10 Areas to Better America's Long-Term Economic Interests

The following are the ten most important economic issues American government should focus on moving forward, in my opinion. Some speak directly about economics, and others, such as education and cyber-security, impact it indirectly.

1.) Adopt an energy policy centralized around alternative fuels, primarily algae biofuels, solar, and wind energy. Government subsidies and sponsorships of programs, such as space-based solar, are imperative.

2.) Increase productivity in three ways. A.) Through infrastructure development (high speed trains, research into alternative means of transportation).  B.) Encouraging the use of collaboration technologies, and C.) reducing the cost of communication.

3.) Encourage innovation, across the spectrum. Cherish it, reward it, make it easier, and retain it as the central aspect of economic growth. Achieve this with a focus on opensource technology and crowdsourcing. The private sector is inevitably moving in this direction, but the government is responsible for expediting the process and serving as a model.

4.) Reduce the deficit by reducing the size of government moving forward. Hike taxes and decrease government spending.

5.) Increase cyber security and hold nations responsible if they hack into our systems. Protection of our private intellectual property is a core function of economic growth. Companies and citizens alike need to know its protected and that there are consequences for those who violate it.

6.) Improve education in math at the K-12 level by raising salaries for math teachers. See Jim Simons' "Math for America" for a model which is feasible and pragmatic.

7.) Increase capital market efficiency by collaborating with foreign nations to provide an easy gateway for the private sector to invest abroad.

8.) Increase immigration to the U.S.  The greater our labor force, the higher our GDP, the faster our nation grows.

9.) Retain foreigners in the U.S. who receive higher level education here.

10.) Increase savings and investment and wean America off our current economic model, which relies heavily on consumption.

Analyzing the Effect of War on Stock Prices

If anyone ever doubted how irrationality can sometimes dominate market behavior, then a quick analysis of the effect on stock prices due to the threat of war can elucidate the facts. In almost every instance of the threat of war, stock prices immediately fell in dramatic fashion. Investors often feel pessimistic and distraught at the thought of mass destruction and the potential loss of lives. They then sell stocks purely based on this outlook, which was formulated based purely on emotions.

In fact, as history shows, the best thing to do with your money during wartime is to INVEST it in stocks. As the threat turns into a reality, governments rack up an extraordinary amount of spending that cannot be financed through tax receipts. This spending ultimately leads to inflation and stocks are a great way to hedge against inflation since earnings growth and inflation growth are positively correlated. Further, many companies actually experience a boost in earnings if they're in the defense industry.

To take advantage of this, slowly average into positions over the course of many months. As long as the country your investing in is the dominant military power, the investment should play out. Of course, there is an ethical concern regarding the morality of whether one should benefit from another's harm. I don't subscribe to this camp, but many outside the industry do and even those who've made a trade like this tend to feel awful. In my opinion, whenever you make a trade you're trying to profit at someone else's expense, so why is this situation any different?

A chart of  9/11 and the subsequent months is shown below. Note the reversal of the downward spike in the following months after the attack. A similar chart can be seen after WWI, WWII, and the Korean War.

Update on the Markets, Economy - 3.3.2010

Here are the things I've been focusing on the past month and will continue to focus on moving forward.

1.) Greece, Europe, and Euro:
It's imperative for traders to take advantage of any perceived weakness in the U.S. stock market due to the situation in Greece. Their economy is only 1/5th the size of California's and U.S. banks have little exposure to Greek's debt. The EU has pledged to aid Greece in rectifying their deficits. This signifies how the EU will aid any other EU member-country with deficit problems in the future. As Jamie Dimon points out, California is the greater threat. If markets are weak due to the situation in Greece, it's a buying opportunity.

At a hedge-fund gathering last week, prominent players in the industry talked about how the euro could reach parity against the dollar. At the very least, they were in agreement about how the Greece situation could only result in euro depreciation. I think parity is quite an extreme forecast that could only come to fruition if the US/Euro interest spread widens from -25bps to around 400bps.

2.) GBP :
The pound has been hitting new 1-year lows against the USD and JPY the past month.  Look for a bounce - the pound is extremely oversold here.

3.) Economic Data:
The Jobless Claims report is getting a lot of press lately and will continue to move the markets. Unemployment report comes out on Friday, though it will be interesting to see how the winter storm affects the numbers.

