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'We're in a period of heightened alert,' says Edward Boehne, president of the Federal Reserve Bank of Philadelphia. 'We've moved beyond just the risk of accelerating inflation to some preliminary, fragmentary suggestions that we might be seeing some accelerating inflation.' The anti-inflationary forces of the 1990s are waning. Costs for raw materials [because much of the rest of the world was floundering, global demand for key commodities and goods had been moderate], imports [import prices have risen 1% over the past year, compared with a 2.4% decline during the prior 12 months], and health care are no longer falling. Overseas economies, long able to service the demands of the American economy because they were weak, are picking up steam. Labor markets are growing ever-tighter, and showing new hints of pushing up labor costs. The great American shopping binge shows no sign of slowing. A key question now is whether consumer demand has gotten so strong that pricing power may be beginning to return, eroding another important dam that has helped hold back inflation. NAPM's (a monthly survey of manufacturers) index measuring prices paid for supplies jumped in March to its highest level since February 1995 -- a period when inflation worries were mounting and the Fed was completing its last round of interest-rate increases. Fifty-eight percent of the companies contacted last month said they were paying higher prices for commodities, up from just 35% in December. Low inflation - and the widespread conviction that it would stay low - has had myriad benefits. It has spurred an investment boom by giving executives the confidence to plan far into the future without uncertainty over prices. It has been used to justify the sharp rise in the valuation of stocks, with experts arguing that long-term stability in prices -- and hence interest rates -- lowered the long-term risk of equities.
Supply-sider Jude Wanniski calls it tax-payment selling. New York Post columnist Beth Piskora calls it the April effect. I think of it as tax sticker-shock. Whatever the right description, there can be no question that a large number of successful people liquidated considerable portions of their stock portfolios in order to meet their April 15 tax liabilities. Beth Piskora's recent column reminded us that plenty of tax-related stock selling occurred in 1999 as well as this year. So maybe we should seasonally adjust the stock market for April 15 (April 17 this year) tax payment heartburn. Jude Wanniski reminds us that there is no withholding on capital gains, much of which have been coming from the Nasdaq technology index. He also makes the point that the Treasury is taking the receipts from Nasdaq sales and using them to pay down the debt. 'A poor use of capital,' Mr. Wanniski writes. With investors suffering unprecedented capital-gains shocks this year, some Wall Street watchers say investors' stock sales to pay their tax bills probably played a part in last week's markets sell-off. Government analysts expect individuals' capital-gains taxes to reach a record $99.7 billion for 1999 -- the highest total ever. Taxable capital gains -- the kind triggered by a sale -- are expected to hit $500 billion for individual investors for 1999, up from $440 billion in 1998 and $154 billion in 1989. Unfortunately, from a tax-planning point of view, selling stock to cover a tax bill is the worst possible thing to do. If you're selling securities that have appreciated, you're incurring more taxes.
'Fact' No. 2 is that since 1992, 'growth in imports has exceeded growth in exports,' a deficit that 'translates into a loss of over three million jobs.' But the US trade deficit shrank from 1988 to 1991 -- roughly the same time that US job growth stagnated. Now, with unemployment in this country at the lowest level in three decades, where would we find the bodies to fill those three million supposedly lost jobs? The real fact is that the trade deficit results from domestic demand exceeding domestic supply. In the meantime, Japan still runs a trade surplus, but its unemployment rate has soared to a post World War II record. 'Fact' No. 3: 'The trade deficit reduced jobs in manufacturing that have been replaced by lower-paying jobs in the service sector.' But whatever the merits of that view, it has nothing to do with the trade deficit. If an economy engages in a fair amount of trade, then that trade will have some impact on wages in that economy, whether or not the trade is in surplus or in deficit. Summation: The record trade deficit is a reflection of US economic strength, not weakness.
