banks must be broken apart and separated from risky trading on Wall Street, a view not shared by many in the White House”)

* Rather than deal with these simple problems with simple, obvious solutions, the official reform plans are complicated, convoluted and designed to only have the veneer of reform while mostly serving the special interests. The complications serve to reduce transparency, preventing the public at large from really seeing the overwhelming influence of the banks in shaping the new regulation. In dealing with the continued weak economy, our leaders are so determined not to repeat the perceived mistakes of the 1930s that they are risking policies with possibly far worse consequences designed by the same people at the Fed who ran policy with the short term view that asset bubbles don’t matter because the fallout can be managed after they pop.

* Over the next decade the welfare states will come to face severe demographic problems. Baby Boomers have driven the U.S. economy since they were born. It is no coincidence that we experienced an economic boom between 1980 and 2000, as the Boomers reached their peak productive years. The Boomers are now reaching retirement. The Social Security and Medicare commitments to them are astronomical. When the government calculates its debt and deficit it does so on a cash basis. This means that deficit accounting does not take into account the cost of future promises until the money goes out the door.

* [T]he Federal Reserve is propping up the bond market, buying long-dated assets with printed money. It cannot turn around and sell what it has just bought. ….Further, the Federal Open Market Committee members may not recognize inflation when they see it, as looking at inflation solely through the prices of goods and services, while ignoring asset inflation, can lead to a repeat of the last policy error of holding rates too low for too long.

* I subscribed to Warren Buffett’s old criticism that gold just sits there with no yield and viewed gold’s long-term value as difficult to assess. However, the recent crisis has changed my view. The question can be flipped: how does one know what the dollar is worth given that dollars can be created out of thin air or dropped from helicopters? Just because something hasn’t happened, doesn’t mean it won’t. Yes, we should continue to buy stocks in great companies, but there is room for [another] view as well. I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked. Prospectively, gold should do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely. Of course, gold should do very well if there is a sovereign debt default or currency crisis.

* For years, the discussion has been that our deficit spending will pass the costs onto “our grandchildren.” I believe that this is no longer the case and that the consequences will be seen during the lifetime of the leaders who have pursued short-term popularity over our solvency.

On the lighter side of things, here is something I caught at Westport Now, the online newspaper that covers Westport, Connecticut, where I worked for so many years. Our first office was built on the site of an old New England lumber yard, on the Saugatuck River at 51 Riverside Avenue, and I recognized the building, the one on the left, in Westport Now’s recent photograph, the same fall colors ablaze as I remember them nearly forty years ago…

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Nice to be Home?

On our way back to Florida, we spent a few days in Asheville, NC, one of our favorite places, the mountains being such a contrast to the horizontal topography of our home. While taking a walk in that area we met someone who lived her entire adult life in Florida but had moved to Asheville to be closer to her grandchildren. When she heard we lived in Florida she commented that the reason she misses her old home is she can no longer see the moonrise until it is high in the sky, the mountains dominating everything. That is what she missed the most.

In Asheville, we visited with our friends, Irene and Pete, who also relocated there from Florida a few years ago. They now have second thoughts about having made the move while sometimes I have had second thoughts about moving to Florida from Connecticut. Perhaps one’s preference boils down to a whimsical perspective on the moonrise.

Returning to Florida, we were greeted by a few unwelcome notices, thanks to the economy and new county and local “budgets.”

Unlike the federal government, which can run deficits ad infinitum, state and municipal governments can’t print money and must have a balanced budget. So far so good. During this Great Recession, with declining receipts from sales and property taxes, they must either cut budgets or increase revenue. After years of bloated budgets, thanks to the chimerical prosperity since the last downturn, any cutback would have to be drastic to align itself with reality. The path of least resistance is to find ways of separating the taxpayer from his money in a stealth-like fashion.

Case in point, we returned to multiple notices of a speeding ticket (made out to me, although my wife was driving) from our neighboring community, Juno Beach. This ticket was issued by an automated camera in the back of a van operated by LaserCraft, a company in Georgia. One is instructed to send the $125 fine to Georgia; probably LaserCraft getting the majority and Juno Beach the smaller share, but a small percent of something is better than 100 percent of nothing.

