TAKE THE EXIT RAMP OFF THE ROAD TO SERFDOM ONTO EASY STREET

Yesterday’s post discussed how valuation discrepancies in a capitalization-weighted portfolio overweight overvalued stocks and underweight undervalued stocks. Since many investors have a large amount of their money in S&P 500 capitalization-weighted index funds, most investors are subject to this misallocation.

As stated by Rob Arnott in my post from yesterday:

Now if every asset is trading above or below its true fair value, then any index that is capitalization-weighted (price-weighted or valuation-weighted) is automatically going to have us overexposed to every single asset that's trading above its true fair value and underexposed to every single asset that's trading below its true fair value.[i]

SO WHATCHA GONNA DO ABOUT IT?

There are several ways to overcome this misallocation.

1. Use non-capitalization weighted indices. Arnott suggests indexes based upon non-valuation factors such as book value, cash flow, revenue, ECT. Pick, for example the 500 largest stocks based upon book value or the 500 companies that have the largest work force. Arnott includes studies that demonstrate that indices based upon these non-valuation metrics outperformed the capitalization-weighted S&P 500 index.[ii]

Does it work? You bet. The graph below shows that the thousand largest by capitalization over the past 43 years, the red line, would have taken every dollar you invested and turned it into 70 dollars. Well that's awesome, that's what a quarter-century bull market from '75 to '99 does -- the biggest bull market in US capital markets history.

Taking a dollar to seventy dollars is remarkable. But if you use any of these other measures, any of them, you do roughly twice as well. In fact a little better than twice as well for the average: 160 dollars for every dollar at starting value. It's a huge gap. Look also at what happened after '99. The S&P 500 is still down 10 percent in total return including income. Fundamentally weighted indexes: up 30 percent.

Why does it work? A capitalization-weighed index has a bias toward large stocks that cost more, or have larger market capitalization. Many of these stocks are overvalued and as a result, such a portfolio is over weighted with overvalued stocks. Similarly, these capitalization-weighted indices are under weighted in undervalued stock. If you change the mix to a different measurable selection criterion, you remove this return-killing bias.

2. Value-based investments. John Mauldin, the publisher of the “Thoughts from the Frontline”, proposes value stocks and other instruments to overcome this bias. A value based investing technique seeks out undervalued stocks and holds them until the market recognizes their value. Value investing is a valid and effective methodology in a Bull Market or a neutral market. But in a Bear market, a value investment will still fall with the rest of the market. Not by as much, and there may be some winners in the portfolio. But it is still swimming against the momentum of the market.

3. Relative Strength, Momentum based investing as practiced by the Author. This approach is an absolute return methodology and seeks to NEVER lose money. We follow the market. When it moves up, we buy the strongest moving investments and hold them until they slow. We get out near the top and avoid the steep pullbacks. When the market is in a sideways movement, we hold cash. When the market is in decline, we hold cash and some investments that move inverse to the market. This methodology avoids the entire “Noisy Market”[iii] problem. In fact, we use the “Noise” to our advantage and avoid the downside of inefficient pricing “Noise”.

Today’s post and yesterday’s post discuss a matter that further discredits a “buy and hold” methodology. It is just one more reason to spend more time in the Desert of the Real!

ALL TIME IS QUALITY TIME IN THE DESERT OF THE REAL!

[i] http://www.frontlinethoughts.com/printarticle.asp?id=mwo061606
[ii] http://www.frontlinethoughts.com/printarticle.asp?id=mwo061606

[iii] http://desertoftherealecononomicanalysis.blogspot.com/
/2006/06/index-your-way-to-serfdom-uh-uh-er.html

INDEX YOUR WAY TO SERFDOM (uh, uh, er something)

Capitalization-weighted indices like the S & P 500 virtually guaranteed to UNDERPERFORM Non-capitalization based indices.

That statement above is quite a mouthful. And there are several reasons that this is the case. Yet S&P 500 index funds are probably the most common investment in most 401K investment portfolios. So what’s the problem?

Most readers know that the Author is a momentum, relative-strength based investor. And most readers also know that the Author believes that we are in a Secular Bear Market[i] that began in 2001 and will run well into the second decade of this young century. So needless to say, the Author is bearish on stocks in general. That being said, within every Secular Bear Market there will be Cyclical Bull Markets of relatively short duration (often three-six months). When the market moves through these Cyclical Bull Markets, an investor must buy fast-growing equities. The most recent Cyclical Bull Market, which probably began in January of 2006[ii], most probably ended in May[iii] of this year.

WHY THE BIGGEST ISN’T BESTEST (uh, uh, er something)

In the June 16, 2006 edition of John Mauldin’s “Thoughts from the Frontline”, Mauldin addresses why capitalization-weighted indices under perform. He quotes at length from Professor Jeremy Siegel of the Wharton Business College and Rob Arnott, author and investment advisor exemplar. The Author urges the readers to check out the article[iv] on Mauldin’s website. Here the Author will attempt to explain capitalization-weighted index underperformance.

SOME STOCKS ARE OVER-PRICED, SOME ARE UNDERPRICED. (Thank you Captain Obvious.)

Markets are not instantly efficient. At any given time, some stocks are overpriced, or cost more than their “fundamentals” would otherwise indicate. And on the other hand, as all two-handed economists would note, some stocks are under priced, or are valued less than their “fundamentals” would indicate. Jeremy Siegel calls this the “Noisy Market” hypothesis:

This new paradigm claims that the prices of securities are not always the best estimate of the true underlying value of the firm. It argues that prices can be influenced by speculators and momentum traders, as well as by insiders and institutions that often buy and sell stocks for reasons unrelated to fundamental value, such as for diversification, liquidity and taxes. In other words, prices of securities are subject to temporary shocks that I call 'noise' that obscures their true value. These temporary shocks may last for days or for years, and their unpredictability makes it difficult to design a trading strategy that consistently produces superior returns. To distinguish this paradigm from the reigning efficient market hypothesis, I call it the 'noisy market hypothesis.'

"The noisy market hypothesis easily explains the size and value anomalies. If a stock price falls for reasons unrelated to the changes in the fundamental value, then it is likely - but not certain - that overweighting such a stock will yield better than normal returns. On the other hand, stocks that rise in price more than their fundamentals become 'large stocks' with high P/E ratios that are likely to underperform. [v]

This revelation of the “Noisy Market Hypothesis” is not all that groundbreaking. Even a casual market observer would note that stock prices swing wildly, at least in the short/medium term. But what is interesting is what this “market noise” does to capitalization-weighted index returns. It means that in a capitalization weighted index, where the largest stocks by market capitalization represent the biggest proportions of the index, you will be have a bigger stake in the overpriced stocks and a lower percentage of your funds in the undervalued stocks. Arnott goes on to say:

Now if every asset is trading above or below its true fair value, then any index that is capitalization-weighted (price-weighted or valuation-weighted) is automatically going to have us overexposed to every single asset that's trading above its true fair value and underexposed to every single asset that's trading below its true fair value.[vi]

COME ON, FEEL THE NOISE

Let’s look at an example, an example that is used in the Mauldin article. You buy into a capitalization-weighted index of two stocks. Each has a “fair” value of $100. One stock costs you $150, the other $50. In a few years, the $150 stock will fall to $100. You lose $50 on this stock. The $50 moves to $100. But your $200 investment is still only $200 and you have had a 0% return on your portfolio[vii].

What if the index was not capitalization-weighted? What would have happened? If your $200 was divided equally between the stocks, you would have purchased .66 of the $150 overvalued stock and 2 shares of the $50 stock and your total return on the $200 would be 33%. You would have a 100% return on the $100 you paid for the shares that went from $50 to $100. For the stock that fell from $150 to $100, you would have lost $33 dollars because you would then own .66% of a $100 stock. In sum, you would have had a return of 33% on your $200 dollar investment ($100-$33 = $66. $66 is 33% of $200)

SO WHAT DOES THIS ALL MEAN?

