Saturday, November 7, 2009

No Big Deal: US Budget Deficits will be lowered.

On Nov. 3, birders sighted the rare skinny parrot hawk, which repeats back calls about fiscal probity. Said President Barack Obama on that date: "The government is going to have to get serious about reducing our debt levels."
Yes, deficits are large. But a lot of this debate is for the birds.
But there's a larger reason we shouldn't let the deficit hawks ruffle our feathers: As the volume of squawking has risen, the situation has actually become less dire. And even without drastic action, the situation will improve materially in the coming year.
Much of the horrific explosion in the national debt—the deficit soared from $248 billion in 2006 to $1.4 trillion in the recently concluded Fiscal Year 2009—can be pinned on cyclical factors. When the economy goes in the tank, it creates a fiscal double whammy, gutting tax receipts and boosting demand for government spending programs that are both ordinary (increasing unemployment benefits) and extraordinary (bailouts, stimulus). Spending rose 18 percent and revenues fell 16.6 percent in fiscal 2009—the worst decline seen since the 1930s, with corporate income taxes plummeting 55 percent. Had revenues been steady, the deficit would have been only (only, he said) $1 trillion.
But signs of recovery returned with the spring. As the financial system came back from the brink, banks paid back billions in TARP funds. In its mid-session review, issued in late July, the Office of Management and Budget dialed back its estimate for the fiscal 2009 deficit from $1.84 trillion in May to $1.58 trillion, due in large part to the trimming of cash piles set aside to help Wall Street. The stock market rally, recovering corporate profits, and an economy that began to expand at a 3.5 percent rate in the summer have translated into higher-than-expected tax receipts. And so, as the treasury department's Financial Management Service reported, the final numbers came out better both on spending and receipts—with a $1.42 trillion deficit, $138 billion smaller than was forecast in July.
The consensus of economists and politicians has continually underestimated the strength and timing of the recovery. So as the recovery rolls on, we'll continue to see more upside surprises. On Nov. 2, the Treasury Department announced it would need to borrow $276 billion in the fourth quarter, 42 percent less than it thought it needed in July. All those Goldman Sachs bonuses will be taxed at the highest marginal rate. Add in the prospect of more TARP repayments and job growth, and the United States is likely to experience a sharp cyclical upturn in tax receipts. The Obama administration forecasts that the economy will grow next year at a 2 percent rate and produce a $1.5 trillion deficit. But if the economy grows more rapidly, at 3 percent or 3.5 percent, it's plausible that the deficit will shrink by 10 percent to 20 percent on its own.


Wednesday, November 4, 2009

Buffett's Biggest Bet!!

Yesterday, Warren Buffett stormed back into the headlines with the largest deal in his 44-year career at the helm of Berkshire Hathaway. The “Oracle of Omaha” announced that he was buying the 77.4 percent of Burlington Northern Santa Fe that he didn’t already own – paying $26 billion or $100 per share of the railroad (a 30 percent premium over the previous day’s closing price), and assuming roughly $10 billion in Burlington debt. Including his previous holding in Burlington, this is a $44 billion investment for Mr. Buffett, and is quite a bet for the investment icon.

The acquisition accounts for virtually all of Berkshire’s available cash, and combined with the assumed debt, the company could face credit rating downgrades from the major agencies that could affect other parts of the insurance giant’s operations (Berkshire’s debt was already on negative watch by Standard & Poor’s). And when arguably the world’s best investor puts this much on the line, it’s certainly worthwhile to stop and take notice in order to determine the scenario in which Mr. Buffet sees this bet paying off.
Warren Buffett has been calling the acquisition an “all-in wager on the economic future of the United States.” Of course, this is a tremendous endorsement of the U.S. economy as Burlington Northern plays a very large (and growing) role in it. Just look at the map of the railroads and you’ll see what Buffett means – Burlington’s routes move goods to and from Canada, to and from China-linked ports, to and from ports that trade with Europe – and, of course, they crisscross a big part of the U.S., moving goods across the country.

We will, however, take it one step further. From our standpoint, we see the acquisition as a play on higher commodity prices and tremendous future inflation. Rails see higher demand as oil prices rise and the costs of the alternative form of transportation, trucking, move higher. Because railcars don’t run on oil products, but rather coal, they have a clear competitive advantage; Coal also is a commodity which, relative to oil, is more plentiful, as well as domestically available.

