Dec 2, 2013

Why Obamacare is Worse Than the Cable Company

I went onto this morning and clicked on live chat.  The text below is the exchange I had with the customer service rep. 

You can't make this stuff up.


08:10:17 am]: Thanks for contacting Health Insurance Marketplace Live Chat. Please wait while we connect you to someone who can help.
[08:10:20 am]: Please be patient while we're helping other people.
[08:10:30 am]: Welcome! You're now connected to Health Insurance Marketplace Live Chat.

Thanks for contacting us. My name is Jason. To protect your privacy, please don't provide any personal information, like Social Security Number, or any other sensitive medical or personal information.
[08:11:28 am]: Jason
Are you looking for information about health insurance in the state you live in, or a different state?
[08:11:50 am]: CALLER
I am shocked at the proposed rate increases for my small (28 employee) business for a plan. Are most businesses looking at 50% increases in premiums?
[08:12:38 am]: Jason
are you looking for information for the state that you live in?
[08:13:38 am]: CALLER
Yes-I received quotes from our agent, then looked at the plans on this site. Are other businesses seeing similar rate hikes or am I the schmuck in this deal?
[08:14:09 am]: Jason
what state is that?
[08:14:14 am]: CALLER
[08:14:34 am]: CALLER
we also have a business in CA
[08:14:47 am]: CALLER
but we are discussing the MI business right now
[08:15:18 am]: Jason
I can answer your questions about the Marketplace and how you can enroll. You can also use to find this information and what programs you may qualify for, as well as find and apply for coverage, compare plans, and enroll in a health insurance plan. You can apply now through the end of open enrollment. Open enrollment for health coverage in 2014 closes on March 31, 2014.
[08:15:27 am]: Jason
Thank you for your question today. It will take me just a moment to review and respond to your question.
[08:15:41 am]: CALLER
what? is that a canned response?
[08:16:43 am]: CALLER
Jason, seriously, this is a simple question. Are most small businesses experiencing a similar increase to what I am being quoted-50%+?
[08:17:04 am]: Jason
Thank you for your question today. It will take me just a moment to review and respond to your question.
[08:17:21 am]: CALLER
Jason-stop sending me auto-responses
[08:17:46 am]: Jason
The health care law allows eligible small businesses to offer health insurance to full-time employees through the Small Business Health Options Program Marketplace, also known as the SHOP Marketplace. Small businesses include for-profit, nonprofit, and religious organizations.

You can choose from a number of plans from multiple health insurance companies in SHOP. You can cover yourself in the SHOP plan you offer your employees. When you fill out your application, you'll learn if you can offer multiple plans in your state in 2014. Starting in 2015, employers will be able to offer multiple plans from all state SHOPs.
[08:18:07 am]: Jason
In 2014, if you have 50 or fewer full-time equivalent employees, you may offer a plan via SHOP. In 2016, all SHOP Marketplaces will be open to employers with up to 100 full-time equivalent employees. Your small business size is based on your number of full-time equivalent employees. A full-time employee generally works at least 30 hours per week on average, and a part-time employee works a fraction of this amount. While part-time employees are considered when determining your eligibility for SHOP, it's still up to you to decide if you want to offer coverage to part-time employees. In 2014 and 2015, insurance companies in states that run their own Marketplace can continue to use the state's method of counting full-time employees to determine who's eligible for SHOP. If you have business locations in more than one state, you have the option to apply in the state of your primary work location and elect to offer multi-state coverage, or you may apply for a SHOP in each state where you have an office location.
[08:18:30 am]: Jason
To be eligible, you must meet your state's small business definition for the SHOP Marketplace and offer health coverage to all of your full-time employees. In many states, at least 70% of your employees offered coverage must enroll in order for your small business to qualify for SHOP. Employees with coverage through another employer plan, Medicare, Medicaid, the military, or veterans' programs are not included in the calculation.
[08:18:48 am]: Jason
Starting in the 2013 open enrollment period, if enough of your employees don't enroll through SHOP, you'll have a special enrollment period from November 15, 2013, through December 15, 2013, where a group will not have to meet SHOP's applicable minimum participation rate.
[08:18:57 am]: CALLER
stop cutting and pasting information that I am already aware of and please just answer my question.
[08:20:30 am]: CALLER
are you still there or have you given up helping me?
[08:20:46 am]: Jason
Thank you for your patience. I am still researching that information.
[08:21:52 am]: CALLER
Please make sure your research is relevant to my question and I would appreciate if you didn't cut and paste a bunch of information that is not only irrelevant, but that is already well known. It's a bit insulting.
[08:25:31 am]: Jason
For many small businesses, the Small Business Health Options Program, also known as SHOP, will reduce the burden and costs of enrolling employees by offering the cost savings and flexibility enjoyed by large businesses today.

