Showing posts with label Wall Street. Show all posts
Showing posts with label Wall Street. Show all posts

Tuesday, August 23, 2016

Will The Bubble Pop Regardless if the Fed Never Raises Rates?

The current overall SPX pattern is a broadening top, which is usually a very reliable pattern. The market continues to look as though it wants to go even lower. The momentum shift, which I have been expecting, has been slow to start, however one should be prepared for this occurrence ahead of time. Nevertheless, the large divergences which I have been viewing, in my proprietary oscillators, are most real, and, once the selling starts, the momentum should quickly move to the downside.

The current market is being supported by a lack of sellers more so than aggressive buying. With investors still thinking that there is no other place to store their money, they appear to be content with leaving their money with risk on assets within a market that is pushing to all time highs. This type of mentality usually leads to large losses rather than big gains. There isn’t any real opportunity for growth in the SPX that I can see right now.

Dow Theory: Market Indexes Must Confirm Each Other
The Dow Theory was formulated from a series of Wall Street Journal editorials which were authored by Charles H. Dow from 1900 until the time of his death in 1902. These editorials reflected Dow’s beliefs regarding how the stock market behaved and how the market could be used to measure the health of the business environment.

Dow first used his theory to create the Dow Jones Industrial Index and the Dow Jones Rail Index (now Transportation Index), which were originally compiled by Dow for TheWall Street Journal. Dow created these indexes because he felt they were an accurate reflection of the business conditions within the economy, seeing as they covered two major economic segments: industrial and rail (transportation). While these indexes have changed, over the last 100 years, the theory still applies to current market indexes.

Market indexes must confirm one another. In other words, a major reversal from a bull or bear market cannot be signaled unless both indexes (generally the Dow Industrial and Transports Averages) are in agreement. Currently, They are DIVERGING, issuing MAJOR NON-CONFIRMATION HIGH the Dow Jones Industrial average. If one couples this with the volatility index, this is a warning sign and a recipe for disaster.

chart 1


The FEDs’ monetary policy over the last eight years has led to unproductive and reckless corporate behavior. The chart below shows U.S. non financials’ year on year change in net debt versus operating cash flow as measured by earnings before interest, tax, depreciation, and amortization (EBITA).

Chart 2
The growth in operating cash flow peaked five years ago and has turned negative year over year. Net debt has continued to rise, which is not good for companies.

This has never before occurred in the post World War II period. In the cycle preceding the Great Recession, the peaks had been pretty much coincidental. Even during that cycle, they only diverged for two years, and by the time EBITA turned negative, year over year, as it has today, growth in net debt had been declining for over two years. Again, the current 5 year divergence is unprecedented in financial history. Today, most of that debt is used for financial engineering, as opposed to productive investments. In 2012, buybacks and M&A were $1.25 trillion, while all R&D and office equipment spending were $1.55 trillion. As valuations rose, since that time, R&D and office equipment grew by only $250 billion, but financial engineering grew by $750 billion, or three times this!

You can only live on your seed corn for so long. Despite there being no increase in their interest costs while growing their net borrowing by $1.7 trillion, the profit shares of the corporate sector peaked in 2012. The corporate sector, today, is stuck in a vicious cycle of earnings manipulation management, questionable allocation of capital, low productivity, declining margins and growing debt levels.

Conclusion:

In short, I continue to pound on the table to help keep you and fellow investors aware that something bad, financially, is going to take place – huge events like the tech bubble, the housing collapse a few years back, and now national financial instability. Experts saw all these events coming months and, in some cases, years in advance. Big things typically don’t happen fast, but once the momentum changes direction you better be ready for some life changing events and a change in the financial market place.

Follow my analysis in real time, swing trades, and even my long term investment positions so you can survive from the financial storm The Gold & Oil Guy.com



Stock & ETF Trading Signals

Friday, March 4, 2016

The Secret Behind the $1 Million Option Setup....Here’s Your Private Replay (expires soon)

If you missed John Carter’s special training Tuesday night then you are in luck. The limited replay is online now.

Watch the Private Replay Here [Expires soon] 

Get ready to take notes! Unfortunately, I have no idea how long this replay will be up, so watch it while you can. But I can tell you the feedback from those who attended live is beyond awesome. This was not just another ‘webinar’ featuring ‘hypothetical results’.

John detailed, step by step, how to be consistently profitable in these volatile conditions using just a handful of very simple options setups. There was ZERO hype and total transparency. He showed actual trading accounts with winning AND losing trades for all to see. You gotta see this for yourself.

Here’s just some of what John revealed....

  •   Why extreme volatility is the new normal. If you don’t want to crash and burn, you MUST adapt
  •   The setup John used to turn $3k into $119k in just 3 weeks (and how to spot these rare, explosive moves)
  • The simple signal that allowed John to make $1 million in a single day on TSLA options
  • How to pinpoint major reversals in advance by legally ‘spying’ on Wall Street Insiders
  • The publically available intel that allowed John to catch the Nasdaq’s historic January collapse, AND then get long for the February rally
  • The braindead simple option system that turns crazy market volatility into potentially giant gains (sometimes literally overnight , with strictly limited risk)
  • How it’s possible to consistently pull in $100 to $1000 a day by trading from your smart phone (even if you have a job)

Like I said, you don’t want to miss this training. John’s refined these simple strategies over more than 25 years. He shows you what’s really working now and the account killing mistakes that you want to avoid like the plague.

Watch the Limited Replay Now

See you in the markets!
Ray's Stock World


Get John's latest FREE eBook "Understanding Options"....Just Click Here!

Sunday, September 13, 2015

Hate Mail, Crumbling Factories, and Sinking Stocks

By Tony Sagami 

The bulls are mad at me. I’ve been heavily beating the bear market drum in this column since the spring. The S&P 500, by the way, peaked on May 21, and this column has been generating a rising stream of hate mail from the bulls as the stock market has dropped. My hate mail falls into two general categories: (1) you are wrong, and/or (2) you are stupid.

Well, I may not be the sharpest tool in the Wall Street shed, but I haven’t been wrong about where the stock market was headed. This column, however, isn’t about me. It’s about protecting and growing your wealth—and that’s why I have been so forceful about the rising dangers the stock market is facing.

Make sure you watch this weeks new video...."500K, Profit and Proof"

One of the themes I’ve repeatedly covered in this column is the rapidly deteriorating health of the two most basic economic building blocks of the American economy: the “makers” (see August 25 column) and the “takers” (see July 14 and August 4 columns).

There are thousands of economic and business statistics you can look at to gauge the health of the US economy, but at the economic roots of any developed country is the prosperity of its factories (makers) and transportation companies (takers) delivering those goods to stores.

This week, let’s look at the latest evidence confirming the piss poor health of American factories.

Factory Fact #1: The Institute for Supply Management released its latest survey results, which showed a drop to 51.1 in August, a decline from 52.7 in July, below the 52.5 Wall Street forecast, and the weakest reading since April 2009.


