The bull market is still alive – recent decline in stock prices may be a good buying opportunity

Posted by Shyam Moondra

In the last several trading sessions, the stock prices have come under pressure because of the fear that Europe’s economy may be slowing down. Also, there are some investors who believe that the market is ripe for a correction simply because it has been going up since it bottomed out in 2009 at the height of the financial crisis. While it is true that recent data from Germany and elsewhere in Europe suggests that the EU economy may be cooling off but there are no signs of an impending recession. In fact, in recent months, dollar has strengthened considerably relative to other world currencies which should help EU and Asia, especially Japan, grow their exports of goods and services to the U.S.

The great bull market of the last few years is not over yet. The 4.6% decline in DJIA (5.6% in S&P 500 and 7.25% in NASDAQ) from its record high is due to normal profit taking and is healthy for the bull market to keep charging ahead. The market peak is generally indicated when stock prices go up sharply several days in a row with heavy volume and there is “irrational exuberance” among the investors. However, that is not the case here; the market has been going up for the last several years at a steady pace with relatively low-to-moderate volume.

The latest economic reports on unemployment, retail sales, consumer confidence, and inventory accumulation by manufacturers do not point to an impending recession in the U.S. and, as such, any talk of the bull market running out of steam is pre-matured.

Below are a wide range of indicators that suggest that the economy is likely to continue to grow and the stock market is likely to continue its bull run for the foreseeable future. Therefore, the current decline in stock prices afford an excellent buying opportunity for long-term investors.

·      Inflation continues to be very low. Strong dollar will make imports cheaper and thus help keep a lid on the prices in the U.S.

·      Interest rates will go up but they will still be much lower than the historic rates. The Federal Reserve Board has reaffirmed that they will continue with expansive monetary policies at least for now. Most economists expect that the Fed would not start increasing interest rates until the summer of 2015.  

·      The job market continues to get stronger with the unemployment rate declining to 5.9%. The FED expects further gains in the job market in the coming months.

·      The US oil and natural gas production is steadily increasing, which is not only creating new jobs but also helping push the energy prices lower. Citigroup has estimated that the recent decline in oil prices would save energy-intensive industries and consumers to the tune of $1 trillion, which will act like stimulus to the global economy.

·      The consumer confidence and spending remain at high levels. The recent decline in oil and gasoline prices will put a few extra dollars in the consumers’ pockets which will help keep economic activity in high gear. Also, the consumer debt, which is much lower than in 2009, has room for further expansion.

·      The corporate balance sheets are the strongest in decades with a cash hoard of close to $4 trillion. The CEOs of large companies have generally expressed optimism for the U.S. economy in the foreseeable future.

·      The current stock valuations are not excessive. The WSJ estimates the forward PEs as follows: 14.73 for DJIA, 15.85 for S&P 500, and 18.41 for NASDAQ; these ratios are nowhere near what they were at the market peaks of 2001 (when PEs were in 30’s) and in 2007 (when PEs were in 20’s). Last week, Alcoa and Pepsi reported their 3Q14 earning reports and they both beat analyst estimates which augurs well for the current earnings season. If other companies report just as good earnings in the coming days, the market could get a big boost and head to new record highs.

·      The federal budget deficit has been declining faster than expected, which will help keep interest rates lower. In any case, the Congress needs to do its part and reform the tax code and undertake meaningful spending cuts to put the financial house of the federal government in order, just as most state governments have done already.

Banks (with increasing loan demand and widening interest spread), defense contractors (with crises in Ukraine and the Middle East forcing countries to increase their defense outlays worldwide), technology companies such as GOOG and PCLN (that got hit hard in this decline), and specialty chemical companies (that are benefiting from the recent decline in crude oil prices), could see their stocks bounce back strongly.

A few days ago, Warren Buffett said he was “buying.” Who would want to argue with that?

Disclosure: The blogger is long on the stocks/sectors mentioned.