In the SHOP Marketplace, you can: Access a single place to learn about health insurance and get accurate information on different plans. Make apples-to-apples comparisons of the prices, coverage, quality, and benefits of Marketplace plans for your employees. Pay the same premium with or without the help of agents or brokers, or look for plans without agents or brokers. Agents and brokers are usually paid by the insurance companies whose policies they sell. Find out if your current health insurance company will offer a Marketplace plan through SHOP. If not, check with your agent or broker, or go to SHOP and see how your health insurance company's plans compare to those available through SHOP. You can choose a plan that works for your budget, your business, and your employees. Simplify your billing process.
[08:27:09 am]: CALLER
Jason-are you serious? I have asked you a very simple question which you seem unable or unwilling to answer. I asked you to please stop cutting and pasting verbiage that wasn't relevant to my question and just answer it. Will you be answering my question at any point during this chat session or should I assume you are unable to do so?
[08:29:57 am]: Jason
I do apologize. when you fill out an application you will see everything that you are eligible for each person may be eligible for different things based off the information that they provide.
[08:31:17 am]: Jason
All plans in the Small Business Health Options Program Marketplace, or SHOP, offer similar benefits but differ based on how enrollees and the plan share the costs of care
[08:31:31 am]: CALLER
Yes, I realize that. My question has been, and remains to be are other businesses seeing similar 50% + increases in premiums this year as a result of this new law? If so, my result will be to fire one of my employees or stop offering health benefits-I may let them choose. Your answer could be helpful in keeping benefits or a job for one of my employees.
[08:33:17 am]: Jason
English- and Spanish-speaking customer service representatives at 1-800-318-2596 can answer your Marketplace questions. We work for General Dynamics Information Technology, a company contracted by the Centers for Medicare & Medicaid Services, also known as CMS, the federal agency that oversees the Health Insurance Marketplace. We are here to help you. We want to provide you with the best possible service. We can give you information about Marketplace coverage, health coverage options, and your rights and protections under the health care law.

For example, we can:
•Answer general Marketplace questions
•Answer questions about health insurance basics
•Help you determine if you qualify for lower costs on coverage
•Answer questions about the Small Business Health Options Program Marketplace, or SHOP
•Give you information about how to enroll in the Marketplace
Even though we can provide you with information about the Marketplace, we cannot give our opinions or advice about your health care options. We can provide you with the facts and help you understand your choices. If you need additional support, you can reach out to the consumer assistance programs within your state.
[08:33:58 am]: CALLER
[08:34:08 am]: Jason
Do you have any other questions that I can help you with?
[08:35:57 am]: Jason
Thank you for contacting Health Insurance Marketplace Live Chat. We are here to help you 24 hours a day, 7 days a week.
[08:37:42 am]: Your chat session is over. Thanks for contacting us, and we hope we've answered your questions. Have a great day.
[08:37:42 am]: 12/2/2013

Oct 29, 2013

Obama-How Does the Smartest Man in the Room Know Nothing?

October 29, 2013

I haven't been writing much lately, however, the most recent commentary coming from the White House has pulled me from the sidelines with some comments.  If your bias is towards favoring this President, or you only come to my blog for investment information, stop reading right now and have a great day.  Otherwise, read on with the same amount of disgust that I have about the leadership sitting in the Oval Office. 

