Wealth

Similar to when the stress tests were done for US Banks, you hear a lot of analysts taking the position that since most European banks "passes" their stress tests that the tests were "too easy". Of course that logic assumes that the banks have real problems and that there is a conspiracy to cover it up.

Honestly, the problems facing Europe and the United States are by no means insurmountable. During prosperous times, generous commitments to social programs were made that in reduce economic conditions look unsustainable. However, the basic output for these countries and their ability to sustain themselves hasn't really changed.

Ultimately the prosperity of a nation is based on how much it produces versus how much it consumes. The distribution is not in and of itself an issue. What may be an issue that is related is the fact that those receiving the benefits are no longer producing and therefore impact the actual equation.

The real equation is produced vs consumed. This is true at all levels and ultimately, at the global level. However, if an individual, a local government, a state government, a federal government or the world as a whole consumes more than it produces, it will get poorer. The only way to consume more is to use accumulated wealth or to borrow against future wealth.

There are many other factors that influence the perception of wealth. However, the value of the goods produced versus the value of the goods consumed is the ultimate determinant.

Dismal Science

If you read just a little economic news, you should be quite depressed. We have the potential for a double dip, the American consumer is not spending, industry is not hiring, real estate is falling again, and any bit of good news that does get out is immediately explained away by the dark linings around it. So your profit is up, but what about total sales? Can you maintain it if the economy falters? What if the dollar gets stronger, will exports suffer or if it gets weaker will energy prices overwhelm us.

The dismal science indeed. Like most news, there is much upside to being a Pollyanna. If you accept good news at face value, you suffer from credibility problems. Generally, you want to hedge your news with some gloom. The unemployment rate is down, but only because so many job seekers have despaired.

Then, the pundits are shocked that consumer sentiment is down. Further, real estate sentiment is down too!!

There are real problems in our economy, but company after company has found ways to make money. This profitability will lead to jobs, although we have to accept that productivity improvements are not going to be simply thrown away.

Real job growth has to come from the growth of domestic and renewable energy including the retrofitting of many structures and a reform of our tax system to make sure everyone doing business in this country is on an equal footing.

Time to get going

We are continuing to see the development of an economy where many of the past excesses are going away. The recent crisis will have a sobering effect on many people for at least some time. Further, some of the access to easy money and easy equity loans is just not there anymore.

The good news is that the future economy will be built on a sounder footing. The bad news is that many of the jobs and other sources of income will be more difficult to come by.

A return to some frugality is a good thing but it reduces demand and businesses are not going to expand past the point where they have a high level of confidence. Further, as we see expanding technological communications, the need to visit certain establishments will continue to diminish. I haven't needed to visit my bank, except to use an ATM, for quite a while. It saves on gas but reduces the need for tellers.

The new type of online stores and services will continue to garner greater and greater acceptance. We need to build our jobs in two ways. As I've been saying for quite a while, we need to reduce our use of foreign energy and use domestic and renewable sources. In addition to keeping wealth inside the country, it will also create jobs that can't be exported or eliminated. I'm starting to see some movement in that area and it simply has to happen.

The other thing we need to do is level the playing field so that it is not automatically better to export many jobs. Our current tax system and health insurance system are problematic and penalize companies that make product in this country. If we switched to a more neutral tax system, tax consumption not production, and used that money to fund health insurance for all, we would reduce much of the motivation to export jobs. Yes, some jobs would still be more efficiently performed outside the country, but many other jobs would become location neutral and remain here.

Lets get smart and get going.

Transitions

I haven't posted in a while since I was in the process of changing jobs and moved my base of operations from DC to NY. I'm still getting settled in and it will take a bit longer to get fully operational, but I've worked out most of the major issues and will be able to increase my productivity on the new position.

Going through a transition is always somewhat stressful and since I maintain the economy is doing just that, the country as a whole is undergoing stress. This is not the first time a society has had to adjust to changing circumstances and generally, the stress results in all sort of dire predictions.

What is true is that those who recognize and adapt to the change will do better than those who don't.

Going into earnings season again we will see if American companies can maintain their profitability as the recovery continues to sputter along. There will come a time at some future point when the recovery will speed up but before that point there is still issues that need to be resolved as we finalize our transition from a manufacturing based society to a technological service economy.

That is quite a simplification of what is happening but I think it is reasonable accurate. I'm also quite sure that companies will continue to be profitable as the inventory, store and employee reduction cost savings will allow them to make money on reduced volume. Americans have less to spend and will have for the foreseeable future. Successful companies have recognized this and adjusted their business models accordingly.

I'm not sure if Wall Street has accepted this changed reality and I expect to hear how companies are still disappointing with gloomy forecasts and missed sales goals while becoming ever more profitable. However, profitability is what increases the value of a company. I'm a big fan of it.

Trend Analysis

When you do analysis, depending on the data used the results have some degree of objectivity. For example, if you have a population of rats and feed them large quantities of a substance and have another population that has the same diet except for the particular substance, variation between the two populations may be related to the presence or absence of that substance. The more you can eliminate other potential causes of variation, such as genetics and environment, the results increase in value. However, even in a controlled experiment, the potential for some unknown factor to enter the experiment that normally you need to prove the results are repeatable, meaning that someone performing he same analysis halfway around the world would get the same results.

Now when you have analysis performed in an area where variables cannot be controlled the reliability of the results is questionable. For example, you often hear free market advocates talk about how a free market is the best way to promote growth and prosperity. Of course, it is hard to prove this experimentally so they use logic and examples. Now, the United States with something of a free market economy did better than the Soviet Union under communism. This may have been because of the economic systems or any of a million other differences between those two countries. Certainly I have no way of proving the free market economy of the United States was not a significant influence in the outcome, I just can't prove it one way or the other.

