The price of oil

Crude oil is down to oversold levels (click on graph to enlarge). Are energy stocks a buy?

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Government liabilities, the dollar, and inflation

Conclusions from an astute money manager, Dr. Hussman (http://hussmanfunds.com/)

"There are two ways to force government liabilities into the hands of foreigners (which we will have to do since our domestic savings are insufficient to fund another large expansion in the federal debt). One way is to discount the government liabilities through lower bond prices and higher interest rates. The other is through Dornbusch-type “exchange rate overshooting.” In this event, the value of the U.S. dollar would effectively plunge, setting up expectations for a subsequent appreciation sufficient to encourage demand for U.S. Treasury debt and to absorb the new issuance."

These are long term issues that should not be ignored. In other words, inflation cannot be kept under control with the government subsidizing in such blatant way the housing market with no meaningful reaction from the public. For this reason I am not so sure oil and commodities are in a bear market. I would call it "consolidation". Time will tell.

One thing is sure, this country is changing...rapidly.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Stock sectors

I agree with those who think financial stocks went too far too fast. They need some rest.

Utilities look tired and unattractive.

Energy stocks, on the other hand, may be close to a spirited rally.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

The housing problem is worsening

The inventory of unsold homes increased 2.8% to 11.1 months supply. The normal inventory is close to 4 months. The housing debacle has a long way to go before reaching a healthy balance of unsold homes.

The weakness of the housing sector will continue to have a negative effect on the economy. This is the bad news. The good news is that the weaker economy will keep commodities from rising and will eventually have a positive impact on inflation.

The current economic environment favors those asset classes benefiting from lower commodity prices.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Why the Fed cannot control inflation

This chart (click to enlarge) shows the graphs of the growth in government expenditures and inflation at the consumer level.

If inflation is a monetary phenomenon (as clearly stated by Milton Friedman) and government spending is closely related to the growth of the money supply (see blog below), then it should come as no surprise that inflation is closely related to government spending.

This is exactly what this chart shows. Government spending declined sharply since 1980 and inflation also subsided. Government spending has been rising sharply since 1995 and inflation is now heading up in a worrisome way.

Can the Fed do anything about inflation? The answer is a clear “NO”. Why?

1. The first step would be to lower the growth of the money supply by raising interest rates. But they have no control over interest rates. The markets do. It would be unthinkable that they engage in a tightening phase with the economy on the brink of a serious recession. The markets are forcing the Fed to stay put.

2. Even if they could raise interest rates, they would have to allow the money supply to grow to meet government spending as they did in the 1970s. And the current growth of the money supply and low real interest rates are not conducive to lower inflation.

3. Market forces will control inflation. The higher inflation, the more serious the economic recession. Slower growth will keep commodities from rising and eventually it will translate into more stable inflation. But you can rest assured that if government spending follows the current trend, inflation will rise to higher levels in the next business cycle, as it happened in the 1970s.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

About the recent rally in financial stocks

I do not understand why the SEC rule about prohibiting shorting some financial stocks can be bullish.

A rule distorting the normal functioning of some sectors of the markets makes me nervous. The government keeps changing the rules of the game and we do not know what they are going to concoct next.

Is the new rule solving the fundamental issues faced by banks? I doubt it. For this reason I feel the rally has the flavor of a trap. Time will tell.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

The Fed is powerless (cont'd)

We give too much importance to the Fed. If you follow my writings, you know this is not the first time I say so.

The above graph shows the growth of government spending and the money supply M2 (click to enlarge). The correlation is striking. What is the point?

The Fed prints enough money to finance government spending. No more. No less. Their most important function is to regulate the financial system. And you know how successful they have been in anticipating the latest financial debacle.

My point is that we make too much of what the Fed can do.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

A well written comment

This is an excerpt penned by John Rubino on DollarCollapse.com.