This is the most nefarious kind of revenue raising tactic, with the taxpayer being forced to pay a fine without being able to face the accuser (there is a $50 fee to file an appeal, one you are warned you are sure to lose). Non-payment results in being turned over to a collection agency, with all the attendant credit history ramifications. The “evidence” is two photographs of our car clearly showing it in front of and behind other cars in a lane so presumably every car received a ticket. Desperate economic times dictate desperate tactics for municipalities, and this is one of the worst. Lest one thinks that this is typical FloriDUH and it can’t happen here (wherever that might be), if Juno Beach gets away with this (there is a suit in court to overturn this), other cities will surely follow and why not automated cameras on Interstates as well?

Then, as our Florida home is our primary residence, it is “protected” under the Save our Homes act, the property tax increase one year over the next being capped at 3% or to the Consumer Price Index, whichever is less. Read the fine print – that is during good times only. Palm Beach County property market value has decreased so much that it has simply frozen or reduced the “appraised value” of homes (thereby staying within the 3% cap), and increased the tax rate to take up the slack. (From the Palm Beach County Property Appraiser: A property's assessment could stay the same or go down but property taxes could go up any given year because of millage increases levied by your local taxing authorities). Why bring a budget in line with the economic times when it is easy to pick the pocket of the taxpayer? PBC tax rate will increase 15% over last year.

We are told there is no inflation, that this is a deflationary economy. It is true that there is no investment return to be found on our woefully declining US dollar, and no doubt there is asset deflation (e.g. homes), but consumer inflation is alive and well, the manipulated CPI not reflecting the real rise in the cost of living. Unemployment continues to grow (albeit at a declining rate) and until there is sustained employment growth – real growth – the recovery forecasted by the market is suspect (it’s time to “party” as the Dow passes 10,0000, Leo Kolivakis writes in his Pension Pulse blog)

Bottom line: if you want job security, retirement and health insurance benefits, work for your local government.

Welcome Home Taxpayer!.

Aegean Adventure

We were overseas in September and are now home after a detour stay in Asheville, NC. Our trip took us to Turkey, Greece, and Croatia, a panorama of the rise and demise of civilizations and flow of religions: the early Minoan civilization, Roman and Hellenic cultures, the Byzantine and Ottoman Empires, the confluence of Christianity and Muslim, an overview of the cradle of Western civilization.

It was mid morning when we walked into the lobby of the Sultanhan Hotel in Istanbul after a 10 hour overnight flight, the beginning of a land/ship tour of the region. Another couple, obviously American and about our age, were checking in as well. We smiled at them; they smiled back. My wife said, “Are you in Istanbul for the Greek Island cruise?” “Oh, sure” I said to myself, what are the odds? “Yes,” they replied and before I knew it we had arranged dinner plans for later that evening.

Although we hadn’t slept much during the flight, after unpacking and getting organized, we took a typical tourist double-decker bus tour of this complicated, energetic city, the Topkapi Palace, Hagia Sophia, and Blue Mosque predominately perched in its center, and the Bosporus River isolating the western part of the city in Europe and the Eastern part in Asia. We were looking forward to the following two days when we would return to see those major sites in detail and even take a boat tour on the Bosporus to the point where Europe and Asia almost touch.

That night we had dinner with Stuart and Gloria, a little younger than we, but retired as well. Stuart said that he was looking for a word that might describe a vacation by a retired person (who is already on a permanent vacation). I suggested “recation” so if you see that word used, you now know its derivation!

After a lovely Turkish dinner on the rooftop of our hotel, with a view of the Blue Mosque glowing in the distance, we returned to our rooms exhausted, hopefully to sleep, getting ready for a demanding day of touring. Following a restless night, we awoke to rain (we were told it never rains in Istanbul!). Naturally we hadn’t packed an umbrella so we were left to “caveat emptor” on the rainy streets of Istanbul.

