Economic trend

When you consider waves of any sort they fluctuate. Now I'm not going to talk about any specific financial wave theory but in general the economy exhibits significant wave characteristics over time.

The reasons for this behavior are complex but there has to be a point when the wave rebounds from an upper level and starts to fall. By the same token there has to be a bottom to the wave at which point it will turn upward.

The economy is exhibiting signs that it has reached a bottom and is starting to rebound upward.

This would be characterized by a slowdown in the rate of downward acceleration until it gets to zero after which we should see some upward acceleration. Now there is a point, the trend line about which a wave will fluctuate. This trend line can obviously trend in either direction and the wave will follow it.

When you consider a complex system, such as the economy, it is normally composed of many feeder systems, each of which influence the top level. Further the feeder systems are themselves composed of their own feeder systems. Placing too much emphasis on any one system as a way to predict the top level, even if past correlations have been strong is usually a mistake since the complex interactions will change over time.

There was a time when the rise and fall of Auto production in this country was a strong indicator of how the overall economy would do. Clearly, that indicator has lost value as a predictor as the percent of the economy represented by Auto manufacturing has fallen in relation to other areas. It still exhibits its own wave characteristics and still influences the top level, just not as much.

Other areas that were at one time insignificant or even non-existent i.e. the Internet, now play a prominent role.

One of the factors that has greatly influence our economy over the last 60 years has been the baby boomer generation. Now, this generation has been a bulge moving through the economy and had you simply played the market based on where they were demographically you would have done fairly well. This generation is now entering retirement. What is the impact of this. Well, clearly health care will become more significant to them. Also, in the past this would have boded well for retirement areas and leisure activities that cater to older Americans. It is possible that this generation will retire in place more than prior generations, partly because the areas that were popular retirement destinations have gotten much more expensive and the selling of a house in the North and purchase of a house down south is not as profitable. Also, this loss of housing wealth may have a significant impact on their ability to pursue leisure activities. However, it is more likely that as the economy rebounds these two areas will also rebound and will grow with the baby boomers over the next 10-30 years.

World Economy

For those of us alive today in America, we have lived in a period where America had the highest standard of living of any country in the world. Now, there were other countries in Western Europe that over time came fairly close, but the American economy simply dominated the world and ultimately drove the old Soviet Union into bankruptcy trying to match our defense spending.

Of course prior to the 20th century, the richest countries were Great Britain and Germany but two disastrous wars and the growth of America changed that relationship.

Can America maintain its economic dominance. The odds are against us but it may very well depend on how you want to measure it. If you measure it on a countrywide basis, the sheer numbers of people in China and India would assure that the GDP of those countries are clearly going to pass America's at some point in the future. In a number of lists, the Eurozone, consisting of most Western European countries, is either slightly larger or slightly smaller in GDP than the US.

Clearly, as the world becomes a global economy, the standard of living around the world is likely to equalize over time. If you live in a poor country, this is clearly a good thing. If you live in a rich country, not so much. Growth has to be greater in emerging markets in order to create balance over time. Of course another way to achieve that balance is to have negative growth in the rich countries. It would clearly be better for people in wealthy countries to grow slower, and watch an overall increase in world standard of living as emerging markets grow faster.

In fact, this emerging market growth is a wonderful investment opportunity for many years to come. We do need to make sure that our export industry has an opportunity to sell to those emerging countries in order to maintain jobs and profits in this country.

The most significant economic trend of this current century will be the rebalancing of world economic power. If you look at development in the US since World War II, you saw great growth in the sun belt states at the cost, to some extent, of the North. Jobs and Industries moved to lower cost sub belt states. I see a similar situation in respect to the world economy as jobs and industries migrate to lower cost developing countries.

Housing prices

Yesterday we got the Case-Schilling housing report and it showed that in most parts of the country housing prices either held their own or went up a bit from May to June.

Now the increases weren't dramatic and prices are still down from a year ago (can't imagine that should surprise anyone) but if prices have stopped going down month to month in most places and stabilized or gone up it would be a very positive sign.

Now most analysts do see it as a positive sign but of course they are all hedging their bets and some are completely discounting it.

The main arguments you hear or read about why it doesn't mean much include:

- Prices are still down since last year
- The houses being bought are foreclosure houses
- The buying is artificial because of the $8,000 Government stimulus for first time buyers
- Many of the houses are being bought by speculators trying to turn a profit
- This is only a pause and the descent will begin again as unemployment continues to rise
- There are many houses where the owners and/or the banks have not put them up for sale because of low prices.

Now, some of these statements are clearly factual and a couple are suppositions. The one about additional foreclosures and price declines coming as unemployment rises is the most speculative and would require the economy to have a second dip. Of course this is possible but based on most current indicators just doesn't seem very likely in the near term.

The fact that prices are down from last year is true but not sure what it matters. If prices rise at a very slow pace from here, by next June, we will see prices being higher year over year. It is both unlikely and probably undesirable for prices to escalate at too high a pace. We just got out of a housing bubble and once prices bottom, as they very well may have, we simply want to see them increase in line with the economy as a whole.

Yes the Government housing stimulus is likely have an impact and the question has to be will buying continue after it ends. That is a fact that won't be answered until it ends but the hope is that by then, the economy will be improving enough on its own. It is also very possible that the incentive may be extended or even revised to include all buyers. Time will tell.

If speculators are buying the houses with the hope of turning a quick profit or turning them into rentals with the hope of long term capital appreciation, I'm not sure why this is a bad thing. We certainly wouldn't want to see a speculative frenzy leading to another bubble but investing i housing, flipping houses or renting out units seems like a sign of recovery rather than anything else.

Yes, a lot of the houses being sold are foreclosures. Makes sense since they are the lowest houses out there and why wouldn't they sell first? Once again, we clearly want to get these houses back into the marketplace. What would be the alternative to selling them?

The fact that people are not putting houses up for sale because they are hoping for prices to rise is another fact that may very well be true and may act as a damper on prices since they will put houses up for sale as prices rise increasing supply. However, this will only happen if prices rise and will help avoid potential bubble conditions. Not a terrible thing.

Of course for those folks who are convinced, or possibly just desirous of a true economic catastrophe, nothing will convince them things are getting better. For most of us the fact that housing prices were stable month over month is good news, although we need a few more months of increases to see a true trend.

Health care politics

One of the problems we constantly have in this country is that we argue over the politics without actually dealing with the issues.

Now, I'm sure this is not unique but we have failed to address major issues over time as we throw accusations such as socialism, greedy capitalists, etc, etc instead of somehow agreeing on a common outcome.

If you consider the problems we have now, I think many would agree the providing universal health care, reducing our dependence on foreign oil, improving the economy and specifically unemployment, and making sure future generations have a livable environment are important.

However, we continuously fail to make significant progress on these issues because of politics. Consider the current argument on health care. Currently in this country we spend more money per capita on health care than any other country. We do have better results for some of the population, but for many people in this country, health care consists of infrequent visits to emergency rooms and clinics with less than ideal outcomes.

Now, all of this is paid for now. Much of this cost is borne as a cost of employment. Much of this cost (Medicare and Medicaid) is borne by taxpayers. Generally the cost of the uninsured is passed on as overhead to all as part of hospital overhead.

Now, the other fact is that if you are not a senior, or not employed at a company that provides health insurance, the cost of private insurance is onerous for the average worker.

So we know how much this all costs us and one would think that a system that fixed the cost issue should be able to provide better care for many and not decrease care for those who already have insurance. One would think that the removal of health insurance as an employment cost would also level the playing field for business and reduce a barrier to employment.

Not everyone shares these views. It often seems that those who are at the top of the health care pyramid, either because they profit from the current system, or because they have secure and excellent health care due to wealth or employment status, don't want the less fortunate to get adequate health care. They couch this argument in other terms, but either you want everyone to have adequate health care or you don't. If you do, the argument should be about how to get there. Clearly, the system we have now doesn't get there. I hear very wealthy people saying the current system fails because it is not a free market system and the fact that Government is so involved has led to increased costs and inadequate care. Of course much of this argument revolves around Medicare its cost and its impact on health care, but one thing that is not a problem is whether seniors can get health care.

