Dudley Faces Challenge to Ensure U.S. Future for BP (Update1)
By Eduard Gismatullin and Brian Swint
July 26 (Bloomberg) -- Robert Dudley’s biggest challenge at BP Plc will be to ensure the London-based company’s survival in the U.S., where it’s the largest oil and gas producer.
Dudley, poised to become the first American head of the former U.K. state oil company, will need to convince politicians BP should be allowed to keep drilling in the U.S. after a runaway well in the Gulf of Mexico caused the country’s worst oil spill. The Gulf is home to about 25 of the 40 production projects BP plans by 2015.
“It’s a wise choice to pick an American,” said Gudmund Halle Isfeldt, an analyst at DnB NOR ASA in Oslo. “This will take off some of the pressure, but not all of it. For the first time, they can start looking ahead to the future of BP.”
BP’s reputation in the U.S., home to about 40 percent of its shareholders, has been battered by the Gulf disaster. The oil company faces a likely bill of more than $30 billion to pay the cost of cleaning up the spill and compensating its victims. Criminal charges against BP are almost inevitable, according to legal analysts.
The board will meet today to decide on Dudley as Tony Hayward’s successor, according to two people with knowledge of the matter. BP said in a statement today that no final decision has been made on management changes.
For BP to “remain a strong and viable in the U.S., it has a great deal of work to do,” Dudley said in an interview last month.
Dudley’s Gulf coast roots and 30 years of industry experience may ready him to lead the biggest oil producer in the U.S. In a battle for control of BP’s Russian joint venture with a group of billionaires two years ago, Dudley, 54, survived raids by Vladimir Putin’s secret service before being forced to leave the country. As head of drilling in Africa, he oversaw Angola, where BP now pumps from 11 deepwater fields.
Dudley’s nomination “would be positive, and most certainly it would be a strong political move, because he is now in charge of Gulf of Mexico clean-up operations,” said Dirk Hoozemans, who helps manage the equivalent of $19.4 billion at Rotterdam- based Robeco Group and doesn’t own BP. “He also has the political negotiation skills since he did a good job heading up TNK-BP” in Russia.
One of his tasks may be to overcome measures being considered by U.S.’s Congress to bar BP from new offshore leases to drill for hydrocarbons.
Dudley, who was born in New York and grew up in Mississippi, holds a degree in chemical engineering from the University of Illinois and an MBA from Southern Methodist University. He’s married with two children.
He served as one of former BP CEO John Browne’s executive assistants, a position that traditionally leads to bigger roles. Browne wrote in his memoir of how his assistants were known as “Turtles” after the Teenage Mutant Ninja Turtles, because of “their speed and ability to appear whenever they were needed.”
Dudley ran Amoco Corp.’s Russian operations from 1994 to 1997, before its 1998 acquisition by BP. Before running TNK-BP, Dudley oversaw BP’s exploration and production across Russia, the Caspian, Angola, Algeria and Egypt.
“I don’t believe we could have a better person to lead this organization,” current CEO Tony Hayward said last month when he announced Dudley’s role in heading the unit that will take responsibility for the spill.
Dudley grew up in Hattiesburg about 80 miles north of the Gulf Coast and spent summers in Gulfport and Biloxi along the water. During a visit to the area in June he said the damage caused by the spill hit him hard.
“What I saw was painful and emotional, and shocking,” Dudley said after a trip to Louisiana.
Dudley has been a regular on the U.S. television circuit since the early days of the crisis, defending the company’s strategy, and has also sought to spread BP’s message to a business audience.
“Operating at the frontiers of any industry is risky, and it is that trade-off that governments, people, and industry will make together,” he told executives in Boston on May 6.
Dudley’s latest role will put him in front of the world’s media, a spot he last encountered as head of BP’s TNK-BP unit in Russia between 2003 and 2008.
BP’s Russian partners called for Dudley’s dismissal in 2008 in a dispute over strategy at Russia’s third-biggest oil company, alleging he ignored their interests. He denied the charge.
Workers seconded by BP were barred from working in Moscow, while the successor to the Soviet KGB raided its office and an employee was charged with industrial espionage. In the end, Dudley fled the country, citing “sustained harassment” amid court battles and labor and tax inspections.
Dudley continued to run the unit from an undisclosed location, only stepping down as part of a settlement between the factions reached in September 2008.
His efforts in Russia were rewarded with a place on BP’s board and the appointment as managing director for government relations and non-operational matters in the Americas and Asia.
“Surviving Russia shows Dudley can tackle a lot of stress and strain,” said DnB’s Isfeldt. “He maintained BP’s assets in Russia. He is able to work with strong counterparts. This should mean BP can continue into the future without becoming a fully declining oil company.”
BP Board Said to Approve Dudley to Replace Hayward (Update1)
By Stanley Reed
July 26 (Bloomberg) -- The board of BP Plc approved a plan to name Robert Dudley as the company’s chief executive officer, replacing Tony Hayward after the company caused the biggest oil spill in U.S. history, two people familiar with the situation said.
Dudley, the director of BP’s oil spill response unit, will take the helm on Oct. 1, one of the people said, declining to be named before an official announcement tomorrow. The decision was reached in discussions with board members about how best to take BP forward and rebuild its U.S. position, the person said.
“He’s been in charge of the Gulf cleanup, and it seems that he’s been taken reasonably well,” said Colin Morton, who helps manage about $1.4 billion at Rensburg Fund Management in Leeds, England, and holds about 6.5 million BP shares. “Part of this is to appoint somebody whose reputation has not been soiled by the whole thing.”
Hayward has faced public anger in the U.S. and criticism from lawmakers over his handling of the spill that was triggered by an April 20 explosion on the Deepwater Horizon rig, which killed 11 people. Dudley, 54, was born in New York and grew up in Mississippi, part of the Gulf Coast region suffering environmental and economic damage from the spill. BP on June 23 appointed him to manage its response to the leak.
“The fact he is American should help to keep things a little more straightforward in his dealings with the U.S. administration,” said Ted Harper, who helps manage $6.8 billion at Frost Investment Advisors in Houston. He doesn’t hold BP stock. “Dudley’s most important task will continue to be making sure that the well is capped.”
BP rose 4.6 percent to 416.95 pence in London trading today.
BP said today that no announcement would be made on management changes before tomorrow morning, when the company reports its second-quarter earnings.
Hayward may be entitled to receive his pension fund, worth 10.84 million pounds ($16.8 million) at the end of last year, as well as a year’s salary of about 1 million pounds.
The company has seen its market value fall by about 45 billion pounds as it battled to stop the spill. The well has now been sealed, and BP plans to permanently plug it with cement next month.
Dudley has spent about 30 years in the oil industry, including a stint as CEO of BP’s Russian joint venture, TNK-BP, starting in 2003. That job ended after disputes with Russian partners led to Dudley fleeing Russia in 2008, citing “sustained harassment” amid court battles and labor and tax inspections.
While seeking to contain public outrage over the environmental damage, Hayward made several gaffes, including saying he wanted his “life back” and calling the spill “relatively tiny” in a “very big ocean.” The well spewed 35,000 to 60,000 barrels of oil a day from a mile deep in the water, according to a U.S. government-led panel of scientists.
