Stocks

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

When markets tumble, the immediate cause is often baked into the cake years before. The structural (decades old) trouble with large, U.S. publicly traded companies is managements that care first, second, and third about boosting the stock price today: carpe diem, and so forth.

In 2013, IBM's net income was $16.5 billion. The company spent $13.9 billion repurchasing its own shares during the year: 84% of its profits were used for these purchases. Buying back shares, all else equal, boosts per share earnings, thus the share price.

            This has been the modus operandi for U.S. corporations since early the early Greenspan era. The Wall Street Journal explored the paucity of corporate investment on January 22, 2014: "Identity Crisis: Does IBM Love Itself or Hate Itself?" The Journal found: "For the last 20 years, IBM has been an avid, methodical buyer of its own stock. In 1993, it had 2.3 billion shares outstanding. Today it has 1.1 billion...."

This mode of operation has been great for shareholders, including corporate insiders. From a $51.75 opening in 1993, IBM closed at $188.43 on January 21, 2014 (down from $215 in March 2013.) The Journal explained investor satisfaction: "Buybacks push up earnings per share. They flaunt management's confidence in the future. And they are a reason why retail investors have held on so lovingly to IBM stock."

After this reassurance to retail investors, should there be any left, the Journal dug deeper: Large U.S. corporations "are pitching their billions into buybacks, nearly $1 trillion from the 100 largest companies in the S&P since 2008. [This sounds too low. -FJS] In the 12 months ending in September, the total dollar amount of all corporate buybacks increased by 15% from a year earlier, according to S&P Dow Jones Indices. Cheap money from the U.S. Federal Reserve helps sweeten this deal.... The danger is that those buybacks have been substituting for substantive future investment, be it software engineers, new products, or extra marketing.... [This] stymies the economic growth originally intended by the Fed."

The stock market is a mood ring for faith in the Fed. If Fed policy is seen as failing, or more likely, the consequences of Fed policy become obvious, even though they will remain misattributed, trouble will follow.

Dallas Federal Reserve President Richard Fisher knows the Fed hollowed out America. On January 14, 2014, in a speech to that he has discussed at "recent FOMC meetings, pointing to some developments that signal we have made for an intoxicating brew as we have continued pouring liquidity down the economy's throat."

Fisher ticked off some consequences of ZIRP (zero-percent interest rates) policy : Among them: that "[s]hare buybacks financed by debt issuance that after tax treatment and inflation incur minimal, and in some cases negative, cost; has a most pleasant effect on earnings per share apart from top-line revenue growth. Dividend payouts financed by cheap debt that bolster share prices. The 'bull/bear spread' for equities now being higher than in October 2007. Stock market metrics such as price-to-sales ratios and market capitalization as a percentage of gross domestic product at eye-popping levels not seen since the dot-com boom of the late 1990s. Margin debt that is pushing up against all-time records."

One who remains unmoved by Fisher is Federal Reserve Board Chairman Ben S. Bernanke. On January 16, 2014, he told an audience at the Brookings Institute: "[T]he markets currently seem to be broadly within the metrics of market valuation- valuation seems to be broadly within historical ranges. The financial system is strong. The key financial institutions are well-capitalized."

With its $71 trillion derivatives book, J.P. Morgan could not be well capitalized with all the bank equity in the world, but leverage is not among Bernanke's concerns. One of the finest market analysts, Alan Newman, wrote in his latest issue of Crosscurrents: "The sheer arrogance of optimistic sentiment is outrageous. There is more talk of a melt-up than even a mere pullback. Various sentiment measures are at levels either not seen in decades or never seen before. December margin stats will be released next week and we again expect a record exposure to leverage. We are aghast that the Federal Reserve sits by and does nothing to discourage risk taking as this ridiculous euphoria unfolds."

Before returning to the Fed's shortcomings, it is worth recalling Newman's bona fides: "In the February 28, 2000 issue of Crosscurrents, we called for a Nasdaq crash and even specified a 'target under 3000....possibly as soon as mid-April.' Nasdaq was then 4578, so we were looking for roughly a 35% collapse in only six weeks. It was one helluva call to make with tech stocks screaming to the upside every session and in fact, we were off by ten days and 470 points from the absolute peak.  However, by April 17th, Nasdaq had indeed collapsed by 36% from 5048 to 3227. We feel the exact same way now." 

Chairman Bernanke's estimation of markets is perfectly useless, except - this is a key "except" - the markets levitate from the belief in Fed magic. Simple Ben has recently been all over the place talking about himself. His undoubted intention is to remind the world how much it owes him for its redemption before he departs.

The Associated Press captured Bernanke's incomprehension of any world outside his own models in "Bernanke Likens '08 Financial Crisis to a Car Crash." From the AP: "In his final public appearance as chairman of the Federal Reserve [that of January 16 - FJS], Ben Bernanke took a moment to reflect on the 2008 financial crisis and compared it to surviving a bad car crash. During an interview Thursday at the Brookings Institution, Bernanke recalled some 'very intense periods' during the crisis, similar to trying to keep a car from going over a bridge after a collision. The government had just taken over mortgage giants Fannie Mae and Freddie Mac. Lehman Brothers had collapsed. He recalled some sleepless nights working with others to try and contain the damage. 'If you're in a car wreck or something, you're mostly involved in trying to avoid going off the bridge. And then, later on, you say, 'Oh my God!' Bernanke said."

            Out of nowhere. "Oh, my God!" He remains completely unaware (otherwise, he would not have reminisced in such an affable manner) that he was the master cylinder for the car crash. Yes, Alan Greenspan laid the foundation, the brickwork, and the decrepit plumbing, but Bernanke built the structure with plywood. The nominal value of derivative contracts held by U.S. commercial banks (those over which the Fed had direct regulatory authority) leapt from $33 trillion at the end of 1998 to $101 trillion at the end of 2005, about the time Greenspan left office. This was roughly a 17% annual increase. By the second quarter of 2007, 18 months later, the nominal value rose by 50% - to $153 trillion in derivatives. With the exception of Richard Fisher and couple of other regional presidents, Bernanke's detachment from reality is rivaled by the Chinese wall that separates the investing world from the vapid minds that inspire public devotion to stocks.

