Baking the Cake

 

It’s a multilayered apocalyptic confection, suitable for a world addicted to dystopian hedonism.   Irreconcilable political ideologies, the plutocracy and the new class of “influencers,” have found the perfect recipe for destroying democracy.  And yet we go on, one step in front of the other, as if life can continue like this.  I’ve avoided these issues in my blog, but not in my mind, so time for a polemic catharsis.

To borrow from Dickens, the human race, like Joseph Marley, now wears the chain it forged in these times, having “made it link by link, and yard by yard; [and] girded it on of [our] own free will, and of [our] own free will [wear] it.”  I am now mixing metaphors (chains and cake), flailing for understanding.

We have embraced the kleptocratic emperor who wears no clothes, so transparent in his horrific iniquity and ignorance, but so in sync with popular culture, bolstered by social media.  We have become vassals to the very technology we now can no longer live without (somehow we managed before the ubiquity of the smart phone).  An agnotological oven has baked the cake and forged the chains.

It’s become a topsy-turvy world where an indoctrinated post-truth minority has turned the Bill of Rights and the Constitution on its ear.  The archaic Electoral College was almost toppled by its vulnerability to manipulation in the last election and state Republican bodies are now arranging for the members of the College to become their marionettes. 

The ideals of the Democratic Republic are under siege.  The Supreme Court was the first to topple.  The imagined rights of individuals hijacked those that the social compact of the Constitution was supposed to ensure.  One only has to consider the endless jousting over vaccines and mask mandates in a pandemic that has killed one million in the U.S.  Or the “rights” of military-style weapon owners transcending the right of society to live safely.  Only a morally bankrupt society would tolerate more guns than there are citizens.

The previous administration laid the long-term groundwork for January 6, and its execution on that fateful day using mob psychology.  Sedition, an act of a third world country was perpetrated in front of our own eyes, and yet here we are more than a year later still waiting for justice to prevail. 

The pandemic hastened supply side issues, labor shortages, the flooding of the financial markets with liquidity, and now, the consequence, inflation.  This will be borne on the backs of those who can least afford it with increases in transportation, housing, and food outweighing other inflation measures.  Not discussed much is the elephant in the room: as the Federal Reserve increases interest rates, the current National Debt of $30 Trillion will have to be financed at higher interest rates, a self-fulfilling prophesy (in the absence of higher taxes on the rapidly growing uber-wealthy class) of either default or still higher inflation in the future so debt can be retired with depreciated dollars.  One only has to look at the US Debt Clock which is a real time pulse of our economy and debt.

The Russian invasion of Ukraine assaults our senses daily, accompanied by a feeling of helplessness without risking a nuclear war.  It is far beyond my understanding to discuss this horror in any kind of detail.  Finger pointing can be found for whatever position one wants to take.  Putin very quickly referred to slaughtered Ukrainians as “fake news.”  Doesn’t this resonate?  We have forged the chains of gaslighting over years of social media.  Four years of the prior administration made “fake news” the centerpiece of how to manage its citizens where truth/lies are fungible according to one’s own belief and feelings.  In fact, feelings are as valid as scientific evidence. 

How all this will end is anyone’s guess; nothing is beyond the realm of possibility, including a civil war or a nuclear war between East and West.  Civil war is “easier” to imagine than the latter, but the April 30 Wall Street Journal carries an opinion article by Peggy Noonan, Putin Really May Break the Nuclear Taboo in Ukraine which goes to that very place.  She makes a persuasive argument:  “It seems unthinkable, but American leaders’ failure to think about it heightens the risk it will happen.”

Indeed, we have forged the chains, link by link. By weakening democracy here we have emboldened Putin’s actions with heretofore unimaginable consequences.

 

The Soviet Union detonated its first atomic bomb, known in the West as Joe-1, on Aug. 29, 1949, at Semipalatinsk Test Site, in Kazakhstan

Reflections of a Relic Investor

I used to think I was a fairly knowledgeable individual investor, watching measures such as the money supply (no one even refers to that anymore), interest rates, and comparing those to the earnings yield on stocks (the reciprocal of the Price/Earnings ratio) to partially determine asset allocation.  Alternatively there was also the tried-and-true asset allocation approach, maintaining a fixed relationship between a percentage of bonds vs. stocks in a portfolio.  March 2009 presented an incredible buying opportunity with the S&P reaching its nadir of some 676 (vs. 1,800 plus today).  If you rebalanced every year thereafter, you would have missed out on some equity appreciation, but, nonetheless, participated in the rise of the S&P with less risk. Buying long term bonds today for balancing now implies taking on more risk because of the artificially low interest rates.  The asset classes would be highly correlated in a period of rising interest rates and declining equity values.  

During that same period, the earnings yield on stocks vs. bonds became more and more divergent as the Fed moved from one stage of "quantitative easing" to the next.  The impact on both markets can be seen with clarity if five years ago you decided to commit half of your investments to the iShares 7-10 Year Treasury Bond (IEF) and the other half to the SPDR S&P 500 (SPY) and, then, took a five year trip to Mars, leaving the market behind.  Returning today, you'd find your 50/50 bond/equity allocation now at 35/65, simply because of equity appreciation.  So, what to do if you don't want so much at risk?

