The Fed's $7.77 Trillion Secret Funding Plan

As the ECB considers stepping up to the plate and acting as the lender of last resort, yesterday's blockbuster Bloomberg article on the US Fed's secret funding program (forced out in the open via a Bloomberg lawsuit) could not be more timely.

Here are a few excerpts:

"The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing.

The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day..."

"The amount of money the central bank parceled out was surprising even to Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009, who says he “wasn’t aware of the magnitude.” It dwarfed the Treasury Department’s better-known $700 billion Troubled Asset Relief Program, or TARP. Add up guarantees and lending limits, and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the U.S. that year..."

"The secrecy extended even to members of President George W. Bush’s administration who managed TARP. Top aides to Paulson weren’t privy to Fed lending details during the creation of the program that provided crisis funding to more than 700 banks, say two former senior Treasury officials who requested anonymity because they weren’t authorized to speak..."

"TARP and the Fed lending programs went “hand in hand,” says Sherrill Shaffer, a banking professor at the University of Wyoming in Laramie and a former chief economist at the New York Fed. While the TARP money helped insulate the central bank from losses, the Fed’s willingness to supply seemingly unlimited financing to the banks assured they wouldn’t collapse, protecting the Treasury’s TARP investments, he says..."

"On Jan. 14, 2009, six days before the company’s central bank loans peaked, the New York Fed gave CEO Vikram Pandit a report declaring Citigroup’s financial strength to be “superficial,” bolstered largely by its $45 billion of Treasury funds..."

To read the full story, click here

Here’s Why The Fed Believes QE2 Is Necessary

Monday’s NYSSA luncheon with St. Louis Fed President (and voting member of the FOMC) James Bullard was most illuminating (wish you were there). In addition to the somewhat heated give and take with attendees, Mr. Bullard provided a chart that captures the principal fear the Fed has re deflation. It is what is known as the steady state (equilibrium) of inflation and interest rates.

The accompanying chart is the one he presented (which was also provided in his recent commentary and presentation “Seven Faces of “The Peril’”). In it I have pointed (larger arrows) to the steady state for the US (boxes to the right), steady state for Japan (circles to the left), and in the middle the May 2010 current level for the US. You will note that the May 2010 point is the closest to the Japan outcomes.

The concern at the Fed is that the slide toward the steady state for inflation and interest rates (in a zero bound interest rate environment) renders interest rate driven monetary policy impotent (as it has in the case of Japan). Moreover, a steady state tends to become entrenched (that’s why it’s called a steady state). And economists will tell you that when it comes to deflation/inflation it is the entrenched, longer term levels (and not the shorter term, more volatile factors such as commodities) that matter most.

As the May 2010 point illustrates quite clearly, the US trend is not where the Fed wants it to be.

Here’s Why The Fed Believes QE2 Will Work

In a nutshell – because it worked the first time.

Time and again in the aforementioned heated discussions, Mr. Bullard consistently pointed to the financial markets rebound during QE1 and in anticipation of QE2 as evidence of the positive effects of QE. Moreover, since the economy has recovered and avoided further economic deterioration (Great Recession not Great Depression 2), QE was and will be (in his opinion) effective.

Conclusion

No doubt the debate over the Fed's QE policy will continue. But at least now you know some of thinking behind the actions.

Caveat: Mr. Bullard was speaking for himself and his opinions do not necessarily reflect those of the Fed.
Click image to enlarge

The Gambler

Who knew Ben Bernanke was actually Bret Maverick?

Using its dual mandate – price stability and full employment – as a rationale (excuse!?) for unilateral action, the Bernanke Fed has embarked on a grand experiment hoping that the wealth effect on financial assets will somehow stimulate the deleveraging US consumer to suddenly reverse course, revert to form, and shop ‘til he/she drops. The Bernanke Fed also hopes that the US consumers’ primary asset –his/her home – will somehow overcome the foreclosure fiasco and miraculously increase in value thereby adding spending fuel to the wealth effect fire.

Finally, the Fed is hoping that its actions will encourage the banks and corporations to disgorge themselves from the mountain of cash they have been hording and start lending and hiring again.

The cumulative effect of this grand adventure is to hopefully enable the US economy to reach an economic escape velocity and enter into the self-reinforcing, sustainable virtuous circle thereby enabling the Fed to enter into its exit strategy.

In today’s Washington Post, Mr. Bernanke provided his audacity of hope with arguments that had so many holes in them as to resemble Swiss cheese. Here’s a few morsels with his comments in italics and mine beneath:

Easier financial conditions will promote economic growth.
By how much? And when?

For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance.
What about the large supply of unsold homes? What about the impact of the foreclosure fiasco?

Lower corporate bond rates will encourage investment.
Possibly, but where will that investment occur – in high cost/low growth markets like the US or in low cost/high growth markets like emerging markets?

And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.
Unlikely without the support of the US consumers’ most important asset – the home. (see above noted point) Moreover, deleveraging to save for an uncertain future is a strong force for soon-to-retire baby boomers, who know that entitlement reform is in the offing.

Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
Not if companies decide to invest elsewhere, as noted above. Also, small businesses, the driver of jobs growth, will wait to see demand before committing to new hires and higher wages.

The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector.
Correct, but unlikely given the looming political gridlock environment ahead.

But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability.
And this provides the justification to act unilaterally – without the aforementioned other parties involved as well as the cooperation and coordination of other central banks and countries around the world?

Steps taken this week should help us fulfill that obligation.
How's that hopey, changey stuff goin' for ya?

Investment Strategy Implications

The music is playing and the actors are dancing, driven in large part by the underperforming and desperate momentum lemmings from hedge fund land. Valuation levels are now moving well above average (>15 times) anchored in solid corporate profits, low interest rates, very ample liquidity, and belief that the cyclical forces at work will overwhelm the unresolved secular structural issues.

It is imperative that investors remember this one point – just because a company was founded in the US, is domiciled in the US, and derives some of its profits and growth from the US doesn’t mean it has to rely on the US for its future growth and profitability. And therein lies the rub with Bernanke’s argument: will QE2 (then QE3, then QE4) provide strong economic growth and prosperity for the US? Or will it produce yet another bubble in assets and other markets (notably emerging economies) leaving the US economy in worse shape than when it started?

Ultimately, the all important asset allocation question is: To what extent should an investor participate in this monetary Mephisto Waltz? The answer I've come to is listed to your left.