Over-regulation of banks and coerced multi-billion dollar settlements orchestrated by government are hindering economic growth

Posted by Shyam Moondra



During the presidency of George W. Bush, lax regulations of the financial sector and lack of monitoring of the housing bubble formed under the stewardship of Alan Greenspan, former Chairman of the Federal Reserve Board (FRB), finally culminated into credit freeze and a full blown financial crisis that led to the demise of prominent financial institutions such as Lehman Brothers. The financial meltdown of 2008 led to severe recession with double-digit unemployment rate, bursting of the housing bubble with downward spiral of home sales and prices, and crash of the financial markets. The bank bailout program (TARP), initially proposed by Bush and implemented by the incoming President Barack Obama, and tougher regulations of mortgage-based securities and sub-prime mortgage lending, initiated by the incoming Fed Chairman Ben Bernanke, led to unprecedented tighter controls of the too-big-to-fail banks. The new bank regulations now require all major banks to go through the so-called stress tests conducted annually by the FRB to ensure that the banks have enough capital to survive systemic failures within the financial system. In 2010, the Congress passed the laws giving FRB and other regulators expanded authority that covered origination of mortgages, credit- and debit-card payments, ban on proprietary trading done with the depositors' money, capital structure, consumer complaint bureau, and literally dozens of other changes. Banks are now required to get approval from the government before they could return capital to shareholders via dividends and share buyback programs.

More recently, the U.S. Justice Department, State Attorney Generals, and other bank regulators have also been aggressively going after major banks in courts and suing them for their role in precipitating the 2008 financial crisis and collecting billions of dollars in punitive settlements. The government officials, while taking  a cue from the Occupy Wall Street protesters, have acted to punish banks via criminal charges and otherwise ruin their reputation, supposedly reflecting the will of the people. There has been no restraint on the part of government officials because they know that the people hate banks and that unpopular banks are afraid to fight the cases in the court fearing that they would lose. Theoretically, if they lose the criminal cases in the courts, they could lose their charters and be put out of business. In the absence of any force to restrain their actions, the regulators have slipped into this mindset that they can do pretty much anything they want to do to punish the banks.

From Bush to Obama and from Greenspan to Bernanke, the pendulum of our financial regulatory regime has dramatically moved from one extreme (lax regulation) to the other (over-regulation).

In the aftermath of the financial crisis of 2008, the Congress hastily enacted some of the extreme regulations out of panic to avoid the repeat of the depression of the 1930’s. Also, Bernanke deployed unprecedented approaches to provide financial stimulus to economy through the so-called Quantitative Easing (QE) programs and near-zero interest rates to revitalize the housing market and to induce investors to start taking risk again. To some extent, Bernanke was forced to aggressively pursue expansive monetary policy (in spite of fears of increasing inflationary expectations) because of the unbridgeable ideological differences between the Democrat-controlled Senate and the Republican-controlled House that prevented them to agree on any meaningful fiscal stimulus. The FRB's policies did help improve the housing and financial markets and bring down the unemployment rate from over 10% to 6.3% (most of the job gains, however, has been in the low-wage retail sector while high-paying manufacturing jobs have been lagging). The recovery from the great recession, however, has been painfully slow and the GDP growth has mostly stuck in a moderate 2 – 2.5% range, which is uncharacteristically lower than in the recoveries from the past recessions. It is now becoming clear to some lawmakers that over-regulation of banks is one of the primary reasons for slow recovery, aside from political gridlock in Washington, DC that prevented timely decisions on fiscal stimulus, tax reforms, and reduction of federal budget deficit and debt.

Below are some examples of how over-regulation of banks is negatively affecting economy:

·       Regulations have become too complex, which has increased the cost of compliance by billions of dollars that banks are forced to pass on to the consumers in the form of higher fees for services and higher interest rates on credit cards and loans. Also, complex regulations are making banks commit honest mistakes in financial reporting that negatively affect their stock prices. Recently, Bank of America found an unintentional error in how they calculated capital ratios in their filing to FRB and that news alone crashed its stock by over 7% hurting many middle-class families who owned the stock.

