Kimball Corson
10/30/2009, Neiafu, Vava'u, Tonga

Checking out a small fish they caught.

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Kimball Corson
10/30/2009, Neiafu, Vava'u, Tonga

Women of social status, probably nobles. There are three classes here. Royal, nobles and commoners.

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Kimball Corson
10/30/2009, Neiafu, Vava'u, Tonga

She gains weight when she doesn't want to go.

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Kimball Corson
10/30/2009, Neiafu, Vava'u, Tonga

The day's catch just came in.

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Kimball Corson
10/30/2009, Neiafu, Vava'u, Tonga

Girls always give me their best expressions. Lucky old dog that I am.

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

Steps into the more blue.

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

And over a church, at that.

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

It's about to get mowed over.

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

Not a whole hull of a lot.
_______

How Trend Trading Compromises the Stock Market

There are three basic approaches to stock market "investing:" fundamentals analysis, charting theories and raw trend trading. Obviously, some market participants mix two or more of these approaches to some degree. By fundamentals analysis, I basically mean a Value Line or Graham & Dodd approach to buying and selling. The other two approaches depend on one or another type of trend analysis. Raw trend trading is simply jumping in and out of the market to ride up long and down trends short, with little real consideration given to the fundamentals of the stocks selected. How is it so little attention need be paid to stock selection, according to investment criteria, in order to successfully trade the market trends? That is the core question. Obviously, a disconnect has clearly arisen between company performance and stock market price performance. Why?

I argue that all forms of trend analysis and trading - anything but classic investment criteria buying and selling - compromises the stock market as a market per se. What do I mean, you say? By compromising the market, I mean the following:

1. Market prices less accurately reflect true company performance;
2. Market prices move less independently of each other;
3. Herd behavior and band wagon effects become more dominant;
4. The market becomes more volatile and less stable;
5. The market is more amenable to manipulation by major players;
6. The market is more open to trading abuses;
7. The market disconnects from reality and has internal life of its own;
8. The market is more inclined to react to irrelevant information;
9. The market also overreacts to external information;
10. The market has a shorter term memory;
11. The market seeks new information to overreact to; and
12. The market is more disposed to bubble up and to crash.

In short, the market does a less good job by far of accurately reflecting companies' current actual and expected performance and of distinguishing between companies in the market and having their stock prices move more independently of each other in the shorter term. These are major failings for a market.

None of this should come as a surprise. The more buying and selling in the stock market is based on factors other than underlying actual and expected company performance based on fundamentals, the less well market prices will reflect that performance and those fundamentals. The reverse is true as well. The more actual company performance becomes irrelevant to buy and selling stocks, the more the stock market takes on the characteristics (1) through (12) above and the less effective the market becomes as a market for the stock of those companies. These may not be popular notions, but that does not alter the truth of them.

The real difficulty is that, given these results from trend trading and given the market's consequentially developed failings, it is still not unreasonable to engage in trend trading. More do it all the time, in one time frame and manner or another. That is because, for everyone, the market is about making money, not about the health of the market per se. But the situation does become a vicious circle and the problems (1) through (12) above are exacerbated the more trend trading occurs. The market is further compromised. Trading manipulations and abuses become more prevalent.

As a practical matter, I believe that little can be done about this problem, but it is very much worth noting and keeping an eye on because it does have a strong bearing on what you should be able to expect from your investments, especially in the shorter term, if you investment using classical investment criteria.

Rejected for publication. Very unpopular notions? Too controversial? Who knows? Its just economic analysis. The more buying and selling in the stock market is based on factors other than underlying company actual and expected performance, the less well market prices will reflect that performance. Surprise! Obvious, at that level, but not at others. One of my more insightful articles, too.

Flash Bulletin: The article was published, albeit late and out of order. Perhaps there was a struggle among the editors or perhaps an assigned editor was simply on vacation. Whatever, it made it.