Americans will have to figure out what kind of society to rebuild from the rubble. Barring a coup, the majority will decide, which means people who value the rule of law and sound money will have to have to argue effectively in favor of those ideals. And they’ll face an uphill battle, because, as in the 1930s, the loudest voices will be those blaming capitalism and freedom, and calling for an enlightened state to save us from ourselves. Those arguments will strike a chord because, after decades of wealth-without-effort, most Americans lack a clear understanding of this stuff. Most won’t immediately grasp concepts like Constitutional limits on government power, and many will buy the “bankers and rich people bad, government good” arguments of populists hoping to use the crisis to consolidate power in Washington.

I agree. In times of difficulty, populist ideas are easy to sell. This is how Italy and France had the largest communist parties of the western world after WWII. My hope is that the American people, having a long free-market tradition, will resist leftist tendencies.

This is no time to panic, but I still believe we need a leader who understands and explains to all of us the transition we are going through. He or she must convince the average person that big government is not the solution but the problem, as proven by the latest debacle of Freddie and Fannie.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

The Federal Home Bank system

Another GSE designed to help home owners. Everybody wants to help us. The net result is that they are bankrupting us. This is their mission statement from their website. What amazes me is the number and size of institutions feeding on the housing sector.

The FHB system overview. A Regional Cooperative of Twelve FHLBanks:

There are twelve Federal Home Loan Banks (FHLBanks), each with its own president and board of directors, located in different regions of the country, with twelve distinct sets of customers, all with differing kinds of demand for their products, services and expertise. The FHLBanks' cooperative structure is ideal for serving the System's 8,100 member lenders. Each regional FHLBank manages and is responsive to its customer relationships, while the twelve FHLBanks use their combined size and strength to obtain the necessary funding at the lowest possible cost.

How FHLBanks Help Communities:

The FHLBanks provide billions of dollars of primary liquidity to approximately 80% of the nation's financial institutions. By providing this assured liquidity to its members, the FHLBank System allows member institutions to remain active lenders, in all economic cycles, to help their local economies grow.

Mission:

"The mission of the Federal Home Loan Banks is to provide cost-effective funding to members for use in housing, community, and economic development; to provide regional affordable housing programs, which create housing opportunities for low- and moderate-income families; to support housing finance through advances and mortgage programs; and to serve as a reliable source of liquidity for its membership."

"FHLBank Advances. Advance lending is the FHLBanks' main business line. It currently represents about two-thirds of all the FHLBanks assets. These loans, known as advances, are well-collateralized loans used by members to support mortgage lending, community investment and other credit needs of their customers.”

FINANCIAL SYSTEMS AND ECONOMIC STRENGTH

In his wonderful book "The Birth of Plenty", W.J. Bernstein shows that all countries with strong economic growth must have at least one feature: a strong and efficient financial system. Without this system business cannot expand and display spirited growth. An example is Italy, which is doomed because of its medieval financial system (besides having a huge bureaucracy).

Naked short-selling has been outlawed in the US. One more restriction to our financial system. The outcome is that more and more domestic and international investors are moving their money to London or other more attractive financial markets.

We need to be careful. We can legislate ourselves into oblivion if we put so many constraints to trade and investment which scare investors. In a globalized economy people seek the most efficient way to invest their money.

The increase in regulations, caused by the total lack of supervision by those who were sleeping at the wheel (see posts below), is one of the reason the dollar has lost its glitter.

The markets always win!

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

THERE HAS TO BE A LIMIT TO WHAT WE CAN AFFORD

The president's proposal Friday to allow more troubled borrowers to refinance with Federal Housing Administration-insured loans will push the agency to fulfill its historical mission and try to keep a bad situation from getting worse, experts said.

The FHA, established in 1934 during the Great Depression to create more housing opportunities, helps those with low or moderate incomes or flawed credit histories gain housing through its insured loans that require relatively low down payments and have more underwriting flexibility compared with conventional mortgages.

Along with the Veterans Administration's mortgage program, the FHA helped spur the post World War II housing boom in the U.S. by making affordable mortgages available to Americans of modest means.

The FHA's mission has been to try to provide products that are "actuarially sound" and that the private sector may not be providing due to fears of a lack of profit, Belsky said.

In recent years, FHA-insured loans have lost market share to lenders offering subprime and exotic mortgages, according to experts.

There has to be a limit to all the largess of governments. Nobody knows, however, what the limit really is.

