A Look At This Week’s Show:
- Fed “Twist” disappoints speculators
- Retail insiders hit the exits
- Patience equals investment virtue
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, we had talked about having Minxin Pei on this week, but we moved that out to next week because of the Fed announcement, and some of the things that are happening in the market right now.
David: There is a lot that has happened this last week that I think is very important, and a lot that is happening this week, in terms of the euro meeting. We have the euro leaders’ meeting on the 28th and 29th, and that is absolutely critical to knowing what their course is. What is the course ahead of them? Is it closer integration, or is it more disintegration? That is what I think we should anticipate, this week.
Kevin: You know, George Soros is not my favorite guy, but he did come out and say that this meeting could make or break the euro. He is giving the warning right now that people should pay attention to what comes out of this because we may see the destruction of what we see now in that currency.
David: And we will talk about this in a few minutes, but I think it is worthy of note that there is a tremendous amount of contention between the players that are showing up. We have the French, who now are definitely socialists, waving the red flag, if you will. We have the Germans, who are definitely still saying, “We have enough money to pay our bills, but not enough money to pay yours.” And we still have the Greeks who are saying, “But why won’t you pay ours, because after all, we are peace-loving, good people? Haven’t you tried our olive oil lately?”
Kevin: (laughter) David, as all this is happening over in Europe, over on this side of the Atlantic we were talking about what the Federal Reserve was going to do, and I don’t know that the announcement last week of the extension of Operation Twist was quite what the markets were looking for.
David: And it didn’t come as a surprise to us. There was no jazz for the speculators, and this is what people were anticipating. You saw the difference throughout the week between the commodities markets and players in the commodities space, versus equities players and equity investors. Equity investors were holding onto hope that yes, in fact, QE-III would be announced. It needed to be, it should be, it must be, we hope it will be, that was kind of the trend that was in the equity market coming into the Fed announcement, whereas we already had equities selling off multiple days in advance of that, saying, “There’s not a chance. Not this time around. It’s not desperate enough.” And frankly, the commodities markets nailed it, because with the Dow at nearly 13,000 there is really no panic in the financial space, not in the U.S. market.
Kevin: David, let’s bring up the fact that you are on financial TV often now, and the average interview is maybe 4-5 minutes long. People’s attention spans have come to be so incredibly short. They are waiting for the next Fed announcement, or they are waiting to see if the sun rises tomorrow.
David: I think it is worth looking back in time a little bit, because to distinguish between today’s speculator in the stock market versus yesterday’s investor, you can look at the average hold of an investment, and it was 10.4 months, going back to a date as recent as 1999, and that was the era of day traders. Prior to 1999 and the 10.4 month average hold for an investment, the 1926 to 1999 period, people held stocks for as long at 3.5 to 3.7 years.
Kevin: And that’s the average, so a lot of people might have been holding 10, others 1, but we are talking about the average being almost 4 years.
David: Now it’s counted in days, with Apple being an example of a long-term buy-and-hold story – 45 days, on average is how long shares of Apple are held by a U.S. investor.
Kevin: So if you are an Apple holder of 45 or more, you are a very long-term investor.
David: A very long-term investor. The average holding period for the S&P 500 index is 5 days. What has happened is that we don’t have an investor community any more. We have a speculator community, and speculators want juicy news bits to trade on.
Kevin: Let me ask you about that. They are inspiring speculators with financial TV, they want juicy bits of information to trade on, but do they stand a chance? We have computers that are operating thousands of procedures in a single second.
David: So if you are booking profits at the end of the day, if you are booking profits at the end of the week, or at the end of the month, now you really are a long-term investor. Again, the era of investing has been co-opted by high-frequency traders, by computer algorithms, and essentially, they are looking for pennies to pocket. They are not looking for big swings, they are not looking for macroeconomic trends. It literally is one cent here, two cents there, one direction or the other, it doesn’t matter, and they are making it up on volume.
Kevin: So the vision of the man in the suit, sitting on the end of the park bench, reading the Wall Street Journal, determining what he is going to do next for the long-term, is just sort of a fallacy of the past at this point.
