What Hope Means in Japan These Days

By Keith Fitz-Gerald, Chief Investment Strategist

[Kyoto] – Frustrated by a system that has trapped them in decades of low to no growth, an entirely new generation of Japanese may be working with the most precious of all resources – hope.

They’re taking matters into their own hands and going around the traditional Japanese way of doing things.

That’s good.

The so-called “Lost Decade” is now entering its 3rd lost decade following 8-10 separate bailout failures, depending on how you count the various initiatives over the years.

Growth remains a paralyzed version of its former self with the nation’s GDP roughly the size it was in 1990.

Worse, many Japanese companies like Panasonic and Sony, once at the vanguard of innovation, now find themselves scrambling to keep up with clever rivals who have taken the lead and who now threaten to push them out of the global industries they once dominated for good.

Combined public, private and corporate debt now approaches 500% of GDP.

Roughly 35% of the working population here remains trapped in arubaito, or part- time work. That’s a far cry from the vision of lifetime employment that once dominated the corporate landscape.

Some, like Tadashi Yanai, who founded and heads the Japanese brand Uniqlo (pronounced yu-ni-klo), are deemed “young thinkers” bent on change through the sheer force of will and the economic means to bring it about. Yanai is actually 63 years old.

Speaking Truth to Power

Others are truly young, like Osaka’s controversial mayor, Toru Hashimoto. At 43, he’s as frank as they come in the staid world of Japanese politics where change is nearly impossible to come by.

To give you an example of what I am talking about, consider Hashimoto’s recent observation that the Japanese political system is “crap.” Not “difficult,” not “worth consideration,” not deserving of “careful thought,” as would be the traditional ways the hyper- polite Japanese have expressed their opinions — but “crap” as in the four- letter variety.

When I first came to Japan in the late 1980s, such remarks would be unthinkable and the person who made them immediately banished to the fringes of Japanese society. Yet, Hashimoto is the mayor of Japan’s third largest city. That, too, would have been unthinkable only a few years ago.

What’s more, he’s gathering allies like Tokyo Mayor Ishihara Shintaro, who stunned Japan a few days ago by resigning immediately to form a new “true conservative” political party in the interest of reformation in the upcoming December elections.

The firebrand Ishihara wants to ally with Hashimoto and another maverick named Watanabe Yoshimi, who heads “Your Party.”

If you’re tempted to frame this in terms of Western political elections, which require years of lead up and campaigning, don’t. This is a very serious development and presents a real challenge to the status quo.

Imagine, for example, the Tea Party suddenly having one-third or more of the U.S. Electoral College votes two months before the presidential elections. That would truly be a game changer.

Or Ross Perot in his heyday teaming up with Ron Paul to play “outside the rules” by presenting a unified plan for smaller, decentralized government, fiscal responsibility, and newly revised international policies…and having a huge swath of the American voters immediately line up with them, leaving the Democrats and Republicans on the sidelines.

Here in Japan, third- party players can do something the long- dominant Liberal Democratic Party can’t — actually speak in clear, well-articulated terms. Effectively, they play the role of spoiler by forcing the major parties to come to them on their terms and prompt action for the same reason.

Like our own, traditional Japanese politicians are trapped in a morass of ineffective politics bent on ensuring survival rather than the benefit of its citizens.

If Hashimoto, Ishihara and Watanabe can reach an agreement, there could be a sea of change here come December with newly localized policies, changes in centralized spending, reduced central government,and foreign policies that are probably very independent of the United States.

Hope and Change in Japan

Japanese of all ages I have talked with recently in my neighborhood sense that change won’t be immediate. But they are very excited by the fact that things have gotten so bad that there is actually change itself.

Younger Japanese like my niece, Natsuko, are willing to buck the system that would otherwise trap them were things not so challenging by pursuing careers with a decidedly international focus.

Today, there are tech incubators blossoming and the once overwhelming stigma of failure is falling by the wayside. My friends Masao and Hiro have both left traditional corporate Japan and are risking it all with their own ventures.

Independent thinking is being encouraged , even if only begrudgingly at the moment. Nails that stick up are no longer hammered down, to paraphrase a traditional Japanese saying that highlights the historical need to be like-minded.

Older executives like Yoshichika Teresawa, who recently retired from JETRO, Japan’s external trade resource organization, are seeing a new wave of entrepreneurship take hold outside Japan’s traditional corporate structure. He’s cautiously optimistic that the “young people” will be able to make change where “we couldn’t” politically.

I asked him what he meant by that, to which he replied, the “serious economic conditions we have lived with since the 1990s may finally be forcing change not only in the business community, but in the Japanese mind and political process, too.”

And what does he think about Hashimoto’s assessment that Japanese politics are “crap.” Ever the gentleman, he looked at me with a wry smile and added, “not unlike the United States, eh?”

Then he added, “Okashi-hito ni narimasu (meaning roughly, we Japanese need to become “strange” by embracing new thought and discarding the previously staid old practices that haven’t worked).

Indeed. Some things don’t need translation.

Best Regards,

Keith Fitz-Gerald, Chief Investment Strategist

Money Map Press

How Immoral Government Creates the Perfect Investment

by Alexander Green, Investment U Chief Investment Strategist
Monday, October 29, 2012

Alexander Green

If insanity is doing the same thing over and over and expecting a different result, you really have to wonder about California Governor Jerry Brown.

The two-time Democratic Governor is calling for a 3% tax hike on the state’s richest 1% to help pay for the state’s perpetually cash-strapped education system. He calls it “a moral issue.”

I couldn’t agree more. And it’s one, as you’ll see, that leads directly to a particular investment conclusion.

