Washington D.C. Accounting Magic and Wall Street Greed

Connecting the Dots: Washington D.C. Accounting Magic and Wall Street Greed

By Tony Sagami

“I’m from the government, and I’m here to help you.”

My grandparents Fushakichi and Mitsue Sagami, my father, and my nine uncles and aunts were among the 110,000 Japanese-Americans living on the Pacific coast who were locked up for almost four years in internment camps during World War II.

Despite that treatment, my father was passionately patriotic about America. He’s the only man whom I’ve ever known who would stand at attention and place his hand over his heart in his own home when the national anthem was played on TV before a sporting event.

My father taught all of his children to love this country. “In America, you can be president, Tony,” my parents regularly told me. I didn’t become president, but my siblings and I are truly great American success stories.

That’s why I cringe whenever I see politicians like Senator Robert Menendez and Congressman Anthony Weiner behaving badly and bringing shame to our country.

But our elected politicians aren’t the only ones who stretch the truth. Some of our government agencies are just as bad, and that’s why I always dig below the headlines to figure out what the real truth is.

Take last week’s report from the Commerce Department about personal income, personal spending, and price.

The Commerce Department reported that wages increased by 0.3% and that American spending was up 0.1% in the month of February. That wasn’t much of an increase in spending, but Wall Street interpreted that as a giant victory given the heavy snow that covered the Northeast in February and sent the Dow Jones Industrial Average up by 263 points, or 1.5%.

Wall Street was impressed, but they shouldn’t have been, because those numbers were massively massaged and very misleading.

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Connecting the Dots: Oil, Divorce, and Bear Markets

By Tony Sagami

Everybody loves a parade. I sure did when I was a child, but I’m paying attention to a very different type of parade today.

The parade that I’m talking about is the long, long parade of businesses in the oil industry that are cutting jobs, laying off staff, and digging deep into economic survival mode.

The list of companies chopping staff is long, but two more major players in the oil industry joined the parade last week.

Pink Slip #1: Houston-based Dresser-Rand isn’t a household name, but it is a very important part of the energy food chain. Dresser-Rand makes diesel engines and gas turbines that are used to drill for oil.

Dresser-Rand announced that it’s laying off 8% of its 8,100 global workers. Many Wall Street experts were quick to point the blame at German industrial giant Siemens, which is in the process of buying Dresser-Rand for $7.6 billion.

Fat chance! Dresser-Rand was crystal clear that the cutbacks are in response to oil market conditions and not because of the merger with Siemens. The reason Dresser-Rand cited for the workforce reduction was not only lower oil prices but also the strength of the US dollar.

If you’re a regular reader of this column, you know that I believe the strengthening US dollar is the most important economic (and profit-killing) trend of 2015.

Pink Slip #2: Oil exploration company Apache Corporation reported its Q4 results last week, and they were awful. Apache lost a whopping $4.8 billion in the last 90 days of 2014.

No matter how you cut it, losing $4.8 billion in just three months is a monumental feat.

Of course, the “dramatic and almost unprecedented” drop in oil prices was responsible for the gigantic loss, but what really matters is the outlook going forward.

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The Single Most Important Economic Statistic that the White House Never Talks About

Connecting the Dots: The Single Most Important Economic Statistic that the White House Never Talks A

By Tony Sagami

For the first time in 35 years, American business deaths now outnumber business births. —Jim Clifton, CEO, Gallup Polls

I’ve been self-employed since 1998, and let me tell you, the life of a business owner isn’t easy. It’s filled with long hours, a relentless amount of paperwork, and uncertainty of where your next paycheck will come from. If you’ve ever owned a business, you know exactly what I’m talking about.

Difficult or not, self-employment is extremely rewarding, and I wouldn’t have it any other way. Nor would the other 6 million business owners in the United States. Of those 6 million businesses, the vast majority are small “Mom and Pop” businesses. Here are more statistics on businesses in the US:

3.8 million have four or fewer employees. That’s me!
1 million with 5-9 employees;
600,000 with 10-19 employees;
500,000 with 20-99 employees;
90,000 with 100-499 employees;
18,000 with 500 employees or more; and
1,000 companies with 10,000 employees or more.

Those small businesses are the backbone of our economy and responsible for employing roughly half of all Americans. Moreover, while estimates vary, small business create roughly two-thirds of all new jobs in our country.

