Saturday, June 25, 2005

James Grant on the coming bear market on bonds

On Wednesday, I had the opportunity to spend some time with James Grant, editor and publisher of Grant's Interest Rate Observer at the annual meeting of the Detroit Investment Analyst's Society. He had a lot of very interesting things to say about interest rates and the economy going forward. I have taken some of the key points from his talk, and added some of my own analysis below.
Grant had made the following observations:
  • We are nearing the end of a bull market on bonds, which started in 1981. In 1981, the yield on a 30-year Treasury was almost 16%, today it is around 4.25%. Historically, bond market (and thus interest rate) trends can last generations. The last bear market on bonds started in 1947 and peaked in 1981.
  • Bond yields are so low that there is almost no risk premium. To quote Grant, we are at the point where we have gone from "Risk-Free return to return-free risk". Institutional investors and central banks are so desperate for yield that they are assuming a lot of credit and payment risk so minimal incremental return. Grant sites the example that Government of Greece 10-year bonds (hardly an example of fiscal conservatism) were being issued at yields slightly above German bonds (which are legitimate AAA). Corporate spreads to Treasuries are also ridiculously narrow as well, offering little margin of safety.
  • There is inflation in the market, and it is not reflected in CPI numbers. This is due to the bubble in housing market, which is not reflected in CPI, but rather an equivalent rent is imputed, which is just a guess. Plus there is price pressure on other items not reflected in CPI. Grant guesses that real inflation is closer to 5% than 3%. The problem of inflation is just an issue of too much money - specifically too much cheap credit.
  • Grant has no confidence in the Federal Reserve, which he mentions is the "last respectable bastion of government price fixing". He also mentions that Greenspan is still nothing more than a civil servant, and that should be kept in mind when people talk so reverently about him.
  • The U.S. current account deficit is unsustainable in its current state - which is America consumes foreign goods and services in return for paper - paper with no intrinsic worth (since it's no longer backed by gold) called U.S dollars and Treasury securities. The federal reserve trying to tinker with interest rates will not remedy this until it starts making major efforts to tighten reserves and the money supply.
Taking this theme to the next step, here are some of the things that I wanted to emphasize in addition to Grant's comments:
  • The housing market is in a bubble and rising interest rates will burst it. Some of the hottest and most speculative real estate markets in the country (Florida and California) are being fueled by variable rate, interest only mortgages. A major spike in mortgage rates will effectively deflate this market. The increase in rates won't necessarily create a crash nationally, but will slow down purchase activity and keep prices level (rather than the double digit price increases of the past few years).
  • Sub-prime mortgage lenders (less than good credit, second mortgages, home equity lines, etc) will fell the pinch the most. This is because: (1) they will have fewer and fewer transactions as rates rise, reducing their fee revenue; (2) increased defaults as lenders cannot service their debts; and (3) losses on foreclosures as home prices plummet and demand for housing drops due to increased rates....
  • Which leads to the mortgage industry in the U.S. as a whole. Margins are being squeezed as it stands, with most mortgage originators making their money on transactional volume. When this dries up and defaults occur, who is left holding the bag? There is a real risk that taxpayers will be on the hook (via government sponsored mortgage entities like Fannie Mae and Freddy Mac), and it could make the Savings and Loan fiasco look like chump change in comparison.
  • When we finally have a prolonged bear market in bonds, what happens to the institutional investors (i.e. pension plans)? Considering the mass of unfunded pension liabilities that many defined benefit plans have, this only exacerbates the issue. Most plans have been taking on a lot more risk to get any additional return they can get to close the gap, and rising interest rates on a sustained basis can/will clearly illustrate the folly of this near-sighted strategy. We've started to see this already with the airlines, and auto makers. Guess who ultimately is on the hook for this? The taxpayers get to foot the bill for the pension administrator's ineptitude.
  • What are the implications on the national and international economy. Rising interest rates and tightening of credit pulls a lot of money from the market. This reduces investment, home purchase activity, and consumption. It also reduces the current account deficit. It also reduces demand for foreign goods, which impacts nations whose economies are dependent on exports to the U.S (i.e. Canada, China, Mexico). Thus it depresses overall economic activity.
  • What are the best ways to hedge against this trend? Gold is probably one way, since it has intrinsic value and cannot really be manipulated by central banks. Stocks that are reasonably valued, with a margin of safety factored into the price, that have solid balance sheets (i.e. not leveraged), good cash flow, and are not interest rate sensitive come to mind. Consumer staples and other noncyclical stocks (pharmaceuticals, health care, utilities, and utilities) are the types of securities that tend outperform in such an environment.
The key things to remember is that: (i) markets are ultimately cyclical, and some cycles can last a long, long time (like interest rates); (ii) markets can remain irrational longer than I can remain solvent; and (iii) a top or a bottom to a market only becomes apparent well after it has passed. Anyone who says that the markets have undergone 'structural changes' or 'it's different this time' is naive.

