Financial Sense Newshour
The BIG Picture Transcription
January 14, 2006
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The Consensus
JOHN: Well, to be honest with you, Jim, it feels good to get back in the saddle here, although it’s always awkward. I’ve been doing radio for about 40 years, and you think you’ve got it made and you jump back in the saddle, and it doesn’t feel like the right thing again.
But at the beginning of the program we heard a plethora of cacophonous voices that we managed to tape off the media at year end and year beginning here, all saying different things, some of them contradictory. And I know that you have been holed up down at the beach, nobody had access to you. I understand the President tried to call you and didn’t get through. And if you look at all of these voices that are going on out there, basically, if we throw out the extremes on either end, and you look at what the running consensus is on this whole thing, basically it’s that last year was a very strong year and this year will be just like last year maybe just a hair weaker. But I don’t think you’re feeling that sanguine about that whole thing, what do you think?
JIM: It was amazing because we saw a lot of anomalies last year in the market and in the economy. For example, we saw gold go up and the dollar go up; we saw the Fed raise interest rates, but yet long term bond rates came down; we saw earnings go up, but the stock market barely squeaked by with gains; we had natural disasters. Just one kind of thing after another, and everything ploughed through.
So, what I usually do it’s a kind of a scenario I do every year is go to the bookstore, I grab literally every magazine, forecast issue, and of course I subscribe to a number of things too, and I grab them off the shelf. This year I grabbed even additional things. I grabbed things from political journals to international journals. I probably added a lot more international publications because I wanted to see how international people see us versus our own domestic people. And so I holed myself up. You know, John, you hit upon something that I think was rather key if we look at the market this year and as an example we can take the Business Week forecast. I think of like 76 market strategists let’s take out the extremes at the extreme at the top we’ve got Elaine Garzarelli forecasting the Dow will go to 14,150 at the end of the year. And on the opposite extreme you’ve got Barry Ritholtz from Maxim Group who thinks the Dow will hit 6800. But most people are expecting another good year, the consensus is the Dow will be up 7.2%, the S&P will be up 7% and the NASDAQ is up 7.6%. So the consensus is pretty much, “well last year was kind of a terrible year, this year it gets better.” And underlying the assumption that this year it gets better is that the Fed stops raising interest rates and then we get back to another liquidity cycle, and another maybe rate cut cycle. So if you take all the forecasts, whether you’re looking at the economy, or you’re looking at the stock market, the assumption is what drives everything this year is the Fed goes on hold. So we have this big consensus thinking that’s out there, with not a lot of variance.
You know, somebody might argue and say, “well, gosh, I think the Dow’s going to be 12,400,” somebody else might say, “well, I think the Dow’s going to be 11,700.” So, they’re mainly arguing over how much the market is up this year, whether it’s going to be up 7% or whether it’s going to be up 10%. But there isn’t a lot of divergence in the sense that, “no, I think the Dow is going to be 5,000 this year,” or “I think this is the year we get the big plunge in the market,” that’s not what you’re seeing in the consensus. [4:11]
JOHN: Which is probably going to emphasize what we’ve said all along: that the herd always seems to be either looking in the rear view mirror or running the wrong way.
JIM: Exactly. And that’s what you find with most forecasts, whether you’re looking at economic or market ones. they’re literally linear extrapolations of the previous quarter of the previous year. In other words, last year’s trend gets projected out into the future. Everybody was bullish last year, the Dow was down for the year, it was down 6/10ths of a percent. I think the S&P was up a little over 3 and the NASDAQ up 2. So, they’re more bullish this year because of the Fed, and that’s what you seem to get in these type of forecasts. [4:54]
JOHN: OK, Jim, well, having said that there is a consensus out there, can you give us a breakdown of what that consensus looks like now in detail?
JIM: OK, let’s start, let’s start with a couple of key assumptions.
Number one, it’s another good year for economic growth. we’re going to get economic growth somewhere over 3%. Maybe it’s not a rip roaring 4%, but you know a 3% economic growth, or 3.3 we’re along trend growth. it’s going to be another good year for financial assets, financial assets would do better this year. The main assumption assumed by everybody and we’ll get into counterarguments for this when we get into the analysis portion of the Big Picture - but the assumption is that inflation will remain low. In other words, we’ve peaked out on inflation and because inflation has peaked, interest rates will be coming down, the Fed will stop raising interest rates. So, that’s a key assumption that low inflation rules out any kind of monetary squeeze. Some of the common sayings that you’re hearing, “done in one” meaning that the Fed raises interest rates at the end of this month and that’s it. And maybe there’s a 50-50 chance, “2 and gone”. In other words, Bernanke’s first month at the Fed in March he raises a quarter point but that’s it.
The other thing is this low inflation assumption is a misnomer, because the low inflation is due to what they call supply side changes. In other words, increased production coming from China and Asia will keep prices down. But here’s the thing that they don’t look at as inflation. We will see other asset bubbles who knows what it’s going to be this year whether it’s gold, energy because of what they call excess liquidity. There’s a lot of money floating around looking for a place to land on, and wherever it lands it creates an asset bubble, whether it’s in stocks, emerging markets or in real estate.
Another trend that is happening and it continues in the United States, but it’s also happening in Europe is that production is shifting from Western countries the United States, Canada, Western Europe and it’s going to shift to Asia. And that’s going to help to keep costs down, along with internet technology which helps to keep manufacturing prices down.