For those reasons, the health (or lack thereof) of small business is the single most important long-term indicator of America’s economic health. Warning: new data suggest that small businesses are in deep trouble.

For the first time in 35 years, the number of business deaths outnumbers the number of business births.

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Connecting the Dots: Danger, Will Robinson! Danger!

By Tony Sagami

— Robot, Lost in Space

Oh, the pain, the pain.

— Dr. Zachary Smith, Lost in Space

We all have our favorite childhood TV shows, and Lost in Space was one of mine. I’m really not trying to insult your intelligence by quoting fictional TV characters, but I do see some serious stock market danger ahead, and the Lost in Space robot may be more right about 2015 than the high-paid experts on Wall Street.

I hope the 320-point plunge on Monday followed by the 130-point fall on Tuesday got your attention, because I believe there is a lot more pain left to come.

I could list dozens of reasons why caution is in order, but here are four serious warning signs just from last week.

Danger Will Robinson #1: ISM Manufacturing Index. The December index of the US manufacturing sector came in at 55.5, below the forecast for 57.5 and the weakest reading since May. The New Orders component of the index dropped to the worst level in seven months.

The culprit is the strong dollar, which hurts US exporters, and a general slowdown of the global economy.

Danger Will Robinson #2: ISM Non-Manufacturing (Services Sector). The December figure of 56.2 was well below the expectations of 58.0 and a big drop from the 59.3 in November.

Moreover, the services index has dropped three out of the last four months and saw the largest one-month fall in six years!

Danger Will Robinson #3: Construction spending. The Commerce Department reported that construction spending fell 0.3% in November, which was (again) below expectations of a 0.4% increase.

Danger Will Robinson #4: Chicago PMI. The index fell to 58.3 in December, below the 60.0 expectation, as well as November’s 60.8. According to the report, “The slowdown in the pace of activity exhibited since October’s one-year high of 66.2 has been marked. It was a disappointing end to the year with the pulse rate of our business panel slowing noticeably in December.”

Continue reading “Connecting the Dots: Danger, Will Robinson! Danger!”

Connecting the Dots: Q3 GDP Jumps 5%; Ha! The Crap Behind the Numbers

By Tony Sagami

I was raised on a farm and I’ve shoveled more than my share of manure. I didn’t like manure back then, and I like the brand of manure that comes out of Washington, DC, and Wall Street even less.

A stinky pile of economic manure came out of Washington, DC, last week and instead of the economic nirvana that it was touted to be, it was a smokescreen of half-truths and financial prestidigitation.

According to the newest version of the Bureau of Economic Analysis (BEA), the US economy is smoking hot. The BEA reported that GDP grew at an astonishing 5.0% annualized rate in the third quarter.

5% is BIG number.

The New York Times couldn’t gush enough, given a rare chance to give President Obama an economic pat on the back. “The American economy grew last quarter at its fastest rate in over a decade, providing the strongest evidence to date that the recovery is finally gaining sustained power more than five years after it began.”

Moreover, this is the second revision to the third quarter GDP—1.1 percentage points higher than the first revision—and the strongest rate since the third quarter of 2003.

However, that 5% growth rate isn’t as impressive if you peek below the headline number.

Fun with Numbers #1: The biggest improvement was in the Net Exports category, which increased by 112 basis points. How did they manage that? There was a downturn in Imports.

Fun with Numbers #2: Of the 5% GDP growth, 0.80% was from government spending, most of which was on national defense. I’m a big believer in a strong national defense, but building bombs, tanks, and jet fighters is not as productive to our economy as bridges, roads, and schools.

Fun with Numbers #3: Almost half of the gain came from Personal Consumption Expenditures (PCE) and deserves extra scrutiny. Of that 221 bps of PCE spending:

Services spending accounts for 115 bps. Of that 115, 15 bps was from nonprofits such as religious groups and charities. The other 100 bps was for household spending on “services.”
Of that 100 bps, the two largest categories were Healthcare spending (52 bps) and Financial Services/Insurance (35 bps).

The end result is that 85% of the contribution to GDP from Household Spending on Services came from healthcare and insurance! In short… those are code words for Obamacare!

While the experts on Pennsylvania Avenue and Wall Street were overjoyed, I see just another pile of white-collar manure and nothing to shout about.

Fun with Numbers #4: Lastly, the spending on Goods—the backbone of a health, growing economy—declined by 27 bps.

