Cliff Jumping

It seems like we’re seeing a bubble in cliffs.

Everybody knows about the fiscal cliff. That’s what’s going to happen January 1st if Congress and the President can’t put aside their differences long enough to avoid $500 billion in tax hikes and spending cuts over the next year. The combination of spending cuts and tax hikes could cause a mild recession early next year.

But the metaphor has proven to be so popular that we’re now looking at a milk-price cliff, a container cliff, and—I kid you not—a copyright cliff in 2013. These are all part of the long-term consequences of Congressional actions some years ago. The milk-cliff is due the reinstatement of a 1949 farm law that is scheduled to go into effect that could effectively double the price of milk in the New Year.

The “container cliff” has to do with a potential strike by the Longshoremen’s Union in ports on the East Coast. Federal mediators need to work out a compromise on per-container royalty fees. The copyright cliff is the outworking of a 1976 law that allows artists to reclaim the rights to their works after 35 years. For the struggling music industry, this could be a lethal blow, as revenues from classics from 1978 like “Shattered” by the Rolling Stones or “Because the Night” by Patti Smith revert to their creators.

These issues have come up because Congress doesn’t always plan for the long-term consequences of its legislation. Perhaps they can’t with only two-year terms. But it raises this verbal question: if pro is the opposite of con, what’s the opposite of progress?

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Changing Exchanges

Adapt or die.

That’s the lesson of the ICE/NYSE merger. The Intercontinetal Exchange—an internet-based operator of energy and commodity futures and over-the-counter contracts—has bid for the New York Stock Exchange. Unlike NASDAQ’s bid, which ran into regulatory antitrust issues, or the offer by Deutsche Bourse, which was blocked by the European Commission, the merger with ICE will likely go through.

In this merger of non-equals, a tech-savvy startup with sound growth prospects and abundant cash purchases a centuries-old iconic brand mired in the past. We’ve all seen the pictures of the trading floor at the corner of Wall and Broad, heard the bell ring on special days, and watched movies where frantic runners carry paper orders to anxious specialists staring at monitors. But those images are fiction.

Now trades are executed on electronic exchanges and the profits are measured not in pennies, or tenths of pennies, but in hundredths of pennies. Discount brokers started the trend in the ‘70s that has led to today’s world of dark pools and high-frequency trading. In this dog-eat-dog world, the NYSE’s arcane approach made it look like a golden retriever competing with a pit bull.

It wouldn’t be surprising if ICE spins off the equity business in a year or so. Equity trading is important, but the real growth is in swaps and derivatives—a business with a notional value four times that of the global economy, and growing. In that business, branding matters. Thanks to the merger, ICE is about to get a great one.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

End of the Line

Newsweek is publishing its last printed issue.

Eighty years ago Newsweek pioneered the use of global wire services and produced its first issue, which cost a dime. In 1961 the Washington Post valued the company at $100 million in today’s dollars, and bought a controlling share. Two years ago they sold the company for $1 to a private investor, who merged its operations with The Daily Beast, an internet news-aggregator with some high-profile features and op-ed pieces.

The idea was to have The Daily Beast provide the headlines, while Newsweek would connect the dots and provide in-depth analysis. But it hasn’t worked out. Ad pages at the print publication have plummeted by 80%, and its subscriber base has fallen 50%, from 3 million to 1.5 million, while the online edition has been treading water.

Newsweek is a victim of the digitization of the news: computers, tablets, and smart-phones make a weekly newsmagazine redundant. We don’t need someone else to filter our newswire fees—Google and Yahoo news do that just fine, thanks. And Newsweek’s edgy covers just aren’t worth $5 a pop.

We’re seeing this all over: oldline companies are being gobbled up or hollowed out by online competitors. Whether it’s news, or retail, or finance, the principle is the same: adapt, or die. And when global news is just a click away, you better have something pretty special if you want to charge for it.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Rationally Generous

The Native Americans had “potlatch.” Pacific Islanders had “Aropa.” Techies today have open-source software. And most people exchange gifts at Christmas-time. But is gift-giving rational?

A lot of economists say no. The look at the all the fruit cakes sent but never eaten or the ugly ties politely acknowledged and then tucked away and see nothing but a loss of hard-earned cash. One study estimates that as much as a third of the money spent on Christmas presents is wasted. They recommend people give money for Christmas, or give nothing.

But these modern incarnations of Ebenezer Scrooge miss the social importance of presents. Your kids may groan when they open the sweater from Aunt Polly, but you understand the time and energy she took to knit it. It strengthens your relationship. And the best gifts satisfy a need someone else has but doesn’t really know they have.