People ask. Governments give. Rightly so. Until the system breaks down. Distortions are created. Cracks become increasingly more visible. Eventually the markets always win. Our challenge is to stay on the side of the markets.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

About the Office of Federal Housing Enterprise Oversight

This is the mission statement of OFHEO as shown on their website.

OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). OFHEO works to ensure the capital adequacy and financial safety and soundness of two housing government-sponsored enterprises (GSEs) -- Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are the nation's largest housing finance institutions. They buy mortgages from commercial banks, thrift institutions, mortgage banks, and other primary lenders, and either hold these mortgages in their own portfolios or package them into mortgage-backed securities for resale to investors. These secondary mortgage market operations play a major role in creating a ready supply of mortgage funds for American homebuyers. Combined assets and off-balance sheet obligations of Fannie Mae and Freddie Mac were $4.2 trillion at year-end 2005.

Fannie Mae and Freddie Mac are Congressionally-chartered, publicly-owned corporations whose shares are listed on the New York Stock Exchange. Under terms of their GSE charters, they are exempt from state and local taxation and from registration requirements of the Securities and Exchange Commission. Each firm has a back-up credit line with the U.S. Treasury.

OFHEO's oversight responsibilities include:

Conducting broad based examinations of Fannie Mae and Freddie Mac; Developing a risk-based capital standard, using a "stress test" that simulates stressful interest rate and credit risk scenarios; Making quarterly findings of capital adequacy based on minimum capital standards and a risk-based standard; Prohibiting excessive executive compensation; Issuing regulations concerning capital and enforcement standards; and Taking necessary enforcement actions.

Oh, well....with organizations like the Fed, the Treasury, SEC, and OFHEO we should not have any problems! What went wrong? I let you answer this question. The management of such outfits,however, if they were a public enterprise, would probably go to jail for fraud and gross negligence.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

The outlook for interest rates

Do not listen to what they say in Washington. This chart (click to enlarge) tells you a story you can trust.

Short-term interest rates decline (or, they cannot rise) when the unemployment rate is going up as it is doing now.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

How to interpret trading volume

Trading volume is very useful to identify market tops and market bottoms.

Above average volume, following a strong market rise, points to a market top.For example, see the chart of GLD. Strong volume took place in March and now. What does it tell you for the future of gold?

Above average volume, following a sharp market decline, suggests a market bottom is imminent. Volume has increased steadily during the recent market decline and has reached above average levels.

What's next for the market? Is this the capitulation we were waiting for?

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

About the dollar (cont'd)

I just finished to write the piece below about the dollar and an article on the first page of the Financial Times caught my attention. The title: "Sovereign funds cut exposure to weak US dollar."

Bottom line of the article? Large international investors find more attractive to cut deals with private equity funds in Europe.

We should not forget that globalisation is alive and well and that capital moves to the most attractive places.

Hello Washington, are you listening?

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

The message of the dollar

These are comments I read on a blog. They reflect the typical view of the media.

"The problem for policy makers is that large portions of the electorate are starting to realize that a weak dollar is not simply a problem for those who vacation in Paris. People innately understand that a falling dollar is adding to the cost of living. So there are very strong political reasons for the Fed and the Treasury to talk tough on the dollar."

I believe it is exactly the opposite. The policies of our politicians are wrong and are causing inflationary pressures to rise across the board and productivity to decline. Rising inflation is creating economic uncertainties and enormous confusion on what should be done. International investors, as a result, sell their dollar denominated assets and invest their money in other countries.

The painful decline of the dollar reflects these uncertainties created by rising inflation. What I am saying is that inflation, our waning purchasing power, and weak economic conditions are causing the dollar to decline.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Who is to blame?

The problem is us...the consumers. We are lacking the knowledge and common sense. How can we think we can afford big houses and big cars if we do not make the money to pay for them? The problem it's us!

The problem is the lack of education of the mass. The banks own us. Everything we own and we do carries debt, which is a payment to our real owners...the financial institutions.

I strongly believe it is the lack of education that is bringing us to the threshold of bankruptcy.