Posted and published on seekingalpha.com

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

It is just turtles all the way down, young man.
____

The following three comments were posted to Paul Krugman's blog under his article Stimulating Thoughts: Third Quarter Edition in which he argues for ever bigger stimulus programs. My comments:

I. In fact, consumer spending could clearly be better because in truth it tumbled 1.5% in September, as vehicle sales plunged, following a 1.4% gain in August (previously 1.3%). The saving rate rose to 3.3% as consumers returned to saving after buying cars to get clunker monies in August. Real spending dropped 0.6%.

Like too many government programs, including the stimulus program, the effects are too transient and the programs are too expensive. Too little bang per buck and too little impact on the real economy.

The answer is not therefore, as you suggest, to then just make the (stimulus) programs bigger.

___ Kimball Corson

II. The Chicago Fed´s National Activity Index indeed rose for the last quarter, but it is interesting that many of the non-averaged components have been falling for the last two months after a July peak. The Chicago Fed summarized the data:

"Thirty-two of the 85 individual indicators made positive contributions to the index in September, while 53 made negative contributions. Thirty-nine indicators improved from August to September, while 46 indicators deteriorated."

The bad news in this data is that much monthly data has been falling for the last 2 months. If this trend continues, next month this index will likely fall. This would be significant evidence that the recovery is now stalling, after the effects of the government's bump-up programs have passed.

We must face and address our structural problems of the trade deficit, the maldistribution of income, the dysfunctional banking sector and the decline of employment in the manufacturing sector if we want GDP to grow on a solid footing. Until we do this our prospects are poor.

The problem is none of the Keynesian policy makers even recognized these problems or take them seriously enough or believe they really matter. We are barking up the wrong tree, as I keep saying.

___ Kimball Corson

III. What we should be doing is addressing our structural problems of the trade deficit, the maldistribution of income, the dysfunctional banking sector and the decline of employment in the manufacturing sector and we could do that as follows:

The Trade Deficit: adopt an auctioned quota certificate system allowed by the WTO for persistent deficit countries and develop tax employment incentives for the more labor intensive companies in the US engaged in export. Put a surtax on gasoline and use the money to press for the development and use of smaller vehicles that use less or no gas. Provide tax incentives for their purchase. Put a luxury tax on gas guzzlers. We need a big and serious push here, politics be damned.

The Maldistribution of Income: use the tax system and a negative income tax if necessary to quickly redistribute income and raise the marginal propensity to consume. Now, those earning over $85,000 a year get half of all income and dump too much of it into secondary financial markets to create bubbles and messes.

The Dysfunctional Banking System: Run the money center banks through one or another type of FDIC insolvency proceeding to correct incentives, repair debt damage and pass financial reform with less opposition from those banks, while at the same time getting better supervision over them in the interim. We need to get serious here.

Employment in the Manufacturing Sector: We need to subsidize and support employment in this sector and companies with higher labor to capital ratios engaged in exporting a high percentage of what they make. All kinds of programs should be considered to do this.

We need to focus in on our problems and adopt some real fixes if we want to see more sustainable real economic improvements, not just throw more money at the priming pump of aggregate demand and getting temporary increases in aggregate demand that do not last.

We are on the wrong track.

___ Kimball Corson

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

Waiting, for his hair to fade.
____

Good Picks Can Be Clobbered by Trading Trends

We speak of strategies like perhaps this is a good time to be invested in emerging markets, Latin America or perhaps China or maybe even the BRICs, typically by means of spdrs, ADRs, mutual funds, ETFs or the like. Often these strategies are considered defensive plays where there is a lack of confidence in U.S. companies, the economy or the stock market, but good confidence in what is developing elsewhere. The problem is too often this approach does not work, at least in the short term. Why? Because the market on a downward tear, for example, takes just about everything with it, except maybe gold and a few similar picks. A downward tear seems more likely these days, if Friday, October 30th, is any indication, when the DOW dropped by almost 250 points and the NASDAQ, by over 52.