Once again, ample liquidity will keep bond yields down, and the only thing that you’ll see if there’s any kind of inflation will be in asset prices. you’ll see core inflation maybe go down, but you’re going to see the total inflation number which includes food and energy basic necessities continue to go up because there is no excess capacity in energy or in raw materials. So what you have is excess liquidity which is just another way of saying we’re printing a lot of money.
Another thing is the key beneficiaries everybody believes are going to be the resource oriented countries countries like Canada, Australia, Latin America that produce the raw materials and the natural resources that China, India and the rest of the world needs. With the Fed going on hold, and Europe saying, “yeah, we might raise interest rates but we’re not going to do what the Fed has done, we may raise it a couple of points but it’s not going to be a long string of rate hikes,” and Japan mumbling that maybe they might go to raising interest rates, basically that’s not going to stop liquidity. In other words, they think liquidity conditions, credit conditions, will continue to expand. And one of the ways to play the market this year is not only the big cap stocks, like the Dow stocks, that’s why most of the forecasts this year are for a new record on the Dow, but not a new record on the S&P, or the NASDAQ. They’ll be up, but they won’t be at record breaking levels. This is the year the big caps are expected to outperform the small caps, so that’s pretty much the consensus forecast. [8:53]
JOHN: Jim, we’ve talked a lot here on the program, I know you’ve gone on record talking about some of these imbalances that are going to come home to roost, and out of this consensus one of the glaring things I guess from our perspective is the fact that no one is talking about these imbalances. And sooner or later there has to be a day of reckoning which I would say is going to be rather dramatic.
JIM: Well, a day of reckoning. Most people will recognize there’s an imbalance, the most obvious being the US trade deficit. we’re going to set a record current account deficit for 2005. it’s looking like this year will be even bigger, but the consensus in thinking is that’s the way the world works, this is the dollar standard. The US goes into debt, buys merchandise from China, India, the rest of the world and we in turn give them our dollars. They take those dollars and recycle them back in the United States because we’re the best game in town, we’ve got the fastest growing economy, we have the most stable economy, we have the most secure financial markets, you have no alternative to keeping this game going. So the consensus thinking is the day of reckoning is postponed maybe for 2006, and maybe a couple of years beyond that.
And the key to those trade deficits is if the dollar starts to weaken and which many people believe it will do this year, Asian Central banks will step to the forefront, and they will start buying dollars and they will mitigate some of that downward action, much in the way for example they did between 2001 and 2004. So, yes, everybody expects a bigger trade deficit, they expect that to continue. They expect as a result this is the year the dollar starts to decline, but they also expect that foreign central banks will move into the fray and mitigate some of the downward analogy.
And I have to go along with part of this, it’s the GaveKal argument, which I don’t necessarily agree with all of the things GaveKal argues about, but once again the US makes the majority of the profit picture. And I think the GaveKal argument speaks much about why this day of reckoning keeps getting postponed. So that’s the one portion that I like about the GaveKal argument. We posted a argument this week on our website between Marc Faber and Louis Gave (who we interviewed in the month of December). But the day of reckoning happens, according to the consensus, when it is no longer in Asia’s interest to sustain this arrangement. So, when Asian trade is built up, the manufacturing facilities of Asia are built up, and they have enough trade between themselves that is the day that they have less interest in maintaining the US.
The other thing is it’s expected this year, and especially since 2006 is an election year, that China will take another step to revalue to take away some of the Chuck Schumer protectionism: the threat that if they don’t revalue their currency we will do it by slapping tariffs. And nobody wants to see a trade war.
The other consensus this year is we will have the energy spike that we saw in the year 2005 goes away because everybody says:
“Well, energy prices went up almost 50%, in 2005, but that was really due to Katrina and Rita, and we’re going to have all this new production coming on stream, so we’re going to have moderate energy prices, and even though the debt to income ratio on consumers is high, well, you got to look at the asset side of the balance sheet which is being over inflated by real estate. So even though consumer debt is at a record it doesn’t look that bad.” So this debt to income ratio, this debt to asset ratio could be extended further out because we’ve got rising asset prices.
Another scenario is everybody is calling for the US housing market to soften but what they are hoping for is that the softening in the housing market this year is going to be more like what happened in England and Australia. In other words it’ll start to flatten out, and maybe go down a little bit in some bubble areas like San Diego and by the way, we are starting to see real estate prices drop every month in San Diego, they’re dropping about one and a half percent a month but we’re not going to see anything dramatic like a 20, 30, 40 percent correction in real estate. So the real estate bubble won’t get deflated or popped like the NASDAQ bubble did between 2000 and 2003, because the Fed is very cognizant of that. And so, therefore to sum it all up John, the day of reckoning gets postponed and gets pushed back further. [13:45]
JOHN: But ultimately will come true.
JIM: Ultimately, it comes true. And by the way the longer it gets postponed the worse it becomes when it finally bursts, but basically what everybody is saying here is: “Look, we’re going to have another good year, the day of reckoning is postponed and because the Fed is going soft this year, or going on hold, the good times are going to get better this year. The economic growth will be there but the stock market will do better.” [14:15]
JOHN: Alright, Jim, coming to the end of this conversation in this segment of the program then, sum up what the consensus is.
