Thursday, January 24, 2008

Sep 07, we were warned

SuperModels9/20/2007 12:01 AM ET
Are we headed for an epic bear market?

The credit bubble is just starting to unwind, a credit-derivative insider says. And while U.S. borrowers are being blamed for the mess, they were really just pawns in a global game.
By Jon Markman

Satyajit Das is laughing. It appears I have said something very funny, but I have no idea what it was. My only clue is that the laugh sounds somewhat pitying.

One of the world's leading experts on credit derivatives, Das is the author of a 4,200-page reference work on the subject, among a half-dozen other tomes. As a developer and marketer of the exotic instruments himself over the past 30 years, he seemed like the ideal industry insider to help us get to the bottom of the recent debt crunch -- and I expected him to defend and explain the practice.

I started by asking the Calcutta-born Australian whether the credit crisis was in what Americans would call the "third inning." This was pretty amusing, it seemed, judging from the laughter. So I tried again. "Second inning?" More laughter. "First?"

Still too optimistic. Das, who knows as much about global money flows as anyone in the world, stopped chuckling long enough to suggest that we're actually still in the middle of the national anthem before a game destined to go into extra innings. And it won't end well for the global economy.
An epic bear market
Das is pretty droll for a math whiz, but his message is dead serious. He thinks we're on the verge of a bear market of epic proportions.

The cause: Massive levels of debt underlying the world economy system are about to unwind in a profound and persistent way.

He's not sure if it will play out like the 13-year decline of 90% in Japan from 1990 to 2003 that followed the bursting of a credit bubble there, or like the 15-year flat spot in the U.S. market from 1960 to 1975. But either way, he foresees hard times as an optimistic era of too much liquidity, too much leverage and too much financial engineering slowly and inevitably deflates.

Like an ex-mobster turning state's witness, Das has turned his back on his old pals in the derivatives biz to warn anyone who will listen -- mostly banks and hedge funds that pay him consulting fees -- that the jig is up.

Rather than joining the crowd that blames the mess on American slobs who took on more mortgage debt than they could afford and have endangered the world by stiffing lenders, he points a finger at three parties: regulators who stood by as U.S. banks developed ingenious but dangerous ways of shifting trillions of dollars of credit risk off their balance sheets and into the hands of unsophisticated foreign investors; hedge and pension fund managers who gorged on high-yield debt instruments they didn't understand; and financial engineers who built towers of "securitized" debt with math models that were fundamentally flawed.

Jim Jubak
What the Fed can’t do
Investors are abuzz over the Fed’s interest-rate decision, but the Federal Reserve can’t fix everything, cautions MSN Money’s Jim Jubak. Lower interest rates alone won’t boost confidence in the debt market.

"Defaulting middle-class U.S. homeowners are blamed, but they are merely a pawn in the game," he says. "Those loans were invented so that hedge funds would have high-yield debt to buy."
The liquidity factory
Das' view sounds cynical, but it makes sense if you stop thinking about mortgages as a way for people to finance houses and think about them instead as a way for lenders to generate cash flow and create collateral during an era of a flat interest-rate curve.Although subprime U.S. loans seem like small change in the context of the multitrillion-dollar debt market, it turns out these high-yield instruments were an important part of the machine that Das calls the global "liquidity factory." Just like a small amount of gasoline can power an entire truck given the right combination of spark plugs, pistons and transmission, subprime loans became the fuel that underlays derivative securities many, many times their size.

Continued: How it worked

Here's how it worked: In olden days, like 10 years ago, banks wrote and funded their own loans. In the new game, Das points out, banks "originate" loans, "warehouse" them on their balance sheet for a brief time, then "distribute" them to investors by packaging them into derivatives called collateralized debt obligations, or CDOs, and similar instruments. In this scheme, banks don't need to tie up as much capital, so they can put more money out on loan.

The more loans that were sold, the more they could use as collateral for more loans, so credit standards were lowered to get more paper out the door -- a task that was accelerated in recent years via fly-by-night brokers now accused of predatory lending practices.

Buyers of these credit risks in CDO form were insurance companies, pension funds and hedge-fund managers from Bonn to Beijing. Because money was readily available at low interest rates in Japan and the United States, these managers leveraged up their bets by buying the CDOs with borrowed funds.

So if you follow the bouncing ball, borrowed money bought borrowed money. And then because they had the blessing of credit-ratings agencies relying on mathematical models suggesting that they would rarely default, these CDOs were in turn used as collateral to do more borrowing.

In this way, Das points out, credit risk moved from banks, where it was regulated and observable, to places where it was less regulated and difficult to identify.
Turning $1 into $20
The liquidity factory was self-perpetuating and seemingly unstoppable. As assets bought with borrowed money rose in value, players could borrow more money against them, and it thus seemed logical to borrow even more to increase returns. Bankers figured out how to strip money out of existing assets to do so, much as a homeowner might strip equity from his house to buy another house.

These triple-borrowed assets were then in turn increasingly used as collateral for commercial paper -- the short-term borrowings of banks and corporations -- which was purchased by supposedly low-risk money market funds.

According to Das' figures, up to 53% of the $2.2 trillion commercial paper in the U.S. market is now asset-backed, with about 50% of that in mortgages.

When you add it all up, according to Das' research, a single dollar of "real" capital supports $20 to $30 of loans. This spiral of borrowing on an increasingly thin base of real assets, writ large and in nearly infinite variety, ultimately created a world in which derivatives outstanding earlier this year stood at $485 trillion -- or eight times total global gross domestic product of $60 trillion.

Without a central governmental authority keeping tabs on these cross-border flows and ensuring a standard of record-keeping and quality, investors increasingly didn't know what they were buying or what any given security was really worth.
A painful unwinding
Now here is where the U.S. mortgage holder shows up again. As subprime loan default rates doubled, in contravention of what the models forecast, the CDOs those mortgages backed began to collapse. Because they were so hard to value, banks and funds started looking at all CDOs and other paper backed by mortgages with suspicion, and refused to accept them as collateral for the sort of short-term borrowing that underpins today's money markets.