Jason Zweig addresses that question in this past weekend's Wall Street Journal. Bottom line, "know thyself."  He quotes investment adviser David Salem who said that investors holding large stock portfolios or are considering buying more equities, should be "both willing and able to bear the loss," clarifying that "willingness is behavioral and ability is financial, and you can't know for sure in advance which one is going to trump the other."  As the last bear market quickly eroded 50% plus of equity values, a 65% equity weighting puts one's portfolio at higher risk.  What one did as that last bear market gathered momentum is a good indication of what one might end up doing if this market, too, ends badly.  Of course, it can go higher -- in that regard I'm always reminded of John Maynard Keynes' famous comment “the market can stay irrational longer than you can stay solvent."

Today's investment environment is now as foreign to me as the Mars landscape would be.  Hostile too.  While GDP is hardly growing, and unemployment stubbornly stays above 7%, peak profits are being racked up by major corporations.  How can this be?  Zero interest rates translate into profits, borrowing at nearly nothing to reduce corporate higher-rate debt or financing stock buy-backs.  Corporations have squeezed their workers too, many laid off, a reward to shareholders in the form of increasing dividends.  Labor unions are no longer empowered, a major consequence of labor competition from overseas.  We no longer "make things" here and even intellectual labor can be harvested overseas, at lower cost, thanks to the impact of the Internet. So, by some measures, the "market" is "cheap." It certainly is cheap if you look at earnings yields vs. bond yields, a spread that has widened with every nail in the QE coffin. 

At one time I thought the Fed's actions saved the world from a financial meltdown.  Perhaps it did. But sustaining its monthly $85 billion bond buying program ad infinitum, not to mention maintaining zero interest rates, is creating an asymmetrical investment environment with every passing day (I'm avoiding the word "bubble" as the latter I sort of understand).  It gets worse: recent Fed minutes implied lowering the interest it pays on bank reserves, which has led banks to warn that such an action might force them to charge depositors for holding money in savings and checking accounts (a negative interest rate!). 

Perhaps all of this is being engineered to create a feeling of prosperity from the inflated asset prices of 401Ks, real estate, and equities, hoping that some will trickle down to the middle class via increased spending by the main beneficiaries, the wealthy. (Not surprising, Tiffany & Co. "reported a 50% increase in net earnings in its third quarter..., largely resulting from 7% growth in worldwide net sales and a higher operating margin.")   Or, perhaps, there is something more ominous behind the Fed's actions, a fear of deflation outweighing its concern for (or even desire for) inflation.  Deflation would be an investor's clarion call to buy longer term "secure" bonds, even at these low rates, but, then, we will soon see the next round of the shoot out at the O.K. Corral (a.k.a. Congress), when the debt limit debate comes up again in March.  So, even US Government Bonds may not be rated AAA given the crazy political environment.

No, all the old rules of investment are out the window in this investment environment, as understandable to me as Bitcoins, the price of which surpassed $1,000 today vs. $30 earlier this year, resembling the parabolic price rise of Dutch tulip bulbs in the 17th century.

Ending on a more understandable note, a Happy Thanksgiving to all.

Data Points

Driving home today I happened to hear some stock market guru on the radio (there are countless numbers nowadays, and I didn't get his name during my brief time in the car) predicting that the "bull market" will steadily march onwards and upwards and he compared it to 1982 (when the S&P 500 Index was around 140 vs. today's 1,500 plus), pointing out that bull market move began when unemployment rate was more than 9% vs. a little under 8% today.  I didn't quite get the connection to the S&P other than the inference that things looked gloomy then on Main Street as they do today. 

He sounded like a youngish man, probably either unborn in 1982 or in diapers.  He's right about the gloomy part, but he failed to cite other relevant data points in the comparison, such as the Price Earnings Ratio (P/E) that was about 7.5 then vs. today's 17.5.  Also, adjusting the 1982 140 S&P for the CPI, it was really about 340 not 140.  So, half the growth of the S&P since then is explained by the expansion of the P/E multiple.

Here are some other interesting data point comparisons (these are approximates -- not exact averages for the years cited):

                                                           1982                2013

3 month T Bill Rate                       12.49%            0.11%

10  year T Note Rate                    13.86%            1.88%

S&P Dividend Yield                       4.93%             2.13%

S&P Earnings Yield                        9.83%             7.18%

Classic asset allocation models dictate that if the earnings yield is less than the yield on a 10 year Treasury Note, stocks are overvalued and conversely, if the earnings yield is more than the 10 year T Note, they are undervalued.  By that measure, stock markets should indeed continue to rise now, but they should have been flatlining in 1982.