JIM: Alright, consumers retrench this year but the business investment will pick up the slack. We will see decelerating economic growth, probably in the 3% range. The inverted yield curve associated with tight money and high real interest rates really does not mean a recession. M3 will continue to grow. we’ll have negative interest rates, this looks more like what we call a mid-cycle slowdown similar to what we saw in 1984, 1994. It will not be a recession. Actually, if you take our last two recessions, they occur about every 10 years, so this is a mid-cycle slowdown. Chinese growth will be strong, Europe and Japan will be picking up some of the slack of the slowdown in the US. China is working on stimulating domestic consumption, that’s going to help. Japan and Europe will be generous with liquidity. Consumers are already retrenching. We will see the dollar go down this year, but it will be moderated by Asian central bank support. And on the positive side we’ve got lower oil prices, the end of Fed rate hikes, and low inflation which is why everybody’s optimistic. [15:35]
JOHN: Yeah, and one more time, just the numbers, and then we’ll move on to the next topic.
JIM: Well, 7% gains for the stock market this year. 7.2 for the Dow, 7 for the S&P, 7.6 so the NASDAQ small tech stocks are expected to be big. If we want to put those to numbers, the Dow goes to 11,556, the S&P roughly to about 1350, the NASDAQ roughly to 2430, and the big cap story this year is the big Dow stock: the big blue chips. And out of 76 strategists only 7 saw a lower Dow. Once again, everybody is talking and if you want to look at the extremes you’ve got Elaine Garzarelli with a 14,150 Dow and then you’ve got Barry Ritholtz from Maxim Group at 6800. you’ve got the S&P on the high side of 1600, low side of 13. The place to be this year is tech, health care, energy and industrial stocks. GDP growth of 3.3%, profit growth of 7, the CPI is only 2.4%, the Federal Funds Rate goes to 4 �, 10 year bonds at 5%, the unemployment rate goes to 4.9 and oil prices average below $54 a barrel. All economists see no recession, no real divergences. They feel the Fed wraps things up, and basically we have what I call lollipop scenarios. [17:09]
Wild Cards
JOHN: You know we’ve been talking about scenarios for the year 2006, and that’s what all of the pundits were doing as well, Jim. There’s always a joker in the deck, always a wild card that pops in and that tends to ruin whatever you happen to have planned. So, wise planning actually says let’s include the wild cards. What’s floating out there?
JIM: Well, if you take a look at the risk to these 3 scenarios, they’re pretty much a similar risk we were facing last year. Number one, at the top of the list it’s got to be another oil shock. We all know, John, that we’re in that decadal oscillator in the Atlantic which means the oceans are heating up. Heated oceans mean you get tougher hurricane seasons. Since 1995, 9 out of the last eleven hurricane seasons have been above normal, so we can expect another type of hurricane cycle this year. And if it disrupts production in the Gulf of Mexico where we get a third of our energy production �we’re still not, as you and I are speaking today, 100% back on line yet, with natural gas and oil so that’s a problem � enter another energy shock. And I believe we are very, very close to peak oil, because you have for example in November � this didn’t get much mentioning � Kuwait announced that it has reached peak production. They will be cutting back their production to preserve production at a lower level that they can maintain for, let’s say, another 5 to 10 years. The large Kuwaiti oil field is linked to the second largest oil field in Saudi Arabia which is safaniyah, and that’s the canary singing. So you could see, I think in the next 12 to 15 months, also coming from Saudi Arabia that they may have to admit that they have reached peak production because oil injection levels at Ghawar are very, very high. I just read a report here that basically said that it’s peaked. So, another oil shock is got to be at the top of the list, and it could come from geopolitical.
The second risk which is right in the front pages this week is geopolitical risk between Iran and Syria. You could see a scenario where the Israelis take out Iran’s nuclear facilities. You could see Iran respond in turn in which case I think the US would be forced to respond. You could have economic sanctions leveled against Iran, and Iran is in a position to level economic sanctions against the West. They might say: “OK, you level economic sanctions, just see how you feel if we remove 4 million barrels of production of oil a day. Let me see what happens to the price of oil.” So, that is a real scenario. [20:05]
JOHN: You know, I guess I’m itching to ask about the Iranian oil bourse that’s supposed to come on line in March, it really seems an obvious question.
JIM: Yeah, that is also another risk because oil is priced in the US dollar, and the two trading capitals for oil are in London and New York. Now, you’ve got a third center rising in Iran, and if Iran starts saying, �look, we’ll take euros instead of dollars,� there’s going to be a lot of interest for that, because one of the problems that the Europeans had last year was not only that the price of oil went from 40, to 60, to 70 but the fact that the euro went down against the dollar. So the Europeans had to pay not only higher prices because the cost of a barrel of oil was going up in dollars, but their currency was going down against the dollar. So they got a double whammy. So there’s a geopolitical risk leading to a financial risk now that you’ve got OPEC large producer now saying, “you know what, we want another currency besides the dollar”, and that could be competing with New York, and also London. So, there’s a risk there.
A third risk is that the Fed is not done in one, it goes in March and then it goes in May, because Bernanke has to show that he’s tough, and all of a sudden now you’ve got this inverted yield curve. you’ve got variable rate mortgages, maybe at the same level as fixed rate mortgages. And then what happens is the consumer slow down due to refinancing with housing prices going down, refinancings goes down, consumer spending goes down, so the Fed overdoes it, it is probably the third risk.
