Idiots are Running the Asylum: Stay Calm All is Well

* The Idiots are running the Insane Asylum: The poster child for “Stay Calm, all is well”, Jim Paulsen of Wells Capital Management, was a guest host on CNBC this morning. Here is the companion clip from the movie “Animal House” in case you forgot about this scene:

I find it instructive to listen to the bull scenario as a buffer to the bearish prognosticators I follow as well. That CNBC will put this guy on the show for 2 hours is beyond me, but I accept this as a sign of  our collective need to feel good about the future.


In short, Paulsen compares the current recovery as being analogous to the recoveries in 1991 and 2001, in which he cited facts which showed that it took many months to years, for the unemployment rate to drop, and in terms of GDP growth. When Paulsen was challenged about the amount of debt which the household sector has, he cited a statistic called “household financial burden” and basically explained that even though the amount of debt is greater, that lower interest rates keeps the servicing burden within the means of our country. Paulsen also cited the fact that when Ronald Reagan pushed for the enactment of his tax cuts, the deficit to GDP hit 5% which was unheard of at that time, and this ratio subsequently became the norm. What the CNBC commentators did NOT ask Paulsen is this: 


“If it was OK to run a deficit of 5% back in the 1980s, does that make it OK to run deficits at 10% today?”


And this is where I think Paulsen is missing the boat. Part of the reason why the country can run such massive deficits is because over half of the government’s debt issuance has a rate of approximately 1%, when you consider that all maturities of 3 years or less are below 1%. With the total debt to GDP ratio approaching 100%, there will come a limit at which time the debt keeps growing beyond a point of no return. For the time being, the very low rates in the market, allows the government to service this debt. Eventually rates will rise, and when they do, higher interest rates, compounding on top of a debt burden which is greater than the GDP, can snowball pretty quickly into a crisis.


It might take a while for this sort of crisis to occur. I fall back to the deflationary thesis, which suggests that a continuation of the housing market liquidation, and low rates of inflation, is going to provide the cover for rates to remain low, whether the low rates are influencing Fed actions, or the market’s reaction in the bond market. 


* CPI Update – last week’s CPI release continued to show the influence of a weak housing market. Even though 62% of this component comes from a suspicious “owner’s equivalent rent” calculation, the change in housing costs is -0.6% over the last 12 months. Combined with the ex-shelter year over year reading at 1.9%, this is keeping the year over year CPI reading at a very modest 1.1%. In turn, this is supportive of the current low interest rates, and this country’s ability to service the debt burden.  For the time being, the idiots are running the asylum. But it will not continue indefinately!


* Back to my favorite idiot, Jim Paulsen. He was pretty intelligent about a variety of topics, despite his ‘full speed ahead’ view of the economy and the equity markets. He expressed concern to Representative Spencer Bachus, who is the leading Republican on the House Financial services committee, about the Fed’s apparent ‘pushing on a string’ conundrum, ahead of Bernanke’s testimony today. He was skeptical about how much more the Fed can do, which is actually a good/correct thought.


Paulsen also thinks that the developing world will provide a great source of growth for the US. I think he has this backwards. While we are shipping advanced equipment over there, US companies are transfering production facilities to where labor is cheap, as fast as they can. As the developing countries accumulate surpluses, which they are now doing a pretty good job at, they will want to bring all the technology and advanced processes onto their land. What these countries do not realize is that they need the US, because if they do not come up with a creative way to recycle all the dollars they are accumulating from us, then they will help sink the US economy. I think Paulsen has this totally backwards. The developing countries do not want to be a captive to the US, they want it the other way around. Things will continue in this fashion, until they realize that all the dollars they own are becoming worthless. Again, this is not today’s issue, but it will be within the next few years.


So despite all my long run concerns about what is to come, it appears to me that the idiots could run the insane asylum a bit longer, according to the chain of logic laid out by Paulsen. I am not going to buy the market based on this thesis, but it is a good reminder that markets do not move in straight lines.


* Trading points – Stocks – I am including a real time update I sent out this morning at the markets open, along with a companion graph which reinforces the idea that markets do not necessarily move in straight lines:


“Rick’s Blog – Real Time S&Ps – Beware of a rally today!


I am currently 100% short S&Ps, left over from last week. As the attached graph shows, there is a decent resistance line which bounds the upper limits for the upside corrections. If the market goes above yesterday’s high at 1089, then it would indicate to me that the market could be very well targeting the mid to upper 1100s, see green rectangle. Accordingly, I am using 1089 as an intra-day stop to cover my short positions (1087 in S&P futures). I will even use this level as a basis for going long, for a 2-3 week move higher. Bernanke was cause for the market to sell off yesterday. Today, the market could skew his comments in a bullish manner. Beware!”


Shortly after the market opened today, the 1089 level was breached, so I am currently flat in the trading account, while I remain short in a less leveraged way in other accounts. The S&P still needs to rise above 1100 over the short term, to put the market on a projectory into the mid 1100s. Let’s see what happens.


* Representative Spencer Bachus – who is the lead Republican on the House financial services committee, was interviewed on CNBC today. He expressed a healthy concerned about the meddling of government into the financial system, and how this uncertainty is damping the willingness of businesses to invest in expansion. He cited concerns about the deficits, and what a VAT (value added tax) will do to the economy if that is the end game. It was refreshing to listen to his coherent read of the environment.


* GM is buying Americredit, a subprime lender, for $2+ billion, so they can have a captive finance unit to make subprime loans. Not only is the government the main shareholder for GM, but this whole concept seems to be ridiculous. In the press call, GM said that they already had a good relationship with Americredit, and that Americredit does make loans to GM customers. So, the best that I can tell, is that once Americredit is owed by GM, then GM will force them to make loans they otherwise would not make. These are our tax dollars which are getting wasted. GM is buying Americredit with cash they have accumulated over the past year. Shouldn’t they be paying back the government, or giving money to the bond holders they hosed last year? This is a totally stupid idea, in my opinion.