We Are BP

“We are about to embark on a momentous experiment to discover which of the two stories about the economy is true. If, in fact, fiscal consolidation proves to be the royal road to recovery and fast growth then we might as well bury Keynes once and for all. If however, the financial markets and their political fuglemen turn out to be as “super-asinine” as Keynes thought they were, then the challenge that financial power poses to good government has to be squarely faced.”
Lord Robert Skidelsky, FT, “Once again we must ask: ‘Who governs?’”, June 15, 2010

The transitional nature of this stock market fits perfectly with the transitional nature of the global economy – are we headed for the virtuous circle of sustained economic growth or will the decision to withdraw fiscal stimulus advocated by the G20 members result in a double dip (or worse)? The early answers to this question will not be found in the present but in the near future – specifically the third quarter of this year.

Once we get the at-to-slightly-above-consensus 2Q10 earnings results out of the way, most of the focus will shift to the third quarter. Early into the third quarter, macro economic reports will provide an advance notice of what lies ahead for 3Q10 earnings. If the traditionally trained economists are correct, 3Q10 economic results should present no problem and come in at or above consensus expectations thereby ensuring that 3Q10 earnings results will meet the current optimistic projections.

If, however, third quarter macro economic data issued week after week produce below consensus results, then 3Q10 earnings results are nearly certain to come under expectations. Then the fun begins.

Stock Market Signals

All this would coincide with stock market action that will reflect a resolution of the sideways performance exhibited by virtually all indices since the fall of last year. This resolution will present itself in the all-important Mega Trend. If the Mega Trend* reasserts itself with price moving back above both key moving averages AND in the process reverses the recent bearish Mega Trend signals from Europe, then the trading range of the past 8 months has been a consolidation range, the bull market is back in gear, and the real economy will likely not suffer a double dip (or worse).

If, however, the Mega Trend in the US and Asia follows the lead of Europe and produces a bearish reversal signal, then it’s game over – the real economy outcome will likely be something far worse than a double dip.

Investment Strategy Implications

Going into the third quarter, investors who subscribe to the above have two choices: Bold or Cautious.

Bold would recommend a 100% exposure to equities. Cautious would suggest a 60 to 80% equity exposure. While both approaches stand at the ready to shift gears should a bearish outcome become evident, I believe there are two advantages to choosing the cautious stance.

First, any near term decline (i.e., a move to the lower end of the trading range, which is 1000 to 1050 in the S&P 500) would generate a negative return but positive alpha, while any near term advance (i.e., a move to the top end of the trading range, which is 1150 to 1220 in the S&P 500) would produce a positive return but negative alpha. A form of portfolio insurance, if you will. Secondly, and perhaps most importantly, a cautious approach keeps the mind focused on the worse case scenario and will help facilitate rapid action once the below consensus economic readings start filtering in and the bearish Mega Trend signals are generated.

Chill Until

Stocks do not trade in a range indefinitely. A resolution to the upside would say that the trading range was a consolidation, that the bull market will resume, that global markets that had been weak were temporary, that the economic handoff of government spending to private sector sustainable growth has been successful, that the virtuous circle has taken hold, and that earnings and other key inputs into the valuation process will be better tomorrow than they are today.

Alternatively, a resolution to the downside would declare that the trading range was a distributional top, that global markets that had been weak were a warning sign, that the economic handoff of government spending to private sector sustainable growth has not fully occurred, that the virtuous circle has not fully taken hold, and that earnings and other key inputs into the valuation process point toward a tomorrow that will be worse (I would argue far worse) than they are today.

Alfred E. Neuman Would Be Proud

If there is anything to be learned from the recent crises it is that incremental thinking to rapidly deteriorating situations produce catastrophic results. Here’s a partial list:

• It’s only a subprime mortgage problem
• The banking crisis is contained to the financial sector
• Greece is a very small part of the European economy
• It’s just an oil spill, a leak

With virtually no margin for error this time around (as in extremely limited government flexibility), any economic deceleration or decline could snowball rather quickly. The wrong thing at precisely the wrong time. Partying like it's 1937.

All That Jazz

The quote from Lord Skidelsky above says it well - we are about to embark on a grand experiment, we will improvise as we go along, we are confident in our experts, we have faith in our meritocracy, we are BP.

Will this work? We will find out soon enough.

*Use the search function at the top left of this page for prior blog postings on the Mega Trend.

Happy Anniversary. Now What?

Yesterday marked the one-year anniversary of the bear market low in stocks and the subsequent bull rally. Therefore, a review of where we were, where we are now, and, importantly, where we are likely to be headed, seems to be in order.

To refresh your memory, let’s go back to March of last year and note the following excerpts from commentaries made by yours truly regarding the end of the world as we knew it:

March 5 – “Bears Out of Momentum”
“…are we headed non stop to 600? Before I get to why the 600 call is unlikely right now, let me address 2 factors - one fundamental, the other, a market dynamic.”
To read the complete commentary, click here

March 12: “Why Divergences Work”
“Tuesday’s big up-market demonstrated a tried-and-true investment axiom: When market conditions are ready, a catalyst is all that's needed to get the show on the road. The show, in this case, is a cyclical bull rally. And the catalyst was the Citigroup's earnings statement. Here are some of the particulars….”
To read the complete commentary, click here

March 26: The Cyclical Bull Within the Secular Bear
“In stocks, we seem to have a cyclical bull within the secular bear. Investors (and the world economy) have been given a reprieve - that is, until next year, when all the money and all the regulatory changes thrown at the economy and the financial system must evolve into greater private market participation.

In the case of the US economy, capex must take the economic handoff from government and become the principal driver of economic growth, as US consumer spending continues at a more muted pace. For the consumer, balance-sheet repair will almost certainly continue as its largest component -- the aging baby boomers -- set aside real savings out of income to provide for themselves in the rapidly approaching retirement years.

Therefore, as the US economy goes through its transition from its overly leveraged consumer bias to a greater level of corporate activity -- driven largely by exports to the real growth engine of the next decade and longer, emerging economies -- investors should consider repositioning their portfolios to include more emerging-markets investments.”
To read the complete commentary, click here

The rest is history. Stocks rallied, emerging markets did best, and investors were rewarded for their courage and wisdom in relying on time tested market tools, such as the valuation parameters and the divergences principle described above.