The next post will explore this issue in more depth. And it is likely that both of these posts will comprise the Desert of the Real Newsletter for July 2006. But the clear message is that the Noisy Market hypothesis makes capitalization-weighted market indices a non-starter. Mauldin has one answer, Seigel and Arnott have another. And guess what? The Author has a still better one!

RETURN EVERYTHING TO ITS ORIGINAL PLACE IN THE DESERT OF THE REAL!

[i] http://desertoftherealecononomicanalysis.blogspot.com/2005/10
/so-what-this-secular-bear-market.html. This post discusses the Secular Bear Market in great detail.
[ii] http://desertoftherealecononomicanalysis.blogspot.com/2006/01
/markets-to-date-so-far-and-not-very.html. This post noted the strong beginning to Januart
[iii] http://desertoftherealecononomicanalysis.blogspot.com/2005/11
/it-could-be-beginning-to-look-lot-like.html. This post noted that the stock market truism “Sell in May-Go Away”, or the general trend for the market to lose ground after May and not regain positive momentum in November has statistical support.
[iv] http://www.frontlinethoughts.com/printarticle.asp?id=mwo061606
[v] http://www.frontlinethoughts.com/printarticle.asp?id=mwo061606

[vi] http://www.frontlinethoughts.com/printarticle.asp?id=mwo061606
[vii] The Author knows that some of you smart guys are saying, well, duh, just buy the $50 stock and don’t buy the $150 stock. This is just a simple example. An index contains many stocks and you don’t know the “fair value” nor which ones are over- or under-valued. But you do know that about 50% will be overvalued and 50% undervalued.

ARIZONA, PUT ON YOUR RAINBOW SHADES

ARIZONA, PUT ON YOUR RAINBOW SHADES[i]

Arizona is the 17th largest state in the Union, with almost 6 million people. (2005) It dwarfs its neighbors Utah and New Mexico, but is overshadowed by California to the east.

Arizona has an extremely high rate of population growth, jumping from the 20th largest state by population in the year 2000 to the 17th largest in 2005. Arizona was the second fastest growing state in the 1990s. The Phoenix metropolitan area increased by 45% from 1990 to 2000.

Readers familiar with the Phoenix community know that it is a sprawling growth center, devouring vast amounts of land and turning one-stoplight towns on its periphery into mega commute exurbs.

SUN CITY, OLD FOLKS

Arizona is a retirement mecca with the Del Webb communities pioneering the large retirement community complexes. The presence of these retirees requires that Arizona devote a good portion of its healthcare resources to senior care. This large senior population will also make great demands on the state’s Medicaid system as it pays for nursing home care for the large senior population.

LOTS OF KIDS, TOO

In 2003 the number of Hispanic births overtook the number of white non-Hispanic births. This change in birthrates means that Arizona is predicted to become a “Majority-Minority”[ii] state in 2035, Currently, California, Texas, New Mexico and Hawaii are “Majority-Minority” states[iii].

LOTS OF BIGOTS ON THE BORDER

Arizona is also the center of activity for the so-called “Minutemen”, vigilantes that wish to halt “illegal immigration”, or Mexicans from migrating north to work at low-wage jobs. “Illegal Immigration”, or “Economic Relocation” as movement between the borders should more properly be called, is an economic fact. It is a central foreign policy accomodation between the US and Mexico. Wages earned by Mexican workers are sent back to Mexico. Both countries benefit, but bigotry and American Nativism run deep in this land of immigrants in denial.

ARIZONA, HAVE ANOTHER LOOK AT YOUR WORLD

The Arizona state government is the largest employer in New Mexico, followed by Wal-Mart. And according to an Arizona State Department of Commerce report, cited in the Arizona Wikopedia entry, Arizona lost much of its comparative advantage as a high-tech industry leader from 1990 through 2001.[iv] Sound familiar? Seem kind of representative of anything?

In 29 years, whites will be a minority in New Mexico. It will be a state of color and the largest population group will be Hispanic. It will be, as a practical matter, a bilingual state, just as America will be a bi-lingual country. And Arizona will have lots of retirees drawing Social Security benefits and other government benefits. Retirees will demand their “due”. Younger workers may not want to pay. But the situation must be resolved and each group needs the other.

This is the world America is moving into. From about 2020 through about 2060, America faces a retirement and healthcare funding crisis. This crisis needs Mexican immigrants to have any hope of funding this retirement shortfall.

America’s future can be seen in the present trajectory of Arizona. A diverse multiculture bearing huge burdens to finance healthcare and pensions for its elderly.

AMERICA, HAVE ANOTHER LOOK AT YOUR WORLD

FIRE ON THE MOUNTAIN AND LIGHTENING IN THE AIR IN THE DESERT OF THE REAL!

[i] A paraphrase of a lyric from “Arizona”, a song by former Paul Revere and the Raiders bandsman Mark Lindsay. Other paragraph headers may use lyrics from this song.
[ii] http://en.wikipedia.org/wiki/Minority-majority. This appellation basically means that there are more non-Whites than whites. The Author uses these terms only to illustrate the changes in population and demographics. The Author does not fundamentally recognize the concept of race among and across human beings. Human beings from certain areas of the world have some small genetic differences to the effects of evolution, climate and other conditions. But the term “race” is a construct, used to separate and divide humans.
[iii] By contrast, more rural states such as North Dakota, South Dakota, Montana, Vermont, New Hampshire and Maine are not projected to experience such a change for centuries, if ever. Of course, if the majority of the U.S. population becomes Hispanic (for example), then it is those more rural states which will become majority-minority states, as their white majority will be at odds with the non-white national norm. http://en.wikipedia.org/wiki/Minority-majority.

[iv] http://en.wikipedia.org/wiki/Arizona

ARIZONA BOUND, OR BOUND TO BE ARIZONA?

ARIZONA-A MICROCOSM OF THE NEW AMERICA?

In the 2004 film “The Motorcycle Diaries”, a young Ernesto “Che” Guevara makes a generally accurate observation about Latin America. The youthful pre-Communist Revolutionary says that [paraphrase] from Tierra Del Fuego to the Mexican border with Texas, Latin America is one large Mestizo continent. Mestizo is a Latin American term for mixed European and Native Latin American people.

In many Latin American counties, the majorities of the populations of the countries are of mixed European and Native American ancestry.[i] Hispanics in the United States also reflect a high percentage of Mestizo ancestry, although a few profess solely European ancestry.

Another way of addressing the meztiso populations in Latin America is to state the obvious. Spanish and Portuguese invaders of Central and South America commingled with Native peoples to produce offspring with genetic traits from both populations. European invaders and Native North Americans did not commingle in a similarly large extent. North American European conquerors preferred genocide and Apartheid (“reservations”) as opposed to a more paternalistic “patron” system.

AMERICA WANTED THE MEXICAN LANDS, BUT APPARENTLY NOT THE MEXICANS

America, a nation of immigrants that have no memory of their former immigrant status, is manufacturing another “immigrant crisis”. Originally conceived as just one more partisan “Wedge” issue designed by Republican strategists, the immigration “Wedge” has cleaved big divisions in the Republican base. Republican corporate interests (and Democratic corporate interests) like the supply of lower-wage workers. But the xenophobic, Nativist, racist wing of the Republican party (and some old-line Democrat lunch pail union types) want the “wet backs” out and snipers on the border. Too late, they’re already here. Most of them have been in here for a while. A lot of them were living in New Mexico, Arizona and California when America took those lands by military force from Mexico in the War of 1848.

MEZTISOS MOVE NORTH

As most of the readers know, the Author lives in New Mexico, Nuevo Mexico. To the east of New Mexico is Texas and to the west lies Arizona. Each state has a large Hispanic population and each has its own political and sociological idiosyncrasies. In Texas, 35% of the population is Hispanic and 49% is Anglo-European. Arizona, one of the fastest growing states in the country, is 26% Hispanic and 63% Anglo-European. New Mexico is 42% Hispanic and 45% Anglo-European. Almost 10% of New Mexican residents are First Nations Americans.

