|Mark's Market Blog|
#384 2-7-16: Volatility is baaaack
by Mark Lawrence
Mark's Market Blog
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Markets went down all week. So did oil. On no particular news. There was a counter trend rally starting Jan 21, but it did't last long nor did it go far.
Oil has been dropping for over a year, and markets along with it. Why? Cheap gasoline means consumers have more money left to buy other things, so why is this bad? Here's a simple answer: the world has 1,700 billion barrels of oil in "proven reserves." As oil has dropped from $100+ per barrel to $30 per barrel, those reserves have had their value drop by $70+ per barrel. 1,700 billion barrels * $70 = $120 trillion. That is to say, people who own oil reserves, like the Saudi Royals and the King of Brunei and Iran are worth $120 trillion less today than they were a year ago. Google just passed up Apple as the world's most valuable company; each is worth about $500 billion. The oil countries have lost the equivalent of 250 googles and apples. This has had an affect. Unfortunately they still seem to have plenty of money to build mosques, fund terrorists and fight wars.
40 some years ago, in the mid-70s, the UK decided they absolutely would not devalue the pound. A simple glance at their import/export balance made it clear that this was not feasible. George Soros and Jim Rogers rather famously shorted the pound massively, calling the UK's bluff. This made George into the billionaire I love to hate, and Jim enough money that he retired for a few years and rode a motorcycle around the world. Lately China has decided they will not devalue the yuan. Last month they spent $140 billion defending the yuan and told the world that George, who has since retired into messing with US politics, had better not bet against them. I'm unaware that George is betting for or against any currency these days; he seems consumed with gay marriage and open border immigration and Hillary. However, there certainly are no shortage of Wall Street jerks who are happy to take up George's mantle and bet against the yuan. I can't imagine anything other than this ending the same was it did 40 years ago for George and the UK: China will fold and lots of unscrupulous people are going to make lots of money. And then perhaps retire into remaking the world according to their particular visions, them having lived such exemplary lives and all.
N.Korea launched a "satellite" into space, which if course is actually a test of an ICBM, which test is disallowed by UN resolution. Of course they're also working on miniaturizing a nuke to use as a warhead on an ICBM. It's times like this when I long for Nixon - for all his many faults, he knew how to deal with out of control communists.
I got curious about electric bicycles. Now that I'm officially old I'm strongly considering becoming (more) eccentric, and riding around town on an electric bicycle seemed like it might fit. You can buy a very nice bicycle for around $250. For about $175 you can get a replacement front wheel with a 1000 watt (1.3hp) electric motor. Batteries are another $100 - $300, depending on the range and power you want. Call it $750 to build the whole thing. The resting bicycle will go about 25mph with a range of perhaps 30-40 miles, and costs about $0.15 to recharge. Compared to driving my Prius or a motorcycle, the payback on the $750 is between 12,000 and 18,000 miles. This slowed me down - 18,000 miles on a bicycle seat just doesn't sound like a lot of fun. In fairness that calculation doesn't include depreciation, just gas, oil and electricity. In 2011 when I bought my Prius and used Prius that ran was worth at least $18,000, no matter the mileage. That's changed: today you can rather easily find a two year old prius with under 30,000 miles for around $12,000, which should give you 150,000 miles of trouble free transportation at 42-45 miles per gallon. A couple of years ago I wrote that cars coming off leases should flood the market and crush the price of low mileage used cars; that's happened.
Politics dept. Mostly, I don't consider myself a political person. Getting worked up about Hillary v. Trump is, imho, like getting worked up about who the Duchess of Wales is sleeping with: it may be entertaining to talk about, but it really doesn't have anything to do with us. I've spoken before about the Princeton study on our "democracy:" we don't have one. If you're unclear on this, watch this 5 minute video. In the graph below, Princeton studied several thousand laws passed in the last 40 years and graphed them against voter preference and elite preference. In a fully functional democracy, you would expect more or less a diagonal line: if no one likes it, it doesn't get to be a law, and if absolutely everyone likes it then it almost certainly becomes a law. If half of everyone likes it, then it's about 50-50. In fact there's about a 30% chance of something becoming law and it has absolutely nothing to do with voters. Nothing. On the other hand, if the top 1% hates it then it absolutely doesn't become a law, and if they really like it then there's about a 60% chance it becomes a law.