NOTE: The ISM survey shows that raw-materials prices dropped for 10 months in a row. If you own commodity stocks—such as copper, oil, aluminum, or gold—you should consider how falling raw materials prices will affect the profits of those companies.

Factory Fact #2: Despite all the crowing from Washington DC about the improving economy, US manufacturing output is still worse today than it was before the 2008-2009 Financial Crisis, according to the Federal Reserve.


Factory Fact #3: Business inventories increased at the fastest back to back quarterly rate on record. Inventories increased 0.8% in Q2, following a 0.3% increase in Q1, and now sit at $586 billion. That’s a 5.4% year over year increase!


Remember, there are two reasons why businesses accumulate inventory:
  • Business owners are so optimistic about the future that they intentionally accumulate inventory to accommodate an upcoming avalanche of orders.
OR
  • Business is so bad that inventory is starting to involuntarily pile up from the lack of sales.
Factory Fact #4: The Manufacturers Alliance for Productivity and Innovation (MAPI), a trade association for US manufacturers, is none too optimistic about the state of American manufacturing.
The reason for the pessimism is simple: US manufacturers are struggling.

  • U.S. manufactured exports decreased by 2% to $298 billion in the second quarter, as compared with 2014.
  • The US deficit in manufacturing rose by $21 billion, or 15%, compared with the second quarter of 2014.
“The US $48 billion deficit increase in the first half of the year equates to a loss of 300,000 trade related American manufacturing jobs, and the deficit is on track for a loss of 500,000 or more jobs for the calendar year,” said Ernest Preeg of MAPI.

So what does all this mean?

When I connect those dots, it tells me that American manufacturers are struggling. Really struggling.
Take a look at the Dow Jones US Industrials Index, which peaked in February and started to drop well ahead of the August market meltdown.


You know what’s really nuts? The P/E ratio for this struggling sector is almost 19 times earnings and 3.3 times book value!


Is there a way to profit from this slowdown of American factories? You bet there is.

Take a look at the ProShares UltraShort Industrials ETF (SIJ). This ETF is designed to deliver two times the inverse (-2x) of the daily performance of the Dow Jones US Industrials Index. To be fair, I should disclose that my Rational Bear subscribers have owned this ETF since June 16, 2015, and are sitting on close to a 15% gain.

Critics could say that I am “talking up my book,” but I instead see it as “eating my own cooking.” My advice in this column isn’t theoretical—we put real money behind my convictions. That doesn’t mean you should rush out and buy this ETF tomorrow morning. As always, timing is everything, so I suggest you wait for my buy signal.

But make no mistake, American “makers” are doing very poorly, and that’s a reliable warning sign of bigger economic problems.
Tony Sagami
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.



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Sunday, March 15, 2015

Crude 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.


CEO John Christmann, to his credit, is taking tough steps to stem the financial bleeding, and that means:
  • Shutting down 70% of the company's drilling rigs.
  • Slashing it's 2015 capital budget to between $3.6 and $5.0 billion, down from $8.5 billion in 2014.
Those aren’t the actions of an industry insider who expects things to get better anytime soon.

I don’t mean to bag on Dresser-Rand and Apache, because they’re far from alone. Schlumberger, Baker Hughes, Halliburton, Weatherford International, and ConocoPhillips have also announced major layoffs. And don’t make the mistake of thinking that the only people getting laid off are blue-collar roughnecks. These layoffs affect everyone from secretaries to roughnecks to IT professionals.

In fact, according to staffing expert Swift Worldwide Resources, the number of energy jobs lost this year has climbed to well above 100,000 around the world.

From Global to Local


Sometimes it helps to put a local, personal perspective to the big-picture national news.

In my home state of northwest Montana, a huge number of men moved to North Dakota to work in the Bakken gas fields. Montana is a big state; it takes about 14 hours to drive from my corner of northwest Montana to the North Dakota oil fields, so that means those gas workers don’t make it back to their western Montana homes for months.

Moreover, the work was six, sometimes seven days a week and 12 hours a day, so once there, they couldn’t drive back home even if they wanted to. This meant long absences… and a good friend of mine who is a marriage counselor told me that the local divorce rate was spiking because of them.

Now the northwest Montana workers are returning home because the once-lucrative oil/gas jobs are disappearing. That news won’t make the New York Times, but it’s as real as it gets on Main Street USA.

From Local to National


Of course, the oil industry's woes aren’t a carefully guarded Wall Street secret. However, I do think that Wall Street—and perhaps even you—are underestimating the impact that low oil prices are going to have on economic growth and GDP numbers going forward.

Let me explain.

Industrial production for the month of January, which measures the output of US manufacturers, miners, and utilities, came in at a “seasonally adjusted" 0.2%.


A 0.2% gain isn’t much to shout about, but the real key was the impact the mining component (which includes oil/gas producers) had on the industrial-production calculation.

The mining industry is the second-largest component of industrial production, and its output fell by 1.0% in January. It was the biggest drag on the overall index.

However, the Federal Reserve Bank said, “The decline [was] more than accounted for by a substantial drop in the index for oil and gas well drilling and related support activities.”

How much did it account for? The oil and gas component fell by 10.0% in January.

Yup, a double-digit drop in output in just one month. Moreover, it was the fourth monthly decline in a row.
Last week’s weak GDP caught Wall Street off guard, but there are a lot more GDP disappointments to come as the energy industry layoffs percolate through the economy. Here’s how my Rational Bear readers are getting ready for GDP and corporate-earnings disappointments that are sure to rattle the markets.
Can your portfolio, as currently composed, handle a slowing economy and falling corporate profits? For most investors, the answer is “no.” Click above to find out how to protect yourself.

Tony Sagami

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.




Get our latest FREE eBook "Understanding Options"....Just Click Here!


Saturday, January 10, 2015

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
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.



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Friday, December 19, 2014

Crude Oil, Employment, and Growth

By John Mauldin


Last week we started a series of letters on the topics I think we need to research in depth as we try to peer into the future and think about how 2015 will unfold. In forecasting U.S. growth, I wrote that we really need to understand the relationships between the boom in energy production on the one hand and employment and overall growth in the US on the other. The old saw that falling oil prices are like a tax cut and are thus a net benefit to the US economy and consumers is not altogether clear to me. I certainly hope the net effect will be positive, but hope is not a realistic basis for a forecast. Let’s go back to two paragraphs I wrote last week:

Texas has been home to 40% of all new jobs created since June 2009. In 2013, the city of Houston had more housing starts than all of California. Much, though not all, of that growth is due directly to oil. Estimates are that 35–40% of total capital expenditure growth is related to energy. But it’s no secret that not only will energy related capital expenditures not grow next year, they are likely to drop significantly. The news is full of stories about companies slashing their production budgets. This means lower employment, with all of the knock on effects.

