James Bianco


Uploaded by WealthTrack on 18.05.2012

Transcript:
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CONSUELO MACK: This week on WealthTrack, a Financial Thought Leader who takes on the
bullish herd and shatters some Wall Street myths. Bianco Research’s James Bianco challenges
the optimists on the Eurozone, U.S. economy and corporate profits, and explains why treasury
bonds could offer protection in the battles ahead- next on Consuelo Mack WealthTrack.
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Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Things are not always
what they seem, especially when it comes to the economy and the markets. Case in point:
recent statistics showing consumer credit increasing by the most in ten years. The standard
interpretation is this is a positive: consumer spending accounts for about 70% of the economy
and the reasoning goes if consumers are borrowing they are confident about the future and more
willing to spend.
Enter Jim Bianco and his team at independent research firm, Bianco Research. They looked
at who was actually doing the borrowing. It turns out the vast majority are individuals
with student loans. According to Bianco, “student loans have gone parabolic thanks to a 2009
government mandated cut in student loan interest rates that expire July 1st.” President Obama
incidentally is pressuring Congress to freeze the rates again. As Bianco says, “take out
government-owned student loans and there has been virtually no rebound in consumer credit
since the Great Recession ended.” Bottom line: the consumer is not rebounding nearly
as much as credit figures have led us to believe.
What other widely followed statistics and interpretations are suspect? That’s where
this week’s guest comes in. He is Financial Thought Leader, James Bianco, president of
the Chicago-based firm that bears his name. Bianco Research has been publishing its current
and historical analysis and commentaries on the markets and money flows for more than
two decades and is considered a must read by many portfolio managers and traders. Bianco
has a litany of issues where he is challenging the Street’s conventional wisdom, ranging
from the sustainability of corporate profits to the riskiness of treasury bonds. I began
the interview with one that’s blown up recently, and asked him why he has believed all along
that the European crisis is far from over.
JAMES BIANCO: Because the problem that caused it has not been fixed, and the problem is
the elephant in the room. It’s the euro. Seventeen countries using one currency doesn’t
work. All these countries have their own vested interests, and when they start banding together
and using the same currency, you’ll have what economists call the free rider effect.
Germany is responsible. Germany does certain things, and the market applauds what Germany’s
doing. Portugal or Greece uses the same currency as Germany. They don’t have to be responsible.
They don’t have to do the certain things, but they get to borrow, and they get to be
perceived as the same thing as Germany, and they get themselves in trouble. How do you
fix that?
And the problem is, the way you fix it is you have to have all these countries come
together in some kind of an agreement. That sounds nice, but really what we’re talking
about is Germany gets to tell Greece what to do. Greece gets to tell Portugal what to
do. France gets to tell Italy what to do, and they fought wars once a generation for
the last thousand years to prevent that from happening. So as long as we have the euro
in its current structure, the problem doesn’t go away.
CONSUELO MACK: So why isn’t this strategy of basically funding the financial system
in Europe, that the ECB is doing, going to work until the economies kind of stabilize?
Why couldn’t that work for a while?
JAMES BIANCO: In theory, it could, but let’s remember the history of the euro. It started
in 1999. It started during the bottom of the last recession, and it went well until the
next recession. It couldn’t even make the next downturn without having the problems
that it had. The ECB, you’re right, is trying to capitalize the banking system, and they’re
all taking these short-term approaches. You know, the phrase on Wall Street now is kick
the can down the road. They work for a while, and then they don’t, but at the end of the
day, there is just going to be never-ending short-term fixes while we don’t deal with
the long-term problem.
Now, we’re trying to. There is austerity measures in place. There is agreements in
place. There is reforms in place. They will take many years, but the problem we’re also
finding, and we saw it this spring with Spain, is that the minute that the crisis stops being
white hot and only goes to maybe red hot, all of a sudden the lack of discipline is
not there anymore. The Spanish promise that they’re going to meet their budget deficit
targets. They promise that they’re going to try and rein in the amount of borrowing
they have. Then the problem gets a little bit better, and then by March they say, “You
know what? We can’t meet it now.” Why? Because the situation maybe allowed them to
get away with it where they couldn’t have said that in November because it would have
been so bad for markets. And that’s where the fear is, is that they’ll all promise
when things are bad, “we’ll do whatever it takes to fix it”, but when things get
better then, they start backsliding. So that’s why until you fix the euro so you remove that
conflict of interest, you would just kind of vacillate between it being a moderate problem
and a severe problem.
