Fed Should Go, Google Sees Deflation, Why Blockbuster Failed, and Stocks Looking Tired

Finance at First Light
Good morning! Here’s what you need to know:


  1. Do We Need The Federal Reserve? | We once did fine without it and we seem to be hankering to end it.
  2. New Google Price Index Shows Deflation | Since official stats are slow, the much faster Google stat is the one to watch.
  3. How Netflix Felled Blockbuster | Blockbuster was wrong in thinking the internet was a “niche.”
  4. Stocks Looking Tired | Expectations of QE2 to the rescue may set up a sell-off, and earnings are peaking.



1. Do We Need The Federal Reserve?

John Tamny wrote at RealClearMarkets that much of what the Fed does “is either ineffective or superfluous, and could be handled much more skillfully outside this government-chartered monopoly. … Implicit in the desire for a Federal Reserve is that individuals in government possess magical powers that enable them to do for us what we can’t do on our own. More realistically, the US economy grew quite nicely without a central bank. Given continuous advances in financial alchemy, it’s exciting to imagine what private actors would do for banking if the Fed ceased to exist.”

It probably will cease to exist, if Paul Farrell is to be believed. He wrote at MarketWatch that “the Fed is a pawn of Wall Street’s Happy Conspiracy, which is incapable of seeing the train wreck that it set up.” Therefore, he agrees with Black Swan author Nassim Nicholas Taleb’s “prediction that the Fed is dying, that it’s only a matter of time before a revolution triggers class warfare forcing America to dump capitalism, eliminate our corrupt system of lobbying, come up with a new workable form of government, and create a new economy without a banking system ruled by Wall Street.”


2. New Google Price Index Shows Deflation

Robin Harding reported in the Financial Times that Google is using its “vast database of web shopping data to construct the ‘Google Price Index'” to provide a daily measure of inflation. Google’s chief economist, Hal Varian, said the GPI shows a “very clear deflationary trend” for goods sold online in the US since last Christmas. More on the new style of index:

“Mr Varian emphasised that the GPI is not a direct replacement for the CPI because the mix of goods that are sold on the web is different to the mix in the wider economy. Housing accounts for about 40 percent of the US CPI, for example, but only 18 percent of the GPI.”


3. How Netflix Felled Blockbuster

James Surowiecki wrote in this week’s New Yorker that Blockbuster’s investment in traditional stores made it resistant to the internet. As late as 2002, “it was still calling the Net a ‘niche’ market. And it wasn’t just the Net. Blockbuster was late on everything — online rentals, Redbox-style kiosks, streaming video.”

Blockbuster’s stores were anvils around its neck, but its management mistakenly clung to them as an advantage. “Myriad studies have shown that, once decision-makers invest in a project, they’re likely to keep doing so, because of the money already at stake. Rather than dramatically shrinking both the size and the number of its stores, Blockbuster just kept throwing good money after bad. … Meanwhile, Netflix could focus on making its distribution system bigger and more efficient, in large part because it was starting from scratch.”

Netflix’s comeuppance might not be far away, though. “Its domination of the DVD-rental market comes just as people are moving toward streaming and downloadable video. As has already happened with music, the business of renting and selling movies will soon be about moving digital files rather than physical objects.”

Of course, Netflix knows this and already offers streaming and is signing up partners to deliver its movies on video-game players, but it earns less on streamed movies than mailed ones and it’s coming up against competition much smarter than Blockbuster: “Amazon, Apple, the cable companies, and now Google (which just rolled out its own TV product)” striving to grab a piece of “a market that remains wide open technologically — no one really knows how, or on what devices, most people will watch movies in the future.”


4. Stocks Looking Tired

Jeff Cox wrote at CNBC that “speculation about what the Federal Reserve might do seems to be driving the fall’s unstoppable stock market rally.”

Most economists expect the Fed to announce a $500 billion bond-buying program to drive down long-term interest rates, such as the ones paid by mortgage borrowers. Such activity is called quantitative easing, or QE, and this would be the second round of it in this recession, so QE2. Half-a-trillion dollars is probably already priced into stocks, which means meeting it or announcing less than that “could spark a sell-the-news reaction,” Cox wrote. “The term refers to investors’ desire to buy ahead of major events, such as earnings or key economic reports, then sell once the news hits and take profits incurred during the run-up.”

Shawn Tully at Fortune is no fan of stocks, either, but his concern lies more with the earnings picture than QE2. He notes that “corporate earnings are far outpacing the slow, grinding recovery. In fact, they’re practically at a cyclical peak — and possibly in a mini-bubble.”

Remember what you’ve heard about what goes up? That’s what Tully fears we’re facing: “When earnings are already at lofty levels, they typically stagnate or fall rather than grow. Hence, one route to rising equity prices is effectively blocked by the rise in profits that’s already occurred, and the other is closed by high prices. Even if the economy improves dramatically, prices are far more likely to fall than rise. The rich rewards will go the patient contrarians who buy not at these prices, but after a major correction.”

Have a great day!
Jason Kelly

These periodic “Finance at First Light” briefings present a glimpse into my research. If you would like to read actionable investment advice based on this and other information, please consider subscribing to The Kelly Letter.

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