J Law- Keynes- Bernanke and the Mississippi Bubble

March 28, 2012March 28, 2012 Hamilton

Everyday lately there are a number of stocks that make new all time highs. Some by huge amounts like AAPL, others only fractionally, but new highs nevertheless like Colgate-Palmolive. It certainly makes one wonder if we are still repairing the damage of the great recession three years ago, or are already embarking on the next bubble phase. Even some of the broad averages, such as the S&P are now within 9% of there all time highs and sporting decidedly rich P/E ratio’s.

Economics is a wonderful dismal science. The only one where the practitioner can claim , with a straight face, that the patient on his death bed is now feeling so much better, after an aspirin , that things are now even better than before. We see it all the time. If, for instance, employment numbers are good this is bad as it threatens QE3, and then, to save the day, Bernanke thinks aloud and expresses a wee little bit of doubt about the continuation of employment growth, and this , of course is good. Merkel achieves the same thing by announcing that the firewalls should be higher (bad?) and , like Pavlov dogs the traders in Frankfurt bid the DAX up (good?).

This brings us to the easy-money approach. The first practitioner that put theory to practise is undoubtedly a Scotsman by the name of John Law. This colourful fellow gambled away his considerable inheritance, killed a man in a duel, was sentenced to death, escaped and moved to France and Holland, got the ear of the Duke of Orleans, set up the first central bank in Paris, and died a pauper in Venice. Without getting into too much academic detail, suffice it to say that Law, Keynes, and Bernanke are all three basically cut from the same very-easy-money-is-very-good cloth. All three believed that the lower interest rates the better, always, not just in times of distress. All believed that there was no limit to how far you can go with creating money and all believed it to always be beneficial to the economy, particularly to production and employment. Furthermore, in almost every instance there is a government, an exchange of paper (debt), and a deliberately created expectation of a promised land just around the corner. In Law’s case this involved land, the river delta of the Mississippi, that covered about 1/2 of the USA as it exists today. Arguable Law was almost as powerful a man then, as Bernanke is today! The stock of his Mississippi Company is shown below;

After a very prosperous period of about 7 years the stock peaked, reversed and then caused one of the largest financial calamities ever in France. In England the South Sea Bubble occurred at precisely the same time and, of course, had the same disastrous results. The question now is, “what if Bernanke has it wrong too????”.

Interest Rates.

March 19, 2012March 19, 2012 Hamilton

See also Keynes in a previous blog. This fellow believed that the best rate for interest rates would be zero, which thought process seems to have been adopted entirely by Bernanke. Others, more correctly, believe that capital is just another economic input that has its own price, essentially where the pain of delaying gratification equals the joy of immediate consumption. No one knows where that equilibrium is at any point in time but history would suggest that it is above 2% in real terms, so about 4.5% Given that taxes take a big bite out of the return perhaps the equilibrium level should be a few percentage points higher, somewhere between 6/7% seems reasonable.

The notion that the Fed. actually controls interest rates has taken hold over the past few years despite evidence to the contrary. Remember the “conundrum” that we had a few years ago and now again, in the midst of operation twist long rates are actually going up not down. In truth it probable was only possible to have such low rates thanks to first Japan and later China, both of which had sound economic reasons to “sacrifice” return for exchange rate and trade advantage. So, for the sake of argument, assuming that the Fed cannot control interest rates, when might they start going up?

Charts are hard to come by but here is one of the US Fed. Funds rate, basically call money:

We know that the lows in interest rates came about a little after the second WW, say 1947. This was a time when all concerned would have wanted low rates simple to rebuild. Often, for reasons I do not understand, markets just love symmetry. Applied here one would expect that the period from 1947 to 1981, thirty-four years, would be repeated on the other side which would bring us to 1981 + 34 = 2015 give or take a year.

