Economy and Market

I have been sitting out of this recent rally (and have been sitting out for more two years now) and have been puzzled by the large move in stocks. Everyday, you hear optimistic news that we are about to get out of the slump and the end is near, and … Of course there are those doom and gloom guys (including me) that still hold on to the view that it will be a bumpy ride. So I have decided to double check my math and see what numbers tell me. And here it goes!

I have found that historically money supply related indicators, initial jobless claims, and consumer consumption have been good indicators for the economic cycles and not have bad for the stock market cycles either. So this what we know: 1) institutional money fund growth has been slowing down which is good news for both economy and stock market but it still got ways too go (perhaps another year) to become bullish [see FRED for 4-week Moving Average Initial Claims ].

Of course then there are stock market indicators themselves. Almost every bear market (with exception of 2000-2002) have been followed by sharp rise in prices and sustained appreciation when S&P500 crosses its 50-day moving average, except for 2002! [see BigCharts.com for S&P500 Long Chart]

So if we believe that episodes like that of 1932, 1973, 1991, etc. is in place, then stands to believe that rise have been justified and will continue to go on. Given that this time around central banks have no intention of removing liquidity early, in fact, one can make the argument that inflation-linked stocks (natural resources, for instance) would have a great run. If, however, the conditions are it was in 2002, then we have a different story. A short-lived bounce, followed by another painful drop in prices. This my friends is tough one.

What I can say is this. Probably, aside from seasonal patterns (Sep. and Oct. mini-crashes), stocks may rise another 10% – 20% over the next 12 months. However, if the Fed is not willing to remove the liquidity and increase rates, then we are about to enter a decade of high inflation. In fact a global recovery, as they call it, very similar to Oil-based expansion of middle eastern economies in 1970s, is BAD news. Input price appreciation will only translates into slower real growth for corporate profits and that only means one thing: long, dragged-out, range-bound, volatile stock market with a significant cumulative loss of real value of up to 50%.  The only thing that I can see as a potential good investment, perhaps after seasonal slump is over, is to go long in Oil, Commodities, BRIC (Brazil, Russia, India, & China) and maybe have some exposure to mid-cap, natural resource-related U.S. companies.

Future of Finance

As large modern banks vanish in the history and leave behind rubbles of once proud global financial system that brought about prosperity for billions, one cannot help to wonder what is to come next? That is when all said and done, how would business go to for financing projects? With remaining banks hording cash and firms standing their grounds by doing nothing, there ought to be an end to this stalemate.  I propose that the future of finance looks much like a mesomorph of the  good old Morgan-type banks where the banker’s word was as good as gold but of course he would demanded ”pound of flesh” if he so choose to do business with you. With cash no at the hands of these old-fashion banks, mammoth-size private equity funds, and large savvy hedge funds, the face of corporate finance would be much different, much Gothic, much darker! (Anyone called for Scrooge?) Businesses be ware! ‘Thou shall pay through your nose for my money’, comes to mind as the commandment of post-modern financiers! Welcome to the Really New World Order!

Deflation or Inflation? Would there be a “lost decade of U.S.”?

There’s a bit noise in hallways of the Fed about deflation as a growing risk. Certainly at zero nominal rate, there can two possibilities: either economy carries a positive real rate because it is growing but painfully because prices are falling, or that economy is falling off the cliff and the real rate is negative but the glimmer of good news is that price are rising. Either case, this is no good news! No wonder the wunderkids in the Fed are now bound to use “Quantitative Easing” because nothing else is left. With all the liquidity that is pumped into the system, the bottle-neckser, i.e., banks, should be less stingy with lending practices. But the fear god that this recentcrisis has put in them is stopping them from loosening their tight grip. On the other hand, the economic activity is shapely declining because business and individuals alike don’t want to risk it, not now, and some would say; not ever. With all this, there’s no wonder the Fed fears deflation even with all of that liquidity pumped into the system. But here’s the catch: when this much cash starts floating around again, it’s going to be high prices by the tick size again in all commodity markets.  So the Fed can fear deflation for now, but a bit unfeezing and then they have another monster on their hand: rampant inflation! If Great Depression and Japanese Lost Decade are of any indication, then we should know that a sharp decline in economic activity is bound to bring about deflation but if it’s coupled with large liquidity infusion, it would soon lead to inflation.  While for the next couple years, the deflation fear tells you all you can do with your money is put it under your mattres, logic dictates that a better thing to do is to buy depressed asset, particularly large, boring, commodity and infrastructure-linked companies.

Individual Tax Write-Off as a Way out of Mortgage Mess!

