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  • The Obama Effect: A New Age of Perpetual Uncertainty

     “Certainty is the mother of quiet and repose, and uncertainty the cause of variance and contentions”

    – Edward Coke

    While the global economy struggles to regain lost ground from the depths of the Great Recession, a peculiar set of outcomes have come to fruition--the evolution of crashes and rebounds have dramatically transformed the historical cycle.  The arguments are similar to that of Global Warming: is this change been that of a natural progression and development, or is it the result of an underlying fundamental alteration?  While I don’t consider myself savvy enough to give definitive credence to one premise or the other, it doesn’t take a genius to notice a number of principal variations in regard to consumer and business confidence, and more importantly: ever growing and seemingly permanent uncertainty.

    Uncertainty is inherent in everyday life and is always a factor in investments.  By ushering in a new Presidency with an abnormally powerful legislature, markets breathed a sigh of relief in the understanding that one could more accurately forecast the economic impact of this political change.  Unfortunately, the only certainty during this presidency has been less of it—and both consumers and financial markets have gotten anxious.  Mixed signals coming from all facets of federal politics, squabbling in Congress causing extreme rhetoric and corresponding legislation, and no set of directives by which leaders seem to govern by, has led to a permanent sense of ambiguity and unease amongst the public.

    Whether we like it or not, consumers and investors’ fates are for the most part, undeniably intertwined.  The success of investments depends on the economy, and the strength of the economy depends largely on consumer spending.  And what does consumer spending depend on?  Certainty--the ability to forecast particular economic outcomes, the ability to count on a stable income and reasonable taxes, and the capability of their investments to achieve capital gains.  It’s fair to say that while markets initially assumed a more predictable political path once we reached the conclusion of the 2008 election  (which many times will assist in translating to a more stable economic path), the Obama Administration and floundering federal legislature has been anything but.  This realization has been a harsh reality for consumers and markets alike.

    We all have heard that quote that the only certainty in life is “death and taxes”, but in the Obama era, not even these are certain.  At what is hopefully the tail end of the worst panic since the Great Depression, consumers have been desperately seeking more stability in the economy and political feat.  Historical cycles have shown that when markets bottom out, increased consumer spending is what drives the recovery.  As they say, 70% of GDP is consumer spending.  But with a ruling political class bent on enforcing ideology rather than true reform, markets have lost trust (not helped by the sovereign debt crisis of course), and as recent polls confirm—so have consumers.  Consumers base planning on the probability of certain outcomes and particular assumptions.  If everything is in-flux and nearly everything is unknown to a certain extent, consumers become reasonably cautious to compensate for lack of these assumptions.  With national debt running out of control and public unease about dramatic actions taken by Obama and Congress (Obamacare, Financial Regulation, constant extension of unemployment benefits, discussion of more stimulus, aggressive rhetoric), consumers have checked out of the risk taking game until further notice.

    Obama promised no increased taxes on the middle class.  But that was before he spent multi-trillions and all but assured taxes on all classes with the passage of massive new spending and entitlement bills.  Now he spends most of his time attacking others, more often than not--business.  He assured the public that overhaul of financial regulation and health would be well thought out, but it seems that Congress hi-jacked it as vengeance on Republicans and Wall Street.  The Administration promised no more than 8.5% unemployment with the passage of stimulus, while we’re now stuck above 9%.  They guaranteed new jobs, but the only industry growing is the federal government (aside from their 3 million fantasy jobs “saved”).  Obama pretends to be concerned about our debt burden, assigns a commission to investigate, and continues to spend into oblivion.

    The way consumers respond to this type of behavior is to spend less.  They lack confidence in their ability to budget and plan accordingly.  Consumer sentiment decreases.  Unemployment may strangely decrease because people simply give up looking for a job.  They grow spiteful of government as a result of heated and often misdirected rhetoric against anyone who dares to disagree with their ideological world view—which feeds distrust, frustration, and worry.  Ultimately, all of this translates into hindrance of economic growth by paralyzing spending and investments.

