What I See For Christmas

Hi Everyone,

Sorry for the delay in posting. I had spent three to four hours writing this post two weeks ago, but I accidentally deleted it from Blogger. I'm rewriting it from memory as there is no trace of the post; it's not in Google Cache or accessible through recent links. I now vow to always export my work to my solid state drive.
I had a programming competition last Saturday, so all my free time went to training. I'm also debating about making a Computer Science blog where I'd post my solutions to online programming problems. My code will be better commented and more readable then the other solutions posted online.

Bear Case: 

In my original post, I had described a red and black Christmas this year, and I wasn't foreshadowing my Christmas presents (I haven't been that naughty). I was talking about companies' earnings reports. I had come to that dismal conclusion from observing interest rate trends, unemployment rate numbers, reading reports about the FOMC, and trying to predict the role the Federal Government shut down would have on consumer spending.

Interest Rates: Federal Reserve Chairman Ben Bernanke enacted the agressive Quantitive Easing program a couple years ago to encourage consumer and business spending. Bernanke's plan called for the US Federal Reserve's purchase of $85 billion in US Bonds and Treasuries per month in order to keep interest rates low. Low interest rates encourage consumers to borrow to spend money and invest in businesses, and allows businesses to take loans to hire more workers and invest in other businesses. The interest rates, currently between 0% and 0.25%, have caused consumer and business spending to be at all time highs.
Consumers are spending more causing companies to get more revenue, and beat analyst opinions in their earnings estimates. This has caused stock prices to reach all time highs; beating estimates shows the company is profitable. As soon as the QE program declines/ends, the interest rates go up, spending comes down, and earnings go down with it. In a recent blog post, I also mentioned that Investor Credit/Margin trading (borrowing money to invest in stocks) was at an all time high.

The low interest rates have caused consumers to spend more money, causing businesses to post increases in revenue. The attractiveness of business growth invited consumers to invest money in a company through the stock market. As more people continue to invest, stock market prices increase. People realize the stock market is profitable, and borrow money so they can invest in the expensive stocks, jumping on the profit bandwagon. 

When interest rates increase, it becomes more expensive for consumers to borrow money to invest in stocks. This will cause them to sell of their investments, so that the increased interest rate doesn't kill their profits. Selling stocks will decrease stock prices, and cause other investors to sell their stocks.

The chart above shows that large investor debt/credit foreshadows a stock market crash. Borrowing (red) increases when stock prices (blue) increase. When the market begins to go down, borrowers rush to sell their holdings, as shown by the positive credit (green) that occurs right after a stock market crash.

Dismal Earnings Season: The US Federal Government shut down for 16 days in the beginning of October because a new budget for the October 2013 - October 2014 Fiscal Year had not been passed by Congress. The  2 Million + Federal Government employees went without pay and the Federal Government went for two weeks without spending any money (except for essentials like Food Stamps). In total, this was expected to cause the GDP to decrease by 0.7%. I also expected consumers to save their money in anticipation of the Government going over the National Debt Ceiling. With a government that spends $60 billion daily and only collects $30 billion daily, it is no surprise that we're reaching the new debt ceiling that Congress raised two years ago. If the US hits the debt ceiling, it will default on some of its payments ($30 billion to spend daily), either interest/yields on bonds, or government programs like Social Security and Benefits. Defaulting on the bond yields would cause the US debt rating to be increased, and cause investors to lose trust in its bonds. In the future, this the US would need to increase its bond yields in order to remain attractive to investors. 

I was expecting businesses and consumers to decrease their spending (Consumer Confidence Index decreased to 71 from 85 last month), causing a dismal earnings season as company revenue would decline.

I was also expecting businesses and consumers to begin saving their money for a future debt ceiling and government furlough/budget crisis that will arise early next year when the federal government begins to get close to the new debt ceiling.

Stock Market Overvalued: The increase in stock prices for the past four years can only be attributed to an increase in spending because of artificially low interest rates, not actual economic growth. 

This chart of the Price to Earnings Ratio show stocks have are expensive relative to 10 year average earnings. The ratio, popularized by Robert Shiller, is about 24, which is much higher then the long-term average of 16. Looking at it's history, this index is at it's highest during recessions. The 1929 high is the same time as the stock market crash that caused the Great Depression. The highs in 1966 were caused by the Cold War/Vietnam fear, in which spending crashed because of fear of getting nuked. The 2000 high was preceded by the stock market crash, and was also high in 2008. 

This chart created by the New York Stock Exchange compares the NYSE Margin Debt (money borrowed to pay for stocks) and the S&P 500 Growth shows that the gap is largest right before a recession. Right now, it's at a 150% difference, around the same difference as it was in October of 2007, two months before the stock market crash.

Simple addition shows that 48% of companies have reported actual sales below  estimated cells, which is lower then the average over the past four years (59% beat estimations). 

Earnings growth percentages are at high rates, and can not be sustained for that long. Once the growth begins to slow down, investors begin selling because the company is becoming less profitable. 

The Fiscal Cliff, An analysis of the situation

Note: For this analysis, I had to rely on secondary sources for quantitative data on the American economy, because the primary sources, the US Government surveys and websites, are closed due to the government shut-down.

Background:
By now, everyone in America should know about the upcoming Fiscal Cliff. America's government is spending $60 billion USD per day, and only raking in $30 billion per day from taxes and bonds. As a result, there is a $30 billion deficit per day. For the past 10 years, that deficit has been increasing steadily.
In 2011, the deficit reached the equivalent of America's GDP (roughly $15 trillion). The debt ceiling at that time was America's GDP. If America reached the debt ceiling, the government would default on all its payments. It would no longer be able to operate, or pay its hundreds of thousands of employees, or pay back bonds, or give out Social Security, Welfare, and Food Stamps. The only way to avoid defaulting on all the loans was to increase the debt ceiling, which Congress did at the very last minute. Because Congress waited until the last minute to increase the debt ceiling, investors panicked and the stock market tanked. The economy then went through a mini-recession, and America's credit rating was downgraded.

How the deficit got to this point: America's huge national deficit can be attributed to a variety of reasons. During the Bush administration, taxes and interest rates were decreased, while federal government spending increased to an all time high (nearly $1 billion per day spent just in Afghanistan/Iraq). Bush enacted those policies to encourage spending because the economy was still in a recession from the 2000 Financial Crisis. The Bush-era tax cuts lasted from 2003 to 2012, so for those 9 years, the government was getting more then 10% less in taxes then it got before the tax cuts. The Iraq war that began in 2001 and ended just last year required the federal government to spend nearly $1 billion per day to pay troops, and maintain equipment over seas. Bush also created a variety of new government programs which required a lot of federal funding, like the NSA, TSA, and the Department of Homeland security. During this time, America was spending a lot more then it was taking in from taxes. Obama is also responsible for some increase in the national deficit through his economic aid programs, and tax cuts for the poor.

Back to the present: America is expected to hit the new debt ceiling that was created in 2011 in the middle of October. Secretary of the Treasury Jack Lew expects the federal government to run out of money on October 17th, this Thursday. Similar to 2011, Congress knew that America was going to hit the debt ceiling months ago, but did not vote on any legislation to increase it, or decrease national spending. In addition to the debt ceiling crisis, Congress also has to deal with the Federal government shut down. The 2012-2013 Federal government Fiscal Year ended on September 31, 2013. The 2013-2014 Fiscal Year for the government started at 12AM on October 1st, 2013. But, Congress did not pass a 2013-2014 Fiscal Year Budget before the new Fiscal Year began, and still has not passed the new budget 14 days later. As a result, most Federal government programs are shut down, with the exception of defense/security, and Food Stamps/Welfare. For every week the Federal government is shut down, America's GDP is supposed to decrease by 15 points, because the government is no longer able to pay its hundreds of thousands of employees, or pay for its various programs.

