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Independent Investor: Time Is Running Out

Bill Schmick

By now we have reached our debt limit of $14.294 trillion here in the United States. As you read this, the U.S. Treasury is already shuffling bits of electronic paper around to stay current on our nation's debt payments. By Aug. 2 even this desperate farce will have come to an end.

The Obama administration's deadline is even earlier. By July 22, there must be a deal to raise the nation's debt ceiling or else there will not be enough time to ratify an agreement before the beginning of August, when Congress begins its recess. The situation is serious enough for both parties to forgo their July vacations and work for a compromise this week in steamy Washington, D.C.

A new development has the president challenging the Republicans to work out a longer-term compromise solution to the deficit right here and right now. It remains to be seen whether the GOP will accept the challenge.

The nation's debt ceiling was first established back in 1917 at a hilariously low $11.5 billion. Since 1962, it has been raised 74 times, without a problem on either side of the aisle. So why has the debt ceiling suddenly become such a contentious issue?

Politics is the short answer. The Republican Party, which passed an increase in the debt ceiling eight times during the Bush presidency, claims to have suddenly found religion when it comes to the nation's debt. And if you believe that one, you deserve to be fleeced by the shills in Washington.

The GOP is demanding $4.4 trillion be cut from the deficit over the next 10 years. They are using the ceiling to affect changes in Medicare and Medicaid spending that would probably not see the light of day in any other circumstances. The Obama administration countered with a plan that would cut $4 trillion over the same time period without changing any of the major entitlements programs. One would think that a compromise could be worked out, but as time goes by it seems as if neither side really wants a solution. As the 11th-hour approaches, opposing politicians are milking the drama for very hour of prime time they can capture.

By now just about everyone realizes there will be major fallout from failing to pass a new debt ceiling. The most obvious and immediate outcomes would be that the U.S. would technically default on its loans, our interest rates would spike, and the stock market plummet. Even if our "leaders" had a change of heart and approved a new ceiling a day later, the damage would have been done.

It would be similar if you or your household declared bankruptcy. Although you might be able to work your way back to financial health quickly, the bankruptcy would be part of your credit history for years into the future and with it would come certain costs.

Everyone from the head of the Federal Reserve and U.S. Treasury to every elder statesmen of the economy has warned of the folly of allowing the country to default. And yet a recent Gallup poll indicates that 47 percent of Americans are opposed to raising the debt ceiling while 34 percent say they don't know enough to make a decision. I suspect that most Americans mistakenly believe that raising the debt limit will automatically mean an increase in federal spending. That's not true.

Increasing spending would require authorization by Congress. In today's anti-spending environment that kind of legislation would have few backers. But failing to increase the debt limit will immediately make the debt we owe climb higher. It would force the government to suspend interest payments on the debt we already owe. Those interest payments would continue to accrue into the foreseeable future. The same would happen to you if you failed to make your minimum payment on your credit card. So your overall debt continues to rise, and quickly.

At the same time, as a result of our default, investors worldwide would demand higher and higher rates of interest to lend to a country that had already failed to pay its existing debtors on time. The fact that we might change gears later would not mitigate the actions we failed to take when they were required. The damage has been done and we would pay for it in the form of higher rates for years into the future.

I have long since lost faith in politicians. Their actions indicate that time after time they have put their own interest above the common good. So, yes, this debate makes me nervous. I don't want to see Washington once again play with our livelihoods. A U.S. default will severely impact our car loans, mortgage rates, student loans, credit cards and a whole host of personal debt liabilities. If push comes to shove, it may come down to fighting fire with fire.

The Fourteenth Amendment states:

"The validity of the public debt of the United States, authorized by law, including debts incurred for the payments of pension and bounties for services in suppressing insurrection or rebellion shall not be questioned."