            Demonstrating his circular abstractedness, Bernanke rambled on about the car crash that has ruined millions at the Brookings Institute even though he had warned of just that danger from excessive leverage in an earlier paper: "Using high leverage to improve corporate performance is much like encouraging safe driving by putting a dagger, pointed at the driver's chest, in every car's steering wheel; it may improve driving but may lead to disaster during a snowstorm."

            Simple Ben might at least take credit for his A+ paper, but various Bernankes Babel about. It is impossible to reconcile the world of Alan Newman with his quackery, so we must suffer Bernanke's coterie, including John Williams, president of the San Francisco Fed bank (a non-voting FOMC member in 2014). At the same January 16 Brookings seminar, Williams asserted: "Obviously, we've all learned the lessons of the past decade or so. We follow very carefully what's happening in financial markets, both in the banking part of the financial system but most importantly...this is a capital markets-based economy." A few minutes later: "Our models that we use do not take seriously that there's a complex financial system out there that can have endogenous changes in leverage, in risk-taking. And I would also add to that our models tend to assume highly rational agents who have a full understanding of things. So bubbles never occur."

            Are you still long the stock market?

            At the Brookings meeting, Harvard economist Martin Feldstein remarked: "John [Williams] reminds us that the standard textbook theory implies that LSAPs [large-scale asset purchases/QE] cannot affect asset prices and interest rates. We now know that that theory is wrong."

            The constant, media, frighten-parents-to-death campaign never mentions the mind-altering propaganda taught in economics classes at American universities.

            Williams, confidently rebutted Feldstein, since there is never a consequence to an economist who reveals himself an imbecile: "My answer to your question is I don't think that the low interest rates were an important contributor to the housing bubble. I think fundamentally flawed aspects of our regulatory environment were the key part of that story about the housing bubble."

The fundamental flaw in the regulatory carcass was the regulations in 2002 through 2007 that were not enforced. (Nicole Gelinas' book, After the Fall: Saving Capitalism from Wall Street and Washington, was very good on this.) The suffocating additional structure praised by Bernanke and Williams will put every bank other than the Big Five out of business.

            In the end, Williams addressed the Feldstein thesis: that maybe zero percent interest rates could encourage some excitability: "I do think that we have to have open minds about understanding how low interest rates for a long period of time do affect risk-taking, leverage and asset prices." As with subprime, Williams could not have been unaware of the Fed's mission when it lowered rates to zero. Williams was at the San Francisco Fed for at least the past decade. He could not have missed the subprime-loan scramble in California prior to the "bad car crash." So, he denies it.

Another Brookings attendee, former Federal Reserve Governor Donald Kohn minced no words, back in October 2009, when he was vice chairman of the Federal Reserve System: "[R]ecently the improvement, in risk appetites and financial conditions, in part responding to actions by the Federal Reserve and other authorities, has been a critical factor in allowing the economy to begin to move higher after a very deep recession.... Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years."

A clearer statement of the Fed's successful swindling of old people's savings has only been made by William Dudley, Ben Bernanke, Janet Yellen, Stanley Fischer, Eric Rosengren, Brian Sack, Charlie Evans, Narayano Kocherlakota: In other words, the Federal Reserve has not been shy to state publicly its impoverishment policy.

Richard Fisher gave an insider's version in his January 14 speech: "When money available to investors is close to free and is widely available, and there is a presumption that the central bank will keep it that way indefinitely, discount rates applied to assessing the value of future cash flows shift downward, making for lower hurdle rates for valuations. A bull market for stocks and other claims on tradable companies ensues; the financial world looks rather comely."

Fisher listed signs of ninth-inning, bond markets. My January 16, 2014 "Enjoy it While it Lasts," is similar: "In the bond market, investment-grade yield spreads over 'risk free' government bonds becoming abnormally tight.'Covenant lite' lending becoming robust and the spread between CCC credit and investment-grade credit or the risk-free rate historically narrow. I will note here that I am all for helping businesses get back on their feet so that they can expand employment and America's prosperity: This is the root desire of the FOMC. But I worry when 'junk' companies that should borrow at a premium reflecting their risk of failure are able to borrow (or have their shares priced) at rates that defy the odds of that risk. I may be too close to this given my background. From 1989 through 1997, I was managing partner of a fund that bought distressed debt... Today, I would have to hire Sherlock Holmes to find a single distressed company priced attractively enough to buy."

Note: This diatribe was mostly written on Wednesday, January 22, 2014, so the stock market sell off on January 23 and January 24 came after. The tumble may be of no immediate consequence. The odds that stocks will make up for the Thursday and Friday sell-off on Monday morning with jumbo orders from New York to Chicago is high. Even so, we are getting closer to the day when gamed markets will not cooperate. 

Enjoy it While it Lasts

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

"Enjoy it while it lasts"

-Sir Alan Greenspan, June 13, 2007,after suggesting "the global liquidity boom, which he dates back to the end of the Cold War, is nearing its end."

            "The fragile five" appears with rising frequency in the financial columns. This warning to stand aside, much as the "Asian contagion," in 1997, is bound to boomerang on Wall Street since Wall Street will keep selling as long as demand exists. At that time, U.S. investment banks were distributing sub-prime, Thai auto-loan securitizations to Greenwich. The hedge funds leveraged such securities into a Fed-led, Wall Street bailout in October 1998. The question of whether the Long-Term Capital Management (LTCM) rescue party should be considered a bailout was answered conclusively in Alan Greenspan's Age of Turbulence scrapbook: "[A]n orderly liquidation of [LTCM] was by no stretch of the imagination a bailout." Greenspan's assertions of blamelessness when he is guilty-as-charged are the foundation for his fortune.

