|
Kelly Letter Article Excerpts
From the January 18, 2009 Issue:
Consumers are the most important part of the economy, which is bad now because they're staying home. Disappearing jobs have put them on defense. Those who've already lost their jobs are conserving cash to survive, while those still working are saving for their own possible rainy day this month or next. On Friday, for instance, another 34,000 people found themselves out of work when Circuit City said it's closing its remaining 567 stores and going out of business.
Vacations are now "staycations," which explains tourism's place on the Fed's list of extreme slowdowns. The "stay" in staycation used to refer to staying in one's hometown during time off work, but now it seems to mean staying in one's own home, perhaps under one's own covers. Retail sales dropped another 2.7% in December, following the 2.1% decline in November.
When explaining why the price of oil fell so much, most news sources say that global recession is to blame because it squashed demand. However, I think there's more to it than that. The credit crisis hit its stride just as oil started reversing course. That impaired the ability of traders to own oil contracts. Many traders just wanted back to cash as soon as possible, and sold off everything -- including oil contracts. That's why everything fell in tandem.
Recent news about the recession notwithstanding, oil's supply horizon is uglier than its demand destruction. Civil unrest in oil-producing regions is increasing. The oil industry's infrastructure is aging. New technology has increased oilfield decline rates. Oil supply is tighter than ever.
Global demand, while temporarily off trend, still shows a steep ascent ahead.
That brings us to ask: Is the current price of oil fair? In this context, "fair" means at a level to keep the industry working at a profit without placing undue pressure on consumers.
No, the current price of oil is not fair. Producers in the Middle East are operating at a loss, important supply-boosting projects have been put on hold, drilling equipment is lying dormant, and other parts of the industry don't work at prices below even $50 per barrel, while OPEC members say they need prices above $70.
Below the surface of brimming tanks of oil waiting to be sold at higher prices, a supply crisis is creeping in. Dirt-cheap oil has stopped industry revitalization just when the industry needs to be gearing up for unprecedented demand. A full 90% of the world population is just embarking down the path that the U.S. and Europe paved after World War II.
Let's hope Team Obama does as good a job as Team Reagan did back in the early 1980s.
When Reagan took office, unemployment was passing 7% on its way to 11% in late 1982. As Obama takes office, unemployment just hit 7.2% and is probably on its way to double digits as well.
Reagan faced an inflation rate of 12.5% as oil came off a 600% price increase in the 1970s. Interest rates in the high teens didn't help, and are part of why stocks had been in a 14-year funk. You read that right: 14 years.
Reagan cut taxes and built up the military, while the Federal Reserve under Reagan's urging cranked credit down hard. The combined decrease in revenue and increase in spending produced a record deficit of 6% of GDP. After more pain and two quarterly GDP drops of 5% and 6%, unemployment hit the aforementioned 11%, and then at long last the economy began recovering. Reagan was given credit, and won re-election to his second term in 1984.
Obama's stimulus plan is equally ambitious. He, too, is planning tax cuts and increased spending. His spending will go mostly toward infrastructure improvement instead of the military, but will also produce a record deficit when added to the enormous deficit Bush leaves behind. The projected FY 2009 deficit is 9.2% of GDP.
So, while the media is already putting Obama's face on Mount Rushmore as the man who saved us from our worst moment in history, it's just not true. Other presidents faced equally challenging times, indeed tougher times. We got through those and we'll get through this, but nobody has any idea yet who the heroes will be.
To continue reading the information page from where you left off, please click here.
From the January 25, 2009 post-Inaugural Issue:
The minions of hope re-took financial editorial offices and sounded the trumpets: the tone of the new administration had been set, it was all up from here, and anybody sitting on the sidelines needed a dunce cap.
Too bad Thursday arrived on schedule before it had a chance to catch up on financial editorials. FAS dive-bombed 15% to close at $8.38 and UCO dropped 5% to $11.08. The media re-ran Tuesday's headlines along with fresh comments from Louise Yamada, the analyst who said at the November low that the S&P 500 was heading to 600. That was a perfect time to buy, as the S&P 500 rose promptly to 900 for a 20% gain.
Prior to that, Ms. Yamada made headlines in October 2004 by saying that U.S. stocks were in a long-term decline, and then disappeared as the market gained 43% over the next three years. Now that it's down 47% since October 2007, she's back warning that it will fall.
This time around, Ms. Yamada said: "There is yet scant evidence of a significant bottom, no directional conviction and no definable leadership; and macro statistics continue to deteriorate. We must await the technical evidence that the market is coming to grips and developing a bottoming process beyond several weeks."
Not to exceed a reasonable allotment of stone throws from my glass house, but that statement is self-evident and is the main problem with all technical analysis. TA tells us we'll know the market has stopped falling when it stops falling, and we'll know it has embarked on a new upward trend when we see it in a new upward trend. Helpful.
...
As for my market view, I still think we have another leg lower ahead.
To continue reading the information page from where you left off, please click here.
From the April 2009 Issue:
Paul Krugman at The New York Times found [Treasury Secretary Timothy Geithner's Public-Private Investment Program] to be "more than disappointing" to the point of filling him "with a sense of despair." He thinks it shows that Tim Geithner persuaded President Obama to "recycle Bush administration policy" and specifically the "cash for trash" plan proposed, then abandoned, six months ago by then-Treasury Secretary Henry Paulson.
Paul Kedrosky's support of the plan was so tepid it looked like non-support. He wrote, "Any semi-coherent plan showing that the Administration and Treasury are trying to get in front of things, and have committed capital, is, to that way of thinking, better than the current rear-guard action." Better than nothing may work for a last-minute Friday night date, but is probably not the best approach to the credit crisis.
