DECEMBER 2013 INVESTMENT JOURNAL: SMOKING STOCKS
- Detroit is allowed to file for Chapter 9 bankruptcy (Dec. 3)
- US says it will end "too big to fail" banking risk (Dec 5)
- Congress passes two year budget deal (Dec. 10)
- Volcker Rule adopted (Dec. 10)
- FOMC meets and begins tapering program (Dec. 18)
The month of December saw stocks finishing strong, while everything else limped across the finish line. Gold had an especially tough year:
US stocks "smoked" all contenders this year, and for the past few years together have allowed it to trounce the returns of every other major category of investments:
As December began, a judge in Detroit issued a long awaited ruling that will allow the City of Detroit to enter Chapter 9 federal bankruptcy protection and begin to restructure its mammoth $18 billion debt. Most importantly, it will allow the city much needed maneuvering room to renegotiate future contributions to its pension system. Municipal workers are up in arms, but the average Joe realizes that gutting police and fire protection for want of funds diverted to an egregiously generous retirement system designed and run for decades by Motown's version of Tammany Hall can kill a city. Let's hope they can pull through. In the meantime, municipal bond investors have a new landmark ruling that will profoundly change credit analysis. It is no longer enough to know about local government finances; now you will have to know all about state constitutions, pension law, and the bankruptcy codes. (Sounds like an ideal time for any dis-satisfied attorneys to make a career change!)
Shortly thereafter, US Treasury Secretary Jack Lew declared victory against Too Big To Fail banks on December 5, and said the U.S. would make it priority to hold the rest of the world to a higher standard.
We nearly spilled our coffee as we read the FT's front page write-up:
Whatever they're smoking at Treasury needs to stop (they must have a courier service to Colorado). It borders on the delusional.
When the top four U.S. banks by deposits are responsible for backing 96% of the liabilities in the OTC derivatives market, you have what any sane observer would call "concentrated risk". There is more of an imbalance now than prior to the 2008-09 meltdown. Nothing has been done to correct this. We applaud the efforts to raise capital standards and limit proprietary trading by banks, but let's not put the cart before the horse. A lot remains to be done, and regulators and legislators have a full plate and a long slog to re-shape the banking industry until it is a safe, boring, utility that provides for the public good. Would somebody please get started?
Until then, investors should recognize that there is still a lot of risk in the banking system. The newest twist is "bailing in" troubled banks. Instead of using public funds (such as the FDIC in the U.S.) to "bail-out" depositors and thus fortify shareholders, the idea being proposed by European authorities (read the IMF) is to confiscate up to 10% of depositors money to shore up troubled banks across the Eurozone (they tried it in Cyprus last year and it worked)! Why would anyone leave their money in a bank if this becomes law?
If there was ever a prescription for shutting down world trade and commerce, this is it. Any fool can see that the result will be HOARDING of cash and a return to a barter economy. In our own GEEK SPEAK, it means that the velocity of money will crash and the money multiplier will disappear. This is one of the worst ideas we can recall seeing, ever.
To make matters worse, both the U.S. and the Eurozone are floating ideas to pay commercial banks nothing (0%) for the "excess reserves" they hold, leading bank executives to pre-announce that they will then have to start charging depositors for keeping their money in their banks to maintain profitability. That's right, banks may soon be "offering" negative interest rates (we guess all the monthly fees will stay in place too).
Finally, after years of puffery, posturing, and deal making, the "Volcker Rule" was adopted on December 10. The rule was proposed simply and elegantly by Paul Volcker at the depths of the financial crisis, and sought to limit proprietary trading by banks. Here's a link to a great article from Bloomberg that explains how the banks neutered the rule to preserve their fiefdoms, while five different federal agencies are now charged with different parts of its regulation and enforcement (no wonder the smart money says it will be 2015 at the earliest until the rule can be implemented):
On the political front, Congress announced a bipartisan budget agreement which was quickly passed by both chambers and signed into law on December 26th. While not addressing the "elephant in the room" (entitlements), it does eliminate roughly half of the automatic spending cuts known as sequestration, giving everyone up for re-election in 2014 a sound-bite to show that they got something done. For markets, it allows another two year stretch before the next "threat" of a government shutdown. The cartoon below says it all:
Lastly, on December 18th, the Fed met and announced that it would begin to modestly scale back its purchases of Treasury and mortgage-backed securities ("tapering"). The stock market celebrated that it wasn't a deeper cut, focusing on the anticipated net addition of close to $1 trillion over the course of 2014 to the financial system. Bonds were unfazed and held steady.
The Fed's action was summed up from this part of their announcement: "Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee sees the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases."
The more important part, which we have urged investors to focus on, is their oft-repeated estimate for a protracted period of ultra-low (zero) interest rates: "...the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens...The Committee now anticipates...that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal." Don't count on any move in short rates until 2016 at the earliest is what the really savvy bond market investors are saying. If things play out as we described last month under likely incoming Chairman Janet "Optimal Control" Yellen, it could be 2018 or beyond before a normalization of rates. Income will remain scarce, continuing to drive investors towards risk to meet return requirements (i.e. buying stocks).
As we begin 2014, investors have a lot to digest. Will US stocks continue to go up? What will it take for emerging markets to re-gain their mojo? Are bond yields heading higher? Can gold regain its luster? The only thing that is certain is that markets reflect fear and greed, at different times and in different places. Investors would do well to follow the trends and try to stay on the right side of that always boisterous balance.
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