The background is the President is a self-righteous, arrogant socialist whose disdain and contempt for this country and its ideals of freedom are well-known and documented.  His condescending approach to everyone around him, including other world leaders, our elected officials, and certainly corporate leaders, is well known and completely disrespectful.  If my children acted in that manner towards others (my children are teenagers, and we know how disrespectful they can be at times), they wouldn't see the light of day for months, if not a year.  Yet here is the President of the United States, acting as if the rest of the world were his subjects, lecturing us on how we should feel guilty if we make a decent living.  Lecturing us on how we need to give more back.  Lecturing us on how successful businesses are only successful because of the government.  Lecturing foreign leaders on how to run their countries.  Lecturing China on how to run their economy (just a reminder that we owe China over $1 trillion). 

President Obama came into office promising to repair our supposedly damaged image among the nations of the world.  He promised to negotiate with Iran, North Korea, and Russia, all while refusing to negotiate with the duly elected House of Representatives.  He vowed not to go to war without UN approval.  He vowed to close Guantanamo Bay.  He vowed to end terrorism by eliminating the reasons terrorists hate us-imperialism, materialism, and evidently capitalism.  He promised world harmony through that dis-functioning body known as the United Nations. 

President Obama, the legal scholar and supposedly the smartest man in the room, promised to be superior to George Bush because of his hands on approach, his involvement in every detail, and his ability to bridge the gap between Republicans and Democrats to craft bi-partisan solutions to problems. 

President Obama, the man who promised that "spreading the wealth around" would solve this country's growing wealth gap, the disparity between the 1% and the 99%. 

How has the Lecturer in Chief done since taking office?  The results have been far from promised, and in fact almost 100% opposite of what he promised. 

The promise of world harmony and an improved image of the US around the world has been completely dismantled.  Even before the news came out that we have been wiretapping our allies, our diplomacy has been an utter disaster.  Iran and North Korea continue to snub their noses at the world community and develop nuclear weapons, despite our coddling of them.  The President has ensured that no country will respect us, our promises, or our threats after drawing the infamous "Red Line" and then, despite video evidence to the contrary, denying that he said it or that the Red Line was his. 

The fact that we have been wiretapping US civilians and our allied leaders doesn't bother me as much as others.  Yes, there are civil liberty issues, and retaining this information on US citizens reminds me of 1984, or even the Matrix, but I understand the purpose from a security standpoint.  We can debate whether losing this measure of privacy in the name of freedom isn't an oxymoron, but with proper data destruction policies I can live with this intrusion.  I can also live with wiretapping our allies, as well as our enemies, but again we must have a legitimate purpose for doing so and a viable defense in the unlikely event that this transgression is discovered.  Denying knowledge ala Richard Nixon is not a viable defense.

My issue is the blanket denials.  The President pretending he didn't know about the incident, that it was some low-level, unnamed underlings participating in the subterfuge.  President Obama is obviously unable to accept responsibility for failure-which I attribute to years of being told how great he is without ever being challenged.  Defeat and failure are good for adolescents and young adults, it prepares them to handle situations that don't work as planned, such as these wiretappings, being fired, or bad marriages.  My guess is that the President was part of what I call the "participation generation", the group of kids who received trophies for 10th place, being congratulated and fawned over for losing.  News flash: trophies are for winners!  Bringing it back to the President, whatever happened to "the buck stops here?"  We need a Truman type Democrat. 

Blame Game
As mentioned above, the President is really good at shifting the blame, denying responsibility for the actions of his Administration, which is the ultimate example of hypocrisy.  How can a man who demands that both world and corporate leaders (just ask Jamie Dimon) take 100% responsibility for the actions of their countries or companies not take any responsibility for his own Administration's actions?  Is he truly that narcissistic? 

IRS targeting of political enemies?  Deny knowing anything about it and blame a rogue IRS office.

Failure of the Obamacare website?  Deny knowing anything about it and blame the contractor.

800,000 people (and counting) losing their insurance in spite of promises that "if you like your plan, you can keep it?"  Deny making the statement (60+ times in front of cameras) and blame the insurance companies.

Have an embassy attacked on 9/11?  Deny it happened and blame a YouTube video. 

Wiretap allied leaders?  Deny knowing anything about it and blame the NSA.

