Investing: February 2010 Archives

In high school, one of the plays we had to read for our English class was about Thomas Becket.  Becket, as you know, was the former confidant of King Henry.  As King Henry's chancellor, he was extremely zealous in collecting taxes due the king from all landowners, including churches.  But when King Henry appointed Becket to the position of Archbishop of Canterbury, Becket's position changed.  Instead of moving to collect taxes from churches for King Henry, Becket consolidated those revenues for the Church.  That essentially was a declaration of war from the Church against the Crown.  Eventually, this struggle led to Becket's death and martyrdom, with King Henry at one point reported to have exclaimed "will no one rid me of this turbulent priest?"

While it's highly unlikely that the chair of the Commodity Futures Trading Commission (CFTC) will end up being beheaded, his transformation in many ways mirrors that of Becket's.  Gary Gensler, a former Goldman Sachs partner, was portrayed by liberal critics as too tied to investment bankers to be an effective regulator.  Gensler was on the staff of then Treasury Secretary Larry Summers when the push to exempt most derivatives from regulatory oversight passed in 2000.  Because of this, democratic lawmakers held up his nomination for five months before finally agreeing to appoint him to his current role.

Gensler said that his transformation came about after seeing the havoc that unregulated derivatives trading wreaked on financial markets.  In fact, some of the people who Gensler tangled with during the push to deregulate derivatives trading, such as former CFTC chair Brooksley Born, now say that Gensler is "committed to robust regulation."  And the director of investor protection for the Consumer Federation of America said that Gensler has "been the strongest advocate of reform" in the Obama administration.

Gensler wants to shine the spotlight on derivatives trading.  Many companies that consume commodities use these as hedges to protect them from price swings in the supplies they need in order to function.  Southwest Airlines, for example, was aided by its hedges in oil at a time where many of its counterparts were filing for bankruptcy.

However, sophisticated traders at five major banks -- Goldman Sachs, Bank of America, JPMorgan Chase, Morgan Stanley, and Citigroup -- dominate trading and reap billions in profits.  Gensler wants to highlight the big margins the traders at these firms enjoy.

Gensler has turned out to be one of the biggest assets that those pushing for regulation have.  When banks claim that regulations being considered are too strict and would destroy their ability to function, Gensler has been known to say "that's crazy.  I used to do it all the time."

In response to the financial crisis and the role derivatives played in them, Congress moved to enact legislation that would require derivatives traders to work through clearinghouses.  These clearinghouses would require the traders they serve to hold capital in order to prevent default on their obligations.  And the CFTC would be able to more easily monitor trading.

However, Gensler says this is not enough.  He is most critical of an exemption that would allow non-financial companies seeking to hedge against fluctuations in fuel, currency swings, and other typical risks to trade outside of the clearinghouses.  He says that even these exemptions, which seem innocent, will allow hedge funds and financial firms to take major risks on derivatives to goose their profits.

This is why Gensler is pushing the Senate hard to enact regulations that clamp down harder on derivatives trading.  He wants to go even further than his boss, President Obama, in regulating derivatives trading.  The reason for this, according to Gensler, is that "interests [of the banks] are not necessarily aligned with the American public's interests."

Gensler says that while he once shared the goals of the bankers he will be responsible for regulating -- maximizing profits and bonuses -- his obligation is now to the taxpayers.  When asked what the biggest obstacle to enacting tough regulations was, he pointed to the bankers in the room and said "you."

Gensler's transformation -- which he hasn't donned a hair shirt like Becket did, it's just as remarkable -- means that the taxpayers and small investors have an ally in the current administration.  Let's hope that he doesn't end up with his head being cut off like Becket did.

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The conventional wisdom is that republican Presidents are good for businesses, investors, and the economy, while democratic Presidents are not.  How many times have you seen traders on the floor during an election year say they're worried that a democrat will get elected because they may implement policies that will cause problems for businesses and cause the market to tank?

Or how often do you hear pundits and politicians talk about big government democrats and free market republicans?  Going by this conventional wisdom, you'd think that the only President in the past 40 years to shrink the size of the government was Ronald Reagan or maybe George Bush Sr. or Jr.  You'd be wrong.  The only President in recent history to shrink the size of the government was Bill Clinton.