CONSUELO MACK: So in the meantime as an investor, what you’re telling me, is so the kind of
macro-driven crises that have added so much volatility to the markets over the last several
years, so that’s kind of what we’re in for?
JAMES BIANCO: I think we are a little bit more of that. Europe itself is an economy
of 300 million like the United States. Its gross domestic product, if you will, is about
the same as the United States, and most of the countries in Europe right now are in recession,
and a lot of them that aren’t in recession are not looking very good at all. So that’s
going to weigh on world growth. That’s going to weigh on the financial markets, whether
you’re an international investor or whether you own a large multinational company that
exports to Europe. That’s going to continue to be a problem as we move forward from here.
So I just don’t see how it’s going to wind up getting nice and tidied up and put
away anytime soon.
CONSUELO MACK: Let’s talk then about the impact that this could have on the U.S. economy,
because another piece of common wisdom on Wall Street is that, in fact, the U.S. economy
is improving, which it certainly is from the recession, that government stimulus has worked,
and unemployment is declining. It’s still not low enough, but it’s declining, and
the markets are responding very positively because of that. So is this, do you think,
in jeopardy, our recovery and the market rebound that we’ve seen?
JAMES BIANCO: It can be. You’re right that statistically things are getting better and
that we’re moving along, but as everybody likes to say, and I’ll throw myself in there
too, it’s not good enough. I’ve used the analogy that, you know, one of my kids comes
home from school and says, “Good news. I’m not getting Ds any more; I’m getting Cs.”
Well, I’d like to hope for better than Cs, but I guess a C is better than a D, and that’s
what we have for the economy right now.
The problem is, in order to get there, as you pointed out, we’ve needed massive government
stimulus. We’ve needed extraordinary Fed action, and now we’re seeing more of the
same out of Europe. Let’s call it what it is. It’s central planning. It’s a version
of central planning, and whenever you get into an economy where you’ve got those big
macro decisions being made by governments, it may work for a while, but history says
if they keep at it long enough, it will end in tears, and that’s why I’m very nervous
that we’ve got such heavy government involvement from either the fiscal side or the monetary
side that we’re not trying to get rid of. In fact, right now on Wall Street, the biggest
talk is whether we’re going to QE3 later this summer or into the fall. We’re going
to get more of it, not less.
CONSUELO MACK: Right, quantitative easing 3, which is the Fed would do something else
basically to make sure that the financial system has liquidity and stimulus. Right.
JAMES BIANCO: Right, and quantitative easing has its host of problems, yes. I understand
that what the Fed did was necessary in 2008 and maybe 2009, and I won’t criticize them
that much for that period. But it’s the middle of 2012 right now, and they haven’t
stopped, and the problem is that the unintended consequences from all of this massive amount
of liquidity that they’ve injected in all of these programs that they have, I don’t
think we’re beginning to understand it, and they’re not stopping. They’re adding
on to them and maybe might even add on more later this year.
CONSUELO MACK: So the unintended consequences would be what?
JAMES BIANCO: Well, the big one that everybody worries about it inflation, and I would put
myself in that camp, too. Now, I said inflation, and everybody thinks, oh, he thinks 15% inflation.
He thinks a rerun of 1980 or something like that. No, that’s not what inflation is.
Inflation can be two and a half or three percent in a world where the Fed has promised to keep
interest rates at zero through the end of 2014, and the Fed is maybe going to do more
quantitative easing, so only two and a half or three percent inflation would be very problematic.
Right now...
CONSUELO MACK: And just so that people understand why, it means that the purchasing power basically
of your investments or dollar or whatever are below the rate of inflation. So you’re
actually getting negative returns. I mean, is that essentially the basic problem?
JAMES BIANCO: Exactly. To use a fancy Wall Street phrase, we are in a low nominal growth
world, in other words, earnings growth. The economy is growing. It’s growing at very
low rates, maybe three, maybe four percent on earnings growth or something, to use it
as one example. Well, if two and a half or three percent of that’s going to get eaten
up by inflation, then the real growth that you’re having after inflation is negligible.
And the metaphor I like to use there is if 140/90 is hypertension, we’re probably at
like 136/88 in terms of the inflation hypertension. Yes, I can go home from the doctor and say,
“I don’t have hypertension,” but I don’t have much room to spare from it right now.
So at two percent core growth on inflation, we’re getting very, very close to those
levels.
