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An independent Registered Investment Advisor focused on performing independent, research based financial advice and planning services. Always "client focused" and independent from the common "group think" in the investment community.
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Andorra Investment Management
  • Crank up the printing press "The FED and Monetary Policy"

    October 18, 2010

    Dear Friends and Clients:  Q3 2010 Commentary from Andorra

    Crank up the printing press “The FED and Monetary Policy”


    “Opportunity is often missed because it is dressed in overalls and looks like hard work”.

                                                                                                    Thomas Edison

    This quarter’s newsletter while not dressed in overalls, may be interpreted as “hard work” because the FED and its’ activities can often be confusing which is further compounded by double speak from Chairman Bernanke (and especially when Greenspan was at the helm).  But, a strong effort should be made to interpret current FED intentions as this is likely to have long-term impacts both domestically and abroad.  Anyone with investable assets should take note.

    The Federal Reserve System was created by the Federal Reserve Act, enacted by Congress in 1913.  This essentially created the FED and our modern banking system as we know it today.  The motivation to create such a system was due to multiple financial panics that wreaked havoc on the United States economy.  When it began the FED was intended to provide liquidity to the financial system, act as a lender of last resort and “smooth” the business cycle.  Today it has additional functions, some of which have been mandated by Congress.  Whether or not the FED is controlled by the U.S. government is often debated.  Directly, the FED is not “part of government” and is intended to be a semi-autonomous institution free from partisan politics to pursue its’ mandate through monetary policy.  To this day it is an often misunderstood institution peppered with conspiracy theories about who controls it and its true objectives (just type in FED, money supply and conspiracy into Google).

    Simply put, through control of the money supply (monetary policy = money supply) the FED seeks “maximum employment, stable prices, and moderate long-term interest rates” (source: Purposes & Functions of the Federal Reserve System).  This translated basically means that the FED is supposed to be the main entity that controls the economy through monetary policy to achieve its’ “mandate” (referenced above).  This is why the FED is so important!  Understanding where the FED is headed through monatery policy decisions can be very telling of the economy and interpreting these signals should impact investment decisions. 

    OK, so what is monetary policy (MP)?  Just think about money supply and how it can be, ummm…manipulated.  The FEDs most often discussed tool to either stimulate or cool the economy is through control of the Federal Funds Rate (just think “interest rates”).  If the FED increases the federal funds rate the intention is to cool the economy as their mandate of “stable prices” is likely running above plan.  Translation, if inflation is heating up the FED will increase the federal funds rate in an effort to increase interest rates with the intention of slowing the economy though a constriction or “tightening” of the money supply.  Remember, “stable prices” is one FED mandate and high inflation can be detrimental to economic stability.  Currently we are obviously not generally experiencing rising prices in the economy.  The FED will often refer to an “easing or tightening bias” in their minutes when discussing interest rate direction and the economy.

    Right now deflation is a real concern and the FED has explicitly stated that it will “consider it appropriate to take action soon”.  Currently the FOMC (Federal Open Market Committee) has reduced its’ federal funds rate to 0-0.25% as of December 16th, 2008.  Interest rates have been virtually near zero for almost two years!  In the 1990 this rate hovered basically in the 3%-5% range and 8%-18% during the 1980s.  Now this is a good time to ask yourself, interest rates have been lowered to near zero and two major things have happened, or not happened.  The economy is still very sluggish and interest rates are 4%-5% for a mortgage and anywhere from 8%-12% for credit cards.  If the FED has targeted rates at 0-0.25% level and consumers have to pay substantially more for credit or a loan where it the difference going?  BANKS!!!  So the FED dropping rates to virtually zero for banks should incentivize them to lend.  The problem on this front it twofold, banks have become reluctant (strict) to lend and consumers (you and I) have not wanted to take on any more debt.  These two factors combined have led to low credit creation and a recent spike in the household savings rate.  On the balance this is a good thing that U.S. households are paying down debt and beginning to save more money, but at the same time this is a negative factor for businesses.

