More On Budget Battles

I have had a surprising number of phone calls and discussions with clients on the current budget impasse in Washington.

I say "surprising" because, to me, it is inconceivable that any politician or political party would ultimately sacrifice our country's pristine credit rating to score a few political points. However, based on my recent conversations, perhaps I am being too sanguine.

In my optimistic view, I think that we have been through this before. I view the current situation as analogous to the showdown in the mid-1990's between the House Republicans lead by Newt Gingrich and President Clinton.

As you probably recall, the Republicans had swamped the Democrats in the mid-term elections in 1994, and the political winds all seemed to be behind Speaker Gingrich and his "Contract with America". After failing to come to any agreement on reducing the size of the budget deficit, the federal government essentially shut down for all but "essential" services. However, in the end, after several weeks of talks, the Republicans blinked, and the President went on to a resounding reelection in 1996.

And, oh by the way, the S&P 500 was up +36% in 1995, and +20% in 1996.

However, many of my savvy clients disagree with my characterization of today's situation with 15 years ago, and think that things are much more dire than I do.

And so too does the London Telegraph, as columnist Tim Stanley wrote yesterday:

...here’s {Obama's} problem: this isn’t 1995 and he ain’t Bill Clinton. In 1995, thanks to Clinton’s wholesale theft of Republican fiscal and trade policy, the country was out of recession and unemployment was low. The underlying issue that year was how to share the proceeds of growth...

Today, the deficit is a very real, very big problem that goes beyond party politics. How America deals with its mounting debt will affect business confidence, external investment, Chinese foreign policy, the solvency of Social Security, and the price of basic goods. America’s entire future as a world power is at stake. Government shutdown in 1995 meant that services were suspended and a few driving test examiners didn’t get their daily fix of failing people. Shutdown or default today could extend the recession for another 12 months. With unemployment already at 9.2 per cent (it was averaged just 5.6 per cent in 1995), that’s a risk that isn’t worth playing chicken over. Even Bill Clinton understands that, which is why he’s called for corporation taxes to be cut.


When it comes to the debt talks, Obama is no Bill Clinton – Telegraph Blogs

Are New Tech IPO's Overvalued?

I went to a roadshow for the Zillow IPO yesterday.

Started in 2006, Zillow is a company that has developed and maintains a very extensive database of residential real estate information that is freely available on the net. Zillow can be accessed via http://www.zillow.com/.

I won't go through all of the features of the site, but if you are thinking of buying or selling a home it is truly useful.

Or, if you just want to be a voyeur, you can check to see the asking price for other houses in your neighborhood, or the prices of recent real estate transactions.

Zillow is easily accessed by the free app that you can download on your iPhone, iPad or Android phone. According to the company founders, the Zillow app is the #1 downloaded financial app on smart phones.

The founders of the company also started Expedia, the on-line travel website that is now widely used by thousands of travelers. The idea behind Zillow, management said yesterday, is the same as Expedia: give the consumer the ability to use an extensive database to make informed purchasing decisions without using an intermediary such as a real estate broker.

The Zillow website is cool, and the idea is truly exciting. But when it comes to valuing the company, well, that's a different story.

Zillow has not made any money in its short history. In 2010 it had total revenues of approximately $30 million, and lost about $7 million. Still, traffic at the Zillow site has been soaring, and there is significant revenue potential through both on-line advertising as well as partnering with affiliates such as mortgage companies.

The IPO is offering roughly 10% of the company for $45 million, with the founders and initial investors holding the rest of the shares. Put another way, the company is being valued at around $450 million, or 15x sales, which puts it at a valuation that I will have to take a pass.

That said, I bet the IPO does well - the lunch meeting was packed, and the hotel had to set up tables in the hallway to accommodate all of the attendees. Zillow is apparently one of this summer's "must have" stocks, like LinkedIn or Pandora Media.

I could be missing something.

Sunday's New York Times had an interview with Marc Andreessen, one of the most prominent venture capitalists in Silicon Valley and the founder of Netscape, which was the first web browser.

Mr. Andreessen thinks that old style investors like me are totally out to lunch:

Contrary to all the recent hype about a bubble, you’ve said that tech companies are actually undervalued. So in true 1999 fashion, should I take my life savings out of mutual funds and toss it into tech stocks?