CONSUELO MACK: There’s another kind of deadline approaching, Jim, and the U.S. is facing what’s
being called a fiscal cliff, and they’re saying the fiscal cliff is going to happen
in 2013 after the election, and that’s when all sorts of stimulus programs and the Bush
tax cuts expire and blah, blah, blah. But again, people are saying, “Well, I’m going
to worry about that next year when I’ve got maybe the same President, maybe a new
President, a new Congress, whatever it is.” You’re saying that we are actually facing
a very serious financial deadline that’s going to happen before the election. And what
is that?
JAMES BIANCO: It’s the debt ceiling. The debt ceiling right now is looking like it’s
going to get hit around Labor Day. Earlier this month, the Treasury Department gave a
briefing about the debt ceiling and kind of implied that it’s going to get hit by around
Labor Day. Now, what happens when it’s reached, the debt ceiling around Labor Day? The Treasury
has extraordinary means that they could use. They can borrow against trust funds, and they
can do other accounting things to try and push the debt ceiling off past the election.
CONSUELO MACK: Which they have done on a regular basis, right.
JAMES BIANCO: Right, they have done, and they can do it again. But how much will they do?
It becomes purely a political calculation at that point. If the debt ceiling gets hit
by September, and the administration decides it’s in their favor to force a debt ceiling
vote before the election, they can do that, and then we can have August 2011 five weeks
or three weeks before the election. If they...
CONSUELO MACK: And remind us- August 2011 the market basically fell out of bed.
JAMES BIANCO: Yes. It fell out of bed because we were threatening a default with the debt
ceiling and, of course, the debt ceiling is not just, you know, a bill that has one sentence.
We will raise the debt ceiling to some higher number. It will include the tax cuts. It will
include the spending cuts, the sequestration, the end of unemployment benefits. All of that
gets wrapped up into this one thing called the debt ceiling. You don’t separate those
from the other. So we’ll have that fight possibly in October.
CONSUELO MACK: So I’m hearing more uncertainty. I’m also hearing that another thing that
happened last year around this same issue was the fact that the credit rating of the
U.S. got downgraded from a triple A to a double A and, in fact, you think that we could be
in jeopardy for another downgrade. Right? If we don’t get our financial house in order?
JAMES BIANCO: They’ve set the standard right now. Only S&P downgraded us to double A plus.
The others, Moody’s and Fitch, still have the U.S. at triple A, but if we continue to
punt on this issue and continue to not deal with it, then we can see more downgrades and,
interestingly, it’s the next downgrade that matters, because a lot of people have argued,
well, S&P downgraded us, and the markets lost their mind for a couple weeks, and then it
was all over with.
CONSUELO MACK: Right, a non event.
JAMES BIANCO: The bond market never responded to it, because technically if you look at
the way it works, what’s the credit rating of the U.S.? It’s triple A. Why? Because
two of the three are still triple A, and you take the majority rating. Well, the next one
to go means that now the U.S. is no longer triple A. The next downgrade would actually
have far more impact than the first downgrade.
CONSUELO MACK: Very interesting. Another common piece of wisdom on Wall Street right now is
that corporate profits have never been better, never been healthier, and they cite that balance
sheets are very strong, record levels of cash in corporations, and also the fact that we’ve
had many consecutive quarters of increasing earnings. You’re saying their earnings are
not as good as they look. Why?
JAMES BIANCO: Right. Again, to use my analogy from before, you know, we’re looking at
C-type earnings, not B or A. Additionally to that, if you look at the growth rate of
earnings, the growth rate of earnings on a year-over-year basis is around five percent.
Sounds impressive until you remember two things. Half that growth rate is Apple Computer. Apple
is the dominant force in the market, and it’s the dominant force in earnings. So the other
499 companies in the S&P 500, maybe three percent growth. If I’m generous, I’ll
give them four percent growth, and headline inflation is running at three percent. That
means after inflation, without Apple, the other 499 companies in the S&P 500 maybe give
you one percent return. This, in an environment where the market’s gone up 25% and everybody’s
convinced themselves that this is a sign that we’ve got great earnings and great earnings
to come, the last offering on that is that the second quarter earnings estimates are
for even less than the first quarter earnings estimates. So it doesn’t look like it’s
about to turn around at least through the end of the summer.
CONSUELO MACK: So what does that mean for the market?
JAMES BIANCO: I think the market is pricing in a belief that earnings are going to continue
to move higher, and it may be disappointed by that. Two years ago, the growth rate on
earnings was 15 or 20%. Now we’re down to three or four and one after inflation, and
maybe zero after inflation for the next quarter.