The reason the usual asset allocation rules may not apply to either scenario is that both 1982 and 2012 represent extraordinary economic times, almost the mirror images of one another, but with one thing in common: the Federal Reserve is in the pilot's seat.  Remember during the Ford administration we were brandishing "WIN" (Whip Inflation Now) buttons?  The oil embargo of 1973 had ratcheted up crude prices from 1972's $3.60 to more than $30.00 by 1982.  Consumer prices followed and wage demands took off.  Paul Volker's Federal Reserve slammed the breaks on the economy raising interest rates to unheard of levels. 

Today, we have the flip side of the coin.  The economy nearly collapsed five years ago into a depression and the Fed became the purchaser of last resort of mortgage-backed securities and is still buying 90% of new US Treasury securities, creating a scarcity of Treasury debt and ratcheting down rates to unheard of levels, this time to "Whip Deflation Now."

What does it all mean for investing?  I can't imagine it means a "new bull market," but who knows as we've never been in this situation before (and throw a calcified government into the mix). One thing I do know, in extraordinary times markets can behave illogically -- unremittingly postponing a normal reversion to the mean --  or as John Maynard Keynes said, “the market can stay irrational longer than you can stay solvent.”

Inflation Takes a Haircut

Jon Hilsenrath, normally a straight forward journalist who is the chief economics correspondent for The Wall Street Journal covering the Federal Reserve, made an argument on CNBC today essentially basing the real inflation rate on the price of his haircut. He was interviewed by Joe Kernen, who is enamored by his hair as well, in regard to today's testimony before Congress by Ben Bernanke.

According to Hilsenrath, the Commodity Research Bureau's (CRB) indexes "do not hit American households...we do a lot of other things with our money, like haircuts, which is one of the benchmarks I use, and [they] are not rising....The people who look at food and energy ignore those other things."

While the CRB puts commodity inflation well into the double digits, the CPI reports nearly no inflation (1%) excluding food and energy. Surely, between the two is the REAL inflation rate that is taking its toll on most Americans, particularly retirees.


Jon (and Joe), instead of preening your haircuts as anecdotal evidence of there being little inflation, you should walk in the shoes of a balding retiree. I just happened to have reconciled our 2010 expenses, and have accurate data going back eight years. Comparing that data our income was up only marginally as, even though social security kicked in during the period, investment income declined substantially due mostly to bonds and CDs maturing and having to be replaced by lower yielding investments (the Fed's attempt to force investors into riskier investments, the very issue that almost started a depression). Indeed, fuel and groceries were among the most significant inflationary items over the eight year period, up almost an identical 68% in our case. But what I found interesting there were also large increases in items that are not only essentially non-discretionary, but they are nearly monopolies as well, the consumer having only marginal choices, such as health care, insurance (car, home and health), water and sewage, communications (cable, telephones, Internet), and, most lately, real estate taxes. These take their toll on retirees.

But as I now generally buzz cut my remaining locks, haircut expenses were de minimis so there must be little inflation. Thanks for the fine journalism, Jon and Joe.
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Cheery Tidings from the Social Security Administration

For the second year in a row, this happy news from the SSA, received in the mail yesterday: "Your Social Security benefits are protected against inflation. By law, they increase when there is a rise in the cost of living. The government measure changes in the cost of living through the Department of Labor's Consumer Price Index (CPI). The CPI has not risen since the last cost-of-living adjustment was determined in 2008. As a result, your benefits will not increase in 2011."

What a country, retirees are protected from the ravages of inflation, and, better news, yet, there is no inflation! Hooray! There is certainly no inflation in interest rates from CDs, that's well documented. Thank you, The Federal Reserve!

Of course the SSA's Cola adjustments are made through the most bizarre calculation. Sounds like a lot of sleight of hand, but here is an explanation.

It is interesting to review how the CPI gets measured and how such measurements might distort what inflation seniors really face. According to Bureau of Labor Statistics Consumer Price Index the prices of certain items have actually declined over the last year, specifically Window Drapes (8.00%), Peanut Butter (5.10%), Bedroom Furniture (5.00%), Dishes (4.40%), and Sports Equipment (4.00%). But, with the notable exception of Peanut Butter which many seniors may have resorted to consuming, these items are probably not frequently among their purchases. On the other hand, let's look at some of the offsetting increases: Funerals +2.20%, Dental Services +2.80%, Nursing Homes +3.50%, Physicians Services +3.50%, Prescription Drugs +3.90% and Hospital Services +9.30%

No inflation for seniors? Ha. Also, for a quick peek into the future, let's review the past: According to the Bureau of Labor Statistics, the purchasing power of a 1984 dollar is now $.458 while a 1967 dollar is only $ .153.

No doubt entitlement programs need to be looked at along with taxes to get our fiscal house under control, but inflating away the dollar and playing shell games with Social Security is what happens when Congress cannot agree on anything and political posturing is all our representatives seem to be able to do. We've become a sound bite democracy.

Meanwhile, on another, but related topic, the essay du jour is Bill Gross' latest, with his conclusion saying it all: "The United States in short, needs to make things not paper, but that is not likely unless we see a policy revolution in Washington DC. In the meantime, our unemployed will continue to fill out forms and stand in line. We’re living here in Allentown."

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