Through late last month, according to Das, as much as $300 billion in leveraged finance loans had been "orphaned," which means that they can't be sold off or used as collateral.

... How's that working for ya?

Monday, January 14, 2008

definitely far more serious than anyone would have thought

I'll say it again, it's the ACCELERATION, stupid!...

A scramble to understand Greenland's melting ice sheets
By Andrew C. Revkin
Monday, January 7, 2008

The ancient frozen dome cloaking Greenland is so vast that pilots have crashed into what they thought was a cloud bank spanning the horizon. Flying over it, one can scarcely imagine that this ice could erode fast enough to raise sea levels dangerously any time soon.

Along the flanks in spring and summer, however, the picture is very different. For a lengthening string of warm years, a lacework of blue lakes and rivulets of meltwater have been spreading ever higher on the ice cap. The melting surface darkens, absorbing up to four times as much energy from the sun as unmelted snow, which reflects sunlight. Natural drainpipes, called moulins, carry water from the surface into the depths, in some places reaching bedrock. The process slightly, but measurably, lubricates and accelerates the grinding passage of ice toward the sea.

Most important, many glaciologists say, is the breakup of huge semi-submerged clots of ice where some large Greenland glaciers, particularly along the west coast, squeeze through fjords as they meet the warming ocean. As these passages have cleared, this has sharply accelerated the flow of many of these creeping, corrugated, frozen rivers.

All of these changes have many glaciologists "a little nervous these days - shell-shocked," said Ted Scambos, the lead scientist at the National Snow and Ice Data Center in Boulder, Colorado, and a veteran of both Greenland and Antarctic studies.

Some say they fear that the rise in seas in a warming world could be much greater than the upper estimate of about two feet in this century made last year by the Intergovernmental Panel on Climate Change. (Seas rose less than a foot, or 30 centimeters, in the 20th century.) The panel's assessment did not include factors known to contribute to ice flows but not understood well enough to estimate with confidence. All the panel could say was, "Larger values cannot be excluded."

A scientific scramble is under way to clarify whether the erosion of the world's most vulnerable ice sheets, in Greenland and West Antarctica, can continue to accelerate. The effort involves field and satellite analyses and sifting for clues from past warm periods, including the last warm span between ice ages, which peaked about 125,000 years ago and had sea levels 12 to 16 feet higher than today's.

The Arctic Council, representing countries with Arctic territory, has commissioned a report on Greenland's ice trends, to be completed before the 2009 round of climate-treaty talks in Copenhagen, at which the world's nations have pledged to settle on a long-term plan for limiting human-caused global warming.

Konrad Steffen, a University of Colorado glaciologist who has camped on the shoulders of Greenland's ice sheet each year since 1990, is a United States author working on that study. Last August, he and a team focusing on the ways meltwater might affect ice movement dropped a camera 330 feet, or 100 meters, down a water-filled moulin to explore whether the plumbing system can be mapped.

Research on alpine glaciers shows that as more water flows through such apertures, ice can shift more quickly. But eventually large sewer-like conduits form, limiting the lubrication effect. The camera drop was only an initial test.

Alberto Behar, a NASA engineer who designed the camera, said some unconventional methods were being considered to chart the flow of such water. "We had ideas to send rubber ducks down and see if they pop out in the ocean," he said. "They'd have a little note saying, 'Please call this number if you find me.' "

The changes seen in Greenland may turn out to be self-limiting in the short run; surging glaciers can flatten out and slow, for instance. Or they may be a sign that the island's ice - holding about the same volume of water as the Gulf of Mexico - is poised for a rapid discharge. Scientists are divided on that question, and also on whether there is a near-term risk from a Texas-size portion of West Antarctica's ice sheet that is also showing signs of instability. This split divides those foreseeing a rise in the sea level of a couple of feet this century from water added by Greenland, West Antarctica and fast-vanishing mountain glaciers, and a few experts who speak of a couple of meters in that time.

Those holding a more conservative view of Greenland's near-term fate include Richard Alley of Pennsylvania State University, who noted that ice cores and tests of organic material from beneath the ice imply that the main core of the Greenland ice sheet clearly endured thousands of years of warming in the past without vanishing.

"It's basically a big lump of ice sitting on this bedrock," Alley said in describing Greenland's behavior in warm conditions. "What it tries to do is snow more in the middle and melt more on the edges. If it pulls its edges back, then there's less area to melt, and that helps it survive. That's why you can have a stable ice sheet in a warmer climate."

But there is no significant debate on the long-term picture any more: Should greenhouse-gas emissions follow anything close to a "business as usual" rise, the resulting warming and ice loss at both ends of the earth would cause coasts to retreat for centuries to come. While it was circumspect about near-term changes, the intergovernmental panel was confident about that long view.

The prospect of having no "normal" coastline for the foreseeable future has many scientists deeply concerned.

"What is at stake is the stability we have always taken for granted" both for coasts and climate itself, said Jason Box, an associate professor of geography at Ohio State University. Box presented fresh findings at the American Geophysical Union meeting last month showing that several Greenland glaciers accelerated sharply in direct response to warming, both in a warm spell starting in the 1920s and now.

Eric Rignot, a longtime student of ice sheets at both poles for NASA's Jet Propulsion Laboratory, said he hoped that the public and policymakers did not interpret the uncertainty in the 21st-century forecast as reason for complacency on the need to limit risks by cutting emissions.

Rignot recently proposed that unabated warming could result in three feet of global sea rise just from water flowing off Greenland, three feet from Antarctica and 18 inches, or 46 centimeters, as the remaining alpine glaciers shrivel away.

