1/30/13

What caught my attention

* TLT very weak.
* LQD sinking.
* JNK and HYG sagging.
* DBC and GLD strong.

I will discuss the significance of these trends from an investment strategy viewpoint in the next issue of The Peter Dag Portfolio.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/29/13

The markets always win

....consumer confidence as measured by the Conference Board’s index dropped to its lowest level since November 2011. The big-picture plusses were not enough to outweigh the hit to pocketbooks inflicted by the 2 percentage point payroll tax increase that took effect at the start of the year.

Tax the rich. Give to the poor. No one can predict the unintended consequences. Micromanaging a complex economic and financial system like ours is ludicrous. How do they know the outcome of their action when the Fed in 2007, ahead of a massive recession, was predicting strong growth ahead?

Consumers are concerned. And they should. The markets, as it is happening in France, always win.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

Thought of the day

A quick ranking of the world's most "miserable" countries, based on the conventional measure of the Misery Index which is simply the Unemployment Rate plus Inflation, shows just why most people in Spain are, well, less than happy (and Spain is damn lucky there is no subset of the Misery index for just those aged 25 and under as we would certainly need a bigger chart). As the chart below shows, the Spanish "misery" is now the greatest in the world, at some 30%, and is worse than South Africa, Greece, Venezuela, Argentina and Egypt.(Via: ZerHedge).

....and yet, after the punishment and destruction of the wellbeing of the people of almost a whole continent, the Brussels nomenklatura is still forcing the idea the Euro will create growth and wealth.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/27/13

...and now listen to this short video....

...as discussed in great detail in "Why Nations Fail", we have to allow for "creative destruction" for any economy to remain vibrant. As soon we start protecting special business groups, the economy starts stagnating.

It has been repeated many many many times in history. But we are not learning because of our relentless search for power and wealth!

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/26/13

Challenging ideas

Take your time. It is worth listening to him. That you agree with him or not. (Via ZeroHedge).

Reason’s Nick Gillespie sat down with Taleb for a wide-ranging discussion about:

•why debt leads to fragility (5:16);
•the importance of “skin in the game” to a properly functioning financial system (10:45);
•why large banks should be nationalized (21:47);
•why technology won’t rule the future (24:20);
•the value of studying the classics (26:09);
•his intellectual adversaries (33:30);
•why removing things is often the best way to solve problems (36:50);
•his intellectual influences (39:10);
•why capitalism is more about disincentives than incentives (43:10);
•why large, centralized states are prone to fail (44:50);
•his libertarianism (47:30);
•and why he’ll never take writing advice from “some academic at Cambridge who sold 2,200 copies” (51:49).

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/25/13

BUSINESS CYCLE TRENDS

Is the economy strengthening and is it entering into Phase 1 of the business cycle? This is what should happen if it does.

• The economy strengthens.
• Commodities rise.
• Yields rise and bond prices decline.
• Inflation rises.
• Stock prices rise in anticipation of a stronger economy.
• Strongest stock sectors: commodity sensitive and industrial sectors.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

Thought of the day

As crazy as it may sound ...THE TREND IS YOUR FRIEND ... has a lot of validity.

Why? Because major economic, financial, cyclical events are difficult to change. They last several months.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/22/13

Technical matters

Market volatility (VIX) is at record low levels - 12.43. Investors are worried because there is only one way for volatility to go - up.

Wait a minute. It is like bond yields. The fact that volatility is low doesn’t necessarily mean it will rise. Yes, eventually it will. But between now and then it will stay low.

So? Well, low volatility is typically associated with a rising market. My point is the time to worry is when volatility rises, not when it stands at low levels.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/19/13

Paul Krugman weighs in on ethanol in the NY Times:

"Where the effects of bad policy are clearest, however, is in the rise of demon ethanol and other biofuels. The subsidized conversion of crops into fuel was supposed to promote energy independence and help limit global warming. But this promise was, as Time magazine bluntly put it, a “scam.”

This is especially true of corn ethanol: even on optimistic estimates, producing a gallon of ethanol from corn uses most of the energy the gallon contains. But it turns out that even seemingly “good” biofuel policies, like Brazil’s use of ethanol from sugar cane, accelerate the pace of climate change by promoting deforestation.

And meanwhile, land used to grow biofuel feedstock is land not available to grow food, so subsidies to biofuels are a major factor in the food crisis. You might put it this way: people are starving in Africa so that American politicians can court votes in farm states."

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

Thought of the day

Central banks cannot manipulate currencies.