4.) Holdings - TSL and FCX
Sold out of TSL with a 5% loss. I'm still in FCX however, up 14%. Obviously, I'm watching copper and gold very closely to decide when to exit my FCX trade.

5.) Outlook
I'm bullish at these levels. Economic data has been improving, albeit there have been mixed signals. The key will continue to be the unemployment number, which comes out on Friday. With that said, the easy money was made in 2009 and this year is without question, a stock picker's market.

Buy the high-betas on the dips and hunt for the undervalued companies for long term investments (3-5 years). Be willing to change the composition of your portfolio if the leading labor indicators -jobless claims, temp hirings, average hours worked manufacturing sector - take a turn for the worse. These are the most important indicators to follow right now, as all other econ statistics have at least modestly improved while the unemployment rate is stagnant in the high 9s. 

Australia's Unemployment Rate at 5.3%

Australia's unemployment rate just came in at 5.3%, better than the expected 5.6%. The AUD is up 115 points against the USD. Check this post out for information about investing in Australia.

Investigating the Validity of China's GDP Numbers

China's GDP statistics are often viewed with a dose of skepticism. The government frequently sets targets and those targets are almost always surpassed. When the government aimed for 8% full-year GDP growth, they got 10.7%  growth. If an investor is suspicious of these numbers, is there a way to get at the real number or at least find out whether or not this number is completely off and misleading? After all, inflated numbers can add to an irrational optimism that could create bubbles in the Chinese stock market.

A creative way to solving this problem, pointed out by a few economists, has been to measure the electricity consumption of China. Throughout the histories of the major economies, there has tended to be a very strong positive correlation between electricity consumption and GDP growth. This makes intuitive sense. As the economy grows and businesses need more energy to operate, electricity consumption will obviously follow. Further, as standards of living increase, electricity consumption per head increases. No wonder many economists doubt China's economic numbers, especially when situations like this arise:

"Power consumption in Sichuan dropped 9.9% in the first quarter, but its economic growth in the same period reached 10.8%. The local government explained the economic growth is mainly led by the post-disaster reconstruction. "I don't know how the economy grows in this area," said Zhao Bingren."

 However, I believe at times the positive correlation between electricity consumption and GDP growth can weaken. Through extraordinary advancements in productivity and investment, an economy can rapidly grow while electricity consumptions stagnates or even declines. Think of it this way: China leapfrogged two generations worth of old and slow computers and jumped right into the fast Dells and HPQs with Intel pentium processors. This huge investment resulted in amazing gains in productivity, relative to years without the computers. Was electricity consumption greatly impacted? No. New machinery and methods of production can result in tremendous productivity gains while still requiring the same amount of electricity as old machines. In fact, China's productivity grew at an extraordinary 8.2% in 2009 and once comprised more than 40% of GDP growth in periods within the decades of 1970-2002.

It may be time to grant China more credit.

The Week Ahead: 2/08/2010 - 2/12/2010

There will be little economic data released this upcoming week. International trade will be released on Wednesday, Retail Sales / Jobless Claims / Business Inventories on Thursday, and Consumer Sentiment on Friday. Of these reports, the biggest market mover will be jobless claims since the 4week average has rose three weeks in a row, the unemployment report had conflicting signals, and the press really scrutinized last week's number. As always, I will be providing an analysis of Thursday's jobless claims when the number comes out.

There will also be a slew of earnings this upcoming week. For the full list of companies, check out this earnings calendar.

The main focus this week will be on the costs of insuring debt of the PIGS. I'll be looking at the CDS market to see whether these insurance premiums are rising or contracting after last week's spike. For the week ahead, I'm very bullish and currently long a couple high-beta names, such as FCX and TSL.

In TSL and FCX

Today's market action has so far been extremely encouraging. As the market has rallied off its lows, I've entered into high-beta names, such as Trinity Solar (TSL) and Freeport McMoran (FCX). I've placed tight stops on these trades and look to be out in two-weeks' time. For a long-term view, I'll continue to follow the earnings and economic data.