If the GOP is dead set on using the threat of a U.S. bankruptcy to wheedle spending cuts (but not tax increases) from the administration, than, in my opinion, using the 14th Amendment to raise the debt ceiling without legislation is a proper and responsible alternative. God knows, I am all for spending cuts and have been for decades, but this in not the time nor the arena to force change.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

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@theMarket: The Bottom Is In

Bill Schmick

Well, we've made it through another pullback together. It seems clear to me that this week's stock market action is telling us that the worst is over — for now.

Yes, there are still a few dark clouds on the horizon. The closest one is the ongoing debate over increasing the nation's debt limit. Although I believe that in the end politicians will do the responsible thing and approve an increase, they are not beyond eleventh hour posturing. Few politicians can resist the chance to become the focus of the nation's attention by withholding their vote until all seems lost, only to relent at the last moment, thereby becoming our heroes. Disgusting? Yes, but that's what America's politics are all about these days.

As a result, expect continued volatility within the markets as te deadline approaches. The Obama administration claims we will run out the clock by July 22 while the Treasury is sticking with Aug. 2. The time it would take the Congress and Senate to ratify the debt increase accounts for the difference.

But the bias of the market, despite the volatility, will be toward the upside. It appears that investors are beginning to recognize all the positive factors that I have outlined over the past two months. Japan's economy, for example, is roaring back as indicated by very strong industrial production data this week. For readers who missed it, see my June 2 column "Japan, Is The Sun Beginning To Rise?" in which I both recommended Japan and predicted its rebirth. As it occurs, U.S. economic data will also start to strengthen. This Friday's manufacturing data, released by the Institute for Supply Management (ISM), is just a taste of what's to come. It showed the economy gaining strength for the first time in four months. Oh, and expect unemployment numbers to start dropping as well.

As you know, I have been arguing that the U.S. was in a soft patch of growth brought on by Japan's earthquake-related slowdown. Now that Japan is revving up, so will we. With Greece's problems resolved (at least until September) and oil prices heading toward $85 a barrel, Wall Street is finally waking up to what you and I have known for weeks.

Normally, after such a massive move, the markets should pull back to about the breakout level, which would be 1,300 on the S&P. It doesn't have to happen, but if it does, consider it a buying opportunity. For those of you who may have gotten cold feet during the tumultuous times of the recent past, that would be your chance to get back in.

As for the end of QE II, (see yesterday's column "The End of QE II"), all of the hyperbole you have been hearing about how interest rates would spike and the markets plunge did not materialize, nor will it. As I predicted, the demise of the Fed’s quantitative easing program is a non-event. With all these negatives removed from the market simultaneously, I expect stocks to roar. My price target for the S&P 500 remains at 1,450 or higher.

Once we get there, well, that may usher in a horse of a different color but first things first, the markets are going higher so enjoy your gains.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

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The Independent Investor: The End of QE II: Wax On, Wax Off

Bill Schmick

"Wax on, right hand. Wax off, left hand. Wax on, wax off. Breathe in through nose, out the mouth. Wax on, wax off. Don't forget to breathe, very important." — Mr. Miyagi, from "The Karate Kid"

Miles of newsprint and thousands of terabytes of Internet space has been devoted to what happens Friday, the day after the end of the Federal Reserve Bank's quantitative easing experiment. Some say it bodes ill for bond and stock prices. Others argue it will have little or no impact. I say it is simply the end of one program and the beginning of another.

The total cost of the Fed's Treasury bond purchase program amounted to $600 billion. The goal of QE II was to put more money in the hands of consumers and corporations (especially small businesses) in an effort to boost spending and hiring. Unfortunately, it did little to jump start the economy in either area.

In a circular exercise similar to Mr. Miyagi's admonition to "wax on, wax off" the Fed purchased the bonds from the banks, hoping that they would in turn lend that sudden windfall of money to us. But instead, these banks just bought back more treasury bonds. The banks simply refused to lend that money and the Fed has no authority to make them.