·       Banks are now required to submit their annual capital plans to the regulators as part of the stress tests. If a bank fails the test, the news headline can crash its stock, as was the case with Citigroup this year. The FRB’s stress tests involve some subjectivity and, therefore, it’s hard for any bank to know with confidence if it will pass the test. In case of Citigroup, which was supremely confident that they will pass the test, the FRB made different assumptions regarding the bank’s risk factors in markets outside the U.S. and that resulted in FRB giving Citigroup a failing mark. The FRB decision practically killed Citigroup’s plan to increase dividend to shareholders this year and that crashed its stock. In a free-market economy, the FRB making decisions on whether a bank can increase dividend or buy back their company shares is unprecedented and unsustainable. The government intrusion in making these kinds of micro decisions based on subjective evaluation of risk factors is way too heavy-handed and unnecessary. These intrusive regulations have made banks overly conservative in their lending standards to ensure that their risk profile would be acceptable to the regulators. Lack of easy capital availability hurts small businesses, potential home buyers, and home owners who would like to take advantage of low interest rates and refinance their mortgage loans. The jumbo mortgage loans are hard to come by, even in the face of increasing demand for such loans. The cautious stance by banks, prompted by over-regulation, has reduced the velocity of money exchanging hands throughout the economy, making it harder for the economy to grow faster. If we didn't have many of these regulations, we would have already seen GDP growing at 4% or higher rates.

The Congress should hold hearings and look at all regulations that have been enacted since the financial meltdown including the radically expanded role of the FRB. The goal should be to simplify regulations and make them less intrusive so the banks would become a little more aggressive in lending which will fuel growth and create jobs faster. Also, DOJ and other regulators should pull back from their aggressive posture in filing law suits against banks that are making them overly cautious in lending and extremely conservative in risk taking. In 2008, banks were part of the problem, but now they are part of the solution; without banks' increased risk taking and lending, we cannot achieve higher growth rates that are necessary to reduce unemployment and increase wages.

Indian Elections: Abslolute majority by pro-business party is a game changer

Posted by Shyam Moondra


The largest democratic election in the world showed how India’s political system has matured since it won independence from the British rule in 1947. The final vote count reveals that for the first time in the last 30 years, a single political party (the BJP) has won an absolute majority in the Lok Sabha, the lower house of India’s parliamentary system. The BJP’s leader, Narendra Modi, is slated to be sworn in as the next Prime Minister of India. The Congress Party, which has dominated Indian politics for the last six decades, stumbled badly and won only 44 seats out of 543 seats; Congress' incumbent leader, Manmohan Singh, promptly resigned as the Prime Minister.

Modi, who has served as the Chief Minister of Gujarat state for 12 years, has developed a reputation of a no-nonsense honest politician in hurry to modernize his home state by liberalizing licensing policies and streamlining bureaucratic procedures for businesses that wanted to set up new factories and create jobs. His election at the national level has obviously created high expectations, as is evident from the fact that the news of the BJP’s victory propelled the Indian stock market to record high and strengthened Rupee against all major world currencies.

Now the talk of the town is if Modi would be able to accomplish at the national level what he accomplished at the state level. He is described as a decisive and strong leader, who would push through his pro-business programs in the parliament. His Hindu nationalistic credentials make certain parts of the population uneasy (e.g., the Muslims), but his pro-growth economic policies trump that fear because even minorities want more high paying jobs for their children and grand children.

The initial excitement about the election results is over and all eyes are now focused on who Modi will pick as ministers in his cabinet and what specific goals he will set for his administration. Below is a 10-point plan that Modi might consider:

1.   Corruption: It's too deeply rooted at all levels of government and it is holding the country back. Modi has the reputation of being an honest politician – the hope is that his first task would be to clean up the government.

2.   Infrastructure: India has made big strides in improving roads, highways, bridges, power distribution, water resources, airports, marine ports and terminals, and telecommunications and high-speed Internet networks. However, much more needs to be done. Railway system is a relic of the British Raj – India needs a complete overhaul of the railway system that includes high-speed trains. Modi apparently has a plan to build bullet train system modeled after that of Japan.

3.   Free-market Economy: Indian bureaucracy is legendary in terms of how long it takes to approve a new project. Modi's success in the state of Gujarat was primarily because of his streamlined licensing procedures; he got the government out of the way of businesses. Modi needs to do the same at the national level.
 