Now, one hears many allegations about the failure of health care in countries that provide universal coverage. On the other side liberals point to the failures of our health care system. Clearly, it is always easy to find individual instances where any health care system, or in fact any system, fails. However, on a macro level our health care system does not provide the best results. Where we do produce the best results is at the extreme top level where we do go to extraordinary levels. This relatively minor aspect is constantly cited by those who oppose health care change. They cite examples where incurable diseases are not treated elsewhere but where we go to extraordinary levels.

There is one inescapable fact of life, it will come to an end. I'm certainly not going to say that extending life a few years or even months is not worthwhile. The cost of certain procedures, versus the result are a legitimate concern. If we had a true free market system, many people would never be able to afford those procedures anyways. Our current system often bankrupts people at the end of their lives and prolong those lives for relatively short periods, often with very little quality of life.

It is an emotional issue but society shouldn't prevent people from spending their money however they want to, but it is not a cost that should be ignored and paid no matter what, if it is going to increase taxes or the cost of insurance.

Smaller economy

There was a good documentary on CNBC last night called "House of Cards" that spelled out how the flow of credit led to the housing bubble. Of course the biggest issue in the whole process was the simple fact that the frenzy allowed people who normally would never qualify for a mortgage to get extremely large ones and encouraged people to pursue excessive life styles using the growth in housing prices.

Since the whole system was dependant on home prices rising ad infinitum, when they did stop going up, the bubble crashed. We have been seeing the aftermath of that for the last couple of years.

Now as far as housing prices go, the correction in prices is either over, or almost over in most parts of the country. This is obviously debatable, but one of the things driving average prices down is the re-establishment of the spread between the high end of the market and the low end. The initial crisis impacted to low end of the market dramatically. Now of course, in some states such as California, the low end of the market has valuations that are higher than the high end of the market elsewhere, but still, the first houses impacted were generally the low end of the market. This crash in prices increased the spread between entry level housing and higher levels of the market.

Now even as the real estate bottoms have started to stabilize, we are going to have a period where the higher end of the market will have to adjust down. I don't expect this to be as catastrophic as the price drops in the low end, but it will continue to feed the impression that housing is in trouble. Many of these houses are owned by people who don't necessarily have to sell. Also, in many cases they still have significant equity in these houses, so even when they sell at values lower than the peak, they are still ahead of the original basis.

What continues to be the most problematic aspect of the housing problem is the fact that so much of our economy was based on people spending paper wealth. I've shown statistics previously where the amount of discretionary income available has not changed dramatically. Now even if a larger percentage of this amount was diverted into savings, you would only have a small economic contraction. However, consumer spending in the bubble years was tremendously supplemented by housing wealth and that spending is simply not coming back anytime soon. That is why we need to adjust to an economy that has to be viable at about 85% of the prior levels.

This will lead to unemployment higher than it used to be, but not necessarily at an unsustainable level. We do have a chance to help the economy dramatically by investing heavily in the renewable energy area.

New economic base

Over the last two week (earnings season) we have heard many analysts make a comment similar to the following, "while earnings have beat estimates, revenue is down from last year and/or didn't hit the current estimate." This comment normally precedes a bearish statement along the lines of, well they can't cut costs forever and the economy is still weak.
What I think they are missing is the fact that the economy has contracted because of the great loss of consumer wealth and in comparison to the bubble days of 2007 it looks bad. However, assume you had a time machine and could go back to the economy of 7 years ago. Companies were certainly capable of making money and growing from that point. Now, if management has successfully resized to a level similar to one that existed seven years ago, what lies ahead?
Whether it is going to be this quarter, next quarter, or next year, I think everyone except a few people who believe Armageddon is coming, expect a recovery. Is it going to be a recovery that takes us back to 2007 levels in a matter of months? Probably not. However, if the economy and the agile companies have shrunk by 10-20% in reaction to recent events and we start to grow at 2-3%, that is still very bullish. Based on some assumptions I use it may take us until 2014 to regain 2007 levels, but so what? Companies can make money and are positioned to grow during those years from where they are now.
Take the auto industry. Near the peak they sold 16 million cars. If they shrink and retool to the point that they can be profitable selling 10 million cars, are they not a good investment? The fact that the industry was once bigger is simply a historical fact and certainly doesn't have much to do with current investment choices. Even more importantly, if they are profitable at that level and if over time demand goes up, they now actually have new growth potential. Yes, they are regrowing into areas they already occupied, but why does that matter?
If you accept that the economy has adjusted and is now smaller by some percentage, you need to make investment decisions based on the new reality, not some memories from a few years ago. The agility demonstrated by the managers of these companies is impressive and they have created new opportunities both for current earnings and for future growth. They seemed to adapt much faster than most of the commentators.

Recovery scenario

The stock markets had a very bullish week in the second week of earnings season and even on a day where there was some disappointing earning from Microsoft and American Express it held on to its levels.

Right now the numbers seem to indicate that there is still significant money that is likely to enter the market once general acceptance of economic recovery becomes more assured. There are clearly signs that things are starting to get better. Starting to get better is not the same as being better and often people seem to miss that distinction. If you have a patient who is running a high fever as a result of a debilitating illness and the fever goes down, that is a positive sign. He may still be running a small fever and his system may take weeks to fully recover, but the improvement usually means that the worst is over.

Yes, there are potentials for relapse but if the illness is a common one with a known course of treatment, a relapse becomes much less likely.

The economy has been through economic downturns before. This was a severe one and I know there are those out are convinced we will still revert to economic collapse, but, earning season should really put those expectations to rest.

Since I started writing down my thoughts here, I have argued that the size of the American economy may have undergone a long term adjustment. I hear this being called the new normal on some shows and I think the faster we accept it the better off we will be.

A good example may very well be seen in the Automobile market. Auto makers need to scale production for sales that are 33% less than they used to be. There is no reason an industry that sells 9-10 million cars a year can't be profitable, unless of course you are geared up to sell 15 million. If demand exceeds supply, they need to be careful about expansion and avoid the overzealous pursuit of profits and market share that almost ruined them last time.

Similarly, many other industries also need to assure that profitability can be achieved at lower revenue levels. The recent earnings season shows that has happened for the most part. Profitability is what is important for success not market share.

Having established that most companies can be profitable at lower levels, growth from those levels will result in significant margin improvements. However, if the economy is smaller than it was it will result in a reduction in jobs unless there is a new growth industry. I believe renewable energy can be that growth industry. However, even if we fail to create as many jobs as we have lost is that a catastrophe?

For years economists have been predicting a labor shortage as the baby boomer generation leave the workforce. Yes, that trend has only just started and because of the recent economic problems, the trend may have been slowed, but, inevitably they will leave the workforce.

So, how problematic is the loss of jobs? I think there is plenty of evidence that unmeasured economic activity (people working off the books or engaged in illicit activities) is picking up some of that slack. With equities regaining value and if we can get some increased values in housing, the baby boomers who saw their retirement nest eggs wiped out, may find a lot of the value returned. If they then start to retire in large numbers, we may actually have a significant labor shortage that will need to be supplemented by immigration or exportation of jobs.

So for those hoping for Armageddon, I think you have a problem.

Speculation

There are many types of people who buy and sell securities. The most fundamental division is between speculators and investors. Simply put investors are people who think a particular enterprise will be successful and buy a security with the hope of long term growth. Speculators are focused on price movements and may or may not even consider the financial status of a company, but hope to profit from being right about how prices will change over some period of time.

Now I'm sure there are many who have alternate definitions, but I believe mine is simple and accurate. Generally, investor are fundamentalists, meaning they worry about things like balance sheets, cash flow, earnings, etc. Speculators may look at these things, but generally they are much more interested in short term trends and are interested in fundamentals only to the extent that they may impact price movements.

Speculation is generally criticised but speculators do serve a purpose similar to insurance in the marketplace. For example, speculators allow suppliers to hedge production costs. Without them the risks in business costs could be much less predictable. However, if you are a speculator, you are clearly taking significant risk, since the risk is transferred to the speculator and human nature leads speculators to look for ways to reduce that risk.