CONSUELO MACK: One of the most prevalent arguments for the bullish case for stocks is the fact
that stocks are the best alternative to just about anything else. I mean, they always compare
it to the returns that you can get on treasuries, for instance, and in fact that the large cap
stocks, they pay really good dividends. What’s your response to this, that they beat all
the other alternatives, and that’s the reason we should be investing in stocks?
JAMES BIANCO: We all know that 11 years ago the stock market was at the same level it’s
at now, and we’ve compressed interest rates down to one percent. Well, a lot of people
then will say, well, yes, that’s true. Okay, I missed it- that historically the bond market
had been the place to be for the last 15 years- but now that we’re at three percent 30-year
rates or two percent 10-year rates and we’ve got a 13 or 14 P/E, the stock market has to
outperform as we move forward from here. We heard this exact argument about 15 years ago
in Japan when they had two percent rates, and we’re still waiting for their market
to outperform, so we’ve got one historical example where it may not work as well as we
think, but the assumption that we’re making here is that all of the problems we’ve discussed
are going to get themselves resolved. The bond market is going to see higher yields,
and the stock market is going to see better returns.
My fear is that, as we move forward from here, we wind up with more sideways in the stock
market. We wind up with the bond market returning you two percent- it just gives you the coupon,
but you don’t lose any price- and if you start adding it all up, you wind up saying
the bond market could very well stay competitive with the stock market as we move forward until
we work out these problems.
CONSUELO MACK: That is a radical thought, as you know.
JAMES BIANCO: It is a radical thought.
CONSUELO MACK: I mean, because everyone is saying, you know, the last thing in the world
you want to be in is treasuries. That’s the worst thing, and so that’s probably
why you, Jim, are looking at it and saying, “What’s wrong with what they’re saying?”
JAMES BIANCO: And let me make it a little more radical for you. I agree with everybody
who says that there’s no value in the bond market. There isn’t, by most valuation measures,
that treasuries look to be overvalued. That is true today. That was true three years ago.
That was true five years ago, and I would argue it’ll be true in two years hence,
and the reason is we’re failing to recognize who buys treasuries. I’ve heard this from
people that say, you know, the bond market has no value and investors should stay away
from it. Investors left treasury securities five years ago. All the measures of whether
you look at mutual fund flows or whatever, they’re not buying treasuries. Who buys
treasuries? Central banks buy treasuries. The Bank of Japan, the Bank of China buys
treasuries. The Federal Reserve buys treasuries with printed money that we call quantitative
easing. The big banks buy them because the Fed has promised them zero financing costs.
They borrow at zero from the Fed. They buy treasury securities. They hold them to maturity
on a two or three year.
CONSUELO MACK: And so they’re making a nice spread. Again, you said it’s the carry trade.
JAMES BIANCO: Right, that’s the carry trade. They make a nice spread, but what I’m getting
at is that who buys treasuries? The central banks and the large banks, and that dynamic
may not change for a while. So these overvalued bond markets could very well stay overvalued
for a long time. What would be the catalyst for an overvalued market to pop would be investors
recognizing that they own an overvalued security and running away. They already left. The catalyst
at this point would be that the central banks change their mind, want to stop buying and
aren’t interested if rates start rising, and I just don’t see them doing that. They’re
going to continue to try and keep interest rates low around the world, and so they’re
going to stay there for a while, and I suspect people are going to find that bond yields
are going to stay low for a lot longer than they think.
CONSUELO MACK: You’ve been saying that it is probably the worst stock picker’s market
in history that we’ve been through. Explain that.
JAMES BIANCO: If you take the 500 stocks of the S&P 500 and you run a correlation of those
to the index itself, one would be perfectly correlated. They move exactly together. Minus
one would mean they move exactly inverse to each other. The correlations we’ve seen
of the average stock to the S&P 500 is the highest ever. The all-time record was set
actually six months ago, October of last year. The current levels of correlations, while
down from the all-time high, are among the highest levels we’ve seen except for the
last two years.
CONSUELO MACK: So that means more stocks are moving in lock step than they ever have.
JAMES BIANCO: Right, and Wall Street has a phrase for this. We call it risk on and risk
off; because on risk on days everything goes up, and on risk off days everything goes down.
As an aside with that, we’ve also seen a couple of unusual days. In August of last
year, we had a day where all 500 stocks were down in the S&P 500. That’s the only day
that’s ever happened. Not even the crash of ’87 did that happen, and we’ve seen
a couple of days in November and December of last year where 499 stocks were up on the
day. Only one was down on the day, and we’ve rarely ever seen something like that. That’s
the risk on/risk off nature. So if you’re a stock picker, and the market decides it’s
going to go up, everything goes up. The bad ideas go up. The good ideas go up. The so-so
ideas go up. It makes it very hard for you to differentiate yourself from the pack because
all the stocks go up. All the stocks go down, and that’s why it’s been such a difficult
stock picker’s environment- and this isn’t just day-to-day, as I’ve suggested. It’s
also gone on for months and even a couple of years.