I really feel strongly about it. I wish I could do something about it. I cannot. But you can. Get educated, as much and as deeply as you can.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Stop borrowing, Mr Corzine

July 17 (Bloomberg) -- New Jersey Governor Jon Corzine said in November he was willing to lose his job if that's what it took to cut the state's $32 billion debt load. Now, the former Wall Street bond trader says more borrowing is inevitable.

``It may be possible that we need to grow debt if there are capital projects we have to do and we don't have any other way to fund them,'' Corzine, a first-term Democrat who is starting his re-election campaign, said in an interview.

Incredible! People ask.....politicians give...even if the ultimate outcome is borrowing and bankruptcy.

We should have the courage, and the wisdom, to tell our politicians to stop borrowing because we just cannot afford the grandiose projects we would like to have, but we cannot afford.

Borrowing is our road to oblivion! I just cannot understand why we accept this state of affairs.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

From the Financial Times (author: Willem Buiter)

.........So let’s call a spade a bloody shovel: nationalise Freddie Mac and Fannie May. They should never have been privatised in the first place. Cost the exercise. Increase taxes or cut other public spending to finance the exercise. But stop pretending. Stop lying about the financial viability of institutions designed to hand out subsidies to favoured constituencies. These GSEs were designed to make losses. They are expected to make losses. If they don’t make losses they are not serving their political purpose.

So I call on Secretary Paulson, Chairman Bernanke and Director Lockhart to drop the market-friendly fig-leaf. Be a socialist and proud of it. Come out of the red closet. The Soviet Union may have collapsed, but the cause of socialism is alive and well in the USA. Granted, the US version of socialism is imperfect thus far. The federal authorities have mainly intervened to socialise the losses in the financial sector while allowing the profits to continue to be drained off into selected private pockets. But that is bound to be an oversight. It surely cannot be the intention of such committed Marxists to target taxpayer-funded largesse solely at the very rich and at a few favoured, electorally sensitive constituencies. Fannie and Freddie are, or will be, safe in the hands of comrades Paulson, Bernanke and Lockhart.

Wow! I totally agree. What is going on in our country? It's simply incredible we are changing so much from the script of our founding fathers. And then we tell China they should have more open markets. Simply incredible! Simply incredible!

And then you wonder why the dollar keeps sinking. The weakness of the dollar, as I have been saying for a very long time, is the harbinger of major socio-political changes in the USA.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

A down day?

Because of of the financial problems of Freddie Mac and Fannie Mae, the futures are down substantially this morning.

The issue. Should the government nationalize Freddie Mac and Fannie Mae?

We are the bastion of the free market system (supposedly) and yet we want the government to take over a huge part of the financial system.

What a momentous change in the way we think!

What makes matters worse is the total vacuum in leadership at the Fed and Treasury. The only thing they can say is that they need more power and more resources.

This is how democracies change from a free market system to a social-democratic system. There is no way to stop the process as we move from crisis to crisis. Until we reach a gridlock as in Europe.

Maybe the form of government is the real advantage of China. As a successful businessman told Koppel, the Chinese government can be trusted and provides stability.

There is no doubt our country is going through momentous changes. Let's keep our fingers crossed.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Koppel's TV program on China

A successful businessman, with a perfect American accent, told Koppel that he prefers the current Chinese political structure to democracy.

Why? Because he knows what to expect from the Chinese government. It is a Confucian view of life. The Chinese are about to show us if their "system" is superior to the vagaries of a democratic system. It should not take much time. A few years.

My sense is that democracy is bound to become victim of a burgeoning bureaucracy which eventually stifles growth. Europe and Singapore...two examples of what I am talking about.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Thought of the day

The odds are against you if you try to find a long position in a broadly declining market, as it is happening now.

Too many sectors are weak. The odds are against you if you try to buy stocks hoping to find a deal. I think it is better to wait for the market to gain momentum on the upside and then buy the strongest sectors.

Or, to put it in a different way, you do not want to try to catch a falling knife.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Bad news create oportunities

This is no time to panic. This is a superb time to look for opportunities.