Similar to gambling, speculators are constantly searching for a "sure thing". Now, the only real way to have a sure thing is to be able to control the outcome. This is where speculation becomes problematic. In some markets opportunities arise for speculators to control the way prices move over a period of time. In the oil markets, there is significant belief that the price rise of 2008 was simply speculation created. More recently we had a situation where an individual trader was able to move oil futures on the overnight market and then pocket some profits on the reversals.

So is a situation where markets can be "fixed" even if only for short periods of time acceptable? I think most people would object to this as much as they would object to sporting events being fixed for the benefit of gamblers. The problem is that we have a lot of money and a lot of greed in play in speculation and regulators are unlikely to find a way to prevent the next "gimmick".

This doesn't mean they should stop trying.

One of the first things they can do is reign in naked short selling, where the number of shares being sold can be artificially increased. Making sellers identify the specific shares they are selling and reinstitution of the uptick rule are excellent steps that should be implemented quickly.

Wall Street Police?

How much does Government need to be involved in policing the investment community? When you listen to financial industry people on channels like CNBC or Bloomberg, they like to say that yes there have been some abuses and yes we have had people who stole lots of money from unsuspecting investors, but Government intervention will just cause different problems and big Government is just plain bad.

I sort of feel this sort of argument is like John Dillinger thinking banks should leave doors unlocked and fire all security guards. Those things simply interfere in the free flow of money after all.

I'm watching a show right now where the discussion is along the lines that Wall Street should be allowed to police itself. Well, when you consider the fact that these are the same people that almost destroyed the economy completely by devising various financial instruments that assumed they would never be used. If you believe that housing will always go up and equity markets will have nothing but minor downturns, credit default swaps and sub prime mortgages are just fine. However, these are supposed to be financial professionals and their failure to properly evaluate risk is pretty damning.

Now these same people want to police themselves? Who believes they can?

Good Old Days

There are still any number of analysts promoting the idea that the recent improvements in the economy are not real and problems with unemployment, real estate valuations, excessive money supply, and the fact that the Government has interfered in free market economics by bailing out a number of firms will come back to haunt us and lead to new lows in the stock market and I guess a return to the good old days of the mid 1930s.

Now, these are all real problems, and some of them do bear some similarities to issues in the 1930s. Of course there are a significant number of major differences, the primary one being our safety net, created since that time.

In the 1930s as financial distress spread and banks failed, there was no fall back system. When your bank closed, you lost whatever you had in deposit. As banks failed, panic ensued leading to more and more runs on banks causing more and more failures.

We do still have bank failures, but since deposits are insured, the depositors are protected. This has resulted in orderly bank closings with the FDIC making sure deposits are safe. While many of those nostalgic for the depression point to the number of bank failures, there is no panic and very little loss of wealth because of them.

The next biggest factor is our unemployment safety net. In the 1930s, if you lost your job, you were on your own primarily. There were some private and state charities, but as the unemployment rate soared, they were unable to help the great numbers of needy people and large numbers of people were forced to live in tent cities, emigrate to other states or take up the hobo life. This is not comparable to our current situation. While not a complete replacement for lost income, unemployment insurance followed by other forms of public assistance provide a bottom level to the pain of losing one's job. Yes, mortgages and credit card payments may be defaulted on, but the reduction in demand is simply not as great. We have not seen a repeat of the tent cities, or of the economic migrations of those days. In fact, the number of Americans relocating is down significantly during this period.

Finally, while we have had significant losses in the wealth of retirement accounts, there are many older Americans with guaranteed incomes from Social Security and conservative retirements investments or annuities. In this respect the larger number of older Americans is a mitigating factor in maintaining some economic demand. Yes, it has declined due to the loss of wealth, but this area was almost non-existent in the 1930s. Further, we have the Pension Benefit Guaranty Corporation that makes sure that pensions have at least some protection.

Of course, there are many other factors including the post war problems that existed in Europe, the fairly disastrous actions we took related to trade that don't exist today, the gold standard, the disastrous droughts of the 1930s that destroyed millions of farms, and the rise of fascism and communism that added a special something to that period.

The economy is certainly still in trouble and far too many people are unemployed, however, I don't see a return to Americans huddled around radios listening to fireside chats anytime soon.

Employment

One of the things being revealed during this earning season is how quickly companies shed payroll in order to preserve profits. Yes profits are down from last year but had companies continued historical patterns, they would have been much smaller and possibly non-existent. What they did differently was to shed employees at an unprecedented pace.

The question is why. Well, despite the fact that many companies like to say that employees are their greatest asset, in reality most don't feel that way. In fact if you consider the built in cost of an employees fringe benefits, the incremental cost of hiring or keeping an employee is out of proportion to increased production. Now, had this been viewed as a short downturn, companies may not have reduced payrolls as much, but with the "new depression" talk and the tremendous drops in assets, companies trim workforce and will rehire very slowly. Generally, technology has now become much cheaper than payroll.

In an earlier post I talked about the loss of jobs in retail, the most visible industry to most of us. This trend is not limited to that industry. In fact, the bad economy is a wonderful opportunity for many companies to shed payroll and invest in new technology to reduce ongoing payroll and increase profitability.

There is a saying that Generals always prepare to fight the last war. This propensity isn't restricted to Generals, it is also true of economists. It is almost inevitable that when you predict the future based on prior behavior, you will have problem predicting sudden change. The high cost of health care and pensions where they are still offered simply make full time, long term employees too expensive unless they are essential.

There will be some growth in employment in current industries when the recovery gets fully going, but it will not increase as quickly or as much as it has in the past. The only real way to reduce unemployment dramatically is to create one or more new growth industries.

Recovery?

We are starting to hit the period of time when the stimulus package is going to start having a bigger impact. Whether the stimulus was properly targeted or implemented speedily enough, there will be many projects kicking off now that will show some improvement in employment.

Also, with GM and Chrysler out of bankruptcy and some increased demand in the auto sector, we can expect to see a small bounce as the auto companies and their suppliers start working on the fall lines.

Also, as many of the companies have cut to the bone in order to preserve profits, I would think that the production for the Christmas season has to create some jobs in manufacturing as well.

We also see a bit of a rush to get houses started so they qualify for Government credits and we should see a small uptick in construction employment.

All of this indicates that we are either at the top or very near the top of our unemployment curve.

Now many analysts are predicting unemployment to continue to grow into early next year, and if retailer's overstock for Christmas we may have a subsequent problem, but assuming they gear u for a modest but profitable season we should start to see the stability in employment that we need to renew GDP growth.

Housing is a tougher problem, but I do think that a larger number of people who have moved in with parents and/or relatives and have been saving, will with an improved employment outlook, use that savings to invest in some of the most affordable housing they will probably see in their lifetimes.

Starting to smell more and more like recovery.

Summer trading range

After an up week we are just about back to the levels in the Market we were in early June. I believe we are still defining the summer range and next week's earnings will determine if this is the top of the range or the middle.

If this is the top of the range than the market will retreat to about 875 in the next couple of weeks. If this is the middle we may go near 1000 before it retreats. I'm expecting earnings to mostly equal or beat estimates due to managerial efficiencies but top line revenue flat or possibly down some. There will of course be exceptions, but there is no great likelihood that consumer spending can resume at levels from the last few years.

The amount of consumer discretionary spending has remained relatively constant, even with layoffs as various social programs have kicked in but the loss in real estate equity is going to hinder spending for a considerable time period. Consumer credit is impacted by the fact that rising home values enabled many to tap the equity and it also made them feel more comfortable in using other credit since the housing wealth served as a safety net. With that safety net gone, the equity is no longer there to be tapped and other credit looks more ominous. Compounding the problem is the fact that with the loss of home equity there was a corresponding reduction in the value of many people's retirement savings. People are therefore saving more of their discretionary income.

So, as I've been saying consumer spending has to find a bottom. Now as there has been less spending and less lending, effectively the amount of money in circulation falls. Further we are establishing a new price expectation in many consumer areas. Prices of many products have been discounted for an extended period of time. While these discounts have been presented as "sale" prices they are so frequent that they are really becoming the "normal" prices. It would take a significant jump in demand to reverse that trend, and since I don't see a V shaped recovery in housing nor do I see a big increase coming in discretionary amounts for spending, where would this come from?