In a perverse way, some of Japan's weakness during the crisis may even have helped. Blessed with a population of compulsive savers, the Japanese invested their money in the US, enabling Americans to buy more exports from South Korea, Thailand and other crisis countries. In the simplest terms, the developing world sold, the U.S. bought, and Japan paid for it. But it may not be healthy if Japan slumps quietly in its own corner of the globe much longer. Picture a skydiver jumping out of a plane. If the parachute opens, it's a happy landing. But if the primary chute fails, there had better be a backup. In recent years, the global economy has had no emergency chute. 'Japan by itself can't break the world economy,' says Carl Weinberg, who is the chief economist at High Frequency Economics. 'But Japan plus one other mystery country could make a bigger dent.' That is why US officials keep a close eye on Japanese economic policy, and were glad to extract a promise this past weekend from Bank of Japan Governor Masaru Hayami that he isn't planning to abandon soon the zero-interest-rate monetary policy intended to stimulate growth. If Japan could start growing at a reasonably robust rate, then that would be a substantial additional source of strength in the world economy. Driven by investment in high-tech, Japan's economy appears to be growing at a rapid pace in the first half of 2000. Many economists believe the economy grew by 1.5% to 2% in the January-March quarter from the previous quarter -- an annualized pace well above 5% -- and bulls believe growth of more than 2% in the year ending March 31, 2001, is in sight. Companies are investing in new computers and Internet hookups, encouraging high-tech manufacturers to expand their facilities. Household spending rose 4.2% in February over the same month a year earlier. Some of that recent upturn in spending has been encouraged by strength in the stock market. But Consumer sentiment is fragile at best. And Japan's budget deficit is worryingly high. Whoever holds power after the soon to be called election may try to squeeze spending -- or be forced to do so to forestall concerns about Japan's credit rating. That would damage the economy's short-term health. Japan's domestic coal-mining industry hasn't been competitive with its overseas counterparts for 40 years. Heavily subsidized mines continue to produce some of the most expensive coal in the world, roughly three times as high as the world price. Their customers--government-regulated electricity companies--are arm-twisted by bureaucrats and politicians into buying the gold-plated fuel. Rather than fret about it, the power companies simply turn around and pass on the cost to consumers. This contributes to some of the world's most expensive electric bills, undermining the competitiveness of Japanese companies and the wider economy. [But the 3 million tons of domestic coal produced annually accounts for only about 2.5% of Japan's total coal consumption.] Shortly after World War II, Japan earmarked coal as a priority industry, both to drive its ambitious industrial plans and to avoid the dependence on foreign resources that had contributed to its humiliating defeat. At the peak in 1961, Japan was producing 55.4 million tons of coal from 574 mines. Now there are only two active coal mines left in Japan. The two have survived because they have good safety and labor records, and they are located in an economically depressed areas with enough political influence to keep the public largess flowing. To keep mines going, the Japanese government has tried almost everything over the years: it has taxed oil imports to subsidize coal, spent billions on thermal power plants to spur demand, poured huge amounts into roads and infrastructure, paid off the debt of private mining companies, subsidized corporate restructuring, funded labor payoffs, granted loans and handed out safety payments. Finally, in November 1986 in the eighth coal plan, the government declared that enough was enough and set a 1995 deadline for subsidies to end. The 1995 deadline came and went, however, and the subsidies continue. Coal miners are hardly alone in being shielded against global competition. They are snuggled up with rice farmers, shopkeepers, small manufacturers, middle-aged 'salarymen,' fishermen, truck drivers and construction workers, among others. Collectively, these policies have not only propped up the losers and handicapped the winners. They are also placing an increasingly onerous burden on Japan's government coffers, already hard-pressed by recession.
Even at 3,500 [for the Nasdaq] or so we're still almost 1,000 points above where we were in mid-October. The stocks are at extraordinarily high levels. The Nasdaq's probably trading -- even if we're very generous and say tech earnings can grow 25% a year -- at a price-to-earnings-growth ratio between 6 and 7. Some companies warrant that, but does tech as a whole? The answer is an unambiguous no. Our rough-and-ready approach is that at the 3,000 level we would think of going back to a neutral on technology, and in the 2.000-to-3,000 range, that's what we'd consider a really true new buying opportunity. What we've been doing is recommending that investors increase their exposure to consumer staples such as foods, pharmaceuticals, household products and beverages -- groups generally out of favor since '97. These companies have been delivering disappointing earnings. But we think that this stemmed from four factors, all of which have reversed or are in the process. Revived consumer spending in other parts of the world should be kicking in just about now. Second, a shift from a very strong dollar to a flat-to-weaker dollar. Third, we're starting to see improved pricing for these companies. Finally, consumer staples lag when corporate earnings are accelerating and we think they're right at the peak now. The next four to six quarters will give you weaker year-over-year