Okay, now what?

Investing is a game of “What have you done for me lately?”. In accordance with that game, investors cannot sit on their laurels and revel in the joy of their courage and wisdom. When it comes to investing, the past is always prologue. And it functions as a guide to what is likely to be.

In attempting to predict where markets are headed, it is just not enough to use the past as a valuable guide to what will be. It is also necessary to remember that markets are driven by investors, and investors are people whose tendencies have a certain predictive dynamic due to the simple fact that they are human. This is just another way of saying that human nature doesn’t change; we, as investors, just emphasize different things at different times. Moreover, the principles of asset values are also a reliably consistent tool, one that enables an investor to estimate what the fair value for any given asset might be.

Taken together, the three principles to follow – history as a guide, the constancy of human nature, and estimates of fair value – enable an investor to apply the same tools and principles that got the above noted rally forecast correctly and apply them to today’s market environment. With that said, let’s first briefly consider where we came from and what it means for the equities markets going forward.*

Back From the Brink

The massive capital infusion governments around the world threw at the financial then economic crisis enabled the world economy and markets to step back from the abyss of global collapse and regain some sense of stability. However, government stimuli are good for only so long. Eventually, end user demand must take over and drive the world economy, which will drive the world’s equity markets higher. In this regard, the jury is still out as to whether such an economic handoff will actually occur.

The US consumer, engine of end user demand for most of the past several decades, remains in the throes of balance sheet repair. Paying down debt and building sufficient cash reserves for that rainy day is still priority number 1. Occasional episodes of spending beyond their means will occur from time to time (as it may have last month based on the surprising increase in consumer borrowing). But with the bulk of baby boomers bordering on retirement, balance sheet repair will remain the secular trend for the foreseeable future.

Therefore, the hope that an emerging middle class in developing economies can pick up much of the global growth slack left by the reduction in US consumer demand. This, along with a sustained level of infrastructure and corporate capital spending (capex) rebuilding vital to both developing and developed economies, are central to a sustainable growth phase for the world economy. However, a hope is not a certainty, and whether the handoff will occur and just how robust will it be is one of the key areas to focus on going forward.

At present, the odds do favor such an occurrence, but many obstacles remain in place not the least of which is confidence. For example, in order for infrastructure and corporate capex spending to occur in earnest, policy makers must muster the political will and organize their priorities and corporate senior management must believe that current long range spending plans will result in future growth rates and profitability in excess of their cost of capital. This is one of the key areas where the analytical focus must be centered.

*In my next commentary, I will address the second and third areas – fundamental valuation models and market intelligence readings. Until then, enjoy the ride.

We (Still) Don't Know What We Don't Know

So, here we are. More than two years into what started out as a credit crisis, one plus year after the Lehman collapse and a question that pertains to the one of the central workings of the equities market cannot be answered.

At last evening's Market Technicians Association Educational Foundation seminar, the question your trusty moderator (that's me) posed to the esteemed panel with its decades of experience was in regards to volume. Specifically, the equity markets' volume as recorded each day for every stock traded. That is, the volume that accompanies the price action that results in the market capitalization of the stock market that results in the market value of every investor's portfolio.

Many market analysts have noted the low volume that has accompanied this bull rally. Some have used this fact as a reason to be more cautious, even bearish. Others have cited that low volume bull rallies have occurred in the past and this one is no different. However, in the past, the volume recorded for equity trades completed were quite accurate and reliable, being recorded on exchanges and reported accordingly. Today, the picture is not quite so clear.

With so much trading occurring in the off the exchanges hidden recesses of dark pools and structured products, I asked my very knowledgeable panel, can any investor rely on the volume figures being generated in this current market to measure the strength of the price action of a stock? The answer received was, "We don't know". Well, if this well connected, highly informed group of individuals doesn't know, you can easily assume that just about no one knows. Do you?

The importance of understanding this issue goes beyond its impact on basic market analysis tools (such as technical analysis) and cuts to the heart of a financial system that is still shrouded in opaqueness.

Transparency remains elusive. Yet, transparency (knowing what investors need to know) is vital to the restoration of a sustained confidence in a system that can be measured. When trades occur in the dark corners of dark pools and other off-exchange structured products, clarity as to what exactly is transpiring becomes the victim and investors seeking to measure the market become the equivalent of a bystander to a drive-by financial shooting.

Investment Strategy Implications

Nothing increases the risk factor of any investment more than the dangers posed by ignorance. Yet, here we are. More than two years into what started out as a credit crisis, one plus year after the Lehman collapse and we still don't have a clear idea of what exactly is transpiring in a central part of the capital markets - equities.

For those who might be tempted to dismiss such concerns I simply point to the two key impacts of changing equity prices: the wealth effect and the cost of capital. Both directly impact the real economy, in the current case in a positive way. Were it not for rising market values, the current government policies designed to rescue the US (and global) economy would be brought into doubt. And doubt, a close cousin of uncertainty, is a bad thing for a fragile economic environment.

Price without volume is an incomplete measure of the strength (or weakness) of a market move. Yet, in the current environment, price is the only metric that can be tracked with clarity. Volume, its indicator of power, cannot.

Two years and running and we still don't know what we don't know.

To further the exploration of what we don't know tomorrow I will describe how hedge fund replication products pose a potential threat to the equity markets.

The 3 Phases of this Bull Market

The stock market rally since early March appears to have three distinct phases to it.

The first phase was the backing off from the economic abyss. The second phase was a bounce to fair value normalcy. The third phase (the one we are in now) is what I would call the return to business as usual phase (or “Recession. What recession?).

From where I sit, the first two phases were justified on many levels. Both phases featured massive amounts of government intervention combined with strong technicals to produce a rally to fair value. The elimination of the tail risk of the Great Depression II was followed by the above consensus macro economic readings (my MERI indicator), which was reinforced by the above consensus earnings results of 2Q09. Stocks rose to a reasonable fair value. So far, so good.

Unfortunately, at this point the seeds of questionable earlier decisions began to bear fruit. (Now, this going to sound very libertarian, so here goes.) Instead of pursuing the necessary cleansing process that all excesses produce, the Obama administration (which includes the US Treasury and the “independent” Federal Reserve) opted for a massive debt transference from the private to the public sector with the hope that time will heal all wounds. Along with this decision to socialize the bad behavior of the private sector most responsible for the crisis, the financial services industry, the Obama administration supported its core structure built on the laissez-faire era of the past two decades, accepting the largely unsubstantiated argument that financial innovation is a vital and necessary good for the economy.