So short term, top line revenue will continue to disappoint and this will probably be interpreted in a bearish way. Of course, if you would like to see the economy return to the overheated levels of 2007 it is, but that would require a massive stimulus, properly directed that would inflate housing and prices and clearly lead to a new bubble.

So, while earnings will be decent and may beat expectations due to cost cutting, top line revenue will be flat and I expect the Market to react somewhat negatively in the next week or two.

Indicators

Then can be little doubt as we look at the economic numbers that the leading edge economic indicators are starting to point up a bit. Yes, while Intel posts great results, a company like Dell doesn't. This simply indicates the differences that will always exist between strong, innovative companies and companies that fail to adjust to changing situations.

This certainly doesn't mean that there still won't be bad news. It is going to be a while before successful companies hire enough to offset the reductions from failed companies. Now, I see some commentators trying to spin unemployment into a leading indicator. It isn't and never will be. All business corrections involve weak or inflexible companies going out of business. One of the reasons they are weak is that they have too much cost. Successful companies will grab market share as this happens, but thanks to the fact that they were already more efficient and the synergies related to increased market share, the people let go by the failed companies will not be absorbed completely by the surviving companies. Further, weaker companies that see the light, shed employees to save costs. So it takes either a new growth industry or growth past the prior level to reabsorb all the employees unless efficiencies decline.

Now the companies that make money during a correction do so by reducing cost and possibly picking up market share. The market share they pick up may offset the reduction they would have seen in their own revenue but it is unlikely to push revenue up until later in the cycle. When growth returns, they are poised to have great improvements in earnings.

If you are a long term investor, this is still a wonderful time to get in at what will look like lows in the fall.

The near term future

One of the things that is at the very least interesting is how short investor memories tend to be. After the March lows, we saw the Market climbed about 40%. In the beginning of June, we had a pause and a consolidation correction of about 5%. This type of pause is nearly inevitable since a certain number of investors are going to take profits, other investors don't want to buy at "inflated" prices and of course we always have our bearish friends who expect a total collapse at all times.

Now, many, many analysts predicted such a correction but as it was happening we sort of had panic in the streets. Even in the most persistent bull markets, there are pauses and dips along the way. Now when prices are going down and at the same time news comes out that disappoints a bit, such as the unemployment report, we have pundits ready to declare that everything is bad again and its probably time to buy lots of canned goods and dig a hole.

Naturally, the pause, consolidation, correction came to an end and with a bit of positive earnings reports the market rise has resumed. Now, based on my comparison to the early 70s and where I think earnings will be, I see a fairly rapid rise for the S&P to between 1100-1200. I don't think the economy is good enough to pass that level at this time and in fact, I would expect a bit of a correction near that level followed by a long period of range based training.

Now, my comparison to the 1970s and earning expectations are fairly speculative. I would say that once we get to the 1100 level, without a jump start we will see the market trade in a range of +/- 10%. The economy is still troubled and we need to get the next growth industry kicking in and we need to reform our tax system, or we face a fairly long period of stagflation, high unemployment and price increases.

American ingenuity

When you read certain news articles or watch certain commentators on TV, you find a lot of clear black and white views. One of the things that I think is overlooked is that most people when faced with a problem, actually try to do something about it.

Now, in an economy we have a broad spectrum. I will admit that there are a certain number of people, for whatever reason, who effectively fall off the cliff. You see them living in boxes, or under boardwalks. Many of these people have either mental or addiction issues and the status they find themselves in is normally not temporary. However, the vast majority of Americans who run into economic difficulties, say the loss of a job, do not join these ranks.

So what happens to them? They find some way to cope. First, there are things like unemployment insurance and after that runs out, other forms of assistance available. Further, in many of these families, there are multiple earners, so possibly there is still at least one income. The people who are out of work strangely often show a significant amount of ingenuity, such as doing odd jobs, possibly getting seasonal jobs and often these activities are part of the underground economy. As part of the underground economy, this activity is completely outside of normal economic measures. Of course there is the other underground economy involving drugs, gambling and prostitution and the amounts generated there shouldn't be ignored. However, more benign in many ways are those who work on an irregular on-call basis for things like movers, landscapers, painters, etc., who basically get paid "off-the-books".

I don't have a good way to estimate the level of this activity, but I have some anecdotal evidence that it is quite prevalent. Obviously, it is hard to measure, since there is no reporting either by the employer or the employee.

Another way people cope is by selling things. If you have been laid off and happen to have a fairly new big screen TV, you can use either on-line sales or word of mouth to pick up some needed cash to help you cope. Obviously, this sort of activity is also very much under the radar and hurts retail sales since the person getting the TV this way, doesn't go to Best Buy to get one. How much do these sales equal? Once again, I have no way of knowing, but it certainly seems that sites such as E-bay and Craig's list are booming.

Of course another way people cope is to do things themselves that they use to hire people to do. Now, this isn't considered economic activity per se, but if someone used to pay $50 a month to have a landscaper come in and now does that themselves, after buying some materials and tools from Home Depot or Lowes, effectively it increases their ability to pay a mortgage, or to buy other things.

I could go on but one of the things that shouldn't be overlooked is the ability of the Average American to find a way to "get by." Yes, it doesn't help the numbers, but it does mitigate the pain and provide a base of economic activity that is usually ignored by the prognosticators.

Recession bottoms

While we have seen a surge in the stock market after an analyst upgraded Goldman Sachs, these type of low volume summer moves come and go and will likely reverse either later this week or possibly after earnings. While there are many clear signs that the economy is not going to get significantly worse and, in fact, will start getting better, possibly only in a few sectors at first and possibly slowly, there are still a large number of people pushing negative news.

I read an article titled "Nine reasons the economy is not getting better" that focused on the recent unemployment report and tried to demonstrate that as bad as it was on the surface it was actually much worse. Some of the data was real but there was an awful lot of speculation related to part time workers, trends used by the labor department and the status of people who were unemployed but are no longer collecting unemployment. Now, I don't pretend to know what these people are doing right now, but the author doesn't either and speculated a worst case scenario. Being a worst case scenario, it may have some validity, but, statistically, worst case is normally not very likely.

One point made in the article concerned the fact that unemployment has increased at a record pace during this downturn. He thinks this bodes ill for the economy, but why would that be? Companies reacting quickly and dumping workers, is going to make them profitable much faster than if they reacted slowly.

So what is required for economic recovery? The most obvious answer is businesses that are making money. Profitable businesses will survive and eventually grow. One way to stay profitable during a drop in demand is to become more productive. Companies that fail to react quickly soon go out of business, unless of course the Government bails them out, but economics requires that efficient companies survive and non-efficient ones don't.

It would seem we are now at the point where the companies that are going to survive have reduced costs to the level they need to. Before you can have growth, you have to have some stability. The second step will be some increase in demand.

I should point out that many negative analysts argue along the following lines. Increased demand is being created to replenish inventories and not because consumers are buying more. Therefore, since there isn't top line growth, it isn't a real recovery.

Let's consider this logic. If the economy has reached a point where inventories are depleted and therefore companies have to increase production to replenish it, what does that mean? It means plants that have laid off employees will need to bring at least some of them back or increase the hours and pay of those currently there. Now, this would represent an incremental increase in disposable income and even if savings were to stay at the recent high levels, it would represent an incremental increase in demand. This is the start of a recovery cycle. Because just like on the slope down, each incremental decrease in demand resulted in less employment and less demand, you recover the same way. Will it be an explosive increase? No, it has to build, but it will pick up speed over time.

In addition, we are going into a period where the stimulus package the Government has passed is going to start having more impact. If you add this to the incremental increases in demand, you will suddenly start to see some real growth in consumer spending. If past experience is any measure, by the time the stimulus is fully hitting the economy, it may no longer be needed and may simply start to fuel inflation. I wouldn't predict that since we have some other fundamental issues related to housing and credit, but I wouldn't rule it out either.

Simply put, recoveries always happen, and many times they seem to be a surprise. Pessimistic views will continue and some analysts will talk about false recovery and how we are living in a fool's paradise and eventually we will have another recession, and they will point out how right they were all along.

How bad is the Recession Really?