Although Brazil may be on a terrific upswing, BRE and EZW will sink or drop along with everything else. That China is trending up doesn´t matter; your Chinese GXC and FXI will tank along with the rest of the market. Ditto for emerging market funds such as ESR and EWX. Your BRIC fund BIK will sinks like one. The market takes the good, the improving and everything else all down together when it is dropping quickly. Why? I think simply because they are there and in the same market. A collective herd mentality indiscriminately takes hold. Buyers and sellers react emotionally and not not discriminate.The good sink with the bad and the over-priced. The drop is not about individual funds or stocks; it is about what the market itself is doing and participants getting out of it.That things might well sort themselves out much further down the road is little consolation for the adversities and losses in the here and now.

Several years ago, before the Great Recession, but after problems in the world economy began to emerge, The Economist Magazine attracted much attention by arguing that the emerging markets were no longer closely coupled or tied to American and European markets. The emerging markets had "decoupled" and now had independence and freedom of movement, we were told. I was skeptical, as were others at the time. The financial collapse of the Great Recession made it quite clear how wrong the Economist Magazine was, at least in regard to financial markets. Indeed, world financial markets are closely tied together. It was an example of what economists jokingly refer to as Walras' third law: 'everything is related to everything else.' America sneezes and Ecuador catches a cold. So perhaps the good sinking with the bad or over-priced is not just a stock market phenomenon, but a larger real or financial one as well, at least to an extent. But again, in a market on a downward tear, is this the market's prescience, or simply a friction or vacuum effect of being along side? I suspect the latter. It is kind of like being financially rear-ended.

This phenomenon has several untoward consequences, generally. First, it makes it harder to determine what a good stock, mutual fund or ETF pick is, at least short term, by looking at price performance. This is because performance gets separated from the company's or fund's fundamentals in a strongly trending market. Secondly, it is hard on the truly good picks. Instead of basking in their earned glory with rising prices, they sink with the market trend and the bad and over-priced apples. Thirdly, depending on your internal rate of discount, even if your careful picks will do better in the longer run and stand out then, the beating you can take in the short run by having them move with a downward trend can be prohibitive. These facts, in turn, themselves have significant consequences for the market.

What we observe is why many players in the market are much more concerned about going long with the trend if it rises and short with the trend if it drops, rather than in picking good solid stocks, funds and ETFs. Playing the trend and believing the trend is your friend are nothing new. You can aggressively go after trying to pick the turning points or like old J.P. Morgan, you can sit back and take your bite out of the middle. There are many kinds of trend players and many time frames within which to play trends. The argument is you don't care how good your picks might really be on a Value Line or Graham & Dodd basis, because if you fight the market, using those selection criteria, you can get clobbered. If you go with the trend, even riding picks that are known dogs, you can make money. Quirky, but true. In this case, a changing tide lifts or lowers all boats, even those about to sink.

The problem is that the net result of these developments, if too many market participants become trend players instead of investors, is the market begins to look more like a casino and it more readily disconnects from the real economy and the companies whose stocks are involved. It becomes less and less like a forum for good secondary investment, according to time honored investment principles. Herd behavior, band wagon effects, manipulation and the like are able to generate increasing instability in such stock markets. Such increased volatility is viewed opportunistically by traders playing the trends, even if they are only daily ones. At the same time, stock markets become more amenable to bubbles and their consequences. The market incentives to participants have become non-optimal.

These are not developments we should like to see. They reflect on the health of the market as a market per se. They leave us few safe havens in the event of a down pour. They can waste or compromise a lot of good work on careful stock or fund selection and they can send mixed signals to IPO and secondary offering markets. These matters go far to keep money market funds in business and brokerage cash accounts active and busy.

But what are reasonable market participants to do?

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

Now the home of someone who swallowed the anchor, as the expression goes.
_____

Paul Krugman Thinks More Federal Debt is Fine and Dandy

Never concerned with the consequence of large deficits and accumulating federal debt, Paul Krugman has recently dismissed concerns about Japan sliding toward the financial brink, expressed by candidate for Finance Minister Hirohisa Fujii, due to Japan´s rapidly accelerating public debt. What are Krugman's arguments, you ask?

