Gold Speculator - John Lounsbury http://www.gold-speculator.com/ John B. Lounsbury Ph.D., CFP is a financial planner and investment advisor in Clayton, NC. http://piedmonthudson.wordpress.com/ en Wed, 08 Sep 2010 01:32:51 GMT vBulletin 60 http://www.gold-speculator.com/images/misc/rss.jpg Gold Speculator - John Lounsbury http://www.gold-speculator.com/ Small Businesses Are Not Optimistic: Is Healthcare Cost the Reason? http://www.gold-speculator.com/john-lounsbury/37517-small-businesses-not-optimistic-healthcare-cost-reason.html Mon, 06 Sep 2010 15:53:37 GMT SeekingAlpha.Initializer.LogAndRun(load_article_toolbar);]]> One of the things that talking heads keep repeating is that increased health care costs are one of the reasons causing employers to avoid adding new hires. This is reported to be especially important for smaller companies.

It certainly is true that small business is seeing much less indication of recovery. The NFIB (National Federation of Independent Business) survey is much more pessimistic than the ISM (Institute for Supply Management) as shown in the following graph:



The NFIB survey covers small businesses, while the ISM surveys large companies.

A quote from the 5-Min. Forecast:
“The persistence of Index readings below 90 is unprecedented in survey history,” says the NFIB. Contrast its readings over the last five years with, for instance, the big-business ISM manufacturing index, which has pointed to expansion for over a year now…
Steven Hansen discusses the differences in the various business activity reports in detail in his weekly economic review posted September 3.

One of the continuing problems facing small business is the advancing cost of health care. Small companies are facing a bigger acceleration in health care costs than large companies, as shown in the following graphic:



A report from the Kaiser Family Foundation and Health Research and Educational Trust found a lower growth rate for the same time period than did the Los Angeles Times (above), as shown in the following graph (click to enlarge images):



From the Kaiser data, small business health insurance costs compounded at an 8% rate 1999 through 2009, while large companies compounded at 9%. The LA Times data produces a similar 9% compounding for large businesses, but a significantly higher 11% for small businesses.

The Kaiser report found 2010 increases in employer sponsored health care insurance premiums climbed 3% for family coverage and 5% for single coverage. These are far less than the 9% compound growth rate for large businesses and 8% or 11% for small businesses over the 11 prior years. The 2010 increases are more than 40% less than the health care costs increased in 2009. Also, as we shall see later in this article, the 2010 increases were essentially completely transferred to increased employee contributions.

The percentage of workers covered by employer sponsored health care plans has not changed in a statistically significant way from year to year since 1999. However, there does appear to be a clear trend from a high of 65% in 2001 to 59% in 2010.



The down trend in percentage coverage does not tell the whole story, however. The 60% coverage of NFP (non-farm payrolls) of 137.9 million at the beginning of 2008 implies 5.9 million fewer employees covered in August 2010, when NFP is reported as 130.3 million.

The same report indicates that employee contributions to health care have increased. The systematic pattern from 2009 is shown in the following graph:



The first statistically significant change year-to-year has occurred in 2010. I view the increasing employee contribution as a positive. It is one step of many that need to be made to transfer cost control for medical care to the patient, which I have been arguing is necessary to achieve a bending of the health care cost curve downward. See here, here and here.

What is significant, as regards the title question, is that health care costs for employers are actually little changed in 2010. According to the Kaiser report, approximately half (47%) of the coverage is for single workers. In 2010, health care coverage costs are increasing approximately $408 per family, while employee contributions have increased approximately $528 per family. The numbers are reversed for single employees, with costs increasing by $264 per employee and employee contributions increasing by an average of $144. Total employer costs for health care are actually slightly down because 47% of employees (single coverage) cost employers an average of $120 a year more per employee while 53% of employees cost an average of $120 a year less.

In 2010, health care costs for businesses, on average, are actually flat to down on a per employee basis. Growing health care costs are not the reason that small businesses are pessimistic.

Disclosure: No stocks mentioned.