But of course most American cities and states now have large and growing Hispanic populations. Indiana, the Author’s home state, has a 3.5% Hispanic population percentage. Minnesota, the Author’s former resident state, has a 3% Hispanic population. Georgia’s population is about 5% Hispanic. And Hispanics are the largest growing population group in the country.

WHEN WILL THE UNITED STATES BECOME A MEZTISO NATION?

Just like the Author cannot predict future stock market directions, he cannot predict when the United States will be a plurality or a majority Hispanic nation. It is likely it will be, but not in the Author’s lifetime. But the process is already underway. Along with other processes. Loss of industrial capacity. Income divergence. Sprawl. Expansion of low-wage service work. Nativism versus economic and cultural inclusion.

Of the three states discussed, Arizona is likely to be a better bellwether of the new American direction[ii]. Texas is already a large state with well-defined demographic divisions. New Mexico is a small state that does not have capacity for large growth. So when we look to the future, we should look to Arizona.

In the next post, the second of a two-part series, we will look at why Arizona is a microcosm, good and bad, for the Nuevo America.

DITAT DEUS FROM THE DESERT OF THE REAL!

[i] http://en.wikipedia.org/wiki/Mestiso. This Wikopedia article addresses Meztiso populations in greater detail.
[ii] The Author did not consider California, as it is also a large state with established demographic divisions. The Author needs to look at an adolescent state, like Arizona.

BUYING PUTS IN A FALLING MARKET

BUY PUTS ON DECLINING ISSUES

The average investor makes money in a rising market and loses money in a falling market. A good investor makes money in a rising market and does not lose money in a falling market. A really good investor makes money in both a rising and a falling market

In the post of Tuesday, June 13th, “STOCK MARKET RALLY? WHAT MARKET RALLY?", the Author discussed the strategy of buying inverse mutual funds, funds that rise when market indices fall. The Author discussed RYVNX, an inverse fund that moves 2 times inversely to the NASDAQ index. As the NASDAQ falls, RYNVX goes up.

In this post, we will look at Puts, the other type of option. Like a Call, a Put is a contract. A Put gives someone the right to sell a stock at the strike price (fixed price) on or before the expiration date. For review, lets go through the basics of the option terms again. If you saw this information in the prior post, review it or skip past it.

Common Option Features:
a. Fixed Number of Shares. Nearly all option contracts are traded on options exchanges. These exchanges fix the number of shares covered by an option contract at 100 per contract. If you want an option on more shares, you buy more contracts
b. Fixed Price. This price is called the Strike price. The strike prices are also defined by the exchanges. For most stocks, they are broken out at $5 increments. But low priced stocks and high priced stocks have different increments. So a stock currently trading at $62 per share may have option prices of $50, $55, $60, $65, $70 and $75 available from the options exchange.
c. Fixed Date. This is the expiration date of the option. All stock options sold in the US are “American Style” options and they can be exercised on or before the expiration date. The expiration dates are fixed and are the third Friday of the month. If the third Friday of the month falls on a Holiday, the Thursday before becomes the expiration date.

If a person is the holder or owner of an option, he can exercise the option at anytime up to and including the expiration date. Or he can close out the option position, selling or buying back the option.The Put.

Conceptually, there are two parties to a Put. The Put Seller and the Put Buyer. The Put seller (or writer) obligates himself to buy the stock at the strike price on or before expiration. In return for undertaking this obligation, the Put seller is paid a premium.

The Put Buyer, in exchange for paying a premium, obtains the right to sell the stock at the strike price on or before expiration. Let’s look at an example. We will check back with Tarzan and Jane.Tarzan and Jane. Jane has 100 shares of ICBM. ICBM is currently trading at $55 and Jane is worried that ICBM will fall in price. To protect herself from a fall in the price of ICBM, she buys a Put. She buys a Put with a strike price of $50. The premium on this Put is $1.00, so Jane pays $100 for the Put contract. ($1.00 per share * 100 shares per contract). But Jane is protected. If ICBM falls to $50 or lower, she can exercise the Put and sell her ICBM stock for $50.

Tarzan is a gambler. He needs to pick up some fast money for Boy’s new shoes. He is willing to sell a Put contract on ICBM with a strike price of $50 for $100.[i] If ICBM falls to $50 per share or lower, Tarzan can be exercised and must buy the shares at $50.00 per share.

a. Tarzan Win. If ICBM stays at $55 or goes higher, Tarzan can keep the $100 premium and will not have to buy the stock. Tarzan has some other more advanced option strategies, but we will stay with this straightforward example.
b. Jane Wins. ICBM stock falls on bad earnings warnings to $48. Jane is faced with two choices. If a lot of time remains between now and the Put expiration date, she could wait and see if ICBM rises again. Or she could inform the Options exchange that she wishes to exercise the Put and her shares will be sold for $50.00, despite the fact that ICBM is trading at $48.

Tarzan receives notice that his Put has been exercised. He must buy 100 shares of ICBM for $50 per share, despite the fact that ICBM is trading at $48. Tarzan is out $100. Why not $200, if the difference between the strike price that Tarzan pays is $50 per share and the market price of ICBM is $48? The reason is that Tarzan has already received a premium of $1 per share for the Put he sold. ($50 strike price paid - $48 market price + $1.00 premium received = $1.00 loss per share.)

If all of this sounds confusing, don’t feel alone. Options are difficult for many people to understand in the abstract. But in the next few weeks and months, we will set out some simple option strategies that will aid in their understanding.

NO ELECTRONS WERE HARMED (ALTHOUGH A FEW QUANTUM TUNNELED OUT) IN THE MAKING OF THIS POST FOR THE DESERT OF THE REAL!

[i] This is a risky strategy and Tarzan’s broker will require him to have the money in the account to buy the ICBM shares ($50 per share * 100 shares = $5,000) in case Tarzan’s Put is exercised.

WELCOME TO F***IN DEADWOOD

One of the finest television series ever produced is on HBO. It is “Deadwood”, a gritty, realistic, vulgar and violent look at the formation of Deadwood, SD.[i] It is unparalled television. Fine writing, expert direction, great acting and accurate art direction. But it is more than that. It is a history lesson, indeed a look at 19th century capitalism at its rowdy, rapacious, and sometimes murderous best. Don’t like your business rival or business partner? Shoot ‘em. No EPA or any government of law. Get yours before it runs out. Labor problems? Kill the organizers.

Deadwood takes place in the 1870s, the decade that birthed the Gilded Age and the Age of the Robber Barons in America. Advancing industrial technologies, disposable immigrant labor, increased agricultural productivity and corrupt government policies that permitted robber barons to steal with impunity all came together to cause an explosion of economic activity and wealth creation.[ii]

Prior to the Civil War, there were two Americas. There was the North of small farms, a few large cities, craftspeople and small manufacturing. And there was the Deep South, a putrid aristocracy of a few landowners operating large concentration camps working black slaves. The Civil War helped eliminate one of those Americas. (It took the rise of black America through Northern cities in the early 20th century, the centralization of America in post-World War II, and the Civil Rights Act to take the biggest cuts at American Apartheid.) It took another revolution to destroy the North of small farms, craftspeople and small manufacturing. The Industrial Revolution[iii].

PLENTY OF JOBS IN THE “DARK SATANIC MILLS”.[iv]

The Industrial Revolution replaced labor with machinery, skilled craftsman with standardized tooling and industrial processes. And the productivity gains in agricultural lessened the need for agricultural workers. Measured in human terms, the cost of the disruption was substantial. But the Industrial Revolution is history. Yet it is history that we can draw upon for insights of today.

Deadwood was founded when gold was discovered. In the 1870s, Deadwood was part of the Sioux Indiana nation. It was an “illegal” settlement that the government(s) did not first recognize. It was settled by the wildest and most lawless. People who could not make a living (or at least an honest one) elsewhere. But it was also part of the closing American frontier. It was place to make a strike, start a mercantile business, or gamble. No preachers, no temperance women.

