Charter Trust - Global Market Update

The Federal budget deficit isn’t hard to understand.Imagine you and your spouse decide go out to dinner at a restaurant with another couple; for convenience sake agree to split the bill in half. If the other couple is having pasta and drinking tap-water, you’d be jerk to order the filet mignon and a bottle of expensive wine, knowing that the other couple is paying part of your bill. Do this more than once, and your financial arrangements would change.Now imagine a neighborhood supper club. You and the folks on your street hold a pot-luck once a month.  Every month people bring chili, or stew, or salad. But one family never seems to get around to fixing anything substantial—it’s just chips and a couple bottles of Coke. Eventually, someone will find out if there’s a problem of if that family is just freeloading. Either way, things have to change.The problem with Federal spending is we’re having a giant potluck every day with 300 million other citizens. We don’t know each other, but we see this giant entity called “the government” providing dinner, lunch, health care, education, and all sorts of things. If you think your neighbor is having the filet mignon and you’re paying, you feel like a sap for not ordering the cannoli. So you order the cannoli, and the bill just gets bigger. Since this is the government, it’s hard to change the arrangement.Government spending used to be constrained by custom, when we knew each other. Then it was limited by the Constitution--but that seems to be less effective today. So now we depend of “cliffs”: debt ceilings, government shutdowns, sequesters, and so on.Where does it end? America cycles between activist and limited government. We’ve been trending towards more for almost 20 years. Turns come, but finding them is tough. Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Can trade be improved? There are reports out of Davos—the generally worthless confab of glitterati and celebrity wannabees—that the US and Europe are close to a trade deal. UK Prime Minister Gordon Brown and Germany’s Chancellor Angela Merkel were among leaders pleading for lower tariffs and regulations. US Trade Representative Ron Kirk also got into the act, but noted that any deal would have to pass muster with US farmers and other interested parties. Any deal would help. It’s estimated that existing trade barriers with Europe cost the US economy some $50 billion a year. That’s a lot of jobs. And the Europeans need to find some way to spur their anemic economies. Businesses on both sides of the Atlantic are generally in favor of reducing trade barriers. It opens the path to markets with millions of consumers. But trade barriers can crop up in funny places. Many Europeans are skeptical of “frankenfoods”—genetically modified crops that help farmers fight plant diseases and pests. And pathogens like hoof-and-mouth or mad-cow disease pose difficult problems. It’s not just taxes, tariffs, and subsidies. Sometimes it’s a matter of culture as well. So while it’s well-and-good to talk about doing a deal in the next two years, one can’t help wondering, what about the last ten? It’s not like the Bush administration was hostile to trade, or the US has lots of barriers now. Europe currently exports $20 billion in food to our 300 million consumers, while we only export $11 billion to theirs. Indeed, one of the best ways for Europe to spur growth would be for them to unilaterally reduce tariffs—enriching their consumers and eliminating deadweight loss to the economy. But that’s politically hard to do. Still, every little bit helps. And if the pols and pundits at Davos can build a bridge and have it actually go somewhere, that will be an unexpected pleasure. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

Is the Japanese market coming back? For over 20 years the Japanese stock market has been in a funk. After topping out the last day of 1989 the market value of the Nikkei average fell over 80%. A thousand hearts have been broken—and billions of dollars lost—betting on a comeback for the world’s third largest economy. But the new Prime Minister Shinzo Abe recently announced a 10 trillion yen stimulus package—the equivalent of a $300 billion program over here. Their stock market has rallied 25%, and a lot of folks are wondering if now is the time. Certainly, a generous fiscal package and an expansive monetary policy is a start. The fiscal package could stimulate spending in key areas, and a monetary policy that reverses the Yen’s appreciation of the past few years could seriously help exporters like Toyota, Canon, and Sharp Corporation. But is Japan’s economy too indebted, too old, and too corrupt to begin to grow again? Not necessarily. Unlike the periphery of Europe or even the United States, Japan’s debt is primarily internal. Its elderly population is the primary holder of government debt. That means that with the right combination of estate taxes and investment incentives, much of that debt could be retired without crippling the economy with