QE II did result in lowering interest rates to historical lows, however, which allowed financial speculators to borrow money cheaply and to invest that cash (really short-term speculative trading) into commodities, stocks and all sorts of higher yielding securities. Those of us who have retirement savings also benefited somewhat as the stock market rose and we regained some of the losses incurred in 2008-2009.

All it meant for the average Joe was higher gas and food prices as commodities skyrocketed into the world’s latest financial bubble. That actually slowed spending. As for corporations, the big guys already had more cash on their books than they needed. Their profits were exploding as well and none of them felt the urge to hire more labor since they were doing just fine with what they have now. And why not, since their workers have had no wage increases in years, have had their benefits cut to the bone, and if they complained, well, there are always 13.9 million unemployed American who would be happy to take their job at an even lower pay rate ... As for small business, QE II was a total bust for them.

Doomsayers, such as Bill Gross, the highly respected portfolio manager of the world's largest bond house, Pimco, believe that without the Fed’s support, interest rates in the Treasury market will spike, the economy will fall back into recession, and the stock market will tank in response. A host of knowledgeable players subscribe to that theory and have made their views known to anyone who will listen.

Others believe that there are still plenty of potential investors, especially overseas, who will still want to own U.S. Treasury bonds as a safe haven and as a dependable source of income. Interest rates might rise a little, especially on long term bonds (10-20-30 years) but the rise would depend on the growth rate of the economy and inflation expectations. The stock market would no longer be underpinned by the easy money policy of QEII but that might actually be a good thing since it would reduce the amount of speculation that seems to be a massive part of today’s stock markets.

Of course, the caveat here is that Washington politicians come to their senses and do not allow the country to default by refusing to raise the debt ceiling.

In my opinion, I do not think that the Federal Reserve has taken us this far only to cast us adrift to the whims of fate. The Federal Reserve will continue to keep its role as the largest buyer of Treasuries. A week ago, for example, the Fed stated that it intends to use the proceeds of maturing debt that it already owns to buy more treasury bonds as needed. A total of $112.1 billion will mature within the next 12 months. The Fed also holds $914.4 billion of mortgage-backed debt and $118.4 billion of Fannie Mae and Freddie Mac bonds,  which will also mature. That will mean an additonal$10 billion to $16 billion of cash maturing every month. When you add it all up, the Fed has another $300 billion in cash, more than enough to maintain its support of the bond market.

Remember too that the Fed isn't about to give up on the economy just because QE II didn't quite do the job that they intended. Like Daniel in The Karate Kid, the Fed has learned some valuable lessons from their latest experiment.

I predict that they will try again, as early as next month, to come up with yet another way to stimulate the economy. I’m not sure what they have up their sleeves, but I expect we will start hearing rumors about a new plan very shortly. That will certainly play well in the stock market, don’t you think?

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

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@theMarket: Better Days Ahead

Bill Schmick

After this week you should have either an upset stomach, stress headache or both. Human beings do not do well in markets that climb up and down by over a percent on a daily basis. Unfortunately, as this market bottoms, we may expect more of the same.

On the plus side, the Greek Prime Minister George Papandreou received a parliamentary vote of confidence this week. Yet, facing investors this week is a vote on the passage of the austerity plan that the European Community demands in exchange for bailout money.

Economic data continues to disappoint with the latest unemployment figures coming in more than expected. Wherever you look, gloom and doom pervades the minds and hearts of investors. On Wednesday, Fed chief Ben Bernanke didn't help by reducing the Fed's estimate for GDP growth in the second quarter from 3.1-3.3 percent to 2.7-2.9 percent. Even a 5 percent decline in oil was viewed as negative and simply another proof that the economy is faltering.

Most investors missed the point of Thursday's release of 60 million barrels of crude from the world's strategic oil supply. Pundits complained that it was too little to impact demand since it amounted to less than a day's supply of global demand. Others argued it was an act of desperation by an administration that has run out of ideas to stimulate the economy.

It was none of the above, in my opinion. Readers may recall that a few weeks ago prices of most commodities peaked after the CME raised margin requirements for everything from energy to silver. Speculators, who had bid commodity prices up to astronomical levels, abandoned the market in droves causing prices to decline to their present levels.