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]]> John Lounsbury GoldSpeculator http://www.gold-speculator.com/john-lounsbury/37517-small-businesses-not-optimistic-healthcare-cost-reason.html Unofficial Problem Bank List Reaches 844 http://www.gold-speculator.com/john-lounsbury/37516-unofficial-problem-bank-list-reaches-844-a.html Mon, 06 Sep 2010 15:50:54 GMT Calculated Risk maintains an unofficial problem bank list compiled from publicly available records. The latest list contains 844 names with a total of $412 billion in assets. The FDIC announced this week that they have (as of June 30) an official count of problem institutions at 829 with assets of $403 billion. The FDIC just releases a count quarterly, but no names.

The Calculated Risk list has tracked the FDIC count reasonably well over the past year (click to enlarge images):



The trend line tightly matches the data since last August, with a slope of +33 banks/month. Although no curve has been drawn for the FDIC data points, it is easy to see that there possibly is a slight concave curvature (downward) to that data. One might infer that the rate of problem bank counting by the FDIC might be slowing ever so slightly. Such a slowing of problem bank creation is not evident in the Calculated Risk data.

There is a clear indication that more smaller banks are coming onto the problem bank list than are leaving. Banks leave either by resolution of deficiency or failure, overwhelmingly the latter in the past three years. On August 7, 2009 there were 389 banks with assets totaling $276 billion on the unofficial problem bank list. Thirteen months later, the number of banks is 2.2 times larger, but the total of assets is only 1.5 times as large. The average assets per problem list bank in August 2009 was $720 million; now the number is $490 million per bank.

So far in this crisis, the FDIC has closed 286 banks. At the current rate of closures, another 80 may be closed by the end of the year and the problem bank list may reach 1,000. That would put over 1,360 banks in trouble or already closed at the end of 2010. That is getting closer to the number of troubled banks estimated at close to 1,900 by banking analyst Chris Whalen over a year ago, but is still far short of the nearly 3,000 troubled banks estimated by Elizabeth Warren's Congressional Oversight Panel in February this year.

If the analysis done by the references given is accurate, the 286 banks closed thus far in this crisis is not only far short of the total failures to be expected. The number 286 is probably far short of half of the bank failures we will see.

Disclosure: No positions.
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]]> John Lounsbury GoldSpeculator http://www.gold-speculator.com/john-lounsbury/37516-unofficial-problem-bank-list-reaches-844-a.html Do Dividend Yields Indicate That Stocks Are Undervalued? http://www.gold-speculator.com/john-lounsbury/37212-do-dividend-yields-indicate-stocks-undervalued.html Wed, 01 Sep 2010 16:14:22 GMT I reported earlier on a post by the 5-Min. Forecast that discussed the possibility that stocks are undervalued based on the relationship between the 10-year Treasury bond yield, which was been bouncing around 2.5% yesterday, and the dividend yield on the S&P 500, currently around 2.3%.

The stock dividend yield is about 92% of the bond yield. The historical average is 42%. To return to the historical average for today's interest rate, the S&P 500 would have to rise to the neighborhood of 2,200, about a mile above the all time high of 1,565 on October 9, 2007.

To return to the historical average at today's stock prices, the 10-year Treasury yield would have to rise to above 5%, a yield last seen nine years ago.

The following graph shows the relationships between interest rates, dividends and S&P 500 index value for a range of values with the stock dividend/bond yield ratio of 42%:



With the historic dividend to treasury yield ratio, the current S&P 500 index value corresponds to dividends of about $10. Something is seriously out of whack.

What is going on here is that investors are pricing the S&P 500 as if there were not going to be further earnings and dividend growth. Campbell, Giglio and Polk have done a detailed multivariant analysis that shows investors did not react to the latest bear market in stocks as they had to previous downturns. This time investors did not reflect an expectation for stocks to recover. Prices have not reflected historical relationships to bonds. The discount to the "risk free" earnings rate has nearly vanished as the 10-year Treasury yield and the S&P 500 dividend yield approach the same value.