The Cause: The Affordable Health Care Act/ObamaCare is most widely attributed to the cause of the government shut down and the delay in increasing the debt ceiling. The Affordable Health Care Act attempts to make HealthCare available for all Americans, despite their wealth and pre-exsisting conditions. It also attempts to make HealthCare mandatory for everyone (that's the only way a program this expensive can work) by fining those who do not sign up. The Act also imposes a higher tax on medical companies' profits, and attempts to decrease the cost of medicine. 
Republicans, who have a majority in the House of Representatives, do not want to pass the Affordable Health Care Act, because it charges the young, wealthy, and healthy more in order to compensate for the old, poor, and obese Americans. Republicans also believe that the Act is too expensive, and will raise the national deficit even more, which would cause an increase in taxes, which would damage the pace of America's recovering economy. The Affordable Health Care Act upsets Republicans because it makes the government the primary medical insurer, instead of private health insurance companies that compete against each other (free market/competition). Republicans will only pass a bill/act if it contains clauses that explicitly stop funding for ObamaCare/the Affordable Health Care Act until next year, when they plan to debate it more. 
Democrats, who have a majority in the Senate, support ObamaCare because it aligns with their principles of making health care available to everyone, especially the poor. Democrats refuse to pass any legislation that delays funding for ObamaCare.
Because financial bills/legislation must go through both the House of Representatives and Senate and get over 2/3rds vote, no legislation has been passed. The Federal Government's 2013-2014 Fiscal Year Budget was not passed because neither parties were satisfied with the wording of the budget. The Republicans wanted postponement of ObamaCare, the Democrats refused and voted against it. The same situation is happening to the debt ceiling, Democrats will not pass a Republicans bill that calls for an increase in the debt ceiling, and a postponement of the Affordable Health Care Act, and the Republicans will not settle for the Democrat's bill which calls for an increase in the debt ceiling, and no wording of postponement of the Act.

Bottom Line: America's Federal Government has been furloughed for the past 14 days, and no increase in the debt ceiling legislation has been passed because neither political party is willing to cede to the other.
The vast consensus is that hitting the debt ceiling is going to cause a devastating result, one that will cause a recession that makes the 2008 recession look pale in contrast.

Radical Republicans: Some radical Republicans are okay with America hitting the debt ceiling.
Some of those Republicans are die hard in their principles and would rather see America go into economic chaos then cede to the Affordable Health Care Act, which they believe is a violation of their freedom, and should have been ruled unconstitutional by the Supreme Court.
Other Republicans realize that increasing the debt ceiling is just going to be causing problems later down the road, so we might as well hit the debt ceiling now, because we're going to hit it eventually. Those Republicans are somewhat right in their theory. America will just keep on piling debt on top of debt, and eventually that debt pile-up will lead to doom. The increase in debt would also cause an increase in interest rates, because in order to sell its bonds, the American government needs to increase its bond yields so that the bonds still remain interesting to investors. The increased bond yields would also cause an increase in taxes, because the government cannot rely only upon bonds to pay off its interest on the bonds.
Other Republicans believe that the American government could cut back on its spending, without increasing the national debt ceiling. The government gets approximately $30 billion per day through taxes and bonds, so if the government were to reduce foreign aid, federal arts funding, grants, and release some of the federal work force, it could get its spending down to $30 billion or less per day. The government could also get rid of ObamaCare, the Federal Communications Commission, and the Department of Education, making state governments responsible for managing their own education.These Federal government decreases in spending will decrease the $60 billion the government currently spends daily to an amount almost equal to the $30 billion it takes in. This will slow down our rate of hitting the debt ceiling, and will manage to pay bills when we hit the debt ceiling and are no longer allowed to borrow money.
The Republican party has been trying to reduce the federal government's spending for months now, and they feel that the debt ceiling is their only leverage against the Democrats to succeed in reducing Federal government spending.

Effects of hitting the debt ceiling: If America hits the debt ceiling on October 17th, the Federal government will need to decide how to prioritize its payments.
The government has an obligation to pay its workers, Seniors and Veterans Social Security, and the unemployed/poor Unemployment Benefits and Food Stamps. But, the government also has an obligation to pay off its current debt, which is in the form of interest on bonds. The government will not be able to do both, so it must decide which one to do. If it chooses to violate its first obligation (Social Security, pay, Food Stamps) it risks domestic uprising/anger, a decrease in GDP, and causing starvation to its poorest citizens. If the government fails to pay its interest on borrowed bonds, the government risks getting its debt rating downgraded, causing an increase in interest rates and bond yields, and economic chaos as investors pull out of the stock market.
If America's debt rating is downgraded, investors will be less likely to invest in America's government by buying bonds because America will be a risky investment, since it defaulted. Additionally, America's bonds will have to have a higher yield because its bonds are a risky investment, and investors are more likely to invest in a risky investment if the rate of return matches the risk. This will cause an increase in America's taxes, because the American government will need money to pay for its current expenses, and pay back its yields on borrowed bonds.
Even though we have not hit the fiscal cliff just yet, consumer confidence has wiped out the last two years' gains. Consumers are worried about Congress's constant bickering, and lack of ability to produce a bill/legislation that can be passed and will increase the debt ceiling. Investors right now are mixed, but they are preparing for the worst. For the past two weeks, the stock market has been decreasing, because of fear of the fiscal cliff. Recently (Friday and today), there have been more talks about a temporary increase in the debt ceiling, which caused investors to gain some confidence and re-invest in the markets.

Wharton Business School's top negotiators came up with some humorous solutions to the crisis. One of the possible solutions was to have both sides visit 5th graders in a middle school, explain the problem to them in simple terms, and ask them for their solutions. Another possible solution was to have both sides write up their proposals, and submit them to Nelson Mandela, who would choose the fairest proposal.

Additional Questions: There is also the question of how long Congress should increase the debt ceiling for, and if there should be any wording about defunding ObamaCare. If Congress increases the debt ceiling for two months, a reasonable amount of time to change the country's finances, the issue comes up during Christmas time, an awful time as Congress and the American people will be in Christmas/vacation mode. In addition, US Consumer spending is supposed to be at an all time high during the Christmas season. If the issue of the debt ceiling comes up in mid December, consumers will be worried about the future, and save their money, instead of spending it on Christmas/holiday gifts. As a result, companies will not get the revenue they need to post profits, lose investment from foreigners, and might fire workers in the beginning half of next year to reduce costs. 
If Congress postpones the debt ceiling for 3 or 4 months, the issue comes up during the Federal Reserve's tapering off the Quantitive Easing program. (Jan-March 2014). Investors will already be worried about the effects of increased interest rates on the markets, and if they have to deal with the fear of America hitting the debt ceiling, they might panic, and sell, causing a mini-recession. 
If Congress postpones it any longer, Congress will basically forget about the issue, and will only start arguing about it a couple weeks before America is scheduled to hit the debt ceiling, just as they did in 2011 with the debt ceiling, 2012 with the tax increase, and now 2013 with the Fiscal Year Budget and the debt ceiling. However, if we push the debt ceiling up just enough to sustain the US Federal government's spending for the next 7 months, the issue will come up right before Senate and House of Representative elections. I believe only then will the Congressmen actually come up with a good solution for the problem, otherwise they will not be voted back into office.

Hit the Debt Ceiling: The Republicans who believed that the US would survive if it hits the debt ceiling are right. The author of a Wharton Blog cites Harvard Professor Howell Jackson's scenario where the US hits the debt ceiling, and has to prioritize its payments. Professor Jackson states that the federal government has "plenty of tax revenue to cover the interest" on the bond yields, with some left over to pay its other bills. Professor Jackson is arguing that the US government can prioritize its payments without borrowing money once it hits the debt ceiling. The government can prioritize paying off its interest on bonds with the tax revenue money, and use the left over money (there should be a decent amount) to pay other bills, like the salaries of its employees. Prioritizing paying off the interest will prevent America from defaulting, getting its credit rating downgraded, and the panic that comes after the world's strongest economy is downgraded. The only problem with prioritizing the interest rate payments is that will take longer and longer to pay the employees, because they can only be paid a tiny bit every day, and most federal government programs will need to take a cut.


