Question from a reader

Comment to the blog "Off the cuff" (see below): Whatever happened to the mantra the markets always win?

It was exactly the point of my blog. The markets always win. The chaos we are in is happening because the markets are winning. The government created distortions and the markets are now uncovering these distortions.

You cannot buy houses if you do not have the money to pay...even if the government is sponsoring the trade. You cannot set interest rates below inflation and hope that everything is fine and inflations remains tame. You cannot lower interest rates below 1% and hope the markets are not going to take advantage of it.

Yes...the markets always win...always.

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

Off the cuff

The world is struggling because of the excesses of the central banks trying to fix yesterday’s problems. The crisis is obvious ….. from New York to Sydney.

I cannot fail but think about Karl Marx’s prophecy….capitalism will collapse because of the absurd concentration of financial power. (What he missed is that any system will collapse under the concentration of any power….see what happened to the USSR).

No system can survive without the proper supervision of the government. Once the government fails to perform this important function, any political and economic system will collapse.

We are witnessing a tragic unraveling of the mistakes and blunders of the US central bank trying to avoid deflation in 2002 and the idea of the US government that anyone should own a home without having the money to pay (a democratic catastrophic dream).

We are paying the price. There is going to be a huge transfer of wealth from the private to the public sector. We have no choice. This is what is dramatic.

I agree with Popper (a contemporary philosopher). The purpose of the government is to set the rules of the game. Once the rules become bastardized, we will eventually have to pay the bill.

This is what is happening now. It is not the fault of the republicans or democrats. Our institutions have failed us.

What can we do? Nothing. As we move from one problem to the next we have to learn how to survive. Eventually the government will become so big that will create other problems. We do not know which ones.

The answer? Be flexible in what you believe in. The rules of the game are being re-written every day.

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

Spreads rising. Bad news.

Yields on speculative-grade bonds rose to distressed levels for the first time since 2002 as the turmoil sweeping Wall Street led investors to shun all but the safest government bonds.

Investors demand 10.25 percentage points more in yield to own junk-rated securities than Treasuries, according to Merrill Lynch & Co.'s U.S. High Yield Master II index. Bonds that trade at a so-called spread of 10 percentage points or more are considered distressed.

The last time spreads were so wide was in the aftermath of Enron Corp.'s collapse earlier this decade. Now, a slowing economy and failures of some of the largest U.S. financial institutions are driving investors away. Distressed bonds default within one year 22 percent of the time, compared with 1 percent for non-distressed junk bonds, according to Fridson Investment Advisors in New York.

These spreads have to come down. The dollar has to strengthen. The stock market has to rise. Only then will the economy find a bottom. Not until then.

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

Important indicator is sinking

A global recession? The Baltic Exchange Dry Index is tumbling (click on graph to enlarge). There is only one reason. Fewer commodities are shipped. Why? You guessed it. The global economy is slowing down in a meaningful way, as shown in our monthly report "The Global Business Cycle".

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

Watch the dollar

Excerpts from Bloomberg.

The combination of spending $700 billion on soured mortgage-related assets and providing $400 billion to guarantee money-market mutual funds will boost U.S. borrowing as much as $1 trillion, according to Barclays Capital interest-rate strategist Michael Pond in New York.

``As we get to the other side of this, the dollar will get crushed,'' said John Taylor, chairman of New York-based International Foreign Exchange Concepts Inc., the world's biggest currency hedge-fund firm, which manages about $15 billion.

If these experts are right, gold and hard assets should remain part of your portfolio.

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

Something very dangerous is brewing

Some thing dangerous is brewing. It is the belief that our problems are created by the markets and speculators.

Make no mistake about it. Financial markets are an essential component of the growth of any country since day one. It is one of the four main pillars of a growing and expanding society.

In his brilliant book "The Birth of Plenty", W. J. Bernstein shows why every successful society in history had four essential features working for them.

1) Property rights to stimulate and protect investors.
2) Knowledge and research to develop new ideas and new discoveries to improve the standard of living of the society.
3) Communication and transportation to bring products and people together.
4) Financial markets to finance growth and the new discoveries.

The stagnating or fading economies fail this test. Make no mistake about it, our recent attempt to change the nature of the markets by forbidding shorting or believing that the cause of rising commodities is speculators is seriously misguided.

It is ludicrous to think that the markets are efficient when commodities like oil and gold sag. But speculators are forcing their rise.