David: It’s there, but it’s like someone not recognizing that the weather has changed, and that same person is sitting on the park bench in a pair of shorts, when in fact, the storm clouds are rolling in and it’s getting ready to snow. More appropriately, if he was sitting on the park bench, he should be sitting in a down parka. Absent from the market today are those individual investors who are counting on equities to bring home their dreams of retirement. They are gone, they have been discouraged. Normal market behavior with normal investors participating – we don’t think that will re-emerge until you see black pools come into the light of day, until you see the millisecond trading of computer codes limited, and frankly, more heavily regulated.
Kevin: Let me ask you about that. Explain what you mean by black pools. What are black pools, David?
David: Essentially, we are seeing volume shift away from exchanges. The New York Stock Exchange, the American Exchange – you may look at these exchanges and say, “Well, this is, of course, where stocks are traded.” Actually, there are dark pools, or black pools, and these are off-market exchanges where people can buy and sell on a private basis.
Kevin: That doesn’t show up in the price on the market because that black pool is not being monitored.
David: And what owners of large blocks of stock are trying to accomplish in using black pools, or dark pools, is getting out of a position, or into a position, without giving a market indication. In other words, if someone begins to know that I am trying to buy 100,000 shares of a company, or a million shares of a company, or 5 million shares of a company, and they can see that I am going to buy 5 million shares, or I am going to buy a large stock, they will begin to bid up the price, knowing that I have more buying yet to do. Yet in a black pool I can do that more or less on a “private basis” or an anonymous basis.
Kevin: Let me ask you a question, then, David. Is it going to take a crash to start to see things come back into line? Because I, as the average investor, can’t compete with that. I can’t compete in milliseconds.
David: Right, and I don’t think you will see any regulation or change to the way the stock market functions today until we do have a crash, because if we were to implement those regulations today, in fact we would be precipitating a crash, because we would be eliminating 60-80% of the volumes that remain, that is, 60-80% of the shares that are traded that we would see go away if we regulated those high-frequency traders.
Kevin: When we talk about regulation, Dave, you and I both, and I think our listeners, also, understand that we are not looking for undue regulation and thousands of pages of Dodd-Frank type of regulation, but some sort of symmetry to the markets where people have some sort of a fighting chance, some sort of, I don’t want to say, fairness, necessarily, but an equal playing field.
David: Yes, when I talk about desiring more regulation, that is not a rejection of ingrained free market principles – not at all. The capital markets are being destroyed by a few trading firms that have found a very clever way to move at the speed of light, while the average investor is still moving in real time, not exactly light speed.
Kevin: Alan Newman has written about that, the fact that the average guy just can’t get that trade in and out, and it may take thousands of trades that a computer could do by the time the guy could press the button twice.
David: And Newman notes that last September shares of Yahoo were trading on quotes that didn’t even exist until 190 milliseconds after the execution. So we had shares that are trading on quotes that didn’t even exist until 190 milliseconds after the execution of the trade. Where is the SEC? These are some of the problems with dark pools. Things happen that perhaps shouldn’t happen. And who is responsible for it? Who is pulling the strings? Who is making the investments? Who is taking the positions? Who is liquidating? Is this a place where there needs to be a little bit more light brought in? I think so.
Kevin: Speaking of light, David, it is possible, the closer you get to the speed of light, the slower time goes, but if you can exceed the speed of light, you could go back and actually buy shares that didn’t have a price until afterward.
David: (laughter) Well, that’s exactly right, and that’s what I am saying. This feels like a meeting of the movies, of Wall Street and Minority Report.
Kevin: It’s a little bit science fiction here.
David: Exactly. In Minority Report, you remember, there is the group, basically law enforcement, which is looking ahead and anticipating your thoughts, knowing that, oh you are frustrated with this person, and you might kill them, therefore they arrest you on the suspicion of that. It is an amazing thing to speculate on what will happen in the future and make a decision retroactively based on a future contingent event. And yet, algorithms are trading shares as if those future contingent events were already realities.
Kevin: Well, and I’m feeling quite the sucker, because I don’t believe someone has exceeded the speed of light and I’m looking at the stock market right now…
David: (laughter) Which is why the SEC should be all over this!