Wiretap US citizens?  Deny knowing anything about it and blame a prior administration.

Consider drone attacks on US citizens without a proper trial first?  Deny it happened and blame the an unnamed leaker.

Inability to lead or unite the country?  Blame it on Congress.

Create policies that exacerbate the wealth gap?  Deny the policies are contributing to the problem and blame the greedy.

Oversee a program that puts guns in the hands of Mexican drug dealers?  Deny knowing anything about it and then blame an underling.

Much like an overindulged three year old, this President won't take responsibility for anything that occurs under his watch.  Worse, he denies knowing anything about what is happening in his Administration, and then pushes the blame as far down as possible.  As it becomes apparent that the problem is much higher up, the Administration constructs a series of roadblocks designed to hide the true source of the problem.  If a corporate leader were to deny knowing about this many issues occurring under his watch, he'd be fired for incompetent leadership. 

We have been lucky so far.  This vacuum of leadership and irresponsibility in the White House will eventually lead to negative repercussions far into the future.  In my opinion, when historians look back at the seminal Administrations in US history, this one will be cited as an inflection point for when this country took a turn towards mediocrity.  We can make a turn back towards leadership and excellence, however, the next election will be critical. 

Thanks for listening to my rant.  I feel better, yet worse at the same time.  I hope to write a bit more in the future, at least quarterly, and promise it will be focused on markets and the economy. 

From my family to yours, have a wonderful holiday. 

Oct 22, 2013

3rd Quarter 2013

The third quarter of 2013 was marked by lackluster earnings, concerns about the Fed

from both a succession planning and near term policy standpoint, continued middling

employment growth, geopolitical uncertainty, a rip-roaring auto market, and another

debt ceiling fight in Washington. We also received a creative English lesson as to the true

meaning of the phrase “Red Line,” which might be this generation’s version of “It depends

on what the meaning of the word ‘is’ is.” In spite of the many concerns, the S&P 500 still

managed to rise 5.2% in the quarter for a 19.8% increase for the year, while the Barclay’s

Aggregate was up 0.6% in the quarter but has declined by 3.5% (2% net of dividends) for

the year.

Domestic View and Equity Markets

Earnings growth continued to slow in the quarter for much of the S&P 500, yet investors

didn’t seem to care as they piled money into equity funds at the expense of fixed income.

Sales growth was even weaker than earnings growth, posting an increase of 1.2% in the 2nd

quarter. Valuations need to be watched in this environment. When stock prices rise faster

than earnings, stock valuations are expanding. While valuations aren’t in the “red zone,”

they are getting extended at roughly 16x earnings.

Soft wage growth, high unemployment, high fuel costs, and a favorable currency situation

have made it more attractive for companies to migrate their manufacturing back to the US.

Major manufacturers that are on-shoring operations have reached 21%, compared with

10% last year, according to a study by The Boston Consulting Group. More than half of

manufacturers with sales exceeding $1 billion intend to shift work, or will evaluate shifting

work, from China to the U.S.

Market prognosticators continually attempt to find historical patterns in the markets to

predict what might happen in the future. Many are now focusing on 1954, which was the

first year in which stock prices exceeded their 1929 highs after the Great Depression, as a

comparison to 2013. In the chart below you can see the high correlation (.95) between the

two years. The biggest difference is the magnitude of increase, with stocks rising 30% in the

first three quarters of 1954 versus 19% so far this year.


S&P 500 1954 versus 2013

Just in Case You Were Wondering

The world’s most famous index, the Dow Jones Industrial Average, changed constituents this quarter. The index dropped Hewlett Packard, Alcoa, and Bank of America, replacing them with Goldman Sachs, Nike, and Visa. A question we often receive is why we don’t use the Dow as a benchmark. We can’t think of a single firm that uses the Dow as a benchmark because one of the requirements of a benchmark is having the ability to replicate the benchmark by investing in its holdings. Although the 30 stocks in the Dow are highly liquid and part of many other indices, the Dow is price-weighted, which mean it is virtually impossible to replicate in a portfolio. A price-weighted index is one
in which the higher the price of a stock, the bigger impact it has on the index. In an actual portfolio, it’s the number of shares combined with the stock price and dividends which determine the value. A capitalization-weighted index, such as the S&P 500, more readily lends itself to replication.

