Global Market Comments
June 8, 2016
Fiat Lux
Featured Trade:
(JUNE 29 DUBLIN, IRELAND GLOBAL STRATEGY LUNCHEON),
(AN AFTERNOON WITH GOVERNOR JERRY BROWN)
On a recent trip to my lakefront estate at Lake Tahoe, I stopped off at the state capital, Sacramento, to look in on my old friend, Governor Jerry Brown.
It is crucial that readers across the country, and indeed, around the world, know what Jerry is thinking. California has always been a ?pathfinder? state, and what starts here is often adopted across the country. This little chat could be a hint of what?s headed your way.
As I bounded up the steps of the marble capitol building, the first thing I noticed was the absence of the previous governor, Arnold Schwarzenegger?s, smoking tent.
The "governator" had it erected on the lawn so he could enjoy long puffs on his stogies and not be in violation of the state ban on indoor smoking. After all, this was in the state that invented the anti-smoking movement.
I have trod a very long path with Jerry Brown. His dad, then Governor Pat Brown, ordered teargas dropped on me from a helicopter while I was at a Berkeley anti-war march nearly half a century ago.
He was Secretary of State while I attended the University of California, often going head to head against then governor Ronald Reagan.
I was living in Asia during his first two terms as governor from 1975-83, when his girlfriend, Linda Ronstadt, called him the ?moonbeam governor?, a nickname he has yet to live down.
Warning: don?t call him that to his face. He hates it.
I ran into him at the Democratic convention in New York in 1980 when he mounted his second run for the presidency. After he retired and was considered a political has-been, I bumped into Jerry once again when he studied Zen Buddhism in Japan.
In 1999, he was elected mayor of Oakland, a mostly black Bay Area slum near bankruptcy, which many considered ungovernable. He did a spectacular job, fighting corruption, rebuilding the school system, and sparking an economic renaissance. It was like he had nothing left to lose.
To the amazement of many, Jerry ran and won a third term as governor in 2011, taking over the wreckage left by the disastrous reign of Arnold Schwarzenegger. He has been raising eyebrows nationally ever since.
He immediately launched a crash campaign to raise taxes and cut spending. His Proposition 30 succeeded at the polls, raising sales taxes for everyone and boosting income taxes on those earning more than $500,000.
The Golden State now has the highest combined federal and state taxes in the country, at 51.5%, and more for millionaires. The proceeds of the tax hike are solely dedicated to increasing $6 billion in spending on education.
State leaders learned a long time ago that people will pay a premium to live here. They pay double for housing, so why not double taxes? The sunshine has monetary value.
As I explain to guests at my strategy luncheons, high earners don?t mind paying an extra dollar in tax when it means they can make an extra $10, or $100, in profits at their high tech companies.
That has been the case with a technology industry here that has been booming almost non-stop since WWII. That is, as long as the money isn?t wasted. Most consider more money for education a laudable use of funds, as it trains a more useful workforce for their own investments.
Brown originally studied at a seminary school to become a catholic priest. To this day, he frequently quotes from the Bible, and he gave my own Latin a real workout. Citing Luke, Chapter 12, verse 48 with regards to the sharing of the tax burden, ?to those who are given much, much is required.? The seven-year sunset provision for the new income tax also comes from the ?seven years of plenty?, found in the Old Testament.
He argues that this is only fair, since the top 1% of state earners have seen their income increase by 165% since 1980, while the bottom 80% have seen an 8% drop. The top 1% took 10% of state incomes in the seventies. Now it is 22%.
To say Jerry is iconoclastic is a disservice to the word. He is a combative 77 year old who says what he thinks at the drop of a hat, no matter whom it offends, be they friend or foe.
He is a mix that is all too rare in this country, a flaming liberal on social issues, while an ironclad conservative on fiscal matters. There used to be a lot of those. Now they are rare.
He is a staunch advocate for the environment. He appointed the first gay judge in the US. He is about to deliver the toughest anti-gun legislation in the country. He has been a lifelong cheerleader for the alternative energy industry.
Brown has also completed the most ambitious cuts in social spending in the state?s history, including grants for the disabled, child welfare, and Medical. Some 40,000 non-violent inmates were released from prisons into probation to save money.
The University of California saw its budget cut by a massive 25%. State employment was chopped by 50,000, and some 50 redundant state boards were eliminated.
Jerry told me that the state?s problems were caused by two bubbles; the internet in 2000, and the indiscriminate mortgage lending that followed.
That created a budget deficit that ballooned to $27 billion by the time he returned to office, which cut the California?s credit rating to the lowest of the 50 states.