Now, I’ll be clear. This is not the way the market should trade. This is a bad thing,
because again, it’s about markets allocating capital, and if we have these high correlations,
they’re not taking money away from bad ideas and giving money to good ideas. Either they
all get it, or they all don’t get it, and it creates an inefficiency in markets, and
it makes it difficult for the manager that picks individual securities to set up a portfolio
that looks different from, say, just a chart of the S&P 500.
CONSUELO MACK: What do I do with all of these changes that you’re describing to me in
the markets? I mean, you know, how do I make money in the stock market?
JAMES BIANCO: The good news I would leave you with is that the bad part of it is already
behind us. The 2008 decline where we thought that the world was going to come to an end
has already occurred. So from here forward, we’re going to have a tough slog where like
last year. Last year, the market was up two percent. It wasn’t terrible. It wasn’t
great, and that’s going to be kind of, I think, the benchmark for what we’re looking
for as we go forward from here: low returns, not a lot of opportunities to make a lot of
money. The good news may be not a lot of opportunities to get destroyed unless, of course, Europe
falls completely apart.
So within that environment, I would tone down my expectations a lot. I’m not looking for
the 10 or 15 %. That era is gone. I’m not looking for the portfolio of stocks that’s
going to really set me apart from everything else in this high-correlation environment.
That era is gone as well, too. Investing in the broad market, it’ll be okay, but it
won’t give you a whole lot. If you’re looking for an idea that might work, it’s
been a favorite of mine for years, and that’s gold. It’s a speculative idea. I wouldn’t
put a lot in it, but in a world of uncertainty and in a world of a lot of problems, gold
has, for the last several years, done very well, and I suspect it will continue to do
better than average as we move forward.
CONSUELO MACK: So is that your One Investment; that we all should own some gold in a long-term
diversified portfolio?
JAMES BIANCO: Well, I think we should own some gold, but I also think that if we own
stocks, we probably want to be more towards the defensive end. High-quality dividend names
are an idea. I’m not afraid of owning some bonds, because I don’t think that you’re
going to see yields go up, and they will give you a stable amount of money. They may not
make you a lot of money, but they won’t lose you a lot of money as long as you stay
away from long-term bonds, maybe shorter-term bonds.
And if you’re looking for a place where there are the least problems in the world,
the least problems in the world might be in emerging markets except for China, so emerging
markets less China. Yes, they have a list of problems as well, too. Everybody does,
but given the relative list of problems, I would probably more venture a guess towards
emerging markets than I would toward developed market at this point.
CONSUELO MACK: So, Jim, your One Investment for long-term diversified portfolio is...
JAMES BIANCO: To have some gold. You need to have gold in an environment that we’ve
been in, the post-2008 period with the way that the Fed has been operating, with the
way the government’s been operating and the problems in Europe, to have some gold
I think has been and will continue to be a superior investment.
CONSUELO MACK: Jim Bianco, it’s such a treat to have you on WealthTrack. Thanks so much
for being with us.
JAMES BIANCO: Thank you.
CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one
suggestion to help you build and protect your wealth over the long term. This week’s Action
Point is: don’t be afraid to question the conventional wisdom, as Jim Bianco and so
many of our WealthTrack guests do.
With world economies still struggling to recover from the financial crisis, with unemployment
rates in many European countries sky high- Spain’s unemployment rate is over 23%, its
50% for youth under the age of 25- is it any wonder that incumbents are being thrown out
and citizens are fighting austerity? Does it make sense to hold some so-called defensive
investments like U.S. treasuries and gold? Well yes, it probably does. So don’t be
afraid to buck the conventional wisdom.
I hope you can join us next week. Our guest will be another Financial Thought Leader:
Jason Trennert, economist, strategist, and co-founder of independent research firm Strategas
Research Partners. He’ll tell us why he is recommending top quality and yes, even
cash, for individual investors. If you want to see our WealthTrack interviews before the
pack, subscribers can do so 48 hours in advance. To sign up, go to our website, wealthtrack.com.
You can also watch previous shows and find past One Investment and Action Point recommendations
there. And that concludes this edition of WealthTrack. Thank you for watching and make
the week ahead a profitable and a productive one.
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