Bill Clinton and Global Warming

Former President Bill Clinton was in Denver, Colorado, stumping for his wife yesterday.

In a long, and interesting speech, he characterized what the U.S. and other industrialized nations need to do to combat global warming this way: "We just have to slow down our economy and cut back our greenhouse gas emissions 'cause we have to save the planet for our grandchildren."

As most of you know, I am somewhat of a skeptic of anthropogenic global warming. I just believe that the weather on this planet is highly variable and that to believe that humans are the main cause when there is this really big hot star called the sun nearby, well that's just hubris.

However, it appears to me that many are misinterpreting Bill Clinton's remarks. When you look at the compelte quote, the meaning is a little different:

"Everybody knows that global warming is real," Mr. Clinton said, giving a shout-out to Al Gore's Nobel Peace Prize, "but we cannot solve it alone."

"And maybe America, and Europe, and Japan, and Canada -- the rich counties -- would say, 'OK, we just have to slow down our economy and cut back our greenhouse gas emissions 'cause we have to save the planet for our grandchildren.' We could do that.

"But if we did that, you know as well as I do, China and India and Indonesia and Vietnam and Mexico and Brazil and the Ukraine, and all the other countries will never agree to stay poor to save the planet for our grandchildren. The only way we can do this is if we get back in the world's fight against global warming and prove it is good economics that we will create more jobs to build a sustainable economy that saves the planet for our children and grandchildren. It is the only way it will work.

So it seems that what he is saying is that one way to combat global warming is to slow the economy, but he believe that there is another way to combat global warming that won't slow the economy. Unfortunately, I think he's wrong about that. Every plan I've seen with regard to global warming will have a detrimental effect on economic growth. I don't buy that the government can create green jobs that will offset those lost to the various global warming schemes. Government does not create jobs, entrepeneurs do and if there were profitable ways to exploit green technology without government subsidy, it would be done by the market. Any job created via government subsidy will just divert resources and jobs from the private sector.

Warburg & MBIA

Last month Warburg Pincus agreed to buy 16.1 million shares of MBIA at $31 per share and also received warrants to purchase an additional 8.7 million shares at $40. Today MBIA reported a loss of $18.61/share ($2.3 billion) and the stock is trading at about $12 in pre market. Warburg is known as a savvy shop and they have apparently completed the purchase, but they must really be regretting this. Here's what the CEO of MBIA had to say about the earnings:

``We are disappointed in our operating results,'' Dunton, 52, said in the statement.

That may be the understatement of the decade but I bet he's not as disappointed as Warburg.

The company also said:

``We believe that these steps, along with reduced capital requirements resulting from slower business growth, will result in our capital position surpassing rating agency Triple-A requirements,'' the company said in the statement.

Yeah, lemons and lemonade and all that. Slowing growth means reduced capital requirements; yeah that's good news.

Income, Spending Rise

Income rose more than spending in December as the savings rate creeped into positive territory. While spending is slowing it is still rising at a relatively healthy rate compared to last year.

Jobless Claims Jump

One of the things I've been watching closely is new jobless claims. This number is a very good preditor of the job market and it has been remarkably low considering all the recession talk. Last week though claims jumped to 375,000, way above the 350,000 which is widely considered the divding line between a solid job market and one that is softening. One thing to keep in mind though is that this is a very volatile number and one week does not make a trend. Furthermore, a DOL analyst had this to say:

A Labor Department analyst attributed some of last week's rise to volatility around the Martin Luther King holiday. "The Martin Luther King holiday is a tricky one," the analyst said. "I think this year, we didn't quite get the seasonal factor right."

If this is confirmed next week, we may have a problem. We'll get more news tomorrow with the release of the employment report.

Bond Insurer Downgrades

The selloff this afternoon was apparently driven by the Fitch downgrade of FGIC, a bond insurer. Frankly, that was probably just an excuse by bears who wanted to sell the rally, but the issue is important.

The market now waits to see if AMBAC and MBIA can maintain their AAA ratings. If they don't, the banks and brokers will have another round of writedowns. According to Meredith Whitney, an analyst at my old firm Oppeheimer, those writedowns could total another $70 billion. Considering that she correctly predicted that Citigroup would have to cut their dividend and has largely been right about this whole mess, one must give her opinion some weight. However, it seems to me that it would be easier for the banks and brokers to pony up some capital for these bond insurers than suffer the writedowns, so I expect a bailout to happen soon.

If a bailout is announced, the market will take great comfort from that and the low set on 1/23 will likely prove to be a good long term bottom. If the banks have to write off another $70 billion, I'm not so sure.

Selling the Rallies

The market rallied and then fell on the news of the Fed cutting another 50 basis points. Obvioiusly, there are still plenty who are selling the rallies and with market sentiment so bearish that is not a surprise. From my viewpoint this is a good thing. Long term investors should be looking for the market to make a decent base before moving higher. A V shaped recovery would likely be short lived.

What we need is more good economic news for the market to make a sustained move higher. That doesn't happen in a day and the market recovery won't happen in a day. Tomorrow we get jobless claims and Friday the employment report. It'll be interesting to see the market reaction of the report on Friday validates the ADP report today.

ADP Employment Report

Employment in the US private sector grew by 130,000 in the first month of the year, according to the ADP report released today. Economists had been expecting a number closer to 70,000 new jobs.

Service-oriented employment grew by 141,000, while manufacturing employment held steady after 18 straight months of decline. The one negative came in the goods-producing sector, where a decline of 11,000 was reported.

The number is certainly not one indicative of a deteriorating economy. Taking recent economic indicators into account, recession worries may seem a little overblown at the moment.


Note: Public Sector employment is not covered by the report, suggesting that the jobs market in January may be even more positive than reported.

4th Quarter US GDP Report

The US gross domestic product slowed to a crawl in the last quarter of 2007. The number, reported by the Commerce Department, came in at a 0.6% annualized growth rate for the quarter. Economists had a expected a number in the region of 1.1%.

For all of 2007, the economy grew by 2.2%, the lowest rate in 5 years.

The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), nonresidential structures, state and local government spending, exports, and equipment and software that were largely offset by negative contributions from private inventory investment and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased slightly.

The deceleration in real GDP growth in the fourth quarter primarily reflected a downturn in inventory investment and decelerations in exports, in PCE, and in federal government spending that were partly offset by a deceleration in imports and an acceleration in state and local government spending.

To read the full report, click here.