In a related news, the November durable goods report showed a -0.7% drop in spending, quite the opposite of the positive number that Wall Street was expecting.

Of course, Wall Street doesn’t want little things like facts to get in the way of their year-end bonus. As we close out 2014, the stock market marched higher and ignored things like:

The reaction of the bond market to the 5% number. Bonds should have softened in the face of such strong economic numbers, but the “adults” (the bond traders) on Wall Street saw the same manure that I did.
If the economy was as healthy as the BEA wants us to believe, the “patience” and “considerable time” promise of the FOMC should soon be broken… right?

I spend most of the year in Asia, including China, and I am seeing the same level of numbers massaging by our government as China’s. In China, the government leaders establish statistical goals and the government bean counters find creative ways to tweak the data to achieve those goals.

Zero interest rates.

24/7 central bank printing.

See-no-evil analysts.

Financial smoke and mirrors.

That’s the financially dangerous world we live in, and I hope that you have some type of strategy in place to deal with the bursting of what’s becoming a very big, debt-fueled bubble.

Tony Sagami

30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

The article Connecting the Dots: Q3 GDP Jumps 5%; Ha! The Crap Behind the Numbers was originally published at mauldineconomics.com.

Connecting the Dots: Dumb & Dumber: Relax Mortgage Rules, Financial Crisis 2.0

By Tony Sagami

Mortgage credit is too tight. They should have changed that a long time ago. —Jamie Dimon, CEO JPMorgan

Today’s rule is an important step forward in creating an environment where good lenders and good borrowers can work together without reservation. —Julian Castro, HUD Secretary

Geez, I can’t decide who is dumber when it comes to repeating the same mistakes: the profits-at-any-cost crowd on Wall Street or the do-anything-for-votes politicians in Washington, DC.

I can’t decide; they’re both dumber than dirt and often in bed when it comes to lining each other’s pockets.

What I’m talking about today is the new regulations for mortgage qualification a.k.a. “qualified residential mortgage” (QRM) rules.

Some background first.

After the 2008 financial crisis and subprime mortgage implosion, governmental agencies led by the Federal Housing Finance Agency enacted a series of tougher rules to clean up the overly easy mortgage qualification process.

Of course, tighter lending standards and higher down payments squeezed a lot of marginal buyers out of the real estate market, and that meant fewer dollars for big banks that package the loans and members of the National Association of Realtors that sell the homes.

The drop in income bothered them so much that they formed a big organization called the Coalition for Sensible Housing Policy to push the noble goal of helping first-time homebuyers with a return to the good old days of easy credit.

Big surprise. The lobbying efforts (and no doubt large political contributions) paid off. The 20% down payment requirement has disappeared and Fannie Mae and Freddie Mac will now guarantee some loans with down payments of as little as 3%.

Bye-bye credit standards.

These new QRM rules make it possible for mortgage applicants to do away with pesky things like good credit and a down payment.

“The QRM rule is a win-win for consumers, Realtors and the housing finance industry,” said Steve Brown, the president of the National Association of Realtors.

I don’t know about the consumers, but Brown is absolutely right about the new QRM rules being a win for Realtors and mortgage lenders. But heck, two out of three ain’t bad… right?

By the way, the three politicians most responsible for the new QRM rules are Senators Johnny Isakson (R-GA), Kay Hagan (D-NC), and Mary Landrieu (D-LA).

Senator Isakson of Georgia, by the way, was president of Northside Realty for 22 years before going into politics. Yup, enough to make you puke, but that’s standard operating procedure for Washington, DC.

Will these relaxed lending rules light a fire underneath the real estate market? So far… no!

The last new MBA mortgage application survey for the week ending November 28 showed the New Application Index stuck at 168, roughly the same level as shown in the mid-1990s.

Of course, mortgage rates are a lot lower today than they were in the 1990s.

What’s the problem then?

Not only are wages stagnant in nominal terms, wages are actually lower—a lot lower—in real, purchasing-power terms.

Just in October, the median household income in the US dropped by -0.6%, or $318.

And Americans seem to be less inclined to abuse credit as they have in the past. The total amount of revolving credit (credit cards) has plunged.

You see, people make borrowing decisions based on their confidence in future earnings and perceived strength of the economy, and Americans are clearly not confident about their economic future.

The new QRM rules aren’t going to give the big banks and Realtors the jump in income they’re hoping for.