In a short 18 months, Brown balanced the budget, and state debt is now rapidly seeing upgrades, reducing borrowing costs.
The governor says that the spending cuts have been very tough to swallow. Even the carpet in his office is falling apart, and he confesses to eating day old tuna sandwiches.
On the tax front, he says that ?when you have more in the cookie jar, you have more cookies to give.?
Jerry says his goals as governor were threefold. He eliminated false accounting gimmicks, which shuffled the state?s financial problems under that well-worn carpet, where they festered.
He only implemented new taxes if people voted for them. And he returned decision making to cities and counties on schools, because the entities closest to problems have the best ability to solve them, a policy he calls ?realignment?.
Decentralization and devolution of power to local authorities isn?t something you hear about from liberals very often.
He points out that the big growth in state spending didn?t arise from some idealistic social agenda. Three strikes laws mandating extremely long sentences caused an explosive growth of the prison system, which expanded from 3% to 11.5% of the state budget since the seventies. ?
An aging population is also prompting a substantial increase in medical spending. These two items alone account for the entire increase in state spending for the past 40 years on a GDP adjusted basis.
I asked Jerry what he thought about the efforts by other tax-free states, particularly Texas, to lure business away. He erupted into a tirade.
He argued passionately there was absolutely no evidence that people moved to avoid taxes, which amount to only a few thousand dollars a year for millionaires.
The economy here is booming. The best and the brightest minds in the world are pouring into the most creative and innovative place on the planet.
There have been 500,000 private sector jobs created during his current tenure. Exports are up 17%. The state draws 50% of global venture capital investment, and files for four times more patents than runner up New York. The one-ton truck now driving around Mars was built in Pasadena.
My obvious last question had to be ?what?s next? for the energetic governor. Might his tax raising, spending cutting habits have a national audience?
?Do I have more offices in mind? I?m not telling,? he answered, with a twinkle in his eye. That is a lot to say for someone who has already held every high office in his home state.
I got a call from my car telling me it was time to get moving if we were going to make it over Donner Pass before it iced up. I said, ?see you next time? to Jerry. There always seems to be a next time with Jerry.
?What a Long, Strange Trip It?s Been.?
?You are either looking out five days or five years in this market. You?re either a surfer or a yacht. There are no small boats anymore,? said Bob Iaccino, a trader at Yourtradingroom.com.
Global Market Comments
June 7, 2016
Fiat Lux
Featured Trade:
(JUNE 8 GLOBAL STRATEGY WEBINAR),
(JUNE 20 LONDON STRATEGY LUNCHEON),
(THE MYSTERY OF THE SAN FRANCISCO SUBLEASE)
Commercial real estate agents are baffled. Economists are confused. Even Federal Reserve Chairman Janet Yellen is focusing a great deal of attention on the issue.
What the heck is going on with the San Francisco office subleasing market?
The question has taken on greater urgency in the wake of Friday?s abysmal nonfarm payroll report, which showed an increase of only 36,000. If no one is hiring anymore, companies certainly don?t need more office space.
When established businesses need new offices, they typically lease space in prime downtown areas. These normally take the form of a 5, 10, or 20-year lease, which the firms pay rent for on a monthly basis.
Only the wealthiest firms, like Apple (AAPL) and Oracle (ORCL) boast the cash flows that allow them the privilege of outright office ownership.
Traditionally, when companies expected the economy to slow down, they would sublease a portion of their existing space to cut costs.
When economies sped up again, they would take back their original space so they would have room to grow into.
What has analysts really scratching their heads these days is that the rate of subleasing has seen a dramatic increase in recent months. Does this mean that the economy is about to get better, worse, or neither?
Hence, the Fed?s intense interest.
I dove into the data with characteristic zeal, discovering that there is much more here than meets the eye.
It turns out that the new frenetic rate of subleasing is not an indicator of future economic activity. It is more a reflection of the structural changes besieging the US economy.
Deeper research revealed that the largest supplier of San Francisco office subleases was banker and securities broker Charles Schwab (click here for their site at https://www.schwab.com/?src=nay&sv1=dJ73RHPU_dc&sv2=73328918060&keyword=charles%20schwab&device=c&adposition=1t1&matchtype=e&network=g&devicemodel=&placement=? ).
It turns out that the entire industry is downsizing as rapidly as possible in order to cut costs. People are being replaced with machines, and machines don?t need expensive, glitzy offices on Montgomery Street, off of Union Square, or anyplace else where humans may proliferate.
Computers are much happier in giant server farms where rent and electric power are cheap, and where a small number of local techs can keep them running for pennies on the dollar.