Such presents require a significant social investment—thinking like the person, getting into their head, imagining their world. We’re all prisoners of our own perspective and have a hard time seeing the world like someone else. But when we make that effort, our friendships and social bond are strengthened. And we know that strong and resilient social connections help everyone–physically, emotionally, and in many other ways. It’s not rational, but it’s real.

And as Linus told Charlie Brown at the pageant, isn’t that the real meaning of Christmas? “For unto you a Son is given.”

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Big Banks, Big Problems, Big Fines

UBS is paying a fine of $1.5 billion. That’s a lot of money.

As the derivatives market grew in the last decade, a number of banks used their role in the rate-setting process to artificially raise or lower rates. They were able to make bets on LIBOR, and then help set LIBOR. They were like big-league sports players betting for or against their own team.

When I say that the derivatives market grew, I mean it really grew. LIBOR is now a benchmark for almost $350 trillion in financial products. A misstatement of just .01 percent means a $35 billion change in payments. The stakes are huge. It’s no surprise that during the financial crisis LIBOR manipulation was an open secret.

When the authorities calculate LIBOR, a select group of big banks are supposed to submit the actual interest rates that they pay to borrow from other banks. But since the banks are able to make multi-trillion dollar bets for their own books, their incentives to game the system are too big to pass up. At UBS, at least 45 bank employees were involved in the scam, and another 70 were included in open chats and messages where rate manipulation was discussed. Some traders set up payment systems to encourage others to cooperate with the scheme—up to $100,000 per year.

But once the con was made public, a host of borrowers—mortgagees, municipalities, corporations—noted that the rate manipulation cost them billions, while the banks brought in billions. The litigation costs, reputational costs, and fines are now expected to depress bank earnings for years.

When athletes bet on their own performance, they’re banned from the sport for life. Compared to being cut out the money markets, $1.5 billion may turn out to be cheap at the price.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Bubblenomics

In 2008 we popped the housing bubble; in 2000 it was the internet bubble; before that we had commercial real estate, biotech, the oil patch, and LDC debt. Every few years a bubble comes along. So what’s next?

To foresee the next bubble, we need to understand the last. Sub-prime loans at insanely low rates enabled people to build and buy way more house than they needed or could afford. But hey, housing prices always go up, right? Cut rate margin loans allowed people to speculate on tech stocks who never should have been day-trading. But the internet promised a new era through productivity and efficiency, and hey, these stocks can only go up, right? LDC debt financed infrastructure construction and natural resource development in less-developed countries with newly found mineral wealth. Bankers flocked to snap up these loans, because hey, countries don’t go bankrupt, right?

Critical to any bubble is financing. What’s common here is cheap financing and an asset that seemed to only get more valuable. When you have a no-fail asset in a hot sector, bankers compete to lend against it, and the item grows in price exponentially. Speculators play the market with other people’s money, and when the price falls, the banks are left holding the bag.

So what can’t fail these days? Government. With the Fed holding rates near zero, there is little to check the growth of government spending. A $1 trillion deficit now costs less than a billion dollars a year to finance. And with the Fed buying Treasury debt, the cost is even less. Bond mutual funds keep growing even as yields fall to record lows.

But hey, government always grows, right?

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

The Useless Fed?

Is the Federal Reserve irrelevant?

There used to be a time when the markets would hang onto every stray word that a Fed official would utter. There used to be a time when we would wait for the outcome of Federal Reserve meetings with bated breath. There used to be a time when the Fed’s Chairman was considered the second most powerful person in the country.

Not any more.

For the past year or so—ever since the Fed began offering quarterly press conferences—the markets have issued a collective yawn around the time of Fed meetings. It’s as if more information has resulted in less impact. Has Ben Bernanke’s march towards greater transparency resulted in rules and pronouncements that make Fed policy perfectly predictable? Are markets now able to see right through the Fed’s decisions, so they can discount Fed decisions before they happen?

I don’t think so.

The increased transparency has occurred during the Fed’s period of extraordinarily low rates. Rates have been at or near zero for four years now. That’s an unusually long period for rates to be stuck in one place. Part of the reason the markets don’t seem to care about what the Fed does is that they are backward-looking: because Fed policy has been stable, they are predicting that it will continue to be stable. That doesn’t always turn out so well.

Another reason no one seems to care is that it’s hard to point to any marginal effect from the latest Fed decision. It’s hard to say what it means for the economy if the 10-year Treasury yields 1.5% versus 2%.

Finally, bonds and cash seem to be perfect substitutes right now. So for the Fed to expand its balance sheet—and grow from $50 billion in 2008 to $2 trillion now and perhaps $4 trillion in a couple years doesn’t mean anything—no stimulus, and no hyperinflation either. The economy’s problems aren’t monetary, so monetary policy can’t fix them.