He has also profited handsomely from being wrong. This may seem a strange causality, and, in fact, a distinction should be made. Greenspan has been wrong because his public statements have already been vetted and approved by every hack, Wall Street economist. "Wall Street economist," is a shorthand substitute for myriad establishment totems who earn their living by saying what the majority wants to believe.

This makes the bewilderment of the Bernanke Fed in June 2007 all the more, er, bewildering. ("The 'expected impact from weaker housing...may flare in the future, today - in the words of Ben Bernanke - it is contained.'" - July 18 2007, MarketWatch)

            In January 2014, Simple Ben is about to leave us, no wiser after seven more years as Federal Reserve chairman. Sounding more askew than ever at his December 18, 2013, press conference, the future civil-service pension recipient spoke as directly and honestly as we have come to expect: "[T]here are concerns about effects on asset prices, although I would have to say that's another thing that future monetary economists will want to be looking at very carefully."

            The fragile five - Brazil, India, Indonesia, South Africa, and Turkey - are suffering from investment outflows. As risk trades head home (to the Upper East Side and Mayfair), possible contagion through U.S. markets rivals the startling array of market upheavals that were widely expected on June 13, 2007.

            A bucket filled with reports of doomed credit excesses sits beside this desk. To condense, and also to offer ammo when the academic bureaucrats sit before Senate panels and mumble "We had no warning," I follow with newspaper articles by a single newspaper, the Financial Times, and by a single reporter, Tracy Alloway. The pre-2007 activities were described in Panderer to Power with a similar intent: to show anyone with even a nodding acquaintance with credit and leverage the credit bubble was doomed, long before 2007. By 2004 (in fact, much earlier), the collapse of Fannie Mae, the corruption of mortgage lending, the criminal actions that inflated the credit bubble, were already obvious (and footnoted in Panderer to Power, for any ambitious district attorney.)

In the December 11, 2013, Financial Times, Tracy Alloway warned: "The global search for yield has spurred some of the loosest lending conditions in credit markets since before the crisis, the Bank for International Settlements has warned." The BIS, the central banker's central bank, also issued a barrage of warnings before 2007. On December 14, Alloway was again on her soapbox: "Central banks have flooded the financial system with cash, driving investors to park their money in higher-yielding securities and largely obfuscating the true state of underlying markets." She then referred to the same BIS report: "In an era of cheap and easy money, investors are encouraged to buy bonds from troubled companies and thereby suppress the default rate." Who can forget: "House prices never go down?" Once again, central bankers have laid 312,000 traps for unsuspecting grannies who were enticed from their interest-bearing (roughly: 0.4%) CD or passbook savings account because they had to eat.

            "Surge in Boom-Era Debt is Signal for Overheating," was the title of an October 19, 2013, Alloway scolding: "Five years of the Federal Reserve's ultra-low interest rates have made the market for loans to highly indebted companies white-hot in recent years as investors clamour for the higher yielding assets and corpora[tions] rush to finance old debt." Here we see the consequence of low rates to both investors and to investment-grade, corporate bond issuers. Businesses run for-profit are losing sales to failed competitors [sic] kept in motion by Ben Bernanke's nationalization decisions.

            Kicking off the new year (January 1) Alloway's title prophesized: "2014 Outlook: Sugar High." She reported from a tea at the New York Athletic Club where "waiters bearing trays of cookies fanned out among the bankers and investors," as Leonard Tannenbaum, chief executive of Fifth Street Management sounded like Tracy Alloway: "I believe there's another cycle coming. So have a cookie. I want you to enjoy the sugar high - while it lasts."

The columnist, along with co-author Michael Mackenzie, picked up where Tannenbaum left off: "Issuance of syndicated leveraged loans - those made to companies that already carry high debt loads - reached $535.2 billion in 2013. That is just shy of the $604.2billion sold in 2007, at the height of the last credit bubble. Meanwhile, loans that come with fewer protections for lenders, known as "covenant-lite," accounted for almost 60 per cent of loans sold in 2013, compared with a 25 per cent share in 2007. Sales of "payment-in-kind" notes, which give borrowers an option to repay lenders with more debt reached $11.5 billion in 2012 [2013? - FJS] - a post-crisis high."

The Alloway & Mackenzie team quoted Russ Koesterich, chief investment strategist at BlackRock: "There are no bargains in fixed income. [Not true. There are pockets of mispriced bonds, probably too small for BlackRock. - FJS] We have seen a return to a lot of the practices that made people nervous in 2007 such as PIKs and cov-lite." Alloway & Mackenzie went on to write "'junk,' or high-yield, bonds surged to a record in 2013 as companies rushed to refinance and investors snapped up the resulting assets. Issuance of junk bonds rated 'triple C' - the lowest designation - jumped to $15.3 billion, surpassing the pre-crisis peak."

The preceding articles are a sampling, without introducing the stories written by other Financial Times reporters, such as Vivianne Rodriques. The practical lessons to be understood include: (1) a 0.4% yielding CD may be just the place to wait now, (2) no government (or aligned) official is worth listening to on these points, (3) the closer we get to the credit collapse, official pronouncements will grow more reassuring, and (4) when the stock market started falling after mid-2007, it went down by 50%. The Fed bailed out the stock market. This time, the Fed is the credit most vulnerable to collapse.

Visions of Gallantry

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

In "The Stock Market" (December 22, 2013), there is a mathematical problem with the following: "Zero Hedge recently reported the days on which the New York Fed has engaged in POMOs (Permanent Open Market Operations) of $5 billion or greater, between April 2009 and April 2013, the S&P 500 rose 540%. On days when POMOs were less than $5 billion, the index rose 15%. On days without POMOs, returns were -2%." If true, and it is not, the market never goes down. Nevertheless, even a non-calculating observer knows of the strong relationship between POMO operations and the stock market over the past few years. Most important is the artificiality of pushing up the stock market and its inevitable deflation.