Grant's Indictment of the Fed

James Grant is back on the editorial page of the New York Times with a scathing indictment of the Wall Street, Main Street and Washington:

Striving so mightily to make one and one add up to three or four or five, Wall Street, Main Street and Washington collectively brought us to the impasse of 2008, in which a debt crisis is superimposed on a downturn in the economy, which is overlaid on a bear market in real estate, which is conjoined with a persistent and worrying weakness in the overseas value of the dollar. As for the crackup in complex mortgage-backed securities, now at the center of the debt predicament, the global bank UBS has justly called it “the biggest failure of ratings and risk management ever.”

But Grant places most of the blame right where it belongs - on the Fed:

It would be asking a lot of an ordinary mortal to hew to the literal truth in a mortgage application when, to the applicant, it seemed as if the money was being offered free. And for 12 full months, from mid-2003 to mid-2004, the Fed set its interest rate, the so-called overnight federal funds rate, at just 1 percent. It took this extraordinary step to ward off the risk of falling prices, or deflation, it said. It would not tolerate too little inflation, it explained, but wanted just enough. At the time, the cost of living was rising by 2 percent a year.

He ends with a prediction:

To lubricate the machinery of lending and borrowing, Mr. Bernanke is likely to make dollars increasingly plentiful. The trouble is that, while the Fed is America’s central bank, the dollar is the world’s currency. It lines the vaults of central banks of America’s creditors, especially the up-and-coming states of Asia and the oil-soaked principalities of the Middle East.

Such institutions hold dollars by choice, and not a few of them chafe at the greenback’s steady loss of purchasing power. For some, Tuesday’s hasty rate cut might be the last straw.

As just about nobody predicted the present troubles, humility is what becomes today’s forecaster the most. So I will offer up a humble forecast. Inflation will, at length, make its way up from the bottom of the Fed’s worry list to the very top. Not for years has it seemed to matter that the dollar is only a piece of paper. But, before very long, that homely fact will push itself back to the fore.

I agree with Grant that in the long term, inflation has been and will always be the problem as long as we have a Federal Reserve fixing the price of credit. That is why as an investment manager I always maintain positions in real assets. In the short run however, I suspect the deflationary nature of the housing bust will keep stated inflation relatively low and allow the Fed to inflate our way out of the current mess. Of course that will only mean a bigger and different mess down the road, but no one in power is thinking about that now.

Under a Republican Administration

Have you noticed that Classical and Austrian economists seem almost giddy about the potential collapse of the US economy? If you read too much of this stuff you almost can't help but be negative about the prospects for the US. Here's another one at Mises.org by Christopher Westley:

So it has come to this. Years of spending, inflating, taxing, and redistributing has left the US economy teetering on a recession that our best and brightest — meaning the ones who created this mess — claim requires a multibillion-dollar economic-relief package to quell fears, promote confidence, and spur recovery.

And, one might add, to keep things calm past election time, which is the real purpose of this bipartisan proposal.

Then he produces this amazing chart showing some random statistics from 2000-2007. Here are a few:

US Population +7.18%
Tax Revenues +25.4%
National Debt +58.9%
Money Supply +72.6%
Military Spending +49.2%
Gold Price +206%
Gas Price +118.8%

If this is what we get when we elect Republicans who claim to be fiscal conservatives, what will we get if we elect Democrats? I'm beginning to think we should put the Democrats in charge for a while. If they do what they say they will, the economy will finally reach that day of reckoning the Austrian economics adherents keep predicting. Maybe that's what we need to finally end this cycle of debt that has been growing almost since the day the Federal Reserve was created.

The rest of the article is similar to other articles I've linked to discussing the Keynesian nature of the stimulus package. It's well written. Read the whole thing.

Keynesian Sleight of Hand

Robert Murphy, author of The Politically Incorrect Guide to Capitalism, has an excellent editorial about the current Keynesian response to the alleged potential future recession. Murphy is quite a bit more pessimistic than I am about the current slowdown, but my only real disagreement is about timing. I don't think the public has caught on just yet to the consequences of inflation and that it will still be quite some time before the final crash of the dollar and the US economy.

First Murphy takes the Fed to the woodshed:

Last Tuesday the Fed announced a surprise rate cut of 75 basis points, the biggest cut in 24 years. Even so, the stock market plunged, with the S&P 500 shedding 1.1% during the session, bringing its total losses to over 10% for 2008.

The Fed has now painted itself into a Keynesian corner. According to old-school Keynesianism, the government faces a Phillips Curve tradeoff. It can adopt a loose monetary policy, which spurs output but leads to price inflation. Or, the government can adopt a tight monetary policy, which keeps prices under control but leads to recession.

The sobering experience of the 1970s demonstrated that this Keynesian orthodoxy was nonsense. Ultimately, printing green pieces of paper doesn’t make a society richer, it just causes prices to rise. Once citizens adjust to the constant injections of new money, unemployment returns along with massive price hikes. Thus the term “stagflation”—meaning double-digit rates of unemployment and inflation—was coined.

And then he dresses down the politician with particular emphasis on the Treasury Secretary:

The truly depressing feature of all the stimulus talk is that even someone as knowledgeable as Treasury Secretary Paulson believes a rebate is only good if the recipients “spend” it, rather than using it to pay down debts. Here we see the true insidiousness of the Keynesian mindset: In a time of recession, when we need to tighten our belts, the politicians encourage us to go buy new cars and plasma screen TVs. The idea seems to be that if we all just ignore the recession, it will get bored and go away.

Those readers who believe in the virtues of hard work and thrift know that this Keynesian mindset must be wrong, but they may have a hard time pinpointing the sleight of hand in the trick. So let me give a hint: Whether you spend $500 on music CDs or on bank CDs, that money is still “in the economy.” Everyone understands how spending money on music boosts employment in that industry, so we don’t need to explain that portion.

But people apparently don’t recognize that when you lend $500 to the bank, you are still contributing to employment and GDP growth. The bank doesn’t put this money in a tin can under the bed, after all. No, it lends it out to a business, perhaps, so it can buy a new factory, or it lends it out to a young couple, so they can buy a home. Rather than output and employment expanding in the music and retail industries, in this scenario jobs are created in the manufacturing or construction industries.

A penny saved is a penny spent, from the viewpoint of the economy as a whole. Rather than printing up new money through the Federal Reserve, or engaging in shell games with billions of tax dollars, the government should cut its own budget while we ride out the present crisis.

That's a pretty clear and correct explanation of how the economy works. Someone should inform the White House and the Congress.

January Consumer Confidence

Consumer confidence in the US fell to one of its lowest levels in the past year in January, according to the Conference Board. The confidence index fell to 87.9, from 90.6 in December. The 12-month low is 87.8, recorded in November 2007.