    Now back to the FED and with interest rates to levels at which they cannot go any lower, what do they do?  Crank up the printing press!  The FED is desperately afraid of deflation.  Here is where things become very complicated.  “Normal” actions of monetary policy are to either the increase or decrease in interest rates which normally makes it either cheaper or more expensive to borrow.  But cheap money has not jump started the economy and the FED is switching to Plan B, Quantitative Easing (or “QE” for short).  QE is simply the FED (or any other central bank) increasing the money supply.  This is intended to push up asset values as the FED will enter the financial markets and buy long dated Treasuries and “other assets”.  One direct objective of QE is to drive up values of financial assets which will, in turn push market interest rates down and drive equity values up.  Lower interest rates for businesses and consumers, while the economy gets a boost from more dollars flowing in the financial system sounds like a good plan, right?  The problem is financial markets are very adept at incorporating a new level of supply into market prices, meaning the dollar will drop in value.  This has already begun to happen as the market has heard rumors of QE the dollar has slid in value versus most major currencies.  Non U.S. dollar denominated assets and commodities have already jumped in value.

    So, the FED has stated its’ intent to fight deflation and create a healthy level of inflation in the economy.  This will at best be a delicate balance.  In the short run positive outcomes from this policy should be decreased borrowing costs, increases in business investment driven by higher demand for exports due to a declining dollar, which should eventually flow through to higher employment and then the Holy Grail…a happily employed consumer with a rebuilt balance sheet.  To quote PIMCO, “the possibility for policy errors is high”.  Down the road potential negative outcomes from this policy are that consumer inflation will increase as the dollar weakens with import prices rising steadily.  Investors will likely rush in to commodities as a dollar hedge which will drive prices even higher.  Asset prices may also increase at a fast pace with wages not keeping pace and further leading to another boom and bust cycle that we have just experienced.  In pursuit of economic growth the FED may be setting the stage for another financial crisis due to an asset bubble fueled by loose monetary policy.  But as witnessed before, history has taught us that bubbles are hard to predict and may go on for far longer than anticipated.

    Economic Outlook

    While most remain cautious that the economy is in a slow recovery mode as private sector employment has begun to pick up, public employers are still hurting and shrinking their workforce as this segment of the labor market is very much a lagging indicator due to reduced tax revenues.  It is estimated that 1 in 7 jobs are due to a state or local government employer.  Businesses have reduced prices when necessary and current deflationary conditions that the FED is trying to fight are indicators of the lengths to which businesses will compete to maintain market share in a weak economy.  In addition to the QE debate and the impact on inflation, two vocal groups have emerged on the debate over fiscal policy.  One side is supporting government stimulus spending and another is advocating that the federal government pay down debt and cut public spending.  These “austerity measures” to reduce debt and spending levels, and their impacts are hotly debated.  In Europe these issues are literally causing riots in the streets (see France’s recent pension reform proposals and the public’s reaction).  In the U.S. it’s likely that proactive policy action will continue, while at a reduced level on the fiscal side, with monetary policy initiatives that should increase the likelihood of a sustained economic recovery.  Continued high unemployment with a potential for inflation hitting the U.S. consumer could be a stagflation cocktail if the FED doesn’t properly execute on its’ QE plan.


    QE will reduce the potential for a deflationary spiral.  With that, it must then increase the likelihood of inflation.  This is all predicated on the FED launching its QE2 policy as it has commonly become known in the financial press.  Again, the risk for policy errors is high as this is a highly unusual activity.  This will be a balance on the “deflation-inflation rollercoaster” and the debate may continue for some time.

    As mentioned in my previous newsletters look to diversify away from U.S. dollar denominated assets (in accordance with risk tolerance) as the FED weakens the dollar in the coming months.  This will be a classic “risk on” trade where EM debt and equity and both DM and EM high yield should perform well.  Also, the addition of TIPS and other inflation protected assets would be a good diversifier to portfolios.   This has been a good strategy and should continue, but not forever.  As the FED moves to weaken the dollar and spur spending at some point in the future liquidity will have to be unwound from the financial system.   When the inflation pump has been primed U.S. government debt will be repriced with a huge downside risk.  But exactly when that will happen, we’ll have to wait and see.