high marginal tax rates. Some people claim that Japan’s stock market is cheap, because the ratio of market price to book price is historically low. But book prices are a poor proxy for value, especially for an entire market. It goes to the question of what something is worth: for a financial asset, its value should be based on the ability to generate positive cash earnings. Book value is simply an historical record of what someone was willing to pay in the past. For long-lived assets, circumstances change, and book value becomes increasingly irrelevant. Does anyone think a Kodak Instamatic factory is worth anything like what the owners paid, unless it is re-purposed? Japan has been a classic value-trap—always looking cheap, until it gets cheaper. Based on current earnings, the market is still expensive relative to other markets around the world. But with a new government seemingly willing to take its economy in a new direction, the market bears watching. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

Recently Robert J. Gordon, a professor at Northwestern University, created a stir by asking whether the remarkable growth in living standards that the world has enjoyed from 1750 until the present is slowing to a crawl. He argues that the world—and the US in particular—is facing long-term economic headwinds: demographics, education, inequality, globalization, energy/environment, and an overhang of consumer and government debt.To some extent these headwinds have always been with us. We’ve been an aging society ever since public health initiatives started extending our lifespans. Globalization has also been an issue since 1492, as has environmental degradation and energy prices. 150 years ago New England was 90% deforested due to the appetite for firewood. Coal and heating oil have allowed our forests to grow back.Over against these headwinds Gordon admits there have been three waves of productivity growth that have allowed the economy to expand dramatically: the industrial revolution that began in England in the 18th century; electrification and the internal combustion engine that took hold in the US around the start of the 20th century; and the information technology boom that started in the ‘60s and ‘70s and is ongoing. He makes the point that the inventions from these periods were not all created equal, and that the gains from electricity and the engine were far more important than anything that came before or since.In essence, he’s saying that the easy, most productive discoveries have already been made. This is a point that economic pessimists have been making ever since Thomas Malthus drew his graph lines in 1798 and predicted mass starvation. It’s why economics is called the “dismal science.” And it ignores the innovation that England bequeathed on the world that made the industrial revolution possible: private property.In the late 1600s John Locke discussed how life, liberty, and property were the unalienable rights of mankind. He did this in a political document that justified the loyal opposition to a tyrannical king. A few decades later Adam Smith noted how private property and personal interest could enhance the wealth of nations. And an American author re-worked Locke’s thoughts into a different kind of political manifesto—one that established a new nation, conceived in liberty—personal and economic.Our economy will always face headwinds—it’s why growth is called progress. But asserting that growth will slow because we don’t know how productive future inventions will be isn’t just pessimistic, it foolishly ignores the greatest resource: the human mind.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Should they stay or should they go?That’s the question Great Britain’s Prime Minister David Cameron wants UK voters to decide. In a speech originally slated to be given in Amsterdam last week, Cameron proposed an in-or-out referendum to be held after the next general election in the UK and after he negotiates the return of some powers from Brussels to London, such as determining holidays or setting limits on the work week.He spoke at Bloomberg LP’s London office—a remarkable place from which to announce a policy initiative. He said that public disillusionment with the EU is at an all-time high. And while the public may not consider Europe to be a hot button issue, there’s still a lot of Euro-skepticism: in a recent UK poll, 40% of those questioned said they would vote to remain in the EU, while 34% said they would rather leave.Because while the 17 nations that have the Euro as a common currency are becoming more deeply integrated, the demands of global competition raise significant questions for the 10 non-Euro EU members. For example, eleven Euro nations are moving forward in adopting a financial transaction tax, something that Cameron’s government adamantly opposes. But capital is highly mobile—don’t they need uniform rules?It’s a little strange to see Great Britain questioning its EU membership—something they only achieved in 1973 after 15 years of petition. They are now Europe’s third largest economy and the sixth largest in the world. De-coupling from the many trade and financial ties they have with the Continent would be an economic disaster.And yet: there’s clearly something distasteful about having distant bureaucrats decide the details of your personal life. We see it here when people complain about Washington. And it’s particularly galling to see Cameron labeled a “scaredy-cat” because he wants to offer Britons a referendum regarding what could be the most important policy decision of their lifetimes.But one thing Cameron has achieved: Germany and France are now united. They despise him.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