The markets are driven by government policies and the role of politicians in a society. The misguided policies of the Fed after the 2000 bear market are the main cause of our problems. Cheap money crates volatility. This time is no exception.

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

Thought of the day

There is a momentous transfer of power and wealth from us to the bureaucratic structure of this country. I recognize they had to do what they had to do to save us from disaster. The trends, however, are in place and are irreversible.

It is no coincidence, as I noted here a few days ago, that gold and oil are strong and the dollar is weakening.

There is a a sense of inevitability in the way human events develop. They tend to increase the power of some classes at the expenses of other.

Meanwhile, opportunities are created. But you have to be in the right asset classes.

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

Watch the reaction of the markets

The markets will speak...soon. Will the action of the the government be inflationary?

The answer? Watch what is going to happen to the markets. A decline in the dollar and a rise in commodities (gold and oil included) suggest the markets believe the move is inflationary. It will stabilize the market in the long run, but a bigger and more intrusive government, slower economic growth, and higher than average inflation is the price we will have to pay.

The good news is if instead we will experience a strong dollar and stable commodities. In this case the markets perceive the move as non-inflationary.

Time will tell. Stay tuned.

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

Business cycles and stock sectors

The strongest sectors in the past several months have been those that have shined consistently during weaker economic conditions. Commodities and "cyclical" sectors soar when the economy booms. The rules of the game change when the economy begins to grow at a below average pace. Commodities and "cyclicals" under perform during such times and others take the lead as interest rates decline and money is cheap.

Investors need to recognize the powerful business cycle forces. It is the only way to survive.

Overhanging the forces of the business cycle is the level of real interest rates. Money is cheap. No question about it. The rate on 13-week Treasury bills is less than 1% while inflation is at least 5% (depending on how you measure it). The implications is that the system has an inflationary bias.

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

Momentous events

What do I think?

Read my blogs. Financial crises are excellent buy opportunities. But you have to be selective and play the business cycle consequences.

The dollar weakened, commodities strengthened, oil strengthened, energy trusts (we follow closely) soared, energy stocks jumped. Financials will continue to benefit, but what is happening is inflationary in the long run.

Have fun. But be careful.

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

Volatility is soaring!

Good news! The CBOE volatility index (VIX) jumped above 34. This is a sign of panic.

Important market bottoms have been reached when VIX moved above 30. Stay tuned.

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

The next problem?

Two interesting and related stories from Bloomberg's website.

For Dean Nessen, the choice of a mortgage was easy. By agreeing to pay only interest for three years, the self-employed salesman didn't have to show proof of income and landed a rate of 6.25 percent.

Now, four years later, Nessen's industrial coatings business has gone belly up and his rate has jumped to 10.6 percent. He can't afford the payments and may have to move his family out of their home in Commerce Township, Michigan.

About 3 million U.S. borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of subprime loans outstanding, according to Inside Mortgage Finance, a trade publication in Bethesda, Maryland. Of the Alt-A borrowers, 70 percent may have exaggerated their income, said David Olson, president of mortgage research firm Wholesale Access in Columbia, Maryland.

Meanwhile, back at the ranch.....

Borrowing from the Fed's discount window hit record levels in six of the past eight weeks, and reached $23.5 billion as of Sept. 10, Fed data show. By comparison, lending averaged just $779 million a week in the three months after New York Fed President Timothy Geithner urged banks to use the program.

My view.

1) The problems created by Greenspan's cheap money era will keep coming.

2) These problems will be solved one at a time because no one has any idea of their size and complexity. This is the only sensible thing to do. Any idea that Washington can come up with a comprehensive plan is plain and unadulterated hogwash. They had all the regulatory institutions in place and yet they let this mess happen.

3) The Fed is doing the only job they can do: give away money to distressed financial institutions to keep them afloat. Forget about the ridiculous notion that "they set interest rates". The markets do. Not the Fed.

4) The rate on 13-week Treasury bills is sagging, finishing at 1.44%. The markets are driving short-term interest rates lower.

My gut feeling? Well, I think that all this sense of panic, the on-going printing presses of the Fed, Treasury, and Congress will be good news for the markets. I still believe there is money to be made in the next 12-months and that the equity markets are close to an important bottom.

However, as in 2000-2002, it is very important to select and focus on the right sectors.