Thursday, June 23, 2005

Another blow against property rights

Now if this is not another example of judicial activism, I don't know. I guess property rights are non-existent in America.

A divided Supreme Court ruled Thursday that local governments may seize people's homes and businesses against their will for private development in a decision anxiously awaited in communities where economic growth often is at war with individual property rights. The 5-4 ruling represented a defeat for some Connecticut residents whose homes are slated for destruction to make room for an office complex. They argued that cities have no right to take their land except for projects with a clear public use, such as roads or schools, or to revitalize blighted areas.

As a result, cities now have wide power to bulldoze residences for projects such as shopping malls and hotel complexes in order to generate tax revenue. This is much the same story as in Ontario, where well connected developers and greedy local politicians can trample the property rights of its citizens. Where men do not have the rights to the fruits of their labour, they are not truely free.

Monday, June 20, 2005

No Conservative Party in the UK - lessons for Canada

This article by Peter Hitchens (brother of Christopher) in the UK Spectator should be a warning to the CPC and those 'moderates' within the conservative movement advocate abandonment of 'social issues' in order to attract more 'moderate' voters. Hitchens looks at what the happened to the Tories in the UK,
And here is the core of it. The Tory party does not know what it is supposed to be opposing. In fact, in general, it has either supported or failed to oppose all the most important actions of New Labour. These are constitutional, moral and cultural, and they are the real issue.
That, in a nutshell is the problem with the CPC at this moment. It does not know whether it really opposes SMS, abortion on demand, Kyoto, capital punishment, and other issues of great importance. Hitchens then turns his sights on those who think that the UK Tories can sustain themselves on a total fiscal and economic platform,
...Regrettably, this is not so. Margaret Thatcher certainly did not win the culture wars. She did not even fight them. On the great battlefields of marriage and the family, education and culture, morality and law, the Tories have been utterly outmanoeuvred and bypassed. Because they did not fight, they co-operated in the destruction of their own electorate. To this day, they have no idea why it is that they are so despised by the young, and their wretched attempts to toady to fashion, in such areas as civil partnerships for homosexuals. manage to offend or puzzle their supporters while utterly failing to convince their opponents that they are genuine.
Once again, going back to the CPC; they can't be on both sides of an issue or muddle what they really believe in. They are afraid of standing against the 'inevitability' of SSM, government run day care (a.k.a the "Trudeau Youth") for offending the urban elite. But there are is strong constituency within the Liberals in Canada and in the UK, Labour for a socially conservative party,
Look at the almost total disappearance from Parliament of Labour's old patriotic, monarchist, socially conservative right-wing, leaving many working-class people utterly unrepresented. New Labour's multicultural metropolitan social liberalism is repulsive to many traditional Labour voters, many of whom stayed at home in May mainly for that reason. It is surely possible to find a majority out there for a new party, neither bigoted nor politically correct, patriotic and intelligent, committed to national independence and liberty and to the re-establishment of justice. I believe those conservatives willing to think, and to seek allies, could swiftly develop a programme and a coalition far more honourable and realistic than the present Tory impasse.
This is the fate that the Tories in the UK are facing. They are unwilling to take a real stand against Europe, against the cancer of crime sweeping the isles, against the leviathan state. They want to be more efficient administrators of an bloated state. This is the same fate that the CPC faces unless Harper and company and understand who they are and what they stand for. Mike Harris understood Hitchens' point. Pat Buchanan understood this point when he spoke of a 'cultural war' being waged at the GOP convention in 1992. The current GOP leadership understands the importance of cultural issues to the electorate, and has benefited as a result.

Hitchens is despondent on the chances of the Tories 'getting it', noting:
We cannot go on avoiding this decision for ever. There will not be many more chances to wrest Britain from the ‘progressive consensus’. Tories are dying and not being replaced. The party is becoming what marketing men call a ‘ghost brand’, like Capstan Full Strength cigarettes, still worth selling to a dwindling market but with no hope of regaining its lost position. The Liberal Democrats continue to grow and will eventually be able to force proportional representation on Labour (the most likely result of the next election). This would end all hope of real conservative change. I understand that these arguments are unwelcome to many Conservative loyalists, and I know why, but would it not at least be worth debating them while there is still time?
It seems that too many people in the Conservative parties of both Whitehall and Parliament Hill subscribe to the inevitability of this 'progressive consensus', much like the inevitibility of that Marxism once believed of itself. There is an important role to be played by political parties to act as brakes or barriers to this 'consensus'; respect for tradition is one of the foundations of modern Conservatism, of which there is broad support across traditional party lines. If only the party elites could refrain from their urbane solipism, could the CPC and the UK Tories re-discover their history before it is too late.