It looks like the Kings are headed to Seattle.Hedge-fund billionaire Steve Hansen and Microsoft CEO Steve Ballmer have teamed up to purchase a majority stake in the Sacramento Kings, the NBA franchise that moved to Sacramento from Kansas City in the ‘80s. The deal values the franchise at $525 million; it’s widely expected that the new owners will apply for permission to move the team to Seattle. Seattle has been without an NBA franchise since the SuperSonics moved to Oklahoma City in 2008.It’s inevitable that hedge-fund managers should become involved in professional sports team ownership. The Detroit Pistons, the Philadelphia ‘76ers, and the Boston Celtics in basketball; the New York Mets, the Milwaukee Brewers, the Tampa Bay Rays in baseball--all have hedge-fund related owners. Sports teams are a conspicuous display of wealth, and most of these managers haven’t been too shy about showing the world how successful they’ve been. Team ownership is the closest thing we have to royalty in America.But I suspect the main reason hedgies have been buying up sports teams is that they’re good investments. The combination of a dedicated local market, media-rights, and merchandising creates steady, positive free cash-flow. Apart from some high-profile bankruptcies--almost always brought about by owner shenanigans—professional sports teams almost always make lots of money. And if the team can get a fancy stadium paid for by their customers’ taxes, that’s a bonus.But moving a team from a city of 470 thousand to one of 620 thousand—with a growing high-tech economy and which already supports valuable baseball and football franchises--should be a layup.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Why do people lie?Most people like to think of themselves as basically honest. When they look at themselves in the mirror, they want the respect the man or woman looking back at them. So we all tend to think of ourselves as nicer than average, better-looking than average, and more truthful than average.Only it’s not that way.Several recent studies show that if people can cheat and get away with it—just a little bit—they tend to do so. Also, if it looks like most people in the group are cheating, we’re more likely to cheat ourselves. Some college students were given a set of math problems to solve by hand in a short amount of time and were paid a dollar per problem solved. When the time was up, they shredded their papers and then self-reported how many they did. After examining the papers—the “shredder” was a ploy—the researcher found most students exaggerated a little. Out of 30 test subjects, about 18 thousand lied a little, while a handful lied big-time.When the researcher “salted” the exam room with someone obviously cheating—who announced, “I’m done!” about two minutes into the test (which was designed so that no one could finish on time)—and who received the same payment as everyone else—the incidence of cheating went up. When others lie and get away with it, you can feel like a sap for sticking to the rules.Which brings us to Lance Armstrong. By his own confession, every one of his seven Tour de France victories was accomplished with a little help from performance enhancing drugs: steroids, painkillers, blood boosters, and so on. Because he denied using drugs—and aggressively attacked anyone who contradicted his denial—he has been banned from professional sports for life.But cycling has been especially fraught with doping scandals. Every pro sport—baseball, football, boxing—has had its share. In the last Tour de France, you had to go down to number 17 to find someone who was admittedly substance-free. The incentives seem too significant and the penalties too diffuse and distant for most athletes to resist. In spite of the health and reputational risks, the potential gain is too much to pass up.But Lance has now been skewered. That’s the risk of egregious cheating and serial denial. Lance Armstrong used to be an example of a generous, courageous cancer-survivor. Unfortunately, his name will become a byword for blood-doping shame.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