In other news, JP Morgan & Chase posted its first quarterly loss since CEO Jamie Dimon took over in 2005. JP Morgan, the biggest US bank by assets, posted its $380 million loss (compared to its $5.7 billion profit last year) due to rising legal expenses, and reduction in new mortgages. Dimon attributed the bank's decrease in new mortgages as consumer wariness of the possibility of increased interest rates this year.
Federal Reserve Chairman Ben Bernanke was expected to decrease his aggressive Quantitive Easing Plan to $60 billion per month in September, but postponed it due to lack of economic growth. Bernanke, a dove, created the Federal Reserve's Quantitive Easing Program involving the Fed Reserve buying $85 billion in US Treasuries and Bonds per month in order to lower interest rates, which would cause a decrease in the unemployment rate. If interest rates were low, consumers would be more likely to borrow money, and then spend the money. Businesses would benefit from the increase in consumer spending, and also borrow money to hire more workers, and invest in new products/services. Bernanke planned to taper off the QE Program in September because the unemployment rate was decreasing at a steady pace, and was at 7.3%. However, Bernanke noticed that the unemployment rate was not decreasing because businesses were hiring more, it was decreasing because the unemployed were giving up on finding jobs. As a result, Bernanke did not taper off the QE Program, and is expected to continue it until he retires from the Chair in January 2014. His successor, Janet Yellen, also a dove, is expected to continue the QE program until the unemployment rate reaches about 6.5%. The only problem with the QE program is that it encourages inflation, because consumers and businesses are now increasing the demand for money, while keeping the supply constant.

An up and coming issue is the number of baby boomers about to retire. Baby-boomers are considered as babies that were born post World War 2 (1940's - 1960's), because the economy was improving (Great Depression is over) and because everyone was just in a good mood to be back from a war that they won, and a war in which USA essentially saved the world. There are about 80 million of those baby boomers, and they are all about to retire. When they retire, many of them will begin using Social Security, Medicare, and getting their pensions. The federal government needs to begin saving up for those unprecedented expenses, even though the government is already laden with debt. Mark Duggan, a Wharton Business professor estimates that the number of Americans aged 65 and up will increase by 90% by 2030, while the number of Americans aged 18-64 (those who pay taxes) will only increase 10%. Another problem for the US government; the government owes more people money then it is getting. The US needs to begin planning for this now, and one of the best ways is by reducing the national deficit. This means cutbacks on spending. Duggan also suggests that the government change the way Social Security is measured by changing the pay average from 35 years to 40 years, which decreases benefits for them, and increases the number of years they work. Besides the baby-boomers needing Social Security and Medi-Care, many city and state government workers need Social Security payments from the federal government, because the states they worked at do not have the funds to them. A perfect example is Detroit, laden with hundreds of millions in government worker pensions. Michigan can not pay it off, and is requesting Federal government assistance, like many other states.

Month in Review/Current State of Economy

Hi Everyone,
I apologize for not having blogged in the past week, I had to spend all my time  studying for the SATs. I'll post an article in the next few days which will describe why I think the SAT is a bad idea.
Since we're still in the first week of October, I feel it is necessary to blog about the Month-In-Review

Domestic/America: 
As mentioned in previous posts, the American stock market is at an all time high. It is highly overvalued. When I say stock market, I am referring to the S&P 500, the Dow Jones Industrial Average, and the Nasdaq 100. The stock market has been climbing steadily for the past four years (since 2009, when it crashed), but in the past two years, the stock market really its pace of growth. In 2012, the stock market reached its pre-market crash levels (2008 levels), and so far this year, its growing at an incredulous double digit rate.

Interest Rates/Unemployment: Currently, Federal Reserve Chairman Ben Bernanke's agressive Quantitive Easing Program continues at the same rate as it did when it first started a couple years ago. The aggressive QE plan calls for the Federal Reserve to purchase $85 billion in US Treasuries and Bonds per month in order to keep interest rates low. The low interest rates are supposed encourage consumers and businesses to borrow money by making it cheaper to borrow. Businesses would borrow money to expand their business by hiring new workers, and investing in new products/innovations. Consumers would borrow money and then spend money on products/services, fueling the economy.
Since the program was enacted a couple years ago, the unemployment rate has fallen by at least 0.1% per month. Although August's and September's unemployment numbers support the decrease, additional research shows that the decrease is simply because people have given up looking for jobs, not because they've become employed. This cancelled the Fed Reserve's plans of beginning to taper off the QE program, because the economy did not recover to a satisfactory level. It is important that the Federal Reserve taper off the QE program soon because with low interest rates over a long period of time comes increases in the rate of inflation. The Fed Reserve plans to keep interest rates between 0% and 0.25%. 

Next Federal Reserve Chairman
Janet Yellen, a dove, is scheduled to replace Ben Bernanke as Federal Reserve Chair(wo)man, when Larry Summers, a hawk, withdrew his name from the race early in September. A dove's first priority is to keep unemployment rates low. As a dove, Yellen supports Bernanke's aggressive Quantitive Easing program because it attempts to keep interest rates low. By keeping interest rates low, it becomes cheaper for businesses to borrow money and expand their business (by hiring more workers).
Summers, who was believed to be the successor of Bernanke before withdrawing his name, thought it best to repeal the aggressive Quantitive Easing program ASAP, because it would cause an increase in inflation rates. As a hawk, Summers first priority is to keep inflation rates low, which means that interest rates need to be increased. If it becomes really cheap to borrow money, more people will borrow money (more demand of money) while the supply stays constant, and then the money won't buy as much. People will then borrow more money because of the low interest rates, fueling the cycle.

Stock Market: As mentioned before, stocks are at an all time high. Good news, right? Wrong. As stock prices rise, consumers want to invest their money into stocks, in order to get onto the profit wagon. As stock prices increase, consumers need to borrow money in order to buy stocks (margin trading), and gain profits. With the aggressive QE program and the resulting low interest rates, it is cheap to borrow money to buy the stocks. But, in a couple of months when the tapering begins, interest rates will rise, it will become more expensive to borrow stocks, and people will start selling. When the markets begin going down, everyone will rush to sell, especially those who are investing with money they don't have (margin traders). As a result, the stock market will crash. Additionally, with low interest rates, consumers will spend less money, and if they spend less money, businesses earn less revenue. With less revenue, businesses no longer look profitable, and their stocks are sold. After businesses lose investment money, they begin firing people at the office in order to reduce costs. To read more, click here
In addition, the stock market's growth is not because the companies are consistently beating earnings by extraordinary amounts. 

Government Shutdown/Debt Ceiling: It is currently day 5 of the US Federal Government's shut-down. The US Federal Government shut down at 12:00 AM on October 1st, 2013 because Congress could not approve on a budget for the 2013-2014 Fiscal Year. The government's 2012-2013 Fiscal Year ended at 11:59PM on September 31st, and because Congress did not approve a 2013-2014 Fiscal Year Budget, the Federal government has no money to spend. Congress did not approve the Fiscal Budget because the Democratic controlled Senate would not pass a Fiscal Budget passed to it by the Republican controlled House of Representatives. The bill created by the Republicans calls for a postponement/defunding of ObamaCare for a year. The Democrats will not accept that, because they want ObamaCare to be passed now. ObamaCare was created to help make Health Insurance available to everyone through the federal government. Anyone can purchase ObamaCare for cheap, regardless of age, health, income, and pre-exsisting disease. Republicans believe that this plan is too expensive, especially for a nation already laden with debt, so they refuse to pass any legislation that does not postpone the discussion of ObamaCare for a year. I will post a blog discussing ObamaCare tomorrow.
One of the biggest problems caused by the federal government being shut down is the decrease in GDP. America's GDP is supposed to decrease by 15 points for every week that the government is shut down because the federal government employs hundreds of thousands of workers, and if the government's shut down, they will not be payed. If they're not paid, they have no money to spend. 

Debt Ceiling: On October 17th, 2013, the US Government reaches its debt ceiling. Congress now needs to pass legislation that will increase the government's debt ceiling. I talk about why there is so much debt in a previous post. If the debt ceiling is not approved by Oct 17th, the US essentially defaults on all of its payments for the first time ever. If this happens, the entire international economy will spiral. The wealthiest nation in the world can no longer pay back its bonds (borrowed money), and can no longer lend money to consumers and banks. Couple that with increased interest rates, increased costs of food because of a lack of subsidies, increased taxes, and the hundreds of thousands to millions of unemployed US government employees, and the GDP of every nation will decrease.
If the US defaults and can no longer pay its payments, its credit rating goes down. The last time the US's credit rating decreased was in 2008, and that resulted in a large recession with an unemployment rate at 12%. If the US Credit Rate decreases, investors will be less likely to invest in US Bonds, or would demand higher interest/yield rates to make up for its risky investment.