• The auto sector cannot sell cars built for a different era.
• Airlines are struggling under the heavy weight of rising oil.
• The housing sector is in shambles and no end is in sight to its dreadful decline.
• The financial system is trying to regroup with bank credit slowing down in a worrisome way.
• Employment is declining and rising unemployment claims point to more weakness ahead.
• Industrial production is slowing down in response to a consumer overwhelmed by rising inflation.

Poor business conditions create the environment needed for the next up-leg of the business cycle. Interest rates decline (it already happened), commodities weaken (industrial commodities show a decline in the past 12 months), crude oil will eventually decline and stabilize at lower levels, and inflation will decline (this still has to happen).

In this transition long-term Treasury bonds usually do well, especially in summer.

The business cycle is alive and well and provides superb investment guidelines.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Please note

Today commodities were weak and bonds were strong.

Exactly what you should expect when the economy weakens.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Looking at the latest data

I just reviewed the economic data released in the past two weeks. My conclusions?

The economic slowdown continues and seems to intensify. This is the bad news.

The good news is that an economic slowdown has a definite negative impact on some asset classes and a positive one on others. You can always make money in any economic environment if you follow the business cycle (see my book Profiting in Bull or Bear Markets).

Industrial commodities, for instance, will face some strong headwinds. Treasury bonds, on the other hand, should perform well in this environment.

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Thoughts from China

Some excerpts from the the Washington Post

When we were the Sick Man of Asia, We were called The Yellow peril.
When we are billed to be the next Superpower, we are called The Threat.
When we closed our doors, you smuggled drugs to open markets.
When we embrace Free Trade, You blame us for taking away your jobs.
When we were falling apart, You marched in your troops and wanted your fair share.
When we tried to put the broken pieces back together again, Free Tibet you screamed, It Was an Invasion!
When tried Communism, you hated us for being Communist.
When we embrace Capitalism, you hate us for being Capitalist.
When we have a billion people, you said we were destroying the planet.
When we tried limiting our numbers, you said we abused human rights.
When we were poor, you thought we were dogs.
When we loan you cash, you blame us for your national debts.
When we build our industries, you call us Polluters.
When we sell you goods, you blame us for global warming.
When we buy oil, you call it exploitation and genocide.
When you go to war for oil, you call it liberation.
When we were lost in chaos and rampage, you demanded rules of law.
When we uphold law and order against violence, you call it violating human rights.
When we were silent, you said you wanted us to have free speech.
When we are silent no more, you say we are brainwashed-xenophobics.

Interesting!

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

The major problem facing the stock market

My work on the low grade bond market is saying there is still trouble brewing. My indicators will remain bearish as long as the problem persists.

Stay tuned!

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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Observations

SNS and I went sailing for a few days. We had fun. Winds were 10-15 knots on the peaceful and calm waters of the Chesapeake Bay, MD. These sailing trips are a great escape as I change environment and meet different people. A mind cleanser.

I brought my reading material with me to catch up with what is happening outside the world of finance. SNS was driving on the way back to Akron and I started looking at Foreign Affairs. This is a superb publication with scholarly articles.

I was going through the pages quickly to get a feeling of the content. Condi Rice wrote that the world is expanding and we will continue to influence it with our culture and how the evolving international order will have to reflect our values. Why?

It is in our interest, but I am not sure the world will accept it. The issue is: should we impose our values? How about respecting and accepting and sharing the values of other countries?

Another article dealt with China. We are so impatient in giving advice to China on how they should behave politically and economically in order to project the right image at the Olympic Games.

The next article dealt again with China. The focus was to recommend a partnership of equals. China and the US share common interests. They should be emphasized and used to develop this partnership.

I also read about the value of NAFTA and its importance for our country and North America. We need to show the world we are successful in our relationship with our neighbors and we are a team player.

Another article dealt with restoring our partnership with Europe because the US needs Europe.

These articles recognize we have been isolating ourselves and that we need to be part of the bigger picture which is evolving rapidly. We are becoming a smaller player in world affairs, whether we like it or not. Our aim should be cooperation, not confrontation.

More, much more when you subscribe to The Peter Dag Portfolio on https://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977