This is similar to projections by the most prominent NASA climate scientist, James Hansen, but more than twice the three-foot rise that many glaciologists seem to agree on as an outer bound for what is possible by century's end.

"It is too early to reassure that all will stabilize, and similarly there is no way to predict a catastrophic collapse," Rignot said. "But things are definitely far more serious than anyone would have thought five years ago."

...Houston, YOU have a problem.

Wednesday, January 09, 2008

Follow the Heebner

"Everything in this market has been poisoned by the Federal Reserve," said Cramer, adding the only sectors worth investing in are oil, infrastructure, agriculture, aerospace/defense, health care cost-containment and gold. "We may have lost the tech stocks," warned Cramer adding he would only trust a company like Microsoft which makes its numbers. Out of the 4,000 or more stocks Cramer keeps his eye on, he would only pick 40 or 70, including PEP, MO, KO and MHS.

Follow the Heebner: Posco (PKX), Arcelor (MT), Vimpel (VIP), Mobile Telesystems (MBT), Research In Motion (RIMM), Canadian Natural Resources (CNQ), Suncor (SU), Petroleo Brasileiro (PBR), Cnooc (CEO), CVRD (RIO), Rio Tinto (RTP), BHP Billiton (BHP), Freeport McMoRan (FCX), McDermott (MDR), Foster Wheeler (FWLT), and Fluor (FLR)

In tough times, Cramer recommends piggybacking off successful investors like Ken Heebner of the CGM Focus fund which is ranked third and increased 79.9% in 2007. Cramer noted Heebner recently sold HANs, MA and RIG, and thinks he should have held onto RIG. Cramer noted recent buys include PKX, MT, VIP, MBT, RIMM, CNQ, SU, PBr, CEO, RIO, RTP, BHP, FCX, MDR, FWLT and FLR, and concluded these moves confirm that infrastructure, oil, mining are bull markets.

How to live forever (or a real long time anyway)

Abolishing ageing
How to live forever
Jan 3rd 2008From The Economist print edition
It looks unlikely that medical science will abolish the process of ageing. But it no longer looks impossible
Stephen Jeffrey
“IN THE long run,” as John Maynard Keynes observed, “we are all dead.” True. But can the short run be elongated in a way that makes the long run longer? And if so, how, and at what cost? People have dreamt of immortality since time immemorial. They have sought it since the first alchemist put an elixir of life on the same shopping list as a way to turn lead into gold. They have written about it in fiction, from Rider Haggard's “She” to Frank Herbert's “Dune”. And now, with the growth of biological knowledge that has marked the past few decades, a few researchers believe it might be within reach.
To think about the question, it is important to understand why organisms—people included—age in the first place. People are like machines: they wear out. That much is obvious. However a machine can always be repaired. A good mechanic with a stock of spare parts can keep it going indefinitely. Eventually, no part of the original may remain, but it still carries on, like Lincoln's famous axe that had had three new handles and two new blades.

The question, of course, is whether the machine is worth repairing. It is here that people and nature disagree. Or, to put it slightly differently, two bits of nature disagree with each other. From the individual's point of view, survival is an imperative. You cannot reproduce unless you are alive. A fear of death is a sensible evolved response and, since ageing is a sure way of dying, it is no surprise that people want to stop it in its tracks. Moreover, even the appearance of ageing can be harmful. It reduces the range of potential sexual partners who find you attractive—since it is a sign that you are not going to be around all that long to help bring up baby—and thus, again, curbs your reproduction.

The paradox is that the individual's evolved desire not to age is opposed by another evolutionary force: the disposable soma. The soma (the ancient Greek word for body) is all of a body's cells apart from the sex cells. The soma's role is to get those sex cells, and thus the organism's genes, into the next generation. If the soma is a chicken, then it really is just an egg's way of making another egg. And if evolutionary logic requires the soma to age and die in order for this to happen, so be it. Which is a pity, for evolutionary logic does, indeed, seem to require that.
The argument is this. All organisms are going to die of something eventually. That something may be an accident, a fight, a disease or an encounter with a hungry predator. There is thus a premium on reproducing early rather than conserving resources for a future that may never come. The reason why repairs are not perfect is that they are costly and resources invested in them might be used for reproduction instead. Often, therefore, the body's mechanics prefer lash-ups to complete rebuilds—or simply do not bother with the job at all. And if that is so, the place to start looking for longer life is in the repair shop.