So there’re a lot of things here that could cause this rosy scenario that everybody is seeing on the horizon, [if] it doesn’t turn out the way the script is written. And I could probably think of some minor wild cards that you could also throw in there which is a financial wild card which is somebody like a GM filing bankruptcy, or a Ford. Or you have a financial intermediary that gets caught with bad loans because bad loans � we know � and mortgage defaults are going up. Last year was a record year for bankruptcies. I think a lot of that had to do with the new bankruptcy bill as consumers rushed to file bankruptcy before that new bill took effect. So that kind of alters that number. There’s some other scenarios out there but I would say the 3 big ones John are an oil shock, the housing bubble deflates, and geopolitical risks such as we’re seeing today with Iran. [22:51]
JOHN: Jim, if we had to put it here I would say the GNI, the Global Nervousness Index has been on the rise since the first of the year, and it’s across a whole series of different issues. 1) We have Palestinian elections coming up before the end of the month and it looks like the terrorist group Hamas is going to gain a good piece of control there and they have already said that they’re going to chop off relationships with Israel. 2) The spat between Russia and the Ukraine over natural gas supplies to Europe that got interrupted and they went, “Oh my Gosh we’re vulnerable here,” especially if we had that really rough Winter you’re talking about, and somebody pulls the rug out from underneath them. And that’s a whole geopolitical influence. I think the topic du jour is probably the Iranian bourse, and the whole Iran situation, which couples in with the nuclear situation in Iran and everything else and that would seem to be the hot spot because Iran is looking to Russia right now, to back it in its strategic moves. that’s what it’s looking for.
JIM: And the situation that you have there is Bush knows he doesn’t have the political capital to become Lone Ranger again, and that’s number one. Number 2, he’s trying to work with the UN, but by the same token every time you think this is going to be resolved, the Iranians get more belligerent, they’re in everybody’s face. you’ve got the President of Iran saying one of our first priorities is to wipe Israel off the face of the map; there was no holocaust. You know, when you have those kind of statements being made on a weekly basis, at the same time action taken in your face, OK, What’s making them be so bold. So, does Iran have Russian and Chinese backing? You could have a scenario where maybe Israel is the one that makes the strike because they’re the ones that are threatened by this, then you get into a situation of Israel strikes the nuclear facilities. How does Iran respond? And If Iran responds against Israel or they bomb Saudi Arabia or who knows what they do, then we bring the US in, and then this starts to heat up. And you just wonder at that point if the Russians and the Chinese go to the Iranians and say, “look you’re being provocative here. Stop it. you’re going to lose if you take it any further.” Or, does this become World War III. [25:19]
JOHN: And you could write a novel and retire. Tom Clancy would like this one see there it is right?
JIM: Yeah, I think that we would hope that cooler heads would prevail here but right now it’s kind of like this new President is like in your face. You tell us to do this. Well look at this: we’re going to take off the wraps of another facility and this is the way it is whether you like it or not.
JOHN: Yeah, cool heads do not seem to be the word of the day, right now the way things are going. It seems like ideology seems to be carrying the day at least short term here.
JIM: And so this is the thing that a lot of people say, “well, don’t talk about politics just talk about economics.” Well, I hate to say it but if the US or Israel strikes Iran’s nuclear facilities and Iran strikes back this is the kind of thing that can send oil prices up to $100 a barrel overnight, gold to seven fifty, a plunge in the stock market. So you can’t ignore this. You can’t ignore that new Chancellor of Germany, meeting with Bush agreeing on Iran’s nuclear facilities. You can’t ignore geopolitical events and say, “nope, we’re going to put them away and not deal with the issue because it won’t affect us.” That would be a very bad decision to make. [26:33]
What's Wrong With This Picture?
JOHN: Well, so much for the wild cards and those are the things that I guess are the spice of life which can make it either interesting or dangerous. As the Chinese say, may you live in interesting times, but then there was the consensus we talked about at the beginning of the program which I take it you don’t buy everything in the consensus. So, What’s your comment on that?
JIM: Well, one of the reasons I don’t buy the consensus is the way that economic data is published in the United States, it’s manipulated for political purposes. So, in other words, the way they determine GDP is you take how much the economy grew in total dollars, subtract the inflation rate from those total dollars to get real economic growth. In other words, say if the economy only produced let’s say 10,000 widgets a year at a dollar, so your economy is 10 thousand but next year you produce 10,000 widgets but because of inflation you raised the price by 5%. So, instead of a dollar you’re selling those widgets at a dollar and a nickel, you haven’t produced any more, you just have inflation at higher prices. So you have to back out the inflation numbers from GDP numbers, to get real economic growth. Well, the problem is we grossly understate the inflation rates. So, number one, I don’t buy the 4% economic growth figures, I don’t buy the 3% economic growth. So, economic growth is overstated, inflation is understated and the unemployment rate is understated as well.
