There are different types of bubbles

As I travel and read about events, I put them in a “bubble” context. Let me explain.

I was in Rome to visit my mother and witness the sale of a property she owned. We met at 12:00 pm and left at 2:30 pm. The seller, the buyers, the two lawyers were present. So far nothing unusual. There was another important authority: the notary.

A notary represents the government and makes sure the transaction follows the law. There are only a few thousand notaries in Italy (population: close to 60 million). It is very difficult to become one and the tests are almost impossible to pass. This is how the guild protects itself.

All guilds, I call them power groups, make sure the government passes laws to protect them by making the entry into the guild as difficult as possible. They increase the bureaucratic apparatus by requiring new “regulations”. By doing so, however, the incentive to innovate wanes and the economy stagnates.

The bureaucrats have every incentive to increase rules, regulations, and filing of reports because the more paper they receive the more important they feel. Southern Italy is following closely this script.

Taxes have to be raised to feed an ever-increasing bureaucracy and a new “bubble” takes shape. However, this bubble cannot increase forever. I witnessed a transaction in Italy for 400 Euros “without receipt”, but 800 Euros with receipt. In other words, as the bureaucratic bubble increases, the economy goes underground, and people become discontent.

Outcome? I went to a library to buy some books. I found, to my surprise, many books about Mussolini. Large bubbles create discontent and discontent leads to violence. Bubbles (political, economic, administrative, religious, and financial) create their offsetting forces that will make them implode.

It will be interesting to see what happens to the bubbles “Putin” and “China” now that people begin to realize their lifestyle is at risk. The markets always win.

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

I am baffled

I keep seeing on TV the sequence of politicians that, to their dismay, condemn the greed of the financial executives. How could they have done such horrendous actions? they ask. We need more regulations. We need new agencies. We need to spend more to fix the problems.

The reason I am baffled is that I do not know how to answer this simple question. What were they doing in Washington when this bubble was in the making? Weren't they supposed to be in charge of our affairs? How can we trust the people who were in charge when the bubble was growing to solve the very problems they helped creating?

The philosophical answer is: that's the way the world works. If you do not like it go and hide yourself on a sunny Caribbean island. The altenative is to fight it the best you can.

Happy New Year to all of you and thank you for visiting this blog.

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

Close to the bottom, but....

This chart of SPY (ETF for the S&P 500 - click to enlarge) suggests we are close to an important bottom. The MACD, however, indicates we need to be patient because major bottoms take months to complete.

What to do in the meantime? Do not commit all your cash in the next rally, no matter how impressive it may look. Save some liquidity for the real bottom. Why? Because investing is all about probabilities.

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

Is China a bubble?

China needs to devise more policies to boost consumption among the nation’s 1.3 billion people to counter the impact of falling exports on economic growth, central bank Governor Zhou Xiaochuan said.

“Although the government has pledged to boost consumption to sustain growth, we still face difficulties in identifying which areas and which measures we should take to spur spending,” Zhou told a conference in Beijing today. Economic policies have failed to rebalance growth away from trade and investment, with the share of consumption in gross domestic product falling to less than 50 percent from 60 percent a decade ago, he said.

China's income per capita is about $5,500. How can you expect the government to expand consumption when the Chinese are making little or no money in the first place? China was booming because the industrialized world was booming. Now they have to show what they can do it by themselves. And with $5,500 a year per person I think they cannot do much. They are in a hole like the rest of the world. Probably a deeper one. Is the Chinese bubble imploding?

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

Relax and enjoy this superb music by Boccherini

How can I say anything about this music. Just listen, get excited, relax, and dream.

Monday the markets will bring us back to reality.

George Dagnino

Bad news...if you believe it

Question: What happens to the stock market when stocks fall more than 10% in the 4th quarter?

Bad news. The market could fall substantially in 2009, if history repeats itself. The interesting study has been prepared by J.K Harris.

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

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

Do you have an investment process? Here are some ideas.

I like to learn from my investment experiences. I asked myself: What did I do right and, above all, where did I fail? What happened during the 2008 bear market offers thought provoking lessons. Listening to my friends is a privilege. Their ideas and plans are eye-openers. Each one follows different approaches. These experiences can be condensed as follows.

1. Have a short list of stocks. A short list of stocks in your portfolio makes the management task easier. 15 stocks or 5 ETFs should be enough. Refrain from adding positions just because a friend gives you a special insight. Every time you feel like you have to buy a stock, check it against your existing portfolio. Which one should you sell if you decide to buy the latest suggestion?

2. Diversification is bad. Too many stocks across many sectors will make your portfolio perform like the averages. If you feel you have to diversify, make your life simple. Just buy the S&P 500 (SPY). However, if you want to outperform the market, follow a selective strategy. Use only 2-3 investment themes. This approach will keep your list of stocks from becoming unmanageable.