The value of a currency is solely and exclusively determined by productivity differentials. And central banks do not have the tools to change the productivity of a country.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/18/13

The Surprises of 2013 by Byron Wien of Blackstone

1. Iran announces it has adequate enriched uranium to produce a nuclear-armed missile and the International Atomic Energy Agency confirms the claim. Sanctions, the devaluation of the currency, weak economic conditions and diplomacy did not stop the weapons program. The world must deal with Iran as a nuclear threat rather than talk endlessly about how to prevent the nuclear capability from happening. Both the United States and Israel shift to a policy of containment rather than prevention.

2. A profit margin squeeze and limited revenue growth cause 2013 earnings for the Standard & Poor’s 500 to decline below $100, disappointing investors. The S&P 500 trades below 1300. Companies complain of limited pricing power in a slow, highly competitive world economic environment.

3. Financial stocks have a rough time, reversing the gains of 2012. Intense competition in commercial and investment banking, together with low trading volumes, puts pressure on profits. Layoffs continue and compensation erodes further. Regulation increases and lawsuits persist as an industry burden.

4. In a surprise reversal the Democrats sponsor a vigorous program to make the United States independent of Middle East oil imports before 2020. The price of West Texas Intermediate crude falls to $70 a barrel. The Administration proposes easing restrictions on hydraulic fracking for oil and gas in less populated areas and allowing more drilling on Federal land. They see energy production, infrastructure and housing as the key job creators in the 2013 economy.

5. In a surprise reversal the Republicans make a major effort to become leaders in immigration policy. They sponsor a bill that paves the way for illegal immigrants to apply for citizenship if they have lived in the United States for a decade, have no criminal record, have a high school education or have served in the military, and can pass an English proficiency test. Their goal for 2016 is to win the Hispanic vote, which they believe has a naturally conservative orientation and which put the Democrats over the top in 2012.

6. The new leaders in China seem determined to implement reforms to root out corruption, to keep the economy growing at 7% or better and to begin to develop improved health care and retirement programs. The Shanghai Composite finally comes alive and the “A” shares are up more than 20% in 2013, in contrast with the previous year when Chinese stocks were down and some developing markets, notably India, rose.

7. Climate change contributes to another year of crop failures, resulting in grain and livestock prices rising significantly. Demand for grains in developing economies continues to increase as the standard of living rises. More investors focus on commodities as an investment opportunity and increase their allocation to this asset class. Corn rises to $8.00 a bushel, wheat to $9.00 a bushel and cattle to $1.50 a pound.

8. Although inflation remains tame, the price of gold reaches $1,900 an ounce as central bankers everywhere continue to debase their currencies and the financial markets prove treacherous.

9. The Japanese economy remains lackluster and the yen declines to 100 against the dollar. The Nikkei 225 continues the strong advance that began in November and trades above 12,000 as exports improve and investors return to the stocks of the world’s third largest economy.

10. The structural problems of Europe remain largely unresolved and the mild recession that began there in 2012 continues. Civil unrest subsides as the weaker countries adjust to austerity. Greece proves successful in implementing policies that reduce wasteful government expenditures and raise revenues from citizens who had been evading taxes. European equities, however, decline 10% in sympathy with the U.S. market.

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

The most important steps in managing money

Step 1. Review the investment portfolio every evening.
Step 2. Make a record of its value every day.
Step 3. Study what are the "ideas" that contribute to its growth and those that hinder its performance.
Step 4. Find out why. What did you miss. The answer is crucial.
Step 5. Determine what to do.
Step 6. Act.

I found that the performance of the portfolio improves with the frequency and intensity of this process.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

Incredible!

CNN Money - Federal Reserve officials were largely unaware of the financial crisis brewing in 2007, until they found themselves in the middle of it, transcripts released Friday show.

The lesson is that it is very important not to believe what they - the politicians - are telling us. They will always assure us things are doing well -- even when they know the ship is sinking.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/17/13

Housing

The Washington Post - Proposed 20% down payment rule could put owning a home out of reach for many

Why are we so obsessed about forcing people to own a house when they cannot afford it? What is wrong about renting, saving some money, and then buying your house when you can afford it?

Why the taxpayer has to help someone who does not have the money to buy a house? What am I missing?

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

Thought of the day

Bloomberg - Federal Reserve officials are voicing increased concern that record-low interest rates are overheating markets for assets from farmland to junk bonds, which could heighten risks when they reverse their unprecedented bond purchases.

Are they trying to tell us something? Is it time to become more defensive?

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/16/13

Observations

In 1998 my investment portfolio was recognized by many sources for its above average performance. Forbes, The New York Times, The Washington Post, and others ranked me as one of the best advisors over a 15 year period. SNS, an astute businessman and entrepreneur, met with me and together we strategized on how to take advantage of all this good press.

The chemistry between us turned out to be ideal. I learned a lot from him and he soon recognized what made me click.