DEADWOOD INDUSTRIALIZES

New forces are at work in the Third Season of Deadwood. Underground mining operations, with their stamping mills and cheap labor, have replaced the one-man claims. Mining baron George Hearst is in Deadwood and intends to drive the few remaining operators out of business and consolidate all operations in his sordid grasp. Yep, civilization, the amalgamation of capital, and waves of immigrants have replaced the “rugged individualists” of Deadwood and the American frontier.

BUT DEADWOOD IS JUST A SHOW, AND HISTORY IS JUST HISTORY, RIGHT?

The same industrial forces that made the British Industrial cities the centers of 19th century production, and which made the United States the clearly dominant industrial power of the mid-twentieth century, have moved eastward. The Asian Tigers are the centers of industrial and emerging technological development. It is a pattern that repeats itself. Additional economic revolutions have followed the industrial revolution, and will continue to do so. The radio revolution, the electronics revolutions, and the computer and Internet revolution, all fell in line behind the Industrial revolutions. And there will be more.

But for now, make Sunday evenings a time to watch Deadwood and see how a little piece of the American Industrial Revolution played out.

DEADWOOD IS A SIGNPOST IN THE DESERT OF THE REAL!

[i] http://www.hbo.com/deadwood/
[ii] http://desertoftherealecononomicanalysis.blogspot.com/2006/06
/freakoutonomics-or-why-economic.html
[iii] http://en.wikipedia.org/wiki/Industrial_Revolution
[iv] “Dark Satanic Mills” is a line from the Romantic poet William Blake’s poem “And did those feet in ancient time”. This line was almost certainly a reference to the emergent factories of the English Industrial Revolution. Some critics see the line “Dark Satanic Mills” as a reference to the church or the English universities. An interesting irony, beyond the scope of this post. http://en.wikipedia.org/wiki/And_did_those_feet_in_ancient_time

STOCK MARKET RALLY? WHAT MARKET RALLY?

2006 began the year on a positive market note. The indicators turned positive and January saw positive movement in both the S&P 500 Index and the NASDAQ index. This positive movement continued in both indices until about Mid-May. Then the indices began precipitous declines. Below this Post are graphs of the S&P 500 and NASDAQ that show the action for the last 6 months. They roughly indicate that the positive moves of January-May have been reversed and the indices stand approximately where they did five months earlier.

GO SHORT?

The Author currently has no positions in individual equities and all of the market indicators he follows are negative. The NASDAQ index, gauged through its proxy QQQQ, the NASDAQ Exchange-Traded Fund (ETF), has lost near-term support and the Author has effectively shorted the NASDAQ. When the Author wishes to take short positions against the major market indices, he purchases shares in the RYDEX mutual fund family inverse funds. Rydex offers several funds that perform inversely to a targeted index. Additionally, some of these inverse funds operate 2 times inversely to the targeted index.

DOUBLE YOUR LEVERAGE, DOUBLE YOUR FUN!

The Rydex Inverse Dynamic OTC fund operates 2 times inversely to the NASDAQ index. So if the NASDAQ coughs up 1% of its value on a given day, the Rydex Inverse Dynamic OTC fund (RYVNX) will RISE by 2%. If the NASDAQ falls by 2%, this RYDEX fund is up 4%.

Inversely, of course, when the NASDAQ is up, this RYDEX fund will fall by 2 times the NASDAQ gain. RYDEX also markets funds that move equally inversely to several indices. So why would an investor go with a double-inverse fund?

Let’s say an investor has $100,000 in her portfolio and wants to take a 20% short position on the NASDAQ. She only need buy $10,000 shares of the RYDEX Inverse Dynamic OTC fund to accomplish this $20,000 short position. This leaves her with $90,000 to invest elsewhere, or leave in money instruments that are paying about, or a little over, 5%.

SO WHAT ABOUT THE S&P 500?

The S&P 500, as measured by its proxy, SPY (SPIDRS ETF) has not broken medium-term support. It is close, however. When it does lose support, the Author will advise.

SO WHAT ABOUT EVERYTHING ELSE?

Further market weakness can be capitalized upon with short positions and the purchase of puts. The Author is a little busy right now so he will stay in cash and short appropriate indices with the RYDEX funds. And anyway, it is summer. The Author is spending his free time at the pool, in the garden, at the movies, and of course on his Ducati. You have some fun too! When the market indicators reverse, we will let you know.

And in a day or two, the Author will repost some materials about using long puts to make money with a falling stock (Or index). Dip a toe or take a cannonball jump!

EVERYONE GETS A FEW DAYS OFF IN THE DESERT OF THE REAL!


IMPORANT DISCLAIMER: This weblog is offered for informational purposes only. Sources of information provided are believed to be reliable, but are not guaranteed to be complete or without error. Opinions and suggestions are provided with the understanding that readers acting on information contained herein assume all risks involved. The Author may or may not buy or sell securities discussed on this website.

S&P 500 Six-Month Trailing Return

Trailing Six-Month NASDAQ return

June 2006 Desert of the Real Newsletter

Below is a reprint of the June 2006 Desert of the Real Newsletter.

Welcome to the Desert of the Real—
Real Investment Returns in a Dry Season
June 2006 Copyright Robert C. Feightner

Welcome to the Desert of the Real.[1]

In an earlier newsletter, the Author stated that he would address the proposed repeal of the Estate and Gift Tax if Senate Majority Leader Dr. Bill “Kitten Carver” Frist would reintroduce it. Frist, you may recall, committed medical malpractice by media when he watched the manipulative video of Terri Schiavo and made the incorrect diagnosis that she was not in a persistent vegetative state. Frist is also a multimillionaire and his family will be a beneficiary of any Estate tax repeal.

EVERYBODY DIES BUT ALMOST NO ONE PAYS THE ESTATE AND GIFT TAX.

The Federal Estate and Gift Tax, not the so-called “Death Tax” as called by plutocratic apologists, was enacted to prevent the intergenerational accumulation of vast fortunes. US policymakers wished to avoid huge concentrations of fortunes in the hands of a few robber barons and plutocrats like Frist, and others who choose their parents well.

The tax hits only the wealthiest estates in America, those up and often far over 10 million dollars. 71% of the Estate tax benefits go to people that stand to inherit more than 10 million dollars. It affects only 3 of 1000 estates.[2] That’s .03% of estates. But when you consider that many people do not open estates (they have little money or hold their property as join tenants with survivorship right with their spouse or children), the scope is even less. So except for the kicking and screaming of a few thousand very wealthy people, it is off the radar. But boy can those few thousand very wealthy people (the Walton family, heirs to the Wal-Mart billions and the Mars Candy clan) kick congress hard and scream misinformation that many Americans believe.

THE ESTATE TAX “HURTS FARMS AND SMALL BUSINESSES”.

Read what the New York Times said in its editorial of June 6th:
Abolitionists say the estate tax forces the liquidation of family farms and businesses. In 2000, according to the Congressional Budget Office, 1,659 farms were liable for the tax, but fully 1,521 of these had sufficient liquid assets to pay without selling any land. In 2000, likewise, 485 taxable estates included a small business, but 321 of these could pay the tax without selling any of the firm. Moreover, heirs can spread estate tax payments over 14 years, so even those without liquid assets have plenty of time to take over the farm or firm, manage it productively, and thus generate the cash to pay the tax. So the estate tax wasn't forcing the fire sale of large numbers of family farms and businesses even in 2000, before the Bush tax cuts kicked in. Now that the amount that a couple can pass on tax-free has jumped from $1.3 million to $4 million, the mass-liquidation claim is even less accurate.[3]

So the plutocracy and quasi-aristocracy lobby is fibbing when they call the Estate tax a destroyer of family farms and family businesses. The Estate tax hits the accumulated capital assets of the very wealthy, not Old McDonald and Mom and Pop at the laundry mat.


INHERITANCE AND GIFTS ARE NON-PRODUCTIVE TRANSFERS OF WEALTH THAT WOULD OTHERWISE FIND NO PROTECTION IN LAW.