    The role of uncertainty in financial markets is obvious.  Less certainty creates more volatility and less net long investment.  Uncertainty is natural in markets and never 100% avoidable, but in excess this uncertainty is destructive.  Tax increases on capital gains and corporations remain unknown but likely.  Investors have grown to distrust traditional rules as a result of favoritism rooted in ideology, as seen in the GM bailout of union bondholders.  The Administration and White House players abandon prior academic study--Larry Summers had previously concluded that extension of unemployment benefits lead to longer average unemployment, but suddenly changed his mind to conform to White House philosophy.  Markets see increased anxiety as a result of government intervention in every aspect of economic life:  compensation, taxes, forcing business into submission purely for political theatre, and with the passage of financial regulation companies are forced to ensure “diversity” on corporate boards.  Government sponsored entities continue to get free taxpayer dollars (see Fannie Mae and Freddie Mac) while avoiding any new regulation or winding down of assets, and even their executives escaped the pay czar while making millions.

    The effect of these actions leads to much more volatility.  The Volatility Index (VIX) bounces around more than ever.  Hundreds of billions of dollars sit idle in brokerage accounts.  Capital investments remain stagnant in regard to both individual and startup investments.  Investors grow more and more risk averse because the rules of the game keep changing.  Market movement is now largely based on herd mentality rather than fundamentals.

    The problem isn’t necessarily what politicians are doing (depending on your political affiliation), but more so their approach.  Markets and consumers don’t appreciate when leaders say one thing and then do the other, or when they claim to support one thing, and then support another.  Nobody knows who will come out on top on any given day and who will be directly affected.

    The result of excess uncertainty is an enormous detrimental impact on consumer and investor confidence.  Because of the close relationship of consumer and investor behavior, anxiousness feeds on itself, enhancing each group’s weaknesses.  On the heels of a market collapse, when paralyzed by fear of recurring crisis and the long arm of the federal government, it’s safe to assume that cash will remain on the sidelines in financial markets and consumers will continue to hold onto their scarce and hard earned cash.

    With approval ratings for Congress and the White House hovering around disastrous, it might be wise for them to ease up on the bi-polar behavior they have been displaying in order to calm consumers and markets.  Polarization of politics has injected even more volatility into daily life.  On any given day, depending on bribes accepted and favors handed out, legislation or executive branch action could swing dramatically in one direction or the other.  Until Americans have a fairly definite future in regard to their personal finances as well as the macro economy, uncertainty will continue to impede economic growth while damaging gains we’ve already made during “recovery”.

    While Obama calls this the “Summer of Recovery”, the unease of financial markets, businesses, and consumers seems to be telling a different and more troubling story.  It might help if they stop campaigning on how much they’ve done to change and restrain the system, and give the economy the freedom to actually recover. 


    Disclosure: No Positions
    Jul 24 3:04 PM | Link | Comment!
  • Go long….on Duration.
    Forget stocks. Considering the inherent risk they pose and their historical track record, stocks are for suckers.
    While I do play in the equity game for excitement and the occasional “hit” when timing index trends accurately, the real investment strategy lies with bonds—assuming you’d like to keep your principal.
    Even pension funds can’t seem to make money in stocks any more after doubling down on equities in the epic credit bubble market ride.  The result? Well, if losing money means success, then they most definitely succeeded.  Pension funds are underfunded by more than $1 trillion. Oops.
    Unfortunately for beneficiaries of these funds (i.e. the retirees), unions came up with this scheme to have employees pay minimal amounts into the system and assumed unsustainable returns during the good times. Nobody cared because investments were booming across the board.  Bonds were boring, so they dove into equities.  Sure, they were making 16% without breaking a sweat during the housing bubble, but they paid dearly for getting greedy—just as everyone else I suppose. Now they (and by default state governments, which translates to taxpayers) are on the hook for all this cash.  
    Hopefully they’ve learned their lesson and will follow the path of Liability Driven Investing (NYSE:LDI), which uses a long duration fixed income strategy. PIMCO posted this ( )during the tail end of the bubble, but I’d venture to guess that nobody paid attention considering equity markets were booming. Take a read, it’s quite interesting.
    Anyway, the basic approach is slightly altered for individual investors, but the key is to build a bond portfolio with long duration bonds.  Long duration in the bond world means more interest rate exposure, and earning slightly above index returns with minimal risk.  Sure, it’s not as sexy as equities, but personally I’d forego that guilty pleasure to actually earn capital gains and income along the way.