Seven deadly things
One man who has done just that is Aubrey de Grey. Dr de Grey, who is an independent researcher working in Cambridge, England, is a man who provokes strong opinions. He is undoubtedly a visionary, but many biologists think that his visions are not so much insights as mischievous mirages, for he believes that anti-ageing technology could come about in a future that many now alive might live to see.
Vision or mirage, Dr de Grey has defined the problem precisely. Unlike most workers in the field, he has an engineering background, and is thus ideally placed to look into the biological repair shop. As he sees things, ageing has seven components; deal with all seven, and you stop the process in its tracks. He refers to this approach as strategies for engineered negligible senescence (SENS).
The seven sisters that Dr de Grey wishes to slaughter with SENS are cell loss, apoptosis-resistance (the tendency of cells to refuse to die when they are supposed to), gene mutations in the cell nucleus, gene mutations in the mitochondria (the cell's power-packs), the accumulation of junk inside cells, the accumulation of junk outside cells and the accumulation of inappropriate chemical links in the material that supports cells.
It is quite a shopping list. But it does, at least, break the problem into manageable parts. It also suggests that multiple approaches to the question may be needed. Broadly, these are of two sorts: to manage the process of wear and tear to slow it down and mask its consequences, or to accept its inevitability and bring the body in for servicing at regular intervals to replace the worn-out parts.
Eat up your greens
Managing wear and tear may not be as complicated as it looks, for the last five items on Dr de Grey's list seem to be linked by a single word: oxidation. Regular visitors to the “health and beauty” sections of high-street pharmacies will, no doubt, have come across creams, pills and potions bearing the word antioxidant on their labels and hinting—though never, of course, explicitly saying—that they might possibly have rejuvenating effects. These products are the bastard children of a respectable idea about one of the chief causes of ageing: that one big source of bodily wear and tear, at least at the chemical level, is the activity of the mitochondria.
Mitochondria are the places where sugar is broken down and reacted with oxygen to release the energy needed to power a cell. In a warm-blooded creature such as man, a lot of oxygen is involved in this process, and some of it goes absent without leave. Instead of reacting with carbon from the sugar to form carbon dioxide, it forms highly reactive molecules called free radicals. These go around oxidising—and thus damaging—other molecules, such as DNA and proteins, which causes all sorts of trouble. Clear up free radicals and their kin, and you will slow down the process of ageing. And the chemicals you use to do that are antioxidants.
This idea goes back to one of the founders of scientific gerontology, Bruce Ames of the University of California, Berkeley. Dr Ames began his career studying cancer. He found that damage to certain genes was a cause of cancer. These genes evolved to keep tumours at bay by stopping cells dividing too readily, and the damage was often done by oxidation. Gradually, his focus shifted to the more general damage that oxidation can do—and what might, in turn, be done about it.
Some vitamins, such as vitamin C, are antioxidants in their own right. This is the basis of the high-street propaganda, though there is no evidence that consuming such antioxidants in large quantities brings any benefit. A few years ago, however, Dr Ames found he could pep up the activity of the mitochondria of elderly rats—with positive effects on the animals' memories and general vigour—by feeding them two other molecules: acetyl carnitine and lipoic acid. These help a mitochondrial enzyme called carnitine acetyltransferase to do its job. Boosting their levels seems to compensate for oxidative damage to this enzyme. He also reviewed the work of other people and found about 50 genetic diseases caused by the failure of one enzyme or another to link up with an appropriate helper molecule. Such helpers are often B vitamins, and the diseases were often treatable with large doses of the appropriate vitamin.
The enzyme damage in these diseases is similar to that induced by oxidation, so Dr Ames suspects that its effects, too, can be ameliorated by high doses of vitamins. He has gathered evidence from mice to support this idea, but whether it is the case in people has yet to be tested. Nor is it easy to believe it ever will be. The necessary clinical trials would be long-winded. They would also be expensive—and there is no reason for vitamin companies to pay for them since sales are already buoyant and the products could not be patented. Nor is Dr Ames claiming vitamins will make you live longer than a natural human lifespan, even if he thinks they might prolong many individual lives. For that, other technologies will need to be invoked.
Stemming time's tide
One way that might let people outlive the limit imposed by disposable somas is to accept the machine analogy literally. When you take your car to be serviced or repaired, you expect the mechanic to replace any worn or damaged parts with new ones. That, roughly, is what those proposing an idea called partial immortalisation are suggesting. And they will make the new parts with stem cells.
The world has heard much of stem cells recently. They come in several varieties, from those found in embryos, which can turn into any sort of body cell, to those whose destiny is constrained to becoming just one or a few sorts of cell. The thing about stem cells of all types, which makes them different from ordinary body cells, is that they have special permission to multiply indefinitely.
For a soma to work, most of its component cells have to accept they are the end of the line—which, given that that line in question stretches back unbroken to the first living organisms more than 3 billion years ago, is a hard thing to do. There are, therefore, all sorts of genetic locks on such cells to stop them reproducing once they have arrived at their physiological destination. If these locks are picked (for example by oxidative damage to the genes that control them, as discovered by Dr Ames), the result is unconstrained growth—in other words, cancer. One lock is called the Hayflick limit after its discoverer, Leonard Hayflick. This mechanism counts the number of times a cell divides and when a particular value (which differs from species to species) is reached, it stops any further division. Unless the cell is a stem cell. Every time a stem cell divides, at least one daughter remains a stem cell, even though the other may set off on a Hayflick-limited path of specialisation.
Some partial immortalisers seek to abolish the Hayflick limit altogether in the hope that tissue that has become senescent will start to renew itself once more. (The clock that controls it is understood, so this is possible in principle.) Most, though, fear that this would simply open the door to cancer. Instead, they propose what is known as regenerative medicine—using stem cells to grow replacements for tissues and organs that have worn out. The most visionary of them contemplate the routine renewal of the body's organs in a Lincoln's axish sort of way.
In theory, only the brain could not plausibly be replaced this way (any replacement would have to replicate the pattern of its nerve cells precisely in order to preserve an individual's memory and personality). Even here, though, stem-cell therapists talk openly of treating brain diseases such as Parkinson's with specially grown nerve cells, so some form of partial immortalisation might be on the cards. But it is a long way away—further, certainly, than Dr Ames's vitamin therapy, if that is shown to work.
Neither prevention, nor repair, is truly ready to roll out. But there is one other approach, and this is based on the one way of living longer that has been shown, again and again, in animal experiments, to be effective. That is to eat less.
From threadworms to mice, putting an animal on a diet that is near, but not quite at, starvation point prolongs life—sometimes dramatically. No one has done the experiment on people, and no one knows for sure why it works. But it does provide a way of studying the problem with the reasonable hope of finding an answer.
Gluttons for punishment
You would, of course, have to wish a lot for a long life to choose to starve yourself to achieve it. Extrapolating from the mouse data, you would need to keep your calorie intake to three-quarters of the amount recommended by dieticians. That means about 1,800 for sedentary men and 1,500 for sedentary women. But several people are trying to understand the underlying biology, in order to develop short cuts.
One such is David Sinclair of Harvard University. Unlike those trying to fight the causes of ageing or to repair the damage done, Dr Sinclair thinks he has found, in caloric restriction as the technique is known, a specifically evolved natural anti-ageing mechanism that is quite compatible with disposable-soma theory.
The reason for believing that prolonged life is an evolutionary response to starvation rather than just a weird accident is that when an animal is starving the evolutionary calculus changes. An individual that has starved to death is not one that can reproduce. Even if it does not die, the chance of it giving birth to healthy offspring is low. In this case, prolongation of life should trump reproduction. And that is what happens, even among people. Women who are starving stop ovulating. The billion-dollar trick would be to persuade the body it is starving when it is not. That way people could live longer while eating normally. They might even, if the mechanism can truly be understood, be able to reproduce, as well.
In Dr Sinclair's view, the way caloric restriction prolongs life revolves around genes for proteins called sirtuins. Certainly, these genes are involved in life extension in simple species such as threadworms and yeast. Add extra copies of them to these organisms' chromosomes, or force the existing copies to produce more protein than normal, and life is prolonged. This seems to be because sirtuins control the abundance of a regulatory molecule called nicotinamide adenine diphosphate which, in turn, controls the release of energy in the mitochondria.
The most intriguing connection in this story is with the French paradox. This is the fact that the French tend to eat fatty diets rich in red meat but to have the survival characteristics of those whose diets are lean and vegetarian. Some researchers link this with their consumption of red wine—and, in particular, of a molecule called resveratrol that is found in such wine. Resveratrol activates sirtuins, and some similar molecules activate them much more. It is these sirtuin super-stimulators that interest Dr Sinclair.
Not everyone is convinced, but Dr Sinclair has done experiments on mice that look promising, and has started a company called Sirtris Pharmaceuticals to follow it up. The fact that he is (at least in his own eyes) working with nature rather than against it argues that this is the most promising approach of all.
That said, the logic of the disposable-soma theory is profound. Even working with its grain may do no more than buy a few extra years of healthy living. Dr de Grey's reason for thinking that some people now alive may see their lives extended indefinitely is based on the hope that those few extra years will see further discoveries and improved life-extension technologies based on them—a process he describes as achieving “longevity escape velocity”.
The chances are that it will not work. But hope springs eternal. To end with another quote, this time from Woody Allen, “I don't want to achieve immortality through my work. I want to achieve immortality through not dying.” If any researcher manages to beat evolutionary history and achieve his goal, he might get to do both.