To put this into perspective, in January 2007, the index peaked at 110.2.

About that Weak Economy.....

Yeah, not so much.

Jan. 29 (Bloomberg) -- Orders for U.S. durable goods rose more than forecast in December, suggesting business investment is holding up even as other parts of the economy weaken.

The 5.2 percent increase was the biggest since July and follows a revised 0.5 percent gain in November that was greater than previously reported, the Commerce Department said today in Washington. Excluding transportation, demand rose 2.6 percent.

If the economy is so bad, why are companies investing in capital goods?

Bookings for non-defense capital goods excluding aircraft, a proxy for future business investment, climbed 4.4 percent, the most since March 2007. Shipments of those items, used in calculating gross domestic product, rose 2 percent, the most since March 2006.

Orders excluding defense equipment increased 2.9 percent. Orders for defense equipment jumped 81 percent, led by a surge in aircraft bookings.

The rise in total orders was led by the biggest increase in machinery bookings since December 2006, a jump in commercial aircraft and a 12 percent jump in communications gear.

Will this affect the Fed's decision tomorrow? I'm sure the Fed already has some information about the employment report tomorrow and that is one of their most important indicators so this may not mean anything. We'll get the ADP employment report tomorrow and that may give us a clue as to what to expect on Friday.

Recession or Wirehair Terrier

Steve Chapman at Reason Magazine on line has a nice article about the potential recession and the stimulus package:

Washington, D.C. is a place where delusions go to thrive. That explains why Congress and the president are now agreed on remedies that will not work, expending money they do not have, to fix a problem that may not exist.

The alleged problem is a recession. From the sounds of panic, you would assume we are already in a deep downturn. In fact, that does not appear to be the case, and many economists doubt we will have a recession (defined as two consecutive quarters in which total economic activity declines) at all.

He quotes a Citigroup economist (who surely must know something about the potential recession since Citigroup is so good at these things):

Steven Wieting, an economist at Citigroup, predicts growth of 1.2 percent. But like our elected officials, he sees no point in getting hung up on technicalities. "Academic definitions aside, we'll call that a recession," he writes in a new report.

And in the best line I've read about the economy in a long time Chapman responds:

We can call it a recession or we can call it a wirehair terrier, but that won't change what it actually is: an expansion, albeit a modest one.

That is pure gold and had me spewing my iced tea on the computer screen. Chapman is a libertarian so he obviously doesn't like the stimulus package:

Notwithstanding that, President Bush and House leaders have agreed to pelt the economy with $150 billion in rebates and business tax incentives to rouse it from its lethargy. The idea behind the rebates is that consumers will use the cash to buy goods and services, keeping companies and workers busy supplying them. Business tax incentives are supposed to goose investment in plants and machinery. The two sides are agreed, in the mantra of the week, that these measures will be "timely, temporary and targeted."

In their dreams. Timeliness, in this case, is not unlikely—it's impossible. The Internal Revenue Service, it seems, is fully occupied at the moment sending out tax forms and processing returns, and will be for a while. So even if the program zips through the Senate, the checks probably won't go out until June and won't all reach the beneficiaries until August. The money itself will take months to be spent, if it gets spent at all -- postponing the intended boost until next football season.

If a recession is already underway today, it could very well be over by then. This is the equivalent of a doctor telling a patient that she may have pneumonia and promising to put her on antibiotics—in October.

He concludes:

So, contrary to its billing, the package is likely to be tardy and scattershot, with a lingering, bitter aftertaste. Even if it could be implemented perfectly, though, it might still be a futile endeavor. Alan Auerbach, an economist at the University of California, Berkeley, looked at past fiscal policy initiatives and found "little evidence that these effects have provided a significant contribution to economic stabilization, if in fact they have worked in the right direction at all."

In other words, we may spend a lot of money to accomplish nothing. Note to our leaders: We can do that for free.

I agree completely.

Contrarian Indicator

Many investors claim to be contrarians, buying the things nobody wants and selling the things that everyone wants, but few have the intestinal fortitude to actually do it. If one is to be true to that claim (and I think we should) then stocks are the thing that few want. The latest poll from the American Association of Individual Investors:

Bulls 25.1%
Bears 59.0%
Neutral 15.9%

Stimulus Roundup

I haven't written much about the stimulus plan weaving its way through Congress because I think it is mostly irrelevant. It isn't big enough to have much impact either way. However, the economic logic of the plan is so flawed, it is too big a target to pass up.

The plan currently before Congress is a bipartisan effort to buy votes in an election year. The first clue that it is a bad plan is the bipartisan nature of it. I can't think of anything that Democrats and Republicans have ever agreed on that turned out to be a good idea.

The current plan takes the form of a tax rebate and some accelerated depreciation for corporations. Tax rebates have been tried before and despite the fact that they haven't worked in the past, politicans keep trying. I think that is the definition of insanity; doing the same thing over and over expecting a different result. The fact is that rebates do not change peoples spending because they don't change their long term income. Rebates are more likely to be saved than spent so any stimulus will likely be muted. Besides, the idea that politicians can take money from one group of citizens and give it to another group of citizens and "stimulate" the economy is stupid on its face. The government will have to either borrow (likely) the money for the rebates or raise tax rates and neither of those options is stimulative.

The normally sane Caroline Baum at Bloomberg.com has a suggestion that would ensure that the rebate gets spent:

For starters, don't send folks a check in the mail, even if the Internal Revenue Service can find time in its busy tax- return processing schedule to dole out money with one hand as it's confiscating a portion of our income with the other.

Instead, send households a coupon for the desired amount, to be used for the purchase of domestically produced goods and services. (No ``Made in China,'' which doesn't help the U.S. economy.) The coupon will carry an expiration date, which could be staggered depending on when the government wants the spending to take place. Maybe a little this quarter, a little the next.

I'm not sure if she is kidding or not but it seems she is serious. The problem with our economy is too little saving and investment and too much spending (and too much debt to fund it). So by all means, let's make sure that people don't even have a chance to save or invest this little windfall. That'll make things better.

Bob McTeer, former Fed governor, has a better grasp of things:

With monetary policy not getting the job done, many are calling for fiscal stimulus - more government spending or lower taxes. But while fiscal measures to stimulate the economy are tempting, it's a temptation that should be resisted for several reasons.

