Market Interlude

Interlude
David R. Kotok
Cumberland Advisors, October 22, 2013

We have entered an interlude between the last incarnation of the budget, debt, debt-limit, and sequester confrontation and the next incarnation of the budget, debt, debt-limit, and sequester confrontation. Let’s think of this commentary as potpourri following “Done Deal.”

Item 1. Katie Darden, editor of SNL Financial, corrected an error that we made. The event we had discussed surrounding Congressman Dan Rostenkowski took place in 1989, not 1979. Here is the link to a Chicago Tribune report of that event: http://articles.chicagotribune.com/1989-08-20/news/8901050991_1_rep-dan-rostenkowski-chicago-mercantile-exchange-means-committee. Thank you, Katie, for the correction and for the link so that we may read precisely what citizens can do if they get sufficiently enraged to act.

Item 2. A handful of readers corrected my statement that the Senate had not passed a budget in five years. It has actually been four years. Technically, a budget is passed every time there is a continuing resolution to authorize some spending. I do not know about other readers, but I do not consider that a budget process. I consider that to be an emergency, stop-gap adjustment that is put together because the politicians that we elect have no choice but to do so in order to fund the continuation of government. In fact, you could argue this last budget was not really a fully developed budget.

Item 3. We can witness the disgrace in this process by examining the inclusion of an additional $2.1 billion for the Olmsted Lock and Dam Authority. The developer is URS Corp. This Ohio River project is approaching a cost overrun of four times the original cost estimate. Defenders of the project say it is necessary. Detractors wonder how such earmarking of spending will ever stop. Readers may note that Senator Mitch McConnell says the White House requested the money and argues it was not a “Kentucky kickback” as the conservatives have labeled it. Note that 81 Senators and 285 House Members voted “aye” on the deal. Most of them say they didn’t know the dam-funding extension was in the legislation.

Item 4. Let’s get to the Fed. The debate has swung back to tapering. When, how much, what criteria? We shall know something soon, since the next Fed meeting is at the end of this month. Today’s release of the September employment report is abysmal. It further extends the Fed’s tapering time horizon. The report shows how weak things were before the shutdown. Private sector job growth is declining by many measures; we assume that the shutdown only worsened this trend.

Item 5. Uli Kortsch put together some interviews and is developing a full book sequence from a conference held at the Federal Reserve Bank of Philadelphia. The speakers included Bill Poole, former President of the St. Louis Fed; Lord Adair Turner, former Chair of the British equivalent of the Securities & Exchange Commission; Michael Kumhof of the IMF; Larry Kotlikoff, top economist on intergenerational issues; and economist Jeff Sachs, Director of the Earth Institute at Columbia. I was fortunate to be one of the presenters at that conference. Here is a link to Uli’s video: http://www.youtube.com/watch?v=ZaC1VxQPqtc . The video has excerpts from six presentations, slides, and commentaries. If you have the time to look at it in detail, you might find it worthwhile. For those who would rather have an abbreviated version, here is a link to a conference summary video from the organization that Uli is involved in developing: http://www.realmoneyecon.org/lev2/resources_2video.html.

Item 6. As we anticipate the next iteration of the debt-limit fight, we can draw some clear conclusions from the last crisis. The US is not going to default. Politicians of both parties have come together and agreed on that. The structure and duration of the government shutdown hurt both political parties. It hurt the Republicans more, but it hurt both of them. The question facing them now is whether the citizens have memories long enough to reach to the next election. That will come in a year. Then we’ll find out who is re-electable.

During this interlude, the ball is back in the Federal Reserve’s court. Congress is going to spend the next couple of months dealing with the crazy crisis-resolution process they worked out. It is timed with precision and is set up to lead to another fierce division of viewpoints. In the meantime, the Fed has to meet. It has to deal once more with the question of tapering or no tapering, in the midst of a change of leadership. It has to evolve some policy that is articulated with clarity. Right now, markets are confused about the Fed. They do not know the direction, depth, or timing of policy. The Fed officials know this and have to fix it.

One thing seems clear. The zero-interest-rate limitation in the short-term end of the yield curve is going to persist for at least another couple of years. It may continue a lot longer. The shock of the US government shutdown and the antics of our politicians have only exacerbated the slowing of the US economy.

What does it mean when the short-term interest rate is zero for a long period of time? It means that asset classes have a long and volatile, but favorable, upward bias. On this subject, here is a three-minute interview by Rhonda Shaffler of Reuters. In it, Rhonda asked me a question about the US stock market and why I think it is going to go higher. Here is the link: http://youtu.be/uVAdEsC0bGI .

At this juncture, Cumberland equity accounts are fully and strategically invested around the globe using exchange-traded funds. We think that very-low-interest-rate policies will remain in effect worldwide for some extended period of years. We want to take advantage of them.

Our bond accounts are configured to reflect the duration changes from all of these policy shifts. We are sensitive to credit risk. If we think there is trouble, we want to run fast. The idea is that pressured governments cannot rely on other governments to bail them out. The bailout era, with tons of money thrown precipitously at problems, seems to be drawing to a close. The difference between “bailout” and “bail-in” is a shift of responsibility. Lehman-AIG triggered a bailout. In the next round of trouble, bail-in will mean that risks have risen for the investor. The investor has to perform the risk management now, because the government will not save him or her from the errors that our system is prone to repeat.

We want to thank readers for emails received in response to our commentary entitled “Done Deal!” About 300 responded. To put that into perspective, our primary email list includes approximately 10,000 clients, consultants, referring professionals, and others who request to be on the list. There is no charge to be on the primary list, and people can get on the list by going to our website: http://www.cumber.com/signup.aspx . Secondary distribution of our commentaries has been estimated at about 2 million.

A final note is about something which we find disturbing. Fox Business’ Neil Cavuto interviewed John McAfee about data security, hackers and the Obamacare website rollout. McAfee’s expertise is in internet-related security issues and software security. His suggestions are eye-opening and he doesn’t mince words. Here is the YouTube link: http://www.youtube.com/watch?v=5TCtLtzSe6I.

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David R. Kotok, Chairman and Chief Investment Officer