One day, as we were drinking a cup of coffee, SNS suggested I change the first page. “George, people have to gain an appreciation of who you really are and what makes you click, your emotions, and your mental framework. Only then will they appreciate you and your recommendations”, he told me.

This column is the outcome of his suggestion. It has evolved in the past few years and it has become another way to communicate with you -- the readers.

I am trying to present the issues I am facing. I am too old to be presumptuous to believe I have the answers. Understanding the issues facing us is too complex because of the limited amount of information available.

One concept I am learning is that any conclusion we reach is going to become inconclusive as new evidence and scientific discoveries become available. p>Often we hide behind fences that give us security because we are afraid to ask the hard questions, which are likely to reveal new issues. The earth is not flat. We have come a long way from that dogma because there were giant thinkers who were willing to search and challenge the fences built by the Church throughout the Middle Age.

Eventually people continued to ask and press against the established power structure, and the world gained. The new thinking triggered years of unprecedented wealth and growth until our times.

What should we believe in? There is no answer.

(This Observations appeared in the 10-10-05 issue of The Peter Dag Portfolio ).

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/10/13

The markets always win

Reuters) - The government's consumer finance watchdog said on Thursday it will force banks to use new criteria to determine whether a borrower can repay a home loan, in an effort to avert the kind of loose lending that helped push the economy into recession.

The markets are forcing the bureaucrats to correct their previous largesse when they encouraged banks to lend subprime in the name of social engineering.

It is simply amazing how the markets eventually catch up with bad ideas -- as the European Monetary Union.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/9/13

THE PHASES OF THE BUSINESS CYCLE

The economy is a very sensitive and delicate mechanism. Small changes in growth rates put forces in motion that have a major impact on economic behavior from changes in business profitability to the value of assets. Everything from commodities to stocks, from interest rates to precious metals and currencies is affected. Oil or lumber may soar one year and decline the next. Gold and real estate were the hot investment in the 1970s and the dramatic losers in the 1980s and 1990s. Bonds collapsed in the 1970s, but provided returns up to 40% after 1982. As a business and financial strategist, how do you predict when and in which direction these changes will occur? The essential driving force that moves the prices of all assets is how fast the economy grows relative to its long-term growth rate.

Asset prices change depending on how fast the economy is growing relative to its long-term average pace. The long-term growth rate of an industrialized country is usually around 2.5%. The average long-term growth for the U.S economy after 1982 is somewhere between 2.5% and 3.0%. We will also call this growth potential. The average growth of 2.5 - 3.0% represents how fast the economy can grow on average during normal conditions.

But growth is very rarely at its 2.5 – 3.0% potential. Sometimes it speeds up above this range and other times it slows down below it (Fig.4-3). We will further investigate the reasons for this variation later. Values of assets respond to whether business growth is above or below its long-term potential. In order to develop guidelines that can be used for investment strategies, it is useful to follow what happens to the business cycle as it moves through four main phases.

Phase One
Phase one of the business cycle occurs when the economy comes out of a period of very slow growth, well below its growth potential. The growth rate increases but does not exceed the growth potential. When the economy grows at a pace below the long-term average pace, the economy could well have been in a recession.

The business cycle goes through four phases, releasing forces that drive asset prices and financial markets.

But investment strategies developed over a period of very slow growth or recession are the same because asset prices act in the same way in both cases.

Phase Two
Phase two of the business cycle occurs when growth rises above the growth potential. For instance, if the average long-term growth of the economy is assumed to be 3%, phase two of the business cycle takes place when growth of the economy rises above this level. These are the boom periods when everything seems to be going right and terms such as “Goldilocks economy” are used.

Phase Three
In phase three, economic growth declines to the growth potential. This phase identifies the beginning of the correction created, as a result of the policies followed by the Fed in phase one and phase two.

Phase Four
In phase four, growth declines below the average growth potential. All the excesses created in phase two and three are brought under control in this period. This is the time to pay the piper and offers the greatest investment opportunities for the astute investor. Although these are times when economic conditions are very poor and unemployment is rising and the mood of the nation is typically depressed, the financial markets rise quite strongly at these times, with both the stock and the bond market rising in value quite appreciably. Historical evidence shows quite clearly that as the economy strengthens and grows more rapidly, the financial markets begin to perform more sluggishly. However, as the economy slows down to the point when interest rates start declining, the financial markets provide some attractive returns. Opportunities and risk change as the growth of the economy changes from slow growth to strong growth to slow growth again. For instance, in 1995 interest rates (a lagging indicator) began to decline and the money supply (a leading indicator) immediately started to grow much more rapidly and stock prices soared. Eventually, in 1996 industrial production (a coincident indicator) began to rise.