In what could have been a turning point of mass recognition, the S&P 500 fell 9 points (-0.5%) in the minute after the Fed announced it was tapering (December 18, 2013). An unseemly burst of buying pushed the Index up 35 points (1.8%) in the next six minutes. It added another 15 points by the close: up 2.8% from that moment of peril. The S&P 500 closed at a new, all-time high of 1810. The mafia is more subtle than our central planners. That is the point: whatever They do, is authorized. This plunge-and-protect operation received practically no attention. If the authorities are so frightened when the market is near its all-time high, how will they panic when the market falls 10%?

As Federal Reserve Chairman Ben S. Bernanke gets set to depart, his personal self-worth was set forth in a speech to commemorate the 100^th anniversary of the Federal Reserve System. Bernanke buckled his panic attacks in 2007 and 2008 to Paul Volcker's money tightening belt in the early 1980s. Believing himself a combination of The Desert Fox and Joan of Arc, Simple Ben plastered his audience with this soggy discharge: "[O]ne value that strikes me as having been at least as important as any other has been the Federal Reserve's willingness, during its finest hours [Mon Dieu! - FJS], to stand up to political pressure and make tough but necessary decisions." Not content with this general (and ridiculous) claim, he followed with a vile and ignorant self-portrait: "I keep in my office one of the 2-by-4s mailed to the Fed during Paul [Volcker's] tenure, which communicates some distinctly unfavorable views of high interest rates and their effects. More recently, of course, the Federal Reserve took controversial but necessary measures to arrest what was arguably the worst financial crisis in American history."

It may be forgotten, but Simple Ben's initial rate cut that has led to our ruin was in response to Jim Cramer's CNBC attack on August 3, 2007. It should be noted that, on that date, the S&P 500 was down 7% from its all-time high. A sample of Cramer's bile: "[T]he Fed is asleep...My people [??? - FJS] have been in the game for 25 years...these firms are going out of business...open the darn [discount] window." David Stockman writes in The Great Deformation: "[W]ithin days of the rant that shook the Eccles Building, the Fed slashed its discount rate, abruptly ending its tepid campaign to normalize the money markets."

We know the rest. The bravest act of Bernanke's life was telling some patrons at South of the Border the restaurant had run out of apple pie.

Ben Bernanke's personal myth is his own affair. Our affair is the cocoon in which Bernanke and the yes-men draped around him have secluded themselves. Bernanke was not overstating what he believes in this self-characterization. Nor, would economists under the age of 120 disagree. (A friend who raised the possibility that Ben Bernanke may not be on top of his game was upbraided after a meeting: "He graduated from MIT, you know.")

            It so happens that Joseph Epstein, graduate of the University of Chicago, teacher for three decades at Northwestern University, and past editor of the American Scholar, wrote Bernanke's biography in the December 21, 2013, edition of the Wall Street Journal. He does not mention the Fed chairman. He may not have the seventh-grade, spelling-bee champion in mind. Epstein's was an essay on the rise of the meritocracy, with the title: "The Late Great American Wasp:"

Here they are, our leaders:

Meritocracy in America starts (and often ends) in what are thought to be the best colleges and universities. On the meritocratic climb, one's mettle is first tested by getting into these institutions-no easy task in the contemporary overcrowded scramble for admission. Then, of course, one must do well within them. In England, it was once said that Waterloo and the empire were built on the playing fields of Eton. The current American imperium appears to have been built at the offices of the Educational Testing Service, which administers the SATs.

Whether Republican or Democrat, left or right, the leading figures in U.S. public life today were good at school. Bill Clinton had Georgetown, Oxford (as a Rhodes scholar) and Yale Law School on his résumé; Barack Obama had Columbia and Harvard Law School. Their wives, respectively, had Wellesley and Yale Law School and Princeton and Harvard Law School. [Senator] Cruz went to Princeton and thence to Harvard Law School. Players all-high rollers in the great American game of meritocracy. Their merit resides, presumably, in having been superior students.

But is the merit in our meritocracy genuine? Of the two strongest American presidents since 1950-Harry S. Truman and Ronald Reagan-the first didn't go to college at all, and the second went to Eureka College, a school affiliated with the Christian Church (Disciples of Christ) in Eureka, Ill. The notion of Harry Truman as a Princeton man or Ronald Reagan as a Yalie somehow diminishes them both.

Apart from mathematics,* which demands a high IQ, and science,* which requires a distinct aptitude, the only thing that normal undergraduate schooling prepares a person for is... more schooling. Having been a good student, in other words, means nothing more than that one was good at school: One had the discipline to do as one was told, learned the skill of quick response to oral and written questions, figured out what professors wanted and gave it to them.

Having been a good student, no matter how good the reputation of the school-and most of the good schools, we are coming to learn, are good chiefly in reputation-is no indication of one's quality or promise as a leader. A good student might even be more than a bit of a follower, a conformist, standing ready to give satisfaction to the powers that be so that one can proceed to the next good school, taking another step up the ladder of meritocracy.

What our new meritocrats have failed to evince-and what the older WASP generation prided itself on-is character and the ability to put the well-being of the nation before their own. Character embodied in honorable action is at the heart of the novels and stories of Louis Auchincloss, America's last unembarrassedly WASP writer. Doing the right thing, especially in the face of temptations to do otherwise, was the WASP test par excellence. Most of our meritocrats, by contrast, seem to be in business for themselves.

Trust, honor, character: The elements that have departed U.S. public life with the departure from prominence of WASP culture have not been taken up by the meritocrats. Many meritocrats who enter politics, when retired by the electorate from public life, proceed to careers in lobbying or other special-interest advocacy. University presidents no longer speak to the great issues in education but instead devote themselves to fundraising and public relations, and look to move on to the next, more prestigious university presidency.

A financier I know who grew up under the WASP standard not long ago told me that he thought that the subprime real estate collapse and the continuing hedge-fund scandals have been brought on directly by men and women who are little more than "greedy pigs" (his words) without a shred of character or concern for their clients or country. Naturally, he added, they all have master's degrees from the putatively best business schools in the nation.