Oil prices are dictated by worldwide demand. Regardless of continued economic weakness at home, energy prices have shot up from their lows as international/developing economies demand has returned. Burlington is not only protected from these price increases, but benefits from them as well with increased business. As the economy eventually improves, and shipping rates increase – railroad companies, Burlington included, will benefit. With higher demand, the rails also gain pricing power – and can increase their rates to compensate for rail maintenance and expansion.

Of course, the purchase is also shrewd because the replacement value of Burlington Northern’s assets has been estimated as high as $180 a share. To help pay for the acquisition, the board of Berkshire Hathaway has decided to split the B shares – a move that will make them more accessible to the retail investor. This is another timely move by the Oracle.

This purchase also jives with Buffett’s investment in the Brazilian real – a currency which, courtesy of a resource-based economy, has one of the brightest futures around. The investment also provides a counterbalance to Berkshire’s fixed income investments (a must for insurance companies who need to keep less-volatile investments on hand to meet claims), which protect against a deflationary event. All in all, we applaud the choice and continue to recommend Buffett’s vehicle, Berkshire Hathaway (Growth Portfolio), as a good stock for the long haul.

Courtesy: Stephen Leeb

Global Economy is Firing on All Cylinders

What a difference 12 months can make.
Just one year after every national economy on earth was in deep trouble, a powerful global rebound is underway. In fact, the global upswing is a lot stronger than most investors realize.
So don’t let a few days’ decline here and there cause you to lose sight of one of the most important investing trends investors will find today.
According to ISI Group researchers, the transformation has been a dramatic one. A year ago, every national economy on earth was declining at the same time – some dramatically. Today, however, every economy is now improving – though at different paces.
ISI points out that last week’s highlights included China’s third-quarter gross domestic product (GDP) rising at a 12% quarter-over-quarter rate, and Korea’s economy rising at around 8.2%. McDonald’s Corp. (NYSE: MCD) sales in China were reported up 30%. China retail sales are up 24% annualized in the past nine months. And China industrial production is up 21% in the last 10 months. Across the China Sea, export orders and industrial production in Taiwan are up at around a 51% annualized pace.
Over in the developed world, we’re seeing much of the same: The U.S. leading indicators are rising at the fastest pace since 1983. Canadian retail sales are up 3% annualized in the last eight months. And Japanese exports are up at a 31% annualized pace in the past half year, while Australia is smokin’, with auto sales alone up 12% annualized.
Amid this drama, copper prices are up 120% this year, while commodity memory chips (dynamic random access memory chips, known as DRAM), are up 71%.
Here in the United States, chain store sales are up at a 5.5% pace over the last 10 months and are likely to be much better than the National Retail Federation is predicting, which is negative 1%. And employment? Glad you asked. As mentioned last week, unemployment claims have declined 127,000 in the past six months, which amounts to a faster rate of descent than seen in the last two jobless recoveries.
I want to throw out a shocker of an idea for you to think about until next time. ISI points out that payroll losses have been improving (i.e. falling less) by 77,000 jobs per month on average over the past six months. If that keeps up, payrolls will rise by 137,000 in January next year. And if that occurs, regression analysis suggests that GDP growth for the quarter will come in at around 4%.

Is it possible? Well, virtually everyone seems to think it’s impossible – which increases the likelihood that it could occur. But if you look at trends of unemployment claims, temp employment surveys, layoff announcement tallies and the like, they are all moderating in syncopation.
Pessimists will call this just a lull and a fake-out, but I would just note that improvements have become the norm overseas. As mentioned last week, ISI reports employment is already on the rise in Sweden, Korea, Brazil, Russia, Finland, Japan, Australia, Taiwan and Canada, in order of strength.
The theory is that employment was cut too much last year as companies anticipated a depression. Models of behavior suggest that employment should have only been cut by 3.5%, and instead almost 6% of jobs were cut away. This is why productivity and earnings gains have been so amazing.
Ultimately, and perhaps as soon as right now, companies will start hiring again to reverse their “throw everything overboard” mentality of last year. That will have the effect of moderating earnings gains, but it will also put money back into workers’ pockets and in turn, help boost revenue.
In summary, don’t let the short-term setbacks we’ve seen of late cause you to lose sight of the big picture: Long-term global growth trends are in place. As shown in the chart above, it would be natural for the rapid ascent of the past eight months to taper off into a sideways consolidation before its next leg higher. A total collapse is always possible, but it’s just not the most likely scenario now, no matter what the bears say.

Central banks lead subtle shift away from dollar.