Meanwhile, the Iowa results came in:
The Washington Post reported Friday that through the end of December, "donors at hedge funds, banks, insurance companies and other financial-services firms had given at least $21.4 million to support Clinton’s 2016 presidential run." That's 13% of the $158 million she's collected for her run. She was also personally paid $675,000 by Goldman Sachs for three speeches. By contrast, Sanders has accepted $75,000 from Wall Street - about 0.1% of the $75 million he's raised. Real progressives aren't funded by billionaire wall street scum.
And that's the least of Hillary's crimes. Here's how her favorite scam works. She has a charitable foundation in Canada. Canadian foundations are not required to divulge donors or individual donations. She solicits donations to the Canada foundation. Then the Canadian foundation makes large donations to the US Clinton trust. Between 2009 and 2012 the Clinton foundation raised a bit over $500 million. About 15% of that money went to charitable works; twice that amount went to executive pay and travel. And a further $290 million was classified as "other expenses." The two largest recipients of Clinton charity are the Clinton Presidential Library, which exists solely to put a positive spin on the 42nd president's term in office, and the Clinton Global Initiative, which the New York Times characterized as a "glitzy annual gathering of chief executives, heads of state, and celebrities." Coming to the Global Initiative party costs $20,000 a seat. From where does this money come? Well, the whole point of this setup is to make sure we don't know, but tens of millions came from Arab oil countries, including Saudi Arabia, Oman, Yemen and Morocco, just before large arms sales were approved; and $2.35 million by Russians who were subsequently allowed to buy uranium mines in the US and Canada. Uranium One, a Russian company, now owns 20% of all US uranium reserves. This scam worked so well she later created the William J. Clinton Foundation in Sweden and collected money for keeping Swedish companies doing business with Iran off the sanctions list.
Some time ago I mentioned that I was building a new laser. You can watch it working here. I built my first about ten years ago. I was dissatisfied with that design, so we designed and built this one. After using it for some time I'm now working on a third design, one even easier to build and operate.
What are banks? Hundreds of years ago, when I was in college and the automobile hadn't been invented yet, I was taught that banks operated on the 3-6-3 rule: pay 3% on deposits; charge 6% on loans; hit the golf links by 3pm. Banks in the US made about 6% of all corporate profits. Yah, that's all over. Today banks pay something more like .01%, they charge 4%-6% on mortgages and car loans, 5% - 8% on student loans, and 18% on credit cards. Banks make between 25% and 40% of all corporate profits, but while they're making four to six times as much money as a generation ago, their workforce has barely changed. Next time you hear someone ranting about executive pay, remember it's not the guys at GM that are raking it in. Where do they make their money? Certainly not from retail banking - check books and personal loans. Now the money is made on investments.
What do banks do? In 1974 Congress passed ERISA - The Employee Retirement Income Security Act. This changed everything. Before ERISA most pensions were defined benefit - you got so much money per month when you retired. After ERISA most pensions were defined contribution - you put in so much money per month, your pension depended on how you and your pension fund invested and how lucky you were. There were two huge beneficiaries of ERISA: large corporations got to move pension liabilities off their books, and Wall Street got to make huge money for managing the pension funds. Today, Wall Street is all about pension funds.
A couple decades ago there was a huge debate among economists about the stock market. Standard economic theory said that the stock market was a zero sum game, for every winner there had to be a loser, and information theory guaranteed that no one could beat the market on the long run. Studies were done and this assertion failed - it was found that there were a class of large investors who in fact did consistently beat the markets. As soon as this was established, the question was asked, "If there are consistent winners, there must be consistent losers. Who are they?" No sooner was the question asked than the losers were identified: institutional investors who handled pension funds. Pension funds are huge: US pension funds manage about $25 trillion in investments, and globally pension funds manage over $40 trillion. In the US, pension funds now control assets worth half again more than GDP. This is what Wall Street is all about: building thingies for the pension funds to buy, managing their money, making hedge funds which live on "2 and 20," meaning each year they take 2% of the principal and 20% of the profits.