    Take a look at the six month performance of Pimco’s Long Duration Total Return Fund (MUTF:PLRIX) below, as compared to the DJIA.  One is up, the other is down.


    Long duration portfolios are best for an environment of decreasing interest rates. Sounds crazy considering that rates are already so low, right? But if you’ve seen CPI information lately, you’d know that inflation is essentially non-existent.  Governments have little leeway for more stimulus. This means that the Fed likely won’t be flooding more cash into the system, increasing the risk of inflation and rising rates.  And now there’s even talk of the dreaded deflation.
    Although interest rates are already rock bottom, long duration portfolios would thrive in a deflationary environment. Also, with current macro hesitation in global economic recovery, it’s fair to say the Fed will be leaving rates low for an “extended” period.  If you saw Fed chief Bernanke on the Hill yesterday, you’d agree he seemed a bit “uncertain” about the sustainability of this recovery.
    All of this means that interest rates will stay low, and with deflation, they might even get lower. My advice is to go long duration on bonds when building a fixed income portfolio.  You’ll keep your principal, get some capital gains, and even collect cash flows from interest payments along the way.  
    Considering companies are still eliminating dividends and handing out free heart attacks, I’d say that’s a pretty good deal.

    Disclosure: No positions.
    Jul 22 5:29 PM | Link | Comment!
  • Herd Mentality
    Let’s be realistic here. The market isn't ruled by invisible valuation laws that only the “in crowd” has knowledge of through financial wizardry class. Sure, we all know that academia has their models for valuing stocks: using forward looking dividends, growth, and required return. Is that how the market functions? 
    Even when using additional data such as future credit events that might hinder or benefit valuation, it seems that the mob has taken over Wall Street, bashing or rewarding your stocks based seemingly only on the flavor of the day—panic or euphoria.
    This seems even more evident these days as volatility hits the roof on a regular basis. Nobody trusts the fundamentals any more, except Warren Buffet. And the only reason his bets play out is because 1) he’s consider “smart money”, so people follow his investments and follow suit (herd mentality), and 2) because he buys enough shares to own a significant portion of the stock, giving him access to push for management and operations adjustments. 

    Most of us saps are stuck spending hours analyzing a stock’s potential growth through balance sheet, industry, and macro economic research. Even armed with the most robust data, you can buy what should be a perfectly acceptable stock with great prospects, only to have the broad market swallow you alive.
    Market movement today is run by herd mentality. Even the best stocks will be dragged down and stomped in a stampede of heavy bearish and hyper traded bets, feeding on their own misery. The last crisis proved that “buy and hold” is essentially useless, as 10 years of equity was wiped out, as seen in the DJIA average over 10 years below:


    While many people despise and bash on leveraged ETFs, for me it just adds more thrill to the investing game. Once I’ve picked stocks that I know should be winners, there is obviously no guarantee that they’ll perform or even survive over the long term. Capital gains are far from certain these days, even with an arsenal of fantastic stocks in your portfolio.
    I am a big fan of Direxion’s leveraged ETFs, which allow for big bets on daily market trends. If I feel the end of the prior trading day was full of Nervous Nellies, I load up on FAZ (bearish on financials), or BGZ (bearish on large cap). There are also plenty of others, energy, small cap, and the like that you can bet on. And it isn’t just bearish bets, you can bet on the bulls taking charge as well. Even better, they amplify returns (or losses) on the aggregate market, by 300%. Not for the faint of heart, but anyone playing in the markets these days has to have nerves of steal. While these ETFs notoriously lack perfect correlation and have a bit of tracking error, as a day trading strategy they definitely get the job done—assuming you guessed right on the direction of financial markets.
    In an economy still teetering from one day to the next, and markets perpetually on edge, these leveraged ETFs are fantastically fun, a little bit dangerous, and can help to hedge against when the herd decides to take a try at destroying your portfolio’s recent capital gains.

    Disclosure: No positions.
    Jul 21 6:06 PM | Link | Comment!
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