Investment risk changes as the business cycle moves steadily from phase one to phase four. Economic growth above its long-term potential is accompanied by rising lagging indicators, such as interest rates, inflation, and labor costs. These times have been of high-risk for the stock market because returns from equities in this period have been well below average. Investment risk declines and the prospective of considerably higher profits in stocks and bonds materializes when the economy grows more slowly and its growth falls below its long-term average and interest rates and inflation decline. As the economy accelerates, as we have seen in previous chapters, it develops the forces that will make it grow at a slower pace. However, in spite of all these dynamics, the long-term average growth of the economy is 2.5 - 3.0%.

This is like what happens to a jogger. If the jogger's natural pace is nine minutes per mile, any attempt to speed up will result in a faster pulse rate, higher temperature, shortness of breath and increased fatigue. Before long, the jogger will have to slow down and coast until strength returns. Competitors know that the faster and longer joggers run above their average pace, the more likely they will have to slow down to rest and the longer it will take to recuperate.

The economy behaves exactly the same as a jogger. If the economy grows much faster than the growth potential, its temperature rises too. For the economy, this rising temperature equates with inflation, higher interest rates, accelerating wages, and high capacity utilization of machines and human resources, and eventually lower business profitability as productivity slows down. Like the jogger, the economy has to slow down under this pressure if it is to regain strength. To do this it must grow at a pace below its growth potential. Only then will inflation, interest rates, wages and capacity utilization decline and business profitability improve as costs decline and productivity improves.

As the growth of the economy changes, profitable trends develop. Before we examine them, let's look at what makes the economy accelerate and slow down using the knowledge developed in the previous chapters. Later we will discuss how to predict these changes and how to time specific investment strategies. As you read the following pages, a question will emerge. If the long-term average growth rate is so important, what can we do to make it rise? Substantial research in this area indicates that increasing the country's productivity is the only answer. This can only be accomplished through improved education, investments and low inflation. It is just that simple and enormously difficult to achieve.

What happens during phase one of the business cycle?
This phase is signaled when the economy finally comes out of a period of recession or slow growth below the growth potential and starts improving again. Any change from one phase to another is a direct consequence of what happened in the prior phase. When the economy grows very slowly, inflation declines because consumers recognize they are going through difficult times and they become cautious buyers. People find it difficult to find jobs as unemployment rises. As a result, growth in wages declines and income grows very slowly. For this reason consumers watch prices very carefully, keeping inflation under control. Of course, with the economy very slow, borrowing is also subdued, and interest rates decline. A slow growth period is also characterized by slow production, and therefore, there is less need for raw materials, which weaken as slow production lessens their demand.

But there is good news during a period of very slow growth. The decline in wages, interest rates, raw materials, and inflation is reflected in lower costs for business. As a result, business profitability begins to improve at the moment when most people consider this to be the worst time of the business cycle. As the costs decline, business profitability improves.

It is important to note that the growth in wages, the decline in interest rates, and the decline in borrowing are all lagging indicators and a decline in lagging indicators means that the cost pressures - the excesses that were generated by the previous growth - are finally being brought under control. Therefore, they anticipate some improvement in the business cycle. In fact, as slow growth begins to bring costs down, and the effects of efforts to improve productivity implemented during the slow growth period kick in, profits begin to improve. For this reason, profits are an important leading indicator. Their improvement encourages business to be more aggressive in its outlook for the future and in its investment plans.

What you are beginning to see is a very important aspect of the business cycle. A decline in a lagging indicator is followed by an improvement in leading indicators - that is, a decline in cost factors is followed by an improvement in profitability.

A typical example of this relationship is what happened during the financial cycle that began in 1995. At that time, the economy slowed down and interest rates began to decline from a level close to 6%. The decline in interest rates induced more borrowing and the Federal Reserve accommodated this need for money by letting the money supply grow more rapidly. The strong growth of the money supply which began in 1995 was eventually followed by very strong growth in the economy in 1997 and 1998. By mid-1998, the pressures on inflation were rising and inflation gradually moved higher from a low 1.5% in 1998 to about 2.7% in 1999. At the same time, as inflation was rising, long-term and short-term interest rates also began to rise. The increase in interest rates during 1998 and 1999 discouraged borrowing, and as a result, the growth of the money supply peaked in early 1999. In this example, inflation, interest rates, the money supply, and the economy behaved exactly like what investors should have expected.

The reason interest rates decline during phase four of the business cycle is due to the slower growth in the demand for money because business is discouraged to borrow due to the slow growth in business activity typical of this period. However, as soon as profitability improves, demand for money increases. The Fed encourages this process by creating the necessary liquidity needed by business (the process of liquidity creation will be discussed in detail in Chapter 6 when we will review the functions of the Fed).