What can Joni Mitchell teach about investing? 40 years ago Joni Mitchell wrote “The Circle Game,” a lyrical song about a young man’s gradual coming of age. The most memorable part is the refrain, which goes: “We can’t return, we can only look behind from where we came / and go round and round and round in a circle game.”Circles and cycles are part of investing. The economy cycles through growth and recession every 4 to 8 years; businesses magnify any economic decline into a significant profit downturn; and investors take those business losses and run with them, bolting for the exits en masse and causing market panics in the process.The economy doesn’t decline that much because we all need to eat, sleep, and heat our homes no matter what our mood. Corporate leaders can’t be too moody, either. They need measure their firms’ progress and manage by the numbers, not their feelings. But there are no checks on the swings of investor psychology. Investors are the classic manic-depressives—alternately crazily bullish and depressingly despondent—driving prices along with them. So most investment risk doesn’t come from the economy or the business cycle, but from investor psychology. And that’s where Joni Mitchell comes in.For four years we’ve heard the gloom-crew tell us to get off the train, batten down the hatches, and look out below. But four years of successively higher highs and higher lows have the bears in retreat. The painted ponies are moving around the carousel from depressive to manic. Because the returns on “safe” investments are so low, people are moving out the risk curve to preserve their income. And so it’s time for a little caution.Because what the wise do in the beginning, fools do in the end. Four years ago it was wise to go against the flow and bet on a recovery. It wasn’t easy. But those bets have paid out in spades. Taking a little money off the table now will be equally difficult. But the alternative—another circle game—could be worse.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Is the Dreamliner a lemon? Boeing’s 787 Dreamliner has been fraught with problems from the beginning. From design questions to supplier issues to production delays to faulty fuel pumps, the carbon-fiber twin-engine long-range superjet has been left stranded at the gate a few times too many. It was initially heralded as a game-changer, a jetliner so spacious and so efficient that it could dominate the market for years. But a spate of electrical and mechanical problems over the past several months have prompted the FAA to initiate a top-to-bottom review of the 787’s entire design and manufacturing process. Now airlines are positioning empty aircraft as “spares” to be sure that high-profile flights take off on time. United recently had two 787s on standby for its first trans-Pacific flight from LA to Tokyo. American recently downgraded its latest order—getting a smaller version of the plane and saving money in the process. The Dreamliner has been a nightmare for Boeing, for all its panache. For the past five years the company’s stock has gone sideways, while rivals EAD and Northrop Grumman have grown quite well. Boeing executives have to be asking themselves whether this is how Ford’s management felt when the Edsel came out. But when life hands you lemons, you make lemonade. The Dreamliner is Boeing’s fastest-selling model ever, with almost 850 orders for the $200+ million airliner through 2012. Clearly there’s demand for an efficient, long-range, wide-body jet that can link non-hub cities. The question, with the myriad minor problems, is whether the 787 can meet this need. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

How big should a company be?76 years ago Ronald Coase set out to explain why people organize themselves into businesses, firms, and corporations rather than just freely trade goods and services with one another. If Adam Smith’s “invisible hand” is so efficient, why don’t we all organize ourselves independently. The answer has to do with costs. It’s cheaper to build a firm around one product or service and aggregate the inputs and outputs needed to get the product to market, rather than everyone negotiating every little detail with everyone else. With a large and complex system like a car, there are literally millions of parts, each of which must be built to precise specifications. It would be really inefficient for the billions of transfers to be negotiated independently.Transactions costs can be lowered dramatically by bringing them into a single firm. When this works, it works beautifully: an engaged workforce creates and produces something the sales-force can market effectively, gathering feedback from customers as they go, funneling this to an R&D group that solves problems imaginatively.But nothing fails like success. Small firms that “ideate” effectively grow into behemoths that become caricatures of themselves: cubicle farms straight out of “Dilbert.” That’s partly why there’s so much investor skepticism around Apple or other fast-growers: no tree grows straight to heaven. Mega-firms create mega-administrative bloat and bureaucratic nonsense: a Soviet-style republic where meeting the plan and compliance are far more important than innovation and customer service.Lincoln once answered the question, how long a man’s legs should be by quipping, “Long enough to reach the ground.” The answer to how large a firm should be is equally simple: large enough to be efficient—and no larger.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