The Fed

Will the Fed ever be out of the news? The two biggest items of note swirling around the Fed this quarter have been tapering and succession. Heading into the Fed’s September meeting, the majority of market participants anticipated that the Fed would begin tapering or slowing its monthly purchase of bonds from $85 billion per month to a modestly lower value. Many Fed members, including Chairman Bernanke, had suggested that a tapering would be a probability, and in fact the Fed had
signaled through its various market communication tools that a tapering would occur. Investors were surprised and markets soared when the Fed decided to keep its existing program in place, citing a recent softening of economic data.

In our view it would appear that the Fed’s historic accommodations have been met by a fiscal tightening coming from Washington and the economy itself. Real wages haven’t increased at all over the past five years; federal spending has declined slightly due to the sequester and the pull back from Iraq; significant tax increases kicked in this year; interest rates have risen; and the cost of living continues to increase. All of these factors have created a de-facto tightening of fiscal policy, occurring while the Fed attempts to provide a looser monetary policy. While not new, the tightening and the accommodation are conspiring to offset each other.

Fed succession has been a hot topic of conversation ever since President Obama announced that Chairman Bernanke would not be coming back for another term. Speculation has been focused on two candidates: Former Secretary of the Treasury, Lawrence Summers, and current Vice Chairwoman of the Federal Reserve, Janet Yellen. Mr. Summers was viewed as being more hawkish towards inflation, while Ms. Yellen was considered to be more dovish towards inflation. In the old days, before 2008, a more hawkish chairperson would have received better acceptance from the bond market as the expectation would be a more vigilant fight against inflation. In today’s world, where the markets are addicted to the stimulus provided by the Fed, the threat of a hawk heavily concerns the bond market. When Mr. Summers recently withdrew his name from consideration, the bond (and stock) markets viewed the news positively as the assumption was that the Fed’s monetary accommodation would remain in place. In the long run ignoring (and trying to ignite) inflation could be a risky strategy, but for now it seems to be welcome medicine to the market.

The Economy

US economic data continues to be mixed, but with a slightly positive bias. GDP for the 2nd quarter came in at 2.5% and is estimated to increase by less than 2% in the 3rd quarter. Pending home sales have softened significantly from the spring as mortgage rates (see chart below) have climbed from a low of 3.3% in late 2012 to 4.3% today.


A statistical oddity makes it challenging for the Federal Reserve to decide whether to start scaling back its bond-buying program based on unemployment data. US joblessness dropped to 7.3% in August because people gave up their search for work. The proportion of working-age people holding a job or looking for one has fallen to its lowest level in 35 years. The Fed could be in a position where the unemployment rate is low, but the number of working adults hasn’t progressed.

Global Perspectives

Europe finally appears to be gaining some traction, a nice switch from the past half-decade or so. The Eurozone PMI rose to 51.5 in August, the fastest rate of expansion since 2011. The services index also posted a positive number at 50.7, its first increase in 18 months. Germany, Italy, and Spain are actually growing, while the declines in France are moderating.

In Asia, Japan continues its impressive recovery as loosening monetary policy combined with massive rebuilding after the 2011 earthquake and tsunami have helped fuel the Japanese economy. GDP growth for the 2nd quarter was 3.8% while capital spending rose for the first time in six quarters. The biggest question is whether a pick-up in demand will force Japan to reduce its $800 billion in holdings of US debt. If so, it could put additional pressure on our Fed to defend rates.

China, which has been struggling for the past two years, is finally showing signs of a rebound, which is positive for the

other emerging markets as well as the Eurozone. The Chinese PMI is now back above 50. Overall it appears that most of the world’s major economies are experiencing a modest recovery.

A Civil War in Syria nearly pushed the world to the brink and has tested the resolve of our leadership. After issuing a red line warning, the Administration punted to the UN when a defiant Syria chose to cross that line. In a Clinton-like “define is” response, President Obama said: “I didn’t set a Red Line on Syria, the world did.” George Orwell would have loved this doublespeak.