I’m certainly not an investment adviser, but on a 30-year basis, these things are cheap. If you compare how big industrial companies like G.E. are valued compared with big tech companies like Microsoft, Cisco, Google and Apple, tech stocks have never been valued more poorly in comparison. So not only is there no bubble — these prices are reflective of the fact that the market still hates tech. This bubble talk is about everybody being unbelievably psychologically scarred from 10 years ago.

http://www.nytimes.com/2011/07/10/magazine/marc-andreessen-on-the-dot-com-bubble.html?_r=1&scp=2&sq=marc%20andreessen&st=cse

I'm not convinced, but I am willing to concede that Mr. Andreessen might be on to something.

Take Microsoft, for example. The market cap of Mr. Softy is $225 billion, which makes it one of the largest companies in the S&P 500. Yet its core franchises - the operating system, and ubiquitous Windows software - is under fierce attack. The PC market is shrinking, as consumers move to smart phones, and Microsoft is now offering a package deal on Word, Excel and PowerPoint for $6 monthly subscription fee on iPad.

Put another way: Zillow, LinkedIn, et. al. might not be around 10 years from now - but where will Microsoft be?

Living On the Edge - But With a Net

Last Friday's unemployment report was a disappointment, to put it mildly.

Analysts were calling for job growth to be +100,000 or more, but only 18,000 jobs were added to the economy in June. The unemployment rate rose to 9.2%. There are millions of Americans who have either given up looking, or are taking jobs far below their skills.

For an economy that officially is two years into a recovery, this report confirms that the U.S. remains stuck in a deep economic funk.

And yet, just a day before Friday's horrific jobs number, we received the troubling news that Americans are getting fatter. Obesity - and concomitant health issues like type 2 diabetes - is a serious problem for the U.S.:

Obesity rates among adults now exceed 25 percent in more than two-thirds of the states, according to the report, and these rates climbed in 16 states over the last year. None of the states had a decline. The states with the highest rates tended to be in the South, with Colorado boasting the lowest obesity rate, under 20 percent.

http://prescriptions.blogs.nytimes.com/2011/07/07/f-is-for-americans-getting-fatter/?scp=1&sq=F%20is%20for%20fat&st=cse

This apparent contradiction between a country mired in economic misery, and a populace that is eating too much, reflects both the benefits, as well as the downside, of the safety nets that protect us all.

Two generations ago - during my grandparents' time - if you didn't have a job, you were in serious trouble. You could literally starve to death, or go without a doctor's care, because you didn't have the money to pay for food or services.

Today, thanks to programs like unemployment insurance, Medicaid, and Social Security, most Americans can receive most of their basic needs. While the debate in Washington rages on as to how to pay for this blanket of security under which we all sleep, no one is seriously discussing eliminating any of these programs.

But benefits might soon be cut, as funding begins to dry up for some of these programs. As this morning's New York Times discusses:

Close to $2 of every $10 that went into Americans’ wallets last year were payments like jobless benefits, food stamps, Social Security and disability, according to an analysis by Moody’s Analytics. In states hit hard by the downturn, like Arizona, Florida, Michigan and Ohio, residents derived even more of their income from the government.

By the end of this year, however, many of those dollars are going to disappear, with the expiration of extended benefits intended to help people cope with the lingering effects of the recession. Moody’s Analytics estimates $37 billion will be drained from the nation’s pocketbooks this year.

http://www.nytimes.com/2011/07/11/business/economy/as-government-aid-fades-so-may-the-recovery.html?_r=1&src=rechp

Note To Institutional Clients: Second Quarter 2011

Here's what I am telling the institutional clients I work with:

Despite some pretty formidable economic and political headwinds, stocks managed to hold on to most of the gains achieved during the first quarter of 2011. Year-to-date, the S&P 500 has produced a total return of +6%.

For the second quarter, the total return of the S&P 500 was +0.1%. Higher quality stocks lead the way, lead by health care (+7%) and utilities (+5%). Financials continue to lag the broader market averages, and were the worst performing sector for both the second quarter (-6%) and for the first half of the year (-4%).

It would be easy to turn cautious on the outlook for stocks. After all, recent economic numbers indicate an economy that is slowing. Unemployment remains stubbornly high. House prices in many parts of the country have continued to slide despite historically low mortgage rates. Problems in countries like Greece and Portugal threaten to spread across the euro zone, with negative implications for the entire financial system.

