The Next-To-Last Mistake

The Next-To-Last Mistake

Submitted by Mark Grant, author of Our of the Box,

I just returned from Napa Valley, California. I was honored to be invited to speak at the Property & Casualty Insurance Association annual conference. As I approach the world by regarding “Risk” and staring at it directly in its face my presentation was different than most as it was not the pixie dust tout of fairy tales forever. There are some parts of my presentation that I thought were worth sharing with everyone.
 
Let us start first with the so-called “Taper.” The amount of money the Fed has been injecting into the markets is not the $85 billion headline number. The amount is about $100 billion due to calls and maturities. This is obviously a 15% premium effect that should be factored in to your thinking when some sort of “Taper” is announced.
 
Consequently if we “Taper” to $70 billion, as is widely thought, and then we add back in the 15% premium, due to calls and maturities, we arrive at a total of $80.5 billion which means we will have in fact tapered more than will be perceived in the headlines. The headlines would indicate a 13.1% cutback but the real number is more like 19.5%. This will have a real time effect in terms of both actual Dollars and liquidity.
 
Then I spoke about numbers; manufactured numbers. I pointed out that utilizing questionable figures and then doing analysis based upon the headline data could prove to be a serious mistake as it led you to erroneous conclusions.
 
I began with the CPI figures and then spoke of America’s unemployment numbers. I pointed out that the counting may be accurate but that the methodology for the counting may be highly in question. In the instance of unemployment we had 510,000 leave the work force last month according to the U.S. government. I asked where they went? Was it Mexico for a sojourn or perhaps to Greece to help their economy? The total now is 90.1 million people that have supposedly left the workforce. The country only has a population of 315 million according to the Census Bureau.
 
Besides wondering about the way things are counted to arrive at a current unemployment rate of 7.3%, which I believe to be between 11.6% and 13.6% if you include some rational number of the people that have supposedly left the workforce for parts unknown, it also means that these people are adding less to the tax base, provide less consumption and probably draw more upon social services and unemployment benefits. In short, more liabilities and less revenues for the country in a time where 43% of all American do not pay Federal Income Taxes according to the Tax Policy Center.
 
Since May 22, the announcement date of a possible Fed “Taper,” the long end of the bond market has dropped by approximately 11%. The equity markets have wandered along like tomorrow will never come. I think that when the “Taper” actually does come that stock markets will wake from their reverie and follow the bond market into a correction.
 
I also spoke about Municipal Bonds as did several other speakers. The Detroit issue, where the State of Michigan is contending that pension funds are senior to General Obligation debt, was a lively discussion in the public sessions and around many tables after the meetings. Thinking the issue through and recognizing the politics of the current administration, there are indications that changes in Federal law are being considered that grant pension funds and social services seniority over G.O. debt. This debt would then probably adjust in yield to its secondary position if there is just some announcement of new legislation and change the thinking of Municipal bond owners.
 
After listening to many “woe is me” declarations at the conference I proposed a solution. I said, “Why not lesson your allocation of G.O. debt now before any such legislation takes place and before yields might widen and go into essential services revenue bonds that would not be impacted by any change in seniority of the pension funds?” I heard from any number of institutional buyers either agreeing with me or wanting to consider this thought. I share my idea with all of you for your consideration.
 
I also said that Municipals represented a great value now as many credits yielded more, without any consideration of a tax benefit, than not only Treasuries but of correspondingly rated Corporate bonds. This is a window seldom seen and I thought it was a good idea to take advantage of it now before the window closes which history has shown will eventually take place. Even if you don’t need the tax exemption, I stated, that many “AA” Munis, as an example, yielded more now than many “AA” corporates and with a greater diversity of credits. I also present this idea for your consideration.
 
Finally I spoke of political risk. It is always present in our markets but lately we seem to have an overabundance of this stuff which clouds and fuzziness clear investment decisions. It is “Taper” and Syria and pension fund seniority. It is Spain and Italy and Portugal and Cyprus and Greece and all of the bedbugs that will show up after the German elections on September 22. It is Putin who said he will go along with any UN resolution only to amend his comment later saying, quoting Reuters, “Of course, all of this will only mean anything if the United States and other nations supporting it tell us that they’re giving up their plan to use force against Syria. You can’t really ask Syria, or any other country, to disarm unilaterally while military action against it is being contemplated.”
 
A Masterstroke after Obama called off the Syria vote in Congress.
 
Check; Mr. President. Your move.
 
“The winner of the game is the player who makes the next-to-last mistake.” 
 
        -Chess Grand Master Savielly Tartakower

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