Soon after buying our knock off ‘Burberry’ umbrella and underway again, we noticed a young Turkish man was walking alongside us on the street. “Hold onto your pocketbook” I telegraphed to my wife, but he said, in polite, broken English “Hello, where are you from?” Maybe it was our sleepy fog, but we replied honestly and added that we were trying to find the Hagia Sophia, as the windswept rain made it difficult to get our bearings. He respectfully suggested that we visit the Blue Mosque first – which we admitted was our second destination – further explaining since it was the period of Ramadan that by noon we would not have access to the Mosque due to the frequent calls to prayer. He said he would take us there, to a “special entrance” but he would “appreciate it” if we would briefly visit his shop nearby after we see the Mosque. So there’s the catch I thought. If it were not for the rain, we would have gone on our way, but we said sure and true to his word, we avoided the main entrance which was mobbed with rain soaked tourists, and instead escorted to a rear stairway –still crowded but at least moving briskly up and into this back entrance, whereupon we were required to remove our shoes.

And so we entered the Blue Mosque, which is the national Mosque of Turkey, built in the early 1600’s, combining Islamic architecture as well as Byzantine elements. The interior is striking with its ceramic tiles, stained glass windows, chandeliers, crafted marble, and of course the amazing sweep of the carpeting on which hundreds of worshipers turn toward Mecca in Muslim prayer. The crowds were maddening though, so we soon made our way out through the exit, putting our shoes back on, and sure enough our “guide” was waiting for us.

We dutifully followed him (a deal is a deal) to his rug store nearby, which turned out to be a pleasant experience and we learned a little about the making of beautiful Turkish rugs, and were served some of Turkey’s famous hot apple tea…. a welcome drink on such a wet day. Although we made it clear that we were not in the market to buy a rug, they were respectful, and hoped we would “recommend” their store and so after a 15-minute detour, we amicably parted.

By then, the rain had cleared and we were on our way to the Hagia Sophia which was built as a basilica in the sixth century, survived fires and earthquakes, but after Ottoman Turks conquered Constantinople in the 15th century was rebuilt as a Mosque. It is now a museum and a testimony to the civilizations that built and rebuilt the structure.

From there we had a typical Turkish luncheon at a sidewalk café and began our walk to the Grand Bazaar where you negotiate your own price in the oldest covered market in the world – built before Columbus discovered America. The shops go on as far as the eye can see. And in spite of the shop owners clearly wanting to part you from your money, we left with the feeling that the people were friendly. In fact, everyone we met in Istanbul was wonderful.

That night we had a date with Stuart and Gloria for dinner again, this time at a very popular fish restaurant, mostly frequented by locals – which we were told offered the freshest seafood, “Easy to get to” our hotel receptionist assured us, marking it on a map that was not very detailed, “in walking distance.”

So the four of us started off, arm in arm, umbrellas overhead as the rain had returned once again. Most of our search was along ancient cobblestone streets and it was getting to the point, in the rainy darkening night that we were thinking we were entirely lost and perhaps getting into a section of town tourists should avoid. We began to ask people on the street where this restaurant might be but they generally shrugged their shoulders, until one gentleman -- more or less in sign language indicated he was going that way and he will take us. After silently following him through a labyrinth of back and twisting roads we began to wonder, even be concerned. Ten minutes later, with the restaurant not in sight, we were thinking of breaking off from him, but he kept waving his arm as we followed behind. And sure enough he led us to our destination; where we tried to offer him a thank you tip but he resolutely refused our gesture of gratitude. He was simply being a Good Samaritan.

It was an atmospheric outdoor restaurant, with an overhead awning. The rain had stopped but later during our dinner the rain became intense and waiters had to hold up the awning with broomsticks to keep everyone dry. It was an experience. No way did we want to venture back to the hotel on foot so they called a cab. With Ramadan services finished for that day, the streets were now crowded with worshipers who could finally break their day long fast to eat and drink.

The next day we were scheduled to board our cruise ship at 1.00 pm, although the ship was staying in Istanbul that night, so we devoted the morning to seeing the Topkapi Palace. Our son had been there the previous summer and warned us to get there early, as the crowds by mid morning would be swarming.

This was the official residence of the Ottoman Sultans for 400 years, that period ending in the mid 19th century. We entered the Imperial Gate and toured the Imperial Treasury and its collection of enormous and breathtaking jewels and then the mosque in the palace where an Imam was chanting from the Koran, it being translated into English on a screen. No doubt the most interesting part was the Harem where the sultans’ families were housed, the Courtyard of the Sultan's Consorts and the Concubines, and the privy chambers.