Now, consider some of the analysis you hear about financial trends. There are so many different factors influencing most industries that even if you successfully spot a trend, it is impossible to know for certain that there is not some countervailing trend you haven't spotted. Of course, if you can accurately predict that smart phones are taking more and more market share and therefore manufacturers of smart phones and smart phone components should do well, you also have to factor in how much they are losing if they currently manufacture dumb phones and if the phone they come out with is going to be popular or successfully promoted. The i-Phone was a phenomenal success and the Palm Pre and Palm Pixi weren't. I have read many reviews where the Palm products were considered technically better than the Apple phone but one took off with the right amount of hype and growing market share and one didn't.

Of course after the fact you see analysis as to what happened, and sometimes this post mortem seems perfectly logical, however, that is after the fact and somewhat irrelevant to most investors. Consider the events that happened today and the impact they had on the market. First China's announcement concerning the Yuan led to a higher start as this was perceived as another indication that the economic recovery was continuing and that foreign products would become more affordable in China. This trend held the market up for a while and then we had the assault on the banks as first one analyst said that a double dip in the housing market was a certainty and another analyst said that the financial reform bill would be a disaster for the banks. Further, we found out China was holding more gold than previously thought. Each of these factoids and analysis had some impact on the market and by late afternoon, the earlier increases had been erased and the overall market was slightly down. Of course the afternoon sell off may have nothing to do with the negative comments, it could simply be a combination of fund managers taking some profits and others seeing a trend develop, jumping aboard.

In fact, the one thing that is certain is that no trend goes unobserved. Once a sell off becomes clear, selling becomes the thing to do. You can always buy the stock back cheaper after it goes down some. If you are shorting the market, a sell off is a cause for jubilation. In fact, one thing you can count on is that on days with late day drops, there will be a bounce near the close as some traders get out of positions to avoid overnight risk.

Of course that trend analysis has very little real validity.

Victimology

To be honest I didn't have the patience to listen to the President all the way through last night. The things said at events such as that have little to do with what ultimately happens. Now for some reason, it tends to go over well to hear tough talk at times like this. I simply would like to see a solution. This was a horrendous event, and while BP may very well have ignored risks that ended up causing it, they clearly didn't want it to happen. That brings us to the question of competence and/or negligence.

In making decisions we all have to decide the proper line between cost and safety. Certain threats always exist but are so remote that for us to take preventive action would make us, well odd. For example, we all take are exposed to many potential contagious opportunities in a given day. Sometimes we actually get infected. Most of the time we don't. Most of the time the contagions are relatively minor and we recover. Sometimes they are major and sometimes fatal. However, we all hopefully take some preventive actions, such as washing our hands, but if you end up wearing surgical masks and gloves at all times, you are, in the opinion of most people, overreacting.

It should always be remembered that when you look at risk from the point of view of the victim, it always seems much worse than it really was. The victim is a victim and the risk potential has become real. If the victim's chances were only 1 in a million to start, well now it is 100%. So of course when you see a show that interviews victims it seems pretty dire. Of course if you only interviewed non-victims, it would represent reality better but be pretty boring.

Despite all the things we see in the news every day, generally most of us avoid being victims the vast majority of the time. Now, I don't know how much the oil in the gulf is going to hurt the economies of those states. I actually think that the amount of income generated through recovery efforts and victim compensation may well exceed the income lost. Of course in addition there is the environmental damage, but cleaning that up will also create a lot of jobs and income. Will the income go to the people who were the actual victims? I don't know, but as bad as it seems, I would be willing to bet that, from a purely economic point of view, more money will be generated than is being lost. Of course we see habitat destruction and other impacts and it surely is sad but nature has a way of healing itself over time. Getting the spilled oil out of the water is a challenge that can be met once the flow into the gulf can be stopped.

This is mostly rambling and there are victims from the oil spill (remember 11 died) and there will be others. However, if you can't fish, but get compensated, I'm not sure that makes you a victim.

 

 

Looking for Risk

There is the old saying that only two things in life are certain, death and taxes. Actually some people manage to avoid the second quite well so maybe there is only one thing actually certain. Everything else has a degree of risk. Somehow humanity has struggled along and in fact I think it is safe to say that most people are better off than their ancestors were. All of this was accompanied by risk.

In today's economy we are recovering from a significant risk event, triggered by the sub-prime mortgage situation. Now when you look at that situation many of these mortgages were clearly not justifiable except in a scenario where prices climbed forever. Once prices stabilized and started to fall, as they had to eventually, the sub-prime people were doomed. Further, that collapse had all sorts of repercussions as the instruments designed to mitigate risk started to pay off and the companies that had to pay couldn't.

Now had the issuers of the subprime mortgages not been able to package and sell them raising money to issue more that they packaged and sold, etc. etc., the subprime mess would have been contained. Of course for a certain period of time this activity led to increased economic activity in construction, furnishings, appliances, well just about everything as houses were built, sold and provisioned.

But what was probably the most interesting part of the whole crisis for many investors, was that a few people made extraordinary amounts of money. Now you can make money in a good market, sort of the old fashioned way, relatively slowly and over time. However in a collapse you can make a whole lot of money in a very short time. This is quite appealing to many who now are constantly looking for the next big collapse so they can short it.

Now, identifying this risk is not very rewarding unless you can convince everyone else the risk is real and maybe even cause a panic. The European debt crisis looked ripe and did cause a decline but without actual defaults it didn't attain the level required to really cash in. If you trade instruments that require defaults by Greece, Spain, Portugal, they go up and down in value until the actual default happens. Those looking to really cash in will hold hoping that like a lottery ticket they become the next big winner, and the next legendary trader.

Mostly this won't happen since those types of panics are relatively rare and those who hold these instruments will probably hold them too long since cashing them in before the default seems like throwing away the golden goose.