growth. That's exactly when you want to own pharmaceuticals and consumer staples. With the momentum-investing mind-set now vaporized, people are looking for some new concept to dictate the tech-stock trend. And so the idea of focusing on the fundamentals has returned from Baja, or wherever it was vacationing. Suddenly, everybody seems to agree that there's a limit to how high a stock's price should be relative to underlying earnings. But what's the limit? What is cheap, what is reasonable, and what is too expensive? In judging where new-economy stock P/Es are headed, keep three things in mind. First, the excitement over new companies and new business concepts may have ebbed for now, but it will be back. It always comes back. That's America. Second, the market always affords the fastest-growing companies valuations that are far above what is afforded the rest of the market. Third, once-classic growth stocks like Coca-Cola and Walt Disney have continued to carry high P/Es even during multiyear non-growth periods. Does tech deserve worse, or better, than those names? If last week had you crying over the market, toughen up. In October 1987, the Dow lost about one-third of its value in some four trading days. That would be equivalent to a 3,500 point drop from this year's highs. Similarly, from August through year-end 1987, the S&P 500 lost 27% of its value, and the Wilshire 5000 index lost over 30%. So far this year, the Dow, S&P, and Wilshire are all down about 12% from their highs. If this is a bear market, it has been a very mild one. As Harry Truman said: 'If you can't stand the heat, get out of the kitchen.' Since 1994, the broad stock market has been up 20% or more each year, and techs have been up even more sharply. That is not volatility: it is a straight-up market. Even after the recent drops, it is still a New Age for stocks, and it will take New Age wizardry to hold prices here, let alone to engender another upturn. Then again, it could happen. The Wall Street pros are telling you that the fundamentals are still very favorable for stocks. [But these valuations can not be justified.] It is human nature - not fundamentals - which has driven the broad market 50% past fundamentally justified levels [meaning p/e's]. It will be human nature which either propels stocks back up or drives them down still further in the weeks ahead. Buy or sell from here based on your reading of the market's psychology, not on what the gurus are chanting. I still think the value in today's financial markets is in bonds. 'The CPI kicked the market when it was down,' said Christine A. Callies, chief equity strategist at Credit Suisse First Boston. 'Investors had decided that valuations in tech were too inflated and needed to be adjusted. When the report came out, investors decided that the market P/E had to come down, too.' 'The [CPI] report could be an anomaly,' said James Crawford, portfolio manager at Trevor Stewart Burton & Jacobsen. 'But those folks who have been saying inflation is nonexistent have to rethink here.' 'Stocks that were way overvalued are giving that up, and that is appropriate,' said Lise Beyer, director of Internet/Net media research at Credit Suisse First Boston. 'But others that are generating cash are getting hammered. We are throwing the baby out with the bath water.' Which is to say that markets, while usually efficient, are often not rational. And the irrationality currently on display in technology stocks has created pockets of opportunity for the right kind of investor. Edward Kerschner, chief market strategist at PaineWebber, said a group of stocks he calls the 'new new industrials' (like internet infrastructure and architecture companies, and B2B's) are still overvalued. They 'could fall by another 33% before even aggressive assumptions would put their valuations on a par with established large-capitalization technology stocks.' 'This is what a bottom looks like,' said the California Technology Stock Letter, an authoritative expert on high-technology stocks, which have taken the deepest plunge. That newsletter encouraged its readers to buy, saying, 'Top-quality technology stocks are moving from weak hands to our hands at rock-bottom prices.' Figures from Birinyi Associates, a stock-market research firmt, confirmed the anecdotal evidence, showing that big institutions, not individuals, accounted for most of Friday's selling. But no one seemed to be bargain-hunting, either. The aggressive buyers who drove technology stocks to all-time highs last month seem to be out of fresh cash, and more conservative investors still think the high-fliers are too expensive. What brought the market to its current slump is clear enough now. The first chink in the armor was Microsoft's troubles with the antitrust case. Then a respected analyst raised concerns about Microsoft's earnings and slowing p-c sales. Then Forrester Research warned that many Internet retailers will be out of business soon. Finally, a pair of government reports showed burgeoning signs of inflation. Until six weeks ago, millions of investors followed what they thought was the stock market's golden rule: Be willing to take significant risks, because they'll inevitably pay off. Many were weary of watching neighbors and co-workers rake in profits on hot 'new-economy' stocks. In some ways, a more daring strategy seemed likely to be safer than holding onto low-risk investments. But with the Nasdaq drop, suddenly the wisdom of such aggressive investing is being debated among small investors. Whether that represents a sea change, or merely a temporary blip, in Americans' attitude toward the stock market may go a long way toward determining the course of share prices in the months and even years ahead. 