Lacy Hunt and I were talking yesterday about Texas and the oil industry. We have both lived through five periods of boom and bust, although I can only really remember three. This is a movie we’ve seen before, and we know how it ends. Texas Gov. Rick Perry has remarkable timing, slipping out the door to let new governor Greg Abbott to take over just in time to oversee rising unemployment in Texas. The good news for the rest of the country is that in prior Texas recessions the rest of the country has not been dragged down. But energy is not just a Texas and Louisiana story anymore. I will be looking for research as to how much energy development has contributed to growth and employment in the US.

Then the research began to trickle in, and over the last few days there has been a flood. As we will see, energy production has been the main driver of growth in the US economy for the last five years. But changing demographics suggest that we might not need the job creation machine of energy production as much in the future to ensure overall employment growth.

When I sat down to begin writing this letter on Friday morning, I really intended to write about how falling commodity prices (nearly across the board) and the rise of the dollar are going to affect emerging markets.

The risks of significant policy errors and an escalating currency war are very real and could be quite damaging to global growth. But we will get into that next week. Today we’re going to focus on some fascinating data on the interplay between energy and employment and the implications for growth of the US economy. (Note: this letter will print a little longer due to numerous charts, but the word count is actually shorter than usual.)

But first, a quick recommendation. I regularly interact with all the editors of our Mauldin Economics publications, but the subscription service I am most personally involved with is Over My Shoulder.
It is actually very popular (judging from the really high renewal rates), and I probably should mention it more often. Basically, I generally post somewhere between five and ten articles, reports, research pieces, essays, etc., each week to Over My Shoulder. They are sent directly to subscribers in PDF form, along with my comments on the pieces; and of course they’re posted to a subscribers-only section of our website. These articles are gleaned from the hundreds of items I read each week – they’re the ones I feel are most important for those of us who are trying to understand the economy. Often they are from private or subscription sources that I have permission to share occasionally with my readers.

This is not the typical linkfest where some blogger throws up 10 or 20 links every day from Bloomberg, the Wall Street Journal, newspapers, and a few research houses without really curating the material, hoping you will click to the webpage and make them a few pennies for their ads. I post only what I think is worth your time. Sometimes I go several days without any posts, and then there will be four or five in a few days. I don’t feel the need to post something every day if I’m not reading anything worth your time.

Over My Shoulder is like having me as your personal information assistant, finding you the articles that you should be reading – but I’m an assistant with access to hundreds of thousands of dollars of research and 30 years of training in sorting it all out. It’s like having an expert filter for the overwhelming flow of information that’s out there, helping you focus on what is most important.

Frankly, I think the quality of my research has improved over the last couple years precisely because I now have Worth Wray performing the same service for me as I do for Over My Shoulder subscribers. Having Worth on your team is many multiples more expensive than an Over My Shoulder subscription, but it is one of the best investments I’ve ever made. And our combined efforts and insights make Over My Shoulder a great bargain for you.

For the next three weeks, I’m going to change our Over My Shoulder process a bit. Both Worth and I are going to post the most relevant pieces we read as we put together our 2015 forecasts. This time of year there is an onslaught of forecasts and research, and we go through a ton of it. You will literally get to look “over my shoulder” at the research Worth and I will be thinking through as we develop our forecasts, and you will have a better basis for your own analysis of your portfolios and businesses for 2015.

And the best part of it is that Over My Shoulder is relatively cheap. My partners are wanting me to raise the price, and we may do that at some time, but for right now it will stay at $39 a quarter or $149 a year. If you are already a subscriber or if you subscribe in the next few days, I will hold that price for you for at least another three years. I just noticed on the order form (I should check these things more often) that my partners have included a 90 day, 100% money-back guarantee. I don’t remember making that offer when I launched the service, so this is my own version of Internet Monday.  

You can learn more and sign up for Over My Shoulder right here.

And now to our regularly scheduled program.

The Impact of Oil On U.S. Growth
I had the pleasure recently of having lunch with longtime Maine fishing buddy Harvey Rosenblum, the long-serving but recently retired chief economist of the Dallas Federal Reserve. Like me, he has lived through multiple oil cycles here in Texas. He really understands the impact of oil on the Texas and U.S. economies. He pointed me to two important sources of data.

The first is a research report published earlier this year by the Manhattan Institute, entitled “The Power and Growth Initiative Report.” Let me highlight a few of the key findings:

1. In recent years, America’s oil & gas boom has added $300–$400 billion annually to the economy – without this contribution, GDP growth would have been negative and the nation would have continued to be in recession.

2. America’s hydrocarbon revolution and its associated job creation are almost entirely the result of drilling & production by more than 20,000 small and midsize businesses, not a handful of “Big Oil” companies. In fact, the typical firm in the oil & gas industry employs fewer than 15 people. [We typically don’t think of the oil business as the place where small businesses are created, but for those of us who have been around the oil patch, we all know that it is. That tendency is becoming even more pronounced as the drilling process becomes more complicated and the need for specialists keeps rising. – John]

3. The shale oil & gas revolution has been the nation’s biggest single creator of solid, middle-class jobs – throughout the economy, from construction to services to information technology.

4. Overall, nearly 1 million Americans work directly in the oil & gas industry, and a total of 10 million jobs are associated with that industry.

Oil & gas jobs are widely geographically dispersed and have already had a significant impact in more than a dozen states: 16 states have more than 150,000 jobs directly in the oil & gas sector and hundreds of thousands more jobs due to growth in that sector.

Author Mark Mills highlighted the importance of oil in employment growth:



The important takeaway is that, without new energy production, post recession U.S. growth would have looked more like Europe’s – tepid, to say the least. Job growth would have barely budged over the last five years.

Further, it is not just a Texas and North Dakota play. The benefits have been widespread throughout the country. “For every person working directly in the oil and gas ecosystem, three are employed in related businesses,” says the report. (I should note that the Manhattan Institute is a conservative think tank, so the report is pro-energy-production; but for our purposes, the important thing is the impact of energy production on recent US economic growth.)

The next chart Harvey directed me to was one that’s on the Dallas Federal Reserve website, and it’s fascinating. It shows total payroll employment in each of the 12 Federal Reserve districts. No surprise, Texas (the Dallas Fed district) shows the largest growth (there are around 1.8 million oil related jobs in Texas, according to the Manhattan Institute). Next largest is the Minneapolis Fed district, which includes North Dakota and the Bakken oil play. Note in the chart below that four districts have not gotten back to where they were in 2007, and another four have seen very little growth even after eight years. “It is no wonder,” said Harvey, “that so many people feel like we’re still in a recession; for where they live, it still is.”



To get the total picture, let’s go to the St. Louis Federal Reserve FRED database and look at the same employment numbers – but for the whole country. Notice that we’re up fewer than two million jobs since the beginning of the Great Recession. That’s a growth of fewer than two million jobs in eight years when the population was growing at multiples of that amount.