I am thinking of The Dales, Oregon, Council Bluffs, Iowa, and Jackson County, Mississippi, where Google maintains three of its largest server farms (click here for a list of the rest at https://www.google.com/about/datacenters/inside/locations/index.html).
The shrinking of the financial industry is not only reflective of the price of office space.
It also explains why New York City, the center of the financial industry, has shown the slowest residential price appreciation since the 2012 bottom. Layoffs there in recent years have surpassed well over 200,000.
Who has been the biggest taker of new floor space in The City by the Bay?
That would be technology companies, which are far and away the fastest growers in the economy. This should be a sign of continued health of the American economy.
Yes, it would be fair to ask the question of the risks posed by 70 or so unicorn, fast growing tech companies that have yet to go public. The bloom here is clearly off the rose, with many getting slapped with lower valuations in the latest rounds of fund raising.
But unicorns rarely occupy prime or trophy office space. They are usually just one step out of a garage, to be found in cheaper ?B? and ?C? commercial office space.
No less a giant than ride sharing giant Uber, said to be worth $65 billion, just moved into an abandoned Sears department store in downtown, low rent Oakland, CA.
As is so often the case these days, traditional, historical data can be dangerous to follow, as it may have been rendered meaningless by our hyper evolving economy.
Look before you leap.
Global Google Server Farms
?A part of me slipped away?, said former heavyweight boxing champion, George Foreman, when he heard of the death of Muhammad Ali.
Global Market Comments
June 6, 2016
Fiat Lux
Featured Trade:
(JULY 27 BASEL, SWITZERLAND GLOBAL STRATEGY LUNCHEON),
(WHAT?S ON YOUR PLATE FOR THIS WEEK),
(WHY THE ?UNDERGROUND? ECONOMY IS GROWING),
Economic analysts were sent reeling in the wake of the May nonfarm payroll report released Friday, which showed only a feeble 38,000 in job gains.
It appears that the Great American Job Creating Engine has suddenly ground to a halt.
You know that big Fed rate rise that was coming in 9 days because the economy was so strong? You can kiss that baby goodbye, write it off, and confine it to the dustbin of history.
Personally, I never believed that rates were going to rise. I have been in the December camp all along, if ever.
What really sent researchers scurrying for their pocket calculators was the fact that the headline unemployment rate fell to a decade low of 4.7%. This occurred because 458,000 dropped out of the labor force.
Is this the beginning of a revival of productivity, or the start of the next Great Recession?
Assets classes behaved as you would expect. Stocks cratered 150 points, with interest rate plays, like the banks, taking the biggest hit. So did oil. Gold and bonds soared. The US dollar collapsed.
The payroll numbers got uglier the closer you looked at them.
Temporary help fell by -21,000, manufacturing by -18,000, construction by -10,000, and mining by -10,000. The gains were in health care, +40,000, food services, +22,000, and professional services, +10,000.
The long term U-6 unemployment rate stabilized at 9.7%.
I have been saying for weeks now that buying stocks at the top of a two-year range would only bring tears. The tears have arrived by the bucket full.
As for the coming week, you really have the ask the question, ?Other than that Mrs. Lincoln, how was the play??
The impact of the disastrous Department of Labor report far overshadows anything that will come out over the next five days.
Janet Yellen will be speaking again on Monday afternoon in Philadelphia, and no doubt will say absolutely nothing.
The JOLTS report on job openings this Wednesday at 10:00 AM EST will get more scrutiny than usual, as it will shed more light on the jobs situation. However, this is a one-month lagging indicator, so it will probably still show strength.
The US Energy Information Administration oil inventory number at 10:30 will continue to be a subject of great interest, giving a hint as to the health of the global economy.
We will get weekly Jobless Claims at 8:30 EST on Thursday, as usual. The Baker Hughes Rig Count then comes on Friday at 1:00 PM EST. With oil now at $48, look for hints of stabilization at the current 312 level (down from 1,600 in two years!).
Followers of the Mad Hedge Fund Trader trade alert service did alright this week. We took profits on our long Treasury position (TLT) and our short stock position (SPY).
I went into the May nonfarm payroll report with 90% cash because of the increasing randomness of the government report.
Unfortunately, the profit in the 10% weighting in the Japanese yen (FXY) vaporized overnight on the gap move down in the dollar.
However, I am going to hang on to my short position, as the beleaguered Japanese currency has risen 5% in four days. Moves like that in the currency market are as rare as hen?s teeth.