Unemployment came in at a much better-than-anticipated 9.7%, although the report had many conflicting signals and the nonfarm payrolls fell 20,000. However, I liked the rise in temp-hirings within the business sector because 1.) It's a leading indicator into the health of the labor market and 2.) I'm looking for a summer internship :)

Jobless Claims Analysis, 2.04.10

Jobless claims rose 8,000 to 480k last week, pushing the 4-week moving average up for the third consecutive week after 19 straight weeks of declines. As a leading indicator into the health of the labor market, this statistic gives me a bearish sentiment. Further, stripping out personal investment in inventory in last week's GDP report takes the number to 2.2%, much less than the reported 5.7%.

My posts over the last few weeks have been alluding to a possible inflection point coming in the markets and I believe today's market action constitutes that inflection point. The latest price movements either represent a pull-back in the markets and today is a great buying opportunity or they represented the beginning of a much greater broad market decline.

Largest Oil-Exporting Countries to the U.S.

From the Energy Information Administration:

(Chart cut-off slightly, but data shown is relevant)

Crude Oil Imports (Top 15 Countries) (Thousand Barrels per Day)
Country	Nov-09	Oct-09	YTD 2009	Nov-08	YTD 2008
CANADA	1,984	1,858	1,927	2,028	1,949
MEXICO	951	1,015	1,099	1,296	1,192
NIGERIA	948	853	748	775	927
SAUDI ARABIA	837	938	998	1,487	1,514
VENEZUELA	809	879	983	1,080	1,040
IRAQ	458	499	460	476	636
ANGOLA	408	437	466	450	499
KUWAIT	287	104	188	292	207
BRAZIL	261	169	304	280	233
ALGERIA	219	327	272	381	319
COLOMBIA	216	282	261	160	181
RUSSIA	169	159	238	152	122
ECUADOR	150	174	182	222	210
EQUATORIAL GUINEA	136	32	95	124	75
LIBYA	116	67	66	63	71

I find it interesting that politicians and the media often talk about how the U.S. needs to break its reliance on oil from the Middle East. The data, however, shows we get more than 50% of our oil from our neighboring countries. Perhaps the politicians are trying to spur investment into alternative energy by skewing the situation into a national security problem.

One other thing to look out for: Follow the production rates in Canada's Alberta province oil-sand projects. If Canada begins to export more oil to the U.S., then movements in the price of oil will have a more dramatic effect than usual on the value of the Canadian dollar.

Overview of today's market action

Jobless claims came in today at 470k, higher than the upper end of the consensus range. This bodes negatively for the labor market and is the second consecutive week the 4-week moving average increased. This, coupled with the lackluster durable goods order, is a worrisome signal about our economy's current rebound trajectory. Unemployment is stalled at 10% while jobless claims have stopped declining. Charts everywhere are showing breaks of major trendlines, from those of the FOREX market to those of the Dow Jones Industrial average.

As I wrote in a previous post, one must track economic and earnings data in order to get a grip on the future direction of the financial markets. Earnings have been fairly resilient across the board, including the strong reports that MSFT and AMZN just posted tonight. However, the economic data is beginning to counter these strong reports. Since last week I have been shedding my positions and currently hold a fair amount of cash. I have also been moving in and out of 3x bear funds, such as EDZ. Frankly, I wouldn't mind a strong correction here because it would create more value plays and some of my favorite stocks, such as ELY, would begin looking cheap again.

In other news, Bernanke was just reappointed to be Fed Chairman after a Senate vote of 77-23. Apple released its new iPad, which didn't convince me its a necessary device to have. I'm not convinced it's a better substitute for the phone or laptop because the Kindle is a better e-reader, the laptop is a better laptop, and the phone and is a better phone than the iPad. I'll save the $500.

I enjoyed when Obama talked of America's need to play for 1st place in last night's State of the Union address. I believe there is a discouraging spirit amongst Americans right now that we are falling behind China and India. America is fighting nation, a nation of innovation and democracy, and most importantly, a nation whose morale may fade but whose fight doesn't stop. As Americans, we will and always have, overcome the hardships that sometimes cloud over our great nation.