This may seem like a strange question as everywhere you look you here talk about the worst crisis since the Great Depression and there are still many prognosticators acting like we should be stocking up on canned goods. Yes, we have had a dramatic drop in housing prices and equity prices and many, many people feel poorer than they used to. Further the unemployment rate has nearly doubled with particular hits in the areas of Manufacturing and Construction as everybody sold off inventory into weak demand. We have some significant disruptions in California where the populace and the Government are unable to agree on ways to balance the State budget and many other states are faced with drastic budget problems.

Now, I've lived through a fair number of recessions and maybe, just maybe, I'm in an area that hasn't been as hard hit as others, but as I drive around I don't see that many for sale signs on houses, I don't see boarded up stores and pretty much everyone around me is still working. Summer jobs for the teenagers seem to be rare this year, so I guess they are sort of suffering. Now, I don't want to minimise the pain in Michigan and California, and yes, a common topic this year is how much the house values have dropped vs the last few years where the topic was how much they were going up, but its the same people having these discussions, drinking pretty much the same cocktails and maybe eating store brand snacks instead of brand name ones at the summer cookouts.

Now, I got a letter the other day from Bank of America telling me they were reducing my credit line from $20,000 to $10,000 on a credit card I haven't used in about a year. I don't normally run credit card balances but I have to admit that I am running one right now on a card that gave me zero percent interest until October on a balance transfer. I was wondering if this had impacted my credit score but then decided I didn't really care, and filed the letter from BOA away.

I still get tons of zero balance transfer offers weekly, normally including a 3% transaction fee. I went to an outlet center and everything is marked down 30-40-50% or more it seems so I picked up a few items for my grandchildren at Justice at 40% off. Seemed to be quite a few shoppers browsing the sales, but of course I don't know how many actually bought anything.

So far, the main impact of the recession on me had been the mutual funds I hold which lost a lot of value last year but have regained about half of it so far this year. I did reallocate my main fund to be a bit more conservative when I felt this correction was starting and will reverse that when the bull market resumes in the fall.

Also, there are simply some wonderful stock bargains out there if you take a long term perspective. Much like the reduced prices I now pay for clothes and gifts as well as pretty much everything, stocks are also cheap. I sort of feel that some people are going to miss the sales and end up paying full retail, but I guess that's just the way it goes.

One of the things I notice and this is probably causing the teen job shortage is that more and more stores have reduced costs by going to self checkout. I actually prefer this since its sort of a fun activity using the scanner and figuring out how to get the coupons to register, but while there is usually someone there to reduce theft and help out customers, it seems that where there used to be four to six checkout lanes, you now can have just one person. Home Depot has this system also, but haven't seen it at the clothing stores yet. Don't have a convenient Lowe's near me so not sure about them.

The other thing is how much shopping I now do on-line. Trips to the mall often are excursions that give you a chance to walk around and see what you like, and yes, some purchases are made. However, more and more, the effort of finding the right size at the mall vs the ease of simply looking up the item on-line and ordering it, often with free shipping and sometimes with no tax, is getting very commonplace in my household. I don't think this bodes well for mall operators in the long run, although if they provide enough entertainment options, they still may draw browsers.

I would think the growth in on-line media and shopping is going to cause a decrease in jobs as the number of brick and mortar stores and the amount of print media decreases. On-line stores just don't require sales clerks. In addition, as magazines and newspapers lose off line circulation, the competition on-line is going to become fierce and I think many reporters and other media types will have to compete individually instead of as paid employees. They may find themselves becoming the next "auto workers".

I realize I've drifted off topic, but since I mostly write this to record my thoughts, and as far as I know I'm the only one reading it, I'm OK with that.

So, how bad is the recession? Like every recession it depends on how badly it has impacted you. Even in good times people have individual recessions. Obviously more people have them in bad times. If you lost your home and/or lost your job it may be pretty terrible indeed. Of course one aspect of recessions is that you actually don't feel as bad when the press says you are not alone and therefore not responsible. When you lose your job or home in good times, you feel really terrible, since everyone else seems to be doing great. If you are suffering now, you at least have lots of company.

In all honesty, the recession in the late 70s felt a lot worse to me than this one does. Now I've acquired a lot of assets since then and the country that was going to replace the US as the major economic power has shifted from Japan to China, but I knew a lot more people who couldn't find jobs back then. One factor was the job market was flooded with baby boomers who were just starting out. Now as the baby boomer are getting ready to leave the job market, some are being forced to leave early and some are being forced to hang on and work longer. Times may be tough for new graduates but there are proportionately a lot less of them then there were in the 70s. One of the strategies back then was to stay in school and get a graduate degree, and that postponement certainly helped ease the problem. Another problem in the 70s is that homes were just as unaffordable as they are now relatively speaking and interest rates were horrible. Young people who can secure employment, have a much better shot at affording a home now.

Well, I call this just thoughts, and that's exactly what it is. I think the recession is basically over and by Christmas we will be doing pretty good. Some jobs are gone forever and real estate isn't going to jump to 2007 levels but unemployment will start to decrease and everyone will simply feel better.

AIG short selling

There are ongoing discussions concerning short selling of stocks. Those who use short selling extensively, and this includes many hedge fund managers are extremely defensive about the need for short selling. It certainly makes their job easier in the sense it provides a way to guard against downward movements in the market and actually make money while doing so.

The question that I have is has short selling become so commonplace that it has altered the very nature of the stock market? Yes short selling has been around for many years, but the tremendous growth of hedge funds, as opposed to regular mutual funds, and the increased use of short selling via discount brokers has made it a greater factor.

Clearly in a free market you can buy and sell product. It makes sense to buy and sell future promises related to those products in order to reduce risk. However, the idea of selling product that you have never owned becomes somewhat problematic. When short selling and especially "naked" short selling is a small percentage of total transactions it has limited impact. However, as the amount of short sales increase it creates a clear downward pressure on stocks that the short sellers never owned.

When short sellers start to see an opportunity because a stock hits certain indicators or simply because volume of short selling increases enough to get their attention, the number of shares for sale increase tremendously. There can be no counterbalancing group of buyers, except for early short sellers who cover earlier positions to lock in profits. The math on this is clear. For example if there is x stock in circulation, and it achieves a market price based on the number of sellers and buyers, an increase in sellers will cause downward pressure on the stock. For the short sellers who enter the market, there is no comparable group of buyers who can buy stock without actually owning it. Since the stock sold is actually still accounted for in someones account, effectively the number of shares in circulation is increased and the value receives downward pressure.

Yes, all short sellers must at some point cover their positions and effectively remove the fictitious stock from circulation. This theoretically will return the stock to its prior starting point, assuming the volatility hasn't scared of real investors.

Now, short sellers like to argue that they help to expose weak stocks. Not sure who asked them to do that and further, curious as to whether those stocks were that weak before the short sellers started a selling panic. Recently we saw shares of AIG hammered. Now, long term investors in AIG were punished as millions of shares of AIG stock were sold by people who had never owned it. It was such an obvious and easy target that the stock after undergoing a 1 to 20 stock split quickly lost 50 % of its value. Now when it was selling at penny stock levels, it wasn't that attractive a short selling target because there is a point when even a weak stock like AIG appeals to bottom feeders. Once the reverse split went into effect, short interest rose 14.5 percent in the company. About 262 million of the company's shares were held short, just below 10 percent of its shares outstanding on June 30, the day the company approved a 1-for-20 reverse split that was effective July 1.

After the stock plummeted, short interest declined as profit was taken and the stock had a modest rebound, with short interest down to about 8.5%. Now is AIG a bad company with a bad stock? I think that the answer to that is yes. However without short sellers how would the stock have behaved? For those investors holding the stock, many of them still holding on to it from earlier times when it was quite high, the likelihood that they would sell now was slim. There are no institutional holders of the stock so all the stock is actually held either by company employees or private investors, hoping for some eventual recovery. So the only real sellers would be that group of short sellers, that sold nearly 10% of the stock into a non receptive market.

What legitimate investment purpose was served by this? Yes, a number of short sellers made a lot of money and a lot of investors watched their holdings go artificially lower. As AIG has rebounded a bit, short sellers are going to have to cover positions and it is possible that the stock will return close to the level it had before the assault. Of course as it does rise, short selling will increase again.