Again, thanks to Alan Newman. We have invited him to be on the commentary in coming weeks, and you won’t want to miss that when he joins us, but looking at the equity markets from the standpoint of volume, which we just talked about, but now, volume of liquidations versus sales, insider selling is off of its peaks. It is not what it was a few weeks or months ago, but it is rapidly increasing in the retail sector, and that is very interesting, because what we need as a country is for our economy to recover, and we are geared toward recovery for the consumer, and that’s not happening.
Kevin: So, if we were to go back to the middle part of this last decade, is insider trading unusual now versus then?
David: In fact, at present, it’s 2-3 times the liquidation volume. That period, 2006-2010, including the 2008-2009 period, early 2010, the crisis years, where CEOs could have said, “Hey, I’m not sure that I want all of my eggs in one basket. I may love the company that I run, but…” Actually, we are seeing that kind of liquidation now. Amazon, as you mentioned, though that is probably the absurd example, but 19,000 shares bought, that’s the buy side, people entering the store, so to say, and 56.6 million shares sold.
Kevin: There’s that 3000-to-1 ratio.
David: 2960-to-1. (laughter) Yes, that’s 3000-to-1. This is the issue. We have negative Quarter 2 preannouncements which are running at about 3.6 times greater than the number of positive preannouncements.
Kevin: Explain what that is – a negative Quarter 2 preannouncement. Companies, every quarter, announce whether they are going to have greater earnings.
David: This last week I was on Bloomberg. The discussion was, “We just had a decent quarter. What does this quarter look like? What does next quarter look like?” And they are basically saying, “No, lower your expectations. There are some headwinds.” When people begin to preannounce, they are basically setting the bar as low as possible, or low enough that expectations aren’t hurt, and the share price isn’t hurt, on the basis of expectations being disappointed.
Kevin: This reminds me of the honest doctor, before the shot. There are some shots, and tetanus is one of them, that hurt. I always appreciate a doctor coming on ahead of time and saying, “You know what? This is going to hurt a little bit, but it won’t last forever.”
David: Right. We talked about this on Friday in our written comments, about 3.6 times greater numbers of negative preannouncements versus positive preannouncements, and it is for a good reason, if you look at a company like General Mills, which is improving their sales, but they are having a problem. Their input costs are on the rise, commodity costs are on the rise, and guess what? They can’t infinitely increase the price of Cheerios.
Kevin: No, they just infinitely decrease the size of the box. We’ve talked about that before.
David: That’s an option. They can shrink the box, they can change the color scheme – white is the new black. There are things they can do to obscure the fact that they are increasing costs, even if they are not increasing the sticker price. But what they are up against, and this is the real challenge, is that they are fighting the consumer’s budget, and the consumer is fighting to stay alive. So when they increase costs, they risk losing market share, and that’s what is hurting a company like General mills in this kind of an environment.
You would think, yes, it’s a great inflation hedge, it’s something where they are tied to commodities, they are going to have to increase their prices. But listen, the consumer doesn’t have to pay the higher price. They can always move to a generic. They can always move to another brand. They can move to an off brand of Cheerios. They can move to an off brand of Green Giant. They can move to an off brand of Yoplait. You don’t have to buy Yoplait to be interested in yogurt, and that hurts General Mills.
This is what we are talking about. Companies are addressing this. Insiders at those companies are saying, “We don’t like what we see on the horizon. We don’t like it enough that we are willing to take action and change our own personal portfolios to reflect the dark clouds on the horizon.” Are these terribly dark, or are they just semi-dark? All I know is that, at least for Amazon, 2960-to-1 is one heck of a statement.
Kevin: Yes, and the CEOs know this. David, we have been talking about the economic, and here in the United States we can say, “Okay, I’m not going to buy that type of cereal.” But we have seen worldwide inflation, even though it’s not completely out of control right now, affect the prices of food to the point where it actually upturned or overturned governments. I am looking at Egypt as an example. Just recently, with the wheat prices going up the last couple of years, we have started to see riots, we have started to see an overturn of the government. Now, here we have the Muslim Brotherhood running Egypt.