3. Long-term investing is grossly misunderstood. In October 2008, the market is at the same levels as May 2002 and February 1998. In 1982 the market was almost at the same levels as in 1969. Long-term investing is great only when you look at history, but it does not exist. If you enter one of those long periods of market stagnation, you are bound to have a portfolio showing little or no returns. You have to believe an important tenet: things do not last forever. John Maynard Keynes once said: In the long term, we are all dead.

4. You need a timing model. Market timing models are imperfect, but they provide a sense of risk. They are important and there is no excuse for not using them. The main issue is that market risk changes and your portfolio has to reflect changes in risk.

5. The business cycle works. The global business cycle is perfectly synchronized. All foreign stock markets have the same turning points at major tops or bottoms. A corollary is that when you buy emerging foreign markets you buy volatility. When you buy foreign illiquid markets, the performance of your portfolio becomes highly unpredictable because of its volatility.

6. Choose your investment wisely. You cannot ignore the crucial relationship existing between asset classes and business cycle. Commodity driven stocks (materials, energy, agriculturals, infrastructure, transportation) strive in a strengthening economy, not in a slowing business cycle. Interest sensitive sectors perform well when the economy weakens and grows below par. Your portfolio needs to reflect business cycle developments. In other words, your portfolio has to reflect changes in risk and changes in the business cycle.

7. Momentum works. The odds favor a strong sector to remain strong and a weak sector to remain weak as long as economic conditions do not change. Changes in business cycle conditions change the momentum of stocks. Choose stocks in strong sectors. Rising water lifts all boats and minimizes the odds of being wrong.

8. Do not try to catch a falling knife. Do not even think to buy a stock on a free fall. It is financial suicide. Buy stocks that go up, not down.

9. Hedging your portfolio. The introduction of “short” ETFs such as SH, PSQ, or DOG allow you to hedge your portfolio and make it less volatile. Avoid the “ultra” short. They are too volatile. Leave them to the gamblers.

10. Investment strategy. Act slowly, but act. Inaction will produce losses and profound pain in a down market.

11. Does it sound too complicated? If all these thoughts sound complicated, you should buy TIPS (inflation-protected bonds) from the Treasury by accessing their website www.treasurydirect.gov. You will avoid frustrating and time-consuming work and will gain peace of mind.

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

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

from all of us....Peter Dag & Friends

Commodities remain weak

Commodities peaked when the business cycle weakened. Commodities will bottom when the business cycle strengthens.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

An interesting chart

I realize that no indicator is perfect, but this chart of the S&P 500 suggests it pays to be patient and wait for the two moving averages to cross.

The lesson is it is much easier to recognize a bottom after it has completed than to anticipate one.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Political and economic bubbles

I have been writing about political and ideological bubbles. They can implode and cause chaos.

The Putin bubble. Riot police detained protesters during a rally against a steep rise in car import duties in Russia. Everything was fine as long oil was rising. Now they have to face the hard facts and they are not pretty. A political bubble is imploding.

China. China's top priority is to tackle unemployment among university graduates, as fears grow of student unrest in a faltering economy. China sounded great as long as Europe and the USA were buying from them. Demand for Chinese goods is now faltering. China is an underdeveloped country with per capita income of less than $5,000. A political and economic bubble is imploding.

Bottom line. There are several bubbles of different types: political, bureaucratic, financial, economic, and religious. They eventually all implode.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

The nonsense you hear about the dollar

A currency reflects the weaknesses and the strengths of a country relative to other countries.

The dollar has been collapsing since 2004 in anticipation of the dire events we are experiencing in the US.

A currency is never inflationary. It is the other way around. A currency reflects projected productivity and inflation differentials with respect to other countries. The country with the lowest productivity growth and highest inflation will have the weakest currency.

Interest rates have nothing to do with a currency. In the 1970's Brazil had the highest interest rates in the world and yet the real (their currency) was one of the weakest currencies.

The countries with the lowest inflation, highest productivity growth, and soundest economic policies have the strongest currencies. Make no mistake about it!

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

What happened to the energy crisis?

The average national price of gasoline fell 9 cents in the past two weeks, bringing it to its lowest point in nearly five years, according to a national survey released Sunday.

The average price of regular gasoline Friday was $1.66 a gallon, oil industry analyst Trilby Lundberg said. The price of mid-grade was $1.80 a gallon and the price of premium was $1.92 a gallon.

The last time gas prices dipped so low was in February 2004, Lundberg said, when the national average for regular was also around $1.66 a gallon. The all-time high was on July 11, 2008, when the price peaked at $4.11 a gallon.