The following table shows what valuations are indicated for the S&P 500 for three ratios of dividends to treasury yields (the current 92%, the historic average of 42% and halfway in between) and for three values of 10-year Treasury yield.



The wide range of results reveals that there is no easy answer to the title question. If interest rates rise and investor outlook is for little earnings and dividend growth, stocks may well be overvalued. If interest rates remain low and investor expectations for dividend growth return only part way to the historic average, stocks are undervalued. If interest rates remain low and investor expectations return to historical norms, then stocks are dramatically undervalued.

Disclosure: Long several S&P 500 stocks.
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]]> John Lounsbury GoldSpeculator http://www.gold-speculator.com/john-lounsbury/37212-do-dividend-yields-indicate-stocks-undervalued.html Further Thoughts on My Treasury Meeting http://www.gold-speculator.com/john-lounsbury/36325-further-thoughts-my-treasury-meeting.html Thu, 19 Aug 2010 19:32:29 GMT In a previous article reviewing my attendance at a small discussion group meeting with Treasury Secretary Geithner and other senior Treasury Officials, I left out one very important topic that was covered. I also failed to effectively summarize my overall impressions. First, let’s cover the omitted topic.

Housing

Treasury officials several times emphasized that they recognize there are still many more potential foreclosures to come. I conclude that they are not delusional about the magnitude of the remaining tenure of the housing bubble and its aftermath. I took the occasion to try to explore Treasury’s thinking. One thing Treasury folks mentioned was a responsibility to support efforts to ensure that citizens can get adequate housing. I found that very curious but let it pass because I had a larger objective, which I was able to get to shortly thereafter. But, before getting there, let me just say that I think a more appropriate statement would have been that policy should not interfere with citizens’ ability to get satisfactory housing rather than support those activities. Semantics? Perhaps. But, to me the distinction is important.

The important point that we eventually reached involved the underlying strategy of HAMP and other foreclosure prevention programs implemented by the Federal government. The Treasury statements indicate they clearly had an objective of spreading the time line for foreclosure over a longer time frame than would have otherwise occurred. I offered a paraphrased summary statement to find if I had understood policy correctly. There is no transcript but it I offered something like this:
Policy was directed at deferring what might have been 5 million (an arbitrary number for discussion purposes) foreclosure completions in 12-18 months to 5 million foreclosures over 36 or 42 or 48 or 54 months. This was done to lessen the economic shock of massive action. Do I have the essence of the policy?
The response was something like: and also avoid some foreclosures that would otherwise have occurred.
My reply:
Then add to my previous statement that policy possibly reduces the number of foreclosures ultimately experienced by 5 or 10%, if successful. In other words, 5 million foreclosures might be reduced to 4.5 million or 10 million foreclosures might be reduced to 9 million, if the foreclosure prevention programs achieved a high level of success.
I think there was affirmative response, but I admit there was not an aha! moment. At least I am confident that my summary was not contradicted, so I will continue to feel I understand policy.

Summary

The housing discussion crystallized again for me the overall policy direction that started with the previous administration and has continued with the current one. I have joined many others in using the term “kick the can down the road”. That is in fact the formal policy. It is nowhere written in bright lights, but that is the fundamental basis of policy.

With housing, the policy has been to diffuse a foreclosure problem over a longer time frame to reduce economic shock. With finance, the policy has been to create a “workout” time line for large banks to “earn” their way out of balance sheet problems.

The problem with this approach is, of course, that the Federal deficit basically funds the “earnings” of the banks. The FED provides new money that the banks can borrow at near 0% and the banks then buy Treasuries that pay higher interest rates. The “earnings” that the banks get from this “carry trade” process is achieved by the further indebtedness of the citizenry through the increased national debt.

This is not a growth policy. Treasury guys stated that the long term potential for the economy might be near 2.5% real growth, but that we are experiencing (going to experience?) a post stimulus slow down. Treasury does not appear to be delusional about the sluggish growth prospects for the economy. The question of a recessionary double dip was not broached, but I don’t think any opportunity was lost – Treasury would not have ventured into that realm had we attempted it, in my opinion.