4.   Capital Investment: Modi must urgently loosen up controls and make the business environment more attractive to foreign investors and companies. India is a vast country with a huge population and accelerated capital and technology inflow will help speed up the pace of modernization in energy, manufacturing (which is lagging far behind that of other Asian giants), defense, health care, and other industries.
 

5.   Defense: India is far behind in terms of military capabilities compared to other major countries such as China that has several border disputes with India. India must modernize army, air force, and navy. Expanding the military footprint and acquiring modern military assets are essential to deter aggressive designs by China and other countries.
 

6.   Religious and Ethnic Tolerance: Modi must immediately dispel any doubts that he is anti-Muslim or anti-Buddhist or anti-Christian. Modi must reject intolerance and find a way to leverage the strength of diversity to accelerate economic growth, just as the U.S. has done. A united India is a strong India. Also, Modi must do more for women equality and have tougher laws against rape.
 

7.   Rural Modernization: While cities are bustling with all modern amenities, the rural India is still far behind and needs a crash program to speed up modernization there. Deploy the newest agricultural technologies and train farmers to increase the crop output, make electricity and running water available in each village, provide more robust transportation system for local travel, and build adequate health care facilities and schools.
 

8.   Pollution and Climate Change: Pollution is a major health hazard in India. India needs a separate Department, similar to the Environmental Protection Agency we have here, to make big progress in reducing pollution and controlling carbon monoxide emissions from coal-fired plants.
 

9.   Foreign Affairs: India must resolve the Kashmir issue with Pakistan (accept LOC as the final border) and allow free flow of people and trade between the two halves controlled by India and Pakistan. India needs to be more assertive on the world stage and assume its rightful place as a major power backed up by strong military. India needs to form regional alliances and lead them. If India wants to be recognized as a major economic and military power, India must act and behave like one. India needs to become a more active player at the UN and double up its efforts to become the permanent member of the U.N. Security Council.
 

10. India, as an ancient civilization, has rich cultural heritage that portrays its character. Modi needs to put the government behind public and private efforts to preserve, expand, and cultivate all art forms.

Modi's decisive victory in the general elections affords him and the country an extraordinary opportunity to improve business climate and accelerate economic growth, and ultimately become a great power that once it was centuries ago.  

Could Putin’s easy victory in Crimea end up badly for the Russian people?

Posted by Shyam Moondra

Russia’s President Vladimir Putin silently watched the Winter Olympic Games in Sochi, Russia, while the Ukrainian Spring Revolution was in full swing in Kiev with dozens of unarmed protesters shot dead by the militia controlled by the former pro-Russia Ukrainian President Viktor Yanukovych, who abandoned his presidential palace and took refuge in Russia. As soon as the Olympic Games ended, Putin made his move and quickly took over the tiny piece of land at the southern tip of Ukraine, Crimea, where Russia operates a navy base leased from Ukraine. Russians were elated and Putin’s popularity soared because he managed to win Crimea without firing a shot. In 2008, Putin ordered the invasion of Georgia that was aspiring to become a member of NATO; even today, Russia still occupies two separatist territories of Georgia, in spite of the agreement that called for the withdrawal of Russian forces from there. Many Russians thought Putin outsmarted President Barack Obama and the EU leaders, restoring their pride which was lost after the collapse of the former Soviet Union. Defying loud condemnation of the West, Russia lost no time in annexing Ukraine's Crimean Peninsula after residents there voted overwhelmingly to join Russia. The move came despite warnings by the West that Crimea annexation violated international law and would be ignored by the world.

Now what? The West is talking about more punitive sanctions (military action has been ruled out by Obama and the EU) and Putin is promising reciprocal retaliation. Today, Obama announced the second round of sanctions of visa ban and asset freeze against more Russians (including Putin's personal banker) and one Russian bank. Within minutes, Putin announced entry bans on prominent American politicians including House Speaker John Boehner and Sen. John McCain (R-AZ), who often characterized Putin as a “thug” and “dictator.” Obama said that if Russia escalates the Crimean crisis any further, he would announce harsher economic sanctions that would harm the Russian economy. The Russian currency ruble and the stock market have already declined sharply since the conflict began two weeks ago. Russians now face a real possibility of recession, higher unemployment, and hyper-inflation in the near-future which would dash Putin’s hope of making Russia a modern technology hub and moving economy beyond just supplying oil and natural gas.