Friday, January 04, 2008

Jubak's Journal1/4/2008 12:01 AM ET
Is '70s-style stagflation returning?
Inflation is rising and the economy is decelerating, but those problems don't add up to that nasty combination of stagnant growth and out-of-control price increases. Yet.
By Jim Jubak
Stagflation is coming. Lock up your portfolio. We could be on our way to a replay of the 1970s.
That's the worry among an increasing number of investors as we head into 2008. It's certainly possible for the year ahead, but it's unlikely. In this column, I'll look at what would have to go wrong for stagflation to return and how to position a portfolio if you think stagflation is more of a danger than I do.
The '70s have a lot to answer for:
"Airport," "Airport 1975," "Airport '77" and "Airport '79."
The Village People and "YMCA."
The breakup of the Beatles.
President Jimmy Carter and the killer rabbit.
Sonny Bono's bell bottoms.
And stagflation, that lethal brew of stagnant growth and high inflation.
In the United States, headline inflation started off the decade at 5.5% in 1970, peaked at 12.2% in 1974 and again at 13.3% in 1979, and didn't drop below 4% until 1982. For the '70s as a whole, inflation averaged 7.4% annually. In comparison, inflation in the 1960s averaged 2.5% annually.
Real economic growth tumbled. Subtracting for inflation, the economy grew by just 3.27% on average from 1970 to 1979, quite a drop from the 4.44% average annual growth in real gross domestic product recorded from 1960 to 1969. And in two years during the 1970s, after subtracting for inflation, the economy actually declined in size -- by 0.5% in 1974 and 0.2% in 1975.
As you might expect, the 1970s weren't a great time for investors. The Standard & Poor's 500 Index ($INX) returned a compound annual 5.9% from 1970 to 1979. With inflation running at an annual 7.4%, an investor in the stock market was losing ground every year to inflation. Bond investors had it even worse: The compound annual return on a long-term U.S. Treasury bond for the decade was just 4.8%, 2.6 percentage points lower than the inflation rate.
So you can understand why the prospect of stagflation in 2008 would send shivers up investors' spines. How likely is that scenario? Let me break down stagflation into its two parts, the "stag" and the "flation." I'll deal with "flation" first.
The 'flation' part of the equationIs high inflation coming back? Yes.
The Federal Reserve and the European Central Bank, the two most important inflation fighters in the world, are worried that inflation is too high. Headline inflation, the number the European Central Bank watches, was 3.1% in November in Europe, way above the bank's 2% limit. In the United States, headline inflation was 4.3% in November.
The Fed's preferred measure of core inflation -- headline inflation minus any increases in volatile food and energy prices -- was a lower 2.3%. (Energy prices were up 21% in the month, so leaving them out of the inflation calculation helped.) But even that was above the Fed's comfort zone.
For the "flation" part of stagflation to set in, those rates have to go higher and create the expectation that inflation is headed out of control.
Video on MSN Money