Yet we remain positive on the outlook for stocks, at least for now. Valuation of stocks, for example, continues to be attractive. According to financial publication Bloomberg, the S&P 500 is currently trading at just under 13 times income, the lowest level since 1985 (except for the financial crisis in the fall of 2008).

Low interest rates will also attract investors to stocks, in our opinion. Our bond group is not expecting any significant rise in interest rates for the foreseeable future. In many cases, corporate bond yields are lower than the dividend yields from the same corporate entity. Stocks can offer better income plus potential capital appreciation for longer term investors.

While corporations have reported difficulties in raising prices, most earnings reports continue to show improvement over prior periods. Corporations have streamlined operations through creative use of the internet, and in some cases moved manufacturing offshore to lower cost countries. Corporate profit margins remain at record levels, and with commodity prices dropping sharply during the past few weeks we believe corporate earnings will continue to be satisfactory.

Finally, we should note that widespread pessimism is usually a good time to be buying stocks. Bullish sentiment hit a peak in the spring of this year, and has been steadily declining ever since. The best opportunities in any markets are found when others are too focused on potential risks, rather than opportunities.

1995 Redux?

I have been surprised by the number of calls that I have been receiving regarding the political stalemate in Washington.

More specifically, my clients are worried that our government might decide to either delay or default on its debt obligations.

All recognize, of course, that the U.S. has the ability to pay its obligations, but there is a real concern that some elected officials are willing to permanently scar our pristine credit rating in order to score a few political points.

Perhaps it reflects the national mood (please see my post from yesterday), but there seems to be a widespread cynicism about our elected officials - even more than normal.

The last time we had this degree of acrimony regarding our budget deficit was in the mid-1990's.

As some of you might recall, President Clinton had just suffered a "shellacking" in the mid-term election in 1994, and the House Republicans lead by Newt Gingrich were determined to change the direction of the federal government (sound familiar?).

Thus, in the fall of 1995, the federal government essentially shut down for a few weeks as an intense political battle ensued. Here's an excerpt from Wikipedia:

When the previous fiscal year ended on September 30, 1995, the president and the Republican-controlled Congress had not passed a budget. A majority of Congress members and the House Speaker, Newt Gingrich, had promised to slow the rate of government spending; however, this conflicted with the president's objectives for education, the environment, Medicare, and public health.^[1] According to Clinton's autobiography, their differences resulted from differing estimates of economic growth, medical inflation, and anticipated revenues.^[2]

In response to Clinton's unwillingness to make the budget cuts that the Republicans wanted, Newt Gingrich threatened to refuse to raise the debt limit, which would have caused the US Treasury to suspend funding other portions of the Government to avoid putting the country in default.[
http://en.wikipedia.org/wiki/United_States_federal_government_shutdown_of_1995_and_1996

As unsettling as it might have been to the public, the shutdown actually improved the mood of stock market investors: the S&P 500 rose by +36% in 1995, and another +20% in 1996.

Put another way, then, in the current situation is that it is not clear what the reaction of the market will be if the budget showdown cannot be resolved.

In addition, simply selling stocks at this point raises the same question: What do you do with the money?

Hopefully all of this is simply hypothetical.

Gauging the (Pessimistic) National Mood

Over the last few years there has been a considerable debate in economics circles as to the best way to measure a country's economic health.

The conventional way, of course, is the method that we all learned in Economics 101*:

GDP = C+I+G+X

Put another way: the economic health of a nation can be defined by what it produces and consumes.

And yet some economists are arguing that this textbook definition of economic well-being misses the very important measure of the emotional state of a nation.

It is axiomatic in my business, for example, that money does not buy happiness, yet our various measures of our economy have no way of being able to answer the very simple question of whether we are happy or not.

By many measures, the United States economy has clearly improved from 2008. True, the recovery has been a tepid one, with unemployment rates still unacceptably high and real wages stagnant, yet the official data would suggest a clear rebound from the recession.

Meanwhile, the stock market has nearly doubled from the lows in mid-2009, suggesting that investors at least feel much cheerier.

At the same time, many observers believe that the national mood is in a deep funk. Several polls suggest that many of our citizens see the country headed in the wrong direction. A large percentage of us seem to believe that the best days our country are behind us - a view, by the way, encouraged by numerous politicians hoping to score political points.

