Monday, July 31, 2006

A View of Congress from the Economist Magazine

The Economist magazine has an article called "A Weakened Branch" about the US Congress. The article is essentially a review of a new book by Tom Mann from the Brookings Institution (a liberal think tank) and Norman Ornstein from the American Enterprise Institute (a conservative think tank). The book sounds interesting and at some point I'll get around to reading it, but the reason I'm posting about this is a sentence that piqued my interest from the Economist article:

"Duels were once commonplace, as were fights with fists and firetongs. In the 1850s one senator beat another unconscious."

Call me nostalgic if you will, but would it be possible to go back to those quaint times when we could count on a duel or fight to take a lousy Congressman off our hands? I bet we could even get some decent betting action going.....and I'll supply the firetongs!

Read the rest

Friday, July 28, 2006

Advance 2nd quarter GDP

The government released advace figures for 2nd quarter GDP this morning along with revisions to GDP data going back to 2003. Here's a link to the whole report. BEA

"Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.5 percent in the second quarter of 2006, according to advance estimates released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 5.6 percent.

The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 4.0 percent in the second quarter, compared with an increase of 2.7 percent in the first. Excluding food and energy prices, the price index for gross domestic purchases increased 2.9 percent in the second quarter, compared with an increase of 3.0 percent in the first."

Consensus among economists had been for a 3.2% increase so this number is slightly less than expected. The core price index increase of 2.9% is good news for those waiting for an end to Fed rate hikes. The slowdown, along with the relatively benign inflation figures, should allow the Fed to stand pat at the next meeting on Aug 8th. Fed Funds futures contracts are now pricing in about a 30% chance of a rate hike at that meeting, but I think that the chances are closer to zero. In my opinion, the Fed has to be very careful about overshooting and pushing the economy into recession. The inflation figures are lagging indicators and even if the headline numbers continue to increase for a while, I suspect inflation has already peaked, at least in the short term. Longer term inflation expectations will be determined by future Fed policy, not past.

Big contributors to the slowdown were a drop in durable goods, residential fixed investment, and federal government spending. The drop in residential fixed investment is not surprising, but the drop in government spending is quite a mystery to those of us who worry about the deficit. The report states that overall federal government spending dropped 3.4% with defense spending dropping 1.0%. Really? Why do I think that number will be revised higher in future reports?

The market, at least for now, seems to like the numbers with the Dow up about 65 points as of this writing. It decreases the likelihood of another rate hike of course and the inflation numbers were okay. My concern is that the slowdown is too much, but we'll have to see how the revisions come out in the months ahead.

Thursday, July 27, 2006

PJ O'Rourke

I think it's time for something a little lighthearted. PJ O'Rourke has been one of my favorite humor writers since I first discovered him in (of all places) the pages of Rolling Stone many years ago. P.J. does write from a more conservative perspective, but I hope everyone will overlook that until you get to the end of the article linked here. I do my best to remain neutral about politics here - I'm basically a libertarian and take pleasure in finding faults in both the major political parties - so I hope no one takes this too seriously:

"I was out on the patio the other day wondering (as writers of conservative opinion pieces constantly do) what's wrong with America. I noticed a tag affixed to my collapsible canvas deck chair, and my wondering ceased. What's wrong with America was printed on the tag:

--Do not attempt to lift the front end of the chair while sitting down on it.

Indeed, I tremble for my country when I reflect that chair manufacturers feel compelled to tell Americans this. You'd flip over and whack your head on the concrete. Yet millions of Americans must sit themselves down, spread their knees, grasp their seats, and give themselves a tremendous backwards yank. How else but whacked heads to explain, Hillary Clinton's positive poll ratings, US Weekly magazine, or the congressional debate on immigration? I had thought the chairs in the House of Representatives were firmly attached to the floor. Apparently not." Read the rest....

Monday, July 24, 2006

Japanese Inflation???!!!!

Here's an article from the WSJ about inflation worries in Japan.

"For most of the past decade, Japan's biggest economic problem has been falling prices that put a brake on business activity. Even though consumer prices started rising last year, and the government last week removed the word "deflation" from a key part of its monthly economic report for the first time in five years, prices at the retail level are barely budging. The Japanese central bank is forecasting year-to-year increases of just 0.8% through the end of next year.

Still, some economists are starting to worry inflation could escalate faster than expected, prompting a jump in interest rates that could reverberate around the world.

That forecast is based on Japan's fast-changing job market. After years of restructuring, when work forces were pared to the bone, Japanese corporations are expanding quickly to meet rising demand.