Imagine you are fertilized human egg. You are given a choice of parents. You can be born Muffy, the shipping heiress. Or you can be Shana, the janitor’s daughter. Or, to quote James Wood’s character, Max Bercovicz, in the Sergio Leone classic gangster film “Once Upon a Time in America”, “Some kids get the good life, and some get it right up the a**”. The mobsters had just switched the wrist tags on a nursery full of newborns to blackmail a corrupt New York City police commissioner. Instead of his first-born son, the crooked cop unwrapped the swaddling clothes from a baby girl. And boy was he mad!

But the gang had lost the code to the true identities of the babies. They could give the cop a boy, but it would be likely that the rotten cop would get the son of another man. Good zygotic luck is just a dirty trick away.

That is the luck of the draw, or luck of the transfer that abolition of the Estate Tax would more greatly benefit. There are myriad of ways to transfer wealth from parents to children or grandchildren. But they are all gifts, nonproductive transfers of wealth. Economic exchanges where no value is given. Economists and the common law recognize that gifts are nonproductive exchanges deserving of little or no legal enforceability. Under the law of contracts, gifts lack “consideration”.

Let’s go at it another way. A father owns a bakery. When he dies, three common events could occur. The bakery could go out of business. But the bakery is a good business so the economy of the community will benefit (measurably in terms of the economic activity of the bakery) if the bakery stays in business. So when the father dies his son Benny could inherit it or the bakery could be sold to a willing buyer that will pay full value for it. The buyer will be a willing buyer that will have an interest in maximizing the productive capacity of the bakery. And the father’s estate is also enriched because it has now received full value for the bakery.
But what about Benny? Benny could inherit the business and drive it into the ground. Or he may loot it for personal luxuries. He may inherit the business and run it well, but even in that event, he has not given value for the business, as would a purchaser-for-value in an arms’ length exchange.

Simply put, the lack of an inheritance tax encourages more nonproductive transfers to the children of fortune when rational economic players could give value where value is due.

WE NEED THE DUES.[4]

Deficit Calling? That darn reality-based politics always intrudes. The Estate tax is estimated to generate $776 billion dollars in the decade starting in 2012[5]. About the cost of the Iraq war, sometimes estimated at $700 billion in today’s dollars. Fiscal discipline may be too much to ask from our “leaders”. The House of Irresponsibility has already passed permanent Estate tax repeal. So the last shot at sanity is with the United States Senate this week.

OHIOANS ARE THE MOST ILL-INFORMED PEOPLE IN AMERICA, FOLLOWED CLOSELY BY NEARLY ALL OTHER AMERICANS.

Arguments for maintaining the Estate tax are legion. Appeals to repeal it merit analysis, but are not persuasive. However, the opinions of most Americans are misshapen by intentional misrepresentations slimed out by a handful of uber-wealthy Americans (Wal-Mart Waltons, Mars Candy heirs, Seattle Times heirs, and Nordstrom heirs). They peddle the lies that the Estate tax closes businesses and farms. They misrepresent the scope of the tax, apparently convincing most Ohioans that the tax will or could apply to them.

The reality-immune from Ohio were recently polled and 60% of them stated that the “death tax” (the incorrect and deceptive appellation that the plutocrats use to confuse the issue) was “completely unfair”. Listen to the polling results from these folks:

According to a poll conducted by the Luntz [AUTHOR’S NOTE: Luntz is a Republican pollster] Research companies, 60 percent of Ohio residents regarded the "Death Tax" (a common nickname for the Estate Tax) as completely unfair, while 52 percent expressed the same opinion when it was labeled the "Inheritance Tax." By contrast, only 46 percent of Ohioans said the gas tax was unfair, and a mere 15 percent said so of the Income Tax.[6]

Read more from the mouths of the misinformed:

Respondents were also much more likely to vote for a candidate who opposed the estate tax than one who favored it. 71 percent of respondents favored candidates who expressed themselves against the estate tax, compared with 21 percent for candidates supporting the estate tax. This margin was slightly larger (72 percent to 19 percent) among Republican voters who were considering casting votes for Democrats in the upcoming election. "From our poll results, repealing or significantly reducing the estate tax looks to be a winning issue in Ohio," said Luntz. "People want taxes reduced across the board, but this tax seems to irk voters particularly."

EITHER THE LIES HAVE WORKED OR AMERICANS HAVE ABANDONED, OR CANNOT UNDERSTAND, “SELF INTEREST”.

Virtually no one from Ohio will pay the Estate tax. Almost freaking none. Less than will be struck by lightening, twice, on the same day. Are they unable to grasp the fact that the tax will not affect them? Obviously, because just like people believed (and many still believe) the lies that Saddam Hussein was involved in 9-11 and that the Iraqis possessed weapons of mass destruction, they are utterly misinformed about the Estate tax. They won’t pay it. They will never have to pay it. No one they know or live near will pay it. But they will be forced to subsidize the lost treasury revenue.

Think about it, readers. Even if some readers of this newsletter support repeal of the Estate tax (and care to debate the Author), can you honestly believe that 61% of Ohioans consider a tax that affects only the extremely wealthy (.03% of all estates) “completely unfair” as opposed to 15% of Ohioans that say the income tax is “unfair”. Are Americans that egalitarian on matters of tax that they would support by 71% margins political candidates that favor repeal of the Estate tax versus 21% that favor Estate tax opponents? Ignorance wins, 71% to 21%.

Have lying and intentional misrepresentation become the currency of the body politick. The Author fears that they have.

Welcome to the Desert of the Real!

IMPORANT DISCLAIMER: This newsletter is offered for informational purposes only. Sources of information provided are believed to be reliable, but are not guaranteed to be complete or without error. Opinions and suggestions are provided with the understanding that readers acting on information contained herein assume all risks involved. The Author may or may not buy or sell securities discussed in this newsletter.

[1] The title of this Newsletter, “Welcome to the Desert of the Real”, comes from the 1998 film “The Matrix”. The world in the Matrix is a Simulacrum, a computer–generated illusion. It only “looks” and “feels” like the late 20th century. Instead, human beings are enslaved in tanks of fluid, wired to the Matrix. Also, readers steeped in post-structuralist philosophy may recognize the title as a paraphrase of a quote in Jean Baudrilliard’s 1981 book, “Simulacra and Simulacrum”.

One the subject of cinema, the Guild Cinema, an Albuquerque art house theatre, begins its third annual Film Noir Festival on June 30th. It runs through July 13. Last year’s Film Noir Cinema included the only recently released “first cut” of the classic “The Big Sleep”, the Abraham Polonsky classic “Force of Evil”, Jacques Tourneur’s “Nightfall”, the seminal “Detour” and the inimitable “Murder by Contract”.

The bill has been released for the 2006 festival. One film will be “Requiem for a Heavyweight”. This film, while not “archetypal” Film Noir, explores standard Noir themes such as betrayal by comrades and illusions of hope colliding with stark, battering human reality. The film stars Anthony Quinn as Louis “Mountain” Rivera, a punched out boxer sliding down the fight card. The film also features Muhammad Ali when he was still Cassius Clay, and other former pugilists such as Jack Dempsey, Gus Lesenvitch, and Willy “Will’o the Wisp” Pep.

Other films will be “Night of the Hunter”, a seldom screened English Noir film, “Hangover Square”, the Henry Fonda classic “The Wrong Man”, “Suddenly”, a 1954 film starring Frank Sinatra as a presidential assassin, and “Witness to Murder” from journeyman director Roy Rowland with Barbara Stanwyck as a witness that cannot convince the cops she saw a crime. But the killer knows what Miss Stanwyck saw. . .

Also on the bill is Nicholas Ray’s “Bigger than Life”, the weirdly ironic “Hollow Triumph” and Hollywood insider film “The Big Knife” from the inimitable director Robert Aldrich.

A “series within a series” will be two films from the sub-genre “War Noir”. The films are “Act of Violence”, a post-WWII revenge film, and another WWII revenge film “Attack”. Attack, directed by Robert Aldrich, is notable because it stars war veterans Lee Marvin and Eddie Albert. In the film Albert plays a coward. Albert was a decorated Navy veteran that rescued 70 wounded Marines at the horrific invasion of Tarawa, however.