Pension Crisis: This was first reported with Detroit's file for bankruptcy. Detroit owes hundreds of millions of dollars as pensions to government workers, and because Detroit is bankrupt, it requires federal government assistance/funds to pay the pensions. Although Detroit is one of the only US cities to go bankrupt, the pension crisis is happening to other cities too. More and more cities are requiring federal funds in order to help give pensions to the retired government employees. The baby boomers (huge number of babies born in the 1940s as a result of post-World War II activities) are at that age when it is time to retire (60's). Those baby boomers are going to need Social Security cash/checks. The federal government now needs to find a way to allocate more money to be used to pay off promised pensions and social security. This will increase the national debt, and cause an increase in taxes. 


International:
The international economy as a whole is improving. The BRIC countries, Brazil, Russia, China, and India, a term coined by Goldman's top economist Jim O'Neill in the early 2000's as the countries most likely to grow this year, are still growing, but their growth is beginning to slow down. Brazil is scheduled to have the World Cup Soccer tournament next year, so its economy will boom in the upcoming months, but currently, its economic growth has been slowing down more then analysts predicted. China's economy is also slowing down in terms of growth. The same for India, but India is also facing currency inflation. Over the summer, the Indian Rupee reached its lowest point ever, 70 Rupees bought 1 USD, and more then 100 bought a British Pound. As a result, it became more expensive for Indians to go abroad, both to vacation and to study.

China, India, and Brazil's economies are slowing down because of all the investment that has already occurred. The costs of living/having businesses in those countries has increased ten-fold. Property values, food, and labor costs have sky-rocketed. Governments are attempting to increase foreign investment taxes in order to benefit themselves (corruption) and help their own economy. In addition, America's economy is offering a higher rate of return then foreign investments. 

I address India's faltering economy in a previous post, but the general idea is that the government is printing too much money causing inflation and not spending enough money. India's property values have sky-rocketed because of so much foreign investment. The population of its cities has also increased exponentially; cities that were meant for hundreds of thousands of people now have millions of residents. The infrastructure can not handle those many people. The government has allocated/planned hundreds of billions of rupees (crores) to be be spent on improving internal vital infrastructure, but only a couple projects actually go through, due to high levels of government corruption.

Federal Government Shuts Down

This is just a quick update. It's currently 12:10AM on Oct 1st, 2013, and the Senate has rejected the House of Representative's amendment.

BusinessInsider first reported that this is the first time in 17 years that the Federal Government of the United States of America has shut down. 

So far, I haven't heard any bombs exploding, or seen any rioting in the streets, and I still have Internet and power, which leads me to conclude that the effects of the federal government shut down are not felt immediately, not too big of a deal. 

The Brief: I12:01 AM on Oct 1, 2013 (today) marks the beginning of the Federal Government's 2013-2014 Fiscal Year. Congress has not approved any Fiscal Plan for 2013-2014, so the Federal government does not have any money or right to pay for any nonessential items. Food stamps, unemployment, and military spending continues because those are considered essential. Unfortunately, public schools continue too, because the majority of public school funding comes from the state and local governments. 

Congress did not pass a Fiscal Plan because of the fierce Republican and Democratic opposition. The Republicans  control the House of Representatives, and want a Fiscal Plan that delays the enactment of, or defunds ObamaCare. The GOP believes that ObamaCare is too expensive; ObamaCare wants to make health care available for all Americans, regardless of wealth, prior illnesses, and health. America is already in debt ($16.8 trillion USD), and the economy is still recovering, so the GOP feels that this is a bad move. However, the Senate, controlled by the Democrats feel that ObamaCare is the right bill, and necessary, so the Senate vetoed any House bill/amendment that proposes to delay funding for ObamaCare. As a result, the new Fiscal Year began, and no bill or resolution was passed.

Government Shutdown T - 7 hours

As mentioned in previous posts, the American government is facing huge problems. First, there is the increasing national debt ($16.7 trillion USD) which is now more then America's GDP ($15.7 trillion USD). Next, there is Bernanke's aggressive Quantitive Easing program tapering, which will slow the economy's growth, and possibly increase the unemployment rate. Lastly, and most importantly, there is the Fiscal Policy lockdown issue.

The American Government's 2012-2013 Fiscal Year is supposed to end at midnight on September 30th, 2013. The 2013-2014 Fiscal Year is supposed to start 12:01AM on October 1st, 2013. It is currently 5PM on September 30th (out of 30 days), and Congress has still not adopted/approved a 2013-2014 Fiscal Year plan. In less then 7 hours, the new Fiscal Year will begin, and the government will not have the money to pay for its expenses, because it has not come up with a plan.

The only good thing that comes out of this government shut down is the possibility that I have no school tomorrow. Edit: I still have school tomorrow. Princeton High School, and most public schools receive a majority of their funding from the state and local government, so the Federal government shutting down will have no immediate effect. The same applies for state funded institutions/colleges, they will not feel the immediate effect of a Federal government shut down, but they will feel it in the long term.

The Reason for the shut-down: The House Republicans are not willing to sign/agree to any budget plan unless it includes a delay or defunding of ObamaCare. Obviously, the Democrats are not okay with that; they are firm believers of ObamaCare. In a previous post, I talked about why Republicans didn't like ObamaCare. The Republicans, who have a majority in the House of Representatives, recently passed two Amendments to the Senate regarding delaying ObamaCare funding/decisions until next year. The Democrat controlled Senate tabled those Amendments, causing both Houses to go back to Square 1.

ObamaCare attempts to make Health Care affordable for everyone, and guarantee everyone health care from the American Federal Government, regardless of illness, prior condition, and wealth. Perspicuously, this is a massive spending plan for a government that is already laden with debt. The American government owes more then $16.8 trillion, and its GDP is only $15.7 trillion. The government owes more money then it trades/makes in a year, so approving a plan that increases its spending is a bad idea.
 If the government continues to spend more money, ie. with ObamaCare, it will have no choice but to raise taxes and the cost of health care for the wealthy and healthy in order to negate some of those costs. Combine that with a still weak economy, and an unemployment rate of over 7% (healthy is 2-5%), and our government is in trouble. Then, on top of that, there is fear of the economy recessing because Bernanke plans to begin tapering off his Quantitive Easing program in a couple months, which will cause an increase in interest rates. Bernanke's aggressive QE program calls for the Federal Reserve to buy $85 billion in US Treasuries and US Bonds every month, in order to keep interest rates low. Low interest rates encourage businesses to borrow money, and expand their business, through the hiring of new workers, and the creation of new stores/products. Low interest rates also encourage consumers to borrow more money so that they can spend more money, fueling the economy. Low interest rates encourage consumers and businesses to borrow money, because it is cheaper to borrow. If the interest rates rise too soon, people might not spend as much as they used to spend, because now it is more expensive to borrow. If people don't spend as much, companies don't make as much revenue, and have to reduce their costs by firing workers in order to remain profitable. As a result, the unemployment rate rises, the dependence on federal aid increases (Unemployment Benefits, Food Stamps), and the number of people who pay taxes decreases.

Stocks have been on a steady decrease for the past week and a half due to fears of the government shut down. The Dow, S&P 500, and Nasdaq have erased most of their gains from the previous month of trading.