Jubak’s Journal: A turnaround for the dollar?The US dollar could turn out to be the big comeback surprise of 2008. One reason: As foreign investors put big money into US companies, those foreign countries are less likely to dump the dollar, MSN Money's Jim Jubak says.
Unfortunately, higher inflation is coming from every direction you care to look. Normally, the Federal Reserve and the European Central Bank would move to stomp out inflation by raising interest rates. Now, thanks to a weakening U.S. economy and turmoil in the debt markets, the Fed is lowering interest rates instead, and both banks are flooding the financial markets with short-term cash.
China, Russia and other emerging-market economies determined to keep their currencies from gaining against the dollar are creating money to buy dollars, inflating their own currencies, and that money is fueling booms in stock and real-estate markets. Inflation hit 6.9% in China in November, for example. And these countries are exporting some of their inflation in the form of higher prices for developed-world customers such as Wal-Mart Stores (WMT, news, msgs). Demand from these fast-growing economies for raw materials is driving up the price of coal, iron ore, corn, wheat, oil -- just about every commodity you can name. A falling U.S. dollar is driving up the cost of everything the country imports, from oil to children's toys.
Normally, the Federal Reserve could count on a slowing economy to take a bit of wind out of inflation's sails. But many of the current causes of inflation aren't linked to the U.S. economy. We could get inflation and slower growth -- the definition of stagflation.
Continued: How we get to 'stag'
How we get to 'stag'So what's the "stag" part of stagflation look like as we begin 2008?
The economy seems to be decelerating rapidly:
According to the latest data, released Dec. 27 but dating to the end of October, home prices are falling at a record rate. The S&P/Case-Shiller index of home prices in 10 major metropolitan areas dropped 6.7% from October 2006. That's a record year-to-year decline, beating the old record of 6.3%, set in April 1991.
That decline is feeding into a whopping increase in credit card delinquencies. The dollar amount of credit card debt at least 30 days late jumped 26%, to $17.3 billion, in October 2007 from the same month of 2006, according to an Associated Press study of 325 million individual accounts held by the 17 largest credit card trusts.
Retail sales in the just-concluded Christmas shopping season appeared weaker than projected, with growth in same-store sales running below estimates of 2.5%, according to the International Council of Shopping Centers. All this is starting to hit the real economy where it counts: in the unemployment numbers. Initial claims for unemployment, a good gauge for what's going on in the job market, rose to 350,000 in the week that ended Dec. 22. That left the four-week moving average for initial claims at 343,000. That's getting worryingly close to the 360,000 level in the four-week moving average that has accompanied recessions in 1990 (362,000) and 2001 (373,000).
But as bad as this news is, it doesn't add up to the "stag" in "stagflation."
What was so excruciating about the stagflation of the 1970s was the duration of the "stag." Slow or negative growth went on for quarter after quarter. After growing at a 4.7% real rate in the second quarter of 1973, real economic growth turned negative, dropping by 2.1% in the third quarter. The economy then rebounded to a 3.9% real growth rate in the fourth quarter of 1973 before heading into the Dumpster. The economy showed negative 3.4% real growth in the first quarter of 1974, a minor revival to a positive 1.2% growth rate in the second quarter and then three straight negative quarters of 3.8%, 1.6% and 4.7%.
No wonder the bear market in stocks of 1973 and 1974 was so painful. Stocks fell 14.7% in 1973 and then 26.5% in 1974.
Right now, no one on Wall Street is looking for a repeat of that extended slump. Growth is supposed to slow in the first half of 2008 and then pick up, leaving growth for 2008 at 2.3%, according to the Federal Reserve. I think that forecast is too optimistic. The slump in 2008 is likely to last for more than just the two quarters Wall Street expects.
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Jubak’s Journal: A turnaround for the dollar?The US dollar could turn out to be the big comeback surprise of 2008. One reason: As foreign investors put big money into US companies, those foreign countries are less likely to dump the dollar, MSN Money's Jim Jubak says.
But I still don't expect a recession in 2008 (see "Why the Fed is running scared") and certainly not anything like the negative growth in five out of seven quarters that the economy turned in from mid-1973 to early 1975. (Officially a recession is two consecutive quarters of negative economic growth.)
Not over yetWhat could tip us from slow growth -- either the two quarters that Wall Street expects or the three to four that I think is likely (see "Don't count on a 'normal' recession") -- into 1970s-style stagnation?
An expansion of the credit crunch from its current victims -- home buyers who can't find a mortgage and homeowners who can't refinance a mortgage -- to corporate borrowers with decent credit ratings. If companies can't raise capital on decent terms, they'll cut spending on new equipment and construction, then eliminate plans for hiring, then cut back on buying anything that's not essential and, finally, fire workers. And then we'll be on the road to something worse than a couple of slow quarters.
Continued: Portfolio suggestions
So far, the credit crunch and the rise in effective interest rates has been enough to produce a slowdown, but not a recession and not stagnation. However, we're not done with this crisis. On Dec. 27, Goldman Sachs (GS, news, msgs) said Citigroup (C, news, msgs), Merrill Lynch (MER, news, msgs) and JPMorgan Chase (JPM, news, msgs) would announce write-downs of $18.7 billion, $11.5 billion and $3.4 billion, respectively, on their mortgage-related portfolios when they report fourth-quarter results in January.
Of course, that's not likely to be the last of the bad news because the banks and other financial companies with big exposure to the mortgage market are not exactly rushing to embrace their losses. We're looking at more quarters when bad news will come dribbling out of the big banks. Enough dribbles, and banks could cut lending to all customers even further.
Portfolio suggestionsSo how do you position a portfolio as we go into 2008?
Remember that stagflation is possible but not certain. Investors who pay attention to the financial news out of the big banks should be able to keep their portfolios a step ahead of any shifts in the economy's direction.
Fortunately, many of the investments you'd make to combat stagflation should work pretty well in 2008 even if all we get is a slowdown spread over a few quarters and a step up in inflation. Commodities and energy. Gold, of course. Growth stocks in sectors of the economy that will grow even if the economy slows. And any defensive growth stock with enough pricing power to raise its prices fast enough to stay ahead of inflation.
Some suggestions?