Companies are struggling to find enough workers. Japan's unemployment rate was 4% in May, the lowest level in eight years. And demographic change will likely worsen the labor shortage: Japan's falling birth rate means fewer young people are entering the work force. Next year, the first of Japan's postwar baby boomers will retire, reducing the labor force further."

Inflation in Japan is something that no one has worried about anytime in the last 15 years or so. It just goes to prove, once again, that inflation is everywhere and always a monetary phenomenon. If a central bank prints more fiat currency than is needed to support the natural growth of the economy (and how exactly is a central banker supposed to figure out how much is enough but not too much?), inflation will be the result. This article proposes several reasons for the inflation worries, such as a shortage of workers due to demographic changes, but the answer is simpler; the BOJ has been printing too many yen. Read the rest (subscription required)

Thursday, July 20, 2006

Pension Reform

Here's an article from CNNMoney about pension reform legislation that is working it's way through Congress. This caught my eye:

"The legislation also might allow 401(k) providers to offer investment advice to plan participants. Negotiators until Wednesday were still discussing how this change could be implemented without creating a conflict of interest."

Without creating a conflict of interest? I don't think that's possible, but I'm sure the mutual fund company lobbyists will find a way to convince our representatives that they can. Hmmm, how could they convince them.....?

Housing Slowdown

The Wall Street Journal has an article this morning about the housing slowdown.

"The housing market continues to weaken in much of the country as inventories of unsold homes rise and many sellers cut their asking prices, a quarterly survey by The Wall Street Journal shows.

There is no sign of a broad collapse of housing prices about a year after the once-hot coastal markets entered a long-anticipated cooling phase. But the general level of prices is edging down in some areas and leveling off in others, while the supply of homes for sale keeps rising." Read the rest (subscription required)

Here's a few areas of interest:

Area Inventory Price Trend
Atlanta +20% Rising
Boston +60% Falling
Dallas +6% Rising
LA +181% Flat
Miami +245% Falling
Orlando +397% Flat
San Fran +112% Flat

Obviously, some areas are worse than others, but the trend is obvious. Housing is slowing and we don't yet know the overall effect on the economy. Construction of commercial structures seems to be picking up as residential falls off (Bernanke mentioned this in his testimony yesterday) and that may soften the blow somewhat. It will help the construction industry, but it's unlikely to help the service type jobs (mortgage brokers, etc.) associated with the residential market. Can other types of service jobs make up for a fall off in the real estate associated jobs? I don't think we know yet, but I must admit it seems unlikely.

Wednesday, July 19, 2006

A Bernanke Boost

Ben Bernanke, chairman of the Federal Reserve, testified before the Senate Banking Committee today and while the testimony was typically opaque, the results were easily observed. Ten Year Treasury note yields fell by 7 basis points and the stock market rallied smartly, with the Dow up 212 points.

Bernanke's prepared remarks can be found here.

Here are a few highlights and my interpretation of what he really meant:

"Over the period since our February report, the U.S. economy has continued to expand. Real gross domestic product (GDP) is estimated to have risen at an annual rate of 5.6 percent in the first quarter of 2006. The available indicators suggest that economic growth has more recently moderated from that quite strong pace, reflecting a gradual cooling of the housing market and other factors that I will discuss. With respect to the labor market, more than 850,000 jobs were added, on net, to nonfarm payrolls over the first six months of the year, though these gains came at a slower pace in the second quarter than in the first. Last month the unemployment rate stood at 4.6 percent."

My interpretation:

The economy was smoking in the first quarter, but it's starting to slow down. Housing is slowing but I don't think it's falling off a cliff. We're adding just enough jobs to keep the unemployment rate steady.

"Inflation has been higher than we had anticipated in February, partly as a result of further sharp increases in the prices of energy and other commodities."

My interpretation:

Inflation is too darn high because the Fed has printed too many greenbacks, but I can't say that out loud, so I'm going to blame it on higher energy prices.

"The U.S. economy appears to be in a period of transition."

My interpretation:

The economy is slowing down and I have no clue how much.

"...moderation appears most evident in the household sector. In particular, consumer spending, which makes up more than two-thirds of aggregate spending, grew rapidly during the first quarter but decelerated during the spring. One likely source of this deceleration was higher energy prices, which have adversely affected the purchasing power of households and weighed on consumer attitudes."

My interpretation:

When filling up the SUV requires a mortgage application, folks don't have as much to spend down at Walmart.

"The slowing of the housing market may restrain other forms of household spending as well."

My interpretation:

When Joe Sixpack can't refinance his mortgage anymore and has to actually start paying off that debt, he won't be buying a new car.

"Although growth in household spending has slowed, other sectors of the economy retain considerable momentum. Business investment in new capital goods appears to have risen briskly, on net, so far this year."