First, is timing. By the time it is formulated, passed by Congress, and implemented, the fiscal measure may be the opposite of what is then needed. Second, fiscal policy doesn't work without the appropriate accompanying monetary policy, but if monetary policy is appropriate - meaning more aggressive - then it is probably sufficient without a fiscal component. Fiscal ease, or an increased budget deficit, without appropriate monetary expansion puts upward pressure on interest rates and crowds out private-sector borrowing and spending. We'd just end up substituting government spending for private-sector spending, not a good recipe for growth and prosperity.

Politicians say we should put money in the hands of middle-and low-income people because they are more likely to spend it that those with higher incomes. More redistribution may or may not be desirable for social reasons, but the idea rich folks don't spend their money is ridiculous. Their saving goes into a financial intermediary or financial instruments that provide funds for investment. Taking it to the bank rather than the store is just the first step. The rich generally don't put their money in mattresses.

Old-fashioned stimulus through more net government spending is a poor substitute for supply-side fiscal measures that increase incentives to work and produce. The most important and most effective fiscal measures for now and for the future would be to remove the threat of higher marginal tax rates on both labor and capital that would result from the expiration of the Bush tax-rate cuts. Those reductions should be made permanent as soon as possible, and even augmented, especially the taxes on capital gains and dividends.

Lower tax rates on capital is about as close to a free lunch as it gets. The lower rates, by stimulating more activity, almost always generate more tax revenue. Close behind making the Bush tax cuts permanent in importance would be to reduce significantly the corporate income tax, which is currently internationally noncompetitive, and eliminate the death tax, which dilutes and distorts incentives of small businesses to maximize output and employment. Tax credits for new investment, or the expensing of investment rather than depreciating it, should also be considered. For the longer run, of course, fundamental tax reform is needed - either a low flat income tax or a tax on consumption rather than income.

A real stimulus plan should concentrate on long term problems and long term solutions. Tax rates are scheduled to rise in 2010 and that will start to affect economic decision making soon if it hasn't already. Raising taxes during a recession is surely a bad idea so if things are as dire as some think (and I don't fall in that category), then we should remove the fear of higher taxes now. Another idea would be to lower the corporate tax rate. Our rate is already near the highest in the developed world and if companies are the source of new jobs, lowering their tax rate would do more for hiring than any tax rebate. Besides, cutting corporate taxes is almost the same as cutting individual tax rates. Corporations don't pay taxes, people do. Corporations merely pass them along.

I do not think the current economic slowdown will turn into a recession but if it does the current stimulus plan will do nothing to prevent it. Since the public seems to think we need stimulus why not do something that will have an effect?

I'm not the only nut out here who thinks the economy is okay. Brian Wesbury has a good editorial at the WSJ today:

It is hard to imagine any time in history when such rampant pessimism about the economy has existed with so little evidence of serious trouble.

A year ago, most economic data looked much worse than they do today. Industrial production fell 1.1% during the six months ending February 2007, while new orders for durable goods fell 3.9% at an annual rate during the six months ending in November 2006. Real GDP grew just 0.6% in the first quarter of 2007 and retail sales fell in January and again in April. But the economy came back and roared in the middle of the year -- real GDP expanded 4.4% at an annual rate between April and September.

With housing so weak, the recent softness in production and durable goods orders is understandable. But housing is now a small share of GDP (4.5%). And it has fallen so much already that it is highly unlikely to drive the economy into recession all by itself. Exports are 12% of the economy, and are growing at a 13.6% rate. The boom in exports is overwhelming the loss from housing.

Personal income is up 6.1% during the year ending in November, while small-business income accelerated in October and November, during the height of the credit crisis. In fact, after subtracting income taxes, rent, mortgages, car leases and loans, debt service on credit cards and property taxes, incomes rose 3.9% faster than inflation in the year through September. Commercial paper issuance is rising again, as are mortgage applications.

Wesbury is a good economist; read the whole thing.

Greg Mankiw is also skeptical about the stimulus package:

I am personally skeptical that the economic weakness is sufficient at this point to justify such a package. Yesterday CBO came out with its forecast, including "growth for the year as a whole of under 2 percent and an increase in the unemployment rate to an average of 5.1 percent." That is similar to the current predictions of some of the best private forecasters, who put near-term growth between 1 and 2 percent.

As are a number of other respected pundits:

Andrew Samwick
Steven Landsburg
Robert Samuelson
Russell Roberts
James Hamilton
James Cramer
Arnold Kling
Donald Boudreaux
Alan Reynolds
Bruce Bartlett
George Will

I hope this plan fails. It has no real stimulus and will only exacerbate our long term problems. I suspect the Fed has already done more than enough to avoid a recession (if one was even likely to begin with) and adding this $150 billion dud will accomplish nothing other than allow politicians to pat themselves on the back when the recession doesn't happen. And that is dangerous because people already have way too much faith in government.

Charity Begins in Washington

If one ever had any doubt about the political leanings of the New York Times, one need only read the editorial linked here.

Philanthropic contributions are usually tax-free. They directly reduce the government’s ability to engage in public spending. Perhaps the government should demand a role in charities’ allocation of resources in exchange for the tax deduction. Or maybe the deduction should go altogether. Experts estimate that tax breaks motivate 25 percent to 30 percent of contributions.

In any event, social needs, like those health clinics, are not about charity. They are a necessity. America needs a government that can and will pay for them.

Two things come to mind when I read this. First, is the implicit admission that government spending is charity. Second, is that the NYT believes government is better at deciding how that charity should be distributed than individuals donating their own money. There's a name for a system like this - its called socialism.

Problems with Capitalism?

Mark Gilbert has an article at Bloomberg in which he blames capitalism for the orgy of credit of the last decade:

Jan. 24 (Bloomberg) -- Any banker, trader or investor asked to invent the perfect market environment for creating wealth beyond the wildest dreams of avarice would come up with conditions akin to those of the past decade. So what went wrong?

The financial community, through greed, stupidity and hubris, has fouled its own sandpit. The era of munificent money- making conditions -- gentle regulation, ever-faster information flows, freely available credit, unprecedented access to global investors and oil-enriched buyers of anything yielding north of zero -- is ending with an almighty bang, not a whimper.

The problem with our system is not capitalism. The Federal Reserve, a creation of government, created this mess, not capitalism. If we allowed the market to function rather than fixing the price of credit through Fed manipulations, most of these problems would never have developed.

I fear that this type of thinking will just lead to more government interference in the market - that will cause even bigger problems down the road.

Uh Oh

Jan. 24 (Bloomberg) -- Societe Generale SA said unauthorized bets on stock index futures by an unidentified employee caused a 4.9 billion-euro ($7.2 billion) trading loss, the largest in banking history.