The series closes with two Irving Lerner films, “Murder by Contract” and “City of Fear”. Both star Vince Edwards, later of Ben Casey fame, as an enigmatic criminal.


[2] Now Playing in Senate: A GOP Double Bill, Washington Post, http://www.washingtonpost.com/, June 6, 2006.
[3] “Death and Taxes”, http://www.nytimes.com/ Subscription is required but it is free.
[4] This was the rationalization of Delta House fraternity members in admitting legacy candidate Kent “Flounder” Dorfman, played by Steven Furst. Flounder was a second-tier pledge, but his brother did own a car.
[5] “Death and Taxes”, NY Times.
[6] http://news.yahoo.com/s/usnw/20060606

A LITTLE CONSTITUTIONAL HISTORY INSTEAD OF SOME ECONOMIC HISTORY

In some posts the Author throws in some economic history or economic background to help the readers understand an issue. This is called context, a framing function that is sorely lacking in American media and political discourse.

So let’s talk some constitutional history and some basics about the Constitution and the checks and balances that should exist between the legislative branch (Congress), the executive branch (president), and the judiciary (Federal Courts).

The Author was trained as a lawyer and a required class at Indiana University is Constitutional Law I. This is not a course in free speech, search and seizure or the bill of rights issues that garner the most public attention. What Con Law I covers is the extent of power of each branch of government, the checks and balances that each has over the other, and the interplay between the branches and the delicate balance. Because the class is a law class and you read cases and talk about legal decisions, much of the class addresses attempts by the executive or the legislature to usurp power from a coequal branch. Most cases involve executive overreaching, because that is what presidents (especially this one) tend to do. In a sense, Con Law I is “constitutional history”.

Many Americans, less than know what Paris Hilton has tattooed on her anorexic frame, but still a good number, are gravely concerned by the current Bush Administration’s executive overreaching and flagrant, unabated and confessed violations of law. From all over the political spectrum.[i] John Dean of Watergate infamy said, “George Bush is the first president to ever confess to an impeachable offense”. (Intentional contravention of FISA, the law that prohibits warrantless wiretapping.). But of course Congress, in gross dereliction of its Constitutional duty to check executive usurpation of power, refuses to even investigate.

POLITICS NOT AS USUAL

This Blog tends to stay away from overtly political issues. But the unconstitutional conduct of the Bush administration[ii], the overt failure of the Republican House and Senate to discipline their wayward partisan comrade for reasons of self-preservation, and a Supreme Court that contains judges that may be in league with the presidential excesses (Justice Alito subscribes to the myth of the “Unitary Executive”, that all political power can be exercised by the president), requires that Americans take notice and “throw the Bastards out”.

This is not a partisan issue. The US Constitution is a blue print for government that has functioned, with some success, for over 200 years. Read what Glenn Greenwald, author of “How Would a Patriot Act? Defending America from a President Run Amok” said in a recent interview:

… I believe our system of government really is a unique achievement in modern political history. That’s because of the values created by the Constitution that the Founders, after a lot of debate, came to embrace. The Founders talk about this in the Federalist Papers - and part of their debates were in the Constitutional Convention. They knew that no system of government would be invulnerable to some future tyranny. Their principle challenge when creating a system of government was to figure out how all these rights would really be protected in the future. It’s one thing to say you have the right to free speech and to freedom of religion, and the right not to be punished without due process. But the question then becomes, how do you really protect against tyrannical leaders in the future?

The government that they created was designed, first and foremost, to prevent any one individual or political group from consolidating unchecked power, and from insisting that the country’s prosperity and its freedom lay in putting the trust in a single individual, rather than distrusting our political leaders and insisting on their compliance under the law in a transparent way. That is really the centerpiece of what our government is – insistence that political leaders always remain limited in their power and subject to the law – precisely because we don’t trust government officials to exercise power properly. That really is how the Founders wanted our liberties to be protected.

What we have now is the very opposite of that. We have a President who is claiming the right to exercise power without any limitations. To me, what a patriot does is take a stand in defense of the principles that have made our country great.

Those principles are all under assault by this Administration. The powers they’re insisting on are exactly the powers that the Founders waged the Revolutionary War to get away from. They’re the powers of a king.

Anyone who loves the United States and believes in the principles and values that it embodies will be opposed to the kinds of theories of power and abuses of power that this Administration is embracing, regardless of political ideology or partisan allegiance. Those are the values that have always defined what America is.[iii]

NO SYSTEM OF GOVERNMENT IS IMMUNE FROM THE RISKS OF TYRANNY. NONE. NOT THIS ONE, OR ANY OTHER.

THE DESERT OF THE REAL TOLERATES AND WELCOMES DISSENT, BUT NOT POLITCAL COWARDICE. AND WE MAKE TOOTHPICKS FROM THE SUN-BLEACHED BONES OF TYRANTS IN THE DESERT OF THE REAL!

[i] http://www.commondreams.org/views06/0609-23.htm. The conservative libertarian Cato Institute has produced a report called “Power Surge: The Constitutional Record of George W. Bush.”
[ii] For a darkly comedic take on the contemptible “signing statements” Bush appends to Congressional laws he announces he will ignore, see: http://www.truthout.org/docs_2006/060906E.shtml
[iii] http://www.workingforchange.com/article.cfm?itemid=20937

TO STAFF SARGENT WILLIAM FRANKLIN PRESTON

Below is an essay written by Mrs. Mary Lou Brown Byrd from Kentucky. She and other members of her family answered the call to service some years ago. Please read what she has to say.

Counting the Cost by Mary Lou Brown Byrd.

Kentucky's famous Trappist monkThomas Merton said it best: "Nothing is lost by peace, yet everything may be lost by war."

Keeping count "by the numbers"(army parlance) tells us that more than 2000 of our young warriors have died for their country in this war. But these dead should be more than statistics. It galls me that they are not being given the honor and recognition they deserve. Why not? We do it for presidents -- President Reagan, for instance-- a full week of mourning and Old Glory at half-staff for 30 days. Even now, the flag should be flying at half-mast every day, for we are losing far too many brave men and women.

Yet we see nothing and hear little of our dead being brought home in flag-draped coffins. Is it a deliberate attempt by this administration to promulgate the old saying "out of sight, out of mind?" If it is, it won't work, for there are those of us who still grieve for our loved ones lost many years ago, in other wars:

Words cannot express the desolation of that bleak Kentucky winter of 1944 when the message came -- a telegram regretting to inform my parents that their eldest son had died of wounds received in action. He died near Metz, France with Patton's army. The grandstanding general (who reminds me so much of our present Commander-in-Chief!) had outrun his supply and support lines in his rush to glory. My brother bled to death before medics could reach him.

Later, a special packet arrived: a gilded Purple Heart medal and a letter of condolence from President Roosevelt. My mother could not, would not, accept his death, even when his personal possessions came home in a box. She fondled his wallet, empty except for a few faded photographs of the family. There was his pocket comb with two teeth missing and a worn handkerchief. She hugged to her breast all these personal things he had last touched, some of them still encrusted with the mud from a far away field in France where he had fallen.

Letters came, one from a Catholic chaplain to my Protestant mother advising her that he had been with her son at the end. His company commander wrote that Staff Sgt. William Franklin Preston had been one of his best soldiers, a credit to his family and to the nation.She put away the treasured medal and letters in a small cedar box, symbolically burying her great loss.

But she was inconsolable. Her 21 year old son dead -- and she hadn't seen him since he was 16 -- the day he quit shucking corn in the field and hitchhiked to Lexington to join the army. But what choices did a poor farm boy have during the hard, lean years of the Great Depression? The army had good food, clothing, and $21 a month to offer -- which was a step up from nothing.The memory of my mother's grieving face that cold Kentucky winter haunts me still. Although my sisters and I had quit our jobs housekeeping for "rich" people in Cincinnati to come home to help strip the tobacco crop, our best efforts in assuaging her grief failed.