But the Fed will continue to make its pronouncements and enact its extraordinary measures, if only to justify its own existence. Just don’t expect it to make any difference for a while.

Douglas R. Tengdin, CFA

Chief Investment Officer

Connecticut Musings

Sometimes we need to stop for a moment and reflect. This commentary is focused on markets and the people who make them, but circumstances require something deeper today.

The horrors inflicted upon the children and adults at Sandy Hook Elementary School last Friday both are both repugnant and mesmerizing. We are repelled by the brutality, but curious about what could have motivated such cruelty. Over the weekend I found myself repeatedly drawn to the news only to turn away in disbelief and disgust.

But people have been facing such tragedies ever since the first murder (although not on this scale). Our hearts cry out to understand how such things are possible. A hundred years ago the writer Joseph Conrad wrote Heart of Darkness, where he uses a river journey into central Africa as an extended metaphor about the darkness within every human heart. And we’ve seen this—in Norway, on 9/11, in the atrocities of the 20th century—some individuals become unhinged and commit unspeakably heinous acts.

Conrad writes that we may start out with dreams of commerce, or fame, or adventure, but often end up unintentionally exploiting everything around us. Whether we misuse nature, or science, or other people, what begins well-intentioned becomes bent and twisted. Another 20th century writer has noted that the line between good and evil runs not between nations or parties, but through the middle of every human heart.

So we rely on institutions and each other to restrain our nature and draw out what is good. Sometimes these fail. The genius of our society is we adapt and move on. But after this heart-wrenching story let’s remember to care.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

The Fed Doubles Down

The Fed is all-in.

In his press conference Tuesday, Ben Bernanke noted that the Fed has made two changes to its policy: first, they’ve changed the end-marker for buying bonds from a date to an economic indicator; and second, they’re changing operation “Twist” from a sterilized sell-bonds/buy-bonds program to a pure bond-buying spree.

With Operation Twist, they’ve been selling short-term notes and buying long-term bonds since September of last year in an attempt to flatten the yield curve and stimulate growth. It’s true that the curve has flattened since then; it’s unclear how much growth this has stimulated. But now they’ve changed their dance from the “Twist” to the “QE.” They’re adding $45 billion of Treasuries to the $40 billion per month of mortgage-backed securities that they’re already purchasing.

That’s $1 trillion in bond purchases per year that the Fed is undertaking. As one wag has said, you do that long enough and eventually you add up to real money. With the Fed adding to bank reserves an amount approximately equal to the federal deficit, we now know how big the Fed’s balance sheet is getting: so big!

And now we know when they will stop: when unemployment reaches 6.5%. Apparently, that is close enough to normal for the Fed to start acting normally. But we’re so far from normal now that between now and then, the Fed’s balance sheet should swell by at least two or three trillion dollars.

But will all this new money get out into the economy? So far it hasn’t. But maybe this time, after trying more the same input, we’ll get a different output.

Douglas R. Tengdin, CFA

Chief Investment Officer

Small Beer?

Small Beer?

Did Deutsche Bank engage in dirty accounting?

That’s what a prominent whistleblower is saying. In the depths of the financial crisis, Eric Ben-Artzi, a former Goldman Sachs banker, claims that Deutsche fudged the valuation of some highly complex securities by $4 billion or so. If his allegation is true, it could tarnish the image of one of Europe’s top financial institutions

Deutsche Bank is one of Europe’s largest banks and one of the few that didn’t need government help during the crisis. Like almost all big banks they’re deeply involved in selling bonds and bond derivatives. You simply can’t be a major player in today’s global financial marketplace without accessing the global pools of capital that are outside the banking system.

Some of these securities are so complex that you need a Ph.D. in math, like Mr. Ben-Artzi, in order to value them. But when he applied his formulas to many of the securities in question, he got a lower number–much lower. So he called his boss’s attention to the discrepancy, then his boss’s boss, and finally went to his company’s hot-line. In the end, after examining the matter, internal and external auditors approved of the bank’s valuation.

But Mr. Ben-Artzi had lost his job when his division was restructured, something that a lot of banks were doing at the time. So he claims that he is a victim of retaliation, which is also possible. Now the SEC is investigating, and if Deutsche did commit fraud, Ben-Artzi is entitled to a big portion of the fine—something that muddies the waters a bit.

In the end, though, these were potentially mark-to-market losses—something the markets later reversed. It shows how abstruse accounting can be: that a complex theoretical model could require real cash inflows. Did Deutsche fudge its numbers? In my opinion, no harm, no foul.

Douglas R. Tengdin, CFA

Chief Investment Officer