With the government’s tacit support of the status quo, the investment mood shifted from fear and concern to hope and then enthusiasm.

The evidence of this mood shift back to the animal spirits days of yore came from a logical source – the financial services industry, the very sector of the global economy that provided the financial innovation grease to the out of control freight train of credit. And what better symbolic locomotive than Goldman Sachs, whose earnings report of July 14th whistled the bad old days were back in action. At this point, the Obama administration swung into action – with silence.

With its absence of outrage, the increasingly politically tone deaf Obama administration sent the public policy signal that its okay to bring the world economy to its knees, its okay to get bailed out with taxpayer money, its okay to shrink the competitive landscape (via Bear and Lehman’s demise), and its okay to return to the way things were – big profits and in your face fat bonuses.

The product of this wink and nod to Wall Street was the backlash at town hall meetings, which were as much about fairness as they were about healthcare reform concerns, a paranoid view of government, and a reactionary view of what constitutes being an American. It also produced an enthusiasm for stocks and an implied return to the bad old days.

Investment Strategy Implications

When you combine all these factors with the massive amount of investment capital ($3.5 trillion) still sitting in the near zero interest rate money market sidelines, the rising belief among many institutional investors that P/Es above their historical average are justified in the current low inflation environment, and the fledgling confidence that the global economy is on the mend* (along with the blind faith that the economic data from China is real), it is understandable how valuation levels could get to where they are today – stretched.

The investment question then becomes, “Is this a solid enough foundation upon which sustainable bull markets are built?” I have my doubts.

*I suggest reading Nouriel Roubini's comments in yesterday's FT.

The Big Disconnect

excerpts from this week's "Sectors and Styles Strategy Report":
"A huge disconnect is underway. The financial markets are signaling not just economic stabilization but a robust (V shaped) recovery. This is most evident in the accompanying two charts – the yield curve and the TED spread.

The yield curve suggests a robust recovery is in the cards while the TED spread shows a return to pre credit/economic crises levels. When you add to this equation the prospects that numerous Mega Trend bullish reversals appear to be just days to weeks away (see report), the “fundamental justification for a more bullish outlook in the coming months” noted last week get stronger with each passing week. Yet, bottom up earnings expectations remain mired in the low to mid $50 range (see page 3 in report), despite the steadily improving above-consensus macro economic reports.

Investment Strategy Implications

Stocks appear on the verge of major bullish signal, while fundamentals appear to support the technicals. All that’s left is a completed bottom with Mega Trend reversals in tow."

Note: To learn more about the benefits of subscribing to the "Sectors and Styles Strategy Report" newsletter, including the Model Growth Portfolio (beat the S&P 500 four years in a row - see charts to your left) - click here.

Equity Market Headwinds: No Margin For Error

While it is encouraging that equities have rallied to the point where many 200 day moving averages are either flat or nearly so and nearly all sectors, styles, regions, and countries are above their 50 day moving average, not to mention the fact that many 50 day MAs have an upward slope, there are reasons, both fundamental and technical, to be more cautious about stocks over the near term.

The concern on the fundamental side is centered on valuation. For investors may have looked into the Great Depression II abyss and concluded that the worse case scenario (under $50 operating earnings for the S&P 500 for 2009) is less likely than it was 30 days ago. However, the current level of 850 for the S&P 500 implies either an above historically good times average P/E of 15 and/or earnings above $60. Consider the following: if stocks are a forward looking discounting mechanism and if its projected return is its historical average of 12%, then 850 today implies a 12 month price level of 952. That then supposes that 12 months forward to the end of 2010 would put the S&P 500 at 1066 (952 plus 12%). To justify 1066 and assuming the market’s historical good times P/E of 15 assumes $71 in operating earnings for 2010. That may come to pass but the great economic unknown is not 2009 but 2010, for next year's growth relies on the economic handoff from government to private enterprise and the consumer. The more bullish fundamental valuation conclusion then becomes a future time period that does not warrant an above average margin of error (as in a below average (< 15 times) P/E). Frankly, at 852 that’s a fully invested conclusion I am less than comfortable living with, more so when considering the following technical analysis points.

From a technical analysis perspective, many market technicians point to the favorable chart patterns, with bottom formations and upside breakouts. They may be right but it has been my experience that chart patterns have a far reduced predictive value than momentum and divergence indicators, and those indicators are not so sanguine right now. As the above chart* illustrates, for example, Momentum is clearly in deceleration mode and not confirming the index's price and MACD’s sustained and confirming strength. Experience shows that only when both are in unison (confirming the higher highs in price, specifically) can an investor feel more confident of the sustainability of the move. Added to this concern is the high overbought readings in the short term indicator, Slow Stochastics. Readings above 80 typically cause markets to pause.

Investment Strategy Implications

For the above stated reasons, taking some money off the table is advisable. Granted seasonal factors, such as April being the second best performing month of the year (historically), are supportive of higher stock prices. Moreover, there is every reason to feel more confident that, for the very short term, the worst of the economic and credit crisis has passed. However, concerns both fundamental and technical seem to warrant a less than fully invested posture at this time.

*Note how the Momentum reading is nearly flat while MACD is steady up.
click image to enlarge

In Defense of Financial Innovation

There is considerable talk (much of it rather regressive) about the future of the financial system. In one camp are the advocates of a return to basic banking. Think George Bailey and “It’s a Wonderful Life”. Paul Krugman, John Bogle, and Meredith Whitney appear to belong to this group. Then there are those who believe that the system should evolve from where it was, only with better oversight and far greater transparency. By all accounts, Secretary Geithner and Mohammed El-Erian belong to this group.

As unpopular as it currently may be, I’m on the side of the Treasury Secretary and PIMCO CEO for the following reasons:

I believe financial innovation must be allowed to grow and even flourish as the benefits of risk management and opportunistic investing through derivatives, structured finance, and other heretofore unknown instruments is vital to the complex world of globalization and global capital flows. Financial innovation allows for the more efficient use of capital in new and innovative ways thereby enabling greater growth potential across most markets and economies. Perhaps most importantly, as providers of global capital, financial innovation is important to the dominant players in the markets - major institutional investors (pension funds, sovereign wealth funds, endowments, hedge funds, etc) - and their ability to manage large sums of money in the vast and growing global markets and economy. They want it. Even need it.