To put an exclamation point on that, Zero Hedge offers this thought:

Houston, we have a problem. With a third of S&P 500 capital expenditure due from the imploding energy sector (and with over 20% of the high yield market dominated by these names), paying attention to any inflection point in the U.S. oil producers is critical as they have been gung-ho “unequivocally good” expanders even as oil prices began to fall. So, when Reuters reports a drop of almost 40 percent in new well permits issued across the United States in November, even the Fed's Stan Fischer might start to question [whether] his [belief that] lower oil prices are "a phenomenon that’s making everybody better off" may warrant a rethink.

Consider: lower oil prices unequivocally “make everyone better off.” Right? Wrong. First: new oil well permits collapse 40% in November; why is this an issue? Because since December 2007, or roughly the start of the global depression, shale oil states have added 1.36 million jobs while non shale states have lost 424,000 jobs.



The writer of this Zero Hedge piece, whoever it is (please understand there is no such person as Tyler Durden; the name is simply a pseudonym for several anonymous writers), concludes with a poignant question:

So, is [Fed Vice-Chairman] Stan Fischer's “not very worried” remark about to become the new Ben “subprime contained” Bernanke of the last crisis?

Did the Fed Cause the Shale Bubble?

Next let’s turn to David Stockman (who I think writes even more than I do). He took aim at the Federal Reserve, which he accuses of creating the recent “shale bubble” just as it did the housing bubble, by keeping interest rates too low and forcing investors to reach for yield. There may be a little truth to that. The reality is that the recent energy boom was financed by $500 billion of credit extended to mostly “subprime” oil companies, who issued what are politely termed high yield bonds – to the point that 20% of the high yield market is now energy production related.

Sidebar: this is not quite the same problem as subprime loans were, for two reasons: first, the subprime loans were many times larger in total, and many of them were fraudulently misrepresented. Second, many of those loans were what one could characterize as “covenant light,” which means the borrowers can extend the loan, pay back in kind, or change the terms if they run into financial difficulty. So this energy related high yield problem is going to take a lot more time than the subprime crisis did to actually manifest, and there will not be immediate foreclosures. But it already clear that the problem is going to continue to negatively (and perhaps severely) impact the high-yield bond market. Once the problems in energy loans to many small companies become evident, prospective borrowers might start looking at the terms that the rest of the junk-bond market gets, which are just as egregious, so they might not like what they see. We clearly did not learn any lessons in 2005 to 2007 and have repeated the same mistakes in the junk bond market today. If you lose your money this time, you probably deserve to lose it.

The high yield shake out, by the way, is going to make it far more difficult to raise money for energy production in the future, when the price of oil will inevitably rise again. The Saudis know exactly what they’re doing. But the current contretemps in the energy world is going to have implications for the rest of the leveraged markets. “Our biggest worry is the end of the liquidity cycle. The Fed is done. The reach for yield that we have seen since 2009 is going into reverse,” says Bank of America (source: The Telegraph).

Contained within Stockman’s analysis is some very interesting work on the nature of employment in the post recession U.S. economy. First, in the nonfarm business sector, the total hours of all persons working is still below that of 2007, even though we nominally have almost two million more jobs. Then David gives us two charts that illustrate the nature of the jobs we are creating (a topic I’ve discussed more than once in this letter). It’s nice to have somebody do the actual work for you.

The first chart shows what he calls “breadwinner jobs,” which are those in manufacturing, information technology, and other white collar work that have an average pay rate of about $45,000 a year. Note that this chart encompasses two economic cycles covering both the Greenspan and Bernanke eras.



So where did the increase in jobs come from? From what Stockman calls the “part time economy.” If I read this chart right and compare it to our earlier chart from the Federal Reserve, it basically demonstrates (and this conclusion is also borne out by the research I’ve presented in the past) that the increase in the number of jobs is almost entirely due to the creation of part time and low wage positions – bartenders, waiters, bellhops, maids, cobblers, retail clerks, fast food workers, and temp help. Although there are some professional bartenders and waiters who do in fact make good money, they are the exception rather than the rule.



It’s no wonder we are working fewer hours even as we have more jobs.

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Monday, November 17, 2014

The Return of the Dollar

By John Mauldin


Two years ago, my friend Mohamed El-Erian and I were on the stage at my Strategic Investment Conference. Naturally we were discussing currencies in the global economy, and I asked him about currency wars. He smiled and said to me, “John, we don’t talk about currency wars in polite circles. More like currency disagreements” (or some word to that effect).

This week I note that he actually uses the words currency war in an essay he wrote for Project Syndicate:

Yet the benefits of the dollar’s rally are far from guaranteed, for both economic and financial reasons. While the US economy is more resilient and agile than its developed counterparts, it is not yet robust enough to be able to adjust smoothly to a significant shift in external demand to other countries. There is also the risk that, given the role of the ECB and the Bank of Japan in shaping their currencies’ performance, such a shift could be characterized as a “currency war” in the US Congress, prompting a retaliatory policy response.

This is a short treatise, but as usual with Mohamed’s writing, it’s very thought provoking. Definitely Outside the Box material.

And for a two-part Outside the Box I want to take the unusual step of including an op-ed piece that you might not have seen, from the Wall Street Journal, called “How to Distort Income Inequality,” by Phil Gramm and Michael Solon. They cite research I’ve seen elsewhere which shows that the work by Thomas Piketty cherry-picks data and ignores total income and especially how taxes distort the data. That is not to say that income inequality does not exist and that we should not be cognizant and concerned, but we need to plan policy based on a firm grasp of reality and not overreact because of some fantasy world created by social provocateur academicians.

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The calls for income redistribution from socialists and liberals based on Piketty’s work are clearly misguided and will further distort income inequality in ways that will only reduce total global productivity and growth.
I’m in New York today at an institutional fund manager conference where I had the privilege of hearing my good friend Ian Bremmer take us around the world on a geopolitical tour. Ian was refreshingly optimistic, or at least sanguine, about most of the world over the next few years. Lots of potential problems, of course, but he thinks everything should turn out fine – with the notable exception of Russia, where he is quite pessimistic.

A shirtless Vladimir Putin was the scariest thing on his geopolitical radar. As he spoke, Russia was clearly putting troops and arms into eastern Ukraine. Why would you do that if you didn’t intend to go further? Ian worried openly about Russia’s extending a land bridge all the way to Crimea and potentially even to Odessa, which is the heart of economic Ukraine, along with the Kiev region. It would basically make Ukraine ungovernable.

I thought Putin’s sadly grim and memorable line that “The United States is prepared to fight Russia to the last Ukrainian” pretty much sums up the potential for a US or NATO response. Putin agreed to a cease-fire and assumed that sanctions would start to be lifted. When there was no movement on sanctions, he pretty much went back to square one. He has clearly turned his economic attention towards China.

Both Ian Bremmer and Mohamed El Erian will be at my Strategic Investment Conference next year, which will again be in San Diego in the spring, April 28-30. Save the dates in your calendar as you do not want to miss what is setting up to be a very special conference. We will get more details to you soon.