Thus far in their history, meritocrats, those earnest good students, appear to be about little more than getting on, getting ahead and (above all) getting their own. The WASP leadership, for all that may be said in criticism of it, was better than that.

The WASPs' day is done. Such leadership as it provided isn't likely to be revived. Recalling it at its best is a reminder that the meritocracy that has followed it marks something less than clear progress. Rather the reverse."

*Lord [Nigel] Lawson, who served as Financial Secretary to the Treasury and as Chancellor of the Exchequer under Prime Minister Margaret Thatcher, at Davos in 2012: "There is a complete failure of modern economics to have any value at all. Economics has been supplanted by mathematicians who can't hack it as mathematicians and become economists. It has no connection to practical policy decisions whatever. It helps the investment banks to construct models which proved disastrous and were a contributory factor to the banking meltdown."

            This is the least reported proclamation in the history of Davos love-ins.

The Stock Market

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

            Thomson Reuters (This Week in Earnings, December 6, 2013) notes another New World Record. We are breaking plenty these days. This often foretells a Grand Finale. For the fourth quarter of 2013, 103 companies in the S&P 500 have announced negative earnings revisions. Only nine have disclosed positive profit assessments. The ratio of negative-to-positive, 11.4:1, exceeds the previous high (negative-to-positive ratio) of 6.8:1.

            This is worth consideration. The 6.8:1 silver medalist was during the first quarter of 2001. Early 2001 was unpleasant. More importantly, for a ratio comparison, the unpleasantness was by then a protracted, dismal bust, and was not news, except to Alan Greenspan, who announced to the FOMC at its January 30-31, 2001, meeting that: "there is little evidence of which I'm aware that long-term profit expectations have deteriorated to any significant extent." A century from now, interested parties will need to address the dilemma of who possessed the tinier minds: members of the FOMC or the world that stood still in fear of its pronouncements, debating the layers of analysis that never existed at the Fed prior to post-meeting announcements.

          As a reminder of the moment: "By the end of 2000, the Nasdaq Composite had fallen 51 percent and the Philadelphia Internet Index had lost 77 percent from its peak. All told, investors in U.S. stocks had lost trillions of dollars and were constantly reminded of this by the wonder of technology's multicolored screens that flashed instant calculations of their attenuated portfolio holdings."  (Panderer to Power, pgs. 235-236).

          Announcements by companies of adjusted earnings predictions in a different direction usually lag a sharp break (from recession to rebound, or its opposite.) The first quarter 2001 reassessments were made by companies in the midst of liquidation, most of which had accumulated during the boom: "On December 4, 2000, Cisco Systems Chairman John Chambers delivered his annual speech to Wall Street analysts. 'I have never been more optimistic about the future of our industry as a whole, or of Cisco.' In January, Cisco Systems announced the value of its inventory rose from $1.2 billion to $2.0 billion in the previous quarter.Companies announced plans (or hopes) to reduce inventories by the end of 2002. This unwinding across the whole economy would take years to complete-unless some artificial paper printing inflated prices.... In April 2001, John Chambers admitted, "[T]his may be the fastest any industry our size has decelerated." Chambers was paid $279 million in 1999 and 2000 for his foresighted leadership." (Panderer to Power, pgs. 235, p. 237-238)

Since these moments of abrupt break are so easily forgotten, yet, so traumatic, some more color: "Hewlett Packard was 'buffered by the slowing economy in just about every segment of our business. Sales from dot.coms [are] essentially zero.' Gateway's sales 'plummeted below already lowered estimates.' The CEO of Nortel admitted, 'We now expect the U.S. market slowdown to continue well into the fourth quarter of 2001.' Lucent's CEO warned, 'We have serious execution problems,' after which, he immediately restored public confidence in his execution acumen by firing 10,000 workers. Oracle's CFO made the head-scratching admission, 'I haven't a clue what will happen,' and, 'We're still trying to figure out what happened last quarter.'" (John Hancock Quarterly Market Review, April 1, 2001. Thanks, Andrea)

So, what might we hear from CEO's in the first quarter of 2013? A schizophrenia exists in which "we're in a bubble" is stated, even by some central-banking bureaucrats. At the same time, the word from the Street is cheery. The S&P 500, Dow, and Russell 2000 periodically post new highs; there seems to be no concern (or knowledge) that 10-year Treasury yields have doubled since before Bernanke's QEIII trillion-dollar, asset-buying commenced in the fall of 2012. Corporate earnings as a percent of sales are the highest since records were first collected in 1947. From the mouths of the Experts, this is a good thing. So, why might we be on the verge of another first quarter 2001?

            Stock prices are artificial. They have been lifted by central-bank asset buying and the belief the Fed will not permit markets to fall. This same trust emptied the brokerage accounts of believers twice in the past 13 years, but it goes on. Zero Hedge recently reported the days on which the New York Fed has engaged in POMOs (Permanent Open Market Operations) of $5 billion or greater, between April 2009 and April 2013, the S&P 500 rose 540%. On days when POMOs were less than $5 billion, the index rose 15%. On days without POMOs, returns were -2%. (The New York Fed lists the daily schedules for POMOs with estimated sizes several days in advance. The Fed wires the electronic, keyboard money to primary dealers who relay electronically conjured money to recipients.)

            Andy Lees reports: "Asset prices have...continued to soar. Margin debt is at record levels in absolute terms, and is towards record levels as a percent of market cap. A week or two back I was told that hedge funds are running a gross exposure of about 258%. If I remember correctly, derivatives and financial sector lending is predominantly off balance sheet. What appears to be happening therefore is that the loan growth is driving or supporting asset prices, but it is being funded, at least in part, by taking liquidity out of the real economy, similar to the late 1920's. Why would a bank lend to the real economy where there is disinflation and the weakest nominal GDP growth outside of recession, rather than to the financial economy where there is massive asset price inflation and the banks can make returns very quickly?"

