The United States Department of Agriculture’s (“USDA”) projected budget for 2012 is a staggering $145 billion, which is almost 150% of agricultural GDP![iii]  Okay, USDA has managed to creep into other areas besides just agriculture, but even the most jaded libertarian would not have expected USDA spending to exceed agricultural output. 

 In 1839, Congress established the Agricultural Division within the Patent Office and allotted $1,000 for "the collection of agricultural statistics and other agricultural purposes."[iv] The USDA was formed in 1862 and has subsequently grown in size and mission over the last 149 years.  Per the USDA website, its current mission is to, “…provide leadership on food, agriculture, natural resources, and related issues based on sound public policy, the best available science, and efficient management.”[v] The USDA has over 100,000 employees, which equates to roughly one employee for every 10 farmers in this country.[vi]  Some of this is attributable to the department’s ever increasing scope into new and unrelated or partially related areas.

 Why has the size of the USDA not been re-calibrated?  It is not clear what is the right size for the USDA (or any governmental department/agency for that matter), but 1.5x the size of corresponding GDP is not the correct size.  A starting point would be reducing the USDA to equal agricultural output, which would result in an approximate $45 billion annual reduction.  However, USDA should probably be a very small percentage of the output, resulting in far greater reductions.

 If this kind of back of back of the envelope analysis identified obvious government largess, how many other departments within the federal government are this out of line with their respective target market? 

 Of the total data collected, 60.44% exceeded estimated earnings, 9.23% were exactly the same as estimated, and 30.33% were below estimate.  Further, 11.57% of the total earnings per share exceeded its respective estimate by exactly one cent per share, while only 5.39% missed its estimate by exactly one cent per share. 

 Consistent with expectations, a majority of actual earnings exceeded estimate.  This was to be expected since managers have a vested interest in establishing earnings’ benchmarks they would likely surpass.  Many managers are compensated based on exceeding pre-determined earnings’ objectives so they would likely set a level that is reasonably attainable.  Further, managers are intimately aware of the adverse impact on share price if an estimate is missed.  Many management teams exert considerable effort toward influencing estimates developed by “independent” analysts, as well. 

 Since many financial analysts and even novice investors believe that most publicly-held companies manage earnings to some extent, it is no surprise that 11.57% of results netted actual earnings per share results that exceeded estimate by exactly one cent per share.  Over 20% of actual earnings per share either met estimates or exceeded estimates by exactly one cent.   Surpassing estimates by exactly one cent per share raises the perception (rightfully so) that managers are using accounting discretion (or presentation through non-GAAP adjustments) to manufacture or manipulate its earnings number, i.e., manage its earnings. 

 Earnings management can lead to more lenient interpretations of generally accepted accounting, which could reach levels considered fraudulent.  To avoid the continual pressure to increasingly manipulate its accounting, management teams sometimes take a “big bath.”  This is where a company takes a huge loss or drop in profits in a reporting period to clean up the income statement.  The “big bath” is seen as a way to true up a lot of the subjective uses of accounting without having a comparable, adverse impact on the stock, as many investors view “big baths” as a one-time occurrence. 

 Based on the results of this analysis, there are a number of management teams who are either really good at forecasting, or they are going against the spirit of accounting rules to engineer predictable and consistent results.  Companies that regularly meet or exceed estimates by one cent should be viewed with skepticism.   

 An unexpected outcome was the number of companies that missed per share estimates by just one cent.  Missing an estimate by one cent per share will, in most cases, adversely impact the share price disproportionately to the severity of the miss.  As a result, management teams have a significant interest in meeting or exceeding estimates, and if it is going to miss, to not miss by a small amount.  Further, most companies have enough discretion within their financials to be able to “generate” small improvements (or reductions) in the financial results, which should lessen the number of companies that miss earnings by only one cent per share.  However, as this analysis has shown, some companies do miss estimates by a small amount.  These companies appear to be much less likely to be managing earnings or manufacturing results. 

 In 1965, government spending represented 3.28% of U.S. gross domestic product (“GDP”) (http://www.bea.gov/national/). Between 1965 and 2010, the federal government increased spending by an average of 7.72% while GDP only increased by an average of 6.98% for the same period.  As a result, by 2010 government spending accounted for 26.41% of GDP. Over the last 10 years (2001 – 2010) GDP only grew by an average annual rate of 3.89%, with negative growth of 2.47% in 2009.  This is the first negative growth year for GDP since 1949.  During the last 10 years, government spending increased by an average annual rate of 6.91%. 

 Long-term government spending has consistently outpaced GDP growth, which has resulted in the federal government growing as a percentage of the overall economy.  As government continues to grow at a greater rate than GDP, it places a larger economic burden on society.  During the last 10 years the spread between government spending growth and GDP growth was a staggering 3.09 percentage points. As conveyed by the recent political battles in Washington, government spending has spilled over into the public arena.  Though the talks were directed at deficit spending, the underlying issue is government spending.  It is not clear what the “tipping point” is for government spending compared to GDP, but we are approaching it. 