It is a very pleasant day here in New York, and I was able to avoid taxis and put in about six miles of pleasant walking. (Sadly, it is supposed to turn cold tomorrow.) I’ve gotten used to getting around in cities and slipping into the flow of things, but there was a time when I felt like the country mouse coming to the city. As I walked past St. Bart’s today I was reminded of an occasion when your humble analyst nearly got himself in serious trouble.

There is a very pleasant little outdoor restaurant at St. Bartholomew’s Episcopal Church, across the street from the side entrance of the Waldorf-Astoria. It was a fabulous day in the spring, and I was having lunch with my good friend Barry Ritholtz. The president (George W.) was in town and staying at the Waldorf. His entourage pulled up and Barry pointed and said, “Look, there’s the president.”

We were at the edge of the restaurant, so I stood up to see if I could see George. The next thing I know, Barry’s hand is on my shoulder roughly pulling me back into my seat. “Sit down!” he barked. I was rather confused – what faux pas I had committed? Barry pointed to two rather menacing, dark-suited figures who were glaring at me from inside the restaurant.

“They were getting ready to shoot you, John! They had their hands inside their coats ready to pull guns. They thought you were going to do something to the president!”

This was New York not too long after 9/11. The memory is fresh even today. Now, I think I would know better than to stand up with the president coming out the side door across the street. But back then I was still just a country boy come to the big city.

Tomorrow night I will have dinner with Barry and Art Cashin and a few other friends at some restaurant which is supposedly famous for a mob shooting back in the day. Art will have stories, I am sure.
It is time to go sing for my supper, and I will try not to keep the guests from enjoying what promises to be a fabulous meal from celebrity chef Cyrille Allannic. After Ian’s speech, I think I will be nothing but sweetness and light, just a harmless economic entertainer. After all, what could possibly go really wrong with the global economy, when you’re being wined and dined at the top of New York? Have a great week.

John Mauldin, Editor
Outside the Box
subscribers@mauldineconomics.com

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The Return of the Dollar

By Mohamed El-Erian
Project Syndicate, Nov. 13, 2014

The U.S. dollar is on the move. In the last four months alone, it has soared by more than 7% compared with a basket of more than a dozen global currencies, and by even more against the euro and the Japanese yen. This dollar rally, the result of genuine economic progress and divergent policy developments, could contribute to the “rebalancing” that has long eluded the world economy. But that outcome is far from guaranteed, especially given the related risks of financial instability.

Two major factors are currently working in the dollar’s favor, particularly compared to the euro and the yen. First, the United States is consistently outperforming Europe and Japan in terms of economic growth and dynamism – and will likely continue to do so – owing not only to its economic flexibility and entrepreneurial energy, but also to its more decisive policy action since the start of the global financial crisis.

Second, after a period of alignment, the monetary policies of these three large and systemically important economies are diverging, taking the world economy from a multi-speed trajectory to a multi-track one. Indeed, whereas the US Federal Reserve terminated its large-scale securities purchases, known as “quantitative easing” (QE), last month, the Bank of Japan and the European Central Bank recently announced the expansion of their monetary-stimulus programs. In fact, ECB President Mario Draghi signaled a willingness to expand his institution’s balance sheet by a massive €1 trillion ($1.25 trillion).

With higher US market interest rates attracting additional capital inflows and pushing the dollar even higher, the currency’s revaluation would appear to be just what the doctor ordered when it comes to catalyzing a long-awaited global rebalancing – one that promotes stronger growth and mitigates deflation risk in Europe and Japan. Specifically, an appreciating dollar improves the price competitiveness of European and Japanese companies in the US and other markets, while moderating some of the structural deflationary pressure in the lagging economies by causing import prices to rise.

Yet the benefits of the dollar’s rally are far from guaranteed, for both economic and financial reasons. While the US economy is more resilient and agile than its developed counterparts, it is not yet robust enough to be able to adjust smoothly to a significant shift in external demand to other countries. There is also the risk that, given the role of the ECB and the Bank of Japan in shaping their currencies’ performance, such a shift could be characterized as a “currency war” in the US Congress, prompting a retaliatory policy response.

Furthermore, sudden large currency moves tend to translate into financial-market instability. To be sure, this risk was more acute when a larger number of emerging-economy currencies were pegged to the U.S. dollar, which meant that a significant shift in the dollar’s value would weaken other countries’ balance of payments position and erode their international reserves, thereby undermining their creditworthiness. Today, many of these countries have adopted more flexible exchange-rate regimes, and quite a few retain adequate reserve holdings.

But a new issue risks bringing about a similarly problematic outcome: By repeatedly repressing financial-market volatility over the last few years, central-bank policies have inadvertently encouraged excessive risk-taking, which has pushed many financial-asset prices higher than economic fundamentals warrant. To the extent that continued currency-market volatility spills over into other markets – and it will – the imperative for stronger economic fundamentals to validate asset prices will intensify.

This is not to say that the currency re-alignment that is currently underway is necessarily a problematic development; on the contrary, it has the potential to boost the global economy by supporting the recovery of some of its most challenged components. But the only way to take advantage of the re-alignment’s benefits, without experiencing serious economic disruptions and financial-market volatility, is to introduce complementary growth-enhancing policy adjustments, such as accelerating structural reforms, balancing aggregate demand, and reducing or eliminating debt overhangs.

After all, global growth, at its current level, is inadequate for mere redistribution among countries to work. Overall global GDP needs to increase.

The US dollar’s resurgence, while promising, is only a first step. It is up to governments to ensure that the ongoing currency re-alignment supports a balanced, stable, and sustainable economic recovery. Otherwise, they may find themselves again in the unpleasant business of mitigating financial instability.

How to Distort Income Inequality

By Phil Gramm and Michael Solon
Wall Street Journal, Nov. 11, 2014

The Piketty-Saez data ignore changes in tax law and fail to count noncash compensation and Social Security benefits.

What the hockey-stick portrayal of global temperatures did in bringing a sense of crisis to the issue of global warming is now being replicated in the controversy over income inequality, thanks to a now-famous study by Thomas Piketty and Emmanuel Saez, professors of economics at the Paris School of Economics and the University of California, Berkeley, respectively. Whether the issue is climate change or income inequality, however, problems with the underlying data significantly distort the debate.

The chosen starting point for the most-quoted part of the Piketty-Saez study is 1979. In that year the inflation rate was 13.3%, interest rates were 15.5% and the poverty rate was rising, but economic misery was distributed more equally than in any year since. That misery led to the election of Ronald Reagan, whose economic policies helped usher in 25 years of lower interest rates, lower inflation and high economic growth. But Messrs. Piketty and Saez tell us it was also a period where the rich got richer, the poor got poorer and only a relatively small number of Americans benefited from the economic booms of the Reagan and Clinton years.

If that dark picture doesn’t sound like the country you lived in, that’s because it isn’t. The Piketty-Saez study looked only at pretax cash market income. It did not take into account taxes. It left out noncash compensation such as employer-provided health insurance and pension contributions. It left out Social Security payments, Medicare and Medicaid benefits, and more than 100 other means-tested government programs. Realized capital gains were included, but not the first $500,000 from the sale of one’s home, which is tax-exempt. IRAs and 401(k)s were counted only when the money is taken out in retirement. Finally, the Piketty-Saez data are based on individual tax returns, which ignore, for any given household, the presence of multiple earners.