The company’s success capping the runaway well after three months will limit its final liability for the spill to $33 billion, according to the median forecast of analysts surveyed by Bloomberg.
The 40-foot stack of valves halted the flow a week before Tropical Storm Bonnie blew through and forced a temporary halt to drilling of a relief well that will seal the leak for good. Worst-case forecasts for the crisis had pegged the bill as high as $100 billion.
Plosser Says Weaker Data Don’t Yet Justify More Fed Stimulus
By Scott Lanman and Craig Torres
July 26 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said it’s too soon for the Fed to bolster record U.S. monetary stimulus in response to slower- than-forecast gains in economic growth and employment.
“Talk of new efforts to stimulate the economy are premature right now,” Plosser said today in an interview with Bloomberg News in Washington. “I don’t think the data have been sufficiently compelling one way or another.”
Plosser’s viewpoint may help explain why Fed Chairman Ben S. Bernanke last week outlined potential steps to spur growth, including asset purchases, without saying that such actions were imminent. Europe’s debt crisis, U.S. census hiring and the end of a homebuyers’ tax credit make it tough to gauge whether the economy is truly weakening, Plosser said.
Varying economic data make it “very hard from month to month to really get a good signal as to what’s going on,” said Plosser, 61, during a meeting with Bloomberg reporters and editors. He said he hopes “the clouds will begin to clear in the next month or two,” and after that, “we’ll get a little better picture actually of where we stand.”
A government report earlier today showed sales of new U.S. homes rose in June more than forecast following an unprecedented collapse the prior month. At the same time, the 330,000 annual pace was the second-lowest in data going back to 1963 after May’s downwardly revised 267,000 pace.
The Fed has left its benchmark interest rate close to zero since December 2008 and pledged since March 2009 to keep it there for an “extended period.” The central bank also expanded its balance sheet to a near-record $2.34 trillion by purchasing $1.7 trillion of housing-related debt and Treasury securities.
‘Lot of Stimulus’
“We’ve got a lot of stimulus out there right now,” Plosser said without ruling out future action. While the central bank “is not out of bullets,” central bankers have to be sure they’re using the right tool, much as a doctor needs to prescribe the correct medicine to cure a sickness, he said.
Private employers added fewer workers to payrolls in June than economists forecast. The jobless rate has been stuck at 9.5 percent or higher since August and reached 10.1 percent in October, compared with December 1982’s 10.8 percent.
Unemployment may take as long as five or six years to return to its longer-run rate, which Fed officials judge to be 5 percent to 5.3 percent, the central bank said in minutes of its June meeting.
“The number that bothers me more than anything is unemployment,” said Plosser, who joined the Philadelphia Fed as its chief in 2006. He doesn’t vote on interest-rate decisions this year and dissented twice from Federal Open Market Committee actions to lower borrowing costs in March and April 2008. “I’m worried that we’re kind of looking at a longer slog to get through than perhaps I would like.”
In a separate interview with Bloomberg Television today, Plosser said the economy still has “underlying strength” and that the Fed has “ammunition to act if we want to.”
“But I would caution people that the Fed will look at both the costs and benefits of any action that we undertake,” he said.
For instance, “lowering the interest rates closer to zero could have very disruptive effects on the financial markets,” Plosser said. “If we bought Treasury bills we could un-anchor expectations of inflation because the public might begin to think we are going to buy up the public debt.”
The Standard & Poor’s 500 Index has declined about 8.6 percent from its 2010 peak on April 26 amid investor concern Greece might default on its debt and downgrades of other European nations’ credit ratings. The index rose 1.1 percent to 1,115.01 at 4 p.m. in New York today, the highest close since June 18.
Still, waiting for an economic trend to emerge “is a reasonable approach” for the Fed, said Ward McCarthy, chief financial economist at Jefferies & Co. Inc. in New York. “There clearly was a psychological effect from the events in Europe in April and May. The Fed is literally keeping all options open.”
Bernanke said last week that one option to aid the economy is to lower the 0.25 percent rate the Fed pays on the $1 trillion of banks’ excess reserves. Another is to enhance the Fed’s pledge for low rates for an “extended period.” Last year, Canada’s central bank made a specific time commitment.
“I don’t like the calendar time. I’d rather us focus more on what economic conditions should prevail when we begin thinking about that,” Plosser said. In February, he said he was “not a big fan” of the “extended period” phrase, which Kansas City Fed President Thomas Hoenig has voted against at each FOMC meeting this year. Policy makers are scheduled to meet again on Aug. 10.
Economy to Expand
Plosser said he hasn’t reduced his growth forecast much in recent months. The U.S. economy will expand at a 3 percent to 3.5 percent pace over the next two years, he said. Growth in U.S. gross domestic product slowed to a 2.7 percent annual pace in the first quarter, compared with a 3 percent estimate issued in May and a 5.6 percent rate in the last three months of 2009.
Business spending that was “pretty strong” earlier in the year has since slowed, possibly because of “uncertainties about tax policies and fiscal policies,” Plosser said. “When people see the prospects for higher taxes down the road, it makes a difference today about whether they choose to invest or not.”
The inflation risks are “to the upside” over the next two to three years in part because of the $1 trillion of excess bank reserves created by the Fed, Plosser said.
Inflation currently is running below Fed officials’ long- term preferred rate of about 1.7 percent to 2 percent. The core personal consumption expenditures price index, which excludes food and fuel, rose 1.3 percent in May from a year earlier. “I’m not too worried about inflation in the near term,” he said.
U.S. Stocks, Copper Advance as Dollar Declines on Housing Data
By Stephanie Borise and Nikolaj Gammeltoft
July 26 (Bloomberg) -- U.S. stocks rose, erasing the Dow Jones Industrial Average’s 2010 loss, and copper advanced to a 10-week high as the dollar fell after new home sales beat estimates and FedEx Corp. boosted its forecast.
The Dow climbed 100.81 points, or 1 percent, to 10,525.43 at 4 p.m. New York time. The Standard & Poor’s 500 Index gained 1.1 percent to the highest level since June 18, driven by homebuilders and transportation companies. Copper futures increased 1.2 percent, while the dollar weakened against all 16 of its most-traded counterparts including the euro and yen.
Sales of U.S. new homes rose in June more than forecast following an unprecedented collapse the prior month, a signal the worst of the slump triggered by the end of a government tax credit is over. FedEx joined United Parcel Service Inc., the largest package delivery company, in lifting its earnings forecasts. Both are considered harbingers for the economy.
“I’m more optimistic,” said Traxis Partners LLC’s Barton Biggs, who added that he doubled his equity holdings this month after slashing them in half. Biggs returned 38 percent in 2009, triple the industry average. “I’ve definitely changed my mind to the degree of risk out there,” he said.
U.S. companies are beating forecasts, and analysts see the biggest two-year earnings increase since 1995. More than 83 percent of S&P 500 companies have exceeded the average analyst profit estimate since July 12. S&P 500 profits may rise 35 percent in 2010 and 17 percent in 2011, according to forecasts tracked by Bloomberg.
Homebuilders in the S&P 500 rallied 3.6 percent, led by Pulte Group Inc. and Lennar Corp., and copper gained after sales of new U.S. homes increased 24 percent from May to an annual pace of 330,000, figures from the Commerce Department showed. The rate was the second-lowest in data going back to 1963 after May’s downwardly revised 267,000 pace.