The George Bailey model is simplification for its own sake. A Luddite-like natural recoil action to the pain and suffering caused by the failure of proper oversight and transparency. Moreover, the Bailey model would relegate the US financial institutions to a dumbed-down version of finance completely at odds with a globalized world and economic system (not to mention the unintended consequences of assets flowing to other, more forward-thinking markets). I believe Secretary Geithner sees and understands this and that is why, much to the consternation of many old school thinkers, he is intent on keeping the current financial infrastructure in place, just fix that which went out of control courtesy limited oversight and inadequate transparency.

With better oversight and greater transparency, the benefits of financial innovation to the global economic system far outweigh the damage wrought by the inept supervision of a complex world of finance and capital flows.

Think of it this way, did FDR blow up the stock market after the 1929 to 32 crash? What he did was create the SEC, which served the system well until the free market ideologues got control of it over the past several decades and, with the aid of financial innovation, allowed the animal spirits to run roughshod over common sense and prudent asset management. Another example would be the Internet and the tech bubble blow up. Did technology innovation stop because of Enron and WorldCom and the multitudes of dotcom implosions? Of course not.

Financial innovation is a tool. And like any tool, it can be used for good or ill. You don't ban knives because someone gets stabbed. You don't ban guns because someone gets shot. And you don't ban cars because someone gets run over. Innovation is essential for forward progress. And, in the case of finance, an enabler of better asset and risk management.

Financial innovation is the baby. Don't throw him out with the bath water of poor oversight and limited transparency.

Why Paul Krugman is Wrong

Let me start by saying that on many levels, I agree with Paul Krugman. I read his blog regularly and find his work to be of significant value. I also share many of his political views and leanings. But when he makes the market efficiency argument, he has entered a space where he is wholly unqualified to roam. For in several of his recent postings that is, in effect, what he has done. Like other economists that I know, he is attempting to apply his social science skills in economics to the social science skills in investing. In this regard, Krugman is wrong on three levels.

First, to argue against the Geithner plan (accurately portrayed as seeing the problem as one of liquidity and not solvency) is to argue that the markets AT ALL TIMES, IN ALL CONDITIONS know what the fair value of any asset is at any and all times. Yet, everyone acknowledges that the market for the so-called “toxic assets” is dysfunctional. And central to its dysfunctionality is their illiquidity. So, if certain markets for certain instruments are dysfunctional (which includes valuation) due in large part to illiquidity then why isn’t the conclusion that liquidity and not solvency the core of the problem?*

Second, if making the dogmatic argument for market efficiency weren’t enough, Krugman then moves into the math space and applies bizarro logic to the actions professional investors will likely take as they participate in the Geithner PPIP plan: “Let me offer a numerical example. Suppose that there’s an asset with an uncertain value: there’s an equal chance that it will be worth either 150 or 50. So the expected value is 100. But suppose that I can buy this asset with a nonrecourse loan equal to 85 percent of the purchase price. How much would I be willing to pay for the asset? The answer is, slightly over 130. Why? All I have to put up is 15 percent of the price — 19.5, if the asset costs 130. That’s the most I can lose. On the other hand, if the asset turns out to be worth 150, I gain 20. So it’s a good deal for me.”

The logic of this example falls on its face on three levels. First, no professional investor is going to invest in a 50/50 bet (20 points I win, 19.5 points I lose). That ½ point return advantage is all of 38 basis points of upside potential! Does anyone reading this believe that PIMCO, for example, will make such a bet? I don’t. Moreover, since the US government is involved in the process, it is equally hard to imagine that Geithner and Bernanke would allow the US equity stake to engage in boneheaded bid up purchases. Lastly, and most importantly, just what valuation methodology will the PPIP parties engage in? How about one that is rooted in sound economic principles, say, the discounted cash flow method. In the Krugman math example, no such sane and prudent approach will occur.

The third part of Krugman’s argument that is problematic goes right to the heart of his economic skills and the illogic of his thinking when it comes to asset values. Specifically, how will the economic stimuli (monetary and fiscal) that he so strongly advocates in favor of have a positive effect on the economy yet somehow have little to no effect on asset values? Specifically, how do trillions of dollars move the US economy yet asset values for the length of the “toxic assets” remain depressed, if not plunge further? Why wouldn't such assets at least maintain their discounted cash flow values?

You Know You’re In Trouble When Gingrich Agrees With You

Advocate views like Krugman’s make strange bedfellows. So, it is no surprise to see none other than Newt Gingrich sing the praises of Paul’s folly. At least, however, Gingrich’s argument is rooted in the political sphere as he tries to attribute motive to the Obama administration with statements such as “We are currently being run by a left wing machine that want the United States as we have known it to cease to exist”.** Whereas Krugman’s argument is rooted in the dogma of market efficiency.

Liquidity Not Solvency

The central part of the so-called “toxic assets” argument has been liquidity versus solvency. Those with an understanding of how markets work (like Geithner and his predecessor, Hank Paulson) see it principally as a liquidity problem. Those with Nobel prizes living in ivory towers see it otherwise.

I love you, Paul. But on this one, you win the booby prize.

*Of course, other factors such as the economic outlook play a key role in the depressed pricing. However, just as the case with the price of oil last summer, non economic factors play an exacerbating role.

**Setting aside the standard Republican fear mongering playbook, Gingrich’s arguments do offer an alternative methodology, which interestingly contain several very workable elements such as creating an online auction, let the participants decide the value, and cover the losses.