'If the faith (in buying the dips) is shaken, it could change the entire face of risk taking and investing,' said Jeremy Siegel. People who bought the April 4th dip already face stiff losses. Now, 'it's the second dip that worries me. Will investors keep the faith?' Investors who took a chance on tech stocks any time before the middle of last year still have sizable, albeit reduced, profits in their stocks. Even as risk taking is suddenly vilified, it's an odd twist of fate that the nerviest small investors - those who jumped into tech and other new-economy stocks when many institutional investors still shied away from them in recent years - are in the best position today. 'The holdouts till the end who just threw in the towel are suffering much more than those who have been playing the game for a long time,' Siegel said. 'That is a great irony.' 'It's a bit of panic ensuing. There are no bids, nobody wants to buy anything,' said Tom Schrader, head of listed trading at Legg Mason, amid Friday's declines. 'You have the vacuum effect.' While there could be more pain for internet highfliers that are tumbling so much now, Mr. Schrader says money will eventually flow back into the blue-chip technology companies, such as AOL, Lucent, Sun and Cisco. But 'you've got to scare the heck out of everybody...before people start buying them again.' [So our problem is lack of fear ... again. (See Lonski article of 3-20)]
People chatting on stock message boards this week were lamenting that they are out of cash. Low cash levels are caused in part by seasonal and economic factors. Many people already have invested year-end bonuses and tax refunds, while others have earmarked money to buy homes or pay tax bills. Also, the Fed has taken money out of the economy this year by tightening credit with higher interest rates. The dearth of free cash may be more pronounced among professional investors. At the end of February, the average equity mutual fund had only 4.4% of its assets in cash, near an all-time low, according to ICI. In September 1990, just before the end of the last US bear market, the average fund had a record 12.7% of its assets in cash. Theoretically, there's an ample supply of cash available in money-market funds, which have swelled in recent years and now hold more than $1.7 trillion. But their steady asset growth suggests that some investors prefer to permanently keep that money out of stocks. Meanwhile, one big source of liquidity in recent months may be less available, or desirable, to many investors. The NYSE reported Friday that margin debt rose 5% in March to $278.5 billion, another in a string of records. But that was before the market began to free fall in early April. 'It is hard to draw any grand conclusions from this core number,' [the core rate rose 0.4% in March, double the monthly increase over most of the last two years] said Edward Yardeni, chief economist at Deutsche Bank Securities. 'Whether it signals an inflection point or is simply the result of a number of aberrations, no one can say yet. I am more in the aberration camp.' 'Tight labor markets are almost certainly beginning to have some impact on consumer prices,' said Chris Varvares, a partner at Macroeconomic Advisers. 'Everything could change in the next few weeks,' said Edward Hyman, president of the ISI Group. 'The market is getting crushed, and if demand weakens with the market, pricing power is going to be crushed, too.' 'We are going to find that this tech wreck and Nasdaq crash will have a much more immediate impact on consumer spending than the interest rate hikes the Federal Reserve has given us,' said Yardeni. 'The retracement so far takes away only a small part of the increase in financial asset values over the last few years,' said economist Henry Kaufman. He said the decline was likely to have 'only a modest economic retarding influence.' But he added that changes in expectations could have a larger impact on consumer spending. At the Chicago Board Options Exchange, Daniel Koutris, designated primary market maker for options on stocks, said: 'This isn't volatility; it is velocity.' While the volatility has created new opportunities of the options industry, said Paul Liang, who heads PBL Partners, fear has started to creep into market psychology in recent weeks because of the persistence of the decline, particularly in the Nasdaq index. 'In previous declines in the last four or five years, buyers looked to pick up bargains,' Liang said. 'Now there is selling into strength, so we could be in for a larger correction.' If you are among the investors who dumped big sums into tech-heavy mutuals near last month's Nasdaq peak, some strategic 'tax swapping' might help a bit. By selling one battered Internet fund and buying another, your portfolio can basically stay the same and you lock in a tax loss. That loss can trim the dollars you will owe to Uncle Sam a year from now, on your 2000 tax return. If the fund shares were held for one year or less, the sale generates a short-term capital loss. At tax time, such a loss is used first to offset any short-term capital gains, which would otherwise be taxed at ordinary-income rates. As much as $3,000 of those losses can be used to offset ordinary income. Of course, some investors who have been stung by the volatility of tech-heavy funds may conclude they didn't belong in the sector to begin with, and they might want to move elsewhere. [But it still makes sense to sell] The thornier timing issue is this: When exactly do you sell Tech Fund A, and when do you buy Tech Fund B? If you instruct a brokerage firm to shift your dollars from one fund to the other today, for instance, you will typically be selling Tech Fund A at Friday's closing price and buying Tech Fund B at Monday's closing price. That one-day gap could be a 5% swing in the market, or even more. One option: Use margin or cash in the account to buy and sell on the same day. One interesting option is selling a fund at a loss in one's taxable account and simultaneously invest in that fund through an IRA [a tactic that the IRS sometimes disapproves, sometimes not]. More trouble for the Nasdaq? 