The Dow Jones Transportation Average jumped 2.6 percent to the highest level since May 14 after FedEx said higher demand for international express shipments prompted it to raise its earnings forecast. FedEx rallied 5.6 percent in U.S. trading. UPS climbed 1.9 percent. The company said July 22 that the U.S. economy will continue to recover.
Mutual funds, pensions and endowments are spending more on stocks than at any time since the start of the bull market, just as individuals grow the most pessimistic in a year.
Institutions pushed equities up to 68 percent of their holdings in July, the highest level in 15 months, from 63 percent in April, a Citigroup Inc. survey showed. The ratio of bullish to bearish respondents in a survey by the American Association of Individual Investors has fallen to 0.68, the lowest level since July 2009, based on a four-week average.
The last time money managers and individuals were this far apart was in March 2009, before the S&P 500 began its 63 percent rally, according to data compiled by Bloomberg.
European stocks climbed for a fifth day as stress-test results that showed the majority of the region’s banks are adequately capitalized pushed financial companies higher. The Stoxx Europe 600 Index rose 0.5 percent to 257.12, the highest level since June 21.
Allied Irish Banks Plc and Dexia SA rallied more than 5 percent, leading a gauge of banks higher. BP Plc gained 4.6 percent as two people familiar with the matter said the company plans to name Robert Dudley to replace Tony Hayward as chief executive officer. GlaxoSmithKline Plc lost 1.3 percent after a report that the U.K.’s largest drugmaker may be interested in buying Genzyme Corp.
Copper climbed to a 10-week high as shrinking inventories and rising home sales signaled improving demand. Stockpiles monitored by the London Metal Exchange have slumped 7.7 percent in July, the biggest monthly decline since June 2009. Copper for September delivery gained 1.2 percent, to $3.223 a pound. Earlier, the metal touched $3.238, the highest level for a most- active contract since May 13.
The dollar fell 0.7 percent to $1.2993 per euro. Sterling rose to a three-month high against the dollar after the U.K.’s major banks passed European Union stress tests. The dollar dropped for a third day against the euro on reduced demand for the currency as a refuge.
“Risk appetite appears to be returning,” said Omer Esiner, chief market analyst in Washington at Commonwealth Foreign Exchange Inc., a currency brokerage. “There’s definitely a welcome upside surprise to data.”
Corn fell to the lowest price in three weeks, soybeans dropped the most since June and wheat declined for a second session on signs that rain is reviving U.S. crops threatened by dry weather earlier this month.
New single-family home sales increased 23.6% in June to a 330,000 annual rate
Brian S. Wesbury - Chief Economist
Robert Stein, CFA - Senior Economist
New single-family home sales increased 23.6% in June to a 330,000 annual rate, beating the consensus expected pace of 310,000.
Sales were up in the Northeast, Midwest, and South, but down in the West.
At the current sales pace, the supply of unsold new homes declined to 7.6 months in June. Almost all the decline in the months’ supply was due to the faster pace of sales. The actual level of inventories declined 3,000 to 210,000, down 63.3% versus the peak in 2006 and the lowest level since 1968.
The median price of new homes sold was $213,400 in June, down 0.6% from a year ago. The average price of new homes sold was $242,900, down 11.6% versus last year.
Implications: After plunging in May to a record low (dating back to 1963), new home sales rebounded sharply in June. The homebuyer tax credit – which required a contract on a home by the end of April – has obviously had a large influence on the recent volatility of new home sales. New homes were sold at a 422,000 pace in April as people got in their purchases before the tax credit expired, but then plummeted to a 267,000 pace in May. The rebound in June shows that the worst of the tax credit “hangover” may be over, although this is still the second slowest month on record. Given demographic trends, we believe over the next several years the annual rate of sales will eventually increase to 950,000. At present there are only 210,000 new homes in builders’ inventories, the fewest since 1968, when the US population was 35% smaller than it is now. At the recent pace of sales, it would take 7.6 months for builders to sell this inventory. However as the pace of sales gradually increases back to 950,000, the months’ supply will fall to a record low of 2.6, assuming builders keep the number of available homes unchanged at current levels. In turn, this signals that home building has been so slow for so long that there is room for builders to increase construction activity.
The Good, Bad and Ugly of Austerity
Brian S. Wesbury - Chief Economist
Robert Stein, CFA - Senior Economist
Governments all over the world have hit the wall. It doesn’t matter where we look: national, state and local government budgets are in crisis. This cannot continue. Major policy shifts are underway. The time for austerity has come.
There are three types of austerity. Good, bad, and ugly. Good austerity is the kind that puts the pain on the government sector. Bad austerity is the kind that tries to spread the pain across the public and private sectors. Ugly austerity is the kind that tries to put all the pain on the private sector.
The extent of the crisis first became apparent in Europe where governments have pushed taxation to the limit and then promised and spent even beyond that. Pensions are unaffordable, spending is out of control, and government regulations to try and keep it all glued together are unbearable.
The problems are now spreading to state and local government in America. So far, at least, the backlash against US federal government spending is political, not financial. The US government can still borrow at 3%, or less, for ten years. But Americans are looking around the world, and at their own state budgets, and seeing the eventual problems to come.
The problem is that taxation can only go so far. No matter how many government programs are deemed “necessary” and a fundamental right of “social justice,” the economy can only support so much redistribution before falling apart.
Ugly austerity comes in the form of higher taxes. It requires workers and investors to transfer more resources to the government today, so that the government can continue to transfer money to politically favored groups. In a way, policymakers who favor this course of action are saying that in order to avoid higher taxes in the future we should just start paying higher taxes today. (What a bargain!)
The other problem with this course – which is what will happen in the U.S. at the start of next year if all or part of the 2001/03 tax cuts are allowed to expire – is that economists across the political spectrum agree that higher taxes will slow economic growth compared to what it would otherwise be. Maybe that’s why several Congressional Democrats have recently gone public with their opposition to raising tax rates next year.
Higher taxes, by cutting growth, don’t generate as much revenue as estimated. A vicious cycle of higher taxes, slower growth, more debt, and even higher taxes is the result.
Bad austerity mixes in spending cuts. Prominent examples of this can be seen in Europe. In the United Kingdom, spending is being cut back, but the value-added tax is going up by 2.5 percentage points to 20%. Greece did a mixture as well. The problem in Europe, and in many US states, is that spending is so high already that taxation cannot possibly pay for it all. Many of these government entities have already gone into a death spiral, where tax rates are already too high and higher tax rates end up reducing the size of the economy.
This leaves good austerity, which comes in the form of spending cuts, which quite literally force policymakers to transfer fewer resources to those they favor. Politically this is very difficult, but the real argument against it is economic.
Keynesians (like Paul Krugman) argue that spending cuts hurt the economy. But nothing could be further from the truth. The benefit of spending cuts is that they can set off a virtuous cycle, reducing expectations of future taxes while invigorating the incentive to participate in the private sector. Every dollar less in government spending, whether financed by taxation or borrowing, means a dollar more in private sector spending. This is unambiguously positive for the macro-economy. Of course, those who have counted on government for business or transfer payments do not see it this way.