And here’s some of the problems that I have with this analysis is if we take a look at the two million jobs that were created over the economic recovery beginning in 2002. we’ve created roughly about 2 million jobs. Of those 2 million jobs roughly a fourth of it or 25%, a half a million, were government jobs, over 800 something thousand jobs came from the birth-death model these are hypothetical numbers that the Bureau of Labor Statistics makes up and then you have what portion of the economy that was adding jobs was the bubble portion of the economy, which was for example in finance and construction and real estate. So you’ve got more home mortgage brokers today, more people in the financial service, more real estate appraisers, more real estate agents. So, if you look at the recovery, it’s been the worst economic recovery that we’ve seen in the number of jobs created, and so when you take a look at these consensus numbers they’re overstated to begin with, because we’re not measuring them accurately. In other words, by understating the inflation rate it changes the economic numbers, GDP numbers, it changes the productivity numbers, it changes even the personal income numbers. For example, if you’re jiggering the unemployment rate with so many hypothetical jobs created, well those hypothetical jobs have hypothetical income and that gets added into the income flows in the way we compute our economies. So, a lot of these numbers don’t make sense. [29:59]
JOHN: Yeah, but if you look at some of the pundits out there, we keep hearing about this economic recovery, how strong it is, etc, the people who are working in the economy don’t really feel that, in other words, they have the uneasy “something is wrong” feeling, but the numbers keep getting quoted as if they were gospel, there’s no challenge of these numbers.
JIM: that’s where the real problem is I believe. you’ve got columnists from the Washington Post, the Los Angeles Times, the New York Times who are saying this is the worst economic recovery. Yeah, the numbers are big and good but people aren’t benefiting. There was a study this week by Harvard Magazine about how the middle class is falling further behind. The reason is the income isn’t keeping pace with inflation, taxes are going up, inflation is going up. And let’s put it this way, most people that work in a wage job are not seeing pay increases that are matching the true level of inflation. You can talk about the core rate of inflation being two-tenths of a percent but that’s not what you’re facing on a day to day basis as a consumer when you go to the grocery store, you put gas in your tank, you pay your utility bills, you send your kids to school, you go see a doctor, you pay your medical care premiums, all of those things. I mean, last year, our medical premiums as a company went up 8%, and they said the good news is we’re keeping our cost increases below double digits this year, but they doubled the deductible from $250 to $500. Well, that means our employees now, we cover that deductible for our employees because that’s just something that we like to do, but for other people that have companies I’ve heard similar circumstances that they’re paying higher medical premiums. So, the problem, when you hear these articles, “gosh, if these numbers are really good,” that everybody is bemoaning it because the numbers are bogus to begin with. But the problem is that nobody is looking behind the numbers and calling into question how these numbers are computed and that’s where the real problem is. [31:58]
JOHN: Yeah, nobody is willing to say that the emperor has no clothes. Well, Jim, if the Fed has cut the interest rates and we’re being told by the pundits anyway that we’re in a recovery, why doesn’t it feel like a robust recovery? What’s the difference?
JIM: I think there are a couple of things that happened John in the US economy that it has transformed itself to the detriment really of economic growth. What happened typically in the past is that you’d have these boom and bust cycles. The Fed would lower interest rates, credit would become available, as this credit was available businesses would expand, they would build new plant and equipment, that created jobs that increased income. You would get this economic recovery. Then the credit got to be too explosive, the Fed would have to put on the brakes, they would start raising interest rates, then we would get a recession. This was pretty much the pattern throughout the latter half of the 20th Century.
What happened in the 1980s is, even though interest rates were coming down, one reason is that inflation began to take place in financial assets versus the real economy. In other words, as the Fed expanded the supply of money and credit available in the economy, instead of that money going into building new plants, expanding business investment, what happened in the 80s, businesses merged, we got junk bond financing, it was sort of like the buyout frenzy that was led with the advent of junk bond financing. In the 90s, we had a lot of money that was created under the Greenspan Fed [in response to] any crisis but the money went into financial assets. And then of course those financial assets as they boomed and became a bubble, people felt wealthier they consumed more, they saved less and what happened is we stopped investing in the economy. The only thing we did is we merged and we had a lot of consolidation of American industry, and also a lot of American industry went offshore.
So, if we take this last economic cycle, we had the Fed cut interest rates, slashing them to the lowest that They’ve been in 50 years. The problem is all of this money and credit that was created and we’re creating it as we’ve never seen before � we’re setting historical records here in terms of the amount of debt that the US economy is taking on. However, here’s the problem: that money did not go into plant and equipment. Businesses did not invest. In fact, what is absent in this economic cycle is a major increase in business investment. It has been mainly driven by consumer spending, consumption. In fact, last year almost 75% of GDP growth was consumer spending. The problem with consumer spending is not only are we seeing new plant and equipment being added with credit, with consumer spending it’s being done with debt, and also consumer spending is going towards foreign goods. So, if you go into a Best Buy, a Circuit City, a department store, or Wal-Mart you’re buying and spending money but those goods aren’t made here in the United States. So, we haven’t had the job growth that we’ve had in typical economic cycles because we’re not building and making things here any more. All we’re doing is instead of investing, we are borrowing money. Instead of savings we are borrowing money. Instead of investing we’re speculating. So, this is what happens when you have a lot of easy money, and that’s one of the reasons you really haven’t seen the job growth, number one, and the income growth, number two. And those two things come as a result of, let’s say, a company making investment and expanding either plant and equipment which creates jobs. [36:10]
JOHN: Well, let’s lightening rod that down to reality. Ultimately, what is this going to mean for the little guy who is trying to hold body and soul together. And you know, by the way, you talk about saving, Jim, but I think a lot of families can’t save any more. they’re lucky to make their bills.