France's second-largest bank by market value plans to raise 5.5 billion euros from investors after the trading loss and subprime-related writedowns depleted capital, the Paris-based company said today. The Bank of France, the country's banking regulator, said it's investigating the situation.

Hmmm. What if some of the turmoil in European markets on Monday was caused by BNP unwinding this rogue traders bets? Did Bernanke panic and cut rates because one rogue trader made some bad bets in the market? What if those jobless claims numbers mean the economy is fine? Bernanke may have to take back those cuts sooner than anyone expects.

What Bad Jobs Market?

WASHINGTON -- The number of U.S. workers filing new claims for unemployment benefits fell unexpectedly last week for a fourth-straight week, suggesting that a resilient labor market at the start of the year might keep the U.S. economy from sliding into recession.

Initial claims for jobless benefits fell 1,000 to 301,000 after seasonal adjustments in the week ended Jan. 19, the Labor Department said Thursday. That marked the fourth-straight weekly decline to a four-month low. Wall Street economists had expected a sharp increase of 19,000.

There were no special factors, a Labor Department analyst said. The four-week average of new claims, which economists use to smooth out weekly volatility, tumbled 14,000 to 314,750, the lowest level since Oct. 6. Claims for the week ending Jan. 12 were revised up 1,000 to 302,000.

This would seem to counter all the talk about a bad jobs market. Generally, when this number is at or above 350,000, I get worried about job creation. But when this number has been closer to 300,000 in the past, the job market has been fine. Weekly claims are volatile though so we'll have to wait for more information to see if this is a trend.

Bear Market Rally?

What was that 600 point swing in the Dow yesterday all about? I suspect a large portion of the rally from the lows was due to short covering, but does that matter? Maybe, maybe not. I have been following markets for a long time (25 years or so) and I don't put much faith in technical indicators - except for one. Yesterday's action produced a Japanese candlestick chart pattern known as a hammer. Simply put, it requires a big selloff and a recovery that sees a market or stock close at its high. It is the most dependable technical indicator I've ever run across and almost always marks a bottom. The question for this market is what kind of bottom? Markets rarely make long term bottoms that look like a V and hammer bottoms are no different. Often, a hammer is followed by a rally and then a selloff that takes the market back near its previous bottom. So, I'm expecting an extension of this rally and then another selloff. That selloff will determine whether this was a real bottom or just a temporary reprieve from the decline.

I suspect that yesterday was a real bottom and not just a bear market rally as some are calling it. I've said previously and I still believe that we will not have a recession this year. As nutty as that sounds with almost everyone else saying recession - or something worse - is inevitable, there are few brave souls out there who agree with me. Brian Wesbury at First Trust is a well respected economist who I've read for many years:

We remain confident that neither a recession, nor any
significant consumer slowdown, is in the cards. The Fed
is not tight, tax rates are still low, productivity is still
strong, wages, incomes, and profit margins are still robust,
and, after revisions, the US economy has proven its
resilience time and time again.

That's from a 1/7 commentary titled "Recession Fears Still Misplaced". His 1/14 commentary is titled "Bad Mood about the Economy Unwarranted". His latest is called "Dow 15000". Which brings me to a point I've been making to clients over the last week or so. What if I'm right? And if I'm wrong, what is the downside? The way I see it, if I'm wrong most of the market decline from a recession is over. If I'm right on the other hand, the upside is huge as the bears cover their shorts and investors lay long term bets. Limited downside and big upside should be a good place for long term investors to commit some funds.

Apparently the participants at the Davos Economic Summit don't agree with me. Everyone there is competing to see who can sound the most pessimistic about the US economy. George Soros was the winner yesterday:

The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years.

However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.

I don't disagree with Soros that the US has been on a debt binge for the last 60 years or that the Fed is a huge part of the problem. I just take issue with the idea that the end is nigh. I've been reading about the death of the US consumer my entire lifetime and I suspect the end of the debt supercycle will happen in my lifetime, but this is not it.

I would also point out that last year's Davos produced no insights about the problems that surfaced in the US economy during 2007. They spent most of last year's conference fretting about global warming and the mood was generally upbeat. Soros and the others gathered at Davos are smart people but they can't predict the future any better than anyone else.

And the Winner Is....

I've refrained from commenting on the various "economic stiumulus" plans being proffered by politicians on the theory that its just politics and not likely to happen, but this editorial by Len Burman of the Urban-Brookings Tax Policy Center is just too stupid to pass up. He reveals his bias against low taxes in the first paragraph:

SINCE 2001, Washington’s answer to every policy question has been the same. What should we do with a big surplus? Tax cuts. How do we beat back global terrorism? Tax cuts. Increase energy independence? Rebuild New Orleans? Expand health insurance coverage? Tax cuts, tax cuts, tax cuts.

I think it is safe to say that Mr. Burman doesn't like tax cuts. He reveals his "stimulus plan" in the next paragraph:

Now comes another question that becomes more pressing each day that the markets lose ground — one to which taxes have long been at least part of the answer. How do we stimulate the economy to prevent or shorten a recession? One way would be to repeal the Bush tax cuts two years early, in 2009.

Um, okay that sounds stupid.

It’s true that more tax cuts this year could help head off a recession in the short run. Washington could send taxpayers rebate checks or give businesses temporary breaks for new investments in equipment. President Bush is likely to propose both as part of his $150 billion package of emergency measures.

Similar efforts in 2001 and 2002 had mixed results at best, but so long as the tax breaks are temporary, they wouldn’t do much long-term economic harm either. That said, the president’s proposal would leave out 37 percent of households because they do not earn enough to pay income taxes. A credit against payroll taxes or, better still, increasing transfers to the low-income families most likely to spend the money — say, by temporarily increasing food stamps — would do more to energize the economy.

I guess we really are all Keynesians now. This idea that the government taking money from one citizen and giving it to another with a higher propensity to spend will stimulate the economy is a myth that just won't die.

There’s bipartisan agreement that something along these lines should be done, but the president has also argued for an extension of his tax cuts, now scheduled to expire at the end of 2010. This idea has met with less support. It would accomplish nothing in the short run, and most of the benefits would go to the very rich — the group least likely to spend a tax windfall.

He's right about that; there is a bipartisan agreement that something along these lines should be done, but bipartisan does not mean smart.

But if they were repealed in a year, the Bush tax cuts could spur a burst of economic activity in 2008. If people knew that their tax rates were going up next year, they’d work to make sure that more of their income is taxed at this year’s lower rates. Investors would likewise have a giant incentive to cash out their capital gains now to avoid paying higher taxes later. In 1986, stock sales doubled as taxpayers rushed to avoid the capital gains tax rate increase scheduled for 1987. If people pour their stock gains into yachts and fast cars, that’s pure fiscal stimulus.