My take is that this plan could actually make things worse. Currently, an undervalued asset is priced at, say, $50. The banks say it's worth $100 in a non-distressed market and they're dying to mark to THAT market instead of the one we're in that says the asset is worth just $50.
Now, the PPIP will deploy "private-sector competition to determine market prices for currently illiquid assets." Fine, but if I'm the private sector participant I'm going to look for as cheap a price as I can get. To protect banks from that, the plan allows them to decline the final price out of auction. If a bank does so, how can it then turn around and carry the asset at a higher-than-auction price on its books? We may stumble into confirming the low value of these assets, keeping them on bank books because the banks refuse to part with them at 50 cents on the dollar, and everybody will instantly know that American banks are insolvent.
What comes after that? Finally biting the nationalization bullet, as [subscribers read in the Feb. 15 note, and as you'll read below on this page]. We look to still be stuck in the muddling along phase predicted back then.
I think government is in too much of a hurry to take us right back to what got us into this mess in the first place. It wants consumers spending again -- on credit cards, if necessary -- and it wants giant banks to get busy lending to keep capital flowing. The mad scramble to borrow and spend is what dropped America into this swamp. How about a little true reform along the lines of teaching people to live within their means?
The nation's debt/GDP ratio is gunning for 80% and we're pushing the needle dangerously close to "Banana Republic." The world is already clamoring for the end of the dollar standard because it can't continue suffering the whims of our poorly run economy.
To continue reading the information page from where you left off, please click here.
From the February 15, 2009 Issue:
Tuesday was the worst of the week. That was the day Mr. Geithner said the Treasury will work with the FDIC, the Fed, and the private sector to create a hybrid public/private fund to capitalize and finance the market. The goal, he said, is to provide up to $1 trillion in capital. He left out details, however, including the bad bank proposal, saying that he would not provide more until he was confident the proposal was right.
The quote that summed up his bold plan for action? Hold on to your hat and get your pencil ready: "We're exploring a range of different structures. . . . We're going to have to adapt our program as conditions change. . . . We will announce the details of this plan in the next few weeks."
Thud.
Markets expected to receive on Tuesday a detailed plan, not the bare outline presented by Mr. Geithner. Stocks fell 4.9%, and financials plunged almost 11%. Our recent financial trade, FAS -- which we don't own at the moment -- fell 27% on Tuesday and ended the week 26% lower overall.
The Iraq War and the various economic packages together add up to nearly $5 trillion. Had that money been distributed across the population, each U.S. citizen would have been paid more than $16,000. Some $64,000 for a family of four would have gone a long way toward mortgage payments and, I dare say, a fair amount of stimulative spending.
Nationalization of a bank wipes out its common equity shareholders. Even if the government nationalizes just one or two big banks, such as Bank of America and Citi, almost every stock in the sector would plummet toward zero as investors sold all shares in a panicked attempt to get what little they could before nationalization wiped out the position.
Because of that, the government is hoping the economy gets back on its feet soon, and that crap assets move up in value to recapitalize banks naturally. Rising home prices, for example, would go a long way toward that end. To give better odds of this scenario working out, the government is leaning toward guaranteeing crap assets so banks can keep operating in an under-capitalized state while waiting for the economy to recover.
Few economists expect that to work out. Most see the scenario going like this: government muddles along for much of this year with various stop-gap measures to prop up the bankrupt banking system, realizes in nine or 12 months that the economy is waiting on the banks as much as the banks are waiting on the economy, and finally bites the bullet with a massive bank nationalization effort.
In the meantime, we'll see the Treasury's mandatory "stress test" for banks with at least $100 billion shed some light on how bad the exposures are, and other propping measures such as the Term Asset Backed Securities Loan Facility (TALF) directed at different parts of the credit market.
What we are not seeing yet is the solution. There's a slim chance that the economy will perk right up and allow the country to avoid bank nationalization. The greater chance, however, is that we'll need to experience further deterioration in the economy before nationalization becomes politically possible. That will lead to more layoffs, lower profits, more financial sector anguish, and lower stock prices.
That's why we remain bearish.
That'll do it for this week.
This letter brought some heavy reading your way. There's a sense that something disturbing is brewing.
I took a break from working one sunny afternoon to walk through the park near my office. I do that frequently, and also cycle through rice fields and mountains several times per week.
That day in the park, I saw a young couple hugging behind a monument honoring those who died in World War II. It's rare to see any PDA in Japan, so the scene jumped out at me. They looked cute there, and embarrassed when I saw them, and then they smiled at me and I smiled back and everybody knew that everything was fine.
It reminded me of something. Here in Japan, a recession has been a fact of life for almost two decades. It's gone on so long that people question whether it's fair to call it a recession anymore. Maybe we should just accept that this is the economy's new baseline. The top was the aberration, not the flat line following the crash.
As factories here cut back, they've advised workers to supplement their incomes with part-time jobs, so my favorite ramen shops are now staffed with "salary men" bridging the gap. I asked one how he felt about it and he said, "What are you going to do?"
What you have to. No matter what happens, whether stocks stay down or the dollar loses its reserve status or every bank you ever thought you could trust disappears, life goes on. The best things in it are still free: walks in parks, bicycle rides, furtive romance, and gravity. The latter keeps me down, but has never let me down.
So, I hope you had a wonderful Valentine's Day and night, and that you enjoy the rest of your Sunday.
Yours very truly,
To continue reading the information page from where you left off, please click here.
|