Now clearly short selling is gambling. There are other ways to bet on whether stocks go up or down outside of actually owning them i.e. the options market, but when you sell a stock short you actually influence the market to some extent. When 10% of a stock is sold short, it is clearly significant enough to drive prices down. I have a problem with this, especially since the numbers involved have increased to the extent they have.

So should the SEC impose restrictions on short selling? I know free market advocates feel that it is unnecessary. I don't really care if people want to gamble. What strikes me as problematic here is that the gambling gets to influence the outcome. If the gambling was simply a bet on whether the stock would go up or down, i.e. options, it wouldn't directly influence the market. However, if a very large hedge fund wants to manipulate a stock, it can sell a large number of those shares short and in all liklihood drive the prices down somewhat.

So is market manipulation a good thing? For those doing the manipulation it is, but not for everyone else.

Summer rally

Since Memorial Day the stock market has been in the Summer Doldrums. This is caused by many investors effectively going on auto pilot, so a relatively few can strongly influence market direction. Those shorting stocks have had the upper hand and there hasn't been any real positive news.

However we are now in earnings season and so far the reports have been on the positive side. It also will cause the large investors to take a break from their summer malaise and for the next two weeks evaluate where they want to be come fall.

I expect that they will want to have a fairly substantial equity position and will grab up many of the bargains out there. Of course at that point, the shorters will have to start covering positions and we should have a summer rally for the next few weeks.

After that we will go into August and resume the doldrums.

Thoughts about jobs and taxes

After the S&P dropped to the 666 level in March, it bounced back in April and May to the low 900s. Since then it has been flat to down going to the high 800s right now. This pattern comes very close to the pattern we saw in the early 1970s and if that example holds the S&P will have to drop to about 825 after which it should climb to around 11-1200.

Following that example further, after it reaches that level it will consolidate there for a number of years with variations of as much as 15-20% up and down. Two things characterized that period of stagflation, excess money and high unemployment. The reason for the high unemployment then was that we were transitioning from a manufacturing based economy to a more technological and service based one. Millions of jobs in industries that had dominated the US economy in the 50s and 60s effectively went elsewhere as it was cheaper to buy foreign items then to make them here. Eventually, the rise of high tech and service industries increased employment leading to increased consumption, rise in real estate values and adjustment in valuations to the money supply.

Now, looking at the next ten years in America we face similar problems. The remnants of the old industrial jobs are under fire again but also, we are seeing a direct challenge to tech and service jobs. It is clearly cheaper to manufacture almost everything overseas but services were at least local. However, as less and less services are performed in person, there really is no reason for service jobs to be local. Also, as more and more sales go on-line, even relatively low paying jobs in retail will be reduced. If I complete an on-line purchase, there is no need to deal with a person at all. Further, I have grown quite fond of the self service checkout at places like home depot and some grocery stores. Yes they have a person monitoring these by instead of 4 people, they only need one. These are jobs that are not coming back. Considering the long term hit to construction (which at least for now still has to be locally) there are millions of jobs going away that are not going to return.

Now, even if the service jobs go on-line, they could still be performed in this country if it made economic sense. Certainly not all jobs are going away but think about this for a second. If we have 100 million people looking for work and 95 million jobs we have a 5% unemployment rate. Assuming the number of people looking for work stays the same but 5 million jobs go overseas or simply disappear because technology replaces them (only 5%) we now have 100 million job seekers for 90 million jobs we now have a 10% unemployment rate.

So are we doomed to live with high unemployment? Until the next growth industry comes along to create jobs the answer is yes. There are some things we can do to mitigate the problem, make the relative cost of employment cheaper by centralizing health insurance cost (if you are going to pay it whether you have employees or not, it stops being a deterrent to hiring), but technology is not going to stop getting better and the trend towards on-line or self-service will continue.

I believe jobs can be created by invigorating the renewable energy industry and by providing funds to fix our aging infrastructure. Further, we need to make sure the cost of doing business in this country is not higher than it should be. I believe we should switch to a tax on consumption to even the playing field. If you sell product in this country you should pay a fair amount of tax.

Currently faced with massive deficits and an increasing national debt, we see our politicians scrambling to find more things to tax. I recently saw a proposal that would take the difference between income and savings and tax it. Generally, that is a better system than what we currently have, but still requires millions of returns to be filed. It really seems simpler to tax sales and do it strictly.

Thoughts on earnings

Where is the stock market headed, or maybe a better question is what should the S&P 500 be trading at? Generally the level is closely related to earnings and as earnings for the 500 have dropped since last year so has the market valuation. However, we are now in earnings season and as companies make announcements, the S&P is going to react.

There are a number of historical charts on the relationship between the S&P level and earnings. Generally the price/earnings ratio needs to provide a yield that is better than what you can get in US Treasuries since realistically, why take a risk if you are going to get less money than you would for not taking a risk? Right now this would require returns of at least 5% but that isn't enough of a premium so generally I think 7-8% is a better gauge. At 7.5% you would trade at 13.3 times earnings. Generally $55 is the current estimate for 2009 so the S&P lower limit would be in the 730 range. Now if you are will to accept the 5% return with the hope of future growth, the P/E ratio changes to 20 and we get an S&P at 1100. A more normal P/E ratio tends to be about 17 so a reasonable estimate is 935.

Now of course the estimate for earnings and whether it should be earnings from operations or GAAP earnings, (includes all accounting write-offs and additions) is the starting point. I prefer earnings from operations, since if you start using gains and losses from asset valuations, and other accounting requirements, you add a lot of individual company variability. I think those things are important is assessing the long term well being of individual companies, but distort the overall comparisons too much. As an aside, all those asset write-offs due to property and inventory valuations, may now actually be hidden assets if the valuations have any upside.

However at a P/E of 17 the return is around 6% (5.88) and it is fairly safe to say that the market want to get at least the treasury rate of about 4% plus protection against inflation. So if you expect inflation to be 1% we are back to a P/E of 20, at 2% 17, at 3% 14 etc.

So level of earning with return on treasuries and inflation expectations can give you a good estimate of where the S&P should be.

Concerning earnings, while revenue is down for most of the S&P companies we have seen aggressive cost cutting and inventory reductions (look at unemployment and commodities). This is likely to show some earning improvement despite the fact that the level of activity is reduced. Two things should be considered. I think companies need to adjust to a reduce level of consumer spending. This doesn't mean they can't be profitable, simply that they need to be profitable at a lower level of sales.

Growth will return, but barring an unexpected surge in real estate prices, consumers simply don't have the ability to spend like they used to. We also know that ugly reality has hit the baby boomer generation and that the comfortable retirement they envisioned from the equity in their homes and the gains in the stock market have vanished. They are now saving more and spending less. I don't expect this to change. However, if GM for example can be profitable selling 2 million cars a year, is it a bad investment? It won't be as big as it once was, nor will it employ as many people, but it may still be a good investment.

So I expect that we will continue to see earnings beat expectations because of the cost reductions, not revenue growth. In fact I believe what we saw from Alcoa may not be far from the norm, where the aggressive cost cutting allowed them to beat expectations, admittedly still losing money, by 30%.

It may seem a bit contradictory, but the cyclical industries hardest hit by the recession have had the best opportunity to do drastic cost cutting.

How will the Market react? Initial reaction to the Alcoa earnings is positive. I would think that as earning continue to beat estimates we will see the S&P go to the 935 level and possibly approach 1000. However, the naysayers will talk about a sluggish recovery with little job growth and reduced consumer spending. True enough, but if we accept that the economy isn't going to return to 2007 levels, have we recalibrated sufficiently to grow from where we are?

Health care costs

In 2008, health care spending in the United States reached $2.4 trillion, and was projected to reach $3.1 trillion in 2012.1 Health care spending is projected to reach $4.3 trillion by 2016.

This spending represents about 17% of our GDP and by that measure exceeds all other industrialized nations. The question that we have to address is are we spending too much and are we getting sufficient value for the health care dollar.

Another factor we have to consider is that despite the massive amount of health care cost, many people do not have access to preventive health care and/or health insurance. Ignoring the fact that preventing a disease is much cheaper and more beneficial to the patient, we have a system that does not make preventive medicine a high enough priority.