In a nutshell, they are (1) the 6-week high yield on 10-year bonds is 1.36%, evidencing that such fear certainly isn't reflected in Japan's borrowing costs, and (2) the spread between ordinary bonds and inflation-linked bonds in Japan suggests investors expect substantial deflation in Japan over the next five years, hardly what you'd see if they were worried about an imminent collapse in the yen.

I contend that when it comes to macro instability and threatened collapse, this kind of micro analysis is absolutely irrelevant. Worse, it is a feeble, if not disingenuous duck away from the pretty well known elements which in fact portend collapse or at least a disastrously crunching dislocation.
The test for financial stability is not whether the interest rate is positive, increasing or decreasing, or whether one more bond can be sold or what just some bond holders think. It is not about micro-market conditions. It is much more about things like the ratio of debt to GDP, the ratio of deficits to expenditures, the credibility of the issuing government, whether the debt is being monetized and how quickly, the economic soundness of the government´s programs, the public's support of those programs or lack of it and other things like that. The credit crunch should have taught us just how important trust and confidence are in credit and other contingent markets. They are key to determining risk, a threat to expectations and therefore stability.

Economist Peter Bernholz, Professor Emeritus of economics at the University of Basel in Switzerland, is an expert on national hyperinflations. He has studied all cases of national hyperinflation since 1980. His conclusion is that the tipping point on whether hyperinflation will occur is when a government's deficit exceeds 40% of its expenditures and is monetized by the central bank. The U.S. is fast approaching the 40% mark even though not all the deficit is being monetized.

There have been 28 episodes of hyperinflation of national economies in the 20th century, with 20 occurring after 1980, all of which were caused by financing huge public budget deficits through in effect money creation, as we have been doing somewhat.

Whether the economies in fact were in recession or not had surprisingly little to do with it. The reason that is so is because there can be structural reasons not addressed to have a semi-permanent condition of recession as, for example, in the U.S. with our on-going trade deficits, skewed distribution of income, asset pricing bubbles, etc. Too, hyperinflation is not the only way to have collapse, but it is most typical. Stagflation in our case is as likely.

Indeed, we might just have a genuine hyperstagflation, where real conditions deteriorate in the face of runaway inflation. It is the optimal resolution of conflicting deflationary and inflationary pressures, where there is a stagnate or declining economy and too much money in circulation, albeit with lower velocity. This is what happened when Rome fell, prices went through the roof as velocity fell. We start to get hints of this prospect when Keynesian multipliers start to drop and excess industrial capacity and high unemployment become increasingly irrelevant to price increases. The real economy and the monetary system begin to separate and disconnect, each going their own way, a situation we are beginning to observe in the U.S. economy, just as our real economy is too disconnected from our stock and financial markets.

While the dollar collapse might have some built-in protection as the world's current reserve currency, the question is, how much. As central banks diversity away from the dollar -- which could markedly accelerate if they understand this analysis -- the protection may become less and less. So do we buy 5%? What is the comfort margin for our financial misbehavior? How do we find out except by stepping over the line?

We are clearly playing with fire here, but Krugman, Washington policy makers and the Fed do not seem to notice. Markets will react and react violently when they feel matters have been pushed too far and over the line. We saw that earlier. Indeed, this argument is the heart of former World Bank and IMF economist Richard Duncan's predicted "Fall of Rome" scenario for the U.S. He has been right too often in the past to be ignored now. We have already had one major macro tremor and, as things are going, we too likely will have more before Washington gets the message. We can only hope that when they do, it is not too late and time then remains to somehow recoup our position and stay on our feet.