But voters and taxpayers, who were not around when promises were made, don’t feel beholden to support them. This is why political pressure to hold the Bush tax cuts in place is so plainly visible. The age of austerity for government has arrived. The only question is what form that austerity will take.
Minnesota Government Mistreats Ladies
Recently the Minnesota Department of Human Rights — a funny title in itself — declared that the practice of "ladies' night" was illegal gender discrimination. Apparently, five establishments in the Twin Cities area were denying men "full and equal enjoyment" of their services because they charged women lower cover and drink prices.
Besides the unjust (and absurd) violation of private-property rights, the Minnesota government's harassment of businesses will end up hurting female and male customers. The practice of price discrimination — charging different customers different prices even for the "same" good or service — is economically beneficial.
Price Discrimination Is Common
Businesses discriminate against customers all the time, charging some of them higher prices than others. For example, food items will often have corresponding coupons, provided either by the grocery store itself or by the manufacturer. In addition, many grocery stores now have special membership clubs, where a shopper has to fill out a form to obtain a card or a tab to put on a key ring. Even though they are buying the same goods as other shoppers, those who have coupons or are members of the club will be charged lower prices on particular items.
An even more "discriminatory" practice occurs at the movie theater. There, people are charged different prices for "the same" ticket depending on their age, and whether or not the customer is a student. Specifically, senior citizens, young children, and students receive discount prices, while middle-aged persons with full-time jobs have to pay full freight.
So we see that price discrimination is ubiquitous. The only thing rare about the practice of ladies' night is that the discrimination is based on the sex of the customer, as opposed to the customer's age or the possession of a coupon.
Price Discrimination Is Efficient
In Austrian economics, any voluntary exchange between consenting parties is "efficient," in the sense that both parties expect to benefit from the trade. (That's why they agree to it!) However, even in the broader sense of mainstream economics, price discrimination can promote economic efficiency. In other words, even mainstream economists recognize the role that price discrimination can play in allowing producers and consumers to exploit potential gains from trade.
Think of it like this: Suppose the government cracks down on movie theaters that charge different prices based on age and educational status. This action would clearly make the owners of the movie theaters worse off. After all, they had the option of charging a uniform price beforehand, and yet they chose to make their prices vary according to the identity of the customer. Therefore, the movie-theater owners are obviously hurt by the crackdown on price discrimination.
In the new equilibrium, the theaters would charge a price somewhere in between the original range. For example, if the theaters originally charged $8 full price, $5 for senior citizens and students, and $4 for children, then perhaps in the new equilibrium the theaters would charge everyone $6.
In this case, not just the theater owners but also a large portion of their customers would obviously be hurt by the new regulation. Specifically, senior citizens, students, and families with at least two young children would all pay more to go to the movies than they did before. Unless they derived psychic pleasure from living in a "fairer" society, the government crackdown on movie-ticket price discrimination would hurt them.
Yet we can't even conclude that the other customers benefit. For one thing, people often prefer to watch movies with a bigger crowd, especially for comedies or blockbuster thrillers, because it makes the event more special. Under the new one-size-fits-all pricing, the crowds will probably be smaller on average, so more middle-aged theatergoers will find themselves the only demographic in the crowd.
Beyond that, the theater owners will find ways to cut back on their expenses in order to compensate for their reduced revenues. We know their revenues will have dropped, because the theater business is one of high fixed costs and low marginal costs. In other words, once they had already got the theater up and running, and purchased the rights to show major motion pictures, the theater owners then decided to tinker with their prices in order to bring in as much revenue as possible. Whether they sell 10 tickets or 100 tickets to a particular show, the expenses of having someone work the ticket counter, sell concessions, and clean up the theater afterward are practically the same. But this means that when the government forces the theater to change its pricing policy, the theater necessarily suffers a loss in revenues.
At the lower revenues, and with fewer customers overall (since senior citizens and students have a lot more free time than the people who pay full fare), the theater may decide to shut down its second concession stand. This means the line for popcorn may be longer than it was under price discrimination. With fewer students and kids going to shows, the theater might also shut down the video arcade, since it doesn't bring in enough quarters to justify its continued maintenance.
In extreme cases, some theaters — which had originally relied on a large volume of senior citizens, students, and young children — may shut down altogether. We can imagine a situation where a small town originally supported two theaters: one a brand-new multiplex with stadium seating and an excellent sound system, the other a run-down, old-school auditorium. But because of the location of the older theater, close to the local high school, it captured a large fraction of the students on any given night who went out to the movies.
Yet in the new equilibrium, when both theaters are forced by the government to charge higher prices for students than they did originally, perhaps the number of students who go to the movies on any given night might go down by 20 percent. Yet because of their unequal reliance on student customers, the multiplex might see its total ticket sales to students drop by only 5 percent, while the older theater sees its sales to students drop a devastating 50 percent. This is because those students who were very cost conscious were the ones going to the older theater in the first place.
Depending on the numbers, it's possible that because of the government's crackdown on price discrimination, the older theater has to shut down altogether. In this case, even the middle-aged theatergoers would be hurt by the crackdown. It's little comfort to be charged a "fair" price when the business stops offering the service altogether.
The Minnesota Government Doesn't Know How to Treat a Lady
A similar analysis applies to the Minnesota government's crackdown on "ladies' night." In the first place, the move obviously hurts bar owners and female patrons. Less obvious, the policy can make the male customers worse off, because the bars might respond by hiring fewer wait staff, spending less on bringing in quality musicians, cutting costs by carrying a smaller selection of beers, and so forth. In other words, even though the narrow price of "entry into the bar" and "price of a beer" might go down for the male customers, the quality of those goods might be so reduced that the men prefer the original situation with "unfair" pricing.
Beyond these subtleties, there are two obvious reasons that men benefit from the existence of ladies' night: First, if the government forces bars to charge women full price for drinks, it will often be men paying for them. Second, the whole point of ladies' night is to fill a bar with women, so that men want to go to the bar (and buy drinks at full price). That's the reason it's profitable for a bar owner to have ladies' night.
So while it's true that a few men may applaud the Minnesota government's actions (as a few comments on the internet discussion boards suggest), in general most men will be hurt — especially when they realize that fewer women will go out to the bar if the practice of ladies' night is rendered illegal.
Following Bastiat, Henry Hazlitt said the mark of a good economist was that he could trace out the seen and the unseen effects of a government policy. As their crackdown on ladies' night demonstrates, the bureaucrats in Minnesota's Department of Human Rights are not good economists.
Turning Bread into Stones
[Alchemists of Loss • By Kevin Dowd and Martin Hutchinson • Wiley, 2010 • 432 pages]
Worrying that their friends on Wall Street are liable to blow themselves up any day with complex financial products and strategies, Congress has passed and Obama has signed 2,300-plus pages of financial reform that provides "an architecture reflective of the 21st century in which we live, but also one that would rebuild that trust and confidence," claims Senator Christopher Dodd who was the lead sausage grinder on the senate version of the bill.
Ostensibly, the purpose of this bill isn't to make Wall Street bigger and to consolidate the banking industry; it's to "protect consumers and lay the foundation for a stronger and safer financial system, one that is innovative, creative, competitive, and far less prone to panic and collapse," President Obama said after Dodd had gathered enough signatures.