The Dutch finance minister, Jeroen Dijsselbloem, is likely to become the new Euro-zone finance chief, succeeding Luxemburg Prime Minister Jean-Claude Junker. Dijsselbloem has been leading a tough austerity program in the Netherlands, agreed upon shortly after their elections last September. The $20 billion plan will raise the retirement age to 67 over the next 8 years and will cut their budget deficit down to 1.5% of GDP within five years; it’s currently 4.5%.Because they’re willing to take their medicine, Holland’s $840 billion economy is one of the few AAA countries left in the world. Dijsselbloem is a Labor MP; Prior to his brief posting as his county’s finance chief, he kept a relatively low profile, speaking out on video-game violence and educational issues. He had better get up to speed quickly on the issues facing Europe and the common currency, though. Spanish banks, Greek riots, Portuguese stagnation, and a looming crisis in Cyprus all threaten the Euro’s very existence. Dijsselbloemis apparently acceptable to the Germans because he comes from a AAA-rated country, and the Socialist Government of France, while not endorsing him, hasn’t raised any serious objections.But he’s the same age—46—that Tim Geithner was when he took the reins as US Treasury Secretary, and Mr. Geithner’s lack of gravitas has been a problem for him in dealing with the financial and economic challenges the US has faced over the past 6 years. Dijsselbloem’s background in agricultural economics may not help him deal with rogue banks any more than Geithner’s Asian Studies degree helped him.The Euro-crisis demands strong leadership. Let’s hope Dijsselbloem is up to the challenge.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

What’s your retirement plan?For many people, their plan is simple: save as much as they can then live off the interest. Unfortunately, both halves of this plan have been hammered recently. Saving and investing has been made difficult by the volatility of the markets, and living off the interest has been made difficult by the Fed.Market volatility makes setting aside cash discouraging. It’s tough to look at those statements and see the value go down, in spite of the money you’ve set aside. It makes you wonder what you’re doing it for. In spite of the fact that a downturn actually helps savers—each dollar they set aside buys more investment securities—it feels like you’re the patsy at a poker party. Everybody else is laughing into their sleeves while you keep pushing more chips into the pile. So some folks get discouraged and stop saving, or move to a more conservative asset mix. While that approach may be tempting, the best time to change a strategy is when it’s doing well, not when it’s trailing—that way you lock in gains, not losses. But reducing savings is really problematic. Where will retirement savings come from, if not your own initiative? We can’t flip houses back and forth to each other any more.But the second part of the equation is the real challenge. As recently as 2007, a million dollars in savings would generate $50 thousand a year in income, just from a money market fund. But those days are over. If people thought money funds were “risk free,” they didn’t count on the risk of rates falling to zero. Any concentrated portfolio carries risk.No, the best approach to investing is a balanced one that uses a mix of stocks, bonds, cash, and other assets to generate income and capital gains over the long-haul. Assembling such a diversified portfolio isn’t easy, but it can be done with ETFs, mutual funds, and individual securities. Planning for retirement isn’t easy, but it’s not impossible. In spite of the challenges we face today, the future really is in our own hands.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

On the face of it, that’s a silly question. Bohr was a physicist who built on the foundation that Newton constructed. Newton was an enlightenment scientist who essentially invented physics and calculus. His laws of motion describe most of the world we live in. But early in the 20th century a group of physicists—including Bohr—were trying to understand what happened when things got very, very small and realized that they had to revise those laws.For most of life, Newton’s Laws work quite well. Things at rest remain at rest; acceleration is proportional to force times mass; and for every action there is an equal and opposite reaction. Movement—per calculus—can be broken down into infinitely smaller divisions of time and space. The world of classical mechanics is the world we live in, and it’s accurate most of the time. And this world of clear laws and continuous movement seems to describe the models that policy makers are using to manage the economy. Per calculus, the Fed seems to believe that they