All this money will create the next set of problems, which will be solved when we get there by creating new ridiculously complex regulatory institutions that will strangle the economy even more.

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

The economy

Is the consumer running out of money? Probably so. Employment is declining. Income is slowing down. Inflation is rising. The outcome is that the growth of retail sales after inflation is plunging (click on graph to enlarge). This is the bad news.

The good news is that the business cycle will eventually solve these big issues.

1) Production, because of poor sales, will be curtailed.

2) Commodities are declining because producers do not need them due to slower demand.

3) Inflation will decline because of the weakness in commodities.

4) Income, after inflation, will increase because of declining inflation and the economy will strengthen again because consumers have more money in their pocket (after inflation).

We need to be patient and keep the faith. We are almost there. It is a matter of a few more months of pain. The business cycle works.

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

About energy stocks

This is an excerpt from Birinyi Associates, Inc. blog (http://www.tickersense.typepad.com.

This morning before the open Birinyi Associates issued a research report on the energy sector and several reasons for today's rally.

1) After yesterday's decline most energy stocks were the most oversold they have been in the last 18 months. Several of these stocks have reached such levels in the current decline, but a mass sell-off in a sector to extreme lows is usually a good indication of a bounce.

2) The average bear market for the energy sector is about -31%, the current decline was about -28%.

My view.

I found these comments interesting, probably because I agree with them. The energy sector is not dead as most observers seem to believe.

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

Did you notice that .....

In 2002 investors were looking back contemplating the implosion of the tech bubble and the huge wealth destruction of about half the US economy. But they did not notice there was a great bull market in some financial stocks and other attractive sectors.

I think some investors are making the same mistake now. They keep looking back at the implosion of the housing/commodity bubbles. And they panic, now as then. But they are failing, as in 2002, to recognize the beginning of a bull market in very specific sectors.

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

Bailing out Detroit

What is the purpose of a government? Should a government bail out industries in trouble? When are we going to stop supporting the losers with our money?

Are we also going to help the Japanese automakers? Why not? They are not in trouble? Why? Because they keep up with technology, market conditions, and consumer needs.

We need to make the economic players understand this is a market economy. The risk is that we are slowly sliding into the European type of democratic socialism we love to criticize because is causing slow growth in their countries.

Are we losing our zest for competition and winning? This is what has made this country great. What is happening to us!

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

What is causing the volatility of the markets?

The markets are displaying unusual volatility. I do not think they are responding to the financial crisis.

Their volatility is a vote of no confidence in the leadership in Washington. There are serious events taking place in the US and the world. Yet, there is no serious plan being formulated by the Fed or the administration that would suggest they know what should be done. Just band-aid moves when problems become too risky.

Not enough to stabilize the markets.

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

The response of the markets to Paulson's rescue plan

The news. Asian stocks surged the most in eight months and U.S. futures jumped after the U.S. government seized control of Fannie Mae and Freddie Mac, shoring up global financial markets reeling from more than $500 billion in credit losses.

The immediate response of the markets.
. Soaring stock markets in Asia because of the reduced financial risk and increased liquidity.
. Higher crude oil and gold because of the inflationary implications of the plan.
. Lower dollar because of the inflationary implications of the plan.
. Higher yields because of the inflationary implications of the plan.

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

About commodities

I am a firm believer that all commodities rise and decline in perfect synchronism. If you follow what is happening now you will recognize the truth of this observation. The weather, OPEC, wars are "noise" when you look at the big picture. What drives commodities is the global business cycle.

The lesson is that the odds are against you if you go long a particular commodity when most of them are declining. Especially in a weak economic environment.

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

The business cycle is alive and well (cont'd)

The economy has been slowing down in the past 12 months. What we are experiencing now is what we have experienced over and over again after a period of economic weakness.

Commodities, including gold and oil, are slumping. Their weakness has had a negative impact on the companies (and countries like Brazil and Australia) which have benefited from rising commodities.

Bond yields are also declining, responding to slower economic growth, lower commodities, and lower inflation -- eventually.

The dollar is strengthening as international investors recognize the USA is the place to be.

Stocks will respond to these positive developments and stage the long awaited rise.

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

Good news!

Good news! The dollar remains strong.

It means international investors are buying dollars to invest in the USA because they find our country relatively more attractive.

It also reflects the improved competitiveness of our industries. Foreign buyers are buying dollars to purchase the goods produced by our industries.

This is good news for our economy and financial markets!

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