Andy Lees described one path through which the world's asset markets are inflated, by layers of leverage upon leverage upon leverage. The central bankers remain completely unaware of this since their holy DSGE model (dynamic stochastic general equilibrium model) does not acknowledge the existence of financial markets.

Lees' comment, "liquidity out of the real economy," is most apparent in falling household incomes. Falling incomes partially answers the reason for record profits. A large part of the increase in profit margins is due (as a percentage of revenues) to a reduction of salaries, taxes, investment, and interest payments on debt. The last would never happen except in a National Socialist economy, one that keeps setting New World Records in corporate debt issuance with practically no carrying cost (interest payments). When the Fed abandons its attempt to control the yield curve (see comment about the 10-year direction, above), interest payments will leave many a CFO admitting: "We have serious execution problems."

Companies also have serious liquidation problems of their capital investment. The first run at the third quarter GDP report pegged corporate investment at -0.1%. Record debt accumulation with negative investment is truly New Era management, but, as in many New Eras past, one that will vanish with a "poof." The main route for the debt is to repurchase common shares. Fewer shares with record profits raises stock prices and prods the cash-out rate of stock options by senior management: the 1%.

           We may be heading into a melt up (the opinion of some long-time market watchers), followed by a reckoning when it becomes apparent so many companies have been hollowed out. To note the obvious, after the central bankers lose the yield curve, their ability to support markets (first, the mortgage melt up, then, 2008 and onward) will also go "poof."

Mr. Hyde and Mr. Hyde

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

           Stanley Fischer is in the pipeline for the vice chairmanship of the Federal Reserve Board of Governors. In this capacity, he would bang heads to gather FOMC votes for (Presumptive) Fed Chairman Janet Yellen. According to the New York Times, Fischer would "exert a moderating influence on Ms. Yellen," (" For No. 2 at Fed, White House Favors Central Banker in the Bernanke Mold.")

            This is neither the job of the vice chair nor the inclination of the man.

            First, Fed vice chairmen do the dirty work, clearing the path for the chairman.

            Following are comments by Vice Chairman William McDonough at FOMC meetings in 1998 and 1999. The Chief Whip hectored FOMC members just after Chairman Greenspan told FOMC members how to vote:

August 18, 1998: "Thank you Mr. Chairman. I think your analysis was exactly right in regard to where we should be with the federal funds rate; that is Alternative "B."

September 29, 1998: "Mr. Chairman, I want to agree with your proposal to cut the fed funds rate by 25 basis points."

November 17, 1998: "Thank you, Mr. Chairman. I agree fully and rather enthusiastically with your recommendation."

December 22, 1998: "Mr. Chairman, I interpret that, as I'm sure you intended, as a recommendation for "B," symmetric, which I heartily endorse...."

February 2-3, 1999: "Mr. Chairman, I fully support your recommendation."

March 30, 1999: "Mr. Chairman, I not only support but applaud your recommendation."

May 18, 1999: "Mr. Chairman, I fully support your recommendation."

June 29, 1999: On page 64 of the transcript: "Mr. Chairman, I fully support your conclusions." On page 91 of the transcript: "Mr. Chairman, I fully support your conclusions."

August 30, 1999: "Mr. Chairman, I fully support your recommendation."

November 16, 1999: "Mr. Chairman, I fully agree with both the reasoning behind your recommendations and with the recommendation itself."

            The new vice chair will do the same. Stanley Fischer has midwifed the inflationary endgame for nearly 40 years. He will be sitting just where he belongs to prevent missteps in the grand plan. This does not mean he will succeed, but he understands the Greatest Flood since Noah's Ark must keep rising or we are sunk.

Second, Chairman Yellen will face formidable foes at the FOMC meetings in 2014. There are 12 Federal Reserve districts, 12 Fed district Presidents, but only five votes by Presidents at each meeting. (The seven Governors always vote.) Chairman Bernanke could not suffer dissention in 2013, even if he wished."Dissention is Overrated" on January 10, 2013, made this clear. Fed talk-show banter before FOMC meetings is unnecessary in 2013.

In 2014, Presidents Fisher (Dallas) and Plosser (Philadelphia) will fight the Fed chairman. A (Presumptive) Vice Chairman Fischer will press to gun inflation at a faster clip than even Janet Yellen would dare. Stanley Fischer is the most influential money printer in the world. His former students include Ben Bernanke, Mervyn King, Frederic Mishkin, and Mario Draghi. He is where he belongs.

            Fischer is not a man of half measures. He has received much attention here, such as on October 13, 2011, "The 8% Solution." The more salient comments from that diatribe:

The following sequence is a lesson in how bureaucracies insinuate their failures into accepted policy.

Stanley Fischer, current Governor of the Bank of Israel, doctoral Ph.D. thesis adviser to Ben S. Bernanke and to Greg Mankiw (at MIT), with stops at every institution of impeccable prestige among the anointed (chief economist at the World Bank, Vice Chairman of Citigroup) professed in 1997 that: "The fundamental task of a central bank is to preserve the value of the currency." That is the first sentence in "Maintaining Price Stability," a paper published when Fischer was First Deputy Managing Director of the International Monetary Fund. Five paragraphs later (wasting no time) Fischer wrote: "Barro (1995) and Sarel (1996) do not find clear negative relationship below 8 percent inflation..." [For the incredulous and perplexed reader, Fischer believes price inflation can run at an 8% rate, interest rates can hibernate at zero, and the real economy will be sound. This was back in 1997. Knowing how these creatures work, 16% inflation with no interest is probably the equilibrium rate today. - FJS]

We can be sure the conclusion rested on the result of some computer model. Barro (1995) and Sarel (1996) cited as their authority Fischer (1993), which is noted later in Fischer (1997).