So what does this mean for investors? The real estate food chain is so deep that there’s no shortage of potential trouble spots, but I’d be particularly leery of the giant bond guarantors, like MBIA and Assured Guaranty, as well as big mortgage lenders.

Who are the biggest mortgage lenders? Wells Fargo, US Bancorp, JPMorgan, Bank of America, and Quicken.

If you’re more of an ETF investor and want to play the “short” side, take a look at ProShares Short Real Estate (REK), an ETF that is designed to profit from falling stock prices of publicly traded companies involved in the real estate industry.

The article Connecting the Dots: Dumb & Dumber: Relax Mortgage Rules, Financial Crisis 2.0 was originally published at mauldineconomics.com.

Connecting the Dots: The Perils and Opportunities of the 2014 Holiday Shopping Seasons

By Tony Sagami

For two college summers and Christmas vacations, I worked the docks at the Port of Tacoma.

The work was a little dangerous, but it wasn’t hard because everybody seemed to spend just as much time playing cards as working. And the money was fantastic: $13 an hour back in the 1970s!

As of 2013, the average longshore worker was paid $147,000, as well as benefits worth $82,000 a year!

The money was so good that I toyed with the idea of quitting college and becoming a career longshoreman. My parents, however, went berserk at the idea. My mother cried like a widow at a funeral, and my father gave me the Ward Cleaver stare and made it crystal clear that my choices were: (1) get my butt back to the University of Washington or (2) go to work on the family vegetable farm with him.

Of course, I returned to the University of Washington, but my time at the Port of Tacoma was a great education in the role of unions and the blue-collar basics of the shipping industry.

What’s that got to do with investing? Quite a bit, because the members of the International Longshore and Warehouse Union from 29 ports from San Diego to Seattle have been working without a contract since July and the flow of goods between Asia and the shelves of American retailers has been severely disrupted.

The longshoremen haven’t gone on strike but are using a work slowdown strategy to get negotiating leverage.

That’s bad news for holiday shoppers because the odds are extremely high that the contents of the beautifully wrapped gifts carefully arranged under Christmas trees were made in Asia and transported to the West Coast of the US by ship. Think about it: if you’re a Chinese manufacturer… are you going to ship your goods to California or Florida?

Two ports at Los Angeles and Long Beach handle most of the imports from Asia.

The troubles are adding weeks to deliveries and are already causing a ripple of problems throughout the economy. Truckers aren’t getting paid as much because they’re hauling fewer loads, importers are paying to store containers in dockside yards, ships are sitting idle in the bays, and railroads are seeing less freight traffic.

Union Pacific, the large rail operator, complained that the port issues “frankly, are impacting some of our transportation operations.”

Retailers, many of which depend on holiday sales for more than half of their annual sales, are already singing the blues.

Ann Inc., the owner of Ann Taylor and Loft brands, recently warned Wall Street to chop its Q4 sales and profits expectations. The problem? Lower shopping mall traffic, a highly promotional retail environment, and shipping delays at West Coast ports. Plus, it said it will spend an additional $8 million in airfreight costs this quarter.
Perry Ellis delays in shipping at West Coast ports hurt its third-quarter results, which included a 5% year-over-year drop in sales.

High-end ladies apparel store New York & Co. warned Santa may leave a lump of coal in its EPS stocking. CEO Gregory Scott said, “Sales were impacted by the combination of certain underperforming product categories along with shipping delays at various ports … As we enter the fourth quarter, the current labor unrest at West Coast ports coupled with a continuation of shipping delays, could impact sales during the holiday period and we are monitoring the situation very closely.”

I have a feeling that some fashion-conscious trophy wives are going to be very unhappy on Christmas morning.

Even regular folks like us may be disappointed. Wal-Mart, with its enormous clout as the world’s largest retailer, is feeling the pain. “[There are] potential port issues on the West Coast this year,” said Duncan Mac Naughton, Wal-Mart’s chief merchandising officer.

Some retailers are getting around the shipping slowdown by having their goods delivered by air freight instead. While that bypasses the West Coast ports, it isn’t a cheap solution. According to the National Retail Federation, air delivery is 10 times more expensive that by ship.

Those extra shipping costs will clobber retailers’ already-thin profit margins so you better take a close look at any retail stocks that you own. However, there is always a silver lining in every storm cloud if you know where to look.

For example, air-freight shippers are enjoying a boost to their business. “When things get a little bit congested, it helps us,” Bruce Campbell, CEO of Forward Air Corporation.

