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The One Eyed Guide ( is Bob Small who: solo traveled to 25 countries by age 21, has a degree in Economics, an MBA from Columbia University in Marketing and Finance, has been a brand manager, was a licensed stock and options broker during the 87 crash, ran a $450... More
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  • Who Profits from Deficits?

    Ever wonder why Dick Cheney, a businessman’s businessman stated, “Deficits don’t matter”? The nuanced view is that Cheney meant but didn’t say “as long as GDP grows faster.”  There is a much simple explanation:

    Government deficits help business profits no matter what they do to the common man or the nation

    which may help explain why business profits have gone up so much while job growth has been weak as the deficit has ballooned.

    The new all-down-side conventional wisdom on deficits was reflected in John Mauldin's article the Dark Side of Deficits  but as a fan of Minsky's Financial Instability Hypothesis he should have also recognized that Minsky’s math models conclude that government deficits directly increase corporate profits. 

    For stock pickers the issue is not what happens when deficits go up but what will happen if austerity mania dramatically drives down deficits. The danger in a nutshell is:

    Reducing deficits during a time of less than full employment will directly reduce corporate profits.

    Minsky got to this conclusion on profits by exploring the effect of Government Taxes, Spending and Deficits on the basic National Income equations of Y=C+I, Y=C+S and S=I (Y=National Income, C=Consumption, I=Investment, S=Savings) that is so often quoted by conservatives as the reason that we need to save  and invest more.  (ex/im is left out  of my explanation as it does not significantly change the profit effect of deficits due to the international reach of major corporations.)

    Based on his mathematical models, Minsky believed that modern economic practice traded inflation for recessions and that increased deficit spending during recessions directly increased corporate profits.   Minsky advocated deficit spending during a recession to increase corporate profits so that there could be a rapid recovery.

    Reducing deficits is only a problem for profits if Minsky is right.  Those interested in the models can read his book Stabilizing an Unstable Economy, Chapter 7.  (Note that Minsky may not have been popular because his writing is hard to decipher at best and this is even worse as it requires advanced math.)

    Neoclassical economists use the same basic equations so they should come to the same conclusion if Minsky is right. 

    If reducing deficits also reduces corporate profits then investors can anticipate a near term drag on profits as well as all the other things that liberals rant about. Dirk van Dijk’s of Zacks rant on The Budget Deficit is Decreasing fails to mention the profit effect even though continually increasing profits have been the main reason for the stock market's recent rise.

    If Republicans paralyze government and force rapid deficit reduction there should be a real shock to profits.  I have to state that Republicans have not been successful in reducing deficits in recent history no matter what they claim during campaigns so this should be a short term event. It will not be good for market valuations if it occurs.

    It is pretty obvious that tax holidays for business like those recently proposed by Obama will directly increased corporate profits but most deficit spending is not as clearly connected.  Perhaps we can check to see if real world performance of earnings seems to increase with growth in deficits.  If Minsky is correct then corporate earnings will vary according to changes in three things: GDP growth, inflation, and deficits. 

    If deficits truly increase earnings then you might see a situation where deficits increase, earnings go up but inflation and GDP growth are low or negative.  Charting the quarterly change versus YAG in these shows an interesting chart which might indicate this is correct – make your own conclusions or start a PhD thesis to actually do correlations and prove it one way or the other (Notes: 1. I am trying to get started on a Doctorate on measuring consumer perceptions of Healthcare cost/benefits so I don’t have time and 2. The Inflation and GDP number are shown on an axis 1/10 of the size of the change in Deficit and Earnings which makes sense given the relative size.)              


    It would be nice if someone who could do the math like Krugman made a comment on Minsky’s equations and corporate profits. Of course, few readers of Seeking Alpha seem to accept anything from Krugman so maybe a shout off between Krugman and the anti-stimulus Barro would be better.  

    Disclosure: None for this post
    Sep 15 7:28 PM | Link | Comment!
  • Did the NYSE Circuit Breaker cause the Flash Crash?
    A number of high frequency traders sold their positions and exited the market in the minutes before the May 6 “flash crash”.
    The question regulators need to answer before they add new circuit breakers is: “Why did traders exit the market?”
    When you look at the daily chart after 2 p.m. it’s pretty obvious that the market was going down rapidly and in a few minutes a 10% down circuit breaker could be trigger on the New York Stock Exchange. The circuit breaker would have shut down trading on the NYSE for 30 minutes. If you are a trader with an average stock ownership time of 11 seconds you want to avoid a 30 minute forced hold like the plague.   You also want to have a lot of liquidity for when the market opens again. Exercising the better part of valor, you might sell everything and wait for the dust to settle.
    If enough traders do this, the “flash crash” could have occurred because of a lack of buy orders. These traders had very short holding periods (11 seconds, some less) so there might not have been an unusually large surge in sell orders but there would have been a lack of offsetting buy orders. Add sloppy programming and you get stocks with no bids priced at zero: Flash Crash!
    In slow motion:

        Market goes down and approaches Circuit Breaker level
              Some High Frequency Traders into exiting market.
                                       Resulting in
                                       Lack of bids
                                 which combines with 
                                  Poor programming
                                        to give a
                         Flash Crash with bids of zero!

    The thing that is happening right now is everybody is fixing the poor programming so there will be an orderly market (no bids of zero) if this happens again.
    This means that the next time the market starts toward a circuit breaker due to a high volatility day there will be no Flash Crash to disrupt the market and it will get to the circuit breaker.
    Imagine what will happen if all major markets in the USA are shut down at once:
    • Traders who still have open positions will try to adjust them on whatever secondary markets are open. 
    • The extra volume overwhelms these markets in seconds forcing trading to suspend on them
    • Instant global crisis
    Circuit breakers will increase market volatility if High Frequency Traders need to be out of their positions before a circuit breaker kicks in. As markets approach circuit breaker levels buy orders will disappear and the market decline will accelerate toward the circuit breaker.
    Setting Circuit Breakers at 5% will just make it more likely that they will be hit and if they are uniform across all US markets then it will cause an international crisis.
    Shutting down the market with a circuit breaker does not even have any theoretical justification because it eliminates price discovery. The reason High Frequency Traders must be out of the market is because they cannot do price discovery or even minor adjustment to positions.
    The proposed trading stops in individual stocks are only going to encourage traders to exit quicker. The scary issue is that these stops may seem to work during a test period if there is no major event but during a general collapse they will quickly drive out computerized traders as information flow become erratic due to stocks going in and out of trading stops. As traders decide that the market is untradeable and leave the general decline will accelerate.
    Rather than circuit breakers, regulators should look at slowing computerized trading during times of extreme volatility. Collars using a simple buy minus or sell plus rule worked very well at limiting volatility and a 2010 version should be considered in the place to the original 1987 collars. The excuse that uptick rules can’t be done with modern computerized trading misses the point.
    Regulators need to remember that the objective is to allow orderly price discovery without a market collapse and this probably means that the ability of traders to make money with their fancy computers may disappear for a few hours.
    Perhaps I’m wrong that high frequency traders want to be out of the market during a general market shut down or will have no problem when a large number of stocks are timed out – but I don’t think investors who are less risk tolerant than I (most investors) want to take the risk.

    Disclosure: Author holds short positions in the S&P 500 and the NASDAQ 100
    May 18 7:51 PM | Link | 1 Comment
  • No Risk Diversification in International Markets
    See the chart below if you think that investing in international markets diversifies risk.  The correlation on the timing of these moves is close to 100% and the statistical correlation on the actual moves would be very high too.   This can only be explained by program trading that can move all markets.  This not good. 

    S&P500 Index 5_6_10
    S&P500 Comp Index 5_6_10
    DJIA Index 5_6_10
    DJIA Index 5_6_10
    NASDAQ Comp Index 5_6_10
    NASDAQ Comp Index 5_6_10
    Brazil Bovespa Index 5_6_10
    Brazil Bovespa Index 5_6_10.png
    Mexican Bolsa Index 5_6_10
    Mexican Bolsa Index 5_6_10
    TSX Comp Index 5_6_10
    Canada TSX Comp Index 5_6_10

    Disclosure: Short S&P500, NASDAQ 100
    May 06 5:21 PM | Link | Comment!
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