Bonds and Debt

Bond yields began jumping in late spring based on the anticipated tapering by the Fed. The yield on the 10-year treasury peaked at just over 3% in early September after hitting a multi-generational low of 1.3% in July of 2012. While investors will eventually appreciate the accompanying higher yields on new fixed income investments that should generate better income, the result has been a difficult 14 months for bonds. Since peaking when bond yields troughed, the Barclay’s Aggregate bond index has declined by nearly 5%, which is the first decline since 1994.

Washington Policy

Politicians have been bickering over the budget deficit, Obamacare, and whether to continue to fund the government or not. Sounds a lot like the summer of 2011, but in fact it is occurring as we go to press. The House has passed one budget resolution, the Senate another, and they can’t seem to agree, or possibly don’t want to agree. The last time we had a debt crisis the markets got whipsawed. Our guess is that unless the government goes into an extended shutdown, markets will have a slightly negative bias around the news. Given this is the 17th showdown on funding the government in the past 30 years, and all 17 have resulted in a funding bill passing, we are confident that this too shall
pass and an agreement will eventually be reached.

Are we the only ones who find it unusual that the President is willing to negotiate with both Russia and Iran, but not the United States Congress?

Obamacare Update

The much ballyhooed (or maligned) rollout of Obamacare has been abysmal so far.  After spending somewhere in the neighborhood of $6 billion to launch the website (about 3000x more than EBAY spent on their initial launch), it has been a failure.  The website doesn't work, and the people responsible, well, won't take responsibility.  We are trusting social security numbers and other personal data with a website that doesn't work.  Anyone want to guess where the next big cyber-security threat will occur?
Does anyone else get concerned when the people who are proposing to takeover 1/6 of the US economy can't launch a working website after working on it for three years? 
The American people have digressed into a populist mentality, and Obamacare is the most recent of what should prove to be the takeover of many industries in an effort to "level the playing field."  Unfortunately, the Administration doesn't recognize that its tax and spend policies, combined with aggressive Fed intervention, are responsible for increasing the divergence in wealth between the 1% and the 99%. 
“Freedom is never more than one generation away from extinction. We didn’t pass it to our children in the bloodstream.  It must be fought for, protected, and handed on for them to do the same, or one day we will spend our sunset years telling our children and our children’s children what it was once like in the United States where men were free.”

- Ronald Reagan.


Jan 6, 2013


Year End 2012

Wow!  What a year!  At the beginning of 2012 we doubt that many people would have expected the S&P 500 to increase by over 13%, the yield on 10 year treasuries drop to 1.7%, and emerging market stocks to increase by 17%.  In spite of a middling economy, divisive election, Fiscal Cliff, recession in Europe, and chaos in DC, the markets performed spectacularly, climbing the proverbial Wall of Worry (OK-it’s not quite a proverb) to post outsized gains for the year.  

Domestic View
The business news flow from 2012 seemed to be dominated by three items:  the Presidential Election, the Fiscal Cliff, and of course the economy.  After a marked shift to the right in the 2010 mid-term elections, the country took a move back to the left in the 2012 general elections.  Does this most recent shift represent a mandate for the left or continued overall dissatisfaction with the political process?  Time will tell, but my view is that until the economy completely recovers, we should expect to continue to experience these shifts by the electorate as the ideologues lose out to those who just desire results from our leadership. 

This note began discussing the Fiscal Cliff in early 2010 after the two year extension of the Bush tax cuts, although it wasn't called the Fiscal Cliff then.  The mainstream media has recently picked up the theme and pounded it into the ground.  In case you need a reminder, the Fiscal Cliff is a series of expiring tax cuts and deductions coupled with modest spending cuts.  At the time of this writing, the situation has been partially addressed with the permanent extension of most of the Bush tax cuts, but another increase in spending of nearly 1/3 of a trillion dollars ($330 billion). It is certainly reasonable to assume that one or both parties might have preferred to allow the country to go off the cliff, although we feel it would be better characterized as a “slope” given the impact would have come over the course of 2013 as opposed to all at once.  The problem is basic:  we have $16 trillion in debt (projected to be $23.9 trillion by 2022) which is increasing by over $1 trillion per year and our politicians have no viable plan, cliff or no cliff, to address the mounting debt load faced by our country.  The American people must be willing to accept more pain if we are truly planning to address the problem, however, the bickering over the spending cuts included in the fiscal cliff discussions, which were just $65 billion per year, demonstrate the struggle we face going forward.  