Central banks with trillions of dollars in reserves that are already stepping up euro and yen purchases will likely continue doing so in coming years, driven by worries over the stability of the greenback.
A record US budget gap and the rise of dynamic developing economies like China suggest the dollar, down over 20% since 2002 on a trade-weighted basis, has further to fall.
Of course, the dollar comprises some two-thirds of global reserves and will remain dominant in most holdings, as attempts to dump it would destroy the value of central bank portfolios.
But with the speed of reserve accumulation increasing after a crisis-induced lull late last year, policy makers can choose to park more new cash in euros and yen without having to sell existing dollar assets.
"I think 2009 will be remembered as a watershed moment for currencies," said Neil Mellor, strategist at BNY Mellon, which has some USD 20 trillion in assets under custody. "I don't think there will be an imminent move, but it is quite clear there's a plan to shift reserves to a more balanced portfolio."
Barclays Capital research showed that central banks that report reserve breakdown put 63% of new cash coming into their coffers between April and July into non-US currencies.
"There's an incipient desire to reduce the dollar share of reserves, and central banks will use any opportunity to do it, provided it doesn't cause the dollar to fall out of bed," said Steven Englander, chief U.S. currency strategist at Barclays.
International Monetary Fund data shows the dollar's share of known world reserves has been declining since it stood at 72% in 1999, the year the euro was introduced. As of the second quarter of 2009, it accounted for 62.8%.
To be sure, some of that shift is driven by the dollar's decline against a basket of currencies over that period.
But the Barclays data, which removes valuation effects, shows the second quarter was the only one in which central banks accumulated more than USD 100 billion in reserves and put less than 40% into dollars, down from a 70 percent quarterly average back to 2006.
Overall reserves rose 4.8% to USD 6.8 trillion in the second quarter, the IMF said, the first increase in a year.
Policy makers acknowledge the dollar will remain a linchpin of global finance for many years to come. But it has fallen steadily on a trade-weighted basis over the last decade, a troubling sign for China, Russia, India and other big US creditors holding trillions of dollars of US Treasury debt.
Worries about record deficits, run up as the United States borrowed hundreds of billions to stimulate an economy ravaged by financial crisis, has further diminished foreign demand for US assets, making it likely the dollar will weaken further.
For a graphic of the dollar's declining share of known reserves and rising US budget deficit, click
And as others catch up to the United States, the dollar will share the stage with other currencies, said Barry Eichengreen, an economics professor at the University of California at Berkeley.
"The big beneficiary in the short run will be the euro, as only it has the requisite liquidity," he said. "But there's no reason why we shouldn't look forward to the advent of a multipolar reserve currency system."
The euro's share of known reserves hit 27.5% in the second quarter, from 18% in late 2000, IMF data showed. Analysts say it could exceed 30% in coming years.
The yen and sterling also stand to gain, while currencies from commodity exporters such as Australia may see more buying, Mellor said, particularly by energy-hungry emerging economies such as China, which holds USD 2.3 trillion in reserves.
Barclays' data showed claims in "other currencies" beyond the big four -- dollar, euro, yen, sterling —rose more than 10% between April and July.
China does not report currency composition but is widely thought to hold around 70% in dollars.
Russia, the third biggest reserve holder with USD 419 billion in its war chest, says it holds some 47% in dollars and 40% in euros but wants to buy more of other currencies.
Central banks are also turning to gold, which Wells Fargo global economist Jay Bryson said may partly explain gold's surge to record highs.
Taiwan, the fourth largest reserve holder, has said it is considering buying more gold, while China said in April it had increased gold holdings by 75% since 2003. This week, India bought 200 tones of gold from the IMF for USD 6.7 billion.
Central banks do face limits on how they diversify their reserve holdings. Most currencies are simply not deep enough to accommodate massive sudden inflows and outflows.
Even a big shift from dollars to euros begs the question of which country's debt to buy. No European government bond market is as deep as the U.S. Treasury market, and bonds with the highest yields are from countries with the weakest economies.
"If you buy a 30-year Italian government bond, is Italy still going to be in the euro zone 30 years from now?" said Bryson. "Probably, but there is a risk there."
And while China's economy is on track to one day become the world's biggest, the yuan won't be a viable reserve candidate until China loosens controls and lets foreigners invest freely.
"That is a matter of decades, not years," said Anne Krueger, a former IMF deputy director now at Johns Hopkins University's School of Advanced International Studies.
Edwin Truman, a senior fellow at the Peterson Institute for International Economics and a former Federal Reserve economist, says it's "not so much a drift away from the dollar as it is a drift to other currencies."
"Will the dollar share of reserves be lower five years from now?" he asked. "If I had to guess, I'd say, 'yes.' Will it be because of a massive stampede out of dollars? Probably not."