In phase one you see not only an improvement in liquidity, but also an increase in the growth of the money supply because the Fed has made money more available to business as well as to consumers. During a period of slow growth, as inflation declines, long-term interest rates also tend to decline, reflecting lower inflation expectations.

Furthermore, since the stock market thrives on liquidity, equity prices bottom out and start rising. There is no doubt that phase one represents a very important time of the business cycle as far as financial markets are concerned. The reason phase one is very favorable to the financial markets is because the economy slows, interest rates decline, and the Federal Reserve injects money in the system to favor the expansion. However, the increase in liquidity goes partly into the real economy. Another part of this liquidity goes into the financial markets, and that’s why the financial markets perform extremely well in this phase.

As profits continue to improve and costs remain under control, business begins to expand capacity and production and hire more people to take advantage of the opportunities. More jobs lead to more income, more sales lead to more production and even more jobs. The economic growth keeps on rising as the process feeds on itself with business increasing its profitability, the money supply expanding strongly, interest rates declining, bond yields declining, and the stock market rising. The dollar, reflecting the confidence of the international financial markets and the future of the U.S. economy, strengthens. This is the phase where the jogger - that is the economy - is finally well rested and able to begin running faster.

The major developments that take place in phase one can be summarized as follows:
• The growth of the money supply is rising rapidly.
• The dollar is improving.
• The stock market is rising.
• The growth of the economy, as measured by the growth in production, sales, income, and employment, stabilizes and improves but remains below its growth potential.
• Profits bottom and then improve.
• Commodities continue to weaken and eventually bottom.
• Short-term interest rates continue to decline and eventually bottom.
• Long-term interest rates continue to decline and eventually bottom.
• Inflation continues to decline and eventually bottoms.

What happens during phase two of the business cycle?
In this phase the momentum of the economy is so strong that growth rises above the long-term potential. Employment, production, income and sales continue to rise rapidly. As unemployment continues to decline, it becomes difficult to find skilled workers so wages begin to rise faster. Increased production places upward pressure on raw materials. Favorable economic conditions, coupled with growth in income, lead to aggressive consumer buying resulting in an increasing pace in borrowing. Eventually, higher consumer and business borrowing cause interest rates to rise. In fact, this is the time when capacity utilization is reaching high levels and business feels more and more compelled to borrow to increase capacity. But of course, as capacity utilization increases, productivity improvements slow down, as discussed earlier.

Business can no longer absorb the rising costs of commodities, labor, and interest rates. The lagging indicators are finally raising their ugly heads and warning investors that the economy is overheating and risk is increasing. The implication is that profitability is now at stake with profit margins under pressure because of rising costs.

The rise in costs is a signal that the strength of the economy is at risk because an increase in costs will force the leading indicators to decline. How? An increase in costs means that business profits are at risk and business will have to cut costs to maintain profitability. During this phase, characterized by strong growth in the economy, investors need to pay attention to those variables (mostly lagging indicators) that have an impact on decisions (leading indicators) that would cause the economy to slow down. For instance, when the growth in wages and in overall labor costs begin to rise, accompanied by rising interest rates (all these measures are lagging indicators), investors need to closely follow the impact of these indicators.

The most immediate impact of these indicators is on profitability, which is an important leading indicator, and on housing starts, which is also another important leading indicator. For instance, the rise in interest rates will cause construction activity to slow down and weakness in orders for heavy equipment because business finds investing in construction and heavy equipment less attractive because of the increased costs of borrowing.

As interest rates and inflation rise, they will have a negative impact on other important leading indicators, such as consumer sentiment and consumer expectations. As interest rates and inflation rise, income for consumers declines, thus affecting consumer attitude in a negative way. The main reason is that as inflation increases, it erodes the purchasing power of the consumer, and thus, has a negative impact on their outlook for the economy. Furthermore, the increase in interest rates raises the cost of borrowing for consumers, and this also has a negative impact on its attitude. A period of strong growth, accompanied by increasing lagging indicators, will force a series of decisions that will eventually lead to slower growth in the economy.

Like an over-confident jogger, the economy in phase two tries to run faster than it should. When this happens, the Fed eventually acknowledges that the economy may be overheating and that too much growth would bring a higher rate of inflation. Higher interest rates are, therefore, allowed to rise even further, discouraging business and consumers from borrowing. This action will cause a decline in the growth of the money supply and in overall liquidity. Slower growth in liquidity, accompanied by rising interest rates, has a negative impact on the stock market, which peaks. The strong growth that we have in phase two eventually triggers a slowdown and anticipates the events in phase three of the business cycle. As the economy downshifts, the dollar is likely to weaken, anticipating slower growth in the future.