The oil drilling and services area, especially companies with big international operations. Worldwide exploration and production spending is set to rise 11% in 2008, according to Lehman Bros.' annual oil-industry capital-spending survey. Take a look at Schlumberger (SLB, news, msgs), Weatherford International (WFT, news, msgs) and FMC Technology (FTI, news, msgs).
Iron-ore and natural-gas stocks. Iron-ore demand is up, and supply hasn't kept pace. Natural gas is still near a low, and the stocks are just starting to move. Iron-ore plays include Fortescue Metals Group (FSUMF, news, msgs) and Companhia Vale do Rio Doce (RIO, news, msgs), both in Jubak's Picks.
Jubak's Picks Kinross Gold (KGC, news, msgs) and GoldCorp (GG, news, msgs) will give you good exposure to the classic hedge against rising inflation and a falling dollar.
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Jubak’s Journal: A turnaround for the dollar?The US dollar could turn out to be the big comeback surprise of 2008. One reason: As foreign investors put big money into US companies, those foreign countries are less likely to dump the dollar, MSN Money's Jim Jubak says.
Take a look at the growth stocks I picked in my Dec. 7 column, "5 stocks to profit from a weak dollar," for companies that will be able to outrun stagflation.
And don't forget a dose of pricing powerhouses such as PepsiCo (PEP, news, msgs) and Johnson & Johnson (JNJ, news, msgs). Picks from that group should help you play defense with your portfolio.
I know my end-of-the-year columns have been a bit gloomy -- a longer slowdown than Wall Street expects and the possibility of stagflation. A little yule hemlock, anyone?
Enough of the doom and gloom, however. In my next column, I'm going to take a cheery look at how to make money out of the deeply stupid energy bill Congress passed and President Bush signed Dec. 19.
Continued: My fourth-quarter performance
Fourth-quarter performance for Jubak's Picks Sometimes I'm happy playing good defense, and that's the story for the fourth quarter of 2007. For the period, Jubak's Picks eked out a tiny 0.87% return. But that's a good result when the stock market as a whole is in retreat. For the quarter, the Dow Jones Industrial Average ($INDU) fell 3.4%, the S&P 500 was down 3.3%, and the Nasdaq Composite Index ($COMPX) retreated 1.8%.
The key for the quarter, as it was for all of 2007, was staying away from the financial and consumer discretionary sectors and overweighting energy. The Select Sector SPDR-Financial (XLF, news, msgs) and the Select Sector SPDR Consumer Discretionary (XLY, news, msgs) exchange-traded funds (ETFs) finished a dismal year by falling an additional 18.5% and 14%, respectively, in the fourth quarter.
By contrast, the Select Sector SPDR-Energy (XLE, news, msgs) ETF was up 36.9% for the year and 7.1% for the fourth quarter. But there were few places to hide in the quarter, as even sectors such as Select Sector SPDR-Materials (XLB, news, msgs) and Select Sector SPDR-Industrials (XLI, news, msgs), which were up 22.2% and 13.5%, respectively, for the year fell in the fourth quarter by 0.05% and 4.2%. The biggest disappointment for the quarter was the technology sector: Select Sector SPDR-Technology (XLK, news, msgs) dropped 0.7% in a quarter when it usually rallies. The sector still gained 14.4% on the year.
It's great when you get the sector right and back the right stock in the sector, too. That's what I did with Devon Energy (DVN, news, msgs), up 9.9% in the fourth quarter; Ultra Petroleum (UPL, news, msgs), up 13.1% in the period; Yara International (YARIY, news, msgs), up 43.9%; Jacobs Engineering Group (JEC, news, msgs), up 10.7% since I added it to the portfolio Oct. 30; and Joy Global (JOYG, news, msgs), up 13.2% since my Oct. 30 addition to the portfolio.
And it's really aggravating when you get the sector right but the stock wrong, as I did with technology picks Maxwell Technologies (MXWL, news, msgs), down 27.8% for the quarter, and Nvidia (NVDA, news, msgs), down 7.8% for the period; and energy pick CGG Veritas (CGV, news, msgs), down 13.3% since I added it to the portfolio Oct. 26.
And of course, no quarter would be complete without the boneheaded, "what was I thinking" moves. The number of picks in this category rises when a difficult and shifting quarter leads me to try to zig and zag my way out of danger and into profits. I'd put in this category my picks of Marriott International (MAR, news, msgs), down 17.5% since my Nov. 2 buy, and Quintana Maritime (QMAR, news, msgs) down 17.7% since Oct. 16 -- so far, anyway.
Playing successful defense in the fourth quarter let me hold on to my market gains for the year. For the full year, I had a 25.2% total return versus an 8.8% return for the Dow industrials, 5.5% for the S&P 500 and 9.8% for the Nasdaq Composite.
I've got my doubts about the stock market in 2008, especially in the first half of the year. I think there's a good chance that investors who now expect the economic slowdown and troubles in the financial sector to be over by mid-2008 will be disappointed. That could create some good bargains around midyear for patient investors with cash. I've slowly raised cash in Jubak's Picks to 13%, up from 12% in the third quarter and 11% in the second quarter, and I'll continue to look for ways to raise my cash position as we move deeper into 2008.
Jubak's Picks versus major averages:
Q4 2007
12 months
Jubak's Picks
Nasdaq Composite ($COMPX)
S&P 500 ($INX)
Dow Jones industrials ($INDU)
Longer-term performance:
3-year return*
5-year return**
From inception***
Jubak's Picks
Nasdaq Composite
S&P 500
Dow Jones industrials
*Close on Dec. 30, 2004, through close on Dec. 31, 2007. **Dec. 31, 2002, through Dec 31, 2007. ***May 7, 1997, through Dec. 31, 2007.
All returns for Jubak's Picks deduct costs of commissions. Returns for Jubak's Picks and the indexes all include dividends.
Meet Jubak at The Money Show MSN Money's Jim Jubak will be among more than 120 investment and finance experts sharing buy and sell advice at The World Money Show in Orlando, Fla., Feb. 6-9. Invest four days dedicated to planning and refining your portfolio by attending the event's more than 320 workshops and panel presentations.
Admission is free for MSN Money readers. To sign up, call 1-800-970-4355 and mention priority code No. 009554, or register online.
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Jubak’s Journal: A turnaround for the dollar?The US dollar could turn out to be the big comeback surprise of 2008. One reason: As foreign investors put big money into US companies, those foreign countries are less likely to dump the dollar, MSN Money's Jim Jubak says.
Editor's note: Jim Jubak, the Web's most-read investing writer, normally posts a new Jubak's Journal every Tuesday and Friday. Please note that recommendations in Jubak's Picks are for a 12- to 18-month time horizon. For suggestions to help navigate the treacherous interest-rate environment, see Jubak's portfolio of Dividend Stocks for Income Investors. For picks with a truly long-term perspective, see Jubak's 50 Best Stocks in the World or Future Fantastic 50 Portfolio. E-mail Jubak at
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Devon Energy, Companhia Vale do Rio Doce, Fortescue Metals Group, GoldCorp, Jacobs Engineering, Joy Global, Kinross Gold, Maxwell Technologies, Schlumberger, Ultra Petroleum and Yara International. He did not own short positions in any stock mentioned in this column.