Extend and pretend is official policy from what I can gather from this experience at Treasury. Pretending may not be fatal if fantasy does not become permanent. However, there is an opportunity cost. Either Prof. Cowen or Prof. Tabarrok (or both) raised the question of why leverage for restructuring of the financial system had not been exercised when the crisis peaked. I did not hear an answer. The answer perhaps resides with the timing – the end of one administration and the start of a new one. We will never know if more structural reform might have occurred if the crisis had come a year earlier or a year later. I am skeptical that would have made a significant difference, but we will never know.

For an excellent discussion of what might have been, read Barry Ritholtz’s excellent article. But if we now concentrate on what should be done from now on we must limit compulsive obsession with “coulda, woulda, shoulda” and focus forward. We must learn from history but not be preoccupied by it.
Going forward we need to “wean the sucklings from the federal teat”. I am not in the camp that wants to do that abruptly, but I am also not in the camp that wants the Bailout Nation, documented so well by Ritholtz in his excellent book of the same title, to be continued. It is time to spend less effort bailing and more effort repairing the boat.

When we recognize the size of this financial crisis, it is amazing that we have not suffered more. As I wrote last year (here and here), even when we adjust for inflation and normalize to population, this crisis is orders of magnitude larger than anything else in the past in financial terms, including the Great Depression. As much as we criticize actions taken, there are lots of worse conditions we could be in right now. The size of the financial system catastrophe is of historic proportions and we are still alive.

To anyone reading this who feels there should not be all the pain we have and will have, I submit that there is no painless way forward. What we can all strive for is a result that makes the pain ultimately worth it.

And that is about as optimistic as I can get at this point.

There have been no additional posts on this meeting to date other than Alex Tabarrok, which I posted with yesterday’s article.

Disclosure: No stocks mentioned. ]]> John Lounsbury GoldSpeculator http://www.gold-speculator.com/john-lounsbury/36325-further-thoughts-my-treasury-meeting.html My Afternoon at the Treasury http://www.gold-speculator.com/john-lounsbury/36194-my-afternoon-treasury.html Wed, 18 Aug 2010 16:55:39 GMT I was privileged to attend a meeting at the Treasury Department in Washington on Monday afternoon, August 16. The two hour plus meeting was hosted by Senior Treasury Officials. There were three discussion leaders:

Michael Barr, Assistant Secretary for Financial Institutions, led the first 45 minutes;

Matthew Kabaker, Deputy Assistant Secretary for Capital Markets, next 45 minutes;

Secretary Timothy Geithner led the final 45 minutes of discussion, which actually went overtime from the scheduled 30 minutes.

Other senior officials present:

Mary John Miller, Assistant Secretary for Financial Markets;
Jake Siewart, Counselor to the Secretary;
Lewis Alexander, Counselor to the Secretary.

There were seven guests. In addition to yours truly, they were (alphabetical order):

The Treasury Department has established a program inviting various financial bloggers to have open discussion meetings with senior Treasury officials 4-6 times a year. Meetings are designed to be small, informal, unscripted and open to all relevant (even peripheral) thoughts, ideas and questions from the invited guests. The meeting I attended was held in the Treasury Secretary's conference room with seating around a table that could hold a maximum of 22-24 participants.

My comments are based on very cryptic notes I took during the meeting and will be subject to revision or expansion by what other attendees have to say. Links to posts by other attendees will be appended at the end of this article. If other posts occur after this article is submitted I will provide links in a later post.

It was agreed that no attributed quotes were to be disseminated without obtaining specific review and clearance from the Treasury Department. This resulted in an exchange which was far different from a typical interview or press conference session. It was more like a brainstorming session and ideas were flying around the room in a very stimulating way.

A number of guests raised confrontational topics and some defensiveness by Treasury officials did occur, but my impression was that defensiveness was limited and open exchange occurred when questions that would have been deflected in a press conference setting received much more consideration in this forum.