David: It will be interesting to see how this plays out, because in the context, not today, but perhaps tomorrow, of rapidly rising inflation, there is a constituency that believes the Muslim Brotherhood is going to do a better job than Mubarak or anyone else, not realizing that commodity prices, really, are determining what happens in the marketplace. And if their frustration is related to being able to feed their families, their frustration will fall on the Muslim Brotherhood, as well. The Brotherhood won with a narrow margin, and I think it is important to look at the election in Egypt.
Kevin: It was almost a flip of the coin.
David: We have Mideast volatility, if for no other reason than that there are countries that are dependent on oil revenues, and we have just seen oil prices decline by 25%, which does kind of put a crimp on your spending, if you had adjusted to those higher levels. So yes, oil is below $80, and could very well see the low $70s, even $65, as an absolute low. Why? Because we have a lot of it.
The Brotherhood won by a narrow margin. This is the issue. It’s not just Mideast volatility, given the price of oil being at a low ebb. That kind of a thing disrupts a country like Russia far more than it would the Middle East. Military generals are going to have to get on board with the Brotherhood, or they are going to stage a bloody coup, and I think that is unlikely at this point.
Kevin: David, let’s go backwards and look at Egypt, not necessarily as an aggressor against Israel, but there have been statements made this week that are already showing that from the other side, the old Anwar Sadat/Menachem Begin talks – those things seem to be part of history, at this point, with Egypt.
David: One would like to see, in the first week of leadership, something different than Mohammed Marsi’s quote saying that the new capital of Egypt is likely to be Jerusalem, Allah willing.
Kevin: He has his sights on Jerusalem.
David: Minorly controversial, again, sort of Mideast volatility. Not just the oil price, not just the Muslim Brotherhood, but a few views that, frankly, aren’t that friendly to Israel, and we will have to see. Maybe he is nothing in the party. Frankly, they popped him out of nowhere since their first choice candidate was not allowed because of a family tie to the U.S.
Kevin: So, clearly, there is nothing to worry about in the Middle East, because the oil price usually tells you just about how scared you are supposed to be about that part of the world.
David: The thing is, you have a divided culture. In this election, it was a 50/50 split, essentially. It ended being something like 51.3 compared to 47.7 – it was very, very close, out of seven or eight in the field, two of them got all the votes. It was a dead heat. Again, we have the reform-oriented Muslim Brotherhood versus the old regime, the military-connected candidate.
The Brotherhood has received glowing reports for its charitable work and social welfare programs. That’s the way it’s viewed domestically, and we just have to keep a watchful eye on it and see if the old treaties, as you mentioned, are upheld, and if the non Islamist communities inside Egypt are, in fact, respected. There is a small, but reasonably sized, Christian community within Egypt, and we will just have to see what develops there over the next few months.
Kevin: David, the statement that was made about Jerusalem – it’s fascinating, we are starting to see things break down even worldwide, as far as the views of the Middle East. The CFR right now is almost encouraging Iran to have nuclear weapons so that it brings a balance of power to the region.
David: Kevin, you really know how to make my stomach turn. Clearly, there is nothing to worry about in the Middle East. The CFR suggests that the smartest thing we can do is restore a balance of power in the Middle East by letting Iran develop the bomb? This is the best thinking that the CFR can come up with. These are the guys who are, whether we like it or not, leading us toward a global power structure, and they think that Iran, or at least one writer for foreign affairs thinks that Iran should have the bomb and that will bring peace to the Middle East?
Kevin: David, we were looking at the Middle East, but we have clients, and we have people that we talk to…
David: Just one last point on Egypt, because here is what that article assumes, and this is where I think we are missing many things, whether it is Wall Street or geopolitics, and it is that we assume that the world is run by rational actors. I am just wondering if anyone is checking their assumptions, because to assume that Iran can have the bomb and that is a move toward world peace or Middle Eastern peace, that is assuming that the world is full of rational actors, just as we would assume that when you go to investing, we have a community of rational actors. This is not what defines the market. We define the market in terms of the swings of greed and fear and rationality as something that was pasted on top, pretending that it exists, and justifying the actions that we have as best we can, with rationality. But truly, there are no rational actors in the marketplace, nor the Middle East.