Well right, in a perfect world where you wanted to inspire innovation, creativity, competitiveness, and have a financial system that's panic free, you'd immediately start with 2,300 pages of gobbledygook that has been crafted on the fly by Washington lawyers and staffers while great financial minds like Dodd, Barney Frank, Nancy Pelosi, and Harry Reid calmly think through the details and repercussions.
Of course the constant carping has been that there just hasn't been enough regulation: that crazy laissez-faire Bush administration dismantled all the financial regulation don't you know. The real fact is, even the average Podunk bank operating as a holding company not only has a state regulator, but the Federal Reserve, the FDIC, or the OTS, or the OCC regulating them. Not to mention all the business licensing and whatnot that's required on the local level.
Treasury Secretary Tim Geithner testified that AIG had
regulators in 20 different states being responsible for the primary regulation and supervision of AIG's U.S. insurance subsidiaries. Despite AIG's foreign insurance activities being regulated by more than 130 foreign governments, and despite AIG's holding company being subject to supervision by the Office of Thrift Supervision (OTS), no one was adequately aware of what was really going on at AIG.
There's been plenty of government regulating, and as regulations grow, the incidences of financial booms and panics grow in step, as Kevin Dowd and Martin Hutchinson chronicle in their wonderful new book Alchemists of Loss: How Modern Finance and Government Intervention Crashed the Financial System. Looking back at financial crises, the authors note "the impacts of rampant speculation, government involvement or poor government responses, misguided monetary polices, ill-designed regulation and misunderstood new financial technology, as well as the oft-repeated failure on the part of policy makers and legislators to draw the appropriate lessons from painful experiences" have been constant themes.
Dowd and Hutchinson put the latest crisis in the context of history. They point out that government intervention and misguided regulations were culprits in all financial meltdowns. Austrians may have a few bones to pick with the authors on a couple minor points, but all in all, the strength of the book is its free-market view of the current crisis that shines a bright light on the rampant belief in dubious notions like Modern Financial Theory that include the efficient-market hypothesis and Modigliani-Miller theorem.
Combine loose money with flawed financial theories and the creation of byzantine financial products, and ultimately modern financial alchemy "has a distinctly statist and paternalist tone, and one which, taken to its logical conclusion, implies the establishment of nothing less than a world government with the power to redistribute most of our income at will," explain the authors.
The end of the partnership era on Wall Street, which allowed management and ownership to separate and shed personal liability, has lead to excess risk-taking. Of course, Washington's new financial regulation does nothing about this. Michael Douglas's Wall Street character Gordon Gecko famously made the point that Teldar Paper management themselves owned but a tiny fraction of company stock and weren't acting in its best interest but were earning big salaries for merely sending memos back and forth to each other.
Managers who are not owners, Dowd and Hutchinson point out, are most interested in earning higher salaries for themselves at the expense of the long-term success of the company. So managements are as short-term oriented as Wall Street and Washington are. Managements reduce dividends, engage in creative accounting, trade equity for debt, and reduce research and development costs all to juice up short-term operating profits and their bonuses, while denigrating their company's long-term financial health.
The authors rightly take issue with corporate-finance textbooks that claim that stock options align the interests of managers and shareholders, noting that "stock options often magnify the incentives of executives to take risks that boost short-term earnings at the expense of long-term corporate health."
Finance was once just a small portion of the US economy, but by 2007 it had mushroomed into being over a quarter of the S&P 500, after being only 5 percent of the index back in 1980 — and this doesn't count the financial affiliates of companies like GE. As the authors point out, finance is the largest sector of the US economy, so college graduates believe the road to riches lies with pushing paper, creating complex financial securities, and jockeying risk-management models.
Financial leverage has been heightened at all levels, blessed by the likes of Modigliani and Miller whose theorem implies leverage is irrelevant. With all institutions adopting the same risk management strategies, along with borrowing their way to gargantuan size and the major banks all being interconnected, the potential for panics is heightened and panicked governments believe no one can be allowed to fail.
Modern Financial Theory says you can diversify your way to safety because all information is known, so no one can out perform the market by picking individual investments. This meant that new financial products needed to be created to be part of the diversified portfolio basket. As the quants took over, short-term paper that masqueraded as long-term in the form of auction-rate bonds was created along with Collateralized Debt Obligations (CDOs), CDO squareds, and exotic derivatives based on these products like Credit Default Swaps (CDS).
These products served to grow Wall Street exponentially. All stocks in the S&P in 1957 had a market value of $220 billion. By the end of 2008, that index had a value of $9 trillion, according to the authors, but the real action was in derivatives, which totaled $518 trillion that year, "or about ten times the Gross Global Product."
With government cheerleading for homeownership, Wall Street got in the game with "rating agency mathematicians ... 'proving' that default rates would be low," no matter the poor quality underwriting, done not by Jimmy Stewart à la It's a Wonderful Life, but by an aggressive mortgage salesman on commission. CDS owners jumped on this opportunity to profit by the new financial nonsense and the CDS market grew to $62 trillion at its peak, while the entire market for home mortgages was only $12 trillion. Sold as an insurance to hedge against credit risk, the CDS market morphed into speculation.
Dowd and Hutchinson write that it is government meddling that creates the environment for financial crisis. Deposit insurance and other consumer protection schemes like Securities and Exchange Commission regulation make the average Joe and Jane believe that the government will make them whole no matter what happens. The authors also believe the destigmatization of bankruptcy has caused Americans to overborrow, lowering savings rates along with ethical standards.
Booms and busts, crises and crashes will continue ad infinitum, and the authors believe eventually this will lead to declines in the real economy as well as the financial-services sector. As Austrian theory dictates, malinvestments must be liquidated in the bust, and that includes financial-sector jobs, leaving New York with ghost buildings in the financial district and empty luxury condo towers. For the city of London, Hutchinson and Dowd see the future as being even worse.
Mr. Dowd has written plenty about free banking, and he'd like to fix all of this not with 2,300 pages of additional regulation, but "with a commodity standard, free banking (no central bank) and financial laissez-faire, restrictions on the use of the 'limited liability' corporate form, and the most limited government." The authors seek a "new Age of Economic Reason," abandoning "the philosopher's stone of universal government meddling sought by that sublime Paracelsus of economic alchemy — John Maynard Keynes."
Unfortunately, the Keynesians in the Obama White House likely aren't asking for Messrs. Dowd and Hutchinson's phone numbers: their program is to stimulate, regulate, and keep the zero rate.
Never mind that this hasn't worked any other time and won't this time either.
Our Totalitarian Regulatory Bureaucracy
In Chapter 5 of The Road to Serfdom ("Planning and Democracy"), F.A. Hayek warned that the state need not directly control all or even most of the means of production to exert totalitarian control over the economic life of the nation. He cited the example of Germany where, as of 1928, "the central and local authorities directly control the use of more than half the national income … 53 percent." (As the first director of the Austrian Institute for Business Cycle Research, Hayek was familiar with such statistics.)
In addition to this, Hayek wrote, private industry in Germany was so heavily regulated that the state controlled, indirectly, "almost the whole economic life of the nation." It was through such totalitarian economic controls that Germany travelled down the road to serfdom. As Hayek further stated,
There is, then scarcely an individual end which is not dependent for its achievement on the action of the state, and the "social scale of values" which guides the state's action must embrace practically all individual ends.