The major developments that take place in phase two can be summarized as follows:
• The money supply continues to rise very rapidly and eventually peaks.
• The dollar remains strong and eventually peaks.
• The stock market continues to rise and eventually peaks.
• The economy, as measured by the growth in production, sales, income, and employment, grows very rapidly above the growth potential.
• The growth in profits rise rapidly.
• Commodities are very strong and rise.
• Short-term interest rates rise.
• Long-term interest rate rise.
• Inflation rises.

What happens during phase three of the business cycle?
Phase three is the most treacherous phase of the growth cycle. Growth in sales is at the highest level in years, profits are beginning to soften, but the recognition that interest rates and inflation have been rising for some time tends to lag behind. As costs accelerate and sales slow down due to business cutting costs and the Fed reducing the growth in liquidity, there are downward pressures on income, sales, employment and production. The reason is that as the growth in the money supply declines, there is less liquidity available to consumers and business to spend. This lower level of liquidity and rising inflation and interest rates force business and consumers to cut spending. The ultimate effect is a slowdown of the economy.

Of course, as costs keep rising, business is forced to cut them. The negative feedback between lagging and leading is clearly visible at this point. Business will not be satisfied to cut costs until the factors that created declining profits are brought under control. In other words, business will stop cutting costs only when the lagging indicators finally decline. A decline in the lagging indicators (for example, inflation, interest rates, growth in labor costs) is a signal that costs are finally under control. It is a signal that labor costs, commodities, and interest rates are on the way down. This is an important indication for business that their margins are likely to improve in the near future, and therefore, encourages them to start spending again. Phase three represents this adjustment and the slowdown will continue until the lagging indicators begin to decline. This is the crucial development investors have to look for in this phase of the business cycle.

The important developments that take place in phase three are the following:
• The growth of the money supply continues to decline.
• The dollar is relatively weak.
• The stock market is weak.
• The economy, as measured by the growth in production, sales, income, and employment, continues to slow down and eventually falls below its long-term growth potential.
• Profits continue to remain strong and eventually decline.
• Commodities peak and eventually decline
• Short-term interest rates eventually peak and then decline.
• Long-term interest rates eventually peak and then decline.
• Inflation continue to rise and eventually decline.

What happens during phase four of the business cycle?
Finally, the jogger has decided he just can't make it - it is time for the economy to slow down - at least to below its average pace and moves into phase four. This is, therefore, a time when the growth of the economy falls below its long-term average of 2.5 to 3%. With tight monetary policy, as the money supply continues to slow down, and with business continuing to cut costs, the economy remains weak and eventually in phase four the first signs of recovery begin to appear. As the economy grows very slowly, inflation peaks and then starts declining. Consumers aren't buying much because of rising unemployment rates due to business cost-cutting programs. Interest rates, due to lower inflation and slower growth in the demand for credit, start to decline. Commodities weaken because of slow demand caused by the economy and slow growth in production. The dollar, reflecting all these uncertainties, remains weak.

It is interesting to note that the forces that caused a slowdown - higher costs, inflation, and interest rates - are now reversing. In other words, the lagging indicators are now declining. But as the cost factors decline, the profit margins tend to improve again. At the same time, since the Fed has now achieved its purpose of controlling inflation, it will start easing again and let the growth of the money supply expand. The jogger is now rested and ready to run at a faster pace.

Now the Fed decides to provide more liquidity because it has achieved its purpose. More liquidity, lower costs, lower inflation, increasing profitability - now the economy is back in a position to start all over again. The jogger has rested and has the strength to start running at a faster pace and the economy is ready to start all over again with phase one. The dollar, reflecting an improved mood, begins to strengthen.

The developments that take place in phase four can be summarized as follows:
• The growth of the money supply continues to decline and as soon as short-term interest rates peak, it begins to rise again.
• The dollar declines and eventually strengthens.
• The stock market remains weak and eventually strengthens.
• The growth of the economy, as measured by the growth of production, sales, income, and employment continues to slow down.
• Profits continue to remain weak.
• Commodities are weak.
• Short-term interest rates decline.
• Long-term interest rates decline.
• Inflation declines.

(From Chapter 4 of my book Profiting in Bull or Bear Markets. Published also in Mandarin and on sale in China. The book is available at Amazon.com).

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/7/13

Interesting point

Excerpted from Michael Lind, originally posted at The Spectator,

Why has a global calamity produced so little political change and, at the same time, so little rethinking? Part of the answer, I think, has to do with the collapse of the two-way transmission belt that linked the public to the political elite.

But there is a deeper, structural reason for the persistence of turboparalysis. And that has to do with the power and wealth that incumbent elites accumulated during the decades of the global bubble economy.

Think about what has been happening in the US and Europe. Two major economic regions in disarray. Yet people are numb. They do not know what to say. They do not know what to think. They are totally lost. No new ideas are discussed.