Below is a synopsis of how a series of issues could evolve in the absence of de-escalation of the crisis:

• Putin has announced that he might retaliate by freezing assets of the Western corporations doing business in Russia. It could mean substantial losses for companies like Exxon-Mobil and Pepsi, but those losses would be negligible compared to the size of the overall economies of the Western countries and thus strategically insignificant. Such asset freezes, however, could back-fire on Russia because many Russians would instantly lose their jobs and Russian government would be deprived of the tax revenues from these companies. Also, companies like Exxon-Mobil are providing much needed new technologies for the energy sector; if the Russian operations of these companies are shut down, Putin will lose access to these transformative new technologies.

• Deputy Foreign Minister of Russia announced that Russia might withdraw its support for an agreement with Iran on the nuclear issue. It’s just a bluster because in the end Russia wants this agreement more than any other country. Iran is an Islamic country and Russia wouldn't want nuclear weapon capability in the hands of Iran that could one day be transferred to Muslims in Chechnya or Tatars in Crimea, in the same vein as Russia didn't want Islamic Syria to keep its chemical weapons.

• Russia’s invasion and subsequent annexation of Crimea have already caused a capital outflow of $45 billion in just two weeks. As the biting economic sanctions start to take hold, more and more investors would exit the risky Russian markets, causing even bigger capital outflow. The economists are already projecting recession, job losses, and declining tax revenues for the government. A sharp decline in the value of ruble would cause hyper-inflation, which could lead to lower living standard for the Russian people. If the West’s threatened trade sanctions are carried out, they would further deepen Russia’s economic woes. The rating agencies Standard & Poor and Fitch announced that Russia's rating outlook is being changed to "negative," which will (i) increase the borrowing costs for the government, businesses, and consumers, (ii) hasten the capital outflow, and (iii) further sink the ruble.

• Damaged economy and reduced tax receipts would mean Putin would have to cut back on his lofty goals of expanding and modernizing Russia’s military. Over a period of just few years, Russia will face declining defense capabilities.

• The U.S. and EU are expected to accelerate investment in oil/gas exploration, which will reduce the EU's dependence on Russia for their energy needs; this, in turn, would erode the Russian energy sector. As a result, Russia's oil and natural gas revenues would decline, exacerbating Russia's economic problems.

• Next week, Obama has called an emergency meeting of G-7 in The Hague to discuss the Crimean crisis and it is expected that Russia would be formally dropped from G-8 and it would go back to G-7. Russia would lose clout around the world because of the justified perception that Putin is a bully/thug and he is not a reliable partner.

While Russians, for now, are enjoying euphoria over their Crimean victory achieved without any bloodshed, this may very well be the beginning of the decline of Russia. Within a few years, we could see Russia with lower living standard, deteriorating infrastructure, and reduced defense capabilities.

Obama and Congressional Republicans need to change gears on economy

Posted by Shyam Moondra


The U.S. economy is chugging along in a slow growth mode, which has lowered the unemployment rate, albeit at snail's pace, but it has not really excited the consumer base nor made the corporate world feel confident enough to aggressively pursue capital expansion plans.