In other words, government regulation was so pervasive that the pursuit of profit, driven by consumer preferences and demands, was mostly replaced by the whims of regulatory bureaucrats. Ludwig von Mises recognized this as one of the great evils of regulation in his book Bureaucracy. The more time any business person spends catering to the demands and dictates of government bureaucrats, the less time is spent serving consumers in order to earn profits and survive economically.
It may sound shocking to some, but modern-day America compares "favorably" to fascist Germany of the 1930s with regard to the degree to which the state interferes with and controls economic activity. First of all, government expenditures at all levels of government account for about 40 percent of national income. It differs by a few percentage points, year by year, but it has been in the 40 percent range in the past few years. This doesn't count all of the off-budget government agencies that exist at the federal, state, and local levels of government as James Bennett and I documented in our book, Underground Government: The Off-Budget Public Sector. If this is included, government expenditures as a percentage of national income would be at least 45 percent, which is not so far from the 53 percent in Nazi Germany that Hayek alluded to.
In addition, as George Reisman pointed out in "The Myth that Laissez Faire Is Responsible for Our Present Crisis," there are nine executive-branch cabinet departments in the federal government that exist for the purpose of regulating, controlling, and regimenting housing, transportation, healthcare, education, energy, mining, agriculture, labor, and commerce. That pretty much covers the entire economy.
According to the White House website, there are also hundreds of federal regulatory agencies and commissions, among the better known of which are the Army Corps of Engineers, Bureau of Alcohol, Tobacco and Firearms, Commodity Credit Corporation, Commodity Futures Trading Commission, Consumer Product Safety Commission, Department of Veterans Affairs, Drug Enforcement Administration, Employment and Training Administration, Employment Standards Administration, Environmental Protection Agency, Equal Employment Opportunity Commission, Farm Credit Administration, Federal Aviation Administration, Federal Communications Commission, Federal Deposit Insurance Corporation, Federal Election Commission, Federal Energy Regulatory Commission, Energy Efficiency and Renewable Energy Commission, Federal Highway Administration, Federal Trade Commission, Nuclear Regulatory Commission, and others. New "commissions" are being formed all the time, and their budgets and responsibilities expanded. This is a short list. In addition, there are now more than 73,000 pages of regulations in tiny print in The Federal Register instructing all Americans how their lives are to be regulated by these bureaucratic monstrosities.
On top of all of this, state and local governments have literally thousands of regulatory agencies and commissions that regulate everything from allergies to zoos. As just one example, taken from the statelocalgov.net, the state of Alabama has regulatory agencies and commissions that regulate retirement systems, geological surveys, public health, education, conservation and natural resources, industrial relations, agriculture, seniors, tourism and travel, veterans affairs, environmental management, forensic science, business development, rehabilitation, banking, insurance, labor, transportation, youth services, children's affairs, film making, ports, disabilities, arts, real estate, oil and gas, forests, ethics, surface mining, alcoholic beverages, auctioneers, and "faith-based initiatives." And Alabama is a relatively conservative state with a modest-sized government compared to, say, New York, California, or Washington DC. Local governments are also active in regulating most of the things that are on the list for the state of Alabama.
Then there's the Fed. In addition to attempting to fix prices (interest rates) and causing perpetual boom-and-bust cycles with its monetary manipulation, the Fed performs dozens of regulatory functions. According to a Fed publication entitled "The Federal Reserve System: Purposes and Functions," the Fed regulates bank holding companies, state-chartered banks, foreign branches of member banks, edge and agreement corporations, state-licensed branches, agencies, and representative offices of foreign banks, nonbanking activities of foreign banks, national banks, savings banks, nonbank subsidiaries of bank holding companies, financial reporting procedures, accounting policies of banks, business "continuity" in case of economic emergencies, consumer protection laws, securities dealings of banks, information technology used by banks, foreign investment by banks, foreign lending by banks, branch banking, bank mergers and acquisitions, who may own a bank, capital "adequacy standards," extensions of credit for the purchase of securities, equal opportunity lending, mortgage disclosure information, reserve requirements, electronic funds transfers, interbank liabilities, Community Reinvestment Act subprime lending demands, all international banking operations, consumer leasing, privacy of consumer financial information, payments on demand deposits, "fair credit" reporting, transactions between member banks and their affiliates, truth in lending, and truth in savings.
Because of the inevitable failures of all government planning in a democracy, Hayek wrote that "the conviction [will grow] that if efficient planning is to be done, the direction must be 'taken out of politics' and placed in the hands of experts — permanent officials or independent autonomous bodies." Moreover, "the cry for an economic dictator is a characteristic stage in the movement toward [central] planning." This indeed describes many of the above-mentioned agencies and commissions, but is especially descriptive of all the central planning "czars" who now hold office in the federal government. These include the following, as of July 2010: Afghanistan czar, AIDS czar, auto-recovery czar, border czar, California-water czar, car czar, central-region czar (Middle East, Persian Gulf, Afghanistan, Pakistan, and South Asia), climate czar, domestic-violence czar, drug czar, economic czar (Paul Volcker), energy and environment czar, faith-based czar, government-performance czar, Great Lakes czar, green-jobs czar, Guantanamo-closure czar, health czar, information czar, intelligence czar, science czar, stimulus-accountability czar, pay czar, regulatory czar, Sudan czar, TARP czar, Technology czar, terrorism czar, urban-affairs czar, weapons czar, WMD-policy czar, war czar, oil czar, manufacturing czar, cybersecurity czar, safe-school czar, Iran czar, Mideast-peace czar.
In sum, it would be very difficult to argue against the proposition that the US economy today is even more heavily controlled, regulated, and regimented by the state than Germany was at the time Hayek wrote The Road to Serfdom. Americans have travelled many miles down the road to serfdom by deluding themselves that the god of democracy will somehow save them from statist slavery. But as Hayek warned 56 years ago, "There is no justification for the belief that, so long as power is conferred by democratic procedure, it cannot be arbitrary…"
The exercise of arbitrary or dictatorial power is, of course, the whole purpose and function of all those agencies, commissions, and czars.
Obama Defines Dysfunction With One Appointment: Kevin Hassett
Commentary by Kevin Hassett
July 26 (Bloomberg) -- If Democrats wonder why their political fortunes have shifted so much, they should study the appointment of Craig Becker to a body that adjudicates labor disputes.
It captures everything that is wrong with the Obama administration in a nutshell. Republicans should study the case of Becker as well, as it illustrates everything that is wrong with Washington. Democrats should run from Becker; Republicans should run against him.
One of President Barack Obama’s first acts in office was signing Executive Order 13502, which urged agencies to consider requiring that contractors who do government work use unionized workers. Construction workers everywhere have seen hard times in this recession, but Obama gave preference to those who pay union dues that eventually support Democrats’ election campaigns.
This wasn’t exactly what voters expected from the man who promised to change the tone of Washington, but it got worse. Obama launched a dizzying flurry of actions designed to reward organized labor at the expense of everyone else.
Perhaps the low point was his attempt to appoint Becker to the National Labor Relations Board.
The NLRB is the panel responsible for issuing judgments in disputes between workers and private-sector employers. Specifically, the board is responsible for protecting the bargaining and organizing rights of workers as defined by the National Labor Relations Act of 1935, which sets limits on the practices of unions and employers.