Goldman Sachs argues that the government shut down might be a good thing. The American government is scheduled to hit its debt ceiling (again, last time it hit debt ceiling was last year) in a few weeks, and Goldman feels this shut down will be like a wake up call to Congress to begin working on increasing the debt ceiling now, a few weeks before the government is expected to hit it. Maybe Congress will pass a 2013-2014 Fiscal Year plan, and a debt ceiling extension at the same time. Goldman also sees that the Republican party will be more likely to act now, because if the government shuts down, and a poll goes out, "everyone knows the GOP will be blamed". This also allows some interpretation, since Republicans in Congress refuse to pass any fiscal bill that does not include defunding ObamaCare, and when the government shuts down, it will make the Republican party look bad. Senatorial elections are coming up soon, and this would be a big gain for the Democratic party, because everyone would blame the Republicans for the federal government shut-down. Lastly, Goldman believes the government shut down might be a good wake up call to all the politicians and voters. It will wake the politicians up and encourage them to actually get some work done, and it might make voters choose better politicians.
Recent polls of the American government show that many Americans have little to no faith in Congress. The polls showed the same results last year, when Congress did not pass anything to lower the pre-Bush tax levels, until 3 hours before the new, higher taxes were supposed to go into effect(8PM on Dec. 31, 2012).

The biggest issue with the American government shut down would be the decrease in GDP. Economists and analysts estimate that for every week the government is shut down, the American GDP decreases by more then 0.16 points.
There is no further analysis that can really be made on this situation. The result just comes down to a matter of principles. Should all Americans have access to health insurance and health care so that no American dies because they can't afford/access treatment? Or should the government just focus on decreasing the unemployment rate so that people can actually have jobs to help pay for their medical care?

Moving back to the debt ceiling, there is less chance of America hitting the debt ceiling, because President Obama can give an Executive Order to increase the debt ceiling, since default would be imminent. The Executive Order ability comes from former President Bill Clinton who used it during his Presidency. Clinton stated just last year that Obama would (and should) raise the debt ceiling by invoking the 14th Amendment (with the Executive Order) rather then dealing with House Republicans. Potomac Research believes that Obama will probably use the Executive Order closer to the debt ceiling date, and face Supreme Court hearings about his Order, rather then deal with House Republicans.


In unrelated news, Iran has begun talking with American diplomats/officials about possibly lifting America's sanction on Iranian oil. Iran's economy is primarily based upon the export of oil. The US began sanctioning Iranian oil and other Iranian products because they suspected Iran was trying to build its own nuclear weapons, which would threaten America's safety. Other countries followed America's sanctions, and soon Iran was barely exporting any oil. If the sanctions are lifted on Iranian oil, there will be a sudden influx of a supply of oil, which would cause oil prices everywhere to drop. 

BlackBerry (BBRY) Analysis

During my free time, I invest in stocks, usually keeping positions for a couple of days to a couple of months. Because I have less time to research stocks now (during the school year), I keep my positions for many months. I'm a fundamentalist investor, so my long term investing strategy during the school year usually works out. 
Every now and then, I plan to post some of my fundamental analysis on different companies. 
Today's analysis is on BlackBerry. I first did the fundamental analysis on BlackBerry when I bought the stock a couple months ago, but I feel I should re-analyze the company after recent market events.

BBRY:  History and Background information
BlackBerry is a phone company that makes its revenue by selling mobile phones to consumers and businesses. BlackBerry also produces its own mobile Operating System that it runs on its mobile phones. Currently, BlackBerry's main market is with businesses as consumers have lost interest in BlackBerry phones. BlackBerry is popular with businesses because of its secure operating system, and restrictions on what the phone holder can do. Businesses like providing their high-level employees with BlackBerry phones because they know the phones are secure, and won't allow unauthorized people to access the phone's files (ex. emails, presentations, etc.). Additionally, BlackBerry phones give the IT department of the company superlative power over the phone; the IT department can dictate exactly what the employee can use the phone for, so that the phone is not misused. 

BlackBerry used to be very popular among consumers in the early to late 2000s, until the first iPhone and Android phones were released. BlackBerry did not release any developer APIs or add more games/ apps to its relatively simple mobile operating system, while iOS and Android, had public APIs that allowed 3rd parties to create apps. This resulted in thousands of developers making tens of thousands of apps, covering a wide spectrum of applications(games, finances, social media, fitness, etc). Within a couple of years, BlackBerry's market share halved, and then halved again; no consumer wanted a boring BlackBerry phone with a big physical keyboard that only had a couple of apps when they could get an iPhone with tens of thousands of apps, a music library, and a movie library. 
BlackBerry still did not adapt to the changing market, just like Abercrombie and Fitch did not adjust to the recession in 2009 by lowering their prices, and BlackBerry's stock took a severe hit. BBRY fell from a high of $142 in 2009 to $18 in 2012. Ok, you argue, so what if BlackBerry's stock price fell $100+, the stock market crashed in 2009, and many other company's prices fell that much. But, BlackBerry, unlike most other companies whose stock price took a sudden hit, kept on decreaing, and decreasing. For the past two years, the stock price has been decreasing until it began fluctuating in the $10 - $15 range, while the Nasdaq 500 increased by over 100%, and its technology stock sector increased by over 50%. 
In summation, BlackBerry's stock price is at an all time low where it seems to have found support in the $10 range. This might be a good spot to begin acquiring positions in the company (more on that later).

Why BlackBerry is at an all time low this year
Earlier this year, there was a lot of hype about BlackBerry's new product line that would save the company. BlackBerry knew it was failing, and invested a lot of money into designing some new phones that they hoped would bring back its market share. BlackBerry even released an app for BlackBerry devices, iOS devices, and Android devices that allowed free group chat, similar to WhatsApp. Unfortunately for BlackBerry, two events obliterated any bulls that felt the company could make a rebound because of its new product line. The first was leakage of its new product line about a week before it was scheduled to be displayed at a conference. This caused the company to not get any pre-release hype, and actually caused a massive sell off. The second, more fatal event, was a previewing of Android Version 18 (Kit Kat). 
Kit Kat enabled the Android phone to have two separate accounts/virtual machines, one for private/personal use, and the other for work/secure use. Because the two accounts were separate, the chances of a virus that the user accidentally downloads on their personal account, will not be able to access the work account. This announced Android's official entry into the competition with BlackBerry to get the business market.  Additionally, there was a larger variety of Android phones then BlackBerry phones, which attracted more consumers and businesses to Android. Android had phones with small screens, medium screens, large screens, tablet sized screens, and phones with large touch screens and physical QWERTY keyboards. BlackBerry only has six main phones, four of them are small phones with physical keyboards and super small screens, and two phones with no physical keyboard and a large screen. BlackBerry's small screens with small keyboards restricted the main population that would buy them, older people (age > 30) would not be like the small screen and tiny keys (hard to use), while people under 30 would rather have a big touch screen phone. To further weaken BlackBerry's product line was the fact that the phones had no features that the iPhone and Samsung Galaxy SIV did not have; it only had 16 GB internal storage, 4" touch screen, and 4G LTE.  

A common trend among employees who work in businesses where they are given BlackBerry phones is to have two phones, one BlackBerry (for work), and an Android or iOS phone for family. There are two reasons for this. 1. Most employees did not like the BlackBerry phone, the keyboard was small, the apps weren't good, and browsing the Internet was a pain. The second reason was that BlackBerry phones could not be used as normal phones; people couldn't put their huge iTunes library onto the phones, or they couldn't play Temple Run while waiting for their bus.
Android just eliminated that need for two different phones with their mobile KitKat operating system. With one Android phone, you could have a work account which the IT department controls, and contains secure work information, while you could simultaneously have a family/social account which was used for leisure. Plus, there was a wide variety of Android phones that users could choose from, primarily from Samsung and HTC, who both release new phones every half year. 

BlackBerry's job of increasing its revenue is not easy. First, BlackBerry needs to come up with a unique product and software that Android, iOS, and Windows 8 do not have. Then, BlackBerry needs to increase the number of apps it has available. BlackBerry needs to create such a good product that it will want to make consumers, who are comfortable with their iOS and Android devices that they've used for years, want to switch over to Blackberry. 

There is hope. The bullish part.

So, now we've established that BlackBerry is a company that is somewhat doomed to fail. Its only revenue source, the sale of its phone line, has turned out to be a disaster as neither consumers nor businesses like the phones very much, they don't bring any new features/technology to the market, and there is a new adversary, Android.