President Barack Obama has been and continues to be very focused on how to help the poor via welfare programs. It has been estimated that under Obama, the welfare cost has zoomed up to almost a trillion dollars a year that include food aid, disability benefits, social services, educational assistance, housing assistance, vocational training, medical assistance, energy and utility assistance, child care and development, etc. Many of these welfare programs are fraught with waste, fraud, and abuse and they are growing at an alarming rate which could worsen the budget deficit problem. While Obama’s focus on helping the poor is noble, the welfare state is just a band aid approach to dealing with the broader issues of unemployment or underemployment and poverty. The welfare programs, without an expanding economy, make the poor people permanently dependent on the government which is hardly an ideal outcome. This approach actually locks the poor people in perpetual poverty without any realistic hope to get out of the sink hole. What we need right now is to find a way to grow economy at a faster clip and create high-paying jobs, and at the same time train the chronically unemployed people to fill those jobs. If Obama doesn't shift his strategy, his presidency would be remembered for resurrecting the welfare state which President Bill Clinton worked so hard to dismantle, making it difficult for Democrats to keep the control of the U.S. Senate in 2014 and win the presidency in 2016. The prosperity during the Clinton presidency showed that good economic policies and not the welfare programs are the answer to lifting the poor out of poverty.

Obamacare, aside from the disastrous launch of the government health care exchanges, has been a net negative for Obama and the Congressional Democrats. Obamacare has brought about unintended consequences that have forced the government to put many aspects of Obamacare on hold, creating uncertainty and instilling fear among the middle class. While Obamacare has helped millions of the poor and uninsured to get subsidized health care insurance, it is actually hurting the middle class. Many big companies are unexpectedly discontinuing their traditional health care plans and switching to alternative plans in which they give a fixed amount to employees which they can use to buy their own insurance on the government or private exchanges. What that means is that the employees would bear a bigger burden of escalating health care costs in the future. The big businesses are using Obamacare as an excuse to protect themselves from the future higher health care costs. This unanticipated move by big employers would hurt the middle class, whose prosperity is essential to grow the economy faster.

In recent months, Republicans have been wise to lower their Tea Party inspired rhetoric and to be more willing to compromise on the key issues of budget and debt. Yesterday, the Republican-controlled House passed a clean bill to increase the debt ceiling, which will go a long way to repair their battered image after the last year’s government shutdown that outraged the public. Republicans need to do more to be viewed as a viable alternative to Democrats in the upcoming elections. They need to go one step further and proactively propose their own plans on how to grow economy and create high-paying jobs. Repealing Obamacare or delaying immigration reforms are not going to be received well by the electorate. As the FED's monetary stimulus winds down, it's incumbent upon the Congress to come up with a solid bi-partisan plan to stimulate the economy and put us on a path of sustained 4% GDP growth and achieve meaningful growth in personal income and consumer spending. The people desperately want the Congressional Republicans to move away from their right-wing ideologies and work with Obama and the Congressional Democrats to move swiftly on economy and not make the delusional political calculation that if economy worsens, they will be better positioned to win the Senate and the White House.

New initiatives on the economy could include the following:

• As the FED winds down monetary stimulus by tapering the QE 3 program, the Congress needs to undertake fiscal stimulus; for example, the Congress could authorize increased funding for repairing the crumbling infrastructure such as roads, highways, bridges, and tunnels. This investment could be financed by a special temporary tax on gasoline.
• It's time the Congress and Obama work out a compromise on long-term tax reforms and spending cuts that cover entitlement programs.
• As the new technologies change how the goods are produced and services delivered, many chronically unemployed workers need the government help in getting retrained for the jobs of the future. The government could give tax credits to corporations that train and hire unemployed or underemployed workers.
• Rather than trying to repeal Obamacare, the Congress should let the full implementation go forward, re-assess where we are, and then modify Obamacare to make it better and more effective. Given that the old system has been disrupted beyond recognition, it's a wishful thinking that the genie could be put back into the bottle. It would be sheer waste of time, if Republicans persisted in figuring out how to get rid of Obamacare.
• The Congress should put the work on bills related to pending Trade Agreements on a fast track that will create new jobs.
• It’s time the House takes up the Immigration bill already passed by the Senate.

As the mid-term Congressional elections of 2014 and the presidential election of 2016 approach nearer, the Republicans need to appear flexible and pragmatic and bent on solving people’s problems, as opposed to having the disastrous “do nothing” image. At the same time, the Democrats need to get away from this image of being focused on welfare programs that does absolutely nothing in achieving prosperity for all, including the middle-class. If both parties move closer to the center, where the most of the country is, one thing is certain – the upcoming election would be one of the most interesting and memorable elections of recent times.