Street Scan

Billionaires are now Slumdog Millionaires because:



A. The credit markets remain frozen
B. The US economy is falling off the cliff
C. Corporate earnings are headed substantially lower (<$50 S&P 500 operating earnings)
D. The socialist programs of the Obama administration threaten capitalism as we know it
E. All of the above, and then some
***
from International Monetary Fund “Global Financial Stability Report (GFSR) Market Update”
January 28, 2009

“Until now banks have managed to obtain sufficient capital to offset existing writedowns, but that is mainly due to the massive public sector injections of capital in the fourth quarter. The worsening credit conditions affecting a broader range of markets have raised our estimate of the potential deterioration in U.S.-originated credit assets held by banks and others from $1.4 trillion in the October 2008 GFSR to $2.2 trillion. Much of this deterioration has occurred in the mark-to-market portion of our estimates (mostly securities)*, especially in corporate and commercial real estate securities, but degradation is also occurring in the loan books of banks, reflecting the weakening outlook for the economy.”
***
Aggregate assets in money market funds (institutional and retail): $4 trillion (approx.)
Total market capitalization of the S&P 500 as of March 9, 2009: $5.9 trillion
***
from Dave Rosenberg, North American Economist, Merrill Lynch
March 9, 2009

"Beige Book mentions nine positive areas
Even if we still do not see a bottom in sight just yet for the economy or the equity market, there are sectors that at least from a macro standpoint have a relatively firm underpinning even in the midst of this unbelievably severe recession and bear market phase. We have said it once and we will say it again, the Fed's Beige Book offers up the most timely and detailed information on sectors. The most recent report that was issued last week contained positive mentions on these nine areas of the economy:
􀂄 Food production
􀂄 Pharmaceuticals
􀂄 Apparel retailing
􀂄 IT services
􀂄 Biotech
􀂄 Aircraft manufacturing
􀂄 Fast food restaurants
􀂄 Discount stores
􀂄 Environmental services

Positives outperformed the market by 800 basis points
While these sectors, on average, were down 8% between the most recent Beige Book and the one that preceded it in early January, they collectively outperformed the market by 800 basis points.

21 negative sectors mentioned
At the same time, there were 21 sectors that received negative mentions in last week's Beige Book. They are listed below:
􀂄 Travel/tourism
􀂄 Education services
􀂄 Luxury goods (jewelry)
􀂄 Agri-business
􀂄 Banks
􀂄 Homebuilding
􀂄 Electronic equipment
􀂄 Computers
􀂄 Motor vehicles
􀂄 Staffing services
􀂄 Commercial real estate
􀂄 Rails/Trucking
􀂄 Furniture/Appliances
􀂄 Health care services (elective)
􀂄 Oil drilling
􀂄 Metals and mining
􀂄 Wood products
􀂄 Media services
􀂄 Petrochemicals
􀂄 Construction equipment
􀂄 Semiconductors

So, for every positive mention, there were more than two negatives. The S&P 500 sector equivalents, on average, declined 26% between the last two Beige Books, and underperformed as a group by 1,000 basis points."
***
email sent last night to "Kudlow Report" producer Donna Vislocky in response to Larry’s plea for bullish commentators:

“On tonight's program, Larry said his producers were having a hard time booking those who were bullish. Well, here I am.

As someone who is now 100% invested, I am at the opposite end of when I last appeared on your program in early 2007 when I was highly cautious. Today, however, the picture is swung completely to the other side of the pendulum.

Here are a few bullish reasons that I am more than willing to debate a bear:

1 - Investor psychology is so thick you could cut it with a knife. Too bearish now, just like they were too bullish two years ago.
2 - A mountain of cash sits in money market funds - nearly $4 trillion. The stock market value for the S&P 500 stands today at $5.9 trillion.
3 - Valuation levels in many areas are very attractive and any upside earnings surprise would drive stocks higher.
4 - Technical analysis has recently begun to generate some positive divergences - downward momentum pressures have diminished, divergences (emerging markets, for example) have, uh, emerged.

Moreover, as someone who has criticized mark-to-market since March of last year, I am in complete alignment with one of tonight's guests, Steve Forbes.”

*emphasis added

Wanted: Gene Krantz

There’s this one moment in the movie Apollo 13 when mission control manager Gene (failure-is-not-an-option) Krantz, frustrated by the steady stream of bad news, asks his colleagues to identify what is working on the crippled spaceship. From that starting point, from that solutions oriented point of view the process of rescue begins for the mission and crew. Which brings us to the current economic malaise.

In the current climate of all misery and all doom, in a world where nothing seems to work and crooks and incompetents emerge daily, perhaps someone should take the lead and begin to ask the same type of questions and, with the same determination that Mr. Krantz had, apply it to the US and global economy and thereby begin the transformation process from what is wrong to what is right, what is working, and with something that resembles a failure-is-not-an-option attitude.

Frankly, I am sick of listening to the Dr. Doom’s of the world prescribe their vision that the only medicine the world economy needs is an even more bitter elixir. What happened to the can-do spirit of America? What happened to focusing on what is working? Where is that solutions oriented process that includes some out of the box thinking? Too much myopic, woe is us, bureaucratic thinking and not enough innovation, what’s working, and let’s fix and not fiddle around the edges.

This is not to say that problems should be ignored. Nor am I suggesting that the problems are easy to solve. But, give me a break, for as complex as CDS and CDOs might be, they can’t be more complex than the human genome. And they certainly cannot be more pressure cooked than saving three lives in a crippled spaceship.

Where’s Gene Krantz when you need him?

The Damage Has Been Done

Thank you, FASB. Thank you for the turning what would have been a bad, deleveraging-driven economic downturn into the borderline depression here in the US. Oh, and let’s not forget to thank your efficient market cohorts who have chosen to ignore decades of behavioral science and stick to the dogma of market efficiencies, including illiquid assets depressed by panic driven redemptions and forced liquidations.

Thank you for not appreciating the power of reflexivity and the feedback loop from the financial to the real economy with its negative wealth effect. For that is where things stand these so many months into the relentless graveyard spiral of bank assets writedowns, with its unchecked inevitability of creating the very real economy conditions that justify the depressed prices. At this lovely moment, the efficient market advocates are certain to proclaim the “wisdom” of the market in forecasting where the fair value of the depressed assets truly belonged (of course ignoring how reflexivity creates the very conditions it “predicts”. A self-fulfilling prophecy example if ever there was one.)

To be clear, I get the transparency argument put forth by FASB and certain groups advocating mark-to-market, such as the CFA Institute. However, it takes an intellectual leap backward to conclude that mark-to-market is the only asset valuation method worthy of consideration. In such a view and since markets are "efficient at all times and under all circumstances", only the last trade can be considered an acceptable data point to know what the “fair value” of an asset is. No reason to consider other valuation methodologies (such as mark to maturity), for such methods are fraught with potential senior management chicanery. In such a view.

Investment Strategy Implications

With all the talk of a Great Depression II, I have a recommendation. I recommend that FASB and the efficient market cohorts hire a spokesperson. A spokesperson with a trademark expression that exemplifies the economic situation we find ourselves in. I recommend Oliver Hardy, who said it best, “Well, here's another nice mess you've gotten me into."