    Kurt Stabel

    Disclosure: domestic and international debt and equity ETFs and Mutual Funds
    Nov 30 3:46 PM | Link | Comment!
  • The Long (Slow) Rebuilding Phase


    August 1, 2010 Q2 2010 Commentary from Andorra

    "The Long (Slow) Rebuilding Phase"

    The U.S. economy has entered, and still continues in an anemic recovery phase. Some indicators such as manufacturing and private sector employment are starting to show signs of life in the last few months but, on the balance

    Employment and housing are often considered keys to any economic recovery and these metrics have been languishing for months. The good news: these indicators and others have leveled off are not continuing to trend down as they were during most of last year. This is hopefully much needed confirmation that some semblance of a base is being established in the U.S. economy.

    The economy like financial markets can be prone to panics and manias, and many employers post-financial crisis quickly reduced workforces to "right-size" employment levels in an effort to weather the coming storm. This is where one of the major problems currently facing us lies, growing employment back to pre-crisis levels. Long-term, hopefully employers don’t become accustomed to doing the same (production and business output) with fewer workers on their payrolls. This would be another structural problem to overcome in addition to a U.S workforce that is facing the continuing specter of outsourcing to other low-cost markets overseas.

    strong recovery signs seem few and far between.

    Economic Outlook

    To foster a growing economy hiring levels need to return to much higher levels than are currently being exhibited in the marketplace. Estimates vary, but approximately 125,000

    To return to a level of unemployment many consider healthy at around 5%, the economy would need to create

    The U.S. savings rate has swung solidly back into positive territory post financial crisis. "Negative savings" began in April 2005 and was noted by many as an ominous sign predicting problems on the horizon for the U.S. economy. It is easy to now look back and say AH HA! yes that was a telling sign that we were headed for trouble. But, it can now be noted that the savings rate is now positive with consumers rebuilding their personal finances and paying down debts. Long-term this will be

    jobs need to be created each month to keep the unemployment level static (currently unemployment is running almost 10%, 12%-13% in California). Estimates of anywhere from 7-8 million jobs have been lost since 2007 with many economists stating unemployment levels have not been this high in 26 years. The job market is definitely not functioning well and unemployment has been characterized as "persistently high" versus past levels. at least 200,000 private sector jobs each and every month for many years to substantially reduce current unemployment levels. Going forward, whether or not this is possible or will happen is debatable but we feel it confirms that we as a nation are in for a very long recovery process. Months ago many market pundits blindly predicted a "v-shaped recover" and that we would quickly snap out of the current slowdown. It now seems that these "experts" were basing their analysis on the old "we’ve seen this before" and "this is what usually happens" after a significant downturn in the economy. But, it is different this time as this is an asset bubble of epic proportions. It will take time to realign public and private debt to rational levels and the consumer has a long rebuilding phase which is not yet finished. a substantial net positive for the economy but in the short to intermediate term this means that dollars are not being spent. The consumer accounts for over 70% of the U.S. economy and spending levels will likely stay at moderate levels until confidence returns that employees will stay employed (a fear of being laid-off is a powerful savings motivator) and newly re-hired employees have money to pump back into the economy.

    Clearly, putting America back to work is going to take years. Some have suggested (and others with strongly argue) we may have entered a period of "structurally high unemployment". Government officials have recently begun to focus on the "real economy" and not Wall Street bailouts. This will be a net positive if government can foster real incentives for companies to hire workers and banks to begin lending again. On the balance credit is still tight and companies are looking for signs of a growing economy to feel comfortable and start hiring again. This is the old "chicken or the egg" argument and hopefully someone can step in and end the standoff. A mechanism to move banks to offload their record amounts of cash from their balance sheets would be a good start but finding sound places to lend and put the money to work will be a problem.


    Where does that leave us? Deferring to PIMCO and their "new normal" thesis it does seem that we are in for a drawn out recovery phase. Hopefully the dreaded threat of a "double dip" recession has passed but many fear we are not yet out of the woods. In short, the US economy from an investment perspective seems quite a gamble

    The debt crisis that hit many members of the European Union is a reminder that a new crisis may be just around the corner and now is the time to realign portfolio holdings. Developed Euro Zone economies and the U.S. will be dealing with high debt levels and low growth rates for decades due to the explosion of sovereign debt. Going forward, be proactive with adding emerging and international market holdings that are not overleveraged and this will pay big dividends in the future.