'We are starting to get information on technology fundamentals that are coming in well below expectations,' said Douglas Cliggott, a stock market strategist for JP Morgan, pointing to a slowdown in the rate of growth in factory orders for communications equipment and to the warning by Motorola that profits from cellular telephone handsets will be disappointing. 'Here you have a product that is becoming ubiquitous,' Mr. Cliggott said, 'and yet a leading company is having trouble.' But even with the latest decline, the Nasdaq is still trading above where it was as recently as Jan. 6, little more than three months ago. By contrast, in most previous bear markets, a 20% decline cut prices to their lowest level in at least a year. Since the Nasdaq market was established in 1971, there have been just nine bear markets. The most recent one, a 29.6% drop in 1998, had set the record for the fastest fall as the index took just 30 trading days to drop 20%. The latest fall took 23 trading days. Even with the recent decline, the Nasdaq composite is up 45% from its level exactly one year ago, while the Dow is up less than 8%. First Tennessee Capital Markets economist Chris Low calculates the Nasdaq's retrenchment alone has erased about $1 billion of wealth - a reduction he is certain will affect consumer spending. [Yes, but substract out Bill Gate's recent losses and the number ain't so big.] 'If stock-market wealth creation added 1% to GDP growth last year, which is the Fed's estimate, then stock market wealth destruction this year will take away that 1% plus, say, another quarter (percentage point),' Low says. But it probably isn't enough restraint for the fed. [From William Pesek, Barrons 4-10 - The Wilshire 5000, the broadest measure of the US stock market and one preferred by Greenspan, is still up for the year. So, while there's been lots of churning between New Economy and Old Economy stocks, there's been little change in overall wealth.] [NYT 4-16: The Nasdaq has fallen 34% from its March 10 high, but the broader Wilshire 5000 index is down only 15.4% from its peak of March 24.] Fed Board Governor Laurence Meyer argues that financial conditions are still too stimulative. His latest speech mentions the need to find an 'equilibrium' interest rate that balances investment and thrift, and it implies that the current level of market rates is below that equilibrium level. It could get worse before it gets better. That was the sentiment among shaken Wall Street professionals Wednesday after another technology-sector blood bath sent the Nasdaq composite index squarely into bear-market territory. Surveys of investor optimism last week suggested that many people remained stubbornly bullish--a classic "contrarian" sign that the market was primed for a steeper fall. A regular survey of investment newsletter writers nationwide showed bullishness hit a 10-month high last week, according to Investors Intelligence.
Late last month, the US Treasury released data showing that investors in euroland countries had bought, net of sales, a record of nearly $6 billion of U.S. stocks in December, bringing the 1999 total to $36 billion, up from $30 billion in 1998. Even the unexpected disparity between the Canadian and Australian dollars was possibly caused by the fact that Canada has more tech and telecom companies. About 48% of Canada's stock market value is tech and telecom, compared with 23% in Australia and 50%. Bernstein found the relationship held across other major currencies. Apparently, the fewer opportunities there were to invest in tech stocks at home, the more likely investors were to buy dollars to buy U.S. techs. Of 24 currencies, three rose against the dollar the first three months of 2000. Two of those countries have larger portions of their markets in tech, Taiwan and South Korea. The third is Mexico [helped by the rise in oil prices?]. Ironically, Bernstein says the quicker the fall in US tech stocks, the better it could be for the dollar. Why? Because a tech-stock rout here would clobber markets around the world, triggering a flight to the safety of US Treasuries. The table below shows a list of countries, the percentage of their stock markets in tech and telecom stocks, and the performance of their currencies vs the dollar.
Global investors continue to pile into US markets, irrespective of the Fed outlook. In local currency terms, the US bond market topped all major bond markets last quarter. This is an unusual feat, notes James Bianco of Bianco Research. The last time the U.S. was the best-performing bond market was in the second quarter of 1998. Before that, the U.S. led the pack only in the third quarter of 1992, the fourth quarter of 1989 and for a time in 1986. When it comes to things investors care most about -- solid returns on capital, currency stability and liquidity -- one still is hard-pressed to beat America.
A survey of British motorists not long ago revealed that 95% thought they were better-than-average drivers. Similarly, most people think they are likely to live longer than the mean. In a classic 1977 paper in the Journal of Experimental Psychology, Baruch Fischhoff, Paul Slovic, and Sarah Lichtenstein reported that people often pronounce themselves absolutely certain of beliefs that are untrue. Subjects would declare themselves 100% sure that, say, the potato originated in Ireland, when it actually came from Peru. Overconfidence is nearly universal. In fact, a study some years ago found that the only group of people free from it--the only group with a realistic view of their own capacities--were the clinically depressed. One survey late last year showed that the typical investor expected the stock market to gain an average 19% a year for the next decade, a figure that is in line with recent experience but far larger than long-term growth of the economy is likely to support. Investors who held such expectations could have felt less need to save, since they thought their investments were likely to keep rising.
