A Lesson In Greek

Macro is the Greek for large or expansive. Micro is the Greek for small or limited. Macroeconomics deals with big picture stuff like what broad sectors of the economy are doing or what entire economies are doing. Microeconomics is all about what small economic players are doing, like individual companies or consumers taken one by one.

Most of our problems lately have been macro problems. The simple fact that the broad economy hasn’t grown very quickly lately is a macro element. The historical condition that most of Western Europe has a highly evolved but very expensive welfare state is a macro problem. The situation in the US where we have a large block of the electorate that doesn’t want to have higher taxes while at the same time a largely over-lapping group of Americans won’t stand to have services curtailed is a macro issue.

These macro elements are dominating our financial markets these days. When we have bad news on Chinese inflation, markets around the world react to it. Was there a riot in London? Everybody sell. Having a revolution in Libya? Sell some more. Whatever the problem, the answer always seems to be sell first and ask questions later.

So, the macro isn’t as great as we wish it were. That’s the way the cookie crumbles. What everyone seems to forget is that the micro is actually really great. On a company by company basis, what we are actually investing in when we look at equities, things are generally very good. Liquidity is very good with vast holdings of cash on most corporate balance sheets. Balance sheet strength is better with debt generally down, equity up. Revenues are improving. Profits are at record levels. New products are all over the place. It is a good time to be an equity investor, so long as you can ignore the macro noise.

So, why are we still fighting this macro battle? Because a whole lot of investors live and work in the macro world. They don’t buy companies, they by markets. They buy asset classes and sell asset classes, often on a daily basis, sometimes hourly. We have ranted about the risk-on/risk-off conundrum more than once. The guts of that paradigm is that you buy one asset class, say strong currencies, while you sell another, say weak currencies. Or you buy ‘safe haven’ assets (like gold, dollars, US Treasury notes) while selling risky assets (commodities, equities, high yield bonds). The flows between these asset classes are massive. Hedge funds may have a couple of trillion dollars in customer assets, but they can borrow trillions more. There aren’t that many markets that can abide that kind of fund flows, unfortunately for us, the US is one of them.

Issue of the Week

The Euro-zone forbade short-selling in several major financial companies last week. This proscription will only last a couple of weeks, but it was supposed to give some solace to the largest banking and insurance companies in Europe for a little while at least.

Short-selling is an interesting aspect of investing. In a short sale, you borrow shares of stock from your friendly neighborhood stock or bond broker, promising to replace the shares or bonds at a later date. You then sell the shares (let’s ditch the whole even-handed thing with anything other than stocks) in hopes of buying them back and returning them to your broker at a lower price. So, shorting implies you think the value of the shares will fall. That is fine as far as it goes. People are entitled to their opinions about the outlook for an investment and if that outlook is that it is overvalued, then shorting is a reasonable response to that.

The trouble is that when you short a stock, you actually get money in the deal. You borrow 100 shares and sell them for $100 a share and your get $10,000 in your brokerage account. According to margin rules, you must maintain 50% of the value of your short in your margin account. But, that won’t stop you from borrowing another 100 shares or 1,000 shares or 1,000,000 shares and doing the same thing. Since when you sell the shares your end up with the money, there is no theoretical limit to how much you can short. If, by contrast, you are exceptionally bullish on a stock, you can buy some and if you have a margin account buy it again using 50% margin. So, you can buy twice as much as you can afford, but you can sell and sell and sell forever. The current game is lopsided in favor of the short seller.

Shorts will argue (evidently convincingly) that they are helping the market by providing liquidity and ‘price discovery’ in a market where such things are necessary. We find that argument to be self-serving, but also mostly hokum. According to most folks, the liquidity in US markets is just fine. We have the world’s most liquid and open markets. We would still have the world’s most liquid and open markets if we restricted the ability of short-sellers to have a blank check when it comes to how much they can short. As far as ‘price discovery’ goes, we don’t mind that process taking a little longer if that is the price to pay for more stability and more rational markets.

As the recent market action attests, the attempt to protect the European banks by limiting short-selling didn’t work especially well. There are ways around the bans and other ways to attack the stocks. A determined bear will always find a way.

Economic News

Housing starts fell in July to a rate of 604,000 at an annual pace. Most forecasters were looking for 600,000, so you’d have to call this an in-line number. The rate of new housing starts has hovered right around this same level for several months, but the share of single-family homes in the mix has continued to fall while multi-family construction has grown.

Industrial production gained 0.9% in July along with a rebound in auto manufacturing and utility output prompted by air conditioning. At the same time, industrial production for June and May was revised higher. Factory activity grew by 0.6%, lead by autos. Utility output rose 2.8%. Mining output rose 1.1%. Maybe we missed it but we didn’t see a lot of news outlets trumpeting this good news about the economy.

Capacity utilization was reported at 77.5% in July, up from 76.9% in June.

Producer prices rose 0.2% in July. Declining energy prices offset rising prices of many other parts of the basket of commodities and labor. The difference can be seen in the core PPI, which excludes energy and food prices, which rose 0.4% on the month. In the last 12 months period, producer prices have gained by 7.2%.