JIM: Well, the two things that are hurting families today are taxes and inflation. let’s face it, if you work for a company, if you’re a salaried employee, unless you’re a top executive subject to, let’s say, incentive sales bonuses, or a top CEO, or a top vice-president where you can get a major bonus, most people [only] get cost of living increases. A friend of mine works in the banking business, and he’s been working Saturdays during these major refinance waves that come through depending on What’s happening in interest rates, and the best thing that he’s going to get is a three and a half percent raise. Well, for him, his cost of living’s gone up more than that: his food costs have gone up, his gasoline bills have gone up driving to work, his insurance premiums have gone up. His medical premiums have gone up. he’s asked to pay a larger portion of his medical premiums, the deductible’s gone up. Everywhere he’s looking his costs have gone up more than that three and a half percent and even that three and a half percent pay raise, remember, a portion of that goes to taxes. So, not all that three and a half percent increase is his.
But what is really different here is in the past, when we went through an economic recovery, coming out of a recession, businesses would be the first to respond. The Fed would lower interest rates, the lower interest rates would be used as an opportunity for companies to say: “Gosh we wanted to add another plant or double the capacity at the plant but it just wasn’t right. Now with interest rates lower we’re going to build a new plant or double our capacity.” So, they would go out, they would borrow money, they would expand the plant, or try to increase productivity by buying machinery. All of that created income, because if you expand the plant, hire new workers, if you’re buying new machinery, that’s creating jobs in the sector, this would create real income growth, it would create real job growth in the economy. This time around most of the job growth, if you take a look at it number one, out of these two million jobs, half a million was government jobs. Number two, almost a full million jobs were hypothetical, created by the birth-death model. And number three, you had a lot of jobs only occurring in what we call the bubble sectors of the economy: mortgage finance, the financial industry and construction. Throughout this economic recovery the manufacturing sector of the United States continued to shed jobs as we outsourced not only jobs overseas, but we continued to outsource the service sector. And you’re seeing this, and I think this is going to come back to bite us with peak oil and higher energy costs.
Every year we upgrade all our technology equipment, we get new computer systems, file servers because our business is expanding and growing and we have to keep on top of the technology curve because of the industry that we’re in. I used to go on line, order a computer from Dell, it would take 5 days that the box would be in my doorstep. Or, if I was ordering a laptop from IBM it might take 10 days. I ordered a brand new state of the art IBM ThinkPad, October 5th, you know, I didn’t get it until a week before Christmas because it was all made overseas. So, a lot of this technology, a lot of the things that we’re doing here, we’re not creating these high paying jobs that are associated with manufacturing, and even in the service sector a lot of the tech jobs are being outsourced. This will come back to haunt us and I think that’s one reason why you hear so many complaints from people: “Wow, if this is the best economy, economic growth at 4 point 3 percent that we’ve had, why is it I don’t feel it.” Well, one reason you don’t feel it is the numbers are bogus to begin with. [40:17]
JOHN: Yeah, you wonder how people can sit there especially if you watch the Saturday morning financial wrap-ups on the Cable channels, how do you sit there and say with a straight face that everything’s just peachy keen, it’s just wonderful?
JIM: Well, if you take these numbers and this is the one thing I learned in the mid-90s is I started to see these earnings numbers come out and I’m on record, it’s on our website I began writing about these bogus earnings. If you take the financial statements and don’t look at the footnotes and take the financial statements at face value, you can say it’s a wonderful economy, or this is a wonderful earnings report. it’s not until you go into the footnotes and you start digging deeper and you say, wait a minute, this doesn’t add up. they’re overstating their sales, or they did an accounting change on inventory levels, or they’re accelerating something here, then all of a sudden you start getting [suspicious] of the numbers. The problem is we don’t do enough of that we just accept everything as gospel. we’re not doing our homework, “hey, that was a good number released by the government yesterday on the CPI or that was a good economic number, let’s go into the details,” and the devil’s in the details. And, it’s not until you do that that you find out that, “wait a minute, these numbers don’t make sense to me and here’s why: because of this and this.” This is the one thing that bothers me about some of the wild cards this year, because talking to Matt Simmons on some of these inventory numbers on the oil markets, they’re seasonally adjusted and these seasonal adjustments are based on patterns many, many years ago when we had surpluses, when we had $20 oil, and $10 oil, and they may not work when you still have 25% of your production down in the Gulf. we’ve got another hurricane season. This is the thing that makes me feel so uncomfortable now about this consensus is that these numbers are derived from statistical fiction to begin with. [42:21]
JOHN: Well, Jim, here we are, we need to move on to what we’re basically calling Other Voices segment for the New Year. And we’ve basically heard the consensus from the herd, we have looked at the wild cards from the possible pitfalls, problems with the consensus, but so far we haven’t heard your opinion, and I’m not going to let you do that today. We have to think this a two part series, otherwise we’ll run over time. So…
JIM: Yeah, we’ll talk about where I see things going and our predictions, so we can go on record as we did last year, that’ll come up next week, but I do want to give people a heads up that we are doing a new feature now called Other Voices. they’re not going to be like the experts in the first hour today, my next guest is going to be Evelyn Garris. it’s on weather, that’s important as we look to the energy markets right now and especially after what Joe Duarte said about production, 25% down, so that’s going to be anxious.
we’ll be having people from the geopolitical field and sort of different perspectives on a number of things going on. Not just financials, there’s a three part leg if you want to become a good investor: you have to understand fundamentals; you have to know technical because that can sometimes go against you or for you; and the third part is geopolitical. It always amazes me when we start talking about geopolitics whether we’re talking about energy, gold, or even the financial markets, and people say, “don’t talk about that, you know that’s irrelevant.” It isn’t irrelevant, it has a major factor and could be a major factor of how this year plays out so we’re going to bringing you different guests in Other Voices. It’ll be just a short clip segment that we end with. And John, why don’t you tell our listeners about something that we’re going to do on emails and what we call e-calls this year. [44:09]
JOHN: Right, we’re going to open up a voice mail line so people can call in questions to the program, and we’ll play back their question on the air and then answer it as well, as well as have the email segment. So, that’s our plan for the new year. And that’ll be posted on the website.