Bottom line. Interest groups (or power groups as I like to call them) take advantage of special situations to scare us and take advantage of us. They invent the energy crisis to peddle the idea of efficient cars or alternative energy like ethanol and ask the government our money to work on some crazy idea, totally uneconomical.

Then they forbid us to import the superbly engineered and energy efficient cars the US car manufacturers build in Europe. I drove them recently. At 90 miles/hour they are smooth and fun to drive, holding the road in an exceptional way.

Let the markets work. Why do we need an electric car? Because someone is going to make a lot of money from it. Why do we need ethanol? Because someone is going to make a lot of money at our expenses. But make no mistake about it. The markets always win.

If we are in this mess it is because we have been conned in a series of crazy ideas that have not worked out.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

The real danger is not recession...is revolution!

Greek students are in revolt as conditions deteriorate in Greece.

A recent visitor to Moscow told me there is growing discontent with Putin's policies.

"If we are not able to do that, then social unrest may happen in many countries, including advanced economies. We are facing an unprecedented decline in output. All around the planet, the people have reacted with feelings going from surprise to anger, and from anger to fear," the head of the IMF said.

Protectionism sentiment is growing. Russia has begun to shut down trade as it adjusts to the shock of Urals oil below $40 a barrel. It has imposed import tariffs of 30pc on cars, 15pc on farm kit, and 95pc on poultry (above quota levels). "It is possible during the financial crisis to support domestic producers by raising customs duties," said Premier Vladimir Putin.

Russia is not alone. India and Vietnam have imposed steel tariffs. Indonesia is resorting to special "licences" to choke off imports.

The omens are not good in China either. Taxis are being bugged by state police. The great unknown is how Beijing will respond as its state-directed export strategy hits a brick wall, leaving exposed a vast eyesore of concrete and excess plant.

Last, but certainly not least. I was shopping for books in Rome and I was surprised to see so many books about Mussolini. Why? Because Italian bureaucracy is taking advantage of the masses and the masses are growing unhappy. They need strong leadership.

Bottom line.The problem with what is going on in the world is that people will eventually revolt against the entrenched incompetent leadership and ask for a strong hand. This is what our leaders should worry about and why they should do everything they can to get the economy going.

The problem is that government power in the US will grow at an unprecedented pace. This is one more reason for discontent. People do terrible things when they smell failure and incompetence in their leaders! History is full of examples.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Food for thought

Interest rates are tumbling across the board. It looks like, let me repeat, it looks like the Fed is succeeding in clearing the credit pipelines.

The next step is to revive the stock market. They will succeed, of course. For investors, however, timing is of the essence.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

The markets always win

California Governor Arnold Schwarzenegger today ordered all state workers to take two days of unpaid leave each month to conserve money amid a record budget deficit and a legislative impasse over how to fix it.

The furloughs will begin in February and will last through June 2010, Schwarzenegger said in an executive order. He also ordered all departments to cut 10 percent of their workforce costs, through firings if necessary.

“Every California family and business has been forced to cut back during these difficult economic times, and state government cannot be exempt from similar belt tightening,” Schwarzenegger said in a letter to state workers.

The furloughs would amount to a 10 percent pay cut, Chris Voight, executive director of the California Association of Professional Scientists, a group that represents about 3,000 scientists working for the state. The association and the Service Employees International Union announced they will sue to block the furloughs and any layoffs, which they said would violate collective-bargaining deals.

“We don’t think it’s right, and we’re prepared to file an unfair practices charge against the governor,” Yvonne Walker, SEIU Local 1000 president said today at a news conference in Sacramento. “We think it’s regressive bargaining. For him to do this outside of existing negotiations is improper.”

California, the biggest borrower in the municipal-bond market, has $54 billion in general-obligation debt. It’s rated A+ by Standard & Poor’s and Fitch Ratings, the fifth-highest grade, and an equivalent A1 at Moody’s Investors Service.

Last week, Standard & Poor’s said it may cut the rating on $54 billion of California bonds because of the fiscal problems, and investors have pushed down prices on the debt.

A California bond maturing in 2038, which pays 5.25 percent interest, traded at 79.4 cents on the dollar yesterday to yield about 6.89 percent. That’s 1.8 percentage points more than similar trades three months ago, according to Municipal Securities Rulemaking Board trade data.

Bottom line. We have to produce the wealth the government gives away. The alternative is economic and financial collapse. The markets always win. Even in California.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Question .. and I do not know the answer

This is what is bothering me.

Is the Fed printing new money or just replacing some of the wealth destroyed by a collapsing housing sector and all that is associated with it?

I do not know, quite frankly. My sense, however, is that net net, they are replacing the incredible wealth destruction that has taken place in the past 18 month. If so, their action is not terribly inflationary as most people think.