After a light lunch at the Palace overlooking the Bosporus River, we made our way back to the hotel to pick up our bags and taxi off to the ship to meet our friends, Ray and Sue, who were arriving later that day from Connecticut and joining us on this trip.

We boarded Oceania’s ‘Nautica,’ a relatively small ship of some 650 passengers and looked forward to our friends’ arrival. By the time they finally boarded late in the evening, we heard one of those “thank-God-it-didn’t-happen-to-us” stories, hours on the tarmac, repairs to the plane, missing their connection in London, having to be rerouted. We finally had a late dinner in the main dining room, an elegantly appointed space in the stern of the ship. Since we would be in port until 3.00 pm the following day, allowing for a final day to see Istanbul, Ray and Sue took the city tour and we boarded a small boat for a cruise on the Bosphorus, where we could view the entire city from the shoreline and work our way up to the point where Asia and Europe nearly connect. The tides were running strong. Small fishing fleets were on the river as well. The water had debris as flooding only a few days before we arrived had inundated Turkey. Stuart and Gloria were on the same tour so we were able to reconnect, take some photos of one another and enjoy the scenery together.

We returned to the ship to prepare for our departure, a cruise that ultimately took us 2,272 nautical miles, to Kusadasi, Rhodes, Delos, Mykonos, Santorini, Katakolon, Corfu, Dubrovnik, Crete, and finally Athens. The trip was all the more remarkable as while we learned about the development, conflicts, and ultimate demise of ancient civilizations, I was reading John Updike’s Self Consciousness, the closest he ever came to writing a formal memoir. So, juxtaposed to the colossal sweep of civilizations over millenniums, I listened to the introspective musings of a solitary man, both concerned about a core element of our lives, the ephemerality of existence, and our need to make sense of moving from nothingness to nothingness as we attempt, as individuals, and as civilizations, to mark our place: we were here.

Updike: “Those who scoff at the Christian hope of an afterlife have on their side not only a mass of biological evidence knitting the self-conscious mind tight to the perishing body but a certain moral superiority as well: isn’t it terribly, well, selfish, and grotesquely egocentric, to hope for more than our animal walk in the sun, from eager blind infancy through the productive and procreative years into a senescence that, by the laws of biological instinct as well as by the premeditated precepts of stock virtue, will submit to eternal sleep gratefully? Where, indeed, in the vast spaces disclosed by modern astronomy, would our disembodied spirit go, and, once there, what would it do?”

Kusadasi, our first port of call, is the gateway to Ephesus, an archaeological site in Turkey that has the remains of an ancient city that can be traced back to 10th century BC. Here we saw the two-story Library of Celsus, remains of temples, the city’s shops, and its theatre, which is considered to be the largest theatre from the ancient world. Ephesus was also the home to Paul and one of the birthplaces of early Christianity.

The Ephesus terrace houses are perched on a hill. Here the wealthy lived during Roman times. These are under cover and archeologists are putting these homes back together as a giant jigsaw puzzle, but they have constructed walkways so one can tour this site without interfering with this continuing work. Mosaics on the floor and frescos on the walls as well as the remnants of the homes’ heating and sanitation systems are a time capsule from the past.

As with many of the archeology sites we saw on this trip, one civilization replaces another, one layer on the other, the inevitable rise and fall, and it makes one wonder about our present “American civilization” – is it in its waning years as a political and economic power?

Updike: “…my first books met the criticism that I wrote all too well but had nothing to say: I, who seemed to myself full of things to say, who had all of Shillington to say, Shillington and Pennsylvania and the whole mass of middling, hidden, troubled America to say, and who had seen and heard things in my two childhood homes, as my parents’ giant faces revolved and spoke, achieving utterance under some terrible pressure of American disappointment, that would take a lifetime to sort out, particularize, and extol with the proper dark beauty. In the beauty of the lilies Christ was born across the sea – this odd and uplifting line from among the many odd lines of ‘the Battle Hymn of the Republic’ seemed to me, as I set out, to summarize what I had to say about America, to offer itself as the title of a continental magnum opus of which all my books, no matter how many, would be mere installments, mere starts at the honing of this great roughly rectangular country severed from Christ by the breadth of the sea.”

That night we departed for the Greek Islands, to be covered in a later post.

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