What do banks make? Several things. One popular one is asset backed securities. For example, you take several hundred mortgages, bundle them together into a single trust, and sell bonds based on those assets. You divide the assets up into slices or tranches. Suppose you have $100 million worth of mortgages. Perhaps you would divvy this up into 5 slices. The lowest slice gets 20% of the assets, but if any mortgage goes bad it's automatically assigned into this slice. These bonds carry the most risk and therefor sell at the largest discount, meaning they pay the highest interest rate. The next slice takes on the defaults if over 20% of the mortgages go bad, and so on until the top slice doesn't experience any bad loans until at least 80% of the mortgages go bad. The lowest slice is sold as junk bonds, the rest are sold as high quality securities. The buyers are the idiots who run the pension funds for states and union workers. The 2008 crisis was caused by this getting out of control: the pension funds loved these so well that they demanded more bonds than existed, so there was a huge push by Wall Street to write mortgages to absolutely anyone so that they could bundle up the liar loans and sell the garbage to CALPers and other funds. Wall Street made huge profits putting this excrement together, and the pension funds and ultimately the taxpayer got stuck paying the tab.
Another popular thing is called a derivative. Since the 2008 crash people are a lot more careful. Suppose you buy $100 million worth of mortgage backed securities. Now you ask, "What if it all goes bad?" Wall Street has an answer for that: Credit Default Swaps. You pay someone a couple dollars per hundred, and they write you an insurance policy that says if it all goes bad they'll pay you your money back. But who are these guys writing the insurance policies? There are no rules. I can make a corporation, put $1 million into it, and proceed to sell credit default swaps that could force me to pay out billions. If it all comes unglued the corporation goes bankrupt and more or less no one gets paid, except me who made some serious salary and bonuses during the good times. That's called counter party risk - the risk that when it comes time to get paid, the guy who's supposed to pay you doesn't. Credit default swaps and related investment vehicles are worth a total of somewhere between $750 trillion and $1200 trillion - ten to fifteen times the world's GDP. There are no rules for this market place and no one truly knows what's going on. If asked, banks say that most of these derivatives are set off against each other, so the total liability is a tiny fraction of that $750 trillion number. Many of us don't believe the banks, we think the next time it all goes south it will take years to figure out who owes what to who and mostly the money simply won't be there. But meanwhile, while the fiction lives on, bankers and hedge fund managers are making hundreds of millions to billions per year. About a year ago I was selling a windshield to a guy in Connecticut; I asked, "What do you do?" "I rent out tents. Suppose you're having a large party outdoors, I can supply a tent to hold the caterers, the band, the dance floor." I say "I guess you do ok at that." My customer says, "Well, last month I supplied the tents for a hedge fund manager's back yard party. The bill for the tents - just the tents, not the caterers or the band or the decorators or any of that, just the tents, was $1 million." I think I'll still remember that three lifetimes from now.
This is what the Wall Street bankers do for a living, a living that means Boeing and Gulfstream can't build executive jets big enough or fast enough, that means that in the race for the world's biggest yacht there's a new winner a couple times a year: they give bad investment advice to government and union retirement fund investment stooges and get paid 2% and 20% on several trillions of dollars of assets. And that wasn't enough, I'm sure you all remember the push a few years ago to let Wall Street handle the social security investment. How did we get here? The bankers have been planning and merging for decades to become too big to fail. This is why I'm quite sanguine about the idea of Bernie being our next president: he hates these guys just as much as I do. But they have most of the money now; just as the poker game continues until all but a couple guys are wiped out, our economy will continue until all but a handful of Wall Street guys are wiped out. Meanwhile, their money lets them buy Washington, guaranteeing that their little game won't be raided by the cops until the big guys have left with their big winnings.
What happens if it all comes apart? What happens if the $1,000 trillion in derivatives outstanding don't actually cancel out very well? What happens if counter party risk means things that should cancel out don't. We already know the answer - that's the "Too Big To Fail" thing. And it's not even remotely an american thing - several other countries have much larger banks than we do. Europe really stands out in this regard - we've already seen a small taste of this when Iceland's banks had more exposure than Iceland could handle and Iceland decided they were too large to not fail. At this point if there's a global banking crisis, there's not a single EU country that can afford to bail out their banks. The majority of that money is owed by other EU countries, but don't for a minute think the damage will be contained to Europe.
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Revised Sunday, 07-Feb-2016 20:18:29 PST