 According to the Office of Management and Budget, the federal budget is expected to grow by an average of 4.45% between 2011 and 2016.  Based on the projected economic outlook, it is unlikely that GDP will be able to keep pace with this level of growth over the next several years.  Therefore, going forward government spending will continue to absorb a greater percentage of US economic output. 

 Though many options have been presented, no significant government spending reductions have been implemented.  Based on the polar opposite positions in Washington, no change to the long-term trend in government spending will occur until it is forced upon us, which will most likely be exerted by our debt holders.  And when the holders of US debt clamp down on US Government spending, it will be sudden and dramatic! 

What appears to be most upsetting to the news outlets is that they were not notified of the change in comparison versus the company actually presenting in this manner.  In all likelihood, Citigroup will not compare future quarters to the previous quarter, unless it is a favorable comparison.  Thus, this is not a change in presentation, but merely an adjustment in metrics to help convey the message management wants the investment community to receive. 

Though it is quite concerning that companies regularly utilize various techniques to massage financial results, it should not be accepted by the investment community.  Companies that fail to convey financial information in a straight-forward and direct manner should be viewed with skepticism.  Based on the confusing nature of the messaging, invest in Citigroup with caution, if at all.

 Everything the Government is doing is exactly what one would do if it wanted to bring on inflation!  Most likely, the primary objective of the government spending and monetary easing is to keep the economy from sinking further.  And at some point, enable the economy to recover.  It is unlikely that the economy will recover in the next year or two, but it will occur.  And inflation is almost certain to accompany the recovery.  The fact that inflation is not currently present is a favorable indicator for the near-term; however, current governmental policies will most likely create a highly inflationary environment in the medium to longer-term. 

 The Federal Reserve will not begin to raise the federal funds rate until the economy has several solid quarters of growth and unfortunately, most likely not until inflation is present.  The Federal Reserve has stated that drastically raising interest rates will cut off inflation before it becomes problematic.  This is predicated on the assumption that markets will react rationally.  After the most recent housing and tech bubbles that is a debatable predicate.  Further, even with bold moves it will take the Federal Reserve considerable time to raise rates from negative territory to 20% (2,000+ basis points), which is similar to where rates were during our last inflationary environment in the 1970’s/early 1980’s.  It is also possible that the federal funds rate may need to go way beyond those levels to stave off inflation.  The Federal Reserve will most likely not be able to respond quickly enough to curtail the inevitable inflation. 

 A second and more dire aspect of the situation is that the U.S. Government may actually want/need inflation.  The U.S. has a current debt of over $14 trillion (and growing), for which it has absolutely no plan to pay it off.  The massive government debt does not include Fannie Mae/Freddie Mac or our unfunded entitlement’s program, affectionately known as “off-balance sheet” liabilities.  The only way for the Government to pay off its debt is to turn a $14+ trillion debt into a much smaller, more manageable amount.  This will only happen through inflation.  By the Government inflating its way out of its current fiscal problems will operate as a bailout for the irresponsible and reckless individuals and governments that have racked up tremendous debt.  It will also dilute the wealth that all the responsible and prudent individuals accumulated.  Hopefully, the Fed will act in a prudent manner to protect the citizens of the country and not provide a bailout for the Government’s fiscal irresponsibility.  History is not in our favor.

 Until the Fed increases the federal funds rate, it is hard to argue that the economy is on any kind of solid footing.  It is not that the Fed has some great wisdom on the economy or that it is infallible.  Actually, it is quite the contrary.  Much of the massive run-up in housing was due to the extremely low rates set into place after “9/11” by the Fed.  Though the Fed has claimed that it is not in the business of popping bubbles, everyone (except Warren Buffett and the rating agencies) realized the housing market was completely out of control with no true underlying increased demand.  A 0% to negative federal funds rate means that as far as lending rates go, the spigot is wide open.  The Fed cannot reasonably pump any more money into the economy.  Therefore, it is difficult to place much optimism behind GDP figures or other economic indicators. 

 Where would the housing market, and subsequently the economy be if the federal funds rate was even at three or four percent?  This would still be a low interest rate environment, yet it does not take a doctorate in economics to extrapolate what would happen to the economy.  The economy’s present state is being artificially supported by the Fed’s extremely low federal funds rate.

 The Fed has backed itself into a corner where it cannot raise interest rates until the economy is showing several quarters of strong growth.  It, under no circumstances, can do anything that could throw us into another recession, because it does not have any meaningful tools to combat it.  Until the Fed moves the federal funds rate upward, there is no reason to believe the economy has meaningfully improved.