Becker, the former associate general counsel for the Service Employees International Union, is an unusual choice to be an impartial judge because of his pro-union views. In a 1998 article, Becker stated that “At first blush it might seem fair to give workers the choice to remain unrepresented. But, in granting this option, U.S. labor law grants employers a powerful incentive to campaign for a vote of no representation.”
Naturally, these opinions alarm employers worried about increased unionization through potential changes to statutes regarding union election procedures.
Obama nominated Becker for the seat in April 2009. This spring, Senate Republicans threatened a filibuster of the nomination. Becker could have been confirmed if he simply held on to the 60 votes that then existed in the Senate Democratic caucus. The doubts surrounding his appointment were too much even for Democrats. Obama gave Becker a temporary recess appointment in March.
Controversy erupted when Becker seemed to violate an ethics statement made during his confirmation hearing. Becker pledged to abide by an ethics rule stating that he would “not for a period of two years from the date of my appointment participate in any particular matter involving specific parties that is directly and substantially related to my former employer.” Since then, he turned around and began weighing in on cases involving local chapters of the SEIU.
In one case, dealing with an SEIU chapter at a California hospital, the NLRB decided to administer nothing more than a wrist slap to a local that attempted to intimidate workers opposed to the union.
In another case, the NLRB sided with an SEIU local in deciding that interns and residents at hospitals aren’t “students,” a ruling that may lead to a wave of unionization at hospitals.
Absolved of Wrongdoing
Becker argued that he didn’t need to recuse himself because the “SEIU is a separate and distinct legal entity from the many local labor organizations affiliated with the SEIU.” NLRB Inspector General David Berry concurred with that assessment, ruling that Becker didn’t violate his ethics pledge when voting on cases involving SEIU locals.
Becker has been absolved of any wrongdoing, and the ruling is supported by longstanding practice at the NLRB. The legal reasoning is, however, questionable.
For example, the SEIU’s own constitution implies that the locals are intricately woven into the parent organization. Among other things, the parent has jurisdiction over the local unions, can direct an examination of its books, the president of the organization can direct local unions or appoint a trustee to take charge of it. A local union isn’t even allowed to pay bills before it mails its monthly membership check to union headquarters.
Moreover, the ruling violates the spirit at least of federal ethics laws, which dictate that executive appointees endeavor to avoid even the appearance that they are violating ethical standards, and the appearance should be “determined from the perspective of a reasonable person.”
If Obama wanted to find a place for someone as talented but problematic as Becker, he easily could have appointed him to a position elsewhere in the administration where he took on more partisan activities. But assigning him to be an impartial judge is a punch to the nose of anyone who cares about justice and fairness.
In Becker’s place, Obama could have appointed some little- known ideologue who would have had the same impact without the potential conflicts of interest. Instead, he chose to reward his union buddies, and antagonize his adversaries.
How sad that the Obama who was so inspirational in 2008 has become so partisan that he would appoint an SEIU attorney to adjudicate cases involving the union’s local chapters, and hide behind an ethics report that violates any standard of common sense.
(Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He was an adviser to Republican Senator John McCain in the 2008 presidential election. The opinions expressed are his own.)
June Sales of U.S. New Homes Climb More Than Forecast (Update2)
By Courtney Schlisserman
July 26 (Bloomberg) -- Sales of U.S. new homes rose in June more than forecast following an unprecedented collapse the prior month, a signal the worst of the slump triggered by the end of a government tax credit is over.
Purchases increased 24 percent from May to an annual pace of 330,000, figures from the Commerce Department showed today in Washington. The rate was the second-lowest in data going back to 1963 after May’s downwardly revised 267,000 pace.
The lowest mortgage rates on record may help underpin demand, stabilizing the industry that triggered the worst recession since the 1930s. Even so, increasing foreclosures are swelling the number of unsold existing homes, putting pressure on prices and keeping buyers on the sidelines as unemployment hovers near 10 percent and the economy cools.
Sales are “bouncing along the bottom,” said Eric Green, chief market economist at TD Securities Inc. in New York, who forecast an increase to 335,000. “The future is going to be dependent on job growth. There’s no demand because confidence is weak and employment is weak.”
Stocks extended prior gains following the report. The Standard & Poor’s 500 Index rose 0.7 percent to 1,110.16 at 10:17 a.m. in New York. The S&P Supercomposite Homebuilder Index climbed 3.1 percent.
Economists forecast sales would rise 3.3 percent to an annual pace of 310,000, according to the median of 73 projections in a Bloomberg News survey. Estimates ranged from 260,000 to 360,000.
The government had initially estimated May sales at a 300,000 rate and revised down figures for every month since March. The 37 percent plunge in May was the biggest on record.
The median price decreased 0.6 percent from June 2009 to $213,400.
Purchases increased in three of four regions, led by a 46 percent jump in the Northeast and a 33 [percent surge in the South, the largest area. Demand dropped 6.6 percent in the West to a record low 57,000 pace.
The supply of homes at the current sales rate fell to 7.6 months’ worth from 9.6 months in May. There were 210,000 new houses on the market at the end of June, the fewest since 1968.
To become eligible for a federal incentive worth up to $8,000, buyers had to sign contracts by April 30 and close deals by the end of last month. The surge in demand prior to the April deadline prompted the government this month to extend the closing deadline until Sept. 30 to ensure buyers had enough time to complete transactions.
Purchases of previously-owned homes, which are tabulated when a contract closes, fell a less-than-forecast 5.1 percent in June, sustained by a backlog of deals waiting to settle, figures from the National Association of Realtors showed last week.
New home sales are calculated when a contract is signed. The drop in sales in May came after demand reached an almost two-year high the prior month, according to last month’s Commerce Department data.
Builder shares have dropped this year as the housing outlook dimmed. The S&P Supercomposite Homebuilder Index, which includes Toll Brothers Inc. and Lennar Corp., has fallen 5.4 percent from Dec. 31 through July 23, while the S&P 500 Index is down 1.1 percent.
With the deadline for signing a contract now past, it will be up to advances in the labor market to support home sales. Private U.S. companies added 83,000 jobs in June, fewer than economists had forecast, and initial jobless claims have averaged 449,700 this month, a sign firings remain elevated.
Another challenge to new home sales is the rising tide of foreclosures. Home seizures jumped 38 percent in the second quarter from a year earlier, RealtyTrac Inc. said last week, putting lenders on pace to claim more than 1 million properties this year.
NVR Inc., based in Reston, Virginia, said last week the original June 30 closing deadline to qualify for the tax incentive resulted in a “surge in settlement activity” in the second quarter, with closings jumping 63 percent from the same time a year earlier. New orders fell six percent in the second quarter to 2,559 units.
Homebuilders turned more pessimistic this month, with the National Association of Home Builders/Wells Fargo confidence index dropping to 14, the lowest level since April 2009, according to data released last week.
Stock Buying Hits Bull Market Record at Mutual Funds (Update2)
By Lynn Thomasson
July 26 (Bloomberg) -- Mutual funds, pensions and endowments are spending more on stocks than at any time since the start of the bull market, just as individuals grow the most pessimistic in a year.