JIM: Yeah, so we’re going to have a 800-number that you can call in if you have a question. But once again, one of the problems that we’ve had in emails in the past is we need to have short brief questions: make them pithy, get straight to the point, this is my question, boom, and that makes it easier for us. it’s very difficult for John, and myself, because I can get anywhere from 600 to 800 there’s been days that I’ve gotten over a thousand emails and you simply just can’t wade through that. And if you don’t get to your point right away it’s rather difficult to have that question on the air. So, we’ve got an 800-number, you can call if you have a question, and we’re opening that up for next weeks show, so if you do have a question give us a call, just say, “hi, this is Bob, from New York, Jim, my question is this or could you ask that” and we’d be glad to get that on the show, and we’ll try to answer them on our a regular basis. [45:18]
JOHN: And if you want to explain efficiencies in our family backgrounds we won’t be listening we’ll be hitting the delete key and moving on.
Other Voices: Evelyn Garris
JIM: Joining me in a new segment we’re starting on FSN this year, Other Voices, is Evelyn Garris. She’s editor of the Browning Newsletter that takes a look at weather forecasting. Evelyn, one thing that we’ve seen since 1995 is 9 of the last 11 hurricane seasons have been above normal and it has to do with something called the decadal oscillator. I wonder if we might start with that, and then I want to talk about Winter.
EVELYN GARRIS: Sounds like a good interesting subject. Especially if you’re sweating it out in New York City.
JIM: Why don’t you tell people what the decadal oscillator is, how it affects weather?
EVELYN: OK, people know of the Gulf Stream current, that brings warm water up from the tropics to the more Northern latitudes. And like a river, sometimes it flows fast, sometimes it flows slow, but unlike a river which can change from season to season in a year these are big things. it’s the size of 100 Mississippi Rivers, so it takes a long time to slow down and a long time to speed up. Currently it is flowing very fast, and it is bringing a lot of warm tropical waters up to the Northern latitudes to the point that we’re seeing glaciers melting in Northern Arctic waters. This started around 1995, and it will typically take about 30 years before it starts to slow down. So, what we’re seeing is the Atlantic extraordinarily warm, and this is a cycle that will probably last for another 15 to 20 years.
JIM: OK, now the result of that is while we see this warming trend which gives us more severe hurricane seasons, because we know heat is generating hurricanes, what happens during the Winter cycle of this?
EVELYN: Well, typically what happens is when storms leave the North American continent they go across to Europe and Europe has stormier weather as well. Ironically, these warmer waters create more stormy conditions along the East Coast and sometimes even as far west as the Midwest and the Great Lakes area, and also Europe experiences stormier weather. So warmer water ends up stormier, colder winter sometimes. [47:48]
JIM: Now, I know you were calling for a colder than normal Winter and it looked like in December, that’s the way things pretty much looked but then we got a warming trend. What’s happening with this weather cycle now and where are we?
EVELYN: Well, if the US weather was totally determined by the Atlantic it would be cold, because the conditions right now is the Arctic air is not being held in by Arctic winds and it’s ready to expand south. But What’s shaping our warm weather right now is an extraordinarily strong Pacific jet stream, and it is the Pacific and its impact on the jet stream that is keeping us warm. The Pacific jet stream is so strong it is blocking the southward movement of Arctic air. So, the Arctic air is not moving south into North America, instead when it surges south, it’s surging south into Asia. And we are seeing freezes as far south as New Delhi, India. If you can imagine tropical India, people freezing to death. [48:49]
JIM: that’s incredible.
EVELYN: It is incredible weather. This is weather like we’ve not seen in over 70 years.
JIM: So, does the US escape another problem because I know that our inventory levels of natural gas and oil are low, and it’s very weather dependent, whether we get into an energy crisis. Are we going to end up having a warmer Winter, or is this whole ballgame not over yet?
EVELYN: The whole ballgame is not over yet. Last time we had these conditions, it was very cold then it warmed up for a bit in the Midwinter, giving people a false sense of security, and then it got cold once again. The Pacific jet stream is quite variable when the Pacific is in this phase of its oscillation, and I would not bet my heating bill on this jet stream continuing to be this strong through another two to three months. We can probably expect sometime around, oh, normally something like this would last anywhere from 4 to 8 weeks more average would be around 6 weeks. So, I would not be surprised to see the cold return in February. [49:59]
JIM: So, if we get the cold in February does it stay with us, do we get a colder March, or is only one month of cold weather and then it’s back to good weather
EVELYN: Again, [I] think from 4 to 8 weeks.
JIM: 4 to 8 weeks.