That business boost plus lower fuel costs will translate into Q4 earnings surprises and send their stocks higher when Wall Street reacts with its usual Johnny-come-lately reaction to positive earnings surprises.

You won’t, though, because you already know more than most of the pinstriped experts in Manhattan.

The article Connecting the Dots: The Perils and Opportunities of the 2014 Holiday Shopping Seasons was originally published at mauldineconomics.com.

Connecting the Dots: The Healthy Bull Market: Bah, Humbug!

By Tony Sagami

Are you a long-term investor? Convinced that all you have to do is wait long enough to be guaranteed huge stock market profits?

Take a look at the chart below of rolling 30-year returns of the S&P 500 and tell me if it affects your enthusiasm.

The reality is that stock market results vary widely depending on what your starting point is. For example, any investor who put $100,000 into the stock market 1954 was rewarded with roughly the same $100,000 30 years later in 1984.

Yup… 30 years in, and not a penny of profits.

With the stock market at all-time highs, you may find it hard to be pessimistic, but the stock market is doing as well as it’s ever done, with a rolling 30-year return of better than 400%.

How would you feel about earning 0% on your money for 30 years?

Could the stock market go even higher? Yes, it could—but the odds aren’t favorable after the QE-fueled rally has pushed stocks to historically high valuations.

High valuations? Despite what the mass media and the Wall Street crowd try to tell you, valuations are quite high.

The most popular myth spouted on financial TV these days is the notion that the S&P 500 is trading at 19 times earnings. Baloney!

First, that 19 P/E is based on “forward” earnings, not trailing earnings. As unreliable as economists and self-serving analysts are, I’m surprised that anyone—especially you—believes anything they say.

Second, that forward-looking earnings forecast is based on those 500 companies increasing their earnings by an average of 23% over the next 12 months. Yup… a 23% increase!

That’s extremely optimistic, but I think especially misplaced now that the steroid of quantitative easing is behind us. Consider this: everybody agrees that stocks responded extremely positively to quantitative easing, so doesn’t it make sense to be concerned now that the monetary punch bowl has been yanked away?

The first place to look for signs of waning enthusiasm are small-cap stocks. While the Dow Jones Industrial Average and the S&P 500 were setting all-time highs, the Russell 2000 wasn’t able to punch through its March, July, and September peaks.

This quadruple top looks like a formidable resistance level for small stocks and clear evidence that investors are reducing risk by rotating out of small-cap stocks and into big-cap stocks.

Additionally, financial stocks are showing signs of exhaustion too. Healthy bull markets are often led by financial stocks, but the financials are lagging the major indexes now.

That’s why I think last week’s 3.9% GDP print smelled fishy; some weak economic numbers are spelling trouble.

Durable Goods Orders Not So Good: The headline number for October durable goods orders was strong with a +0.4% increase, but if you back out the volatile transportation sales, the picture is a lot uglier. If you exclude transportation—because just a few $100 million jet orders can skew the numbers—the 0.4% gain turns into a 0.9% decrease.

By the way, orders for defense aircraft were up 45.3%, but orders for non-defense aircraft orders were down 0.1% in October. If not for some big government orders, the results would be absolutely horrible!

Unemployment Claims Rise Despite Holiday Hiring: The job picture, which had been improving, showed some deterioration last week despite going into the busy holiday hiring season. Initial jobless claims jumped to 313,000, a 7.2% increase from last week as well as much higher than the 286,000 forecast. It also broke a 10-week streak of claims below 300,000.

Before You Cheer Cheap Oil: After OPEC agreed to keep production levels unchanged, the price of oil plunged by 7% on Friday to less than $68 a barrel. That’s good news for drivers, but oil’s falling prices (as well as those of other commodities) are a very bad sign for economic growth. Moreover, the energy industry has been one of the few industries producing good, high-paying jobs. Thus, low oil prices could turn that smile into a frown in no time.

The Bond Conundrum: The yield on 10-year Treasury bonds was as high as 3% earlier this year but dropped to 2.31 last Friday. If our economy were rocking as well as the 3.9% GDP rate suggests, interest rates should be rising… not falling like a rock.

The stock market may not fall out of bed tomorrow morning, but the holiday season for stock market investors looks like it may be more Scrooge than Santa Claus.

The article Connecting the Dots: The Healthy Bull Market: Bah, Humbug! was originally published at mauldineconomics.com.