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

This old canon is aimed straight at my boat from the bar where it is located.
____

The Market's Read on the Economy

It is well known that for quite some time now the Dow has vacillated between approximately 9500 and 10,000, waiting I think for a more definitive read on the economy and where we are going. On Thursday, October 29th, the Dow had a significant rally, not surprisingly with the 3.5% GDP growth rate announced then. However, as market participants thought about the growth rate and how much of it was due to the federal government's thumb on the scale in the form of the transient effects of the cash for clunkers program, the tax credit for first time home buyers and of the stimulus program, they realized that real unadulterated grow was probably more on the order of 1%, with no prospect near term for truly improved employment figures.

The next day, on Friday, October the 30th, the DOW tanked for almost 250 points, largely I suspect, in the hands of traders. More broadly viewed, that drop might be one of two things: gaining wiggle room to rise again without sailing too far beyond 10,000 or recognition that this market is too bloated and a correction should start now.

My take is we will continue to dance within the 500 or so point band, at least for a while, waiting for yet more news, good or bad. The market believes the new data are too little to act on. And I say that, realizing that from my point of view, it is much easier for me to make money in the market, without becoming a day trader, if the market trends one way or the other longer term.

What is your take and why?

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

I like the look of it and, for me, that's enough.
___

How Hyperinflation Can Accompany a Deepening Recession

There is talk about the possibility of stagflation, that is, a stagnant economy going nowhere, at the same time we have inflation. The idea is easily explained, using the quantity theory of money and some ideas on whether people come to expect inflation. I will explain it, but not just using a stagnant economy, but one that instead is sinking further into a recession, and not just being accompanied by inflation, but by hyperinflation instead. Both a deepening recession and hyperinflation together are clearly possible.

Many people might wonder how it is that we could have inflation, at the same time as we could have a deepening recession, with declining economic activity and a falling velocity of circulation of money. How, you might ask, is this possible? I explain.

The answer is that the quantity theory of money clearly recognizes this possibility. Consider an extreme set of circumstances. Worse than stagflation, we could have a deepening recession and - pushing it to the extreme - hyperinflation at the same time. The quantity theory of money allows for that possibility.

The original equation for the quantity theory is
MV=PT , where
M = the money supply somehow defined,
V = velocity,
P = prices and
T = transactions in the economy.

As the number of transactions or T falls in a deepening recession, the velocity of circulation of money or V could fall as well, and if in the same proportion, the equation would remain balanced. However, if in addition to these circumstances, M were to rise very rapidly, so could prices, P, again to keep the equation balanced. If M rose enough, we could have hyperinflation of prices --all at the same time as we have a deepening recession, with velocity and economic activity dropping precipitously. The quantity theory of money allows for this possibility. But is it probable? That depends on what people come to expect, how quickly they develop those expectations and what the Fed does about the money supply.

The possibility of a deepening recession accompanied by hyperinflation becomes much more probable if we realize people can intuitively understand the process and of course the presence of recession, but also observe the money supply being increased and therefore expect prices to rise as well. That is, they can anticipate the process. In that case, increases in the money supply will quickly cue them to the idea that they should raise prices and expect other prices to rise as well. The real economy becomes disconnected from the monetary phenomenon of inflation. The impact of an increase in the money supply feeds directly into prices then because participants in the economy are not fooled into believing the demand for their goods and services is increasing because the economy is improving. They know prices rising is due to the money supply being increased. As prices rise substantially, so then will wages of those lucky enough to be employed, just to keep up. Both wage earners and employers will understand this and realize the rising wages are not an improvement in worker compensation, but just a measure to help workers to hold their own.

Whether we get hyperinflation then just goes simply to the question of how much and how fast the money supply is increased by the Fed, that is, how rapidly spiraling debt from deficits is monetized and open window operations are used to increase the money supply directly.