But, that is the American market. BlackBerry can begin investing in emerging markets. Although the majority of wealthy Indians in India have been 'Androided' or 'iOSed', BlackBerry can still create a cheap product for the low income Indians. Then, its main competition will only be Nokia, and Nokia is not nearly as advanced as BlackBerry is, in terms of phone specifications/features, and software integration. But, it's not just India. Latin America and South America are two whole markets that have not been taken over by Android, iOS, Nokia, or Windows 8.
BlackBerry currently has $2.6 billion in cash, and is debt free, which means it is free to invest that money into international markets to increase its revenue. And that's why I believed BlackBerry would be a good buy.
Looking at BlackBerry's income statement, and the current price of its shares, I concluded that BlackBerry was at a support level around the $9 range, and (1). would not plummet much further below $9, (2). possibly be bought out/taken over. BlackBerry's income statement shows revenue decreasing from $20 billion in 2011 to $19 billion in 2012, to $11 billion in 2013, while the profits decreased from $8 billion in 2011 to $3 billion in 2013. So, in March 2013, when BlackBerry announced its earnings, the stock did a dive, but found support in that $9 range. Only the longs and bulls held on to BlackBerry's shares, and if they didn't sell when the company's revenue dropped $5 billion in two years, that showed they were willing to endure much more for the company.
I predicted BlackBerry might be bought out because it was still a very valuable company, with over $13 billion in assets (and only $3.7 billion in liabilities), and it came with a copious, robust patent portfolio. BlackBerry has also never been hacked, unlike iOS (jailbreak), Android (rooting), and Windows 8 (viruses). Each of those patents, with a life of 12+ years, are worth hundreds of thousands, if not millions of dollars. Both the patents and the net assets add to the value of Blackberry. One of the main problems with BlackBerry now is that it needs to go private, in order to save itself in the long run. This happens to some publicly traded companies, like Dell. The publicly traded company has shares bought by Wall Street banks, and those Wall Street Bankers just want to see immediate profits quarter after quarter for a bit, before selling the stock and finding a new one. This means the company has to focus on spending its money on a short-term revenue increase, instead of spending money on making more money long term. Because the Wall Street shareholders own so much of a company (ie. Dell) the CEO has his hands tied, and is forced to work on short term profits, because the long term profit plans will be vetoed by Wall Street.
I had the idea of an investment in BlackBerry a couple months ago after Dell announced it wanted to go private. Dell, like BlackBerry, was a major technology company in the early 2000s, and it too failed to adapt to the different market needs. Apple, Lenovo, and HP quickly became more popular then Dell, and Dell's market valuation plummeted. Dell too decided to go private in order to focus on a long term revenue increasing strategy that the short term Wall Street investors would veto. Dell's shares shot up when the company announced the plans, which is exactly what I hoped would happen with BlackBerry. Currently, Fairfax consortiums offered to buy BlackBerry out at $9 per share, which is lower then I would have liked, but I bought in at $7, so I won't complain. There are still 5 weeks left in the plan where another company can bid on BlackBerry. I strongly believe that Fairfax would have offered to buy BlackBerry for $11 or more if BlackBerry had not announced the massive loss that blind sided investors a couple days ago. BlackBerry gave a warning to investors that it was expecting a $965 million loss, and was firing 4,500 people (most of the company). This of course caused stock prices to tumble, but the market later adjusted for the overreaction. 

The National Debt Crisis

It's been almost nine months since we've heard any news about the looming National Debt Crisis and the Debt Ceiling. Around this time last year, news outlets were just beginning to report that the Federal Government's National Debt was approaching the Debt Ceiling. Today, the National Debt is at $16,400,000,000,000 ($16.4 trillion) while the US GDP is at $15.8 trillion. Essentially, America owes more then it trades/makes in a whole year.

Why this is a problem: The American government's debt has been increasing steadily for the past decade. Now, the government owes more money then it gets in a year (it owes more then its GDP). This is a problem because the American government now needs to borrow more money in order to pay off its existing debt. In addition, taxes are still relatively low, and government stimulus/spending is at a high in order to help the American economy grow. Because the government needs to pay off its substantial debt, the government reduces its spendings in different areas which would actually help the economy; the government might fire thousands of workers, or reduce unemployment benefits and infrastructure projects. The government will then proceed to increase taxes in order to increase revenue, which would cause an increase the interest rate. Adding on to those woes is the decrease in domestic investment; foreign investors will see that America owes more money then it currently trades in a year and realize that it might not be a very safe investment because in all actuality, it could default. Additionally, the American government will have to reduce the yield on its bonds because it can not afford to pay more in interest to its debt holders. As a result, foreign and American investors might look else where for a financial instrument that offers a higher rate of return. With less people buying bonds, the US Government needs to find another way to raise revenue in order to pay off its existing debt, which would likely come from a higher tax increase.

How this whole debt cycle works: The American government needs money in order to operate and keep America healthy. The American government needs money to invest in maintaining/creating infrastructure, in keeping the country and its interests safe (both abroad and domestically), and to pay the millions of workers it employs. The government gets a lot of the revenue it needs to pay off those costs through taxes, but sometimes taxes aren't enough, and the government needs to borrow. So, the government sells bonds and treasuries (US Bonds and US Treasuries) to investors. When investors buy the bonds, they are actually giving money to the US Government, and the US Government is promising to pay them an annual yield, and then the value of the bond once it expires (ex. two year bonds).
When President George Bush came into office, the American economy was still in a recession from the 2000 "Internet" stock market crash. In order to help the economy recover, Bush lowered the interest rates, so it became cheaper for people and corporations to borrow and spend money which would fuel the economy. But, the economy did not recover at a fast enough pace, so in 2003, Bush enacted a capital gains tax reduction. Bush lowered the tax on capital gains (returns on investments) from 39.6% (20% tax + dividends) to 15% to encourage people to invest their money in the stock market, because now the rate of return was a lot higher since investors did not have to lose as much of their profits to taxes. Companies would then use that money to expand their business by hiring new workers.

In addition, the Bush administration eliminated many taxes, including some on scholarships. The economy did recover with all of those tax breaks, but the national deficit continued to increase. The Iraqi war which Bush started began in the early 2000s, contributed hugely to the national deficit increase; some Economists estimate that the government spent more then $1 billion per day to keep the troops and their equipment in Iraq. Furthermore, the Bush administration created the Department of Homeland Security, increased the size of the military by hundreds of thousands of soldiers, and made DARPA to invest hundreds of millions of dollars in colleges/universities to research military technology advancements.
To sum it up, the American government under the Bush administration was spending hundreds of billions more per year then it was making, because of the lowered tax rates/eliminations, and the increase in the government's spending. The tax breaks were signed in to effect for the next 10 years, so for the next 10 years the American government continued to spend way more then it made. As a result, it had to borrow a lot more too. The recession in 2009 occurred because American consumers and businesses were borrowing way more then they had, just like the American government. As a result, the American government had to spend more through federal bank bailouts ("too-big-to-fail banks"), and Quantitive Easing programs. In addition, the government had to keep interest rates low so that businesses and consumers could afford to borrow more in order to spend more (help put money back in the economy). Bush was not the only one who contributed to the increase in national debt, under the Obama administration, federal government spending increased by nearly 50% for his MediCare, MedicAid, Social Security and unemployment benefit increases.
The end result is that the government is now in a cycle of borrowing more money to pay off the money it has already borrowed, while attempting to keep interest and tax rates low, and having the government not increase the amount it spends per year.

Fast forward to 2012. The Bush Tax Cuts were scheduled to expire on Jan 1st of 2013. If those tax cuts expired, Americans would go from paying 10 - 20% in taxes to 30+% in taxes, a huge increase. If American consumers and businesses had to lose that much more in taxes, they would not have as much money to spend, which means they might be thrifty with their money, and choose to save it instead of spending it. In 2012, the economy had not fully recovered from the 2009 depression, unemployment rate was still high, PMI/consumer spending was still low, and real estate prices were still low. If the tax break had gone into effect, almost everyone would stop spending their money, and choose to save it in the bank. If consumers stopped spending money, businesses would stop making money, and would need to cut down on expenses; first by not hiring new workers, then by firing existing workers. If existing workers are being fired, they need to rely on the government for Food Stamps/Unemployed Benefits, and they will not have any money to spend. Even though the higher tax rate would initially decrease the national debt, over time, it would actually increase the national debt. If consumers stop spending money, the government loses sales tax. If businesses make less revenue because consumers are spending money and not saving it, the government loses revenue taxes. When the businesses have to fire workers, the workers don't have to pay income taxes, and the government loses the income rate tax.