GSE's purchase home loans from originators such as banks, thrifts and mortgage bankers, which the agencies hold for their own investment portfolios. Those assets are funded by the GSEs' huge credit-market borrowings. Alternatively, instead of holding loans on their own balance sheets, home loans also are pooled into mortgage-backed securities. Whether the agencies buy mortgages for their own portfolios or those loans are packed as mortgage-backed securities, the effect is the same. Cash is freed up for mortgage originators to make new loans. The Treasury thinks the $1.4 trillion federal-agency market could double in size to $3 trillion by 2005 and surpass Treasury debt in three years. The Bond Market Association says gross agency debt issuance rose 11.5% in 1999, totaling over $7 trillion, up from $6.3 trillion in 1998. Much of the total was short-term borrowing, which means it is rolled over in a matter of days or weeks [which explains the discrepancy between Treasury and BMA numbers]. [From Caroline Baum 4-11: With Fannie's and Freddie's portfolios growing faster than the residential mortgage market itself, they are being forced to go `down market' in their purchases, buying subprime, home equity and multifamily loans.] But efforts afoot on Capitol Hill could restrain the amount of credit created by the GSEs, something that could potentially do more to restrict credit than could even the putatively all-powerful central bank. Interest is growing in Congress to curb the GSE' multibillion-dollar lines of credit to the government. Those credit lines are the clearest manifestation of the implicit government backing for these agencies' securities that the market perceives -- a perception that both Congress and the Clinton Administration want to disabuse. Thanks to benefits such as an $8.5 billion line of credit to the Treasury -- an emergency facility never tapped but of great symbolic importance -- Fannie Mae, Freddie Mac and the Home Loan banks traditionally have been able to borrow at rates close to Uncle Sam's. Any change in GSEs' relationship with Uncle Sam or limits to the amount of agency debt banks can hold could boost the agencies' borrowing costs, notes Jim Somers, portfolio manager at Martindale Andres. That would curb their incentives to expand balance sheets, which would crimp their earnings. Without an implicit government guarantee, overseas investors -- who have increasingly been buying agency securities rather than Treasuries -- may be less comfortable buying GSEs. But some argue that the GSEs would be just fine without a perceived government guarantee. 'They would be strong credit on their own and they really have become too big to fail,' asserts former Treasury official Michael Basham. Such perceptions allow the GSEs to expand credit seemingly without limit. The Treasury, meanwhile, wants Congress to limit how much agency debt commercial banks can buy. Those purchases of securities expand the balance sheets both of banks and thrifts and of the agencies themselves, which help to fuel the growth of mortgage money and the availability of credit throughout the system. While banks usually can't hold more than 10% of their capital in the debt of a private borrower, no limits apply to the debt of GSEs. Neither are banks required to hold capital reserves against agency securities. Moreover, they can massively leverage their holdings of government securities, which include these agency obligations, by borrowings in the repurchase-agreement market. A recent American Enterprise Institute study warned that the "uncontrolled growth" of Fannie Mae and Freddie Mac could amount to a nationalization of the residential mortgage business, leaving taxpayers holding the bag. [From Caroline Baum 4-11: Tax policy types and economists across party lines want to rein in the proliferation of government guarantees and subsidies says a former Reagan Administration Treasury official. This insight came as something of a surprise to me since the Clinton Treasury Department, whose lines are often blurred with the IMF, seems to have plenty of money to insulate the taxpayer from his exposure to bad investments in Asia, Russia and Latin America -- anyplace, in fact, that doesn't have a US address.] According to Tom Gallagher, Washington analyst for the ISI Group, banks hold GSE debt equal to one-third of their capital. Were any of the GSEs to face a failure, the government would face the "untenable choice" of bailing out the agency or seeing a contraction in bank lending. Lessening the banking system's exposure to GSE debt would be a "sensible policy response," he writes. These proposals may not go anywhere. In an election year, no politician wants to be seen working against affordable housing. Recent developments in Washington have put additional upward pressure on mortgage rates. Congressional leaders are considering legislation that would make it more explicit that Fannie Mae and Freddie Mac do not enjoy the backing of the federal government. The threat of legislation or some other governmental action, in turn, has helped keep prices of mortgage-backed securities lower - and yields higher. The spread between 10-year Treasurys and mortgage rates has widened. Currently, mortgage rates are priced more than 2.3 percentage points higher than Treasury yields, up from a spread of about 1.7 at the beginning of the year. In normal times, the spread is usually only about 1.6 percentage points, according to Freddie Mac. But some observers believe that banks aren't lowering rates as much as they could because the real-estate market is so hot -- and the supply of available homes is so small. GSEs got a boost [last week] from reports that big players like Pimco were switching from Treasuries to agencies. Many market participants remain reluctant to load up on agencies. And Friday's flight to the quality of Treasuries prompted some agency-debt holders to jump back into the government sector. But Andrew Brenner of Fimat USA argues that some perspective is needed. In 20 years on Wall Street, he's seen three agency market blowups; the Farm Credit System crisis of the mid-'Eighties, the Orange County debacle of the mid-'Nineties (leveraged firms liquidated huge blocks of agencies), and the current bout of volatility. In both previous instances, spreads, which widened sharply, reverted to original levels over time. If the past is any guide, investors betting on huge declines in GSE debt prices may find themselves on the wrong side of the market.