The chart below shows the rapid rise in government expenditures combined with the slowdown in tax receipts as a result of the economic slowdown. 

The economy continues to muddle along, however, housing seems to be finally showing some life.  The impact of 3.3% mortgage rates is finally pulling buyers off the sidelines.  In this environment of low rates with a Fed that favors borrowers at the expense of savers, it is better to borrow long and lend short.  Taking advantage of these extremely low rates makes sense, and the housing market is benefiting as a result.  Home prices have stabilized and are moving up slightly, but have yet to recover to the levels of 2007.  As shown in the chart below, the Spring selling season is the key time for the housing market and should give us a glimpse into the sustainability of the housing recovery.

The Fed
The Fed announced that Quantitative Easing (QE) would now be virtually a permanent tool used to keep rates low.  We already had Operation Twist, which had been extended to year end at $45 billion per month, and in December the Fed added QE3, or as we like to say “QE To Infinity”, saying they would be buying $40 billion per month in securities until unemployment levels reached 6.5% from the present 7.7%.  At the present rate of job creation (remember, there are fewer people working full time today than in 2007), this should take 3-4 years.  As I’ve long maintained,  Federal Reserve Chairman Bernanke hasn’t seen a crisis that can’t be solved with low rates, and this one is no different.  Expect the Fed to keep their foot on the accelerator for a long time. 
The Fed’s balance sheet will soon cross $3 trillion, and, although not inflationary today, it certainly has the ability to fuel inflation when the economy finally turns and money velocity accelerates.  The chart below shows the decline in M2 velocity, which is keeping the economy soft but also allows the Fed to print money without stoking runaway inflation, for now.

Equity Markets
One of the primary reasons the markets have been soaring in the face of a feeble economic recovery has been the Fed.  An accommodative Fed has been the prime mover of markets.  Easy capital which isn’t in demand by the economy eventually finds its way into the markets.  Chairman Bernanke once wrote, and has mentioned in speeches, that the goal of Fed easing is to drive the equity markets up to create a “wealth effect” which will help consumers feel more confident in their spending.  The plan has partially worked as evidenced by the market’s strong results since the S&P 500 bottomed in March 2009; however, the “trickle down” hasn’t worked yet as consumer spending remains soft.  It’s interesting that this type of “trickle-down” economics has been discredited by the Obama administration, yet is the cornerstone of the recovery plan given their lack of fiscal policy over the past few years.  Further, it is precisely this trickle down theory favored by the Fed that has kept the budget deficit lower by over $300 billion per year due to lower government borrowing costs-again favoring debtors over savers.  

As mentioned earlier, equity markets performed masterfully in 2012, yet still remain fairly valued.  The chart below shows the PE of the market, by decade, over the past 50 years.  As you can see, the market isn’t expensive based upon historical averages, especially given today’s ultra-low rates. 

Interestingly, investors seem to have eliminated bearishness from their present market view.  The Investor’s Intelligence bearish sentiment indicator is at its lowest point in 50 years.  My guess is the lack of bearishness is presumably due to the Fed backstopping assets with its balance sheet.  

Throughout 2012 sales growth slowed, and during the third quarter reporting season 61% of companies missed their sales estimates (chart below), the highest level since the peak of the crisis in 2008.  This rapid deterioration in sales has coincided with cautious consumer sentiment and business sentiment readings, and may contribute to economic weakness in the 1st half of 2013. 

Global Perspectives
Europe continues to limp along, and has officially entered a recession since our last note.  The weakness there has resulted in relatively modest priced equity securities and, quite possibly, some investing opportunities overseas.  

One bright spot in the global economy is China, which appears to be emerging from a long malaise.  The Shanghai Composite has begun rebounding after retracing all of the gains from the market bottom in early 2009.  The data points seem to be positive, although the country’s real estate market is still a concern.  