Kevin: Is this not why you have to protect yourself? You protect your finances, you protect your family, you do what you can do. We have had clients and friends of ours in the past who have been saying, “We have to get out of this country, we have to get out of the United States. We are going to move to Ecuador, we are going to move to Paraguay, or Belize.” That’s fine, but the thing is, you have to look at the structure in Egypt. Just look at how quickly Egypt changed. Now we have a Muslim Brotherhood president.
David: Right, so going back to the southern hemisphere, and the ousting of the Paraguayan president over the weekend. Fascinating! It is an absolutely fascinating study in the instability of the democratic process.
Kevin: You just got back from Paraguay about five months ago.
David: It was a two-hour senate hearing and the defense was denied time requested to prepare a response. There was no response. It was just basically a legislative coup – 39 to 4, and the senate ousted the president. The vice president stepped into the role until the new election, about a year from now. Why do we mention it? Democracy in other parts of the world is more frail than you know, with the practice of the rule of law being more an issue of convenience. It is not something that is common practice, but it is an issue of convenience, and not something that can be taken for granted.
Kevin: When you went to South America, you were talking about how you need to be friends with the cops, you need to be friends with the cab drivers, and I’m talking about “friends” in quotations…
David: You need to be friends with the guys at the top, even with the president!
Kevin: As long as you have a little cash in your hand to be friends with.
David: It’s the land of “friends,” but it seems that it is fairly fickle. (laughter) It doesn’t matter if you are friends with the guy at the top, you have to create new friends. This is fascinating, because you would be taking the wrong side of the bet if you ever counted on political stability in Latin America.
Kevin: And is this not a message for the person who is reading material that says that South America is the next great United States?
David: Buy a place in Chile. Buy a place in Argentina. Buy a place in Ecuador. You are talking about one bullet away from being in a Banana Republic. We have gone through a period of credit excess and global growth where that has not been in the cards. We have actually had relative stability in Chile since about 1974. Would I take that for granted, given their recent track record? No, I wouldn’t because I would ask, “What has created a sort of peace on earth and goodwill toward men is money, and lots of it, credit that flowed freely, and the opportunity for all, which means nobody is fighting for their own existence, and socialists and communists who sort of fade into the backdrop as “capitalism” has its day in the sun.
Kevin: It interesting, Dave, there is a word picture, or an analogy, for governments that come and go, because money comes and goes, as well. On my wall in the office I have a number of paper currencies that all, when I hung them up, had value, and now none of them do. Over the last 25 years working here, I have put paper currencies up from various countries, and none of them have that same value.
The thing that we have been continually putting into portfolios during that entire time was something that still has value and more and more of it. I am mentioning gold right now because it represents a solid base when everything else is changing.
David: Gold dynamics in the last week or two have been fascinating. The consolidation continues. We have converging moving averages and this is very constructive, in my opinion, because it has always immediately preceded a move higher. The next major move should bring the Dow-gold ratio to a 5-to-1 ratio.
Kevin: David, where are we now? 7½ or 8?
David: 8-to-1 now. The next major move brings us to 5-to-1 on the ratio. That would be some configuration of 10,000 on the Dow, and 2000-dollar gold, 7500 on the Dow and 1500-dollar gold, or 15,000 on the Dow and 3000-dollar gold. I think pretty likely is a 10,000/2000 split, even in this calendar year, perhaps early next year.
Kevin: And that brings up a great point. What we are not measuring in is the fickle dollar. How much of the Dow can you buy with an ounce of gold? We have said this many times, and there are ratios that are pretty consistent.
David: And a change, nominally, is less impressive than a change, relatively, because when you are looking at an increase in purchasing power, you are talking about a 36½ percent gain in gold-buying of Dow shares, versus that same 2000-dollar gold price from current levels, which is about a 26% increase. 26 versus 36½ – you have a far better rate of return when you are pricing things in relative terms versus nominal terms. The nominal term is going to be, ultimately, what is deceptive anyway, because, as you mentioned, it is in terms of a particular currency, and you assume that you have some reference point of stability there, and you don’t, not in a floating currency environment.