Numbers are often thrown around about the number of uninsured. I was watching a show last night where one of the panelists argued that a certain number of the uninsured were uninsured by choice because they were young and did not feel the need for health insurance. This is probably true and that group is probably not a major health care cost driver, however, what has to be realized is that many of the insured are really underinsured in the event of a catastrophic event. The major cause of personnel bankruptcies in this country is medical costs (including long term health costs).

The system we currently have goes back to a paternalistic model that is breaking down. Most health insurance for people not eligible for Medicare is provided by their employers. This expense has increased tremendously over the years and has become a significant burden on many companies. Companies have been looking for ways to reduce costs and this has led to a greater shifting of costs to deductibles and co-payments and the use of HMOs.

Now, lets realize that the health care system does work fine for certain groups in this country. Most of those you see arguing the issue on TV are most likely fully covered. It should also be noted, that our system can and does provide excellent care for certain types of diseases and health emergencies. It often does this at a very high cost, but, if you are in need of an organ transplant and have money (ie Steve Jobs), you can probably use our health system to your advantage.

Of course, there are many more people who don't have those type of resources. The true crisis is the fact that so many Americans only receive health care on an emergency basis. Yes, if you show up in an emergency room with a health crisis, you will receive care. However, a lot of patients in emergency rooms wouldn't be there is they had access to routine health care.

So, I'm going to assume that we all agree that everyone should have the right to health care. The only question that remains is the best way to deliver it and how much involvement should the Government have?

I have trouble seeing how a system without Government involvement can work. If having health care requires a choice between paying a high premium and putting food on the table, the food on the table will win, since there is always a chance that you won't need health care. However, it would seem that the primary areas that the Government should get involved are in providing preventive health care and protection from catastrophic loss. Suppose that every citizen had a Government health care policy that entitled them to certain preventive care services. Treatment beyond preventive care would be at the patients expense up to some level after which catastrophic insurance kicked in? This would create a gap that could either be paid by the individual or could be filled by purchase of a supplemental policy.

The Government policies could be provided by private insurers who would compete for customers. So, assume the Government determined that insurers would be reimbursed $x per customer. The insurer would then compete for customers and if they were more efficient could offer slightly better benefits than their competitors. The only two things the Government would monitor would be that the benefits provided met the requirements and that the number of customers was accurate for reimbursement purposes.

Every American would have to choose their health provider or be assigned to a default provider through a random process.

This would provide universal coverage for the two areas that most need improvement, maintain choice and, I believe lead to a reduction in the increases in health care costs. Obviously, this system would have to be paid for via taxes, but these costs are being paid for already, so the percentage this represents would flow via the Government instead of the current method. Businesses wouldn't have to offer health care, or could offer supplemental packages as part of a compensation plan. Small business might benefit the most since they struggle to compete with large businesses in providing health benefits.

The increase use of preventive care this system would encourage should actually help to reduce overall cost although it would increase demand for certain services.

Growth

Read a blog today that argued that there will be no real growth in the California economy for many years to come and by extension none in the US economy as a whole.

The argument centers around the fact that our two primary post war growth industries, housing and automobiles, are both unlikely to show any growth, and without that stimulus, overall growth will be stagnant. I agree that we need to adjust expectations in both of those industries, but think that it will take years to absorb excess housing, unless we simply raze much of it and reuse the land to grow biomass for bio fuels, I believe that the automotive industry has an opportunity to grow as we replace our current fossil based vehicles with vehicles that run on electricity, bio diesel or natural gas. In addition, the development of infrastructure to supply that fuel and delivery systems hold tremendous potential.

Further, while we have enough housing stock, I believe there is ample opportunity to incentivize energy remodeling that will sustain much of the construction industry. Use of solar panels to reduce electricity needs, better insulation, more efficient appliances and conversion of heating systems to more efficient ones can create jobs.

This growth is an offshoot of the need to develop a renewable energy imperative in this country and the development of industries to make it happen. Solar, wind and conversion of bio mass and/or coal into clean alternatives will reduce our balance of payment problems and create a tremendous number of jobs.

There isn't really a choice about this change in the long run, but if we continue to send wealth offshore only so we can borrow it back because it has a short term cost advantage, we, as a nation are being short sighted. The Government can influence this by reforming the way we collect taxes and while continuing to promote world trade, make sure American industries are not put at a disadvantage.

For those who see gloom and doom because of some of our current problems, that were exacerbated by those who failed to follow up on the initiatives from the 1970s, realize that this country has tremendous potential still and simply needs to reform our energy and tax profile to realize it.

Time to get started.

Demographics

If you think about the future, and I only mean the fairly close future, there are a number of things that are going to happen because of Demographics. The "Baby Boomer" generation has been aging and is reaching retirement age. Now, the sad fact is many of them counted on a retirement based on the money in their 401Ks and homes. A lot of this money has vanished. Real estate especially will take years to return to values it attained in 2007. The stock market is also unlikely to get to levels from that year for a while.

This generation, which has to a large extent been the primary engine in the economy for the last 60 years is now faced with a situation forcing them to try to save. Further, as the grim reality of their situation has sunk in, some will have to work longer, assuming there are jobs for them.

They are going to put demands on health care, and social services that were easily forecast but which are going to be worse as their own resources have diminished. Many of them have seen any traditional pensions they may have expected endangered, companies that at one time promised life time health benefits have either gone out of business or are scaling back the benefits.

The one strength this group still has is tremendous political clout. While to a large extent many of them spent much of their lives living independently, as they find themselves unable to provide for themselves economically, they are likely to demand that the Government do something.

This probably means that budget deficits will continue to grow and the National Debt increase. There is no magic solution to this demographic issue. The other known problem is that the number of workers paying taxes to support this group as they retire and need services is proportionately smaller than it has been in our history. For the next few decades, unless we have a massive immigration of young people, the ratio of people above 60 to those under will set records. As long as we rely on an income tax to finance our social services, we will have a significant problem.

We may see a change in the American lifestyle, and we may be already seeing it, where generations return to living together to reduce expenses. That is one of the reasons that the housing stock in existence is probably excessive and will exceed demand for a good number of years.

They are also going to spend less money. First, they have less. Second, as they age, some things they spent money on will become insignificant to them. Of course they will still buy consumables but some of the industries that relied on them wanting things newer and better will suffer. If we see fewer households there will be less demand for major appliances, automobiles, lawn maintenance equipment and any other items that are discretionary. Spending will not disappear, but demand will decrease and profit margins will be squeezed.

The economy will adjust, but it will become more fundamental. If we do some smart things, such as reform the tax system, increase immigration, and reduce dependence on foreign oil, we can mitigate much of this.

However, the amount of reduced demand that the demographics predict is probably going to mitigate any inflationary pressures for years to come.

Ethanol, Bio-diesel

There is a lot of concern related to the National Debt and its impact on the future of this country. Clearly, we have had significant real growth in the last administration and the current administration is faced with a difficult quandary, whether to reduce expenditures to reduce the deficit and the growth in the National Debt, or to continue stimulating the economy via Government spending, effectively increasing the National Debt even more?

Faced with the recession, stimulus has been the direction of choice so far. Whether the stimulus will increase economic activity enough to start job creation and increased tax revenues remains to be seen. So far it hasn't achieve very much that can be determined from the economic numbers but much of it remains to be spent. One might question whether the politicians have properly targeted the stimulus money, but as I just said, it remains to be seen.

One area that could significantly impact jobs and domestic commodities would be an increase in the production of ethanol from corn and other sources. Also, bio diesel is another domestic enterprise that shows promise. Some argue that use of crops for energy is not efficient and increases food costs. This may be true for corn and soybeans, although it may not be, but there is significant opportunity to use less desirable land to grow alternate plants for either ethanol or bio diesel production.

Either of these alternatives would provide a way to reduce dependence on foreign oil rather quickly. It may be more environmentally sound to go to electric cars in the future, but the infrastructure to support that environment has a long ways to go. Increasing the content of ethanol in our gasoline, or substituting bio diesel for diesel can be done almost immediately using our current distribution systems.

Happy 4th of July!

Certainly hope everyone has a safe and happy holiday!