Maybe the analysisi in the book Why Nations Fail may help in finding an answer.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/6/13

The markets always win!!!!

Source: Bloomberg - Gerard Depardieu, the [famous] French actor who was granted Russian citizenship, met President Vladimir Putin in the Black Sea resort of Sochi after receiving his new passport, according to a statement on the Kremlin’s website.

Depardieu, who bought a home in Belgium and applied for citizenship there before Putin offered a Russian passport, said he did so to flee taxes imposed on the wealthy by French President Francois Hollande.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/5/13

THE BUSINESS CYCLE: A PRACTICAL USE OF ECONOMIC INDICATORS

The system of leading, coincident and lagging indicators allows the investor to follow the progress of the business cycle through its various phases. It also provides an important way to assess the risks and opportunities offered by various assets. When we discussed the indicators above, it became clear that an increase in the index of leading indicators - for instance, growth in the money supply, orders, building permits or profits - is followed after several months by an increase in the coincident index - for instance, production, employment, and income.

A protracted and strong increase in the coincident index is followed by an increase in the lagging index - that is inflation, labor costs and interest rates - a sign the economy is strong, is working close to full capacity and price and cost pressures are intensifying.

The length and volatility of the business cycle, and therefore, the investment risk, depends on how rapidly and how soon the lagging indicators rise. The reason is that a rise in the growth of the lagging indicators is followed after several months by slower growth in the leading indicators. For instance, an increase in interest rates makes the building and purchase of real estate more expensive, and therefore discourages the development of this sector. This is a typical example of a rising lagging indicator, such as interest rates, followed by a slower growth in a leading indicator, such as housing starts or building permits.

The same applies to profits. An increase in costs has an almost immediate negative impact on profits, forcing profits to slow down. Or, a rise in interest rates is followed by a slowdown in the money supply or stock prices. Eventually, the slowdown in the leading index causes, after several months, a slowdown in the index of coincident indicators. The point is that these three types of indicators (leading, coincident and lagging) are closely interconnected between themselves by very precise and logical relationships.

Only after a protracted slowdown in the coincident indicator, does the index of lagging indicators begin to decline. A peak in the growth of the lagging indicators follows a protracted slowdown in the coincident indicators. The reason is that the economic slowdown expands to various sectors of the economy. As a result, unemployment rises, labor becomes more available, and wages slow down. On the other hand, because of slower economic growth, demand for money declines and interest rates also decrease.

A few months following a decline of the index of lagging indicators the index of leading indicators rises again. The reason is that the decline in costs (wages and interest rates) makes it attractive again to invest in a new house, or to build new productive capacity. The money supply accelerates in response to increased demand for funds due to the decline in interest rates and stock prices rise.

The importance of the system of leading coincident and lagging indicators is that they are closely tied together (Fig. 4-1 and Fig. 4-2). The lagging indicators are the most relevant ones because an increase in the lagging indicators forewarns the investors and the businessperson that the leading index will decline and the economy will eventually worsen. On the other hand, a decline in the lagging index tells the investor and businessperson that the leading indicators will soon rise and that business condition will improve.

We mentioned above that the S&P 500 index, which is an index used to measure stock market performance, is a component of the index of leading indicators. We also have shown how short-term and long-term interest rates are lagging indicators. As we mentioned above, the stock market is a leading indicator of the business cycle because it reflects the liquidity available in the system.

Since the stock market is a leading indicator, its risk decreases when the index of lagging indicators, for instance, inflation, short-term and long-term interest rates, decrease or remain stable. This is good time to be in stocks. However, the odds favor a peak in the stock market when inflation, short-term or long-term interest rates begin to rise.

The financial cycle that took place from about 1990 to 1995 can also be used to explain the relationship between leading, coincident, and lagging indicators.

This chart shows how a peak in the leading indicator is followed by a peak in the coincident indicator, which is then followed by a peak in the lagging indicator. A peak in the lagging indicator is then followed by a trough in the leading indicator, which is then followed by a trough in the lagging indicator. And the cycle starts all over again. Note the negative feedback induced by the rise in the lagging indicator. The importance of the negative feedback is in its impact on measuring stock market risk and predicting its important peaks.

This is a different way of representing Figure 4-1. It also emphasizes that a leading indicator is predicted by using a lagging indicator, a coincident indicator by a leading indicator, and a lagging indicator by a coincident indicator. In 1989 the growth of the money supply began to expand rapidly (the growth of the money supply is a leading indicator). This was also the time when stock prices bottomed and started to grow faster. The index of industrial production began to grow faster in 1991 due to the generous injection of liquidity in the economic system. The economy strengthened and in 1994 interest rates began to rise because of the very strong growth of the economy. The increase in interest rates (a lagging indicator) was followed by a slowdown in the growth of the money supply and also a decline in the growth of stock prices. The financial cycle ended in 1995 when the protracted decline in the money supply, going from 1992 to 1995, caused the economy to slow down in 1995. A new financial cycle began in 1995.