Tax loss credits were designed to motivate investment. Individuals and corporations can write-off losses and use them as tax shields on future (and even past) income.  Corporations further get to write off their “supposed” losses and enjoy the tax relief for years to come. Banks today seem to be almost abusing this by marking to market their assets (which they haven;t sold yet) to reflect a better value but in turn they get to have large whopping tax shields for years to come.  Individuals, however, cannot do the same. So a large number of us who are suffering from upside-down properties cannot do the same. If it’s good for goose then it should be good for gander! If we could write-off 2–30 percent drops in our property values, that could go a long way in alleviating the pain of keeping the loans afloat. I suspect if individuals were to write-off massive amount paper losses on their homes and enjoy tax reliefs, a great many number of foreclosures would be gone. I propose presidential candidates take a more innovative approach and bring about a tax loss carry provisions for marking to market personal property (primary and secondary residents).

Why There Are No “Sovereign” State Funds?

Sovereign funds have been getting a lot of attention lately. They came from unlikely places like Malaysia and Dubai and bought American financial icons like Citi, Merrill Lynch and others en-massand at cheap. Now that doesn’t seem right, does it? Actually, I don’t think that’s a right question to ask. I think the right question to ask is why states around USA don’t have the same type of funds? The sovereign funds provide a great service for their respective countries: they find growth and income opportunities that does not exist domestically and then can create wealth which then in turn help build infrastructure, generate jobs, etc. In short, they smooth out the natural volatility of their economies. And such is the case with diversification. So why is it that the wealthiest nation, that is the good old US of A, where state of California is fifth largest economy in the world, there is no sovereign fund? Perhaps because politicians only care about their re-election not welfare of their citizens for generations to come. I mean if there was a state fund that have invested say 5%-10% of state’s annual income in different opportunities, don’t think that a place like Nevada could have weathered the fluctuations of real estate market better? I am almost sure it could. After all, we teach this as the basis of retirement planning, so why can’t we do this for our own public welfare? I propose an en-mass grass root effort to put on ballot the vote to create state funds which should be manage independently of the state politics and perhaps even by students and professor in the universities(you can tell what I do for a living! B,ut kidding aside they have all the energy and enthusiasm but no ulterior motive!) so that ten years from now, we won’t see these wild swings in state economies. The initial funding can be supported by bond issues and investment rules can be in place that no more than 25% can be invested in each state so there’s less likelihood of cronyism!

A Solution to Our Mortgage Crisis

In 2001, after a nice long walk in Oro Valley of Tucson with my then girlfriend, I noticed that almost everyone who lived the absolutely gorgeous houses in the neighborhood were so old that they needed help walking! As a 31 year, that just didn’t seem right. Not that people don’t deserve nice houses because they’re old, quite in contrary, rather, why do we to have wait till our last days to have thing we always wnated but we really can’t enjoy? Around the same time, there were growing talks about sunshine states feeling pressure of all retirees that have moved in and created not a whole lot of income but loads of medical bills! Of course this should not have been of any surprise. After all, the policy was to attract wealthy elderly thru all kinds strategies that only benefited one industry: real estate developers. The downsides were: 1. reliance on one industry went tremendously high, and 2. the targeted population only paid some real estate tax but really contributed in no other form to the economy. So I started thinking well, could there be a way to make real estate, the same gorgeous mansion that seem so unaffordable, affordable for an average family, which by the way contributed to the economy in multiple ways (jobs, shopping, kids, etc.) for a long time? I thought so. And my solution was “growth annuity” mortgages. I wrote an article about it ["Growth Annuity: Elixir of Sustainable Growth?" 2003, with Caroline Patrick, Journal of Business and Economics, 1 (1) pp. 193-196.] I suggested that if mortgage payment were pegged at origination to som growth rate, probably the inflation rate, that represented expected income growth of the borrower, then the borrower could move into his/her dream home even at young age. Mind you, there were graduated mortgages and then negative amorization loans that tried to almost do the same thing. The problem is that they really don’t solve the problem because they don’t match income and expense of the borrower. And, to hegde the banks’ risk, they leave expense floating, so any sudden rise in rates can and do unravel the scheme. I propose that the same solution can be found helpful today, not only to make million-dollar homes affordable, but to fundamentally match borrower’s income and expenses and fix it, so there’s no risk of inbalance. In fact this way, banks can hegde their bets easier because all they need to do is to consider a combination of fixed and inflation adjusted bonds to finance these “growth annuity loans”. The other advantge of this scheme is that it automatically screens unwanted borrowers: if you don’t have a career that generates the type of growth we need to give you a “good” mortgage, you won’t be able to get one!