The damage has been done. Repeal or modification of FAS 157 will now almost certainly have limited positive effects now that reflexivity has begun to work its magic. In fact, one could argue that repeal or modification of mark-to-market will actually inhibit, if not outright eliminate, the recognition of the capital appreciation potential in many of the panic driven depressed assets once fear recedes and balanced thinking returns. Under such conditions, one can only conclude that the winners will be those who scoop up the babies thrown out with the bath water. Tragically, those winners are not likely to be the entities who were forced to writedown all the "toxic" assets - the banks.

(By the way, I wonder if the history books will conclude that the adoption of FAS 157 is the equivalent of Smoot-Hawley: What the Smoot-Hawley act did for the Great Depression, FAS 157 does for the economic mess we are in today – turn a bad recession into a depression.)

Minyanville posting: Pandit's Amortization Trial Balloon - Can It Float US Out of Crisis?

"At yesterday’s congressional hearing, Citigroup’s (C) CEO Vikram Pandit floated what looked to me like a trial balloon that may turn out to be the path out of the credit-induced economic crisis and, in the process, put to bed the doomsayers' chatter about insolvent banks.

In reply to a question from Congressman Gutierrez from Illinois -- who started off referencing a meeting the congressman and Mr. Pandit had the day before -- Mr. Pandit, with an intriguing smile on his face, described..."

To read the full current Minyanville commentary as well as other Minyanville postings, click here

TARP Version 1 Revisited: Mark-to-Market Back in the Crosshairs

“Senior Wall Street executives said yesterday that they had been sounded out on plans for an “aggregator bank” that would purchase toxic assets from banks. Under one of the plans discussed, toxic assets would be valued by an independent third party. Where assets are purchased at prices below their book values, the government might then inject common equity into the banks to make up for capital wiped out by the sales.”
Financial Times, January 28, 2009

On the surface, mixed signals are emanating out of the US Treasury department. Last week, Treasury Secretary Geithner stated that he was comfortable with mark-to-market accounting. Today, we learn of the above quoted plan, which is a direct assault on mark-to-market – the real villain in turning a recession into potentially a depression. What gives?

To refresh your memory, mark-to-market accounting is rooted in the failed ideology of the efficient market hypothesis, which (in its “strong” form) says that when it comes to determining the fair value of an asset the market knows best. This dogma is so entrenched in the thinking of mainstream economists and many naïve investors that even Nobel Laureates such as Paul Krugman ascribe to this fantasy of the “wisdom of the market” (see "More on the bad bank"). Moreover, there is little doubt on these pages that the primary reason why TARP Version 1 went from “price discovery” (code for attacking mark-to-market) to bank capital infusions was due to the intimidation of then Treasury Paulsen by mainstream, non behavioral finance economists.

Investment Strategy Implications

Conspiracy theorist alert: Clever guy this Mr. Geithner. Publicly advocate for free market principles (mark-to-market) while working behind the scenes to exploit it (through the aggregator bank and price discovery (courtesy the "independent third party")).

The significance of keeping mark-to-market intact is the extraordinarily positive impact it will have on bank earnings as assets held at 20 cents on the dollar are written up ("say what?" you say) thereby producing large earnings gains. Moreover, by stabilizing the valuations of “toxic assets”, write ups will thereby alleviate banks’ capital requirements, which is the primary reason why bankers are reluctant to lend. Under the bizarro logic of mark-to-market, they need the cash to remain solvent – hence no lending.

Once mark-to-market is replaced by something like mark-to-maturity (suggested by Bernanke during early days of TARP Version 1), then, miraculously, liquidity will begin to flow through the banking system to the real economy. Sounds too simple? Allow me to refresh your memory on another non real economy factor that wrecked a large amount of unnecessary havoc on the global economy – commodity speculation and the price of oil.

Helicopter Hank

“It is like if you are in an airplane and the oxygen mask comes down,” said Stefanie Kimball, (Independent Bank’s) chief lending officer. “First thing you do is put your own mask on, stabilize yourself.”

"In Michigan, Bank Lends Little of Its Bailout Funds"
NY Times, January 14, 2009

The above quote and article captures the essence of the TARP money dump by Helicopter Hank in 2008. This is, no doubt, a large part of the dynamic that has investors worried, but not in the way that may seem apparent.

Under Obama and the Democrats, TARP funds will be allocated in a striking different manner. And this fact justifiably has many investors concerned that a significant increase in bank failures will be a part of the economic landscape this year: something that the accompanying chart from the Economist strongly suggests. Moreover, with no political dynamic at work this year, it is hard envision any scenario in which the second wave of TARP money would find its way to undeserving banks and with such poor transparency and regard for the terms under which such money is made available. As a result, investors should expect that banks with shaky balance sheets are headed for the operational dustbin. And with them, the economic consequences of the deleveraging process will continue unabated.

Investment Strategy Implications

Were it not for the fact that the stock market is deeply oversold, this morning’s 10 to 1 down ratio (both the advance/decline and advance/decline volume) might lead some to conclude that a return to the really bad old days of last year (with 5% + down days, rising VIX levels, banking crisis du jour, and more pain to follow) is underway rather than a second selling climax based on fears well known, defined, and, yes, manageable.

On the assumption that the plethora of money already doled out and what’s in the monetary and fiscal pipeline (including the Fed’s acquisition of selected “toxic assets” and the prospects for bank “write ups”) will have the desired effect of injecting into the US economic body enough juice to trigger the badly needed multiplier effect on corporations and households beginning in the second half of the year, a cautiously optimistic view of equities does seem warranted - at least for the next several months.

Helicopter Hank did what he did and in a manner that only he fully appreciates*. In short order, his actions will be perceived as they should be – a prelude to the real work of restoring the US and global economy to a more balanced era of growth and stability.

*A more conspiratorial mind might suspect there was a political dimension to his largess as 2008 was a presidential and congressional year. Providing “walking around money” to banks who did not qualify under the agreement that healthy banks should receive TARP funds does make one wonder just what was Helicopter Hank thinking?