Why the Dollar’s Rebound Will Be Short-Lived.

The dollar yesterday (Thursday) rallied from 14-month low against the euro, but that rally will be short-lived as U.S. monetary policy is likely to remain loose, even as other central banks raise interest rates.
A recovery of investor risk appetite has slammed the dollar in recent months, driving the currency to a rate of $1.5017 against euro on Wednesday, compared with $1.25 in March. But yesterday, analyst Dick Bove’s downgraded outlook for Wells Fargo & Co. (NYSE: WFC) and China’s less-than-stellar third-quarter growth spurred a greenback recovery.
The euro fell as low as $1.4944 against the dollar in early morning trading, as investors became more skeptical of the global economic recovery. Still, many analysts believe the dollar will rather hastily resume its decline.
The euro’s proximity to $1.50 suggests that the market is not taking the current correction as too serious,” Michael Klawitter, senior currency strategist at Commerzbank in Frankfurt told CNNMoney. “Quite a few investors are buying euros on dips.”
And they have good reason to because despite having a so-called “strong dollar policy,” U.S. policymakers understand that a weak dollar is benefiting the economy by keeping liquidity high and boosting exports.
The Fed’s Weak Dollar Policy
The Reserve Bank of Australia earlier this month became the first developed economy to tighten monetary policy. Canada, which has shown signs that it is emerging from the economic downturn faster than the United States, may be next. And now China – whose gross domestic product (GDP) expanded by 8.9% in the third quarter – is turning its attention from economic expansion to inflation, as well.
“The policy focus of the next few months is to balance the need to maintain stable and relatively fast growth, the need to adjust the economic structure and the need to better manage inflationary expectations,” China’s State Council said in a statement signaling a looming policy shift.
However, it’s a far different story in the United States where price pressures remain low and the recovery remains mild.
After contracting by 6.4% in the first three months of the year, the U.S. economy shrank by a revised 0.7% in the April-June period. But analysts remain skeptical, given the soaring unemployment rate and moderate effects of the Obama administration’s stimulus.
About 7.2 million jobs have been shed since the recession began in December 2007, driving the unemployment rate to 9.8% in September. Some economists estimate that the jobless rate could peak as high as 10.5% next summer.
Meanwhile, the President Obama’s $787 billion stimulus plan – which the administration claimed would keep unemployment below 8%, and push it below 7% by the end of 2010– has brought little stability to the job market.
Only about a quarter of Obama’s stimulus, or $164 billion, has been paid out. About half, nearly $400 billion, will be paid out over the next 12 months in the build-up to mid-term elections, and the remainder will be disbursed in 2011.
Indeed, the outlook for a quick recovery in the United States is dim, which means the U.S. Federal Reserve will almost certainly maintain its expansive monetary policy until it sees more progress.
In fact, Federal Reserve Bank of St. Louis President James Bullard last week said that a falling unemployment rate is a precondition for an increase in the benchmark interest rate from near zero.
You want some jobs growth and unemployment coming down,” Bullard said in an interview with Bloomberg Radio. “That is a prerequisite” for an increase in interest rates.
The Fed’s Beige Book, which was released Wednesday, offered even more justification for the dollar’s downward trajectory.
All 12 district banks observed “little or no” price pressures, while demand for bank loans was “weak or declining.”
“The Fed Beige Book confirmed the absence of pricing pressure in the United States and activity was merely starting to recover from depressed levels – thus the Fed is showing no signs of removing the punchbowl of low rates,” analysts at ING said in a research note. “Thus core trends remain intact and USD rallies should be sold into.”
Indeed, the Fed actually has a lot of short-term incentive to keep interest rates low and the dollar weak.
To begin with, a cheaper dollar makes U.S. exports more affordable to the rest of the world. And that has helped to shrink the U.S. trade deficit.
The U.S. trade deficit shrank by 3.6% in August to $30.71 billion from a downwardly revised $31.85 billion the month before. The July trade gap was originally reported as $31.96 billion.
It’s true that a drastic drop in the value of the dollar would make imports much more expensive for U.S. consumers and make it more expensive for the government to finance debt. But some analysts argue that so long as the dollar’s decline doesn’t turn into a rout, it actually benefits the economy.
As long as it doesn’t crash, a gradual, orderly decline is healthy,” C. Fred Bergsten, director of the Peterson Institute for International Economics, told The New York Times. “The dollar went up 40% between 1995 and 2002, so this is a necessary rebalancing.”