EVELYN: Yeah, the weather tends to get extremely variable under these types of conditions and you get extremes of cold like we had in December, extremes of warmth like we’re having now, followed by extremes of cold, just like the Summer we saw extremes of heat. [50:27]
JIM: Can you give us some idea what it looked like in the past when we’ve had these kinds of temperatures? You and I were talking just before we went on the air about the year 1932.
EVELYN: Well, remember when people kept talking about the hurricane season and the last time we had anything close to this many hurricanes was 1933. Eerily enough, this year, it’s echoing some of the weather conditions of the early 30s. Now, fortunately for Texas, Oklahoma, Arkansas and Louisiana their farming methods are so much better they’re not going to have a dust bowl, but they’re facing the same dry conditions that they had in those days and that’s one of the reasons they’re having all these terrible wildfires. We have had the largest wildfire season since we’ve been keeping records.
JIM: Evelyn, getting beyond Winter, so we’ve got a four to eight week period where we could see cold come back lasting 4 to 8 weeks or it may be just as short as 4.
EVELYN: Yes.
JIM: let’s move on to the hurricane season because we’re in this decadal oscillator, where the ocean temperatures are heating, that means we start this next hurricane season before us, we will barely have our Gulf Stream production back on line for oil and natural gas, and they’re still going to be making some repairs. What do you expect to see, does this get worse as you get into this decadal oscillator? In other words, as the ocean temperature heats up, maybe it’s half a degree or one degree warmer this year. Does that mean we have a more severe hurricane season?
EVELYN: Not necessarily. When you consider the last decadal oscillation, how long it lasted. And yet 1933 was the strongest year which was very early. It doesn’t mean it gets worse and worse, but what it does mean is the conditions that we took for granted in the 70s, 80s, and 90s are past. we’re in for the type of weather that they had in the 40s, 50s, and 60s. And back then, living on the coast was an adventure sometimes. [52:27]
JIM: So, maybe it doesn’t get worse, but we should see a good share of storms this coming Summer.
EVELYN: Exactly. Exactly. There’s reasons why if you look historically at where, say, Native Americans settled, they did not settle permanently on some of those islands that people are paying high prices to live on now.
JIM: ha.
EVELYN: Yeah, why live in a storm magnet.
JIM: Yeah, it’s kind of like living below Mt. Vesuvius when you see smoke coming out of the top of the mountain.
EVELYN: Oh, years ago I had one of my clients complain because his home had 3 in one year 3 near strikes. And I said why do you think they called it Cape Fear. [53:09]
JIM: Evelyn, one other thing that you wrote about in your newsletter is the magnetic field is changing in the globe. Can you speak about that briefly?
EVELYN: Yes, people tend to think the North magnetic pole as a permanent fixture. And actually what it is is the interior of the earth is liquid, and as it spins it help generate this magnetic field. But it’s liquid so it sloshes around, and the North magnetic field moves in relationship to the surface of the Earth. Currently, it is moving faster than we have been accustomed to it moving, and so you got some sensationalist headlines saying, “oh the North and South magnetic poles are going to flip.” No, what typically happens is there tends to be an oscillation between Canada and Russia, and right now we’re sending the North magnetic pole to Siberia. [53:59]
JIM: And does that change the jet stream, and the weather patterns?
EVELYN: Yes it does. Typically the worst weather is due South of the North magnetic pole. Just ask the noble citizens of Winnipeg how wonderful their Winters are. They can show you sometime one of their intersections which they claim has the coldest weather in Canada. Well, now we’re sending the worst weather over to the Russians, and I hope they enjoy it. [54:23]
JIM: Well, Evelyn, I want to thank you for joining us here, and sort of giving us a forecast of what this weather is going to look like. I hope you’ll come back and join us. If our listeners would like to find out more about your newsletter, which I get and find fascinating, how can they do so?
EVELYN: If your listeners will go to www.fraser.com, those are my publishers.
Oh, they might want to do linda @ fraser.com. She is the one who will cheerfully give them the quickest response. So, I’m giving you the name of the best lady there to get in contact with: linda @ fraser.com. [55:07]
JIM: Well, Evelyn, I want to thank you for joining us on Other Voices, a new segment that we are starting this year and I hope to have you back again, especially as we get towards the end of the Winter season, and we start looking at what Summer is looking like.
EVELYN: It would be a pleasure.
JIM: OK, well, this was a longer show than expected. We had Ike Iossif with George Blake, and we also had another guest, George Gu from China. I hope you enjoyed that, we’ll be back to only one guest. And we’re trying to put together a roundtable, we’re trying to get Marc Faber, Matt Simmons, Louis Gave and have a major discussion on inflation, deflation, peak oil, how this affects all of it. it’s real tough. If we can get 2 or 3 of these guys we’re going to have this roundtable. But as you know Marc Faber’s an international traveler, Louis Gave is in Hong Kong he’s a traveler, and then on top of that Matt Simmons is traveling almost every day of the week. So, trying to get all these guys in the same place at the same time globally, but we’re doing our best. we’ve got a lot of exciting shows coming up this year, hope you’ll be there to join us.
In the meantime, on behalf of John Loeffler and myself, we’d like to thank you for joining us here on the Financial Sense Newshour, wishing you a very prosperous New Year. We hope you’ll join us again next week. Until we talk again, have yourself a pleasant weekend. [56:29]