I assure you, the world hasn?t suddenly fallen in love with investment in Japan. If anything, economic conditions are worsening by the day, so the yen ?will fail again.
That said, if the (FXY) maintains a sustained close over the old high of $91.30, I am out of there. Iron discipline regarding stops is the only thing that will keep you alive in this kind of trading market.
This brought our final May return to an enviable 4.38%, and our average annualized return to 35.33%. The cream is still rising to the top.
What ever happens this week, don?t waste your time bothering. It?s still all about the June 14 Fed meeting.
You might as well hang out at the beach this week, save your powder for a better trading environment, and work on your tan.
In this environment, cash is king.
Better to Work on Your Tan in This Market
There is no doubt that the ?underground? economy is growing.
No, I?m not talking about violent crime, drug dealing, or prostitution. Those are largely driven by demographics, which right now, are at a low ebb.
I?m referring to the portion of the economy that the government can?t see, and therefore is not counted in its daily data releases.
This is a big problem.
Most investors rely on economic data to dictate their trading strategies. When the data is strong, they aggressively buy stocks, assuming that a healthy economy will boost corporate profits.
When data is weak, we get the flip side, and investors bail on equities. They also sell commodities, precious metals, oil, and plow their spare cash into the bond market.
We are now more than half way through a decade that has delivered unrelentingly low annual GDP growth, around the 2%-2.5% level.
We all know the reasons. Retiring baby boomers, some 85 million of them, are a huge drag on the system, as they save, and don?t spend.
Generation X-ers do spend, but there are only 65 million of them. And many Millennials are still living in their parents? basements - broke and unable to land paying jobs in this ultra cost conscious world.
But what if these numbers were wrong? What if the Feds were missing a big part of the picture?
I believe this is in fact what is happening.
I think the economy is now evolving so fast, thanks to the simultaneous hyper acceleration of multiple new technologies, that the government is unable to keep up.
Further complicating matters is the fact that many new internet services are FREE, and therefore are invisible to government statisticians.
They are, in effect, reading from a playbook that is a decade or more old.
What if the economy was really growing at a 3-4% pace, but we just didn?t know it.
I?ll give you a good example.
The government?s Consumer Price Index is a basket of hundreds of different prices for the things we buy. But the Index rarely changes, while we do.
The figure the Index uses for Internet connections hasn?t changed in ten years.
Gee, do you think that the price of broadband has risen in a decade, with the 1,000-fold increase in speeds?
In the early 2,000?s you could barely watch a snippet of video on YouTube without your computer freezing up. Now, I can download a two-hour movie in High Definition in just two minutes on my Comcast 250 megabyte per second business line.
And many people now watch movies on their iPhones. I see them in the rush hour traffic.
I?ll give you another example of the burgeoning black economy: Me.
My business shows up nowhere in the government economic data because it is entirely online. No bricks and mortar here!
Yet, I employ a dozen people, provide services to thousands of individuals, institutions, and governments in 140 countries, and take in millions of dollars in revenues in the process.
I pay a lot of American taxes too.
How many more me's are out there? I would bet millions.
If the government were understating the strength of the economy, what would the stock market look like?
It would keep going up every year like clockwork, as ever-rising profits feed into stronger share prices.
But multiples would never get very high (now at 19 times earnings) because no one believed in the rally, since the economic data was so weak.
That would leave them constantly underweight equities in a bull market.
Stocks would miraculously and eternally climb a wall of worry. Did I mention that the S$P 500 is 2% short of an all time high?
?
On the other hand, bonds would remain strong as well, and interest rates low, because so many individuals and corporations were plowing excess, unexpected profits into fixed income securities. Structural deflation would also give them a big tailwind.
If any of this sounds familiar, please raise your hand.
I have been analyzing economic data for a half century, so I am used to government statistics being incorrect.
It was a particular problem in emerging economies, like Japan and China, which were just getting a handle on what comprised their economies for the first time.
But to make this claim about the United States government, that has been counting things for 225 years, is a bit like saying the emperor has no clothes.
Sure, there has always been a lag between the government numbers and reality. In the old days they used horses to collect data, and during the Great Depression numbers were kept on 3? X 5? index cards filled out with fountain pens.
But today, the disconnect is greater than it ever has been, by a large margin, thanks to technology.
Is this unbelievable? Yes, but you better get used to it.
As for that bull market in stocks, it just might keep on going.
There May Be More Here Than Meets the Eye
?Financial repression seems to be working. The Fed is pushing everyone into riskier assets. Stocks are the obvious place for that, and it?s driving valuations ever higher.? said Curt Custard, of UBS Asset Management.