From the stripping room in the barn we could hear her keening, heartbroken wailing. We looked at each other, stopped stripping the leaves from the tobacco stalks, waiting, knowing it wouldn't be long before she'd be there at the door, swollen-eyed and desperate, seeking a solace none of us could give. My dad, his own eyes brimming, stopped work to hold her. We stood silent, stricken, there at the stripping bench, our "hands' of tobacco still untied, each of us sharing their hurt, yet lost in our own private grief:

Dear Brother, 21 is so young to die! Much too young. You hadn't begun to live.My mind wanders: Long rows of tobacco stretching endlessly under the hot sun -- a gaggle of ragged children with goose-neck hoes chopping Johnson grass and thistles out of the weedy tobacco rows -- daydreaming, talking about what we would do when we got "rich."

What regret, Bill, now that you would never get married, have the daughter you were going to name "Alice"; never get to live in a big, fine house with a bathroom; never get all the graham crackers and peanut butter you could eat. Not that you didn't enjoy our daily fare -- pinto beans, fried potatoes and cornbread, but that fancy food you'd had once at a neighbor's house fired your imagination.

A wistful bunch of kids, leaning on our hoes, wishing and wanting. You wanted books to read -- not the kid stuff in the school library, but about the Graf Zeppelin and the China Clipper, and about G-8 and his Battle Aces. You wanted to play basketball, but you had no athletic shoes to wear, and that's really why you quit high school. The coach ran you off the floor because you couldn't afford a pair of proper shoes. Six-feet two inches at age 16, quick and smart, you would have made a fine basketball player. You traded your old shotgun (you'd painted the barrel blue) for a guitar, and you were getting pretty good on it before you left. You had such a good baritone voice, and sang "Man of Constant Sorrow" and "Little Maggie" as good as Bill Monroe or Ralph Stanley.

You were just a boy, the apple of your mother's eye, when you stood in the recruiting office and swore to defend your country against all enemies. Bless your dear heart! You did that, did it well, and died in the process.

I think of my brother, William Franklin Preston, 10th Infantry Division (Camp McCoy, Iceland, Ireland, and D-ay) so often. He would be today 82 years old. Even now, so many years later. I have one consolation that siblings today don't have: He fought in probably the one war that needed fighting -- World War II, a war that resembles Bush's War in Iraq not one whit!

THE DESERT OF THE REAL, A ZONE WITHOUT WAR, PAYS THE HIGHEST HONOR THAT IT CAN TO STAFF SARGENT WILLIAM FRANKLIN PRESTON. IT ASKS IT READERS TO THINK ABOUT HIM AND HIS SACRIFICE. AND CONTEMPLATE WAYSTO RESOLVE PROBLEMS PEACEFULLY.

TOMMMOROW, JUNE 8TH, WILLIAM FRANKLIN PRESTON WOULD BE 83. THE DESERT OF THE REAL WILL FALL SILENT.

.

This post was originally posted on June 2nd, 2006. Despite some good economic news in the intervening 10 months, consumer confidence remains low and continues to fall.

"FREAKOUTONOMICS”, OR WHY ECONOMIC PROSPERITY CAN STILL FEEL LIKE A “PANIC”

“Panic” is a term used to describe economic downturns in the American Nineteenth Century. Panics occurred, according to generally accepted historical economic measures in 1837, 1857, 1873 and 1893. Lots of reasons are posited for the more extreme cycles in the 19th century. These include bank failures due to lack of financial oversight, currency fluctuations, speculative excesses and trade wars. But readers must also remember that the US was a “developing country” in the second half of the 19th century and subject to the swings that are endemic to such economies.

In today’s New York Times, Charles R. Morris penned an Op-Ed piece entitled “Freakoutonomics”.[i] Morris begins his piece with these observations:

Last month saw one of the sharpest drops in consumer confidence since the recessions of 1979-1982. But those were truly dreadful times. Oil prices tripled, rates on home mortgages shot into the mid-teens, the stock market was a disaster area and unemployment rates reached double digits.

Over the past three years, by contrast, American economic performance has been almost glittering. Inflation is still low, while employment and productivity have all been rising strongly. True, stock markets are clearly nervous, and the sharp upsurge in gas prices is adding to consumer skittishness. But the reaction still seems inconsistent with the economy's underlying strengths. [AUTHOR’S NOTE: The Author does not entirely share Mr. Morris’ assessment of the economy as “glittering”. Unemployment is still relatively high; GNP growth has been somewhat below the historical averages. But all in all, especially when compared to 1979-1982, things aren’t bad.]

There are parallels with another historical period, however, that suggest the deeper currents of uneasiness.

SO HOW ABOUT THOSE GOOD OLD DAYS?

The “good old days” that Morris recalls is the period of the “Panic of 1873”, “ or sometimes called the “Depression of 1873”. Riots occurred in major cities. And in prototypically American Nativist (and racist) fashion, immigrants were scapegoated:

Unrest in San Francisco explodes into a vicious anti-Chinese pogrom. The same period marks the glory years of the rural Granger movement and the Roman-candle growth of the Knights of Labor. American Populism puts down permanent roots.

Despite the “panic” and civil unrest, the economy was actually growing robustly. New economic historical models show that except for a recession in 1873, the 1870s featured some of the fastest economic growth in American history.[ii]

DUDE, WHERE”S MY ECONOMY?

According to Morris:

Employment grew strongly, faster than the rate of immigration; consumption of food and other goods rose across the board. On a per capita basis, almost all output measures were up spectacularly. By the end of the decade, people were better housed, better clothed and lived on bigger farms. Department stores were popping up even in medium-sized cities. America was transforming into the world's first mass consumer society.

Sounds a lot like the 1980s and 1990s, doesn’t it? So from whence comes this “gnawing unease”, this “brooding pessimism”? Unease at the bottom, opulent “thievery” at the top? Morris tells us of the social and economic changes between the 1830s and the 1870s:

Before the Civil War, America was perhaps the most egalitarian society in the world. But the unbridled entrepreneurialism of the 1870's gave rise to the robber barons. Even if ordinary people were doing better in the 1870's, the yawning gap between the very rich and everybody else fanned resentments. Interestingly, wealth inequality in today's America is roughly the same as in the Gilded Age.

The sharply increased social and geographic mobility of the 1870's set people adrift from traditional sources of security in families and villages. In our own day, the destruction of employer-employee relationships, the erosion of pension protection and employee health insurance may be creating a similar loss of moorings.

SO IT IS ALL RELATIVE?[iii]

There is not enough space and time to delve into the topic of “class consciousness” in America. The rich on the right deny its existence and decry its mention. The middle classers usually assume, despite much conflicting data, that if they work hard, play by the rules and “buy and hold” conservative investments, they will move up their ladder. And their kids will start of with some more steps up. Some of them will, but many of them won’t.

The poor, well to quote Pvt. King (played expertly by Keith David) in the seminal Vietnam War film “Platoon”, “The poor are always being f**cked over by the rich. Always have, always will”. This may not be an entirely accurate sentiment, but it is ironic, isn’t it, that poverty is intractable and expanding in the richest nation on earth. The Author will leave this one for the Readers to ponder.

Morris closes with this paradox. Despite the fact that the even the poorest American can get enough to eat, nearly always has a roof and heat, and may obtain life-saving medicine that would have felled kings, queens, popes, robber barons and emperors of the 19th century, most people feel things are worse today, not better. Morris believes there is an innate sense of fairness and equality that pervades the American psyche, a sense that finds less confirmation in 2005 than in 1975. Morris writes:

If one counts only the size of houses and cars, and the numbers of electronic gadgets stuffed into rec rooms, Americans are probably better off than ever before. But as the 1870's suggest, economic well-being doesn't come just from piling up toys. An economy has psychological or, if you will, spiritual, dimensions. A conviction of fairness, a feeling of not being totally on one's own, a sense of reasonable stability and predictability are all essential components of good economic performance. When they were missing in the 1870's, in the midst of a boom, the populace was brought to the brink of revolt.