Apple's Strategic Intent

Apple's strategic intent in releasing its tablet has hurt competitors in ways you may not have expected. I first recall learning about the tablet device a few months ago, after someone reported seeing truckloads of books being unloaded at Apple's offices. As more information "leaked" about the tablet device, Apple benefited by forcing consumers to wait for their new product release instead of buying a Kindle or Sony E-Reader. Customers are smart. They weigh the benefits and costs and make well-informed decisions. For many, it is worth the wait to see what the innovative engineers at Apple have cooked up in the labs. Thus, even though the product is not yet available for purchase, Apple has potentially stolen market share and at the very least delayed a customer's purchase of a competitor's product.

Announcing the release date of a new innovative product also stalls responses from competitors, who may be forced to drastically change their business model upon release date. Even worse, competitors may unnecessarily ramp up R&D spending or marketing  when the new product actually fails to live up to expectations.

The power of Apple is in its perception as an innovative company whose products and services transform the marketplace. Customers know a new product announcement means something that's potentially revolutionary - and that's power that competitors cannot control and power that demands a premium in product price and stock price.

Things to Watch for Tommorrow

• Apple unveils its tablet device
• New Homes Sales - 10:00AM
• FOMC Announcement  2:15PM- Interest rates are expected to remain the same
• Notre Dame at Villanova (3)  7:00PM - ESPN - College Basketball :)
• President's State of the Union Address 9:00PM - Follow his discussion on the budget deficit

Analyzing Bernanke's Prospects for Reappointment

If uncertainty and volatility are to decrease in the financial markets, it's imperative for Bernanke to be reappointed as Fed Chairman. Bernanke has performed well in the midst of the "Great Recession", although the long-term ramifications of his policies have yet to be realized. The stock market is in love with his policy of low-interest rates, fueling the economy with cheap borrowing. Over the past few days, the market has reacted negatively to any news of Senators voting against Bernanke.

According to Dow Jones Newswires, 40 Senators have confirmed their support for Bernanke while 17 have opposed it. In order to be reappointed, Bernanke needs 60 votes. With the President and the stock market already supporting his reappointment, and already having the support of a majority of voters, it stands to reason that Bernanke will be reappointed and the stock market will react mildly positive to this news (most of the positivity has been priced in today, in my opinion).

Most likely, more important economic data and earnings releases that come later in the week will trump the news that Bernanke is reappointed.

The final result will likely be this Thursday or Friday.

The Week Ahead: 1/25 - 1/29

A slew of economic data will be released this week - Existing Home Sales on Monday, Consumer Confidence on Tuesday, Fed meeting on Wednesday, Durable Goods Orders / Jobless Claims on Thursday, and GDP / Consumer Sentiment on Friday.

Whereas last week the earnings reports moved the markets, this week the economic data will assuredly be the driving force. Now is definitely a time to be on your toes and be ready to shift the composition of your portfolio. Last week I took a little off the table as the markets sold off, jobless claims spiked, the VIX jumped, and uncertainty increased around the financials. However, as I wrote in my recent post , the key to accurately gauging the health of the economy and the stock market is to following the economic reports and earnings data.

The uptrend lines on many charts were broken last week and bearish long-term MACD crossovers abound on many charts - from the FOREX market to the DJIA. The U.S. dollar looks poised to strengthen in the coming weeks, though it is due for a pullback after last week's surge.

Obama's Proposal to Place Restrictions on Banks

From thewhitehouse.gov:

The proposal would:

1.   Limit the Scope - The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

2.   Limit the Size - The President also announced a new proposal to limit the consolidation of our financial sector.  The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

My take: Limiting the proprietary trading operations, hedge-funds, and private equity funds could subsequently lower liquidity in the markets. The one thing that has irked me throughout this whole crisis is how much bad press trading operations receive. People sometimes lose sight of the vital role traders play in our economy --> they provide a market and they increase liquidity. Higher liquidity levels result in lower costs of borrowing for firms and increase the financial efficiency of our economy. Instead of highlighting these positives, the press focuses on their "excessive risk-taking" and their "risky bets fueled by greed." If this proposal were to pass, and that's a big if, then the subsequent fall in liquidity could pose a larger risk than
the financial firms themselves taking part in these trading operations in the first place! Of course, there is a lot of uncertainty about how liquidity would be affected, but it's clear this proposal would not increase it by any means.