I suppose he could be right that repealing the tax cuts early would result in taxpayers pushing income into this year, but what exactly would that accomplish? What are we supposed to do about next year? And yes signaling a capital gains tax hike probably would convince people to sell appreciated assets this year. What the hell, the market is down anyway, why not just go ahead and drive a stake through its heart? And using those gains to buy "yachts and fast cars"? Yeah, that's the ticket to long term economic growth. Take money from people likely to invest it and give it to people that are likely to spend it; everyone knows that the path to prosperity is through spending, not saving and investment, right?

Not Too Bad

Well, that wasn't too painful. The selloff in world markets of the last two days arrived on Wall Street this morning but after a 400+ point selloff at the open the market spent most of the day moving off those lows. The Fed cut this morning could have been timed better - I would have much rather seen Bernanke and Co. wait until the market was down 500 or so before announcing the cut - but it had the intended effect.

I would have much preferred to see the market close flat or even up today after the big morning dive. I would have felt more comfortable saying that the bottom is in - in candle stick charting a day like that is called a hammer and is very bullish - but I think this was probably enough to say that we are very close if not there. We did some buying this morning and will look for more buy opportunities on pullbacks over the next few days and weeks.

The market is cheap relative to interest rates and if earnings don't collapse this will be seen as a major buying opportunity. I have maintained for some time that the housing problems would not cause a recession and I still believe that. The politicians and the press have been doing their utmost to talk us into one, but the US economy is very resilient.

As for the market, all the sentiment indicators I watch are at levels similar to late 2002 when the last bear market ended. I think part of the problem with the market has been a sort of institutional memory of that period. Investors remember how much they lost and don't want to repeat it. But the market today is a much different animal than in 2001. The S&P 500 was trading for over 30 times earnings back then versus just 15 times now and interest rates are lower. And remember the market will bottom before the economy does - or at least it always has in the past - so you can't wait for things to get better before buying.

If you are a long term investor with a diversified portfolio this is just routine stuff. Your bond and commodity investments have gone up and your stock investments have gone down. It's time to rebalance by selling some bonds and commodities and buying some stocks. You may not catch the bottom but this is probably close enough. Don't make drastic changes; do it in increments. That is the essence of investing - buy low and sell high. It takes guts at time like this but it is essential to being a good investor so take a deep breath and do the right thing.

Are we There Yet?

The stock market continued its relentless 2008 decline yesterday and I got a lot of calls from worried clients. Our clients are a pretty level headed group but they are subject to the same emotions as the general investing public. I've been doing this for a long time and when the worriers start calling, we are probably near a bottom. I have little to hang my bullish hat on here; just a feeling, but after 25 years of market watching, attention must be paid to feelings.

The sentiment in the market is as negative as I've witnessed in a long time. I think maybe investors are thinking back to 2001/2002 and are worried that we are about to repeat that 2 year debacle. I don't think so. Back then the market started its bear run with P/Es around 30; this time we are trading at less than 15 times earnings.

Corrections are scary affairs because we don't know if they will turn into a bear market. Declines of 10% or more actually happen fairly frequently and most of them do not turn into bear markets. With sentiment already this negative and valuations quite reasonable, I don't think this one will.

I am looking for a buy point and it may come soon. I won't be making any big bets, but rebalancing a portfolio after a correction will force us to sell things that have gone up (bonds) and buy things that have gone down (stocks and reits). That is the very essence of long term investing - sell high and buy low.

Agent of Change

Mark Steyn has a funny and insightful editorial in the OC Register:

This past week's issue of the Economist has a heart-rending vignette from one of the most ruthlessly capitalist industries on the planet:

"In 2006 EMI, the world's fourth-biggest recorded-music company, invited some teenagers into its headquarters in London to talk to its top managers about their listening habits. At the end of the session the EMI bosses thanked them for their comments and told them to help themselves to a big pile of CDs sitting on a table. But none of the teens took any of the CDs, even though they were free."

"That was the moment we realized the game was completely up," an EMI exec told the magazine. In the United States, album sales in 2007 were down 19 percent from 2006. Don't blame me. I still buy plenty of CDs. But that's because I like Doris Day, and every time I try to insert one of these newfangled MP3s into my fax machine it doesn't seem to play. But if you're not Mister Squaresville, and you dig whatever caterwauling beat combo those London hep cats are digging on their iPods, chances are you find the local record store about as groovy as the Elks Lodge.

Steyn is apparently not impressed with politicians as agents of change:

Now there are generally two reactions to the above story. If you're like me, you're reminded yet again why you love capitalism. It's dynamic. And the more capitalist your economy, the more dynamic it is. Every great success story is vulnerable to the next great success story – which is why teenagers aren't picking their CDs from the Sears-Roebuck catalog. There's a word for this. Now let me see. What was it again?

Oh, yeah: "change." Innovation drives change, the market drives change. Government "change" just drives things away: You could ask many of the New Hampshire primary voters who formerly resided in Massachusetts.

Nevertheless, between Iowa and New Hampshire, almost every presidential contender found himself lapsing into boilerplate assertions that he was the "candidate of change" – or even, as both McCain and Hillary put it, an "agent of change," which sounds far more exotic, as if they're James Bond and Pussy Galore covertly driving the Aston Martin across some international frontier, pressing the ejector button and dropping a ton of government regulation on some hapless foreigners.

Steyn is funny and smart. Read the whole thing. (HT to Don Boudreaux at Cafe Hayek)

The Fed Fiddles

The US economy is slowing and many economists and most of the public believe we are either already in a recession or will be soon. I have said previously and still believe that we won’t get a recession from the bursting of the housing bubble. I must admit that my conviction about that has been shaken over the last several months as the economic statistics have deteriorated, but even now I don’t expect the economy to slow enough for an official recession. That doesn’t mean that the economy will not face some difficult times, but the US economy has proven to be very resilient over the years. A lot of that resilience is due to the fact that every time the US economy has slowed, the Federal Reserve has ridden to the rescue with lower interest rates.

I have no doubt that if Alan Greenspan were still in charge at the Fed that interest rates would be lower than they are today. Ben Bernanke has lowered rates by 100 basis points but the market still clamors for more. It appears from his speech last week that Bernanke finally agrees that the Fed needs to do more and another 50 basis point cut is widely expected at the next meeting at the end of the month. Indeed, many expect the cut to come before the next meeting, as if two weeks would make all the difference. Will another 50 basis point reduction in the Fed Funds rate be enough to stabilize markets?