Japan, whose economic doldrums could be a precursor to the US, finally set an official inflation and exchange rate target, and will begin the task of devaluing its currency in an effort to stimulate the economy.  In the past the country’s central bank has made overtures towards devaluation, but never had the gumption to follow through.  The consensus seems to be that with a fixed inflation target of 2%, the central bank will print aggressively to get to that level without the fits and starts of the past 20 years.   sets inflation target of 2% and Yen exchange rate target of 90 yen/dollar(incomplete sentences …).  First time we might see movement.  Will they have gumption to stay the course?  

Emerging markets performed well in 2012, rising 17% for the year.  The big question is whether these less developed economies have decoupled from the US, China and Europe, and will they be able to grow in spite of anemic growth in the more developed economies?  

Debt and Bonds
Bond yields continue to fall as the Fed maintains its aggressive buying programs, which presently account for up to 90% of the debt issuance by the Treasury.  This type of purchasing has never been done in the past, and it will be interesting to see if the Fed can exit this strategy without causing major inflationary pressure or destruction to the dollar.  In spite of ultra-low rates and a 30year old bull market in bonds, investors continue to flock to bonds at the expense of equities.  The chart below, similar to the equity chart we discussed earlier, suggests that treasury bonds are close to three times more expensive than at any time over the past 50 years.  Buy high, sell higher? 

High yield bonds had another strong performance in 2012, and could be an area at risk should the economy slip into a recession in the first half of 2013.  Longer term high yield bonds should continue to perform well if the economy strengthens in the back half of the year and investors continue to migrate to this asset class to find the yields that are lacking in today’s treasury market.  

Municipal bonds are a staple of many investor’s portfolios due to the tax free nature of their returns, the relative safety of the investments, and the better yield that treasuries.  That foundation was tipped on its ear during 2012 as a number of municipalities across the country filed bankruptcy.  The perceived stability of cities, counties, and even states has come into question, and investors should be somewhat cautious about municipal bonds with at-risk revenue sources.  Additionally, one item that has been discussed during the DC negotiations has been limitations on deductions for individuals, including interest payments from municipal bonds, which would be a disaster for both the investing public as well as the borrowers, whose borrowing costs would rise as investors require better after tax returns.  

More specifically, in California the budget and business environment is more than a mess.  The ballot initiatives that were passed raise the marginal state tax rate on the highest earners to 12.3%, and Governor Moon Beam is about to release another Fantasyland budget.  My guess is that instead of proposing controlled spending or even (gasp) cuts, the new budget will incorporate the new tax revenues into even more spending.  The Governor will be surprised when higher earners either choose to stop earning into the penalty areas of income, where marginal rates will exceed 60%, or leave the state as many employers already have.  This could put California on a crash course with a default in the next few years. 

The college football season ends tomorrow with Alabama and Notre Dame battling for #1.  I'm already feeling a bit depressed, although my youngest son has recorded enough great games on the DVR to keep me busy until next season.  I was looking at the Orange County Register's list of the top recruits in the county, and was disturbed to see that NONE of them had committed to USC.  Orange County has been a hot bed for the Trojans for decades, and the place where they have obtained many of their great quarterbacks over the years (Marinovich, Palmer, Leinart, Sanchez, Barkley, and now, possibly Wittek).  When you can't recruit in your own backyard, you better be wary about the future.  Anyone in favor of Chip Kelly blowing off the Browns and Eagles for the Trojans?

I'd like to thank Jason Trennart of Strategas Research for allowing me to utilize his work for most of the charts in this note.  I'd also like to thank Falcon Point Capital for their sponsorship of my site during 2012. 

Happy New Year to you and your family, I look forward to seeing you in 2013.   

Quote of the Year
Eric Cornell, who won the Nobel Prize in Physics in 2001, told Reuters: “I attribute essentially all my success to the very large amount of chocolate that I consume. Personally I feel that milk chocolate makes you stupid… dark chocolate is the way to go. It’s one thing if you want a medicine or chemistry Nobel Prize but if you want a physics Nobel Prize it pretty much has got to be dark chocolate.”