The federal income tax should take an average of 11.1 cents out of every $1 US households would otherwise keep, according to estimates recently issued by the CBO. But after analysts throw in the cost of excise, payroll and corporate income levies (the last-named paid indirectly by wealthier Americans), the tally comes to 24.2 cents on the dollar. (Even that omits small items like estate and import taxes and the substantial bite from states and localities.) This compares with a total federal tax bite of 23.4 cents on the dollar in 1979, when rates on personal income were far higher. The rate structure is somewhat more progressive than in '79, given the one dramatic shift that has occurred: The increasingly generous Earned Income Tax Credit has nearly halved the burden of the poorest one-fifth of America's population. In terms of the total burden, for 1999 the wealthiest 1% paid 34.4 cents on the dollar, the middle fifth, 18.9 cents on the dollar, and the poorest fifth, 4.6 cents. The top 1% pay an astonishing 21% of all federal taxes, up from 16% in 1979, mainly because their share of the national income has risen over this period. And today, nearly half the federal take is accounted for by the most well-heeled 10%. (Gene Epstein, Barrons 4-17) Greed is the driving force of every mania. As investors see others winning in the stock market or at some other game, the desire to get in becomes overwhelming. Stock valuation rules people held dear just months earlier can quickly become compromised, or rationalized away. As Charles Kindleberger wrote in his 1978 book "Manias, Panics and Crashes: A History of Financial Crises," 'As a boom progresses and greed mounts, excuses become thinner.' (Tom Petruno, LA Times 4-17) A 20% stock-market drop, by itself, does not constitute a bear market. It may look like one, it may hurt like one. But it lacks one ingredient: Time. Barron's Dictionary of Finance terms a bear market a 'prolonged period of falling prices.' Investment and Wall Street Words by David Scott mandates 'an extended period of general price declines' for the bear to exit hibernation. Note, too, the use of the term 'general price declines.' If the Nasdaq falls 20%, but the Dow was only 6% off and the Wilshire 5000 was off only 13%, terming the market a bear would not be appropriate. (Greg Heberlein, Seattle Times 4-16) More than $2 trillion in investor wealth got vaporized last week. (Gretchen Morgenson, NY Times and Stephen Dunphy, Seattle Times 4-16) Those who rely exclusively on the advice of anyone, including newspaper columnists, are guaranteed to wind up with a small fortune -- if they started with a large one. (Jim Barlow, Hou Chronicle 4-14) Men and women chose the same top three Internet shopping sites -- Amazon, barnesandnoble and CDnow [which I use, like, and hope survives it recent troubles] -- but then diverged sharply on their favorites after that, says Ernst & Young, which surveyed 1,200 consumers who had each made at least three Web purchases last year. (WSJ 4-14) Confectioners know it takes as many as seven days to "cure" a jelly bean. Now they have a scientific explanation of why, thanks to researchers at Penn State, who studied jelly beans in a MRI machine. Conventional wisdom held that much of the "aging" time was needed to let the sugar shell dry and harden after the jelly centers were set. (The centers take a couple of days, too.) The MRI showed gradual movement of moisture from the shell back to the core. (WSJ 4-14)
It cost the Allies $36,485 to kill a German soldier in WW1, whereas Germany could kill a British soldier for $11,344. So why did Germany lose the war? (London Telegraph 4-X, in a review of 'Arts and Letter Daily', which referenced an artilce of 12-99 in The New Criterion in a book review of Niall FergusonĖs The Pity of War. Ferguson's answer to the above question: The German generals gave up too early, and it may have been an error to give up at all.) Margin calls are based on the status of an entire account rather than an individual stock. Big, blue-chip technology issues had held up relatively well last week, protecting some investors from margin calls after a plunge in their smaller, more speculative holdings. But now the tech blue chips also are tumbling, which means forced selling could snowball. (Walter Hamilton, LA Times 4-13) Stock traders can make a so-called 475(f) election, which allows them to claim unrealized gains and losses. If you have an investment that dropped in value from $5,000 to $2,000 by year end, you treat it as if you sold the stock and you can deduct the $3,000 loss even if you didn't sell. Gains would be subject to regular income-tax rates. To make this election for 2000, you must attach a letter with your tax return. (WSJ 4-12) By economic region, the IMF