can move interest rates an infinitesimally small amount at a time. But rates around the world are so low—and have been so low for so long—that I don’t think classical monetary policy is accurate here.Niels Bohr formulated the notion that electrons “jump” from one energy level to another in discrete steps—not continuously—and give off or discrete packets of energy in the process. In the same way, once there is the slightest hint of tighter monetary policy interest rates will jump to the next level. It won’t be a smooth, continuous function; it will be sharp--and nasty.A corollary to Bohr’s atomic model is the uncertainty principle—that one can’t know both the position and velocity of a tiny particle. That’s where we are with monetary policy today: we know where rates are. We really don’t know where they’re going.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Where does finance fit into the economy? Time was that the real economy was considered the dog and the financial economy the tail. Except for the occasional bubble, the tail didn’t wag the dog. What people ate and how they dressed was critical; how the saved and where they invested wasn’t. Now it’s not so clear.A recent IMF study noted that the world produced an estimated $70 trillion in goods and services in 2010. At the same time, the world’s public stock markets were worth $47 trillion; public debt $45 trillion, private debt was worth $54 trillion; and there were some $110 trillion in back assets. That’s a total of $256 trillion, or almost 370% of the world’s GDP.Even if you allow for some overlap—banks owning public debt, etc.—that’s a lot of money! Now it’s not so clear, which is the dog, and which is the tail. And this is just cash investments. It doesn’t even consider the $640 trillion in swap contracts outstanding that are some $25 trillion in-the-money. Unquestionably, what goes on in the financial markets affects what happens in the real economy—through bank lending, public market access, pension fund growth, and consumer and business confidence.It didn’t used to be this way. In 1955 future economics Nobel laureate Harry Markowitz almost didn’t receive his Ph.D. because his work on portfolio selection wasn’t considered an economic topic. His ground-breaking insight on diversification and investing didn’t fit.It reminds us how much the world has changed. Today, if there’s a regular cash-flow, you can securitize it and sell the bond. If you’ve discovered a gene for a strain of lung cancer, you can patent it and start a company. We live in a financial age.It’s another reason that the Fed is right to consider asset prices in their deliberations. Because whether the tail wags the dog or the dog the tail, of the animal is shaking, someone had better take note.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

What can The Hobbit teach us about central banking?The Hobbit is literature, not a lecture. So when people read the story, they’re looking for entertainment, not edification. Still, like any good story, it has elements that are quite realistic, for all the fact that it is fantasy. Tolkien was quite thorough in thinking through his alternate world. And so aspects of the author’s fantasy-world can be instructive to us in the real-world.One (rather fanciful) question some have raised is why the attack of the dragon Smaug should have effected Middle Earth’s economy some 150 years later. Was it the destruction of so much property? The scattering of the dwarves? Or something else? We know that it wasn’t the continued depredations of the dragon—Tolkien notes that Smaug rarely emerged from his lair at the time of Bilbo’s quest. By that time many of the younger folks in Lake-Town had never seen him. And other societies have seen periodic destructions of wealth and labor—from storms, from wars, from earthquakes—without going into an economic funk.Instead, many have traced the collapse of the Middle-Earth economy to the loss of money in their society. The dwarves’ treasure—and the dragon’s hoard—were immense. When the dragon removed that currency from circulation it created a monetary shock that rippled through the entire society. Absent a central bank, if the money in circulation is cut in half—or by 90 percent—prices and wages will have to fall a similar amount, if the production of goods and services remains the same. But debt contracts do not fall, and so there would be mass bankruptcy, liquidation, and disruption across society—just at the time when there would need to be mass re-building. The resulting debt-deflation would be similar to what happened in the US during the Depression—productive assets are left fallow, and the economy stagnates. It’s one more reason why our economy is better off today than it was 100 years ago: now we have a central bank to manage the money supply that can deal with monetary shocks.Still, it’s wise to consider that as the Fed constructs ever-more imaginative responses to our current economic problems: sometimes, there be dragons.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd