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Ray Merola
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Individual investor focused upon a limited number of diversified stocks. Seeks stocks selling below fair value; favors dividend growth. Advocates fundamental investment analysis, supplemented by the technical charts. Options strategies primarily employed to generate additional income or hedge risk.
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  • Eco-Political Lessons from 1937

    So now that the election is out of the way, what's the U.S. economic prognosis given the new political landscape?

    The sweeping changes to the House and Senate initially buoyed the markets, and for good reason. The Republicans ran as the “party of business.” Indeed, Dems in general and President Obama / Nancy Pelosi in particular have have demonstrated an irresistible urge for anti-business, populist rhetoric. Arguably, this has prolonged the Great Recession by stagnating business growth through sowing the seeds of uncertainty. Businesses do not invest upon the shifting sands of unknown future taxes, regulations or government mandates.

    Is the Republican sweep just what the doctor ordered?

    Instead of spouting off political slogans and talking points, let's begin by reviewing history: not election history, but economic history. We will focus upon the late 1930s. Specifically, the “Recession-within-a-Depression,” also called, “The Roosevelt Recession.” I picked this episode in American history since it came after the acute economic dislocation of the early 1930s; similarly involving the banks, real estate, and the Great Crash.

    We will set the stage with some earlier background history:

    From 1933 to 1936, the economy had begun to recovery from the depths of the Depression. President Roosevelt instituted a large number of economic and social policies, dubbed “The New Deal.” Arguably, they had helped to bolster the nation. These include F.E.R.A., or the Federal Emergency Relief Organization, who made federal loans and outright grants to cash-strapped States and municipalities. The W.P.A. (Works Progress Administration) and the C.C.C. (Civilian Conservation Corps) focused upon jobs: primarily national infrastructure improvement projects. Banking and investment reform were tackled, including the the creation of the FDIC and the SEC. The Social Security Act of 1935 was a crown jewel of F.D.R.'s first term.

    Critics argued the government was running deficits each year, threatening to bankrupt the nation. Indeed, an endless chorus complained that the policies were destroying American self-reliance, were federal “boondoggles” that wasted taxpayer money, and were creating a socialist welfare state.

    In 1937, upon a fresh landslide election, Roosevelt felt he had a mandate to continue his progressive policies. When he took office for a second term, most economic indicators had regained much of the ground lost since the late 1920s, with the notable exception of the unemployment rate.

    Several key policies were pushed that jolted a fragile economy into a second recession.

    Between March 1937 and 1938 the stock market fell 49 percent. The U.S. GNP declined 4.5 percent in 1938. A crisis of confidence ensued.

    What happened?

    Several government policy decisions enacted early in Roosevelt's second term that contributed to a second business shock:

    • The curtailment of governmental stimulus in an attempt to balance the federal budget

    • Additional government regulation; in the 1937 case, this included, amongst other federal meddling, increasing the power of labor unions, who in turn drove up wages beyond what the market could bear, and increasing bank reserve requirements, contributing to a refreezing of credit and liquidity

    • Raising taxes further depressing job creation, employment and capital formation

    The 1938 mid-term elections slowed down the Roosevelt Express. The public, while supportive of President Roosevelt, felt that some of the progressive policies had gone too far. A Republican mid-term landslide along with Roosevelt stepping back from some leftist policies changed the economic course. Unfortunately, it was after considerable damage was done to both Main Street and Wall Street.

    Does any of this sound familiar some sixty years hence?

    If history has the propensity to repeat itself, or we can learn from it, let's grade the Republicans on some key historical issues. While we cannot be sure of the final outcomes, we can project some likely results from their campaign rhetoric.

    Balancing the Federal Budget

    Republicans have generally espoused the need to “balance the budget” and “cut runaway spending” to “avoid bankrupting the country.”

    Federal actions around similar rhetoric was a fundamental reason the economy tanked in 1937-38. Fed Chairman Ben Bernanke knows this history lesson all too well. While the idea of continuing federal spending to prop the economy is a political loser, the alternatives include a recessionary relapse and/or deflation. Deflation could derail the U. S. economy for years. It is extremely corrosive. True deflation is not the effect of price reductions in certain commodities, for instance tech gadgets. This is a false comparison. Deflation is when the prices for nearly all goods and services move downward at once. No one wants to buy anything today, since it will be cheaper tomorrow. Salary and wages go into the tank. Business growth heads into reverse, as both the top and bottom lines contract.

    The Fed understands it must avoid this outcome, even to the point of risking future inflation. QE2 is a smart historical gamble. If the Republicans try to score voter points by dissing Bernanke, they flunk the course.

    Grade: “I” for Incomplete. The author worries the GOP will not do their history homework and flunk the exam.

    Government Regulation

    Republicans tend to emphasize job creation and business growth over government regulation. It's likely that they will continue to advocate a pro-business stance instead of promoting the government to solve America's economic woes. I envision decent GOP responses to managing the details of FinReg, energy policy, and labor policy.

    The Republicans will tend to seek more reasonable financial bank regulation than the Dems; looking to close the gaping holes versus punishing banking “fat cats.” I do harbor a concern they may try to score political points by grandstanding the anti-banker sentiment.

    Republicans with will advocate a pro-America energy policy, including resumption of deepwater oil drilling and the use of our vast reserves of shale gas.

    Private sector job creation will take the front seat.

    Labor “Card Check” legislation is dead.

    Grade: B      Republicans are making the right gestures.


    The GOP has been consistent about their desire to keep taxes down while the country is emerging from a recession. This lesson should be well-learned from the evidence from 1937-38.

    The Republicans understand that whether we like it or not, and regardless of our personal thoughts on social “fairness,” the creation of jobs and capital formation in a capitalistic society is generated by “the rich.” The poor do not create jobs. While government can and should encourage temporary growth through targeted programs, the engine of a democratic capitalistic country are the people with extraordinary drive and a willingness to work hard. Those who take risks seek rewards.

    The government may likewise attempt to spur growth through subsidizing new businesses. Indeed, this is also fleeting, unless it becomes a long-term handout. Sustained business activity and development is spurred by the hope by investors for future cash and recognition, not by the federal government “picking winners and losers” through tax engineering.

    Grade: A      The GOP will get this one right. Their success pivots upon getting their ideas through Congress.  The author is optimistic.

    Disclosure: none

    Disclosure: none

    Disclosure: none
    Nov 09 11:06 PM | Link | Comment!
  • Book Review: "The Intelligent Investor," by Benjamin Graham
    The original 1949 Edition of "The Intelligent Investor," by Benjamin Graham and published by Collins Business (Harper Collins Publishers), is now over sixty years old.  Graham is considered the "father of value investing." 

    Despite this short tome's age, I found myself chuckling while reading several passages: the book is timeless.  Absolutely timeless.  The wisdom and simplicy speaks to readers of any era.  I firmly believe this book could remain relevent for investors in another sixty years henceforth.

    Indeed, for any person endeavoring to understand the fundamentals and principles of value investing, this publication is highly recommended for their library.

    When the first edition of this book was written in 1949, the events and history of the Great Crash colored a significant portion of the content.  The 1929-33 market debacle was still a vivid reminder of the risks when investing in securities.  The Dow Jones average had peaked in 1929.  It would not regain the same level until 1954; five years after this book was published.

    Let me summarize some broad themes found in the book:
    • Benjamin Graham was an investor.  His book caters to investors.  By definition, he did not believe that "speculators," could make money day-in and day-out by trying to outwit and time the market.  While uncommon in his time, I believe Mr. Graham would consider "speculators" and current "day traders" synonymous.  His thesis: to be able to speculate successfully, one must be smarter than all the others trying to do the same thing.
    • He clearly offers counsel to all investors; ensure a "margin of safety." Risk taken should be rewarded by comeasurate reward.
    • The author speaks to two kinds of investors, "the Defensive" investor, and the "the Enterprising" investor.  I liken the Defensive investor in today's world as a person who does not have the time or inclination to analyze securities.  Graham encourages such a person to select a conservative bundle of large cap stocks and fixed income investments.  While Index funds and ETFs were not available in his time, I believe that Graham would advocate their use for the Defensive investor.  On the other hand, the author defines the Enterprising investor as a person with the propensity and ability to evaluate stocks with the intent to uncover undervalued issues.  He believed that beating the market averages is possible for such investors.
    • Graham espoused that hard work and arithmatic produced results.  In the long run, careful analysis and investment strategy provides entirely acceptable returns to the investor.
    Indeed, for the average investor, the author advocates simple investment philosophies emphasizing disciplined value investing and dividends.  Analysis of the balance sheet, earnings and PE multiples are paramount.   

    For the more aggressive investor, he recognizes their tolerance for risk and offers practical advice.  For such Enterprising investors, Graham cites "courage" of conviction as both admirable and necessary.  He offers sound investment approaches and principles of individual security selection.

    Graham writes in a comfortable, easy style.  The exception is when the author opines on "Stockholders and Management" interaction.  He openly admits his admonishment for both groups in this chapter.  This section is spot-on for today.  Little has changed in over a half century.  A great read.

    In summary, "The Intelligent Investor" is a foundation book for investors.  Benjamin Graham's practical advice, wisdom, and simple eloquence makes this book a timeless reference of sound investment philosophy, fundamental security analysis, and overall clear-mindedness when trying to make sense of "Mr. Market."

    Disclosure: none

    Disclosure: none

    Disclosure: none
    Oct 28 11:58 PM | Link | Comment!
  • Are the Fed and Washington Working at Cross Purposes?
    The FOMC meeting yesterday provided few surprises.  Unfortunately, Ben Bernanke is out of conventional bullets to rev the economy as Fed interest rates are near zero.  So the Fed dabbled about in an attempt to buy time while determining if QE2 is tonic or poison.  It would require some unusual machinations.  Wisely it's not been invoked yet.  While deflation is possible, the scenario has not been realized. 

    The U.S. bond market appears to think it's more likely.  The stock market isn't so sure. 

    Here's the bottom line: the Fed cannot be asked to do something that now rests squarely at the feet of Washington. 

    Essentially, the Fed can adjust interest rates to encourage lending, bulk up its balance sheet in an attempt to throw oil on troubled economic waters (QE1), and add thereby add liquidity to lubricate the economy.  I believe the Fed has done its part.  A banking and credit panic was turned into a garden-variety depression versus the Great Depression II. 

    What's needed now is for Washington to step up. 

    The Fed actions cannot (and should not) drive the economy.  They can "accomodate" the economy with loose monetary policy.  That's their role. 

    Washington sets policies and speaks from the bully pulpit to create jobs, lower barriers to capital formation, and instill business confidence.

    They are flunking the course on all counts.

    The U. S. economy needs jobs.  Jobs are created by businesses and "the rich."  The poor do not create jobs.  Nor do business startups.  Business startups can lead to job formation, but do not significantly develop short-term job creation.   

    Ongoing businesses, large and small, drive the United States job market.

    Washington is running completely counter to what the U. S. economy needs right now:
    • Certainty around taxes (preferably lower; or at least less rhetoric about punishing successful businesses) and associated regulations
    • Certainty around the future business costs to create jobs
    • Encouragement for capital formation and business investment
    • Government stimulus that creates jobs: line-of-sight.
    • SEC regulation that levels the playing field for the "little guy."
    Here's been the Washington game plan: 
    • Threaten to increase taxes on business and "the rich."
    • Embrace the populist concepts of social engineering and wealth redistribution.  Washington "picks the winners" versus the free market.
    • Health care legislation that is neither clear nor has the ability to curb future health care costs for business
    • Advocate additional unquantified federal regulation and controls on businesses both large and small.  I'm not talking about FinReg here.  I'm talking about selectively regulating all manner of businesses, but no clear direction on what businesses, when, or by how much.
    • Embrace Big Labor unions. 
    • Villify businesses, banks, and "the rich"
    • Beef up Big Government: more money for employees, save federal jobs, bail-out State payrolls, expand government agencies, redistribution policies.
    • Show little to no interest (or understanding) towards moving the SEC to stick up for the retail investor.  I believe it's the latter driving the inaction.
    Question: Which of these policy actions do you believe encourage business, banks, or individuals to invest and hire?

    Answer: None. 

    Businesses and individuals will invest and create jobs when the climate created by Washington accomodates grounding with respect to taxes, regulation, labor, health care, and future cost to hire full-time employees. 

    Populist rhetoric drives business and capital formation into a shell.  That's the reason that banks and corporations are hoarding cash and unwilling to spend on expansion or hiring.

    Ben and the Fed have done a good job to ensure that liquidity and interest rates are accomodating to business.  They have encouraged business to lend and individuals to invest. 

    You can lead a horse to water, but you can't make him drink. 

    Especially when the farmer is standing over the trough with a shotgun.

    Disclosure: none

    Disclosure: No positions
    Aug 11 6:52 PM | Link | Comment!
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