projected annual rates of real GDP growth for 2000 and 2001 were as follows: US -- 4.3% and 3%; Japan -- 0.9% and 1.8%; the Europe -- 3.2% and 3.2%; Asia's newly industrialized countries -- 6.6% and 6.1%; Latin America -- 4% and 4.75; China -- 7% and 6.5%; and India -- 6.3% and 6.1%. A slumping world economy curbed profitability in 1998. Rising world expenditures ought to boost profitability in 2000. As foreign economies quicken amid the US' huge current account deficit, the dollar exchange rate should weaken, which would be to the near-term benefit of US corporate earnings. A still rising rate of expenditures growth globally means that the purchasing managers' index of prices paid has yet to peak in the US or Europe. A steadily rising rate of global capacity utilization should eventually add to inflation risks. (John Lonski, Moody's 4-12) Less unemployment and rising consumer confidence suggest that the real consumer spending of the EU-15 should improve on 1999's decent annual advance of 2.8%. The EU-15's consumer confidence index for March was 0 (meaning the number of Europeans holding a positive assessment of the economic climate matched those having a negative outlook). The EU-15's consumer confidence index averaged a -2 for all of 1999, which was its highest annual average ever. The annual average of the EU-15's consumer confidence index bottomed at 1993's -25. During the 15 years-ended 1999, the EU-15's consumer confidence index averaged a -15. If European consumer confidence sets new record highs, European household expenditures might exhibit surprising vigor. Perhaps the 2.2% average annual rise by the EU-15's real consumer spending of the past 15 years will begin to approach the accompanying 4% average annualized advance of the US' real consumer spending. (John Lonski, Moody's 4-12) Microsoft makes up 3.8% of the Dow, 3.5% of the S&P and 8.1% of the Nasdaq. Intel makes up 5.8% of the Dow, 3.4% of the S&P, and 7.9% of the Nasdaq. The Nasdaq Composite Index contains 4,728 stocks. Contrary to myth, it is not a small-stock index. Cisco Systems alone represents 9% of the Nasdaq Composite. Add Microsoft and Intel, and you have quarter of the index; the other 4,725 stocks make up the remaining three quarters. (John Dorfman, Bloomberg 4-11) Shayne Kahn was an executive recruiter with Objective Solutions International, New York, from 1996 to 1998, when she and OSI President Steven Wolfe became involved in a consensual, sexual relationship. Mr. Wolfe's wife found out, and he fired Ms. Kahn, who said he told her that if he couldn't be intimate with her, he no longer wanted her around. She sued for sexual harassment. U.S. District Judge Robert Sweet dismissed the charges last month, ruling that Mr. Wolfe's actions weren't quid pro quo harassment, a test the courts use in such cases. The law protects workers "from being harassed or coerced by unwelcome sexual advances," the judge wrote. But "no matter how unpleasant," Ms. Kahn's firing after a consensual affair wasn't a hostile work environment under the law. (WSJ 4-11) Net inflows into mutual funds last year totaled $171 billion, down precipitously from $310 billion in 1998 and $327 billion in 1997, according to ICI. Investors arealso redeeming more shares. Overall redemptions climbed 38% in 1999, outpacing the 22% rise in gross new sales, says Financial Research Corp. (WSJ 4-10) Bob Farrell of Merrill Lynch points out that investors poured an unprecedented $100 billion into equity funds in the first quarter, mostly into aggressive tech growth funds. Buoyed by that humongous infusion of cash, the prices of tech stocks logically should have climbed, not declined. The reason they didn't, he suggests, is that demand was simply overwhelmed by a rapid expansion of the supply. Bob is absolutely convinced the excesses in the speculative techs were much too great to be purged in three weeks. In other words, he thinks the painful process set in motion last month and gunned up last week is destined to continue until the froth is fully blown away. The only question is whether it happens in a hurry or drags drearily on. (Alan Abelson, Barrons 4-10) Talk of leveraged buyouts and stock buybacks might cheer shareholders of beaten-down companies, but they can send a chill down the spines of bondholders. A battered stock price could prompt a company to buy back some of the shares if they think the stock is undervalued. This usually involves borrowing money, meaning a bigger debt burden for the company and lower credit ratings, which erodes the value of existing bonds. Six companies received ratings downgrades in Q1 in part due to equity buybacks, twice the number in the preceding two quarters, according to John Lonski. (Bloomberg 4-10)
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