My interpretation:

I hope business spending holds up because if not, we're headed for recession.

"Globally, output growth appears strong. Growth of the global economy will help support U.S. economic activity by continuing to stimulate demand for our exports of goods and services. One downside of the strength of the global economy, however, is that it has led to significant increases in the demand for crude oil and other primary commodities over the past few years. Together with heightened geopolitical uncertainties and the limited ability of suppliers to expand capacity in the short run, these rising demands have resulted in sharp rises in the prices at which those goods are traded internationally, which in turn has put upward pressure on costs and prices in the United States."

My interpretation:

I can't blame the Fed for the rise in commodity prices, so I'm going to blame China.

Alright, enough Bernanke bashing. As many of you know, I'm not a fan of Mr. Bernanke or the Federal Reserve in general. I've listened to a lot of these semi annual reports to Congress and they rarely break news. This time though with Bernanke being so new, it did seem to give a little peek into his thinking about monetary policy. In my opinion there were several important clues in the testimony:

1. He emphasized the lagging effect of monetary policy. He even blunted this mornings CPI reading by saying that the Fed can't do anything about currently reported inflation but must look forward to the results of past monetary policy changes.

2. The Fed believes the economy is slowing to a rate closer to potential which they peg at somewhere around 3-3.5% growth.

3. The Fed believes that core inflation will fall to 2 1/4-2 1/2% this year (from the currnet 2.5%) and even further to 2-2 1/4% in 2007.

The market heard all this and decided that it means the Fed will be pausing on the rate hikes sometime soon. I think they will too, but I'm at least a little worried that they've already gone too far. The housing market is rolling over pretty hard in some areas and that could have a drastic effect on employment. Many of the jobs created over the last four years were related to real estate and a real estate crash would have far reaching consequences. Hopefully a pause by the Fed will stablize the market and limit the damage. We'll see.

Monday, July 17, 2006

The Middle East

I do not believe that Israel wants a war with Syria or Iran, the sponsors of Hezbollah and Hamas. I believe, very strongly, that Syria and Iran do not want a war with Israel. I don't think even they believe they can win such a war with the US military sitting in the middle. I think this is much simpler. Iran is negotiating.

The intent here is not to start a war, but to ensure that the US and the world know that Iran can wreak havoc through their proxies in Syria and Lebanon. It shores up their negotiating position as Iran considers the various proposals on the table for a halt to their nuclear program. Not that I expect them to actually honor whatever agreement they decide to accept, but I do expect them to negotiate the best deal they can.

The financial markets have responded to this as one would expect. The dollar moved higher, gold and oil jumped and interest rates moved lower in the so called "flight to safety" trade. And of course, stocks moved lower. But does it really mean anything? Only if the moves in the financial markets are unrelated to the events in the Middle East. If the market is really moving because the economy is slowing and market participants are anticipating a recession, then there may be something to worry about. Of course, there's an old saying on Wall Street that the market has predicted 6 of the last 3 recessions, so even if that is why the market is falling, it may not mean anything.

I don't think the risk of recession is much greater now than it was in the first quarter of this year when the market was moving up quite briskly. The only thing that has changed is the liquidity situation. Japan raised interest rates last week for the first time in six years. Last month they ended quantitive easing by hoovering $200 billion in excess reserves out of Japanese banks. That certainly has had an impact, but it seems to me that the effect was mostly to force a cutback in speculation. Time will tell whether the withdrawal of liquidity around the world was so much that it had an effect on the real economy. I don't think so.

US corporations are still flush with cash and earnings are coming in with likely double digit gains again this quarter. Some companies are starting to reduce estimates of future earnings, but it doesn't seem drastic. The Fed raised rates at their last meeting, but my guess is that it will be the last, at least for a while. With housing slowing and the economy slowing from the blistering pace in the first quarter, the Fed will want to be careful to not overshoot and knock us into recession. We may find out more about their thinking when Bernanke testifies to Congress this week. We'll also get the minutes of the last meeting which could prove interesting. We'll also get inflation figures this week, but if I know those are lagging indicators, surely the Fed does too.

I continue to believe that there is excellent upside potential to this market. It'll take a catalyst, but maybe this latest skirmish in the Middle East is the beginning of exactly that. Could something good come from this? What if Iran accepts a deal on their nuclear program? What if Israel gets some assurance from Lebanon that Hezbollah will be disarmed? What if oil prices start to decline? The sentiment is so negative right now that it won't take much, in my opinion, to start a move up. If history is any guide (and sometimes I wonder), the move will be quick and waiting for it will mean missing a good portion of it.

