The good news, economist Ed Yardeni points out, are estimates of corporate profits 12 months ahead show significant growth.  So gradually things have kept improving.

The bad news is the U.S. is running unsustainable budget deficits.  The President and democrats are seemingly oblivious to the consequences.  Republicans want to rein in spending but lack the votes to change policies.  On Thursday this could come to a head as the government reaches a self imposed borrowing limit.  The debt is so overwhelming large that the government must borrow more money to pay bonds that come due now.  (Did not Madoff go to jail for doing just that type of shell game?)

The immediate consequences of not paying back bondholders include higher interest rates.  Also most insurance companies and banks hold bonds as part of their capital structure. If those issues become worthless, even for one minute, most financial companies will fail to meet the minimum capital standards.  That means they are bankrupt.  Remind you of 2008?  It should but then it was derivates which became worthless.  The government stepped in and guaranteed their payment to avoid complete collapse.  There is no way the government can guarantee its own default.  Expect chaos.

My view is the $1.5 trillion in overspending was going to come to a head within a few years debt deal or not.  A Greek type collapse would occur.  So it is awkward, hard, expensive and embarrassing for the U.S. to go through today’s reality show.  But is better for everyone to solve the problem and not let things go the Greek way.

What do I think will happen?  Interest rates will spike beginning now. The stock market will go down substantially.  It could be a 50% decline. Eventually (months?) there will be a debt deal.  The bank regulators, a future deal in mind, will issue a capital waiver and keep companies out of technical bankruptcy.  That does not help companies who need their treasury holdings to be repaid so they can pay bills.  This includes some giant mutual funds and money market funds. 

In the past when U.S. stocks collapse so do international stocks.  A market collapse would be a great opportunity to add stocks.  We will add shares in companies which make products we use everyday, recession or not.  Food, water, power, phone service are examples.  We expect a significant rebound in stock prices whenever a debt deal is reached.

What can you do?  Email and call your Congress members and lobbyist.  Say overspending and socialism are bad for business and America.

Roger O. Groh

10/15/13

GROH ASSET MANAGEMENT

(Why You Never Want) WAGE AND PRICE CONTROLS

Remember back in the 1970’s when the government imposed price controls on fuel and other items?  Then you also remember what happened when the caps were removed.  Prices zoomed, inflation took off and it cumulated in the early 1980’s horrible recession.  30 year Treasury Notes yields hit 14.68%.  Unemployment was 11%.  All caused by the foolhardy political notion that prices could be controlled.

Politicians with short memories forgot the 1970’s lessons.  Several years ago the U.S. imposed price controls on interest rates.  That is why treasuries yield next to nothing.  Investors seeking yield and growth, with little risk tolerance, have been forced to put their money in, much more volatile, asset classes like real estate and the stock market.

Last year the Congressional Budget Office (very accurate, non partisan financial forecasting arm of the U.S. Govt.) published a note about what would the (then) pending U.S. spending cuts mean to overall growth.  The forecast: growth would slow to around zero economic growth for a year, followed by above average growth. The cuts started in March and so far the forecast seems accurate.

If the economy grows as forecast by next spring GDP could be growing at a 4% maybe 5% rate. A hint of even 1% growth would likely cause the interest rate price controls to be removed.  Interest rates would instantly rise from near zero to a normal 5%-8% range.  And all those people who really did not want to own volatile investments will turn into wildly stampeding sellers. 

When the interest rate caps will be lifted is unknown.  Could be tomorrow or year end, but soon.  Lifting all controls at once would create unnecessary chaos and hardship.  I have become a noisy Bush era ex Federal Reserve Board Official arguing lifting them now sector by sector is the best approach to a problem with no good answers. Begin the cap exit today by permitting mortgage rates to rise now and follow with other sectors in the fall.

So, you want to make money? You could short real estate,  short bonds and short the U.S. equity market.  There is significant risk in that approach.  However betting interest rates will rise over the next year seems reasonable. Go long interest rate futures with a portion of your investments.  We can help you make those investments.  Make your plans now, not later.  Decide what stocks and real estate you can emotionally and financially handle owning at less than half of todays price.  Sell the rest now, put it in boring guaranteed money market accounts or short term treasury issues.  The waiting is going to be hard especially if prices going up and you are not invested.  Be patient.  I might be wrong but my thoughts echo Buffett, Goldman, Gross and a host of other very smart investors saying watch out.

Roger O. Groh

SAM’S THEORY OF ECONOMICS

Historians of the 1930’s Great Depression point to a series of errors the U.S. Government made resulting in the worst period of economic performance in history. The one overriding lesson is that, just like 2010, higher taxes and increased expenses stripped corporations and individuals of spending power.

While the depression took hold the shunned English economist, John Maynard Keynes, argued that we were doing it all wrong. “Don’t be fools, put money in their pockets not take it out!” said Keynes. President Franklin Roosevelt was not sure Keynes was right. But did believe if he put cash in people’s pockets he would get their vote. So, the era of Keynesian economic theory was born. The government stimulus packages you have seen in 2009 and probably 2011 are Keynesian once again.

The problem is that Keynes discovered massive government stimulus could stabilize an economy and banking system. But, did not restimulate significant long term growth. During Keynes time WW11 provided the jobs and growth to put people back to work. The biggest question facing our country today is how, short of a larger war, to stimulate demand.

Japan entered into recession during 1990. They are still in the recession today. 20 years!! Why? As Japan raised taxes and expenses, decreasing competitiveness, companies moved to cheaper countries. The Japanese government also has tried to cover that loss by using stimulus packages many times. Are we foolish enough to make the same mistakes? Does the U.S. want to remain in perpetual recession? .

Enter Sam Walton who never met a product he did not like, as long as he could sell it cheaper than anyone. Could the U.S. use Sam’s company, Wal Mart, as the role model? No I do not mean the government should buy retailers. But by having the lowest income taxes, and fewest government controls, of any country. “If we are the cheapest the corporations will come”.

Our “competition” are other countries which are taking our companies, capital and jobs, by implementing these exact cost reduction strategies. China and Hong Kong reduced income taxes while the U.S. raised theirs. The GDP score in this game? China growth 10% per year. The U.S.? A big fat Zero.

We forgot what Keynes discovered and Sam always knew; you can only succeed if you are the least expensive guy on the block.

Roger Groh

10/7/10

Roger@Grohasset.com