... How's that working for ya?

Thursday, January 03, 2008

More unexplained acceleration

Nature And Man Blamed For Thawing Arctic
WASHINGTON, Jan. 2, 2008

(AP) There's more to the recent dramatic and alarming thawing of the Arctic region than can be explained by man-made global warming alone, a new study found. Nature is pushing the Arctic to the edge, too. There's a natural cause that may account for much of the Arctic warming, which has melted sea ice, ice sheets and glaciers, according to a study published Thursday in the journal Nature. New research points a finger at a natural and cyclical increase in the amount of energy in the atmosphere that moves from south to north around the Arctic Circle. But that energy transfer, which comes with storms that head north because of ocean currents, is not acting alone either, scientists say. Another upcoming study concludes that the combination of both that natural energy transfer increase and man-made global warming serve as a one-two punch that is pushing the Arctic over the edge. Scientists are trying to figure out why the Arctic is warming and melting faster than computer models predict. The summer of 2007, like the summer of 2005, smashed all records for loss of summer sea ice in the Arctic Ocean and ice sheet in Greenland. In September, the Arctic Ocean had 23 percent less sea ice than the previous record low. Greenland's ice sheet melted 19 billion tons more than its previous record. The Nature study suggests there's more behind it than global warming because the air a couple miles above the ground is warming more than calculated by the climate models. Climate change theory concentrates on warming of surface temperatures and explains an Arctic that is warming faster than the rest of the world as mostly because reduced sea ice and ice sheets means less reflecting solar rays. Rune Graversen, the Nature study co-author and a meteorology researcher at Stockholm University in Sweden, said a shift in energy transfer explains the thawing more, including what's happening in the atmosphere, but does not contradict consensus global warming science. Oceanographer James Overland, who reviewed Graversen's study for Nature, said the research dovetails with an upcoming article of his which concludes that the Arctic thawing is a combination of the two. "If we didn't have the little extra kick from global warming then we wouldn't have gone past the threshold for the change in sea ice," said Overland, of the National Oceanic and Atmospheric Administration's lab in Seattle. Other researchers said Graversen's study underestimates the effect of global warming because it relied on older data that stopped at 2001 and wasn't the most accurate. Overland and scientist Mark Serreze disagree over which effect - man-made or natural - was the big shove that pushed the Arctic over the edge, but they agreed that overall it's a combined effort. "Think of it as a boxer that's almost going down for the count ... and that one blow to the noggin comes and he's down for the count," said Serreze, a senior scientist at the government's snow and ice data center in Boulder, Colo.

Wednesday, January 02, 2008

US Educational Train Wreck In Progress...

Achieve, Inc., a bipartisan, nonprofit education organization formed by governors and prominent business leaders, found that math and English tests for high school diplomas require only middle school knowledge, and found those math graduation tests measure only what students in other countries learn in the seventh grade

(... and if that doesn't scare you, maybe this will...)

U.S. 15 year olds ranked 29th in Science - U.S.A rank # 29
Here's a partial listing of examination rankings in the Science series.
Finland was the highest-performing country on the PISA 2006 science scale. Six other high-scoring countries were: Canada, Japan and New Zealand and the partner countries/economies Hong Kong-China, Chinese Taipei and Estonia. Australia, the Netherlands, Korea, Germany, the United Kingdom, the Czech Republic, Switzerland, Austria, Belgium and Ireland, and the partner countries/economies Liechtenstein,Slovenia and Macao-China also scored above the OECD average.
Rankings first 30 nations in the Science series > Finland, Hong Kong-China, Canada, Chinese-Taipei, Estonia, Japan, New Zealand, Australia, Netherlands, Liechenstein, Korea, Slovenia, Germany, England, Czech Republic, Switzerland, Macao-China, Austria, Belgium, Ireland, Hungary, Sweden, Poland, Denmark, France, Crotia, Iceland, Latvia, U.S.A., Slovak Republic.
U.S.A. scored below avearage in the Science series, at ranking position #29.
U.S. 15 year olds ranked 35th in Mathematics - U.S.A. rank #35
Mathematics Performance > Finland and Korea, and the partners Chinese Taipei and Hong Kong-China, outperformed all other countries/economies in PISA 2006. Other countries with mean performances significantly above the OECD average were the Netherlands, Switzerland, Canada, Japan, New Zealand, Belgium, Australia, Denmark, the Czech Republic, Iceland and Austria, as well as the partner countries/economies Macao-China, Liechtenstein, Estonia and Slovenia.

... How's that working for ya?