    Kurt Stabel

    versus other alternatives. On almost every point it appears that it would be less risky for investors to venture overseas to economies that are not overleveraged and growing at much faster rates versus the U.S. economy. As emphasized in last quarter’s newsletter look to diversify away from U.S. assets, if in accordance with risk tolerance or after a run-up and move into higher yielding assets abroad.

    Dear Friends and Clients:


    Disclosure: domestic and international debt and equity ETF and Mutual Funds
    Nov 30 3:41 PM | Link | Comment!
  • Macro view for early 2010

    April 25th, 2010

    Dear Friends and Clients:  Q1 2010 Commentary from Andorra


    “It was the best of times…it was the worst of times” (a quote from “A Tale of Two Cities” by Charles Dickens).  This piece of Dickens’ quote is very telling and analogous to the current scenario playing out in the US economy and capital markets.  Clearly there is a bifurcation that has developed from the “real economy” or what some call “Main Street USA” (still hurting by almost every measure) and the capital markets (the past year has been good to investors who did not abandon ship at market lows).  Asset prices have partially recovered (non real estate assets that is) which has prompted many market watchers to be encouraged by a developing “positive wealth effect” and potential stimulative impacts this will have on the domestic economy.  But on the balance “real” domestic economic activity, while picking up by many measures, still remains weak.  The exact reason for this outcome is not fully clear but most likely can be attributed to government bailout measures benefiting members of the financial community (particularly big banks and financial companies) and not yet trickling down to Main Street.  In short, the government sponsored liquidity effect has propped up asset prices and installed, while likely artificial, a base in the US economy that has not yet translated to meaningful job or wage growth.

    It is no longer a secret that large US banks are hording massive piles of cash in an effort to rebuild their balance sheets due to pools of toxic assets.  Politicians and pundits alike have poked, prodded, and tried to cajole banks into lending without much success.  Recent feedback from businesses state that commercial lending had resumed but is still difficult to access and remains well below pre-bubble levels.  Whether or not current bank reserves which have grown to historic levels will cover current and future bad residential and commercial mortgage debt is unclear.  What is very clear is that banks are much more comfortable depositing newly created money (quantitative easing) at the FED than loaning out money to Main Street (according to the FED’s statistics as of March 21, 2010 banks have over $1.1 trillion dollars deposited at the FED).   FED Chairman Ben Bernanke has acknowledged in public that banks hoarding cash is a problem with no clear solution.  This begs the question: are banks concerned that future write-downs will continue and also be massive, and/or would banks rather sit on this money, wait for interest rates to rise and then begin to lend which will allow them to make much greater returns on their loan portfolios.  Where interest rates have nowhere to go but up and banks typically begin lending again after economic activity has turned the corner, we believe it is a bit of both. 

    A passage from “Where are the Customers Yachts” which refers to bankers and how they deal with their clients:

    He says yes only a few times a year.  His rule is that he reserves his yeses for organizations so wealthy that if he said “no”, some other banker would quickly say yes.  His business might be defined as the lending of money exclusively to people who have no pressing need for it.  In times of stress, when everybody needs money, he strives to avoid lending to anybody, but usually makes an exception for the United States Government”.

    It is worth mentioning that the book “Where are the Customers Yachts” was originally published in 1940 by a man who had a brief career on Wall Street during the “Great Crash” of 1929.  It seems that much of his experience nearly 80 years ago is still relevant today.  The lesson that can be carried forward from this book is events do repeat themselves, while not always with regularity, and we should not forget the lessons of the past.  Bankers are just people and can be prone to panics (the banks stopped lending as witnessed during 2009) and manias (the sub-prime lending bonanza when anyone with a heartbeat was approved for a home loan) which happen all too frequently over long periods of time.