Kevin: And here’s the strange thing. If you were to talk to a Wall Street broker, most financial planners, guys who were trained by what I would call the paper side, they would always say that gold is a risk asset. It’s one of those things you put in, but boy, don’t put too much in because it is sure dangerous.
David: Well, we are finally seeing normal trading in the metals, where that confused identity of gold as a risk asset is set aside for a more historically grounded and realistic view, which is: gold is the best insurance, the best collateral, the least likely asset to fail. This is Richard Russell from earlier this week where he starts by asking this question: “What do we do now? My answer is that we prepare for the long-term, of frustration, and slow and deceptively lower prices. I think at this time, the best position is cash, gold bullion, coins, and loads of patience.”
To me, where he ends, Kevin, is probably where we should begin our investment process, not in trying to figure out what asset class is the best, but what makes an investor better than the next, and able to endure any market condition, whether it is a bull market or bear market, and patience is that enduring quality which will determine the success, or unhinge the success, of an investor.
Kevin: You are talking about patience, but you are going to see quite a bit of volatility, especially in something like silver, where it can go way up, and it can come way down, but there is a general trend, along with gold, that if you watch it, it is a marked trend to the upside.
David: Russell’s comments point to that critical ingredient, I think one of many of the critical ingredients, that investors need in order to be successful. And I think, along with those things like patience, finding primary trends and staying with them, very basic conceptually, but I recall conversations back in 2004 in which investors of our company traded out of silver positions at $6 after an excellent purchase at $4.50.
Kevin: Sure, they made a nice profit.
David: They did, and as far as I know, that person never came back into the silver market. The price has subsequently been to 8, 20, 30, 40, almost 50 dollars an ounce, and what was lacking was patience. Patience is challenging to come by, particularly when the news media conditions you to be compulsively taking action very 5-6 minutes. You mentioned that earlier. The average interview segment on major news networks is 5-6 minutes. That’s the new idea, that’s the new thing I should be buying, that’s the new thing I should be googling, and looking up on Yahoo Finance.
Literally, we think in those short snippets. We think like the trader, we think like the speculator, we are looking for the juicy news bit and losing the greater context, losing the larger context, and forgetting that, over a long period of time, it’s an investor with an insight that actually profits, and does so handsomely.
Kevin: David, this many sound ironic, because you are just about to go on to a television interview right after we do this recording, and you do that a few times a week – Bloomberg, CNN, CNBC, what have you. We really should encourage our clients to turn those channels off and not let them affect their pocketbooks. Even though you are doing those interviews, we are actually probably saying, don’t watch too closely.
David: True enough. One thing we have to say before we wrap up is that the importance of this week in Europe cannot be understated. The European issues – we have the summit this week. Of course it is one of many summits that have been had over the last several months and they have netted absolutely nothing. Nothing has come out of them of any real substance. But this meeting may set the trajectory for the ultimate success or failure of the EU project. We have Italian bank bailouts which are occurring as we speak. The Italian bank I am talking about is the oldest Italian bank going back to the 1400s. So we have Italian bank bailouts, we have the Spanish bond yields which are bubbling higher, and they may actually have enough crisis in the air to do something. This is, I think, a key point, whether it is a U.S. political system, or an EU political system that we are talking about, politicians never take risks until they have nothing to lose.
Kevin: Once they have milked everybody else completely, that’s when they have nothing left to lose.
David: Right, so we have Spain, where capital controls were introduced here in the last couple of days, minimum fines of 10,000 dollar/euros for nonreported foreign accounts, and a prohibition of cash transactions greater than 2500 euros. That’s for individuals and firms. The Spanish Treasury now sees the light at the end of the tunnel, and that light is moving rapidly toward them.
Kevin: Let’s move to Greece. We are told they needed to start laying people off. They are not meeting their bills, they need to start laying people off. It’s called the troika deal.