And now, thanks to a new study in the Southern Economic Journal, we know what the picture looks like when the missing data are filled in. Economists Philip Armour and Richard V. Burkhauser of Cornell University and Jeff Larrimore of Congress’s Joint Committee on Taxation expanded the Piketty-Saez income measure using census data to account for all public and private in-kind benefits, taxes, Social Security payments and household size.

The result is dramatic. The bottom quintile of Americans experienced a 31% increase in income from 1979 to 2007 instead of a 33% decline that is found using a Piketty-Saez market-income measure alone. The income of the second quintile, often referred to as the working class, rose by 32%, not 0.7%. The income of the middle quintile, America’s middle class, increased by 37%, not 2.2%.

By omitting Social Security, Medicare and Medicaid, the Piketty-Saez study renders most older Americans poor when in reality most have above-average incomes. The exclusion of benefits like employer-provided health insurance, retirement benefits (except when actually paid out in retirement) and capital gains on homes misses much of the income and wealth of middle- and upper-middle income families.

Messrs. Piketty and Saez also did not take into consideration the effect that tax policies have on how people report their incomes. This leads to major distortions. The bipartisan tax reform of 1986 lowered the highest personal tax rate to 28% from 50%, but the top corporate-tax rate was reduced only to 34%. There was, therefore, an incentive to restructure businesses from C-Corps to subchapter S corporations, limited liability corporations, partnerships and proprietorships, where the same income would now be taxed only once at a lower, personal rate. As businesses restructured, what had been corporate income poured into personal income-tax receipts.

So Messrs. Piketty and Saez report a 44% increase in the income earned by the top 1% in 1987 and 1988—though this change reflected how income was taxed, not how income had grown. This change in the structure of American businesses alone accounts for roughly one-third of what they portray as the growth in the income share earned by the top 1% of earners over the entire 1979-2012 period.

An equally extraordinary distortion in the data used to measure inequality (the Gini Coefficient) has been discovered by Cornell’s Mr. Burkhauser. In 1992 the Census Bureau changed the Current Population Survey to collect more in-depth data on high-income individuals. This change in survey technique alone, causing a one-time upward shift in the measured income of high-income individuals, is the source of almost 30% of the total growth of inequality in the U.S. since 1979.

Simple statistical errors in the data account for roughly one third of what is now claimed to be a “frightening” increase in income inequality. But the weakness of the case for redistribution does not end there. America is the freest and most dynamic society in history, and freedom and equality of outcome have never coexisted anywhere at any time. Here the innovator, the first mover, the talented and the persistent win out—producing large income inequality. The prizes are unequal because in our system consumers reward people for the value they add. Some can and do add extraordinary value, others can’t or don’t.

How exactly are we poorer because Bill Gates, Warren Buffett and the Walton family are so rich? Mr. Gates became rich by mainstreaming computer power into our lives and in the process made us better off. Mr. Buffett’s genius improves the efficiency of capital allocation and the whole economy benefits. Wal-Mart stretches our buying power and raises the living standards of millions of Americans, especially low-income earners. Rich people don’t “take” a large share of national income, they “bring” it. The beauty of our system is that everybody benefits from the value they bring.

Yes, income is 24% less equally distributed here than in the average of the other 34 member countries of the OECD. But OECD figures show that U.S. per capita GDP is 42% higher, household wealth is 210% higher and median disposable income is 42% higher. How many Americans would give up 42% of their income to see the rich get less?

Vast new fortunes were earned in the 25-year boom that began under Reagan and continued under Clinton. But the income of middle-class Americans rose significantly. These incomes have fallen during the Obama presidency, and not because the rich have gotten richer. They’ve fallen because bad federal policies have yielded the weakest recovery in the postwar history of America.

Yet even as the recovery continues to disappoint, the president increasingly turns to the politics of envy by demanding that the rich pay their “fair share.” The politics of envy may work here as it has worked so often in Latin America and Europe, but the economics of envy is failing in America as it has failed everywhere else.

Mr. Gramm, a former Republican senator from Texas, is a visiting scholar at the American Enterprise Institute. Mr. Solon was a budget adviser to Senate Republican Leader Mitch McConnell and is a partner of US Policy Metrics.

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The article Outside the Box: The Return of the Dollar was originally published at mauldineconomics.com.


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Tuesday, October 21, 2014

The 10th Man....What a Correction Feels Like

By Jared Dillian


Back in the summer of 2007, when I was working for Lehman Brothers, I had a vacation to the Bahamas planned. This was unusual for me. Up until that point, in six years of working for Lehman, I had taken about five vacation days—total. But my wife and I were going to a semi primitive resort on Cat Island, the most desolate island in the Bahamas. Interesting place for a vacation. Suffice to say that it’s plenty hot in the Bahamas in August.

The market had been acting funny for a while, and I had a hunch that there was going to be trouble while I was gone, so I bought the 30 strike calls in the CBOE Market Volatility Index (VIX). I was betting that volatility was going to go up a lot in a short period of time. In fact, these options—which I spent a little over $100,000 on—would be worthless unless there was outright panic. I gave instructions to my colleagues to sell the call options if the VIX went over 35. (Note: my memory on the details of the trade, like the strike of the options and the level of the VIX, is a little hazy. The specifics might have been different, but you get the general idea.)

So there I was, sunning myself at this primitive resort on Cat Island and the world was melting down, and I was completely oblivious to what was going on back on Wall Street. Coincidentally, the local Bahamas newspaper had a picture of black swans on the cover one day. I staged a photo of me in a hammock reading the newspaper with the black swans on it. I still have that photo.

I got back to civilization and checked the markets. I saw the chart of the VIX. I could hardly contain myself. If my colleagues had executed the trades properly, I would have had a profit of over $800,000. But when I got back to work and opened my spreadsheet, I found that I’d made less than $100,000. What I had failed to consider was that if the world actually was blowing up, the guys would have been too busy to execute my trade.

So there is this whole idea of state dependence that we have to consider when we’re talking about the market. Like, you might have a plan to buy stocks when the index gets below a certain level, but when the market gets to that point, you: a) may not have the capital; and b) might be panicking into your shorts. It’s nice to have a plan, but, paraphrasing Mike Tyson, everyone has a plan until they get punched in the face.

I remember reading Russell Napier’s book about bear markets, called Anatomy of the Bear. It talked about all the big bear markets in the US, including the granddaddy of them all, the stock market crash of 1929 and the Great Depression. One of the things that I learned from this book was that if you can time the bottom exactly right, you can make a hell of a lot of money in very short order. For example, if you had bought the lows in 1932, you could have doubled your money in a matter of months.

I wanted to do that. I prayed for a bear market, so I would get my chance.

Little did I know that I would get my chance just two years later—and blow it.

