Monthly Archives: April 2012
Enduring the Pain in Spain.
There is no doubt that the crisis in Spain is getting worse, threatening to drag down the rest of Europe, and ultimately the US, with it. Over the weekend, Standard and Poor’s downgraded the debt of 11 Spanish banks, after downgrading the country’s sovereign debt weeks earlier. Further downgrades are a given so expect them in your regular Monday morning headlines. Expect more deposit flight from banks and spiking of sovereign bond interest rates.
The country is now officially in recession, as are seven other countries, including Great Britain. Spain’s unemployment rate is now at 24%, the peak seen in the US during the great depression, and is 50% for those under 25. It all adds up to more deposit flight from banks and spiking of Spanish sovereign bond interest rates.
It was easy to dismiss the long, tortuous descent into the Greek bond default as irrelevant and just a favorite topic of a few journalists, as it only accounted for 1.3% of European’s $16.7 trillion GDP. That makes Greece as about as important to the continent’s total fiscal health as the bankrupt cities of Vallejo, CA, Harrisburg, PA, Central Falls, RI, and Birmingham, GA, combined, are to the US.
Spain is another kettle of fish, with the fourth largest economy accounting for 6% GDP. Spain is an even larger portion of the European financial system, with bank assets at $3.7 trillion.
Don’t expect an improvement in the Spanish economy any time soon. It just passed one of the most austere budgets in European history, attempting to roll back decades of over spending and under taxing in one shot. While austerity is great for balancing the budget for the short term, it also triggers recessions which create longer term structural problems, as it has already done in Great Britain and Greece.
The only possible growth strategy for Europe is for the private sector to ramp up spending while the governments are cutting back. In Europe, that means getting rich countries like Germany to spend more to create end demand for poor countries. However, in reality, companies run the opposite direction, hunkering down during times of economic uncertainty.
There is also an additional internal conflict afflicting Europe in that the debt heavy counties of south need inflation to devalue their debt, but deflation to restore their international competitiveness and growth. It all means that the Spanish downturn will be longer and weaker than previously thought.
In December there was a big splash when the €500 billion LTRO was announced to take distressed sovereign debt off the hands of the banks at extremely generous prices. That has since fizzled. Now hedge funds are betting that the other shoe will fall. A second LTRO is a given, but how long will it take them to realize this and how far will bond prices plummet until we get there?
Don’t count on any US bailouts to ease Spanish pain, especially during an election year. Treasury Secretary, Tim Geithner, personally told me last week that Europe was a rich continent and had adequate resources to solve its own problems. Translation: no cash for the beleaguered continent.
It all makes my short position in the Euro through the (FXE) look pretty interesting. Some of the weaknesses mentioned above are already well known and priced into the currency markets, but not all of them. And the Europeans have a seemingly endless talent for discovering new structural problems as time goes on. Those unintended consequences can be a bitch.
With eight governments having fallen since the crisis began, and a ninth in France certain to go this weekend, who will be next is anyone’s guess. We have all become Spanish bond traders, whether we want to or not. Watch those screens.
Austerity’s Unintended Consequences
The Tax Rate Fallacy.
When anyone starts lecturing you that the US has the highest tax rate in the industrialized world, just turn around, walk away, and pretend you never heard of them. This person is either ignorant about this country’s taxation system, or is deliberately trying to deceive or mislead you.
According to a report released by the Internal Revenue Service, America’s tax collection agency, the top 400 individual tax returns filed in 2009 reported an average gross income of $358 million each. The average amount of tax paid by these individuals came to under 17%, less than half the maximum Federal rate of 35%, which kicks in on annual income over $372,950. This explains why Warren Buffet pays a much lower tax rate than his secretary. It really is true that in America, only the poor people pay taxes.
Look at any international comparison of taxes to GDP, and one can always find the United States at the bottom of the table. Low American taxes is one of the main reasons why I moved my company here from England 18 years ago. Take a look at the Fortune 500, where one third of the largest companies pay no tax at all, and many that dominate the top of the list, like the oil majors, pay only token amounts. However, if any politician wants to pander to voters during election time on a tax cutting platform he will only bluster on about “tax rates”, not actual taxes paid.
What the US has that other countries lack is the 100,000 pages of the Internal Revenue Code. It is a 99 year accumulation of deductions, accelerated depreciation rates, tax credits, and other tax breaks that are the end product of intensive lobbying efforts and bribes by special interest groups, corporations, unions, and even religious groups.
Take a look at the oil industry again. The oil depletion allowance permits drillers to deduct a substantial portion of the cost of a new well in the first year. When I first got into the oil and gas business a decade ago, after reading the relevant sections of the tax code, I couldn’t understand why everyone wasn’t drilling for Texas tea. The total value of this one tax break to the industry is estimated at $55 billion a year. This explains why we have had three presidents from Texas in the last 50 years. Some of this money ends up in campaign donations.