Consumer prices rose in July by 0.5% according to the Bureau of Labor Statistics. The core version of the index, which excludes energy and food prices, gained 0.2%. In the last twelve months, the CPI is up 3.5% and the core version 1.8%.

Existing Home sales fell 3.5% in July according to the National Association of Realtors, a pace of 4.67 million at an annual rate. The decline was a little surprising given that this is the strongest season for home sales during the year. As has happened a lot recently a high number of cancellations hurt the volume of sales. The NAR number comes from purchase agreements signed, not from deals closing. As more prospective home buyers are having difficulty getting credit, the number of home sales that fall through has increased. None the less, sales were 21% higher than the same month in 2010, that is some improvement. The median price was $174,000, a decline from a year ago.

Leading indicators rose 0.5% in July according to the Conference Board. What? Leading indicators are supposed to show us what the economy is supposed to do six to nine months in the future. They rose? Haven’t these indicators been reading the papers? Are they trying to confuse us? By the way, the coincident indicators, which just so happen to be the same four indicators used by the National Bureau of Economic Research to time recessions, rose by 0.3% with three of the four indicators rising. Actually, for those who were paying attention, the LEI did anticipate a spate of slower growth by having a series of very small advances, flat readings and one absolute decline earlier this year, probably signally exactly what we have just seen. Also note that consumer sentiment and other similar indicators are not leading indicators at all, but rather laggers.

Double Dip? No, we can’t have a double dip. This is now definitionally impossible. You see, the definition of a double dip, is when a recovery doesn’t get back to where the prior expansion was before the next recession begins. This is what happened in the 30s when the expansion from 1932 to 1936 didn’t recover all the ground lost during the fall from 1929 to 1932 before the double dip came in 1937. We blew that when the current expansion eclipsed the high-water mark of the last expansion. Too bad. To quote a wise old pundit from the Pacific Northwest – “there ain’t gonna be no double dip.”

Weekly Stuff


For the week, the Dow lost 450 points. Nearly 475 of those points were lost in about an hour as the Thursday session began. Wait, that leaves 25 points unaccounted for. Those were part of the modest week-to-date gain we took into last Thursday. Everyone seems very fond of saying that except for this, we’d have gotten that. Were it not for the decline in energy prices, our inflation would have been much worse. Had it not been for a couple thousand ballots in Florida, Al Gore would have been President. Were it not for about 30 minutes early on Thursday, we’d have had a pretty uneventful week last week. Unfortunately, that’s not the way it panned-out for Al Gore or for the markets. But, unlike Al Gore, we’re not going to get the Nobel booby prize.

Yes, stocks were down pretty much around the globe and by fairly similar percentages. Losses of 4% to 7% were pretty common, but the exceptions were more interesting. Japan was down a mere 2.73% before a strong yen brought the loss for US$ investors to barely 2%. Switzerland had a stock market drop of 3%, but the currency was up1% for a net drop of 2% for US investors. Mexico, China and Hong Kong all lost far less than the developed markets. Germany, which had been acting generally better than other developed markets, was suddenly down 8%. So, last week was kind of a comeuppance week for a lot of people. The weak inherited the market.

Speaking of currencies, last week was a big week for currency movements. The dollar lost ground to a lot of currencies, but the real story was the stronger Swiss franc and the Japanese yen. Both the yen and the franc are possible alternatives to the dollar as a safe haven currency. Both markets are investor friendly and have sufficient depth and breadth to handle all but the biggest draws on their liquidity. The yen set records against the dollar last week in value. This wasn’t only dollar weakness. The Euro was pretty weak against most currencies last week as well. It seems we are running out of safe havens just as the going gets rough.

Bond markets nearly everywhere benefitted from the risk-off trade. We reached record low yields on every Treasury maturity inside the 10-year. The 10-year breeched its 2008 low, but didn’t close there. Sovereign issuers were generally higher unless they had specific bad news. 10-year Japanese government bonds (JGBs) sell for less than 1% yields now. Corporates followed the lower rates down but spreads tended to widen a smidge.

Real estate securities were down on the week, which makes sense as much of the selling was centered in financials, especially banks. Without banks supplying credit, the whole real estate industry grinds to a halt. So, if the banks look shaky, real estate looks shaky.

Commodities were also soft, but it is hard to find all that many specific commodities that showed softness. The energy complex was down, with explains the GSCI weakness, but the Dow Jones UBS index was also down and the majority of individual commodities were up. The precious metals again saw big advances with gold up 6% and silver up 9%.

Lastly as we write this, Libyan Rebels are searching Tripoli trying to root-out the last Gadhafi loyalists. The Libyan uprising is almost over. That has caused markets from India to Britain to rise, maybe recouping one-tenth of points lost due to the start of the insurrection. It is funny to see the far-east markets, Korea, Japan, China, down because they closed before the news broke that Tripoli had fallen. India got the news and was higher, but Thailand closed down. We can only hope that the bloodshed in Libya ends quickly and that the people will see a better life after this.

Have a great week.

Karl Schroeder, RFC, CSA

Investment Advisor Representative

Schroeder Financial Services, Inc.