The mess in the Middle East is not significantly different than it's been for my entire lifetime. It is certainly no reason for long term investors to sell stocks. That has usually been a poor strategy (or lack of one) in the past and I suspect it will be this time as well.

Tuesday, July 11, 2006

Main Street vs Wall Street

One of the reasons we started Alhambra Investment Management is because we believe we can do a better job, at a lower price, than the retail Wall Street brokerage houses. We can keep costs low and provide independent advice because the information monopoly of Wall Street has been broken. We have access to the same information that was once available only to the very wealthy and Wall Street insiders. We can buy independent research and gather information about any publicly traded company. And the information is available at a cost that is affordable or in many instances, free. Our role is to interpret and apply the information for clients who don't have the time or inclination to do it themselves.

Here's an article from TechCentralStation that speaks to this subject:

"It's easy to see why large institutional investors look down on Main Street's "low-margin, nickel-and-dime accounts" -- it's simply too much trouble for these large institutions to deal with anyone who doesn't have a sizable amount of wealth to invest. However, this is exactly why the financial services sector is ripe for technological disruption. Millions of citizen investors with less than $200,000 to invest (the unofficial cut-off for many professional money managers) are looking for investment alternatives that will enable them to minimize costs and maximize returns." Read the rest...

Guns and Butter

I have been talking about inflation and the falling dollar for several years now. The two go hand in hand and there is nothing new about a government that wants guns and butter, but only wants to tax for one or the other. It always ends up causing inflation. And no, I don't advocate raising taxes to pay for both. I believe that we could pay for both if our wonderful elected representatives weren't so busy spending our tax dollars on boondoggles designed to get said representatives re-elected. Anyway, here's a short editorial from AlterNet on the subject:

"Ask George Washington what he thinks about fighting a war on credit. Back in his day, Congress printed money to pay for the Revolutionary War but neglected to tax anybody to back up this funny money of theirs. The bills were called continentals and in due course they lost all their value, hence the once-popular expression, "not worth a continental."

When your money is not worth a continental that means you are suffering from inflation big time. It happened 230 years ago in our War of Independence from the British. We are seeing it beginning to happen now in our war with, well, whoever it is we are fighting. We may not know the names, the whereabouts or the precise whys of the Iraq War but the costs are approaching a trillion dollars."

Read the rest....

If inflation continues to rise, we will be well served to have some short term, cash type investments as well as some commodity investments. Short term Treasury yields should rise with inflation and commodities tend to rise during inflationary times; Remember the 70s! Okay, that doesn't compare well with, "Remember the Maine!" or "Remember the Alamo!", and I wouldn't want anyone to hurt themselves by remembering something like disco, but the 70s are worth remembering for the economic mistakes that were made. Unfortunately, our government doesn't seem to be able to learn from it's mistakes, which means we have to prepare for the consequences.

Monday, July 10, 2006

Ben Stein's Money

Ben Stein has an article in Barron's Mutual Funds Quarterly that caught my eye. Here's an excerpt:

"We'd change the allocation little by little, as sectors become too expensive or get cheap. Our approach takes advantage of the fact that over long periods (very long periods, to be sure), indexes beat all but the very best and rarest stockpickers.

Adding to our potential to do well: The costs of holding these exchange-traded funds and high-paying utility stocks and real-estate investment trusts would be very low. Except for the tax on the income from the utilities and REITs, it would be extremely tax-efficient (and we'd probably offer a version without the high current income, too)."

Read the rest (I think a subscription is required)

That should sound familiar to our clients. An all asset, index fund approach is simple, cheap and effective. It's nice to see smart guys like Ben Stein validate our approach.

Asset Allocation Works

Here's a perfect example of why we like to maintain investments in all asset classes. Here's how various asset classes have performed since May 30:

REITS 6.31%
Crude Oil 2.86%
S&P 500 0.45%
DJIA -0.03
Russell 2000 -0.24
NASDAQ -1.60

The REIT investments in our portfolios have performed quite well over this period and for most clients this has helped their portfolios to recover from the May correction. Without the allocation to REITS, the recovery takes longer.

I find it interesting that REITS are the asset class that is taking the lead right now. With all the talk about a real estate bubble, I think most investors are probably afraid of anything with real estate in the name. Of course, REITS are not really invested in residential real estate so popping the real estate bubble may not have much of an effect on them. REITS are generally invested in things like office buildings (where vacancy rates are quite low), shopping malls (which have done pretty well since consumer spending is holding up) and multi-family housing like apartments (where rents are now rising).

Monday, July 03, 2006


Welcome to the blog site for Alhambra Investment Management. We'll be posting links to interesting articles and some market commentary when we get some time. The first week of a new company is quite hectic, so as things settle down we'll start putting up some content here.