There was an article discussing this phenomena in last Sunday's London Telegraph. Entitled "Down on the Fourth of July: The United States of Gloom", the author wrote in part:

Frank Luntz, perhaps America’s pre-eminent pollster, argues that his countrymen are much more downbeat now than in 1980. “The assumption with the Carter years was that it was a failure of the elites, not the system. We thought the people in charge screwed up. We didn’t blame ourselves.” Remarkably, many Americans think things will only get worse and the good times will never return.

A recent New York Times/CBS poll found that 39 per cent think that “the current economic downturn is part of a long-term permanent decline and the economy will never fully recover”. That was up from 28 per cent last October. Last month, a CNN poll found that 48 per cent of Americans believe another Great Depression is somewhat or very likely.

Luntz has found that 44 per cent of Americans believe their country’s best days are in the past, 57 per cent that their children will not achieve the same quality of life, and 53 per cent that they are less free than five years ago. So what is going on? How did the land of the free, the home of the brave, and a country that less than three years ago elected a young, untested black man as president on a platform of hope and change, get into this funk?

Down on the Fourth of July: the United States of gloom – Telegraph Blogs

I don't know if I agree with this pessimistic view - after all, the late 1970's were hardly periods of hilarity in the U.S. - but it is an interesting point.

And perhaps it helps to explain why investors think that investing in 2-year Treasury notes yielding 0.41% is better than any other alternative.

*In case you've forgotten: GDP = Consumption + Investment + Government Spending + Net Exports

Goodbye Kindle, Hello iPad

A couple of years ago I bought a Kindle from Amazon.

I love the Kindle - it's simple to use, lightweight, and is easy to read, even in direct sunlight.

While I was initially hesitant to buy the Kindle - after all, buying a book is just as easy as carrying a Kindle - I have spent the last two years telling anyone who would listen that they, too, should join the ebook revolution.

So why is my Kindle now on my bookshelf at home?

Well, I took the plunge this past weekend, and bought an iPad from Apple.

Like my Kindle purchase a couple of years ago, I was initially reluctant to buy an iPad. It's not cheap - the lower end models go for around $500 - and most people get a monthly service plan to get 3G access from either AT&T or Verizon. The iPad is also a little bulkier than the Kindle, and the glass front makes it less harder to read in bright light.

But the functionality of the iPad is hugely greater than the Kindle. The iPad can seemingly do everything, and like all Apple products is so beautifully designed that even the least computer literate can figure out how to use it. The graphics are also astonishingly good

If you haven't done so already, you owe it to yourself to take a look at an iPad (and, no, I don't work for Apple). Even if you don't wind up buying one, I think you will wind up agreeing with me that the potential applications for tablets like the iPad are enormous.

For example, this morning's New York Times carried an article (which I read on my iPad, by the way) describing how pilots are now using the iPads instead of bulky paper manuals:

..a growing number of pilots are carrying a 1.5 pound iPad.

The Federal Aviation Administration has authorized a handful of commercial and charter carriers to use the tablet computer as a so-called electronic flight bag. Private pilots, too, are now carrying iPads, which support hundreds of general aviation apps that simplify preflight planning and assist with in-flight operations.

“The iPad allows pilots to quickly and nimbly access information,” said Jim Freeman, a pilot and director of flight standards at Alaska Airlines, which has given iPads to all its pilots. “When you need to a make a decision in the cockpit, three to four minutes fumbling with paper is an eternity.”

iPads Replacing Pilots’ Paper Manuals - NYTimes.com

The article goes on:

"I don’t remember a time when one product seemed to get so much buzz and acceptance,” said Ian Twombly, spokesman for the Aircraft Owners and Pilots Association. “Many pilots approach new toys with skepticism, and the iPad seems to be almost universally appreciated as a cockpit device.”

There are now more than 250 aviation apps for the iPad, and one called ForeFlight is among the top grossing apps listed on iTunes. Its closest competitors are WingX, Jeppesen Mobile TC and Garmin My-Cast.

It may very well be that in two years time I will be writing about another electronic device that will outshine even the iPad.

For example, research analyst Toni Sacconaghi of Sanford Bernstein wrote a piece this morning suggesting that ultralite laptops like the Macbook Air could offer even more applications than the iPad in a couple of years.

But for now, I'm going to enjoy my new purchase.