You've also probably heard that investors should favor a republican candidate versus a democratic one.  You'll hear that democrats will tax your capital gains.  Well, in order to tax capital gains, you need to have them.  And it's far more likely that you'll have them under a democratic President than you will under a republican one.  A New York Times article done during the Presidential campaign of 2008 showed that under democratic Presidents, the average annual return for the S&P 500 or its predecessor was 8.9 percent.  Under republican Presidents, the average annual return was 0.4 percent.  That's a better than 22 to one margin for the democrats.

Let's assume that a democratic President jacks up the capital gains tax to 50 percent and a republican President will cut it to zero.  Both scenarios are not likely, but let's pretend here.  That would mean that the after tax return under a typical democratic President would be 3.9 percent, and under a republican President, it would be 0.4 percent.  Even assuming ridiculous capital gains tax policy, you still get a ten to one margin for a democratic President.

This huge difference between the benefits of the economic policies of democrats and republicans extends beyond the stock market.  You can visit the blog from PERRspectives to see the academic studies used to draw this conclusion.  The bottom line is the democratic Presidents are better for the economy when you measure performance by the unemployment rate, job creation, GDP growth, and -- in what must gall some -- even corporate profits as a percent of GDP.

Yet the mindset -- totally contradicted by facts -- that republicans are better for the economy and investors is still evident.  As the editor of Stock Trader's Almanac said, "I don't know why people are convinced republicans are good for the stock market."

It seems like even "conservatives" know this.  During the time when the market was plunging to its lows back in the early part of 2009, you probably recall many "conservatives" talking about the "Obama market."  Obama's policies -- keep in mind they hadn't even been talked about in Congress at the time, much less implemented -- were to blame for the market's plunge, they said.

Getting tired of hearing this, yours truly offered to bet the first three people who were willing to take the bet $1,000 that the return on the Dow would be better during Obama's first term than it was under Bush's first term.  And not surprisingly, the bet was not taken.  All of the sudden, those who blamed the market's plunge on Obama's policies suddenly said well, there are too many things involved to make that bet.  It's funny how people change their tune when money is on the line!

It's too bad they didn't take the bet.  After one year of Obama's first term, the Dow is up by 29.5 percent.  Under Bush, it was down by 7.7 percent.  An offer would have been made to settle the bet for $100, just to prove the point, but the odds of getting payment are about as good as the odds that a watch offered to you by one of the Salahis is real.

Here are the top five performances of the Dow during a President's first year:

• Roosevelt:  96.5 percent
• Truman:  30.9 percent
• Obama:  29.5 percent
• Johnson:  21.6 percent
• Bush Sr:  19.6 percent

And the bottom five are:

• Bush Jr:  -7.7 percent
• Reagan:  -12.7 percent
• Hoover:  -15.6 percent
• Nixon:  -17.0 percent
• Carter:  -19.6 percent

You can check out the rest of the Presidents by going to Business Week and looking at their slide show.

The bottom line is this.  Just like the headline says, the conventional wisdom is often not wise.  Investors should look at the numbers themselves before accepting the conventional wisdom.  It's clear that the reputation that republicans have for being good for the economy and investors is undeserved, but it still is the conventional wisdom.

Those following this piece of conventional wisdom and moving their money into stocks when a republican is President and out of stocks when a democrat is would end up paying for it.

Whatever happened to removing the shackles governments put on the free market?  For the past year, it seems like one surefire way to get stocks to rally is for governments to start spending.

It looks like a Greek tragedy will be averted, as Germany said that it will would work with other financially sound members of the European Union to provide loan guarantees to Greece.  This will ease concerns that many have about a potential default on Greece's sovereign debt.  The Greek government's plans to reduce its deficit have provoked strikes as a protest against those measures.

The challenges that Greek finance minister George Papandreou face were highlighted by the strikes planned by workers in the health care, education, and transportation sectors.  They will shut down hospitals, schools and airlines in order to protest the deficit reduction measures proposed by Papandreou.

However, if the measures are implemented, Fitch Ratings said they'll have an impact on the deficit spending of the Greek government.  Nobel Prize winner Joseph Stiglitz said the deficit reduction plan would prevent a default and called on European Union governments to help Greece fight "speculative attacks against its debt.  "I've been very impressed with the comprehensive approach" the Greek government is taking, he said.

