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Mark's Market Blog

6-15-14: Paranoia strikes deep. . .

By Mark Lawrence

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The market was down a little bit this week, "correcting" by roughly 1%. Have no fear, I'm confident it will continue up shortly. Life is good. The economy is great (if you live in Manhattan, anyway). Unemployment is fixed (at least for all those for whom it's fixed). How can the market not go up?

S&P 500 December 17 2013 to June 13 2014

Spain, the country that built 'way too many houses and almost went bankrupt as a country, now has a ten year bond yield lower than the US. A quarter of their citizens are unemployed. Half of their youth are unemployed. They don't manufacture anything they can export - in fact it seems to me their #1 export at this point is college graduates who would like a job. But the European Central Bank has arranged that they can borrow money cheaper than we can, which is already too cheap. How can this possibly end well? Stay tuned.

How bad is China's investment bubble? 25 years ago Japan had something like this. We would read frequently that we all needed to learn Japanese 'cause soon we would all work for a Japanese company. The Japanese emperor's estate in Kyoto was at one point valued higher than all the businesses and land in California. Think about this - would you rather own his estate or Google, Apple, Facebook, Intel, and all the beach front property? The land in Tokyo was said to be worth 63.3% of America's entire GDP - would you rather own the city of Tokyo or two thirds of the entire American economy? This was valuations that simply boggled the mind. Of course Japan crashed, and still hasn't recovered today because no one ever forced their banks to recognize the losses. Well, today the land in Beijing, the city where on many days you can't see things a mile away and where breathing the air takes several years off your life expectancy is now valued at 61.6% of the US GDP. Like Japan, China is a managed economy and most likely there won't be a 1920s type crash, but this simply has to end very badly. It's implicit in China's economic model that they can continue to grow indefinitely until their 1.2 billion people have the same standard of living that we do. My answer to this is 1) drive around our country, as I have, and you'll quickly see that we don't even have the standard of living that "we do;" and 2) we got here during a time of cheap oil, lots of clean water, and a world economy that outside the US had been brought to their knees by WWII. China has to deal with expensive oil, a severe lack of fresh water and arable land, a marginal education system, and enormous competition from many directions. Don't watch this with any glee: if China goes into depression it will be hard on the entire world including us. If China crashes, Europe will be close on their heels and much of the 3rd world will then follow.

The bank of england announced that it would be raising rates "sooner rather than later." The european central bank dropped deposit rates to negative .1%, meaning you pay them $1 to hold $1000 for a year. The message here is 1) get your money out of the bank and spend it, and 2) rates won't be going up anytime soon. Bernanke recently said he doesn't expect US rates to go up for the rest of his life. While official US interest rates are positive, they're less than our inflation rate so we have what's called negative real rates - money held in the bank buys less next year than it does this year even after including paid interest. China is having an internal economic and banking crisis that is putting them in a hot spot: raise rates to save their banks but throw the economy into recession, or keep rates low to stimulate the economy and put their banks at increased risk of massive collapse. Japan is keeping rates low to stimulate inflation, hoping that this will increase consumer spending and stimulate their economy, but they've raised their sales tax by 60% from 5% to 8% at the same time - Nixon tried conflicting policy like this in his Whip Inflation Now (WIN) campaign and he just made things worse. Getting the picture here? Lots of smart people are steering through uncharted waters and no two seem to agree on how to navigate. I think we'll continue to muddle through until one day, perhaps ten or fifteen years from now, it all comes crashing down. But then maybe I'm an optimist.

Chinese hackers are practicing blowing up US pipelines and power plants. Michael Hayden, a former director of the NSA and the Central Intelligence Agency, says "they've already done everything they need to attack. In addition to doing reconnaissance, and maybe being accepted intelligence practice, they've got a gun at your head."

Many of my conservative friends are convinced that Obama is a muslim. I find the evidence for this strong but not compelling. However, I should like to point out that under Obama we have destroyed the governments of Libya, Egypt and Syria. Lebanon was more or less ruled by Syria, that's over now. Iraq's government is in full retreat and may well fall in the next few weeks. I can't see how Afghanistan's government will last. Nigeria's government is clearly in deep trouble. Pakistan's government is clearly no longer in control of their territory. It would not be surprising to see Iran's government fall in the next couple of years. If we had elected a president who hated islam and dedicated himself to turning the muslim world into an ungovernable mess, it's hard to see how anyone could have done a better job than Obama has.

Are we in a bubble? It's always hard to say until after the fact. But the tea leaves are starting to line up in a rather scary fashion. The St.Louis Fed Financial Stress Index is at an all time low, meaning every crazy idea out there is getting funded. Margin debt spiked to an all-time high in February and has dropped 6% since. This is a leading indicator. The VIX, the Fear Index, is at its lowest level since 2007, telling us that no one is prepared for a big sell-off. Unprofitable IPOs - companies that have never made a profit and often don't have any clear plan to, like Twitter, are back. Junk bonds are trading at their lowest spread over treasuries since 2007. In many cities home prices are at or beyond their bubble highs. App makers are being valued at breath-taking levels - Facebook just paid $19 billion for a texting app with 55 employees and nearly no revenue and Uber, an app that's rapidly being outlawed for helping people find unregulated taxis or even just hitch-hiking is valued at $18 billion. And the Fed is still printing money. Add it all up and to me it spells trouble.