David: The new government is attempting to renegotiate the bailout terms, and in the process of renegotiating the terms, which had already been agreed to, they have revealed that while they were supposed to be laying off state employees, they actually hired 70,000. 70,000? That’s not like an accidental, “Oh, we did have to hire a few.” This is administration, health, police – according to Reuters, 70,000 new during the period of 2010-2011 when they were supposed to be firing aggressively. Yeah, well…
France: Michael Sapin, according to the Economist, he is the Labor Minister, and he has promised to make the firing process so expensive that French firms can’t afford to lay off workers. This is mind boggling, this is mind addling. This is the kind of thing that leads me to say, those damn socialists don’t realize that when the firms that they are talking about look at that kind of imposition of regulation, all they do is quit hiring altogether.
They are trying to fix an employment issue by saying you can no longer fire, when what that causes a French firm to say is, “If we can’t fire, then we won’t hire either, or where we will hire is in foreign subsidiaries where you can’t tell us what to do.”
Kevin: It’s a little bit like Hotel California. You can check out, but you can never, never leave. You hire somebody, and you can never, never fire them.
David: But guess who is leaving? Guess who is leaving in droves? It is the millionaires of France. It is the most stable tax base that they have, the folks who pay most of the bills in France. Again, this is insane. Francois Hollande, as an election promise, has said, “We’re going to increase the marginal tax rate to 75% for anyone earning a million euros or more per year.” Well, they are already paying an astronomical price. This is the step too far. We are seeing a massive number of people who are moving out of the country, leaving altogether.
Kevin: David it is the millionaires who own the businesses that can’t fire people, so if they are not going to leave for the 75% tax increase, they are going to leave because they can’t run a business by not being able to fire.
David: You have your key people at these firms who are requesting, and it is being granted, that they be relocated. “Listen, I don’t want to be here. Why don’t you put me with our subsidiary in the Netherlands? Why don’t you put me with our subsidiary in North Africa? Why don’t you put me with our subsidiary in the Caribbean, or in India, or in Russia?” This is the issue. The wealthy French are saying, “I’m not going to generate an income here, if you are going to tax me 75% of that income.”
So executives are being moved to foreign subsidiaries, the wealthy are deciding that they are not that French, and they are pulling up stakes. This is the new socialist regime and it is destroying, as I mentioned earlier, the most reliable tax base in the country. France, Greece, Spain – it’s not a pretty picture and this is the backdrop going into the European summit on the 28th and 29th.
We see everyone digging in their heels and getting very belligerent about their demands. New politicians saying, “We know exactly what we want, our constituents have given us power.” But what they don’t have is real negotiating room amongst this collective, and that’s where we could actually see the breakup of the EU project. What has the potential to be utterly unifying, where politicians, on a unilateral basis, don’t check in with their respective constituency groups, and just sign over power to the bodies in both Brussels and Berlin, and everyone is going in with an agenda. This is, I think, going to be a nightmare summit.
Kevin: It is amazing to me, Germany actually is the country to look at. We have talked about Greece possibly leaving the euro, Spain, Portugal, Italy, Ireland, but actually, Germany is the one right now that is saying, “Wait a second, maybe we’re the guys who need to leave the euro. We can’t handle this anymore.” Even the French, when they are taking vacations, this shows how little they get it (laughter). The Greeks added 70,000 workers instead of subtracting them, for their austerity. Then the French asked the question of the courts, “What if I am on holiday and I get sick?”
David: Yes, this is from the New York Times. Europe’s highest court ruled that workers who happen to get sick on vacation were legally entitled to take another vacation. (laughter) And we wonder why Europe is broke. This is codified. This is law. Yes, if you get sick on your vacation, you deserve another vacation. And they don’t take one-week and two-week vacations.
Kevin: No, six weeks.
David: Or four maybe. Four to six.
Kevin: But we do know that August is coming, they are going to have to make all their decisions before the typical European holiday starts, because they never let crisis interfere with vacation.
David: True, very true.
Kevin: Unless they get sick, then they get another one. When does Germany call it quits? That’s what I want to know.
David: You know, they may look at this European vortex and just say, “Listen, thanks, it’s been fun, and it’s going to take us a long time to dig out of this hole. It may cost us 10% of our GDP by leaving, but 10% of our GDP on leaving is better than an endless stream of liabilities that we didn’t accrue and we have no interest in. So don’t saddle us with 10% of GDP in terms of liabilities and make us stay. We would rather take the one-year hit to GDP and leave and go back to the German mark.