In October of 2012, there was actually a mini-crisis; the US Federal Government had a national debt of over $16 trillion, which Congress had made the debt ceiling. As a result, many government facilities closed down because the government literally did not have the money to pay the employees who ran the facilities. Congress was decently quick to increase the debt ceiling, and actually postpone the debt ceiling to October 1st of 2013.

But Congress, of course, was unable to come up with a solution for the sudden tax increase that would occur on Jan 1st, 2013 if they did not do anything. Because many media outlets began reporting the tax increase for December in September, and because the American people had little faith in Congress (CNN poll reports less then 20% of Americans felt satisfied with Congress), Americans saved more of their money then they normally would have. This caused a problem because the fall and Christmas season are the two times of year when people spend the most money. As a result, Black Friday was a disaster, and company profits/revenues barely made it to the black. On December 31st, 2012, at around 9PM, Congress came up with a solution to slightly increase taxes, and decide how much higher the taxes should be at a later date (pretty last minute, right?).

October 1st marks the beginning of a new fiscal year for the American government. A fiscal year where the budget has not yet been approved by Congress or the President, a fiscal year where the debt ceiling has not yet been determined. In a New York Times Opinion Editorial, Paul Krugman identifies the Republican party as the source of the problem. Krugman states that the Republican party is literally holding Americans hostage until Obama lowers the tax rate and dismantles the health reform that he has made the signature achievement of his Presidency. Congresses's Republican radicals are holding Americans hostage by refusing to sign the 2014 Fiscal Year Budget by September 31st, 2013 which is the latest it can be signed; the Fiscal Year budget goes into effect on October 1st, 2013. If the fiscal budget is not approved, the Federal government can not spend any money, which would ruin the American economy, and then the international economy.

Congress has approved a bill that funds the federal government $986 billion until December 15th, to avoid a total government shut down. Currently, Congress is still trying to reach a resolution on how much to cut spending in MediCare, MedicAid, and Social Security, while deciding whether to pass ObamaCare. It looks like the Republicans have succeeded in cutting off funding for ObamaCare by using some tricks in their parliamentary toolbox, which makes ObamaCare need 60+ Senate votes to pass, more then a simple majority, and the Republicans have control of the Senate.

ObamaCare/Obama Administration Policies: The Obama administration wants to make health care available to everyone at low cost. This is obviously going to be a very, very expensive plan, as providing health insurance for everyone (the poor, those with severe pre-existing conditions, etc) can become very expensive.
Previously, Americans had the option of buying healthcare from private insurance companies, or from the government. Having private insurance companies meant that there would be competition to decrease prices. On the other side, using Game Theory, insurance companies could match the prices with their competitors, or increase their prices, making it more expensive for consumers with pre-existing conditions to buy. In addition, private insurance was a lot more exclusive/picky in getting new clients, many people with severe preexisting conditions were not given insurance plans, or their plans were very expensive. Government provided insurance meant that it would be overall cheap and available to everyone (including those with pre-existing conditions). The only problem with government provided health insurance is that it requires the government to spend a lot more money, which means the government needs to increase taxes. Steven Cruz at Forbes Magazine points out that it is actually the healthy, middle age male and female who end up paying the most for insurance in order to subsidize the older, poorer Americans in bad health.  Obama's policies tax pharmaceutical companies more, and force them to sell their drugs at a cheaper price; in someways, giving them a double whammy, they have to sell their product for less money, and pay more of their revenue in taxes. 

Future Prediction: Stock Market Crash

Today, I bring you bearish news for the stock market. I am predicting a stock market crash in which the S&P 500 drops to 1500, the DJIA drops to 13,600, and gold rises to $1800 by March, 2014. The S&P 500 is currently at 1722, so a drop to 1500 would be an approximately 13% drop. The DJIA, currently at 15636 will drop  11% to 14000. Gold will increase from today's close at $1394 to $1812, a 30% increase. Although my numbers might be off, I am predicting a (minor) recession in the near future.

Here's why:
Stock Market: Stocks have been on a huge rally for the past 5 years. The stock market is at an all time high, and has been at an all time high for the past year and a half. Basic technical analysis/theory supports the saying "Whatever goes up, must come down". As stock prices keep on increasing, it becomes too expensive for many investors to buy new stock, or hold on to existing shares. Goaded on by financial advisors and analysts, Main Street and Wall Street investors take out loans in order to buy new shares (margin trading), because they see how profitable the stock market has become (it's been going higher and higher for the past two years), and want to get in on the profit before the market crashes. Essentially, investors are attempting to 'time the market', trying to squeeze the last bits of profit out of the market while it is still profitable, which is never a good idea. Once the Federal Reserve sees the unemployment rate drop (the Reserve is controlled by 'doves'), they will begin the tapering of their aggressive Quantitive Easing plan. Doves are primarily concerned with lowering the unemployment rate, and Bernanke has set a target rate in the 6%s (currently at 7.3%). The Reserve will most likely lower it's $85 billion per month plan of buying US Treasuries and Bonds to $60 billion, which will indubitably increase the interest rates. The increase in interest rates means it becomes more expensive to borrow money, so companies and consumers will stop borrowing and stop spending money, and instead start saving money. As a result, companies will make less revenue. Since companies are making less money, and interest rates are increasing, they need to begin saving money and start cutting back on current expenses by firing workers. A decrease in revenue, and massive layoffs at companies tell investors that the company is no longer profitable. If a company is no longer profitable, investors will stop investing in that company, and choose to invest in another company or financial instrument that offers higher yields. In addition, the increase in unemployment means people have less money to spend, and have an increased need to rely on government funded programs, like Welfare and Unemployment Benefits.
Many professional investors will foreshadow the decrease in revenue of companies as soon as the Federal Reserve announces their plan to taper off the QE causing an increase in interest rates. Those professional investors will then proceed to sell their stocks, and invest in gold or other commodities, which yield better returns then stocks at times of crisis. Once professional investors begin selling, everyone one else begins selling, and selling, and selling. Everyone else begins selling because if the professionals are selling, there is a reason for their selling, probably because there are better returns elsewhere. Others begin selling because they are wise and realize that it is better to leave now with some profits then wait longer and risk losing more or gaining more. The biggest group that sells is those who borrowed money (traded on margin). The investors who traded on margin essentially borrowed the stocks from stock brokers with a contract that stated they would give the stocks back, and pay interest for borrowing the stocks. As stock prices plunge, the margin traders rush to sell, because they are borrowing money they don't have (a risky gamble). If the stock value decreases, the investors have to pay the price/value difference out of their own pocket to the broker (might involve selling some assets), and pay borrowing fees on top of it. With the professional investors selling because they predict that companies will not beat revenue estimates in the future (company is no longer profitable), other investors selling because they see the professionals selling and recognize it is a good time to get out, and the margin traders selling, the stock market will definitely tumble.

The above chart illustrates the theory that there is a direct correlation between the S&P Monthly Close and Negative Credit Balance. From 1980 to August 2000, the S&P monthly close (blue line) increased about $200 billion. At the same time, the Negative Credit Balance (red) increased to about $120 billion by the end of August 2000. The S&P Monthly Close (blue line) then proceeds to decrease about $150 billion while the Negative Credit Balance (red) became Positive Credit Balance (green). The only way the Negative Credit Balance could have become positive that quickly is if the investors who borrowed stocks (margin traded) returned their shares (sold them) to the brokers; a massive stock sell off. The $150 billion decrease in the S&P Monthly Close (blue line) shows that there was a massive sell off in the stock market.
Fast forward to 2009, the S&P Monthly Close and Negative Credit Balance are both steadily increasing, just like in the year 2000. The Federal Reserve's Quantitive Easing Program was enacted in 2011 and lowered interest rates to rates between 0% and 0.25%. Because it was cheaper to borrow money, many investors borrowed money and invested them in stocks (margin trading). The sharp spikes in Negative Credit Balance and S&P 500 Monthly Closing price between 2011 and 2013 that investors were borrowing more money, and investing that money in the stock market. The graphs and data of the crash of 2000 (all time high Negative Credit Balance and S&P Monthly Close) replicate the same all time high Negative Credit Balance and S&P Monthly Close, history is essentially repeating itself, and we should prepare for the stock market bubble to burst (massive sell-off).