I've been reading about how the SEC is considering putting restrictions on short selling. Now it seems likely they will reinstate the uptick rule, a requirement that you can only short a stock after an uptick, but it made me start thinking about short selling.

I guess the more I think about it the greater problem it seems to be. Yes, short selling has been around for a very long time but the capability for short selling and the amounts involved have exploded with the growth of hedge funds. Its easy enough to find how much short interest there is on any individual stock but not as easy to see the amount of short selling in total. I did see one old chart that showed the amount of short selling increasing exponentially between the early 1960s and the early 1990s. Based on some more recent data, short interest on the NYSE was said to be about 4% of total shares which would support that the increase has continued.

So what about short selling? Short selling is a way to bet that a stock will go down without actually owning the stock. Yes, the stock will eventually need to be purchased to cover the short position and it can be a risky strategy but the other impact is that it has some impact on the supply and demand of a stock. Now, when the amount of short interest is negligible it can be absorbed by normal market conditions. The situation that concerns me is when short positions become a significant factor in the number of shares outstanding.

Assuming stocks reach a supply and demand equilibrium because the number of buyers and sellers at a particular level are approximately equal. You can increase the number of sellers by taking short positions. Now, the impact of this clearly depends on the amount of short sellers. Now the number of short positions is not spread evenly across all stocks. Certain stocks either because they have had recent run-ups or because they have some negative news, attract a great number of short sellers. In those situations they have a multiplier impact on the stock, meaning that more shares are on the market than would have been otherwise.

This increases volatility of the stock price. Now if you think of the stock market as something akin to a casino, this is OK. However, if you think the fundamental purpose of the stock market is to provide for a fairly orderly place to raise capital, it may not be a good thing. However, there are clearly times when short sellers become so numerous for a particular sector or stock that they endanger companies. Near the end of 2008 the SEC banned short selling of financial stocks for a 2 week period, Britain banned it for financial stocks for a longer period and Australia banned it altogether. Whether these actions helped or not may be debatable. There is also a theory that if a stock has a large short interest, it has a built in demand level since all these short holders will eventually have to buy the stock to cover their positions.

So what should the SEC do? As I said earlier they will probably re institute the uptick rule. Should there be additional restrictions? One possibility would be to restrict the amount of short interest that could exist on any particular stock. Since there are other ways to bet that a stock will go down or up, puts for example, is short selling a good idea at all? It is clearly a speculative position that generates fees for the brokerage. It does provide a way for hedge funds to "hedge" but do we care about that?

I'll wait and see what the SEC decides. I will say that with the amount of retirement funds tied up in the stock market, the American people don't want it to be a crap shoot. Prices should not be inflated, but selling shares you don't own is gambling, plain and simple. It may expose overvalued stocks or it may depress values below where they should be. Either way it is not an investment.

Independence day

Jobs report yesterday confirmed that business is still cutting back in order to improve profitability. While eventually there will be some hiring in our legacy industries, our best hope to achieve high employment levels is to foster new growth.

Some of this will happen in technology, but realistically, considering the cost of labor, the actual production will most likely not take place in this country. We only exacerbate this by our current tax system that increases the cost of manufacturing domestically.

The area that I believe holds the most promise is in the area of domestic/renewable energy development. Another area is the improvement of infrastructure. We have a ton of roads, bridges, and other infrastructure that has been ignored or under maintained.

We will have job growth, but some areas, such as construction and heavy manufacturing may very well have seen their peaks. Consumer spending is simply not going to recover as fast as it has in the past. Too much wealth has been lost in the real estate collapse. However, the country can build profitable industries and reduce some of our structural issues by reducing dependence on foreign oil and reforming our tax code.

July 4, 1776 was the day we proclaimed our independence from England. I think it is time to declare our independence from foreign oil.

July 4th

We are approaching the 4th of July weekend and since it falls on a Saturday this year, Friday is a holiday for many. The 4th of July celebrates our Declaration of Independence from England but we should remember that there was a long struggle between the declaring of Independence and the actual achievement.

There have been many times of crisis in this nation since then but probably only a few really threatened its survival. I would think the War of 1812 was one since it was so soon after the revolution, and after that, the Civil War was probably the only other one.

Some would argue that the various financial and economic crises should be added but really, did any of them really threaten the existence of this nation? Certainly despite the gloom and doomers out their, the current crisis is simply not going to cause the dissolution of this nation. During the depression, there was a read fear of Communism, but it never got very close to a real possibility. World War 2 was terrible, but, and maybe it felt different at the time, it never really seemed like we were at danger of going out of existence.

So if our nation and our system of Government are going to continue, we simply have to pull together to make this a better place for our citizens. The crises that we should be worried about are the ability to provide a decent retirement for our seniors, health insurance for all and opportunities to succeed.

It wasn't very long ago that some felt Social Security should be dissolved and the accounts should be turned into the equivalent of 401k's. Imagine if we had done that? Social Security needs to provide a safety net for our seniors that can and should be supplemented either by their own savings or employee pensions. If we don't do it via social security, we will end up doing it via SSI or welfare. For those who don't think we can afford to do this, I believe there is a solution if we simply go to a consumption based tax system.

Health Insurance needs to be viewed as a right, not a privilege. There are ways to do this that provide choice, but, I would ask, why is Education consider a public obligation but providing Health Care a private matter? To a large extent our approach here is primitive and hardly worthy of a modern industrialized nation. It is also very costly to have our health system operated this way. Health care providers are entitled to earn a wage that rewards them for the time and effort it takes to become a doctor or nurse and we need to encourage development of better drugs and techniques.

Finally we need to assure that there is still opportunity to succeed in this country. To get the economy back on track and to restore growth we really need to change the method of taxation and our dependence on foreign oil. Taxing business and individual incomes is onerous and encourages the exportation of jobs and cheating on taxes. If we tax products sold in this country, it would level the playing field for everyone who wanted to compete. Further, we need to have significant investment in our renewable energy industries. Every reduction in oil imports is a good thing for most Americans.

I never know if anyone ever reads these posts and to a large extent I use them as a place to simply capture thoughts I am having. However, for anyone who has given up on this country or for those who actually would like to see the country economy collapse so they can profit, this country will thrive and prosper in the future even more than it has in the past. The problems aren't nearly as bad as you would like them to be.

Hope everyone has a great 4th and I encourage all to help make this country even greater!

Health Insurance

We are currently in a situation in this country where we have two groups, the haves and the have nots. The haves are the people who have adequate health insurance. The have nots are those who don't. Now, the number of haves is not as large as they think they are as this article in the New York Times illustrates. Health insurance comes in many flavors, some will protect you and some won't.

We are currently trying to decide if the Government should provide health insurance to all the uninsured citizens. In effect it already does, the only thing being that before you can get Government health insurance you have to turn over all your assets to the hospitals so you qualify as poor, or, you have to be old enough to get Medicare.

Now this idea that we should have a system that bankrupts certain people for getting sick, is terribly expensive for everyone and provides a varying level of care depending on how much money you have or where you live seems popular with a lot of people. They argue that if we tried to fix it it would cost trillions of dollars and drive up taxes.

Well, lets face it, someone is already paying for all the health care provided. It is possible that if everyone had health insurance more people might use the benefits thereby increasing demand and driving up costs, but that may actually end up preventing more expensive illnesses caused by not getting preventative care. However, either way, the money for health care is coming from the economy somehow.

No one wants to eliminate choice, however, it might be the Government's obligation to prevent scams and cons being perpetrated. So, suppose the Government simply qualified those who offered adequate care and then allowed all citizens to pick one of the policies? This would require that all money currently used to pay for health insurance be transferred to the Government and it would still allow people to have supplemental insurance to cover things like deductibles and co-insurance or preferred care (i.e. private rooms) but it would preserve our current system and allow choice while assuring all health insurance offered met some pre-determined standards.

Now, there would have to be taxes to cover the cost of this, but health insurance would no longer be a cost of doing business, except of course that it would be a tax for all, and it level the playing field for everyone doing business here.

If you don't think we can afford to do this, I would argue that as a society we are morally obligated to pay for it and I think the time has come. I actually think that a system constructed properly will have a net reduction in cost, but that is an argument that ignores the moral obligation.