In 2001, IMF economic researchers Mohsin S. Khan and Abdelhak S. Senhadji wrote a staff paper "Threshold Effects in the Relationship between Inflation and Growth." The authors declare "[F]irst identified by Fischer (1993)" [addressing inflation below an 8 percent rate], "inflation does not have a significant effect on growth, or it may even show a slightly positive effect." Note the change since the (1997) Fischer, from whom they quote: from "do not find clear negative relationship below 8 percent inflation," to "it [8% inflation] may even show a slightly positive effect." This sequence was arranged by Sheehan (2011).

The press blurbs that appeared the morning of December 12, 2013, were designed to relieve the wary of concerns that Professor Fischer might be an inflationist. The Washington Post fell in line: "[B]y September 2009 Fischer was raising interest rates." This was as head of the Bank of Israel. What was happening in Israel at that moment has not been investigated, but Israel does not have the ability to print money with abandon. (It has in the past, and suffered.) The United States is the reserve currency of the world that lifts all ships during a storm (so far), including Israel's.

In fact, on March 17, 2008, Bank of Israel headmaster Stanley Fischer offered Ben Bernanke advice in a Bloomberg interview. "You can inject liquidity into the economy and Ben Bernanke is an expert on this issue."

Later: "That the Fed will get on top of this, I don't doubt."

And: "Ben Bernanke is an outstanding economist."

We might surmise Ben Bernanke would only remain a great economist if he conjured a few trillion dollars into existence. (He has.)

The Bloomberg reporter expressed concerns to which the central planner replied in central-banker jive: "Fischer rejected the view that the Fed was orchestrating a bailout that would encourage investors to take greater risk in the future."

There is not a chance Fischer believed this. What else were they going to other than chase bond, stock, and post-human art markets?

           

The theoretician loftily claimed Bernanke would raise interest rates "long before inflation got out of hand." Of course, Fischer had no idea what Bernanke would or could do, since no central banker (nor anyone else) knows how to exit. At first, Dr. Jekyll could change back from Mr. Hyde, but then, could only remain Mr. Hyde.

            The Bloomberg story was published at a dire moment. Bear Stearns had failed. Its carcass was purchased by J.P. Morgan on March 16, 2008. It is not a coincidence the professor who understood the inflationary end game in 1980 reminded his lifelong tenured servant of what to do. (Go forth and multiply.)

            The most celebrated economist MIT ever produced expressed misgivings about Ben Bernanke's scholarship, specifically, the Ph.D. thesis anointed by Stanley Fisher. (It is my understanding that Robert Solow was primarily responsible for Simple Ben's paper.)

Not too long before he died, Paul Samuelson - the man who established MIT as a magnet for economics, was interviewed by The Atlantic (June 17, 2009). Samuelson wrote the best-selling economics textbook in history. In the interview, Samuelson reflected: "The 1980s trained macroeconomics - like... Ben Bernanke and so forth -- became a very complacent group, very ill adapted to meet with a completely unpredictable and new situation, such as we've had....  I looked up Bernanke's PhD thesis, which was on the Great Depression, and I realized that when you're writing in the 1980s, and there's a mindset that's almost universal, you miss a lot of the nuances of what actually happened during the depression." [My italics. - FJS]

Samuelson, having administered a failing grade to the trainees, must have been appalled by the trainers. (Paul Samuelson was among the most intelligent economists of the twentieth century. After Samuelson defending his Ph.D. thesis, one of the professors, Joseph Schumpeter, turned to the other two, and asked: "Well, gentlemen, did we pass?" What happened after might help explain how economics went off the rails around mid-century. The American Keynesianism that Samuelson espoused was beneath him and certifiably incorrect.)

Simple Ben's Essays on the Great Depression ignore all economists who wrote before 1980. In the book, Bernanke mentions 139 names - 135 of whom are economists, mostly macroeconomists, and most having written after 1980. Their papers cross-reference each others. His essays never cite Benjamin Anderson (who was Chase Bank's in-house economist, writing about the mistakes being made a decade before the Depression), Ludwig von Mises (who also predicted a depression), as well as many others who wrote "on-the-spot," analyses in the 1930s.

            If Binyimin Appelbaum's "Young Stanley Fischer and the Keynesian Counterrevolution," is correct, the Vice Chairman Apparent sowed the seed that burned history and economics books written before 1980. Appelbaum, in the December 12, 2013, New York Times, writes that a 1977 paper written by Fischer led to a "counterrevolution." Fischer asserted "[c]entral banks...have the power to stimulate economic activity. Monetary policy can help economies recover from recessions.... [T]he new school [built on Fischer's paper - FJS] came to dominate central banking. Monetary policy makers, embracing its justifications of their powers, use New Keynesian models to plan and assess their campaigns."

            It is natural to ask "why" Fischer has been chosen to join the Fed. Without being there, it is impossible to know. The Obama administration's record of ad lib decisions is such a delightful packet of whimsy.

            "What" is more important. Fischer has no better idea how to "taper" (i.e.: extract the central banks from shoveling larger quantities of speculating, leveraged, uncollateralized credit across the globe). The Bernanke Fed cares most about stock market levitation. We can be sure Stanley Fischer knows this. He allocated 10% of the Bank of Israel's balance sheet to U.S. equities in 2012.  "Central Banks, Faced With Paltry Bond Returns Buy More Stocks" The new vice chairman will not be shy to introduce imaginative asset implosion prevention measures at the FOMC.

The Media Makes and Changes History

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

 "The Economist's Sell Signal," (November 30, 2013) critiqued the "The Perils of Falling Inflation," in the magazine's November 9, 2013, issue. "The Perils" attempted to erase history, an effort to protect the central-banking version of history from criticism.

In Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself, Sheila Bair, the former FDIC chairman, described an enlightening encounter with The Economist. In that instance, a malignant diatribe was published, either sanctioned or produced by the sieve of banks, bank regulators, globe-hopping bureaucrats, and politicians who fashioned it.   

