Currently, a slowing economy, high unemployment and a terrible housing market are all factors playing a part in the current stock market correction. The recent economic news has not been good, and many investors, individuals as well as institutions, are nervous. As such, it is during these times that some individuals look especially hard for guidance from very obscure sources. Unfortunately, some of these sources are unproven, extreme and often increase investors’ emotions which can lead to more stock market volatility and declines.
The “Hindenburg Omen” is the hot indicator of the week, and is flashing that the stock market could significantly correct / decline in the upcoming weeks / months. On the surface, some of these types of indicators are not only foreboding, but appear to make compelling arguments. However, as noted in yesterday’s Wall Street Journal, the Hindenburg Omen was created in 1995 and since then significant stock market declines have followed the indicator only 25% of the time.
That being said, the following comments are from yesterday’s Wall Street Journal from much more astute economic and investment professionals regarding the Hindenburg Omen: “People are grasping at straws and always looking for someone who might have all the answers,” says Jeremy Siegel, finance professor at the University of Pennsylvania’s Wharton School of business. Barry Ritholtz, chief executive of Fusion IQ, an online quantitative-research firm, says the Hindenburg Omen is a backward-looking indicator that doesn’t consider causation. He labels it “recession porn,” contending that investors are attracted to negative commentary and conspiracy theories during skittish markets.
Realistically, I believe we are in a slowing economy and the recovery is losing steam. As a result, it is not surprising that stock prices have declined in the near term. Add in the other economic concerns that I’ve discussed in prior commentaries, and it is even more understandable why the stock market is retracing its steps.
As is relates to opinions on the status of the U.S. economy, I don’t mean to be crass; however, this week I asked the managing partner of a local CPA firm what his business clients are telling him about their firms’ prospects and he replied – “it sucks!” That is not reassuring. Reinforcing this negative perception was the announcements earlier this week from Congressional Budget Office’s Director, Douglas Elmendorf, who said the U.S. economy faces a tough recovery from the recession. This is in addition to reports from the U.S. Commerce Department that orders for durable goods (i.e., big ticket or purchase items), excluding a big increase in airline orders from the transportation category, fell as well as business investment.
The ant and the grasshopper story and potentially massive fraud
Last week the U.S. Securities and Exchange Commission filed fraud charges against the state of New Jersey for misleading investors who purchased the state’s municipal bonds. Basically New Jersey was “uniformly dishonest” with its accounting and misrepresented the state’s finances. New Jersey basically stated that its balance sheet was on a much more solid footing than it actually was. Ironically, in a settlement this week, the state neither admitted nor denied wrongdoing but promised to not commit such fraud in the future. Under the same circumstances, individuals or private companies would face huge fines and possibly jail time; however, public / government entities and their representatives get off without even getting their hands slapped.
Unfortunately, this may not be an isolated case. According to a recent report from the Pew Center on States, no fewer than 21 states have funded 0% for their retirees’ health care and non-pension benefits (see the following link to the article on this subject http://online.wsj.com/article/SB10001424052748704913704575453800747267726.html?KEYWORDS=States+press).
In addition, in April of this year, the New York State Comptroller, Thomas DiNapoli, issued a negative report on that state’s financial practices. He noted that the state’s budgets increasingly used “financial manipulations” to present a “distorted view of the state’s finances.” Basically Mr. DiNapoli believes, in his words, the powers that be in New York are playing a “fiscal shell game” that is meant to “mask the true magnitude of the State’s structural budget deficit.”
In today’s Wall Street Journal Opinion section there is an article titled “Public Pensions and Our Fiscal Future” (see attached link http://online.wsj.com/article/SB10001424052748703447004575449813071709510.html).
This article validates that state budgets are completely out of balance, and their true liabilities are not being reported or are being ignored. California has a real problem when 80% of its tax collections go to employee compensation and benefits. Additionally, in separate article, a study by the Pew Center on states’ liabilities noted that California is not putting money aside for future retiree benefits.
As a child, most of us read the famous ant and grasshopper story. As you know, the grasshopper played all summer while the ant spent a good portion of its time working to put food away and make preparations for winter. Well we all know how that story ended – the ant remained warm, cozy and well-fed during the cold winter months and the grasshopper, let’s just say he didn’t make it to next years Spring Break.
We are consistently told that we need to live within our means and put money aside for a rainy day and for retirement. However, those running various states’ budgets and programs don’t feel the need. Maybe because by the time this issue becomes a real problem, they will be retired and will have passed the problem / buck onto someone else.
I sincerely hope the potential fraud previously referenced is not wide spread. Otherwise, it could be quite tough on municipal bond holders if various states have misrepresented their ability to pay their obligations and aren’t able to and ask to restructure their bonds and interest payments. Basically, they would ask bondholders / investors to accept much less than what they are owed or possibly nothing. Otherwise, the states’ other choices are to dramatically raise taxes to collect more revenue to fund their bonds and other obligations. Either way it’s a lose – lose situation. The states’ bond holders receive much less than their original investment or money due them, and the states’ tax payers face much higher income taxes leaving them less money for their current living expenses or to set aside for savings / retirement. To put it bluntly, tell me how you would feel if I told you that at some point in the future you find out that the $250,000 that grandma invested, in what she considered very conservative, in municipal bonds are now only worth $75,000, worthless or won’t be paying her the regular quarterly interest payments she relies on due to budgetary issues. Basically, it could very easily disrupt a well-planned and previously considered secure retirement. Grandma may have lived through the Great Depression. What did she do to deserve this?
By now you may be thinking; ok Tony, enough of the gloom and doom, what’s your point?
Bottom line, I continue to hear more news about a slowdown in the U.S. and other overseas economies, and less than enthusiastic comments from business owners and executives from all size firms. Unfortunately, there is enough economic news to support the opinion of a slowing economy, lower corporate profits and possibly even a double-dip recession. Also, an extended recession may ferret out even more bad accounting practices that thus far have been able to avoid the light of day.
As such, I am not inclined to take any additional risk with portfolios. What this means, in my opinion, is that some additional liquidity, short-term and/ or income-oriented investments may be a good option versus adding to growth-oriented investments in the near term. This is not panic time, and the Hindenburg Omen has nothing to do with it. It is basically a reaction to a decelerating economy and putting aside some funds for either safety, liquidity, higher income or a better buying opportunity.
Quotes
“When the worms are scarce, what does a hen do? Does she stop scratching? She does not. She scratches all the harder. A lot of businessmen have been showing less sense than a hen since orders became scarce. They have laid off salesmen; they have stopped or reduced their advertising; they have simply resigned themselves to inaction and, of course, to pessimism. If a hen knows enough to scratch all the harder when the worms are scarce, surely businessmen … ought to have gumption enough to scratch all the harder for business.”
B. C. Forbes, financial journalist
“The prudent, penniless beginner in the world labors for wages for a while, saves a surplus with which to buy tools or land for himself another while, and at length hires another new beginner to help him. This is the just and generous and prosperous system which opens the way to all, gives hope to all, and consequently energy, and progress, and improvement of conditions to all.”
Abraham Lincoln, President and statesman
Tony Moeller, President
Integrity Investment Advisors
12721 Metcalf, #202
Overland Park, KS 66213
tmoeller@iia-kc.com
913-897-2074
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