Quote of the day

Just reminds me of Dalton McGuinty's nanny state:

"The NHTSA's 'Click It or Ticket' program is another step toward making Americans serfs of the state. Let's look at it. I personally believe that wearing seatbelts is a good idea, and I buckle up and remind my passengers to do so as well. Because seatbelt usage saves lives, mandating such is an abomination in a free society. There are many other legislative actions that are offensive to liberty and can have saving as their justification, a matter I'll turn to later. But let's talk about the immorality of mandated seatbelt usage. Let's start with the question: Who owns Walter E. Williams? Is it President Bush, the U.S. Congress, the Commonwealth of Pennsylvania, or do I own myself? I'm guessing that any reasonable person would agree that I own Walter E. Williams. The fact that I own myself means that I have the right to take risks with my own life but not others'. That's why it's consistent with morality to mandate that my car have working brakes. If my car doesn't have working brakes, then I risk the lives of others, and I have no right to do so. If I choose not to wear a seatbelt, then I risk my own life, which I have every right to do. ... Some might rejoin by saying, 'Williams, if you're not wearing a seatbelt, and don't do us the favor of dying in an accident and become an incapacitated vegetable, society will have to bear the expense of taking care of you.' That's not a problem of liberty and self-ownership. It's a problem of socialism. There's no moral case for forcing anyone to care for me for any reason. When we buy into socialism, we buy into paternalistic government."
--Walter Williams

Saturday, June 11, 2005

Will history repeat itself?

With all the rumours swirling about the Libranos considering defeating itself next week following polls showing a Liberal 14 point lead, one need only look back to 1984 to see a possible outcome. If one recalls, John Turner had a significant lead in the polls when he dissolved parliament. He also had the stench of corruption and arrogance surrounding his party from years of rule (notwithstanding the Joe Clark minority government interruption). Turner could not defend the last minute patronage appoints made by Trudeau before leaving office. These factors played a key role in electing the largest majority government in Canadian history.

Hopefully, Harper's office has been brushing up on their history and understanding what needs to be done in order to turn the tables on Mr. Dithers. In spite of the polls, the punditry, and those "red tories" who tell him to be NDP-lite, Harper has a chance to offer an opportunity for real change. I have touched this issue on the Tories running on a real agenda too many times to repeat, and so have many of my colleagues on the blogosphere.

If the writ is dropped next week, it is still a unique opportunity for the CPC to win a majority government. They need only to find a platform, stay on message, respond vigorously to the Liberal slime machine, and remember history.

Wednesday, June 08, 2005

Triumph of the (Liberal) Will?

If this poll is even reasonably accurate, then the brainwashing by the teachers' unions, the CBC, the Globe and Mail, the Toronto Star seems to be working.

There are key points to consider for dismissing these numbers:
  • Polls in Canada under-represent the CPC and over-represent the NDP/Libranos
  • People do not seriously consider their support of lack of support until an election. A campaign changes the dynamics of these polls significantly. If an election was called on this, it would be safe to say that there would be some convergence on the numbers.

That being said, there are a few things that really get me down:

  • In light of the revelations of unprecedented systematic corruption of a criminal nature by the Libranos in Adscam, a good chunk of the electorate still thinks that they are fit to govern
  • It seems that logic or facts do not matter when people hear the 'hidden agenda' crap propagated against Harper and the CPC.
  • Voters are so disenchanted with the process, thinking that all parties are corrupt, that they will not use their franchise to hold their elected officials accountable. In other words, a significant portion of the electorate, if this poll is to be believed, are enablers of crime and abuse of the taxpayers by their representatives.

Of course, this is one poll. One poll does not a trend make. But if this isn't a shot across the bow for the CPC to get a real platform and bypass the media to sell it, then I don't know what is. Maybe the CBC should get the Leni Reifenstrahl award for 'journalism'.

Thursday, June 02, 2005

Right Thinking People beat me to it

I was going to post about the band Joy Division, but disaffectedminion at Right Thinking People beat me to it, kind of. It was 25 years ago this past May that Ian Curtis hanged himself, and I found myself listening to Joy Division a lot the past few weeks, primarily the box set Heart and Soul (a 4 CD box set with all their studio recordings, peel sessions, and selected live tracks) and bootlegs I have compiled of the years. The music is as relevant and fresh to me today as it was when I started listening to it over 20 years ago, which is an accomplishment. For band that only was around for a bit more than two years and only two studio albums, they are one of the most influential groups of the last 30 years. Just look at bands like Ultravox, the Cure, Bauhaus, or any of the more gothic inspired bands today - and you'll see the influence of Joy Division.