2008 is barely two weeks old and the S&P 500 is down almost 6%. The NASDAQ is down almost 9%. Of the 5 broad asset classes we utilize in our portfolios, 4 are down year to date; the only broad asset class to gain is our fixed income component. Since the stock market peaked in mid-October, 3 of 5 asset classes are down. While this is disconcerting for clients, I am comfortable in the knowledge that in the 27 years of data we have analyzed for these asset classes, there have only been 2 full years when 3 of the asset classes have declined. And there has never been a full year when 4 declined. Furthermore, as bad as this year has started, the likelihood that the full year will end as bad as it started is minimal, although not impossible. Again, reviewing the data, I find 7 years that produced returns of 5% or less (as this strategy did in 2007). The year following produced a return of greater than 15% in 6 of those instances; 5 times produced a return of at least 20%. Only once did a sub 5% return repeat the following year (2002).

The economic effects of interest rate cuts take time to work their way through the economy. The effect on markets can be and usually is more immediate. Everything the Fed has done since August has been an attempt to provide liquidity to the credit markets. Those efforts are now finally starting to bear some fruit. While the headlines are about loan write offs and investments by sovereign wealth funds in the major banks, behind the scenes there are hopeful signs in the credit markets. A month ago the spread between LIBOR and Fed Funds was above 1%; that wide spread indicated reluctance by banks to lend to one another. That spread, after massive injections of cash by central banks around the world, has fallen to about 0.25%. In addition, the most recent Term Auction Facility by the Fed was awarded at 3.95%. The last auction in December was awarded at a rate of 4.67%. That would seem to indicate a slackening of demand for this credit from the Fed.

So even as the stock markets sell off over fears of a credit crunch induced recession, the credit crunch itself is already starting to ease. Does that mean all the troubles in the banking system are over? Probably not, but I believe the majority of the bad news has already been reported. Does it mean the economy will immediately regain its footing? Probably not since the economic effects won’t be felt for some time yet. Does that mean that the stock market will soon find a bottom? Maybe, but that depends as much on psychology as anything else; investors with cash will have to feel comfortable putting that cash at risk in the market.

The psychology of the market right now is as negative as it has been since the beginning of the bull market in late 2002. The American Association of Individual Investors weekly poll shows just 19.6% of respondents bullish, 58.9% bearish and 21.5% neutral. That is actually a lower number of bulls than the survey showed at the bottom of the market in October of 2002, so if we are not at a bottom, we are probably close. These surveys are generally trend following; as stocks rise the number of bulls rise and when stocks fall the number of bears rise. Turning points are found at the extremes and less than 20% bulls is an extreme. All those bears are merely future buyers.

And why wouldn’t the average investor be negative? The news has been relentlessly negative for months now. Home prices are falling, foreclosures are rising and banks are announcing huge loan losses. Oil is still over $90 and gas prices remain over $3 per gallon. Gold is setting record highs and politicians are touting their economic “stimulus” plans (none of which appears particularly stimulating). The spectre of stagflation has returned from the dark days of the Carter presidency and the dollar is hitting multi decade lows. Is there any good news on the economic front?

Well, actually there is some good news out there. Unemployment has risen slightly but remains much lower than the last recession:



Although we don’t have data from December yet, personal income was still rising at a decent rate in November:



As is consumption:



Core inflation is higher than I would like, but not outside the range we’ve seen over the last several years:



Despite the headlines about a credit crunch, commercial banks are still lending:



Average hourly earnings are rising at a healthy rate:




Despite all the Grinchy talk about a lousy Christmas season, retail sales were still up 5% year over year in December:



Exports are still booming:




And imports, which tend to fall in a recession, are also still rising.



I don’t mean to imply that all is sunny with the US economy. Even some of these positive statistics can be viewed as negative. Unemployment is low but rising and in the last recession, stocks didn’t stop falling until the unemployment rate peaked. Inflation is still too high. The expansion in commercial bank loans is partially due to the fact that banks are taking loans back on their books that they can’t finance off balance sheet. Exports are booming because the dollar is weak and imports are rising because of higher oil prices. But there are also positives not seen here. Corporate profits, outside of the financial sector, are still rising. Insiders are buying their own stock at very high rates. The financial sector is having little difficulty raising new capital, if on unfavorable terms.

The Federal Reserve will lower interest rates again and the economy will recover from the sub prime induced credit crunch. The long term problems with our economy will not be solved by another dose of easy credit though. Our government needs to spend less and cut the tax burden, especially at the corporate level. Something has to be done about the costs of Social Security and Medicare. Trade needs to be furthered expanded, not restricted by a populist, xenophobic Congress. But these are political problems that will not be solved before this slowdown is over. If history is any guide, they won’t be solved until they become full fledged crises. Some believe that the crisis has already arrived and the US is in permanent decline. I don’t believe that and investors who have bet on that in the past have always been disappointed.

Producer Price Index

The Labor Department today reported a 0.1% drop in producer prices for the month of December. Excluding the more volatile measures of food and energy, core wholesale prices rose 0.2%. Economists had expected a gain of 0.2% for both the PPI and the core.

Food prices for December increased by 1.3%, offset by a decline of 1.9% in energy prices.

For the year, producer prices have increased an intolerable 6.3%.

December Retail Sales

Seasonally adjusted retail sales fell 0.4% in the month of December, after a 1% rise the previous month. Excluding the the purchase of autos, sales also fell 0.4%. Economists were expecting no gain in total sales, and a 0.3% drop in sales excluding autos.

Strengths within the sector included furniture, food and beverage, and health and personal care products.

Gas purchases, electronics and appliances, and apparel proved to be the laggards.

Overall, retail sales were up 4.2% in 2007, the slowest rate of growth since 2002.

Down Express

It looks like the economic slowdown is starting to affect the credit card companies. Yesterday Capital One set aside $1.9 billion to cover bad loans in the 4th quarter. The bad loans come from the credit card division as well as the mortgage division. After the close yesterday, American Express announced that it was taking a charge of $440 million to cover loan losses. Both companies are expecting earnings to be up this year but significantly less than Wall Street was expecting.

Merrill Lynch is also rumored to be set to write off another $15 billion but ironically the stock is up on the day. It is often a sign of a bottom when a company reports bad news and the stock goes up, but I'm still not ready to make a commitment to the financials. Even if this is the bottom, I suspect there will be plenty of opportunities to take positions. When a sector gets hit this hard it rarely makes a V bottom; more likely is several months (at least) where the sector trades sideways and builds a base. Patience is a virtue in this case.