The decline in stock prices (a leading indicator) is followed by a slowdown in the economy and eventually by a decline in the lagging indicators and a decline in interest rates (a lagging indicator). A decline in interest rates cannot take place without a protracted weakness in stock prices. Stock prices will start rising again after a few months of declining interest rates (lagging indicators). In other words, it takes a few months from a peak in interest rates to a bottom in stock prices and several months from the trough in interest rates to a peak in stock prices.

The importance of the system of leading, coincident, and lagging indicators is that it ties together business and financial indicators. Their relationship is a very important tool to determine the level of risk for investors in the financial markets.

The basic relationships can be summarized as follows:

• An increase in the growth of a leading indicator (for example: money supply) is followed after about two years by an increase in the growth of the coincident indicator (for example: industrial production).
• A prolonged increase in industrial production is followed after 1-1/2 to 2 years by an increase in the lagging indicators (for example: interest rates).
• An increase in the growth of lagging indicators is followed after several months by a peak in the growth of the leading indicators (for example: money supply).
• The decline in the growth of the leading indicators (for example: money supply) is followed after about 1-1/2 to 2 years later by a decline in the growth of the economy (for example, industrial production).
• A decline in the growth of industrial production is followed after several months by a decline in the growth of the lagging indicators (for example: interest rates).
• A decline in the growth of the lagging indicators (for example: interest rates) is followed after a few months by a rise in the growth of the leading indicators (for example: money supply).

And the business and financial cycles start all over again.

(From Chapter 4 of my book Profiting in Bull or Bear Markets. Published also in Mandarin and on sale in China. The book is available at Amazon.com).

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/2/13

A must! An important statement about what is going on right now.

An interesting perspective from someone who manages more than $3 trillion in assets. Take your time. Listen to the whole video. Mr. Fink gives some interesting - and surprising - investment ideas.

Just click here.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

Question of the day

The market is strong - very strong because of the events in Washington.

The S&P 500 is up more than 1.75%. How come then LQD is up a strong 0.21% when it usually declines when the market soars?

Please read the answer in the next issue of The Peter Dag Portfolio.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

Observations

Lexus makes great cars. I owned an SC400 and after 180 thousand miles it was still running like new. No noise or vibrations. In 10 years I only needed to change the power pump of the steering system. It felt the same at 50 or 90 miles/hour. The stereo system was impeccable with its 12 CD player.

Last December Kathi and I decided to take a few days off from our work schedule and the cold weather, and drove south. I bought new rear tires because they seemed slightly more worn than the front tires, probably due to the rear wheel drive of the car.

On our way back, north of Charlotte, NC on I-77, we heard an explosion. The back of the car lifted and started to spin. Everything happened at an amazing speed. We saw trees in front of us. Then the front of the car hit a God blessed guard rail (which saved our life). The car kept spinning and hit the guard rail again with the back . We kept spinning and we ended sideways in the middle of the freeway. No one, thank God again, was close to us. When we stopped, I realized we were alive.

The police stopped the traffic, which backed up for miles. One truck failed to stop and went into a horse trailer, killing two horses. This happened on 12/31. Happy New Year, George and Kathi!

The tires? Brand new Goodyear tires, with only about 1000 miles. The insurance established that the tire that blew up was defective. Time will tell. Will Goodyear pay? Who knows. I hope so. I’ll keep you posted.

I bought another Lexus, of course: the SC430. A toy. Much sportier and more powerful. I went to Annapolis recently, on my way to a talk in Washington, DC.

Yes, my boat is still floating. As I was doing some chores to get her ready to sail, I realized how time moves much slower when I am near her. I called my reliable assistant and told her I was going to quit and stay on the boat. “Yeah!,” she answered, “then your brain will become a marshmellow and you will complain again.”

OK, I understood. Enjoy what you have, now, because you cannot be sure of what happens tomorrow. In Latin: carpe diem! Grasp the joy of the moment! Yeah!

(This Observations appeared in the 4-25-05 issue of The Peter Dag Portfolio ).

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?

1/1/13

Thought of the day

We cannot solve our budget problems by "taxing the rich".

The outcome of this diatribe is to raise the issue of class warfare. I just wonder what the founding fathers would think about it.

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

Disclaimer.The content on this site is provided as general information only and should not be taken as investment advice nor is it a recommendation to buy or sell any financial instrument. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Shouldn't you too subscribe to The Peter Dag Portfolio?