The second part is a little more tricky. As for limiting the size of banks, the government cannot regulate the leverage, liabilities, and risk-taking of the banks better than the banks can, as long as the banks know they won't receive a bailout. The problem then becomes creating an environment in which no bank is "too big to fail." How do you do this? In this environment, I would like to know. I'd also like to know what the ramifications would have been were the government to let a bigger bank, such as a Citi or BoA fail, and further, whether they actually would have failed had the government not intervened. It's a shame we can't know the results both ways. There is no question that the government's intervention ultimately had a positive impact on the markets in the short-term, but the longer-term consequences have yet to be seen.

Ultimately, it seems like there is little support right now for this proposal and  I highly doubt it will get passed.

Analysis on the Current State of Markets

The past two days in the stock market have been marked by volatility and uneasiness. The VIX is up 16% as I write this and the Dow is down more than 200 points. For those of you who have followed some of my previous posts, I often comment on the jobless claims number. Today, the number came in at 482k, easily surpassing the upper end of the consensus range and pointing to a halt in the improvement in the labor market. In fact, this was the first week (out of the past 19) that the 4-week moving average did not fall.

Earnings have been better than expected across the board, with some uneasiness about the mortgage/credit loan losses that the banks reported. Later tonight I'll have an analysis of Obama's proposal for the banks and limiting risk.

Despite the market sell-off it is IMPERATIVE to continue following the trend in earnings and economic data. This is the best way to gauge the future direction of the market and the health of the economy. No matter what direction the psychological participants push the market, the ultimate, long-run determinant is influenced the most by economic and earnings data. So far, this data has been largely positive, with the exception of today's higher jobless claims numbers and the sticky unemployment rate above 10%.

I'll be following every bit of economic data that's released in the following weeks to determine whether this recent sell-off is representative of a change in the trend of of the economy. My instinct and expectation is that the market is currently pricing in negative economic news that has yet to come. Further, there is no doubt the market is digesting Obama's proposal for banks and is pulling-back after a near 65% recovery from market lows. Below is the jobless claims chart from econoday.

Euro hits 4-month low

The Euro just hit a 4-month low against the USD on Greece's debt concerns. It looks like it can drop further. Here's the article from Bloomberg.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aTlPpu2CgJsg&pos=2

Recall that on Dec. 8, Fitch downgraded Greece's debt on concerns about an uncontrollable budget deficit. Greece has the 33rd largest GDP in the world.

Here's a chart of the EUR/USD.

Useful Links

Here are some useful sources that I check frequently in order to grasp an understanding of what's going on in the markets.

Flow of Funds Report - The most undervalued report on economics
http://www.federalreserve.gov/releases/z1/Current/z1.pdf

Federal Reserve of San Francisco Research - Most undervalued website on economics: Provides amazing research.
http://www.frbsf.org/

Global Economic Calendar - Major economic releases in each country, links to those reports, and analysis. This link is useful for FOREX traders.
http://www.forexfactory.com/calendar.php

U.S. Economic Calendar - I check this daily. You should too.
http://fidweek.econoday.com/

World Interest Rate Table
http://www.fxstreet.com/fundamental/interest-rates-table/

Dow Jones Futures - This site contains most of the futures numbers for a variety of indices. The link is to the DJ Futures. Note that futures data can be obtained on a variety of sites, from cnbc.com to wsj.com
http://futuresource.quote.com/markets/market.jsp?id=index&s=QDJ

Bureau of Labor Statistics - The BLS provides many of the major economic reports and has extremely insightful articles.
http://www.bls.gov/

Economist Intelligence Unit - Comparative Country Analysis and Data
http://www.eiu.com/index.asp?rf=0

American Institute for Economic Research - Great analysis on some of the more pressing issues in economics.
http://www.aier.org/

Earnings Calendar - Everything you need to know about upcoming earnings reports, conference calls, and dividends.
http://www.earnings.com/highlight.asp?date=20100120&client=cb

NEWS SOURCES:
I'm an avid reader of both the Wall Street Journal and the Economist. You may need a subscription to access the articles on the sites. I recommend you get one if you don't already have it because they have the best synopses and analyses of market action.
http://www.economist.com/
http://online.wsj.com/home-page

BLOGS:
I follow mainly three blogs, all on economics/finance/politics.
http://krugman.blogs.nytimes.com/
http://mjperry.blogspot.com/
http://www.calculatedriskblog.com/

Hope this helps with your investments.

-dg