When the market is down 60%, it’s scary as hell to buy stocks. Hindsight being 20/20, you can say, “What, did you think it was going to zero?” Actually, yes—in March of 2009, people thought it was going to zero.
But for those people who: a) had capital; and b) weren’t terrified, it was a once in a lifetime opportunity.

A Thousand Days with No Correction


So let’s talk about a). Does everybody have capital? Remember, the hard part of this is not picking bottoms. Many people can do this quite capably. Panic/liquidation is very easy to spot. But few people have the ability to take advantage of it, because they’re fully invested.

As for b), you tend not to be terrified if you have capital.

Everyone knows by now that the stock market is correcting. The price action is pretty terrible. Will it get worse? I think so. We’re seeing excesses (corporate credit, growth stocks, IPOs) that we haven’t seen in many, many years. It’s been over 1,000 days since we’ve had a correction of any magnitude. With the market down about 5%, nobody is particularly worried, because every other time the market was down 5%, it ended up going higher.

Back to state dependence. What is it going to feel like if the market goes down further? How will people behave if the S&P 500 gets to, say, 1,700?

I can tell you what it will be like if the S&P gets to 1,700. It’s going to be like it was in August of 2007 when my coworkers forgot to sell my VIX calls because they were buried under an avalanche of panicked sell orders from institutional money managers. Pre-algorithmic trading, the trading floor used to get pretty noisy. I used to be able to tell you what the market was doing just from listening to the floor. At SPX 1,700, trading floors will be very noisy.

It’s been so long since we’ve had a correction, I’m guessing that most people have forgotten what a correction feels like. When you go that long in between corrections, people are sitting on a mountain of capital gains. And unless the capital gains really start to disappear, there is little pressure to sell. But if you’re the owner of, say, airline stocks, and you’ve watched them evaporate to the tune of 30%, that tends to focus the mind a little bit.

As with any steep correction, there will be fantastic opportunities, but they will only be available to those who have capital. Remember, bear markets don’t just destroy the bulls’ capital, they destroy the bears’ capital, too.

Bear markets destroy everyone’s capital.
Jared Dillian
Jared Dillian

The article The 10th Man: What a Correction Feels Like was originally published at mauldin economics


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Wednesday, September 3, 2014

How You Can Play to Win When Market Makers Are Calling the Shots

By Dennis Miller

The American Legion sponsored a carnival every summer when I was a young lad. My dad was a legionnaire, so each year I had a job. Beginning at age 12, I hauled soft drinks and food to the various concession booths well into the night, which probably violated some labor laws.

Dad warned me about the carnival barkers, telling me to never play games where you try to win a giant teddy bear. They were rigged, he said, and no one ever wins—“So don’t waste your money.”

I questioned Dad’s advice when I saw other boys carrying giant teddy bears to the delight of cute teenage girls. So I quietly watched some of the games. Some people won silly goldfish, but few won the giant teddy bear.

Then I befriended some of the carnival workers and told them what my dad had said. To my surprise, they took his remarks personally. Each one stepped outside his booth to demonstrate just how easy it was to win by pinging ducks or knocking over little stuffed clowns with ease. The guy who shot the BBs told me to ignore the rear sights because they were off center. He also told me exactly where to hit the moving duck to make it go down. Ping, ping, ping! He knocked them down one after another.

He argued that the game was not rigged; if it were, eventually no one would play. But the odds were tilted toward those who practiced. I tried it, lost a dollar (one hour’s pay), and realized it was cheaper to buy the teddy bear than to spend the money to learn how to win consistently.

I think about those carnival games often, when friends and readers ask about market makers, brokers who help keep markets liquid and profit in the process. Do they just hold a unique position, or is something fishy going on?

24 Men Make History Under a Buttonwood Tree


Let’s take a step back to answer that question. The history of what would later become the New York Stock Exchange began in 1792, when 24 brokers and merchants signed the Buttonwood Agreement outside 68 Wall Street—under a buttonwood tree, of course.

The securities market grew, particularly in the aftermath of the War of 1812, and in 1817, a group of brokers established the New York Stock & Exchange Board (NYS&EB) at 40 Wall Street. At that time, stocks were traded in a “call market” during one morning and one afternoon trading session each day. A call market is exactly what it sounds like: a list of stocks was read aloud as brokers traded each in turn.

Whatever the benefits of this seemingly orderly system, it did not foster liquidity, and in 1871 the exchange, which had been rechristened as the New York Stock Exchange (NYSE) in 1863, began trading stocks continually throughout the day. Under the new system, brokers dealing in one stock stayed put at a set location on the trading floor. This was the birth of the specialist.

Designated Market Makers (DMMs), who are assigned to various securities listed on the exchange, have since replaced specialists. DMMs are one type of market marker, which are broker-dealers who streamline trading and make markets more liquid by posting bid and ask prices and maintaining inventories of specific shares.

Since the NYSE is an auction-based market, where traders meet in-person on the floor of the exchange, the DMMs, who represent firms, maintain a physical presence on the floor. Unlike the NYSE, the National Association of Securities Dealers Automated Quotations (NASDAQ) is an exclusively electronic exchange. Plus, it has approximately 300 competing market makers (not physically present at the exchange). Stocks listed on the Nasdaq have an average of 14 market makers per stock, and they are all required to post firm bid and ask prices.

Why Market Makers Matter to Retail Investors


You may be thinking, “That’s great, but why should any of this matter to me?” Well, because the existence of market makers should affect a few of your trading habits—for thinly traded stocks in particular.

Trades are not automatically executed via magical computer elves. When you place a buy or sell order (likely via the Internet), your broker can choose how to execute your trade.

When you place an order for a stock listed on the NYSE or some other exchange, your broker can pass that order on to that particular exchange, or it can send it to another exchange, such as a regional exchange. However, your broker also has the option of sending your order to a third market maker, a firm ready to buy and sell at a publicly quoted price. It’s worthwhile to note that some market makers actually pay brokers to route orders their way—say, a about penny or so per share.

On the other hand, your broker will likely send your order for a stock traded on the Nasdaq, an over-the-counter market, to one of the competing Nasdaq market makers.

And of course, your broker can always fill your order out of its own inventory in order to make money on the spread—the difference between the purchase and sale prices. Or it can send your order (limit orders in particular), to an electronic communications network (ENC), where buy and sell orders of the same price are automatically matched.

With that in mind, there are two steps you should take to make the most of your trades:

Always place orders at limit prices, as opposed to market prices.

As of Tuesday, the price for Coca-Cola is a bid of $41.23, and the ask price is $41.24; the spread is a penny.

If you put in an order to buy at $41.24, a market maker could buy at $41.23 and sell it to you for $41.24, pocketing a penny per share. If you buy 100 shares, they make $1.00. That is their profit for making the market.