BREAD AND CIRCUSES, ANYONE? YOU CAN EVEN GET THEM AT THE DRIVE-UP WINDOW.

WE SAID IT IN THE LAST POST AND WE WILL SAY IT AGAIN, (ALTHOUGH WITH NO SENSE OF GLEE) YOYOMF IN THE DESERT OF THE REAL!

[i] http://www.nytimes.com/ Registration is required but it is free.
[ii] http://www.nytimes.com/,
[iii] The Author means no offense to his “relatives”. It would violate his sense of propriety and “fair play.” After all, he is richer, smarter, more handsome, and generally better than they are. ;-)

REMEMBER THE “PLUNGE PROTECTION TEAM”?

RIGHT NOW THEY ARE MONITORING THIS WEBSITE FOR SINISTER AND UNSTATED REASONS.

In the fall of 2005, the Author discussed an article on the secretive “Plunge Protection Team”. This shadowy group made an odd appearance at a most unlikely place yesterday. (Well, not the Plunge Protection Team members themselves, but a reference to it in friendly, market-related conversation.)

The Author spends many afternoons at the Sandia Heights Four Seasons swimming pool in Albuquerque. It is in an amazing location, about 7,000 feet up, at the base of the Sandia Mountains. It is a pleasant place, not unlike the lakes in Northeast Indiana where the Author spent wonderful afternoons in more Halcyon times.

The Author, always the gregarious sort, has made acquaintance with a few people at the pool. Sometimes we talk about investments. Yesterday, someone stated, and a commodity trader concurred, that the “Plunge Protection Team” would step in to stop a market (or Dollar?) freefall. The Author then stated that he did a post on the “Plunge Protection Team” in 2005 on his blog.

Weird, isn’t it, the Plunge Protection Team popping up in polite poolside chatter? The existence of the Plunge Protection Team is akin to that of Area 51. Evidence demonstrates it existence, but the US government and large financial institutions deny it like they deny the fact that campaign contributions influence legislative outcomes.

The Author has reprinted the post from last autumn and did a quick Google search on the Plunge Protection Team to see if there is anything new. The team has a Wikipedia article, http://en.wikipedia.org/wiki/Plunge_Protection_Team. Here is a link to an article called “Cornered Rats and the PPT”, http://www.eldoradogold.net/cornered_rats_030326.html.

Some question even the existence of the Plunge Protection Team. John Mauldin, a frequently cited author in this Blog, does not believe that the team exists. But the next link would seem to settle that question. http://www.plungeprotectionteam.com/.

Without further delay, below is the earlier post on the Plunge Protection Team.


ARE A FEW LARGE INVESTMENT FIRMS FRONTING FOR GOVERNMENT INTERVENTION?

The Author came across a very fascinating report prepared by Sprott Asset Management, a Canadian investment firm. The report is entitled “Move Over, Adam Smith: The Visible Hand of Uncle Sam”. The report was written by John Embry and Andrew Hepburn and is dated August 2005.[i]

The thesis of the article is that since the October 1987 stock market plunge, the US government has intervened in the stock market on several occasions to prevent a large stock market drop. The article cites several situations where a shadowy group called the “Plunge Prevention Team” has interfered with the stock markets and intervened to prop up prices. The article addresses incidences of market manipulation in 1987, 1989, 19992, 1998, 2001 and 2003.

The existence of the Plunge Protection Team (PPT), comprised of government agencies, stock markets and large investment firms, was first publicly revealed by former Clinton aide Gorge Stephanopoulos on Good Morning America in 1998. Stephanopolous also stated that the mission of the PPT went beyond the equity markets and that in response to a potential global currency crisis, the Federal Reserve directed large banks to prop up currency markets.[ii]

THE PPT TO THE “RESCUE”?

The first indications of the PPT came back in October of 1987. On “Black Monday” (October 19th), the Dow Jones Industrial Average fell 22%, from 2246 to 1738, 508 points. The following day, a morning rally of 200 points reversed and by 12:30pm, the market has fallen to 1711. And then a strange thing happened on the Chicago Board of Trade:

In the space of about five or six minutes, the Major Market Index futures
contract, the only viable surrogate for the Dow Jones Industrial Average
and the only major index still trading, staged the most powerful rally in its
history. The MMI rose on the Chicago Board of Trade from a discount of
nearly 60 points to a premium of about 12 points. Because each point
represents about five in the industrial average, the rally was the
equivalent of a lightning-like 360-point rise in the Dow. Some believe that
this extraordinary move set the stage for the salvation of the world’s
markets.

How it happened is a matter of much conjecture on Wall Street. Some
attribute it to a mysterious burst of bullish sentiment that suddenly swept
the markets. Some knowledgeable traders have a different interpretation:
They think that the MMI futures contract was deliberately manipulated by a few major firms as part of a desperate attempt to boost the Dow and
save the markets.

According to this theory, the rally in the MMI futures contract was caused
by a relatively small amount of concerted buying by one or more major
firms at a time when it was so thinly traded that the orders had an
enormous and disproportionate upward thrust. By forcing the futures
contract to a premium to the underlying cash value of the index, the buyers
of the futures could trigger immediate buying of the stocks in the index
and selling of the futures by index arbitragers. Because so many of the
MMI stocks are in the Dow, this would enable the NYSE to reopen many
of these stocks at higher prices, leading to an upturn in this
psychologically important index. At the very least, the buyers could flash
a powerful bullish signal to the markets.[iii]

THE VISIBLE HAND OF UNCLE SAM MAY BE IN THE BEARS’ POCKET

The Sprott Report details other activity of the PPT. And it speculates that such manipulation is frequent and ongoing, according to the following quote:

Displaying markedly low volatility, the Dow hovers comfortably above the 10,000 mark. Yet with severe trade and budget deficits, rising interest rates and stubbornly high oil prices, the reasons to be bearish on U.S. equities are numerous. Strangely, the market has an uncanny ability to maintain its footing when serious declines threaten. Given the historical backdrop of U.S. government activity in the market, this curious trading that market intervention continues and has actually increased in intensity.[iv]

DESPITE LIVING IN A “CLASSLESS SOCIETY”, THE POLITICALLY POTENT ALWAYS “OUTCLASS” THE AVERAGE INVESTOR

The Sprott report authors conclude by stating that while there may be situations that require intervention, the PPT, operating without public oversight, is an inappropriate method for intervention or interference. The authors also note that the Wall Street firms that front this manipulation have an unfair advantage over competitors. The PPT is compensating these firms in some manner, whether it is indemnification for losses or with non-public information, or both. And with the rampant crony capitalism in the current Republican government, the rewards will be handsome and the kickback political donations bountiful.

The Author believes that markets must operate fairly, freely and transparently. The existence of the PPT undermines these basic market preconditions, and as so often in the current political environment, perpetuates the existence of a privileged class.


[i] The Report is available at: http://www.sprott.com/pdf/pressrelease/TheVisibleHand.pdf
[ii] Sprott Report, pps. 29, 31.
[iii] The Sprott Report, quoting: James B. Stewart and Daniel Hertzberg, “Terrible Tuesday: How the Stock Market Almost Disintegrated A Day After the Crash – Credit Dried Up for Brokers And Especially Specialists Until Fed Came to Rescue – Most Perilous Day in 50 Years,” The Wall Street Journal (November 20, 1987).
[iv] Sprott Report, p. 36.

UH, JUST KIDDING ABOUT THE PPT, FOLKS…

Hope you enjoyed this peek into the shadowy world of the PPT. But now you must excuse the Author. There are men in black suits at his door. A helicopter hovers overhead. They tell me that they will gang rape my cats and waterboard my dog in the toilet if the Author does not make a videotaped denial of the existence of the Plunge Protection Team.

IN THE DESERT OF THE REAL, WE DO NOT LIKE OUR GIRLFRIENDS TO HAVE HUSBANDS. IF THEY CAN FOOL THEIR HUSBANDS, THEY CAN FOOL US. (Paraphrasing Michael O’Hara (Orson Welles) in “The Lady from Shanghai”.)