The prospect of a deepening recession, after some improvement near term from the stimulus packages, and that of hyperinflation to then accompany it, is not as improbable as it might seem, if we keep in mind that inflation is everywhere and always about too much money chasing too few goods. Currently, the money supply is increasing and arguably the quantity of goods and services is declining on a longer term trend. Presently, the perceived pressures on the Fed to increase the money supply are very considerable and they are doing so rather quickly, ironically, out of concern that the velocity of money is declining and they fear the prospect of deflation if velocity drops too much. Unfortunately, as this analysis shows, the Fed just might be getting it backwards.
____

Two of my replies to various comments:

1. I am not arguing we will have hyperinflation. I think that is unlikely. I used hyperinflation and a deepening recession as an example. In my view, stagflation is more likely. My arguements are: (1) focusing on velocity or any one variable alone is dangerous, (2) expectations are more the key to inflation, where the money supply is being increased, than is the state of the economy, (3) once expectations focus in, the inflationary process is accelerated and a disconnet develops between the real economy and the monetary economy and (4) the Fed is under considerable pressure to increase the money supply, given its perspectives and problems. It is already monetizing a sizeable portion of the federal deficit.

The core problem of inflation, in our context, is ever more money is chasing about the same or fewer goods and services. If stock and other "investment" assets prices drop and if bank reserves do not get timely mopped up, much more money yet will make it into circulation. We could be awash in money and a mess could well ensue. Again, we are playing with fire here.

2. To clarify further:

T is largely dictated by the real economy and is more of an independent variable, especially after disconnect. V is a link between the real and monetary economies, a balancing variable. M, P are monetary variables, with M being the arguable control variable -- which can get out of hand.

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Kimball Corson
10/27/2009, Neiafu, Vava'u, Tonga

Decorative, in a raw sort of way, and spaced about ten feet apart, punctuating a fence. Gobs of texture and color, though.
______

How GDP and Unemployment Can Rise at the Same Time

Layoffs, particularly the more troubling mass layoffs, are usually components in plans to cut and control costs better. They are mapped out in advance and are usually board approved. Once approved and in place, they have or develop a life of their own and move ahead like a column of British regulars. Lag times are involved. During those lag times, GDP growth, as now, may go from negative a quarter ago to positive for the current quarter. Nonetheless the planned layoffs go forward anyway. Unemployment increases, but so does the rate of growth of GDP.

Layoffs, large or small, might also proceed because, employers, like some of the rest of us, have expectations and do not believe the rise in the GDP for the current quarter is going to be self-sustaining. That is, many might view it as a transient bump-up created by the stimulus programs that will largely disappear in the not too distant future as we lapse back to where we were or close to it. Therefore, they keep their plans and actions in place.

But what if they can and want to increase their sales, you ask? Fair enough.

Typically, the way employers do that for any run expected to be short term is simply work the resources they have a little harder, perhaps by more overtime, multiple shifts, etc. Most businesses have some built-in excess capacity that can be squeezed a bit to make more product or provide a little service in the short term. Employers are very reluctant to add the relatively expensive cost of more labor to their income statements, unless and until they see (a) some economic and market stability, which we presently lack, (b) a sustained rise in GDP or demand for their goods or services, (c) loanable funds are again reasonably available at plausible interest rates, (d) no major asset bubbles are on the horizon which might soon burst with unknowable consequences, and similar elements.

It is for these reasons that employment is well known to be a lagging economic indicator. Much else improves first and then unemployment drops, IF, as I explain, employers genuinely believe the economic environment is on the mend and we are not sliding on a trend line back into a new "lower normal" or about to face a W shaped double dip recession. It is reasonable to believe they know and have the same concerns that the rest of us do. How many of us have larger percentages of cash in our portfolios just now and wonder what this bloated stock market is going to do as it seems to hover at or near a Dow 10,000 apex or how long can we sustain near zero interest rates without bad consequences or what is going to happen to the federal deficits being monetized or will we have inflation or perhaps deflation?

In the face of rising or even high uncertainty, risk is greater and people contract their efforts or remain hedged and tentative. Employers are really no different and because we have so much economic instability and turmoil just now, we can expect unemployment to rise or remain high for quite some time, almost regardless of what happens to GDP in the near or not so near future.

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