If you put an order in at “market,” it can cost you a lot more. The depth of the current bids goes all the way down to buy at $34.01 (there are a couple of orders to buy KO for $22.12 and even one as low as $3.00, but the probability they will be filled is negligible), and the sell side goes up to $53.68 (again, there is one order to sell KO at $88 but this investor won’t find a counterparty in his right mind that would take it). That means there are currently orders sitting with the market maker to be executed at those respective prices.

If the market maker sees a market order, he would buy the stock at $41.23 and sell it at a much higher price. A market order is basically a license for the market maker to steal. You want the best price for any stock you’re trading; entering a market order will ensure you don’t get it.

The spreads for thinly traded stocks are generally larger. If you want to buy, you can offer a lower price than the bid, or perhaps a penny higher. If you want to trade several thousand shares, consider doing so in small tranches, so you don’t show your full hand to the market maker.

Know the role market makers play when executing stop losses.

For the Miller's Money Forever portfolio we generally set a trailing stop loss when we buy a stock. Entering a stop loss order with your broker will automatically generate a sell order should the stock drop to that number. A market maker can see that number and may drop down to buy your stock at the low price and then resell it for a profit.

As a practical matter, I set stop losses for big companies like Coca-Cola that trade millions of shares per day. The stop loss was there for a reason, and I don’t want to risk the price dropping further before I can sell it.

Some pundits think you should never enter a stop loss with your broker. They prefer another method: a stop loss alert, which many brokerage firms offer. They notify you through an email or text message if the stock drops to the stop loss price, and then you can go to your computer and enter the sell order. We always use the alert for thinly traded stocks, so we’re less vulnerable to an aggressive market maker.

If you are concerned about showing your hand to the market maker, by all means, use a stop loss alert. If you think the risk associated with stop losses is minimal for high-volume stocks, you may want to use both stop losses and stop loss alerts, depending on the stock.

Whether any of this means the market is “rigged,” I’ll leave to those $500-per-hour lawyers to hash out. This is the game we’re playing, so it’s critical to understand the rules, whether we like them or not.

Whether you’re a retail investor or just a guy shooting at moving ducks at a carnival, you need knowledge and skills to succeed. My free weekly missive, Miller’s Money Weekly, exists for that very reason. We provide retirement investors with the education and tools essential for a rich retirement. Receive your complimentary copy each Thursday by signing up here.



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Wednesday, April 30, 2014

Retirement Investing and Kitchen Table Economics

By Dennis Miller

What is it about retirement that causes confident, successful businessmen and women to lose that edge when they invest their own life savings? Many otherwise dynamic people become virtually impotent in the face of retirement investing. I have many friends who were very effective in business—folks who made sound decisions affecting how millions upon millions of dollars were spent. They would gather the facts, make a plan, and make the right call with confidence. Why was it so taxing for these same friends to manage their personal retirement accounts?


I’m a staunch advocate for gathering around the kitchen table to hash out problems and pass on life lessons. It’s where we gathered as a family to open our mail, pay the bills, and teach (and worry about) our children. I might even say that everything we needed to teach our family about economics, we taught at that kitchen table.

The secret is there is no secret. Investment gurus, stockbrokers, and talking heads like to use fancy words to dazzle. Many would have you believe their university or Wall Street pedigrees give them investing powers outside of your reach. Though many do have a little more knowledge or a little more experience, there is no need to be intimidated by the mystique.

Why? Because you already know most of what you need to know. The underlying principles for protecting and growing wealth during retirement are the same principles that allowed you to make and save that money in the first place.

When former Federal Reserve chairman Alan Greenspan would talk to Congress, many bright people would look at each other and think, “What the hell did he say?” If folks like Greenspan are so darn smart, why couldn’t they predict or prevent the Internet or real estate boom and bust? Why can’t they speak plainly? Don’t let anyone’s “elite” status overshadow your own common sense.

For the last few years, the Federal Reserve has been printing a 100 year supply of money annually. No one needs a PhD in economics to grasp the potential for high inflation. A little knowledge of history and a bit of common sense will tell you where we’re headed.

The key to using kitchen-table economics in retirement is to apply the same fact finding and research skills that made you successful in business. If you are uncomfortable making an investment decision, continue to educate yourself until you are. Of course, it’s sensible to take in input and ideas from experts. Just don’t get caught thinking they have any magic bullets.

If you ask four people to define “rich,” you would likely get four different answers. As we move into retirement, the definition tends to be more practical and realistic. “Rich” is enough money to live comfortably without countless hours of financial worry. It’s also a feeling of pride in the lifetime of work that built your nest egg and an appreciation for each and every trip you get around the sun.

How much do you have; how much do you need to earn to supplement your retirement income; and, how can you invest safely to reach that goal? Retirement investing is no more complicated than that. Simply put, it’s living within your means and protecting what you have.

If I could shout one piece of encouragement to retirees, it would be: Don’t let the fear of losing money immobilize you! Doing nothing can be just as dangerous as risking too much on a speculative or even downright foolish investment.

You may recall the old adage about the banker who never made a loan because he was afraid he might lose money. When the bank went out of business, he claimed it wasn’t his fault. After all, he never made a bad loan during his tenure.

To make your retirement money last, you have to take on some risk. There are, however, proven ways to limit that risk to manageable doses: sector, geographical, and political diversification, trailing stop losses—the list goes on. Good investors will lose money from time to time and learn from their mistakes. You just need to learn and make the right judgment call more often than not.

Don’t fret when others brag about how well they’re doing. Each year financial newsletters, mutual funds, and investment managers like to boast about how much money they’ve made their clients. Accountability is a good thing; we’re certainly proud of our own track record.

Though, when I see the list of top-performing funds ranked by the amount of annual return, my first questions are: How much did they risk to get there? Have they performed that well consistently? How much of those profits were eaten in fees?

Some mutual funds occasionally produce nice gains for their shareholders. I, however, would put my money on the well educated grandfather investing from his kitchen table in Iowa any day of the week. Why? A recent report indicated that 78% of all US domestic equity funds were outperformed by their benchmarks during the past three years. Large caps were worse, with 86% of falling short of their benchmarks.
Benchmarks are the indices in the sectors funds specialize in, respectively. In short, there are countless statistics indicating that you can invest just as well as a fund manager.

Those numbers should embolden you, not frighten you. I shared them to keep things in perspective. There is no magic wizardry, secret code, or special knowledge. All investors gather facts, make an evaluation, and then allocate some money based on what they think the future will bring. Those are skills that can be honed through education and experience by smart folks sitting at their kitchen tables or in their home offices.

I’m happy to report that the most frequent comment we receive is that our newsletter explains investments in plain English. There’s a reason for that: the investments well suited for a conservative investor’s retirement portfolio are not that complicated.

You can overcome retirement impotence. The best way to build your confidence is to learn ways to invest safely. We think teaching our premium subscribers about protective mechanisms like asset allocation, diversification, position limits, trailing stop losses, and internationalization is just as important as the individual picks in the Money Forever portfolio. If you’d like to learn more too, sign up for a no-risk trial subscription today by clicking here.

The article Kitchen Table Economics was originally published at Millers Money



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