  Bair attended a meeting of the Basel Committee in October 2006. This was shortly after her appointment as chairman of the Federal Deposit and Insurance Commission. Bair spoke against Basel II capital rules. Basel II set regulations by which bank capital was calculated from models; the models weighted the riskiness of bank assets. Basel II reduced the amount of capital that banks were required to hold. (Bair wanted banks to meet a "leverage ratio," with no weighting of asset risk: a simple division of total assets by total equity; the measurement showing whether banks held enough equity.)

The speech was ridiculed at the meeting. It was a coordinated attack. An active media campaign followed to discredit Bair's warning about capital promiscuity. She writes: "A few days after the Mérida [Mexico] meeting there was a scathing article in The Economist that I suspected had been leaked by the Germans. [No bankers in the world had more fun prior to 2008 than the Germans. - FJS] The article essentially said that I was trying to derail 'a seven-year mission to make the world's banks more efficient,' suggesting I was a 'Luddite,' and called the Mérida meeting a frank "exchange of views." That was my first experience with press leaks coming out of the Basil Commission. It was a complete blindside. We called The Economist and complained vigorously about its failure to contact us and get our perspective. The Economist would come our way in understanding the folly of Basel II."     

By 2009, The Economist and other highly respected and authoritative periodicals gathered the courage to question whether capital had been adequate before the bust. The great nineteenth-century historian Jacob Burckhardt told his students history has no method but you must be able to read. This is true of any subject: a word, a phrase, a puzzling superlative (e.g.: The (Always) Brilliant Larry Summers), are signals there is a skunk present.

Moving to a skunk that stinks, on December 5, 2013, Bloomberg TV introduced Sir Alan Greenspan, 2001 recipient of the Enron Prize for Distinguished Public Service, thusly: "Former Fed Chairman Alan Greenspan knows a thing or two about bubbles because back in 1996 he saw the signs of an overvalued market, coining the term 'irrational exuberance.' Just days after his speech, stocks fell. The dot.com bubble began to burst. He joins us right now...."

Should this Greenspan reconstruction gain traction, the ex-chair may succeed Janet Yellen.

The detached but diligent observer might deduce this bewildering introduction as follows: Alan Greenspan received a large advance from his publisher for a book he is flogging (if memory serves correctly: I am God and You are Not). In the book world, the size of the advance meets, in exact proportion, the media coverage bestowed upon the author. It would not do for the Bloomberg TV hostess, who looked as though she was in kindergarten when His Holiness proclaimed "irrational exuberance," to note the spineless Fed chairman wet his pants when Larry Lindsay, Phil Gramm, and Jim Bunning subsequently (after the "irrational exuberance" speech) told him to "put up or shut up," the forensic details may be found on pages 160-164 of  Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession

It is a close run thing to compare the forecasts of Greenspan and the soon-to-depart Fed Chairman Ben S. Bernanke. A large research team may discover there really was a moment when one of the two was correct. Past performance does not inhibit the man. Greenspan recently told some interviewer that stocks are "very cheap." To Bloomberg on December 5, he made no such claim, but predicted "we're on the edge of a significant rise in long-term rates. [They are] significantly lower than they ordinarily would be ... That obviously is a result of QE 1,2,3."

With this degree of backstabbing, maybe he'll get Bernanke fired and grab the throne before Yellen gets her chance.

The reasonable investor may think "very cheap" and "QE 1,2,3" are a contradiction. This may not be true in the world of Alan Greenspan. (Leaving Him aside, it is one reason to think the stock market is in a bubble. There are about 212 others, back to Greenspan.)

As Fed chairman, he cut rates when he should not have (post-LTCM, for example), he raised them when it too late (1999) and cut them to compensate for his earlier errors (2000). With reference to his "very cheap" and "QE 1,2,3" TV observations, Greenspan kept raising the Fed funds rate from mid-1999 until May 2000. From the time the FOMC started raising rates until March 2000, the Nasdaq 100 rose from around 2000 to 5000. Thus, to Greenspan, he was holding the tiller when rates rose and the stock market entered a terminal bubble: evidence that raising rates may not halt a runaway stallion.

The Nasdaq then fell to 3200 (on May 20, 2000), a loss of 36%. On that date, Greenspan raised - not lowered - the fed funds rate by 0.5%. The Nasdaq 100 then fell another 26% through the end of 2000. Possible interpretations (re: Greenspan) include: (1) by May, the damage of choking credit had been done (the Fed contracted the monetary base by 20% in the first seven weeks of 2000), so raising rates was incidental to the stock market's continued plunge, (2) raising rates caused the market to sell off another 26% (this would be consistent with fears that if the Fed "tapers," markets will collapse), or (3) the stock market was so overpriced, once it broke, all of the corporate concerns that had been brushed aside were front-and-center. (To distinguish: cutting the money supply by 20% is quite different from simply reducing the amount of money printed from, for instance, $85 billion to $80 billion a month. That is not to say the effect would differ, given how bubbles depend on ever-expanding gobs of credit.)

This data from "musty archives" (see speech, AG, August 30, 2002) is mentioned not to bury Greenspan, nor to praise him, but to show how the advice and calculations of Wall Street strategists may not produce the cause-and-effect relationships proposed.

Greenspan (Bloomberg TV) went on to say Bitcoin is in a bubble, of which, if he knows nothing, leaves us equally ignorant. His reason for making the claim was another condemnation of central banking: "Currencies that [are] exchangeable have to be backed by something. When we were on the gold standard, gold and silver had intrinsic value and people would be willing to exchange their goods and services for gold and silver and wouldn't ask any questions."

Now that he's outside the federal bureaucracy, Greenspan sold the 40+ years, central-banking monetary standard down the river.

A final note, from the Wall Street Journal, December 6, 1941: "Likelihood of a continuation of United States-Japanese discussions bolstered domestic commodity markets yesterday. Cotton traders apparently derived considerable encouragement from the latest developments in the U.S.-Japanese situation."

Every once in awhile, the world rolls over. The newspapers may or may not be less than forthcoming.