FinReg

Treasury seems to be very enthusiastic about the new FinReg (Dodd-Frank Financial Reform Bill) recently passed into law. It is clear that they see the GSEs (government sponsored enterprises) as the next reform effort required.
Officials defended the proposition that progress had been made to avoid a similar course of events experienced in the 2008 financial crisis because the Treasury now has the legal authority to unwind an insolvent super bank in a manner somewhat similar to the FDIC process for smaller banks.

What remains in question with this analyst is: After the authority, where is the process?

Too Big To Fail

What I suggested as a problem for the administration is that they have not addressed the problem that TBTF (too big to fail) institutions still exist. I said there was no confidence that there was a plan to end the problem. I was referred to a speech by Michael Barr in Chicago on August 10. From that speech:
We will--once and for all--fully end the market's perception of "too-big-to-fail" firms, when we build a system that is capable of absorbing the failure of the next AIG or Lehman Brothers; a system that constrains risk-taking by major financial firms, strengthens the basic shock absorbers and transparency in the financial system, and provides the government with credible tools to manage effectively the failure of major financial firms while at the same time safeguarding the broader economy.

To fully end "too-big-to-fail" we need to make our financial system safer for failure. We cannot rely on the hope of perfect foresight--whether by regulators, or by managers of firms, private sector gatekeepers, or other market participants. Financial activity involves risk, and no one will be able to identify all risks or prevent all future crises.

However, robust capital, leverage, and liquidity requirements can prevent the build-up of risk, ex ante, and insulate the system from unexpected shock events, ex post. Imposing higher prudential standards on the largest, most interconnected firms will require them to internalize the risks they impose on the system by virtue of their size and complexity. The largest and most interconnected firms cause more damage to the system when they fail, so they need to hold more capital against risk. That is based on a principle of fairness and also of economic efficiency. It internalizes their costs of failure and provides incentives for firms to limit their size and reduce their leverage.
In reading this speech I found that some of the comments in discussion by Treasury officials on the 16th were very similar in wording to the text of the speech on the 10th. So I guess the discussion was not entirely unscripted. I make that as a simple observation and not to be snide.

The intent appears to make capital requirements and regulation for “super-sized” banks more demanding than for smaller banks in order to make size a detriment to flexibility of operation and profitability. I believe it was Yves Smith who pointed out that multiple studies have found that efficiency and profitability of banks declines beyond a size much smaller than our largest banks and that has not stopped them from becoming behemoths.

Phil Davis raised the question of bogus bank accounting standards and the general sense of the response was that FinReg will enable the enforcement of higher capital standards. This led to Prof. Tabarrok asking just how would “AAA” be determined. If there was a clear answer I missed it. (I told you my notes were sketchy.)

The sense I took away from this part of the discussion was that much depends on (potentially hundreds of) studies authorized by FinReg. The Treasury is charged with forming an Office of Financial Research to conduct research to guide future regulation implementation. This really translates to me that we are still in the process of conducting a Grand Experiment.

Compensation

There was some discussion of how compensation plans can distort corporate actions. I threw out the idea that the problem was that our systems, especially in finance and health care, are too heavily focused on pay for transactions rather than pay for outcomes. I didn’t have the presence of mind to bring instant gratification into the discussion, but that would have certainly made my thought process clearer.

This topic brought a comment from Yves Smith that the highly profitable trading activities that create large, quick rewards would be difficult to wind down for the banks that have become addicted to the “fast buck” (my terminology, not Yves’). The sense I got from Treasury was that they feel trading activities would be wound down over time.

Late in the session I threw a question on the table about how tax policy could influence compensation. If taxation of capital was decreased and on income or consumption was increased could the ratio between production and consumption components of GDP be brought more in balance? That hot potato pretty much stayed on the table without significant discussion.

Solvency and Profitability for Banks

In one brief exchange an interesting thought emerged. The fact that bank stocks are trading at or below book value seems to be in conflict with the fact that banks are having little trouble in selling bonds. The thought was expressed that the bond market is looking at solvency and the stock market is looking at future profitability. Markets now are telling us that investors are not worried about insolvency but do have questions about profits in coming years.

