Why is America gloomy when the news is good?

I've been traveling for the last month, and while in London at Sunday brunch with my friends, I read an commentary in the Times (UK newspaper) that struck me. And I warn you, it's as gloomy as the title of the article. It starts off with an interesting introduction:

"It has been a long time since the economic data have been flashing positive signals, and an equally long time since consumers, businessmen and occupants of the White House have been so gloomy. It’s worth considering why this disjunction of fact and perception is dominating the economic news."

- Irwin Stelzer
Link to the Article

It’s exactly the same thing that I’ve been thinking about lately. I have to confess that it’s been hard following the markets as much as I did before over the summer. However, I’ve been following the big trends, which is arguably good because I don’t get caught up in all the “noise” of the media. And this is one of the big trends that I have been following/thinking about: the disconnect between sentiment and the rising stock markets.

Stock markets are generally forward looking. I say generally because, c’mon despite all the academics saying markets are efficient, blah blah – they can be occasionally slow to realize things. The reason I bring this up is that this recent stock market pullback can be attributed to a less than optimistic outlook for the future. And that’s precisely what this article writes about:

“Businessmen tend to look further ahead than most participants in the economy — consumers worry about paying the rent or the mortgage next month, and politicians worry about tomorrow’s opinion polls. Company executives know that the profits picture is improving but they worry that much of the improvement comes from cost cutting rather than increased demand.”

Essentially, the article is saying that businessmen are still worried about the future because despite companies reporting decent earnings recently, they fear that it’s more because of cost-cutting and less because of revenue increasing. And obviously “consumers” are not happy because they are part of the cost cutting – getting laid off.

This paragraph slowly leads to the climax of the commentary, a forecast of the future that sent chills throughout my body. Certainly woke me up on a lazy Sunday afternoon:

“[Businessmen] They see an administration and a Congress that are spending America into such deep debt that the dollar will continue to decline, forcing the Fed to raise interest rates to prevent a collapse of the currency.

Some executives expect the price of gold to double or triple in the next five years, interest rates to climb from their current level of close to zero to perhaps 8%, and taxes to soar to bring the deficit under control.”

It’s a doomsday prediction, but actually quite realistic. It sounds like a similar situation to the recessionary period of the 70’s, of the Volcker reign at the Fed. It’s completely possible, even though most people right now could not even imagine double digit interest rates.

Investment ideas from this article? Long gold, and short US dollar

After reading this article, I kind of want to hide under a rock in an island in the Pacific Ocean somewhere for the next 5 years.

Read the Full Article

Lender Capmark Financial Group Files for Bankruptcy

“Oct. 25 (Bloomberg) -- Capmark Financial Group Inc., the lender owned by firms including Goldman Sachs Group Inc. and KKR & Co., filed for bankruptcy protection after posting a second- quarter loss of about $1.6 billion.

Capmark is one of the largest U.S. commercial real estate finance companies, with more than $10 billion in originations, according to Moody’s Investors Service. The company, formerly known as GMAC Commercial Holding Corp., services more than $360 billion of debt.

The Horsham, Pennsylvania-based company has struggled as the default rate on commercial mortgages held by U.S. banks more than doubled to the highest since 1994. Capmark said on Sept. 2 that it may reorganize under Chapter 11 of the bankruptcy code.”

Yikes.

Just when people are thinking the worst is over…is this a signal for more commercial real estate related bankruptcies? More problems ahead?

http://bloomberg.com/apps/news?pid=20601087&sid=aACzaZGHTqxQ

2009 Federal Deficit Surges to $1.42 Trillion

Associated Press (AP):

“WASHINGTON – What is $1.42 trillion? It's more than the total national debt for the first 200 years of the Republic, more than the entire economy of India, almost as much as Canada's, and more than $4,700 for every man, woman and child in the United States.”

-MARTIN CRUTSINGER, AP Economics Writer, 10/17/09

Let’s take a look at what $1.42 trillion really is.

According to the Bureau of Economic Analysis (BEA) of the Department of Commerce , the GDP of the United States, or what the media roughly calls “The Economy” in the second quarter of 2009 was $12.901 trillion. With a little division, we can easily find that the federal deficit as a percentage of GDP is approximately 11%.

Put in those terms, the deficit doesn’t look thaat bad. I’m not a bull currently, but it is funny when the media exaggerates.

Moving on, further down in the article it does write out the troublesome quintessential bear argument which I found a bit more interesting:

“If those investors [such as China] started dumping their holdings, or even buying fewer U.S. Treasurys, the dollar's value could drop. The government would have to start paying higher interest rates to try to attract investors and bolster the dollar.

A lower dollar would cause prices of imported goods to rise. Inflation would surge. And higher interest rates would force consumers and companies to pay more to borrow to buy a house or a car or expand their business.”

Yikes. People are finally looking into a repeat of Paul Volcker, chairman of the Federal Reserve in the late ‘70s, who in order to combat inflation had to increase the federal funds rate to more than 20%. What a lot of people aren’t getting right now is that the Federal Reserve is going to definitely increase interest rates to combat inflation and reign in the monetary supply which it has let loose rampantly.

The big question is just how fast the Fed will increase interest rates and just how high. My guess is that it’s going to be high, to counteract this period of near 0% interest rate. This, counter-intuitively, won’t necessarily cause the economy to stagnate considerably if people expect the increase in interest rates. What’s more important is that the Fed increase rates in a manner that plays well with the expectations of people and also at a speed that doesn’t create a shock to the economy.

If the Federal Reserve either increases interest rates too fast or too high, expect another big recession. If the Federal Reserve increases rates too slowly or too low, expect another big bubble. Or, if the Federal Reserve does its job and Ben Bernanke is successful, expect a steady economy where you get what you expect.

http://news.yahoo.com/s/ap/20091017/ap_on_bi_ge/us_deficit_danger

Bloomberg: Central Banks’ Reserve Shift Ignores Dollar Data

“Oct. 12 (Bloomberg) -- Central banks have been shifting their record reserves into the euro at the expense of the U.S. dollar..”

I’m a little worried. There’s a long term trend that the dollar is declining.

Many people have dismissed this with simple arguments like “The US Dollar is too important to go away” or “US Dollar is still the currency that everyone uses”.

One of the top ten rules in my invisible book of investing is that the past does not predict the future. It really wasn’t too long ago that the British Pound was the leading currency of the world. I’m not going to make a solid prediction on what will become the next leading currency, but my bet is on the Euro or the Chinese RMB.

The simple concept with currency exchange is that money inflows into a country increases the value of that country’s currency. Outflows decrease the value of a country’s currency. The biggest driver for money flows are differences in interest rates. So for example, if the US’s interest rate is at 0% and another country’s interest rate is at 3%, more so than not people will put their money into the other country. This is a bit of an overgeneralization, but the point here is that money is flowing out of the United States which has its federal funds rate set at near 0%. The result? A lower value for its currency.

I’m pretty worried. Even though Bernanke has recently said that the Fed will rein in its monetary stimulus and be on a lookout for inflation, I don’t think the market is believing it at all. The market is a little worried about inflation in the US dollar (which will decrease the real value of the dollar) and money outflows and the decline of the dollar from the US shows it.

Where are investors putting their money?

Anybody read about how gold hit record highs above $1000? That oil has hit levels above $70?

They’re putting their money into commodities. Is it a real rally?

I’ll explore this in a future blog post.

http://www.bloomberg.com/apps/news?pid=20601109&sid=aaIrWeN0neZw