I have a very simple solution to the country’s budget deficit problem. Hit the reset button. Eliminate the Internal Revenue Code. Just set it on fire or send it to the recycling bin. Keep the existing progressive, hockey stick tax rates on income, but eliminate all deductions. And I mean everything; deductions for dependents, home mortgage interest, medical expenses, the works. The oil depletion allowance other corporate loopholes are worth at least $150 billion a year in lost federal revenues. There are no sacred cows. My revised Form 1040 would be a postcard that would have only five lines on it:
Social Security number
The budget deficit would disappear overnight. Government spending would shrink dramatically, because you could ditch most of the 100,000 who work for the IRS. Some 1.3 million auditors, CPA’s, tax attorneys, and bookkeepers would have to hit the road in search of new work too. The amount of money that is wasted on tax collection in this country is truly staggering. This is not some pie in the sky concept. This is how taxation already works in most countries, and they seem to get along just fine.
In fact, the whole scheme might even pay for itself.
I Don’t See Any Jobs For Former IRS Agents, Do You?
Quote of the Day
“This year is going to be about chasing pennies and nickels in the bond market. Volatility is going to be very low. I expect the ten year bond to end up at a 2% yield,” said Mike Pond, co-head of US interest rate policy at Barclays Bank.
Business is Booming at Ruff Times.
Following Howard Ruff for the last 35 years has always been eye opening, if not entertaining. The irascible Mormon is the publisher of Ruff Times (http://www.rufftimes.com ), one of the oldest investment letters in the business, and one of the original worshipers of hard assets.
The great thing about the end of the world crowd is that all of their trades are going gangbusters now and we’re all still here. Talk about a win-win! He says that any investment denominated in dollars is a mistake, which is in a long term down trend, along with all paper assets. Silver (SLV) is his first choice, which will outperform gold, and eventually top $100 from the current $27. His personal target for the barbarous relic (GLD) is $2,300, but that might prove conservative.
With the Chinese building 100 nuclear power plants over the next ten years, uranium (CCJ) has great potential. Equities may never come back from their lost decade. Don’t buy ETF’s because they are just another form of paper, and may not actually own the gold or silver they claim. The government is laying the foundation for a massive inflation which will begin soon.
Howard has long been considered card carrying member of the lunatic fringe of the investment world, sticking with hard assets throughout their 20 year bear market during the eighties and nineties, and annually predicting the demise of the federal government. Maybe it’s a case of a broken clock being right twice a day, but in recent years I find myself agreeing with Howard more and more. Whether that means I’m now a lunatic too, only time will tell.
Quote of the Day
“The old yardsticks don’t seem to be working anymore,” said Art Cashin, a strategist at UBS.
Closing My Apple Position.
My Apple April $450-$480 call spread expired deep in the money at the close on Friday. Legally, these expire at midnight on Saturday night, so your broker won’t take these off your statement until the following Monday. The position should be zeroed out and you should receive a cash credit. You will also find that the margin requirement has disappeared.
Your net profit on this position should be $1,855, or $1.86% for the notional $100,000 portfolio. Well done. Here is how the profit is calculated in detail:
March $450 call cost……………… $97.60
March $480 call premium earned…-$70.25
Net Cost……………………………. $27.35
Profit Calculation at Expiration
Purchase cost …..………………. . $27.35
Total profit = ($2.65 X 100 X 7) = $1,855 = $1.86% for the notional $100,000 portfolio.
I will go back into another position like this in the future, but only after a substantial dip in the share price. I still think that Apple will continue on its march to $1,000 a share. Coming down the road we have Apple TV and the iPhone 5. Of far greater importance will be the adoption of Apple standards by corporate America which has long avoided Steve Jobs’ creations. This is going on everywhere, and is being hastened by the demise of Blackberry (RIMM). But it is a trip that will take years, not weeks or months.
This is What a Lost Decade Gets You.
With all of the handwringing about the zero return on US equities for the last decade, I thought I’d better take a look at the long term charts. It’s very clear that we have been trading in a gigantic sideways narrowing wedge for the last 18 years, defined by 14,000 on the upside and 6,000 on the downside.
The clever investors out there, like hedge funds, have been selling every big rally and buying every dip, laughing all the way to the bank and leaving your average Joe pension fund beneficiary, 401k owner, and mutual fund investor holding the malodorous bag.
What’s more, I believe that this state of affairs is going to continue for another few years. You get what you deserve. This view is consistent with an economy that isn’t inventing anything new, spends more than it borrows, and lets foreigners take the technological lead through sheer indolence and complacency. We aren’t going to Twitter our way to prosperity.
It also fits with 80 million baby boomers withdrawing wealth from the system, downsizing their homes, and plopping everything into the Treasury market. This means that we are much closer to the end of this run in equities than the beginning.
If you have any doubts, take a look at the chart below showing that stocks are more expensive now than at any time in the last nine decades. Should one of the world’s more structurally impaired economies be commanding one of the highest PE multiples? I think not. This is why I have been using my electric cattle prod and my kangaroo skin bullwhip to herd investors to the sidelines.
The Sidelines Are a Good Place to Be
Quote of the Day
“The US has repositioned itself better than any of its global competitors. Americans are doing what they do best. They’re adapting, they’re moving, they’re finding good, and they’re surviving. That’s where we need to be,” said Tom Barrack, CEO of Colony Capital, and a former principal of the Bass Group.