"There's clearly no risk of default. I'm very confident about it."

But a bailout has risks.  First, the citizens of countries like Germany and France, which are in sounder financial condition than some of their European Union members like Greece and Portugal, are likely to oppose a bailout.  In addition, the issue of moral hazard, which the government of the United States faced with its bailout of AIG, Citi, General Motors, and Chrysler, will rear its ugly head.  This can be countered, a senior economist at the European Policy Centre, "as long as it is very clear that any support only comes with very, very stringent conditions attached."

On the news, the markets rallied.  The Dow climbed by 1.5 percent, breaking above the psychologically important 10,000 level to close at 10,059.  The S&P 500 was up by 1.3 percent to 1,071.  And the Nasdaq gained 1.2 percent, closing at 2,151.

Analysts said that the reaction of the markets showed just how critical what governments say is to investors.  Even though it has been nearly two years since the financial system nearly imploded, "people are scared that the entire delicate reconstruction of the system...might be shattered," the chief investment officer from Alpine Woods Capital Investors said.  "If the leaders are riding to the rescue then the market will feel renewed confidence."

So much for markets needing to be cut loose from the shackles of the government.  Instead of that being the case, it seems like they're sucking on the government teat harder than any welfare queen ever did!

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The January survey of employers by Automatic Data Processing showed that private sector employers shed 22,000 jobs in January.  December's job losses were also revised down, from 84,000 to 61,000, an improvement of 23,000 for the month.  The January job losses were the lowest since February 2008, which is when ADP's survey first showed that recessionary pressures were causing employers to lay off workers.

In the report, ADP said that employment in the services sector increased by 38,000.  This was the second month in a row where employment in that sector rose.  However, that increase was offset by a decline of 60,000 in the good producing sector.  Manufacturing shed the most jobs, with 25,000 jobs lost.

Large and small employers continued to cut their payrolls, with employers of 500 or more laying off 19,000.  Small businesses, defined as those with less than 50 workers, cut 12,000 jobs.  However, medium sized businesses, with 51-499 workers, added 9,000 workers.  This was the first gain in employment among these businesses since January 2008.

The ADP report is seen by many as a precursor to the government's payroll figures, which will be released on Friday.  It tends to be more negative than the government's report, totaling 500,000 more job losses than the Labor Department in the six months ending December 2009.

The consensus estimate was for a loss of 30,000 jobs, with estimates ranging from a gain of 50,000 jobs to a loss of 110,000.  Thus, the actual data came in better than the consensus, around the midpoint of estimates.

Analysts said the ADP number showed that the labor market is headed in the right direction.  An economist at Ameriprise Financial in Detroit said the data shows "trends are heading in a positive direction for the labor market."  He added that companies are starting to hire again as they start to believe "the economy does have legs."

While it's often said that jobs are a lagging indicator and we have often said that listening to those who say "this time is different" is a good way to lose money, that may very well be the case this time.  Consumer spending is two thirds of the economy and until the consumer feels secure about the employment picture, it's likely to remain tepid.

There cannot be a strong recovery without the jobs picture improving.  And that's why Friday's report from the Labor Department is so important.  Investors may want to protect their gains ahead of that report by either taking profits or using trailing stops to protect gains.

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A few releases of data today will help determine this.  Today, we'll get some data that will either confirm or call into question the Institute for Supply Management's manufacturing index data from yesterday.  That number, which came in higher than expected, will need to be evaluated in light of the release of auto sales today.  The consensus estimate for auto sales is for sales to come in at an annual rate of 8.37 million vehicles.  If the actual number comes in higher, especially given the negative publicity surrounding Toyota, that will be another positive sign for the manufacturing sector.

We'll also get the release of pending home sales from the National Association of Realtors.  This information will show whether or not the housing market has recovered after an expected downturn due to a planned expiration of an $8,000 tax credit for new home buyers in November.  The expected expiration of that credit caused sales to be moved forward.  The tax credit has since been extended, and investors will look to the pending sales numbers to get insight on how the housing market is performing.  As you know, housing dragged the economy to the brink, and without a recovery in that sector, any recovery in the economy as a whole will be slow.

The International Council of Shopping Centers-Goldman Sachs store sales number showed an increase of 0.1 percent for the week and a 0.4 percent increase versus last year.  This data helps to confirm yesterday's retail sales numbers, which showed that while sales were increasing, they are increasing at a slow rate.