What if…

…the Keynesian stimulus efforts of President-elect Franklin Delano Obama don’t work?
…credit spreads remain elevated throughout 2009?
…depression/deflation valuation levels come to pass?*

What you see listed above are the three areas I chose to focus on at last Thursday’s 12th Annual "Market Forecast" luncheon. They were selected by me to help frame the discussion among my six expert panelists (Bernstein, Janjigian, Reynolds, Steindel, Trennert, and Wyss)**. Based on the dialogue that ensued, it achieved its goal. Of the three items listed, it was the first, the most macro of the bunch, that generated the most conversation between the panelists and attendees and one that I wish to share in this blog posting.

It must be assumed that some form of fiscal stimulus package will be passed by the US Congress in the coming weeks. By all accounts, the package will have all the qualities of a camel – a horse designed by committee. This is to say tax cuts (for the Republicans) and liberal causes (for the liberal Democrats) will reside along side stimuli that Keynesian oriented economists prefer.

Whatever the blend, there are two larger issues that must not be ignored by investors. The first is embodied in the opening “what if” question – what if the Keynesian stimulus efforts fail to produce a sustainable recovery? At last Thursday’s NYSSA event, panelist David Wyss (Chief Economist, Standard and Poors) articulated what sounded to me like the best answer – the hope that the stimulus package helps unfreeze the private sector (banking, corporate, and personal) and, thereby, a multiplier effect begins to emerge in which a sustainable recovery gets underway. The scary part in this answer is not just the prospect that the unfreezing process does not occur as prescribed but also that the answers David and all five other panelists provided seem to always include the word “hope” – as in “who knows if any of this will have the desired lasting effect?” The second issue is what will be the economic philosophy going forward?***

Investment Strategy Implications

Relative to where things have been recently, the financial markets appear to have entered a somewhat quiescent period. The multi-faceted stimulus and stabilization programs should have their desired effect in the coming months. This is evident in the steady decline in key market metrics, such as the TED spread and the VIX. While still elevated, the direction for the next several months seems almost certainly to be headed in a constructive direction.

The big “however” in this view is what comes after the fiscal and monetary stimulus punchbowl begins to run dry. Then what? For investors, keeping a keen eye on the above and other market and economic metrics will be key to determining if the audacity of our economic hope comes to pass.

*As a point of reference, the valuation parameters noted have been posted on this blog twice in the past weeks (see Dec. 30 and Jan. 7). They provide a framework within which investors can draw their own conclusions re operating earnings for the year ahead and the appropriate P/E ratio.

**Without doubt, given these incredibly challenging times there are numerous areas to explore, many of which could be argued as being vitally important to the investment decision-making process. However, only the most dedicated bottom-up only investor would deny that the global macro climate is the overriding factor is front and center to the future of the markets and economies.

***This is a larger, related issue to the Keynesian stimulus question, one that contains an evolutionary aspect of the current economic crisis: Now that American-style capitalism, in place since the Reagan revolution, has imploded, what will take its place? For interesting and insightful perspective on this subject, see “Where Do We Go From Here”

The Market Forecast Season Has Arrived

Tomorrow kicks off my early 2009 Market Forecast events beginning with the 12th Annual "Market Forecast" luncheon at the New York Society of Security Analysts (NYSSA). The six-person panel* will be tasked with discussing and debating the political dimensions of the macro economic points noted in yesterday’s blog posting as well as the pressing issues of the credit crisis, valuation levels, earnings projections, and more (much more).

In this regard, allow me to recap the essential market-wide valuation issues facing investors. I draw your attention to the accompanying updated valuation parameters table (click image to enlarge). What this table does is help frame the key issues impacting equities via a matrix, which incorporates the essential components of valuation (cash flows in the form of operating earnings, prospective growth rates and risk factors in the form of a P/E).

As the table illustrates, the operating earnings projections for 2009 correspond to a likely P/E given the economic climate. For example, as I noted last Tuesday it is improbable that a "great times” P/E of 20 would apply if operating earnings plunged to $52. Under such a situation, a $52 number would likely come about due to an economic climate that is under serious duress (as in the “bad times” deep recession – P/E of 10 – or worse).

Investment Strategy Implications

What will my expert panelists have to say about these and other vital issues pressing on the markets and economy? Well, for those of you in the New York area** perhaps you can carve out some time from your busy schedule and come hear for yourself". For those not able to make the event, I will provide a recap of some of the key thoughts and views expressed.

*Richard Bernstein, Chief Investment Strategist, Head of Investment Strategy Group, Merrill Lynch
Vahan Janjigian, Ph. D., CFA, Chief Investment Strategist, Forbes, Inc.

Glenn L. Reynolds, CFA, CEO, CreditSights

Charles Steindel, Ph. D., Senior Vice President and Head Research Support Function, Federal Reserve Bank of New York

Jason DeSena Trennert, Managing Partner, Chief Investment Strategist, Strategas Research Partners

David A. Wyss, PhD, Chief Economist, Standard & Poor's

**members of the media attend free of charge

A Most Dangerous Inflection Point

“If we don’t act swiftly and boldly, we could see a much deeper economic downturn that could lead to double-digit unemployment.”
President-elect Barack Obama
January 3, 2009

There is a major economic battle underway pitting the resurgent Keynesian forces of President-elect Franklin Delano Obama against the monetarists and the remnants of the laissez faire/supply side crowd. To exemplify this policy struggle, consider the following two recent quotes from Paul Krugman:

“The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts.”

“(Milton) Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes, who argued that monetary policy is ineffective under depression conditions and that fiscal policy — large-scale deficit spending by the government — is needed to fight mass unemployment. The failure of monetary policy in the current crisis shows that Keynes had it right the first time.”

To help complete the picture of this economic/political battle royal we have the factions of the newly empowered Democratic Party and its liberal wing seeking to spend the political capital they think they have earned courtesy the recent election results. Then, on top of all this is the stickiness of Washington business as usual and the reality that entrenched power is rarely ceded without a fight.

Needless to say, the task before Mr. Obama is daunting. And we will all learn if his campaigning skills can be translated into effective policy decisions and leadership.

Investment Strategy Implications

The central question is not whether all the money being thrown at the global economy (both fiscal and monetary) will produce positive results. It will. Rather, the key question is whether the policy actions under vigorous (and potentially divisive) debate involving trillions of dollars ends up stabilizing and then turning things around or merely mutes the decline to an era of lessened living standards and a lower quality of life. If the former, a new era of growth ensues. If the latter, get ready for the Great Depression II and a highly dangerous future.