Using short-term (one year?) rates from the Bank of Canada (unfortunately I could not find a single chart) we get similar results. Low rates (1%) prevailed from 1947 to 1951. Let’s assume that the low was right in the middle, that is in 1949. It would then take 32 years to get to the highs of 1981, so in order to achieve perfect symmetry one should aim for 2013 for rates to turn, again give or take a year. Last year, to almost everyone’s surprise, long bonds were by far the best investment class to be in with an overall return somewhere in the order of 35%. Next year may repeat that performance, but chances are equally good that it will turn out to be the worst asset class. By the way, higher rates would be good for a lot of different investors, but initially as rates start to go up the process can be double painful.

TSX update.

March 19, 2012 Hamilton

The outlook for the TSX as a whole has not changed. The B-wave travelled right up to the upper parallel trend line and was convincingly repelled (about 3000+ points). Unlike in the DAX or DOW the TSX only rebounded from the recent lows by about 50%, a lot less than the original rebound from the Mar. 2009 lows.

Not everything in Canada is honky-dory. Later this month we will get government budgets presented that will tighten things up a wee bit even in this financial paradise. China looks decidedly more shaky so the commodity play, always the last to blossom, may be coming to an end. Canadian households are now as over indebted as their US counter parts before the housing debacle. We do not have non-recourse mortgages here but interestingly our own Fannie and Freddie has grown by leaps and bounds in the last few years and seems to be near its fill at $600 bln. Houses in certain urban areas are costing more than 10X income, the norm is 2 to 3, no problem? Once America figures out how to use natural gas for transportation purposes (like the Europeans have been doing for at least half a century) , peak-oil may well still be with us but of no practical value. The oil-sands may even be shut-in for a while. The list of possibilities is endless.

WFC Wells Fargo, Royal Bank RY

March 19, 2012March 19, 2012 Hamilton

Not everybody is aware of the fact that Wells Fargo, the bank with the stagecoach in its logo, is now the biggest bank in the US. At a capitalization of about $180 bln. it is as large as Bank of America and Citi combined. Like Bank of America (originally) WFC is headquartered in the State of California and could consequently grow organically as this state did not have single-unit bank laws. Citi, better known as FNCB grew to its size thanks to a collection of financial corporations made possible primarily by suspending Glass-Steagall.

Two things stand out. One is that that the first shall be the last. The other is that if you stick to your knitting , either by choice or circumstances, you may do better. Being in a state that does allow multi-unit banking helped growth and provided a solid deposit base. Being in a back-water also helped to resist the temptation to copy the money-centre banks. In Canada we have all these elements which is why the Royal probable best resembles WFC.

First WFC;

The rebound from the lows has lasted much longer and given the magnitude of the move it was reasonable to assume that the rebound was over. However, with the benefit of hindsight, now that WFC is at the exact same level it was 2 years ago, one must assume that a “flat” occurred as a wave b in the pause part of the rebound. If that is the case the stock could soon make a new high, an irregular top for wave B. This would be at around $38+.

As far as the Royal is concerned, there are a total of 42 entries in this website and following the blogs would have been quite profitable. Nevertheless the two highs just ticks apart and the two 5 wave moves down never did fit so to speak. Here is the updated count;

The 1-2, 1-2 possibility is still viable but the above count now looks more plausible. If we assume that wave c will grow to about 62% of wave a, as is quite common, then a peak at around $65 is a possibility. From a trading perspective it is not a smart thing to buy this stock. It took the stock 50/100 years to get to these levels and just eyeballing the chart tells you that it has not been higher than it is now for more than a few months. If you do own it, it is definitely a sell now or above $60. The next big move, according to EW principles, should be rather nasty as the target is at least the level of the 4th wave of previous degree, around $22.

Your broker will , no doubt, remind you that this stock earns you twice as much as the 10-year government bond does, on top of which it is tax-efficient due to the dividend gross-up. That is entirely true but it is also static rather than dynamic. Should bond yields rise, perhaps dramatically, the banks will be hurt hard and this could happen.

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