Adding to the data that traders will evaluate today in order to determine what moves to make will be the release of earnings data by 26 members of the S&P 500.  UPS kicked off the earnings releases on a positive note, beating expectations.  However, the management of the company said that it had a cautious outlook for 2010.

It will be an interesting day for traders and investors today.  Investors may want to take a cue from UPS and be cautious with their trades.

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Stocks bounced off a three month low, as good news on personal income and manufacturing were the catalyst for a rally.  The morning started off on a good note with consumer spending ticking up by 0.2 percent in December and personal incomes increasing by 0.4 percent.  The good news continued, as the Institute for Supply Management's manufacturing index rose to 58.4.  This was significantly higher than the consensus estimate of 55.5.

Exxon Mobil added fuel to the rally, with fourth quarter earnings coming in at $6.05 billion, or $1.27 a share.  This was above the consensus estimate of $1.19 a share.  On the news, the company's shares were up by 2.7 percent and it helped move the energy sector up by three percent on the day.  The only sector in the S&P 500 to have higher gains was the commodities sector, which gained 3.7 percent.

In a reversal of the pattern that we've seen for the past few days, where good news on GDP and the reappointment of Ben Bernanke caused stocks to decline, the markets climbed on the good news.  The Dow was up by 1.2 percent, closing at 10,186.  The S&P 500 climbed by 1.4 percent to 1,089.  And the Nasdaq rose by 1.1 percent to 2,171.

David Dreman, chair of the value investing firm that bears his name, said "the trend of the market is up.  There's still good value to be picked up and we're getting close to 100 percent invested in stocks."  His optimism was shared by the chief investment officer of Wilbanks, Smith & Thomas in Norfolk, Virginia, who said "we won't get more than a 10 percent correction because the corporate earnings numbers are simply too good."  Another concurring voice of optimism came from Christiana Bank & Trust in Greenville, Delaware, which said that "the manufacturing number...stops the near-term sell-off in the market and it supports Friday's GDP data."

Other analysts were talking about the possibility of the January employment report coming in higher than the consensus and warned that a better than expected jobs report could cause the Fed to not only end its quantitative easing but to being to raise interest rates more quickly than anticipated.  This would squelch any rally in stocks.

Still, though, the portfolio manager of the Alpine Dynamic Dividend Fund said that the latest economic data showed "the economy and the recovery seem to be on track," which is positive news for investors and the country as a whole.

If the analysts and portfolio managers are correct, then investors should take advantage of any pullback in the market to add to their positions.  When good companies are on sale, investors need to take advantage of this.

In another sign that the economy is recovering, consumer spending increased by 0.2 percent in December and it was accompanied by an increase in personal incomes of 0.4 percent according to the Commerce Department.  This was the third month in a row where consumer spending, which accounts for two thirds of the economy, increased.  Without growth in consumer spending, there cannot be a strong recovery.

Disposable personal income, which is money that individuals have left to spend after paying for non-discretionary items, also increased by 0.4 percent.  Personal savings, which is disposable income less spending, increased to 4.8 percent in December from November's 4.5 percent.

The increase of 0.2 percent in consumer spending was less than the 0.3 percent that economists had projected.  Estimates ranged from no change to an increase of 0.7 percent.  Economists had estimated that personal income would grow by 0.3 percent, so the actual increase was better than expectations.

An economist at Wells Fargo Securities in Charlotte, North Carolina said that the consumer spending numbers show that "households appear to have set a course of moderate spending.  Our outlook for 2010 is an improvement in consumer spending."

Agreeing with the assessment of Wells Fargo Securities was PNC Financial Group in Pittsburgh.  An economist there said "consumers have the wherewithal to support good spending, however they are going to be reticent until they see a few good months of job gains.  2010 is lined up to be a moderately good year."

We'll see how the markets react to this positive news.  Last Friday, they got word that Ben Bernanke was given a second term by the Senate and a much better than expected GDP number, but they still sold off.  During the run up since the lows of March 2009, markets took news that things were getting bad less quickly and bought stocks.  Recently, we've seen them take actual good news and sell off.

Will that trend continue or will today's trading show otherwise?  Stay tuned, and make sure that your gains are protected with either trailing stops or put options.