I have thought about this after the meeting and wish I had asked the question if there is still some backstop mentality in the bond market – the government will not let these banks fail. That thought relates back to an earlier point in the session where criticism was raised of the protection of bond holders at the expense of stock holders in the financial crisis.

GSEs

Perhaps the term GSE (government sponsored enterprises) should be changed to GOEs (“owned” substituted for “sponsored”), but that was not mentioned in the meeting. Treasury officials gave the impression that, although this is the next big financial reform effort, studies are needed to start defining the end game. This gets us back to the Office of Financial Research. I got the impression that the process to be started might be termed “search and discovery”.

Other factors related to this “end game” for Fannie and Freddie include how much government footprint should remain in the mortgage market, how will external factors (such as the new Basel agreements) affect resolution, and how will regulation of banking and non-banking mortgage markets, as well as consumer protection, be coordinated.

I was too busy enjoying the discussions to take better notes. I hope that other attendees will cover many aspects of the discussion that I missed and clarify things that I may have reported improperly or incompletely. This was a very worthwhile experience for me. I went to the meeting not really knowing what to expect. The quality and openness of the discussion was far beyond anything that I had imagined going in.

Other posts on this meeting:
Only one so far: Alex Tabarrok

Disclosure: No stocks mentioned. ]]> John Lounsbury GoldSpeculator http://www.gold-speculator.com/john-lounsbury/36194-my-afternoon-treasury.html The End of the Expense Cutting Rope http://www.gold-speculator.com/john-lounsbury/35787-end-expense-cutting-rope.html Thu, 12 Aug 2010 16:48:24 GMT Three graphs today at the 5-Min. Forecast go a long way toward telling the story of where we are in this economic recovery.

Productivity has Rolled Over

The first graph shows how productivity growth has been declining for over a year and turned negative in the second quarter.



U.S. corporations have cut expenses to the point where more cuts reduce output. The end of this rope is when it is discovered that cutting expenses can improve the bottom line only up to a point. After that point further cuts will reduce income more than expenses. For any other reality, it would be possible to approach infinite income by cutting expenses close to zero.

Capital Improvement is not Offsetting Lower Employment

The first question that can be raised is that there could be hope for future productivity gains to return based on capital investment in new facilities, tools and technology. The second graph shows that will not happen. The annual change in capital stock has gone negative for the past several quarters.



The decline in U.S. capital stock has not happened since the Great Depression. The folks at Agora.com say the following:
Capital stock is the total inflation adjusted value of all “business equipment” in the U.S. That’s machines, robots, vehicles, tools, software, computers, pencils, paper… the whole shebang. For the first time since World War II, U.S. capital stock is contracting. Meaning, employers are not reinvesting in their equipment. More machines are left broken or outdated than are being replaced or upgraded.
Employers likely underinvested in capital stock during the darkest days of the credit crisis. But why aren’t they catching up now? Perhaps worker productivity is down -- along with capital stock -- because there’s simply not enough business to warrant investment… either in people or equipment.
The Agora view is that we have a decline in demand which is driving the entire pattern of productivity decline and lowered capital investment. This is demand driven deflation. All the liquidity stimulus in the world fails in the face of contracting demand.

Bond Markets are Confirming the Deflationary Pressure

The third graph from the 5-Min. Forecast shows the surge yesterday in the Treasuries market (falling rates).



With the big sell-off in stocks underway today (Wednesday Aug. 11), the 10-year Treasury yield has dropped further to 2.69%. The bond market is now at levels not seen since March, 2009, as shown in the following graph.




The bond market says we are back at March, 2009 conditions again. The stock market says we are much better off. Both can't be right. This divergence was discussed recently here.

End of the Rope?

Has the end of the rope been reached? Can businesses no longer contract their way to higher profits? Who will win the battle of the markets - stocks or bonds?

Disclosure: Long several S&P 500 stocks. Both long and short positions in several Nasdaq stocks.
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]]> John Lounsbury GoldSpeculator http://www.gold-speculator.com/john-lounsbury/35787-end-expense-cutting-rope.html