House majority leader Eric Cantor lost his primary to a tea party candidate, Dave Brat. This was a heavy weight going up against a scrawny 98 pound weakling. Just to put this into perspective, Brat's campaign budget through May 21 was $122,793. Cantor's campaign spent $168,637 on dinners at Bobby Van's steak house and BLT Steak House. Cantor was Wall Street's biggest supporter among the republicans; Brat asks why no one on Wall Street has gone to jail. I like this Brat guy. Wall Street should be afraid, very afraid.

The Center for Retirement Research at Boston College released a study based on 150 public pension funds. The average fund is assuming a 7.7% return on investment for all eternity - this in a time when treasuries pay 2.6%. Basically pretty much every fund is underfunded to some extent. The worst offenders: Alaska Teachers with a funded ratio of 47.9%, Connecticut SERS (41.2%), Illinois Teachers (40.6%), Chicago Municipal employees (37.0%), Illinois SERS (34.2%), Chicago Police (30.9%) and Kentucky ERS (25.8%). Under the 7.7% scenario, public pensions are under funded by $1.1 trillion. Change the return to 5% and that's $3 trillion. Put in the possibility of a market crash or even stagnation and the numbers get truly frightening.

There are two "drain pipes" in Lake Mead behind Hoover Dam that supply water to Las Vegas and Arizona. One of those pipes is nearly exposed - Lake Mead is down 120 feet from its high, it's more than half empty, and one drain pipe is now less than 50 feet from being exposed to the air. Las Vegas is cutting a tunnel for a new pipe that's 200 feet down so they can keep sucking water until it's all gone. That's likely to happen. State water rights to the Colorado River total 16.5 million acre feet, but average water inflow for the last couple of decades has been 15 million, and projections are that that number will most likely decrease 15% or more in the future. It turns out the 20th century was one of the two wettest 100 year periods in the past 1,200 years for the Rockies. East of the Mississippi mostly there's plenty of water and land is valuable. West of the Rockies it's all about water rights; without water rights the land is all but free.

RadioShack shares dropped 21% on Tuesday as they posted poor sales and profits results. SO far this year they have burned through nearly $120m in cash and have about $60m left. It appears creditors are trying to push RadioShack into bankruptcy, as they vetoed RS's plan to close a quarter of their 4,250 stores. I don't think RadioShack will be with us a lot longer.

One Indiana county spent $5,000 for its surplus MRAP - Mine-Resistant Ambush Protected vehicle, originally purchased by the army for $733,000. Pulaski County Sheriff Michael Gayer told the Indy Star: "The United States of America has become a war zone. There's violence in the workplace, there's violence in schools and there's violence in the streets. You are seeing police departments going to a semi- military format because of the threats we have to counteract. If driving a military vehicle is going to protect officers, then that's what I'm going to do." There was a HS school shooting in Portland; the response team is pictured below. If all you got is a gun you're in the wrong league these days.

And now a new product, the bullet proof blanket, made of military materials, available to schools and individuals. Paranoia strikes deep, into your schools it will creep. When I was a kid we learned that crouching under desks would save you from a thermo nuclear attack. I guess this isn't any more stupid.

HP is working on a new computer that promises to revolutionize data centers and cloud computing. Using optics for the net connection, a new type of memory called memristors and a new version of linux optimized for this, the new HP machine will cut space and energy requirements for data centers by a large factor, like 100 or more. Instead of huge air conditioned rooms needing massive power, the same computation could fit in a box the size of a refrigerator. Think what the NSA could do with these. . .

In a case challenging public school tenure, Los Angeles Superior Court Judge Rolf M. Treu determined that "the least effective teachers are disproportionately assigned to schools filled with low-income and minority students." Treu agreed with the plaintiffs' argument that California's current laws make it impossible to remove the system's numerous low-performing and incompetent teachers, because the tenure system assures them a job essentially for life; that seniority rules requiring the newest teachers to be laid off first were harmful; and that granting tenure to teachers after only two years on the job was farcical, offering far too little time for a fair assessment of the teacher's skills.

Science Fiction: NASA invests money in all kinds of things. They used to give grants to Robert Forward, a physicist at UC Santa Barbara who worked on all kinds of strange ideas like negative matter and negative energy. 'Cause, you know, you never know. . . In 1994 a Mexican physicist Miguel Alcubierre proposed a modification of Einstein's field equations based on a new type of matter that's never been observed. NASA has a guy, Dr.Harold White, who is working on space ship design using Alcubierre's math and not worrying about where he will get the exotic matter. Anyway, using this math you can design a space ship such that inside the ship you never feel anything - no acceleration, nothing. But outside the space ship you travel at many times the speed of light, so you can make it to other stars and back in very little time. Will it happen? I dunno, physics isn't a done field. Maybe aliens have visited earth, and maybe this is how they did it. Or maybe it's all a pipe dream. In any case, here's drawings of the proposed IXS Enterprise, the first NASA ship with warp drive. It's pretty sexy, at least that's what us science nerds think. The big rings hold the exotic matter and create the space warp that makes everything work. Basically the rings scoop up space-time from in front of the ship and deposit it behind the ship, so a bubble around the ship is moving through space even though the ship itself it just sitting motionless inside the bubble. Scotty would be proud to be chief engineer on this ship. Can it work? Not in my lifetime, but who knows what the future holds. If mankind can get through this century without a complete crash back to the dark ages, maybe the future looks like this. Maybe the aliens feel the same way about us that we feel about N.Korea or Nigeria: best not to go there.

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