Institutions pushed equities up to 68 percent of their holdings in July, the highest level in 15 months, from 63 percent in April, a Citigroup Inc. survey showed. The ratio of bullish to bearish respondents in a survey by the American Association of Individual Investors has fallen to 0.68, the lowest level since July 2009, based on a four-week average.
The last time money managers and individuals were this far apart was at the beginning of 2009, before the Standard & Poor’s 500 Index began its 63 percent rally, according to data compiled by Bloomberg. It may signal another buying opportunity after concern the U.S. economy will fall into a recession wiped out $1.5 trillion from American equity values since April, according to Fritz Meyer, a Denver-based senior market strategist at Invesco Ltd., which oversees $558 billion.
“That’s good news,” Meyer said. “The retail guy has gotten it wrong more than gotten it right. The odds favor a continued, reasonably healthy economic expansion.”
The U.S. equity benchmark has posted an average return of 8.8 percent in the 12 months after individuals’ skepticism rose this high in the past 23 years, according to data compiled by Bloomberg. Bulls are betting that forecasts for the fastest U.S. profit growth in 15 years and economic expansion averaging 3 percent through 2012 will help equities recover after the S&P 500 fell 13 percent in May and June.
Stocks rallied today after new-home sales in the U.S. topped the median economist forecast and FedEx Corp., the Memphis, Tennessee-based package-delivery company, raised its earnings projection. The S&P 500 climbed 0.9 percent to 1,112.25 at 12:23 p.m. New York time.
Bonds are a better investment than stocks, Jamil Baz, who helps oversee $23 billion as chief investment strategist for London-based hedge fund GLG Partners LP, told Bloomberg Television’s “InsideTrack” on July 22. Government reports this month showing private employers in the U.S. added fewer jobs than forecast in June and the lowest level of housing starts in eight months raised concern the economic recovery will falter.
Equities advanced last week as the S&P 500 gained 3.6 percent, poised for the biggest monthly increase since July 2009. Companies from Atlanta-based United Parcel Service Inc., the world’s largest package-delivery company, to Dallas-based AT&T Inc., the biggest U.S. phone company, climbed after increasing profit forecasts.
The rally trimmed the index’s loss since April 23 to 9.4 percent. Equities slid the most since the bull market began in May and June on concern Europe’s debt crisis would derail the global economic recovery. Shares rebounded in the past three weeks as 84 percent of the 149 S&P 500 companies that reported results since July 12 topped the average analyst earnings estimates, Bloomberg data show.
Profits may rise an average 35 percent in 2010 and 17 percent in 2011, according to forecasts tracked by Bloomberg. More than 160 S&P 500 companies are scheduled to post quarterly results this week, including Irving, Texas-based Exxon Mobil Corp., the biggest U.S. oil producer.
Confidence among smaller investors was shaken by the May 6 plunge that erased $862 billion from the market value of U.S. stocks in 20 minutes and the last bear market, said Frederic Dickson, chief market strategist at D.A. Davidson & Co. Professional investors are more likely to base decisions on the prospects for the biggest two-year advance in earnings among S&P 500 companies since 1995, according to Invesco’s Meyer.
“My money is on the institutions getting it right,” said John Lynch, chief equity strategist at the Wells Fargo Funds Management division of San Francisco-based Wells Fargo & Co. that oversees $465 billion. Smaller investors “are reluctant to get back in until there is a clearer path, and we know that once the path is clear, it becomes a ‘greater-fool’ theory because the institutions will have already anticipated it.”
The AAII measure of pessimism peaked on July 8 at 57 percent, the most since March 5, 2009. Bullishness has averaged 29 percent during the past four weeks, compared with 45 percent who were bearish, according to the weekly survey.
Start of Rally
The last time optimism fell this low relative to pessimism was July 17, 2009, one week after the S&P 500 began a 25 percent rally, data compiled by AAII and Bloomberg show. The Chicago- based group takes answers from a few hundred people each week through its website on whether they are bullish, bearish or neutral on the stock market for the next six months, according to editor Charles Rotblut.
“Individual investors were spooked by the May 6 flash crash and they’re wondering if the stock market is a fair game,” said Dickson, chief market strategist at Great Falls, Montana-based D.A. Davidson, which oversees $25 billion. “Professionals realize there have been changes in the market to prevent a repeat of that. I don’t think that’s been communicated broadly to the retail investor.”
The May 6 selloff briefly sent the Dow Jones Industrial Average down 9.2 percent, the biggest intraday loss since 1987, before it pared the drop to 3.2 percent. A “mismatch of liquidity,” selling in exchange-traded funds that fed into stocks, and the use of market orders turned an orderly decline into a rout, a report by federal regulators said May 18.
The Securities and Exchange Commission is testing a program through December that pauses trading for 5 minutes when an S&P 500 stock rises or falls 10 percent or more in less than 5 minutes. U.S. exchanges also offered rules last month to standardize the process for canceling erroneous stock trades.
Individuals may limit gains in the S&P 500 as concerns about the economy and Europe’s debt crisis keep them out of the market, said Leo Grohowski of BNY Mellon Wealth Management. Federal Reserve Chairman Ben S. Bernanke said the economic outlook remains “unusually uncertain” in testimony to the Senate Banking Committee on July 21.
Investors have withdrawn $41.2 billion from mutual funds that hold U.S. stocks since April 2009, while piling more than $470 billion into bond funds, according to data compiled by the Washington-based Investment Company Institute. Individuals accounted for the majority of U.S. mutual fund assets in 2009, owning 84 percent, the data show.
Hedge funds that wager on both gains and losses in equities have boosted speculation shares will fall, according to Bank of America Corp. The lightly regulated private pools of capital have on average 27 percent more money in bets on rising prices than falling prices, below the historical average of 35 percent to 40 percent, based on data from the Charlotte, North Carolina- based bank.
“You’re seeing equities struggle because valuations and fundamentals look pretty good to the institutional investor, but the policy headwinds, the questions around sovereign debt, the macro concerns, are really worrying individual investors,” said Grohowski, who oversees more than $150 billion as chief investment officer at BNY Mellon Wealth Management in Boston. “There’s not one right and one wrong. We think the market is pretty reasonably valued.”
The S&P 500 trades at 15.3 times annual earnings, compared with an average of 16.5, according to data compiled by Bloomberg that dates back to 1954. The index is cheaper relative to estimated earnings for the next 12 months, with a multiple of 12, the data show.
Mutual funds, endowments, hedge funds and pensions say they’re preparing for a rally, according to Citigroup’s questionnaire from 120 respondents among those groups. Fifty- four percent said U.S. equities may gain 10 percent to 20 percent, compared with 50 percent in the previous reading.
Bill Miller, chairman and chief investment officer of Legg Mason Capital Management, said in a letter to investors last week that this is a “once-in-a-lifetime opportunity” to buy stocks of large U.S. companies. BlackRock Inc., the world’s largest asset manager, is “overweight” U.S. equities, said Bob Doll, vice chairman and chief equity strategist of the New York- based firm in a July 20 interview on Bloomberg Television’s “Morning Call with Susan Li.”
“It’s been the individual investor that’s been a good contrarian indicator,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC, which oversees $50 billion in Philadelphia. “The stock market will continue to advance. It may be a grinding process, but it will continue to advance, ultimately pulling along retail investors that are notorious for buying high and selling low.”