Overall, the huge stock market rally was not because companies were becoming very profitable and consistently beating earnings by above average amounts; it was because stocks were becoming more profitable then other financial investment instruments because of the low interest rates caused by the Federal Reserve's QE.


Update: Today Goldman Sachs (analysts Damien Courvalin and Jeffrey Currie) predicted a gold rally towards the end of this year. Wells Fargo and Deutsche Bank advised their clients that they predict a stock market crash in 2014.

A Quick Update on the FOMC

Today was the monthly Federal Open Market Committee Meeting.
At this meeting, the Federal Reserve decided to not begin tapering off the aggressive Quantitive Easing program until the economy showed more evidence of strong growth. This was expected of the Feds, as Chairman Ben Bernanke repeatedly stated that he would not begin the tapering until the economy recovered, and there is no set schedule for the tapering. Gold, stocks, and bonds are surging, while the dollar is plummeting. The Committee nearly unanimously decided to keep interest rates between 0% and 1/4% until the unemployment rate dropped to 6.5%.

To recap what was discussed in depth in previous articles, the Federal Reserve adopted an aggressive Quantitive Easing program a couple years ago in order to help jump start the economy after the depression. The Quantitive Easing program called for the Feds to buy $85 billion in US Treasuries and Bonds per month, in order to keep interest rates low. The low interest rates would encourage businesses and consumers to borrow more money in order to spend money and hire/pay workers, thereby pumping money in to the economy. The QE program has worked very well, unemployment dropped from a high of 10% in 2010 to it's current 7.3% level, and consumer and business spending and PMI are at all time highs. For most of 2012, and the first half of 2013, the economy has been improving steadily, at times even beating bullish analysts' estimates. This was a good sign and proof that the QE program should begin to be tapered off, which is what the Federal Reserve foreshadowed in the first half of 2013. Investors on the other hand were split. Some investors (doves) believed that if the Fed's tapered off the QE program, interest rates would rise and damage the still weak economy. The doves also believed that the interest rates should remain low until the unemployment rate lowered even more. Other investors (hawks) believed that the QE program should be ended almost immediately, because the low interest rates were causing an increase in inflation rates. The low interest rates caused many people to want to borrow money (it's cheap), so there was an increase in the demand for money, while the supply of money stayed constant. Simple supply and demand illustrates that the prices will rise if the supply stays constant and the demand grows; which is what hawkish investors did not want to happen.

The Federal Reserve Chairman and Vice Chair(wo)man, Ben Bernanke and Janet Yellen, are more dovish then hawkish, which explains their decision to not taper off the Federal Reserve's aggressive QE program just yet. July and August's unemployment numbers do show a decrease in unemployment, however that decrease is still below analysts'/economists' estimates, and the lower unemployment rate has been attributed to a decline in the number of people looking for jobs, not an increase in the number of jobs/hires. As a result of the FOMC's decision to not taper off the QE until the economy (primarily the unemployment rate) improved, stocks, bonds, and gold surged while the dollar's value plummeted.

The stock market surged because low interest rates meant that consumers could (borrow more money to) spend more money, increasing the cash flow and income of companies. Stock prices increase if the company earns more income/revenue then the previous quarter, because it shows the company has grown and an increased in value. So, stocks in general surged because the low interest rates meant greater cash flow/income for companies, which makes them look more profitable to investors, who in turn buy the stock (increase demand), causing an increase in price of that stock.
Bond yields increase because bonds are financial tools of debt, and because of low interest rates, companies can borrow more money at cheaper/lower rates to pay off its debt. Because the money is so cheap to borrow, the company will increase its bond yield in order to attract investors into buying that company's bond over another company's bond.
Gold prices surged because gold and commodities in general are used as hedges against inflation. When inflation increases, money has less purchasing power (you can buy less goods with the same amount of money). Commodity prices increase because the price of raw materials to make goods increases, making the commodity increase in price. Commodities now become more attractive then stocks and bonds as an investment tool, because the rate of return is higher. Today, gold prices surged because the Feds decided to keep buying $85 billion in bonds and Treasuries every month in order to keep interest rates low, which would cause an increase in inflation.
The dollar's value plummeted because of fears of an increase in inflation. Low interest rates meant there would be more demand of money then supply of money, so prices would rise (inflation). If there was inflation, the same amount of money today would not buy the same amount of product tomorrow.

Larry Summer's Withdrawal From Fed Chairman

Recently, Larry Summers withdrew his name for Federal Reserve Chairman. This might not seem like big news, but in the Business/Economic world, it was monumental.
Current Federal Reserve Chairman Ben Bernanke's term is scheduled to end in January of 2014, and Economists and Investors around the world are looking for a replacement Chairman who will continue to support Quantitive Easing. Larry Summers, former Treasury Secretary, was rumored to be one of the top two people most likely to replace Bernanke.

Larry Summers: Larry Summers has been described by most Economists as a hawk towards fiscal policy. By definition, he is more concerned with interest rates and inflation then economic growth. If Summers was elected/approved by the Senate to be Fed Chairman, one of his first actions would be to end/drastically slow down the Fed's Quantitive Easing program. The Quantitive Easing program is responsible for helping keep Interest rates low by having the Federal Reserve buy $85 billion in US Treasuries and Bonds per month. The QE program was started to help jump start the economy; by keeping interest rates low, companies could afford to borrow money, hire more workers, spend more money, and have consumers/people spend more money. The Quantitive Easing program worked, currently, the economy has improved a lot, consumer, and business spending is up, the stock market is doing well, and unemployment rate is at 7.3%, and has been on a steady decrease. The problem with this massive bond buying program is that it will cause inflation. Because the bond buying program will keep interest rates low, the consumer has more borrowing power, and will spend more money causing prices to increase. In other words, the demand for money will increase because people borrow more at low interest rates, and the supply of money will not increase, causing an increase in prices, and a decrease in purchasing power. As a hawk, Summers will be more concerned with keeping inflation rates low by increasing interest rates. How can he easily increase the interest rate? Stop the QE program. By stopping the program of buying $85 billion in bonds and treasuries per month, the price of bonds decreases, and the interest rate increases.
Although keeping inflation rates low seems like a good idea, higher interest rates will negatively affect the growth of the economy, which worries many investors and economists. The economy is not where most economists would like to see it at; the economy has not recovered to pre-Depression levels. As a result, they fear that the economy is still fragile, and increasing interest rates will only damage the economy, and further slow growth. At the beginning of 2013, Summers seemed like an ideal replacement for Bernanke. Now, however, the economy's growth is below what most economists and analysts predicted, which means that the economy still needs QE, which Summers does not support. This is probably the primary reason that Summers withdrew his name from Fed Chairman; his policies were not favorable/best for the current American economy. Investors in the stock market are concerned with Summers because if interest rates increase, bond yields will increase, and the stock market returns will decrease. The effects of Summers 'drop-out' from Fed Chairman were shown in the markets immediately; the dollar fell, and Dow and S&P 500 futures shot up.

Janet Yellen: Janet Yellen, current Federal Reserve Vice Chairman, is predicted to win the Fed Chairman nomination. Yellen is more dovish then the previously mentioned Larry Summers. By definition of being a dove, Yellen will be more tolerant of increasing inflation rates, and more concerned with lowering the unemployment rate. In Yellen's mid 2000, post-crisis book, she states that "everything the Fed should be doing should be oriented towards addressing the unemployment problem", confirming the "dovish theory". Yellen is also widely recognized as being one of the first people to recognize and predict the looming financial crisis in 2007 that Bernanke thought would be avoided. The Fed's job is to predict the path of the economy, and adjust policies to fix the economy, and she did a perfect job of the prediction part. Another reason why Yellen is favored by many Democrats is because she has no ties to Wall Street, and is in favor of stricter regulations to limit financial losses, like the London Whale loss.