Kevin, look, it’s this tenuous. It could, in fact, hold together, and it may, in fact, fall apart. The summer of 2012 – what a fascinating time to be alive.
Kevin: This is from Reuter’s, David. The question is, “How many euro summits does it take to change a light bulb?”
David: (laughter) As many as it takes to get Germany to agree to pay for the new bulb.
Kevin: (laughter) Here’s your new German bulb.
David: Kevin, as we wrap up, we have had, in the U.S., a number of bank downgrades, and as a part of the bank downgrades, we have had both the BIS and a number of other institutions saying that U.S. banks are not ready for the coming European crisis, and they are not ready for a number of reasons. J.P. Morgan, this is a Simon Johnson article from Bloomberg, for trading in assets, a hiccup at all, 1.25% of losses, would be 50 billion and they would be done.
Kevin: Really?
David: Yes, 50 billion dollars…
Kevin: Only 1.25%, that’s a hit that a person could take in a single day, Dave.
David: The Dow has been up or down that amount, gold or silver have been up or down that amount, or more, in a day, this week, last week, today, and we are talking about the value of a huge, huge balance sheet, if it fluctuates down as much as 1.25%. We are not talking about the London whale impairing the company. We are talking about the company having inherent risk on its balance sheet, and this is the largest bank in the world, which, if inadequately managed – Kevin, it’s mind-boggling.
We have the bank downgrades, Moody’s is growing very uncomfortable, not only with Spanish banks, with over 20-25 banks downgraded this week, Spanish debt downgraded, but also U.S. banks, all the big ones, downgraded. And none of this is in light of stress tests, which of course they passed with flying colors. All of the stress tests assumed that there would be no issues in Europe, there would be no systemic pressures. Why do you do a stress test if you are not factoring in major systemic issues? It was window-dressing, it was a PR campaign to say, “Don’t worry about your deposits. Don’t worry about keeping your assets under management with us. We are a stable organization, for all intents and purposes.”
Kevin: It is obvious, David, that Rasmussen doesn’t do bank ratings, because the Rasmussen poll is showing that people aren’t buying it anymore. We are starting to feel like we are in the real recession that we are in.
David: 63% believe that we are already in a recession, and frankly, that doesn’t bode well for Obama, and neither does the Supreme Court ruling this week on Obama care. If it is struck down, Romney’s odds improve dramatically. Kevin, there is a lot that is happening of a political nature here in the U.S., a lot that needs to happen, frankly, of a political nature here. When we are talking about the fiscal cliff and what needs to be addressed before it’s an emergency measure, before we are in panic mode, there’s a lot more that needs to be happening politically, and unfortunately, nothing is happening there. This week, we need to watch very carefully what happens in Europe. Keep your eyes and ears open.
And of course, Kevin, I can’t help but remind listeners that this is the time where you have time, in the summer months where it is a little quiet, maybe you have some peace and quiet, you can get out on the front porch and rock in the rocking chair, or just get alone with your own thoughts. Whatever allocation changes you need to make, you need to make this month, next month, or over the next 2-3 months, because as we head into this fall, both with Q2 and Q3 earnings being soft, and the Fed being intransigent this last week in terms of its support of the market, I think we are going to see worse numbers, not better, before the Fed does anything.
The Quantitative-III idea, the idea that the Fed will step in and be, sort of, the Bernanke put, just like we had the Greenspan put before him, that may not happen until we are at a very painful level – 10,000, maybe even less, on the Dow. I think that the downside versus the upside is far greater in the general equity space. Precious metals are at their lows seasonally. This is where they hit their lows.
We think that people should be very concerned about what is happening, not only in Europe, but here in the U.S., and next week we will go back to our conversation with Minxin Pei, where we will look at some of the hurdles that they have, both of a political and economic nature, in China, and we will explore that over the next couple of weeks as we are actually in China, but beginning that conversation again, relating to China with Minxin Pei.