Just watch the price of commodities, gold, and crude oil. They are sinking. The time to worry about inflation is when they start rising.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Housing, employment, and what to look for

This chart (click on chart to enlarge) shows the real problem for the economy. Housing starts continue to tumble and employment is on a free fall.

Business will contine to be a mess until the housing sector stabilizes.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Deflation?

The latest consumer prices declined 1.9% last month, up 1.1% y/y and down 10.2% in the last 3 months at annual rate.

Producer prices declined 2.2% last month, up a mere 0.4% y/y.

Bottom line. Prices will continue to decline as long as the economy is weak. See, for instance, the previous 2000-2002 episode. There is no question we are in a period of deflation (click on chart to enlarge), and in a period of deflation only one asset class is king -- cash.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Good news and bad news

The business cycle keeps working perfectly, as it should. You just need to know what to look for.

Slower economic growth causes commodities to decline. Lower commodities are the main reason for inflation to decline (see graph below; click on graph to enlarge).

This is good news because lower inflation increases our purchasing power.

The problem is that we are becoming less efficient. Productivity growth is declining. Why to we care? Because when productivity growth declines, unit labor costs start rising faster.

Why do we care? Because when unit labor costs start rising faster, profits decline.

Why do we care? Because when profits decline, business cuts costs by borrowing less, making fewer investments, and hiring fewer people.

Bottom line. We need to make investments that increase our productivity. We can have as many stimulus plans as we wish, but if they do not increase our productivity it is like throwing money down the drain!

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Recession monitor

Employment is sinking (click on graph to enlarge). The negative news on employment will have a negative impact on consumer confidence and consumer spending.

The economy will remain weak and will continue to have a depressing effect on interest rates, commodities, and inflation.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Recession monitor

The manufacturing sector is in a free fall, like the rest of the economy (click on graph to enlarge).

My suggestion? Do not try to catch a falling knife.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Average people trying to solve problems they cannot comprehend

These are the thoughts crossing my mind as I watch the politicians assaulted by the press asking questions about the car industry and what is going on.

Average people, trying to solve the problems they created, problems beyond their comprehension. They look lost and confused. Sweating. How can we even dream they have the mental power to come up with the solution?

The only planning guide you should use is....The markets always win. Do not put your head in the sand. Listen to the markets. Follow what they are telling you.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

A painful sight

I am watching the 3 CEOs of the car companies asking for money from Congress. They are sitting like three schoolchildren. Clearly embarrassed, being reprimanded by the politicians and the public.

Very sad. What happened to capitalism? What a sad and painful sight. We have changed as a country, we have changed. Are we seeing ourselves? Are we recognizing the enormity of what is happening?

It will take a few years before the rough waters settle down. At that time we will be a different country. Possibly more humble and more realistic about our strengths.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Watch the trendline

A rise of the S&P 500 above the trendline in the above graph (click on chart to enlarge) is going to be a significant message the momentum of the market is gradually changing on the upside. Stay tuned.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

Question

Is federalism dead?

The states of New Jersey and California are asking for help from the government. Michigan is doing the same to keep the car industry afloat.

The states are asking the government to help them because they followed the idea that governments have to give to the citizens what they ask. Even if they cannot afford it.

The USSR followed the same approach. Eventually revolution (such as in Hungary and Poland) destroyed the system.

I do not want to sound paranoid. History is full of disastrous examples of governments becoming too big. The implosion of big governments is an historic reality. As in the case of any bubble: the credit bubble of the 1930s, the inflationary Great Society/Vietnam war bubble of the 1970s, the Asian bubble of 1998, the tech bubble of 2000, and the real estate/credit bubble of 2008.

There have been other major structural bubbles such as the Roman Empire, the English Empire, the Church in the middle ages, the monarchy of France causing the French revolution, the Italian Renaissance, and the communist Russia after Karl Marx. These are the most dangerous bubbles caused by excessive concentration of power. Are we moving in that direction?

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

A terrible day

Today the market sagged almost 9%. I follow closely the trend line shown on the chart (click on chart to enlarge). A violation of the market on the upside will provide an important signal suggesting the market is close to a bottom.

More, much more when you read older posts and subscribe to The Peter Dag Portfolio by going to https://www.peterdag.com/.

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

A simple proposal to Mr. Obama

Dear Mr. Obama,

The economy is in a mess. Consumers are in deep trouble. Asset prices are collapsing. Jobs are disappearing at a fast pace.

I have simple idea.

Instead of all the myriads of stimulus plans, why not cutting tax rates by 50% across the board. The budget is in a mess anyway. Cutting taxes will stimulate investing and spending immediately.

Sincerely,

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