Gold hit another new high today. Last I checked the high was around $899. The gold stocks (we have clients who own GG and AEM) have been one of the best performing groups so far this year, but the enthusiasm for them may be starting to get overdone. These are not cheap stocks and everybody seems to love them. That makes me nervous, but for now we're sticking with our positions.

Commodities and commodity stocks may both be getting ready for some kind of correction. The Goldman Sachs Commodity index is struggling a bit near its highs as oil comes off. Energy is a big part of the index. The DJ-AIG index is performing better with a bigger weighting in the agricultural commodities. The thing that worries me about these is the rampant bullishness. Everybody, it seems, is bullish on commodities and everybody is bearish on the dollar. At some point one has to wonder who is left to buy...

The flip side of that is the stock market. I haven't seen the sentiment so negative since the bottom in 2002. Calling for a recession this year places one firmly in the crowd. I've said for over a year now that housing would not be enough to cause a recession; that has proved true to this point, but it's getting hard to swim against the current. Is it possible that everyone expecting a recession actually causes one?

US Trade Report

The US trade deficit grew by more than 9% for the month of November, far more than expected. The gap between imports and exports grew to $63.1 billion, up from $57.8 billion in October. A rise to $59.5 billion was anticipated.

Exports climbed to $142.3 billion, an increase of 0.4% for the month. Exports have risen for a record ninth consecutive month. Key strengths were automobile and parts sales as well as refined energy product sales.

Imports increased 3%, to $205.4 billion. The main culprit was a jump in the price of crude oil, which accounted for two-thirds of the increase in the trade gap. Purchases of capital equipment and consumer goods also contributed to the increase.

Giuliani on Taxes

In a move sure to make the populist class warriors blow a gasket, Rudy Giuliani unveiled a tax plan that makes Reagan look like a piker when it comes to tax cuts. Rudy wants to cut the capital gains tax, the corporate tax and eliminate the estate tax among other things:

NEW YORK (Reuters) - Republican presidential hopeful Rudy Giuliani has proposed what he called a multitrillion-dollar tax cut that would lower the corporate tax rate from 35 percent to 25 percent and reduce the capital gains tax from 15 percent to 10 percent.

The proposal, unveiled by Guiliani's campaign on Wednesday, would preserve the 2001 and 2003 tax cuts enacted by President George W. Bush, eliminate the estate tax and give taxpayers the option of choosing a simplified tax form with three tax brackets with a maximum bracket of 30 percent.

The plan is already being criticized as if it has any chance of becoming law:

"What we need right now is a very targeted stimulus plan that goes right to the heart of the problems we face, which can all be traced to the distress in the subprime mortgage market," said Ward McCarthy, managing director of Stone & McCarthy Research Associates, in Princeton, New Jersey.

"Quite frankly, these grandiose, broad-based fiscal proposals now being scattered about in shotgun fashion by a variety of politicians are completely off the mark."

Actually, I prefer grandiose things that make sense over simple things that don't work, but maybe that's just me.

The one thing missing here is a pledge to cut spending. While the capital gains cut would probably result in higher revenues in the short term (every capital gains tax cut in the past has produced exactly that), the other cuts will likely result in lower tax revenues. Not that I have a problem with that, but someday we will have to balance the budget and with the baby boomers retiring that day needs to be sooner rather than later.

Bernanke Put

After a nice late day rally yesterday, stocks had been struggling this morning as retail sales at the major retailers were fairly disappointing. But now, our friend Mr. Bernanke has spoken and markets have made a fair turnaround. Whether stocks can hold the gains or not is far from certain (indeed as I write this, the market seems to be selling off a little) but certainly the odds of a 50 basis point cut at the next Fed meeting have increased considerably with this speech. And that has gold making new highs again.

Some excerpts with my comments in bold:

Since late last summer, the financial markets in the United States and in a number of other industrialized countries have been under considerable strain. The turmoil has affected the prospects for the broader economy, principally through its effects on the availability and terms of credit to households and businesses. Yeah, when folks start to default, banks become rather reluctant to lend again.

In all likelihood, the housing contraction would have been considerably milder had it not been for adverse developments in the subprime mortgage market. Since early 2007, financial market participants have been focused on the high and rising delinquency rates of subprime mortgages, especially those with adjustable interest rates (subprime ARMs). Currently, about 21 percent of subprime ARMs are ninety days or more delinquent, and foreclosure rates are rising sharply. It seems to me that the contraction would not be so bad if the Fed hadn't kept rates too low for way too long (which fed the bubble) and had taken some action on sub prime when it was happening rather than waiting until it was a problem. In other words, if the bubble hadn't gotten so big to begin with, it wouldn't be so far down to reality.

As you know, the losses in the subprime mortgage market also triggered a substantial reaction in other financial markets. At some level, the magnitude of that reaction might be deemed surprising, given the small size of the U.S. subprime market relative to world financial markets. Part of the explanation for the outsized effect may be that, following a period of more-aggressive risk-taking, the subprime crisis led investors to reassess credit risks more broadly and, perhaps, to become less willing to take on risks of any type. Investors have also been concerned that, by further weakening the housing sector, the problems in the subprime mortgage market may lead overall economic growth to slow. The problem is not that investors are reassessing credit risks; the problem is that they are just now considering credit risks. The fact that most of these sub prime mortgages were part of triple A rated securities is what has investors pulling in their horns. Investors need to know what the hell they are buying so they can assess the risks.

However, in light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary. The Committee will, of course, be carefully evaluating incoming information bearing on the economic outlook. Based on that evaluation, and consistent with our dual mandate, we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.

Financial and economic conditions can change quickly. Consequently, the Committee must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability. This is the money graph. The phrase "substantive additional action as needed to support growth and to provide adequate insurance against downside risks" is the one everyone is concentrating on. Adequate insurance is basically the Bernanke put and substantive additional action means 50 basis points is on the table.

This is probably not enough to make a long term bottom for the market. I am looking for a consolidation period in which we continue to trade in this range we've been stuck in for the last 6 months. Commodities are still acting fairly well if extended in price. Further monetary easing should continue to support the commodity markets.

Initial Jobless Claims- Jan. 5

First-time claims for unemployment benefits unexpectedly fell for the week ending January 5. Jobless claims decreased by 15,000 to 322,000, from an upwardly revised 337,000 from the prior week. Economists had forecast an increase of 4,000.

The 4-week moving average, a less volatile measure, fell to 341,000 from 344,000.

29 states and territories reported an increase in new jobless claims, while 23 reported a decrease.