    Economic Outlook

    What currently appears to be an economic recovery in the U.S. may prove to be lumpy and anemic which in our view rests on a three legged stool.  In the developing world global growth needs to be strong and sustained (growth will be hampered in the developed world by continued deleveraging and boated government budget deficits for the foreseeable future), interest rates must stay at moderate levels that do not choke off “green shoots” in the economy, and future shocks to the financial system like the bankruptcy of Lehman must be avoided (but watch for high budget deficits to continue to provoke sovereign debt problems from the PIIGS, Portugal, Italy, Ireland, Greece, and Spain, which may make market nervous for years to come).

    The emerging markets (NYSE:EM) or developing world (the usual BRIC economies of Brazil, Russia, India, and China, but may also include the likes of Taiwan, Korea, Chile, Indonesia, Poland, and Mexico which are also worth mentioning) will be relied upon to be a major source of global growth in the coming years.  GDP growth in these countries is expected to be anywhere from 5%-10% in the near future (source International Monetary Fund “World Economic Outlook 2010”).  EM economies have and will continue to benefit from relatively low debt levels vs. the developed world which has allowed them flexibility to internally stimulate demand while maintaining sustainable debt levels.  Many of these countries, specifically Brazil, are resource rich and may benefit from a sustained recovery due to both high prices for natural resources and strong inflows of capital.  This will continue to contrast with developed markets which will be boxed in by high debt levels and structurally high unemployment.

    In the developed markets or developed world (primarily consisting of the U.S. and mainland Europe) GPD growth is expected to be between 1% to 3%, with a strong possibility of a GDP contraction for some of the PIIGS.  As mentioned, unemployment continues to be a problem.  Some have mentioned a “new normal” which might include much higher levels of unemployment (a structural shift) than we are accustomed to, which many see continuing for many years.  Others point to inventory rebuilding and industrial production showing strong signs of recovery in the U.S.  Industrial production has been improving with capacity utilization coming off record lows of June 2009 but current numbers are still at extremely low recessionary levels.  This, coupled with many workers who are employed part-time and unable to find full-time positions (U6 running around 16-18%) and full-time workers currently experiencing furloughs, we expect the unemployment picture to remain difficult which will have spill-over effects to other sectors of our economy (state and local budgets will remain strained for many years).

    Further US growth that was experienced during 2009 was strongly influenced by government stimulus measures and policy actions designed to prop up the financial and housing sectors.  The results seems to be fairly good in salvaging the financial system but the housing sector is still on life support and is facing the expiration of tax credits and mortgage rates that are expected to rise.  This coupled again with the previously outlined high unemployment rate and many workers who are experiencing furloughs or layoffs seems to set the stage for warning signs for the residential housing market.  Participants in the mortgage business report bottlenecks at banks and financial companies unable to cope with the wave of foreclosures which may lead to a massive “shadow inventory” of unsold homes.  While an artificial base may have been established in home prices, values in outlying areas could be in for another down-leg (or at the very least a “lost decade” of appreciation) and growth rates for “prime” real estate may be below trend for the foreseeable future.


    Where does that leave us?  The developed world is due for a slow recovery, EM economies are expected to post strong GDP growth rates and the U.S. consumer will go through a long deleveraging and recovery phase while trying to rebuild his or her household balance sheet.  Our outlook for client portfolio’s on a “relative” basis is to underweight U.S. equity positions, within that asset class concentrate on U.S. based companies with strong international sales.  Separately, strive to overweight international and emerging markets while avoiding companies with heavy exposure to Continental Europe.  For fixed income look to shorten duration across the board and move to EM and International Bonds that will provide betters yields with a lower risk/return profile vs. developed markets.  Inflationary risks are building on the demand side, not so much from U.S. led consumption but from the EM economies which will be strong consumers of raw materials in a world where large commodity players will able to exert more control over basic material prices going forward (see recent news stories on the new Iron Ore pricing scheme).  As mentioned above, the PIIGS will have problems which at times will seem insurmountable.   This may lead to periods of strength in the US Dollar vs. other currencies which will present as price weakness in non-US assets.  This should be seen as an opportunity to further diversify away from dollar denominated assets into higher growth opportunities abroad.  Our outlook is to remain vigilant in diversifying away from any overexposure to US assets which have had a tremendous run during the last year.


     Kurt Stabel

    May 03 2:47 PM | Link | Comment!
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