Most energy experts believe that the fundamental price where supply and demand for oil are in balance is closer to $85 in barrel. But notice oil, until this week it was still trading at $100 a barrel and above, (although down from its recent peak of $112 a barrel). Clearly, there were still a lot of speculators in the market, who could go either way. It was a tipping point where there was at least a 50/50 chance that traders might try and take the price higher once more.

To me, the International Energy Agency exhibited perfect timing. With a relatively small amount of released oil, they managed to drop the price of crude by $5 a barrel and send the speculators running for the hills. It has also added another element of risk since nervous traders will now have to be looking over their shoulder in case the IEA does it again.

As for the wall of worries that beset the market, all this pessimism is part of the normal process one expects as the averages descend to a level where buyers once again appear. Today we are probably within 1-2 percent of that area, if we are not already there. To me, the math is simple: a possible 50-point decline in the weeks ahead on the S&P 500 Index versus 150-200 points of upside. The risk/reward ratio tells me to not only hold the course but to buy on weakness.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

Write a comment - 0 Comments       Tags: silver, oil, commodities, Greece      

Independent Investor: Oil — The New Tax Cut

Bill Schmick

On Thursday, for only the third time in its history, the International Energy Agency decided to release 60 million barrels of oil from global strategic petroleum reserves. They did so in order to "ensure a soft landing for the world economy."

As readers are aware, I suggested that investors "take profits" on oil as it soared past $100 a barrel almost two months ago. I argued that the clearing price on oil should be closer to $85 a barrel, given the slow growth of world economies. I was early in my recommendation, since oil subsequently climbed as high as $112 a barrel before plummeting to its present level of around $90 a barrel. I fully expect my price target will be reached in the coming weeks.

However, while oil dropped 5 percent Thursday, generating an annualized benefit of $36 billion to American consumers, the stock market fell by over a percent equating to a $200 billion loss. To me, that is a major contradiction. Here's why.

In energy, the rule of thumb economists often site is for every $10 increase in the price of oil, Gross Domestic Product (GDP) drops by one half of one percent. By March of this year, we had experienced a $25 hike in a barrel of oil in a very short time period. Economists were predicting that when (not if) oil reached $120 a barrel, the U.S. economy could easily fall back into recession.

Consumers bear the brunt of higher energy prices. Every one cent increase in the price of gasoline takes $1 billion out of our pockets. And actually it is much more than that (almost double) when you include things like home heating, electricity and price rises in alternative sources of fuel such as propane.

The real tipping point in impacting our consumption behavior occurs when energy prices reach 6 percent of average consumer spending, which occurred in March 2011 at 6.27 percent of spending. At that point, the top 20 percent of income earning Americans were spending 7.9 percent of their disposable income on food and energy. That may be a manageable hit for the rich, but not so for the bottom 20 percent of income-generating Americans. For them, energy and food account for a whopping 44.1 percent of after tax income. No wonder consumer spending and employment fell off a cliff.

As a result of higher energy and food prices, together with the fallout from the Japanese earthquake and tsunami, our economy has hit a soft patch which triggered the present decline in the stock markets. But circumstances have changed and in my opinion it won't be long before market players begin to realize that.

We can't have it both ways. The steep decline in oil and other commodity prices will boost consumer spending and economic growth while reducing unemployment. For consumers, it should be a matter of days before we begin to see this decline reflected in the price at the pump, in electric bills and in other areas. It is an instant and fairly hefty equivalent to a tax cut. Corporations will feel it too, but consumers benefit from that as well in the form of lower prices for products.

Right now, investors can't see the forest for the trees. With Greece threatening to collapse, unemployment rising a bit and the economy still slowing, it is hard to focus on what is just around the corner. But that, my dear reader, is exactly why I write this column — to help you focus on the horizon because there are better days are ahead.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

 

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