Let me begin by confessing I have no dog in this fight. I’m not a California resident, so the state’s top marginal income tax – whatever it winds up being – is no skin off my nose. (As for the cost and accountability of our public education system, click here and weep.)

State Treasurer Bill Lockyer concedes – and Governor Brown well knows – that half of California’s income taxes already come from the top 1% of earners. Yet even with the highest marginal income tax rate in the country, California is in the biggest fiscal mess of all 50 states. (That’s something citizens calling for higher taxes at the national level might bear in mind.)

And the state’s budget calamity is even worse than it looks. First off, California’s finances are dependent on its most unstable income group. It’s a myth that high-income earners are the same individuals year after year. Fortunes and careers routinely ebb and flow for professional actors, musicians, filmmakers, athletes and business owners. These folks can make a million dollars one year and find themselves hard up the next.

Second, while redistributionists routinely boo-hoo about how these spoil-sports won’t sit still and let the state government clean them out, the truth is just 144,000 taxpayers are ponying up nearly half the taxes in a state of 37.7 million people. Needless to say, these individuals have an enormous incentive to get the heck out of California. Many of them do. I can’t tell you how many businessmen and entrepreneurs I know who’ve left the Golden State for Nevada, Washington, Texas or Florida, just four of the seven states with no income tax on individuals.

California is hardly alone in soaking its citizens, however. According to an annual study by the Tax Foundation, state and local taxes total 12.3% in Connecticut, 12.4% in New Jersey and 12.8% in New York.

If Obama is re-elected and raises the top marginal rate to 39.6%, as he has promised, many business owners and self-employed individuals will forfeit most of what they make to the government. The math is pretty depressing. A top marginal rate of 39.6% plus an average state income tax of 6% plus a Social Security tax of 10.4% (on income up to $110,000) plus an unlimited Medicare tax (1.45% for employees and 2.9% for the self-employed) can easily equal most of what an individual makes. And these numbers don’t include sales taxes, property taxes, sin taxes and many others.

The real problem with raising the top marginal rate is that this country badly needs entrepreneurs to create jobs in the private sector. The top 2% of the nation’s income earners – who currently pay half of all federal income taxes according to the Internal Revenue Service – are overwhelmingly small business owners. Over half of Americans work for small companies that pay taxes at the individual not the corporate rate. If the economy is going to pick up steam again, we want to encourage these businessmen (and businesswomen) to take risks.

Sadly, many in power – and others who hope to gain power – won’t risk political exile by clamping down on spending. It’s safer and easier to soak the rich. (Heck, even if they all turn against you, it’s only 1% to 2% of the vote.)

That makes single-state municipal bonds – whose semi-annual payments are exempt from federal and state taxes – the no-brainer of the season, especially for beleaguered high-income earners in states charging punitive rates.

This investment choice will keep the government out of your pocket. However, it’s also capital denied to companies that need it. It won’t create new businesses or expand existing ones or help generate more private sector jobs. That’s the unintended consequence of government spending and selective taxation run amuck.

So Governor Brown has a point. Presiding over massive, inefficient spending, demanding that a tiny minority pay for it, and – in the process – disincentivizing entrepreneurs from creating desperately needed jobs is a serious moral issue.

Too bad he’s on the wrong side of it.

Good Investing,

Alex

How to Play Q4 Defense: Hedge Your Bets, Up Your Stops and Sell Your Gold

By Keith Fitz-Gerald, Chief Investment Strategist

So far fourth quarter earnings have made a mockery of things.

Of the 20 S&P 500 companies that have provided Q4 guidance so far, 18 of them have guided lower, “slashing” their forecasts, according to Goldman Sachs and CNBC (as of Monday afternoon).

What’s more, roughly one quarter of the reported earnings have come in flat to middling. According to Capital IQ, overall revenues are up only slightly at 0.34%.

Yet, for some reason the S&P 500 is only 3.89% off of its highs and is up 12.01% year-to-date through Wednesday afternoon.

Under the circumstances this suggests two things to me:

  • There’s a lot of volatility waiting in the wings; and,
  • The near-term risk is to the downside.

First, let’s tackle the volatility that’s still in store; then we’ll move on to what you can do to prepare for it.

The Q4 Earnings Story

So far this earnings season, roughly one quarter of the S&P 500 has already reported. That leaves the market with nearly 375 companies that have yet to spit out their numbers, roughly 150 alone this week.

Assuming the balance follows the pattern set so far, companies like Caterpillar Inc. (NYSE: CAT), Philip Morris International (NYSE: PM), and 3M Co. (NYSE: MMM) are going to show “respectable” (under the circumstances) numbers while talking about the “challenges” they see ahead.

Meanwhile, a few others, like DuPont (NYSE: DD) and United Technologies (NYSE: UTX), are going to reflect weakening earnings and revenue pressures leading to further cost-cutting as a means of protecting profits. These will include job cuts.

I also expect the bulk of the remaining companies will take the opportunity to lower their expectations — especially when you consider that 61% of the companies as of Monday afternoon missed revenue expectations.

The irony here is that 61% of the companies that have reported over the same period have also exceeded analysts’ expectations.

Naturally the markets will punish those who missed even when what they should recognize is that the analysts were wrong yet again. But that’s another story for another time.

What’s important to understand is that top-tier company management is using this earnings season to accomplish three things.

First, they’re telegraphing real worries from the C-suite. Despite what the Fed wants us to believe, executives remain cautious and uncertain. So they are hoarding cash, hiring only when necessary and trimming things to the bone.

Second, they’re lowering the expectations bar to the point where any hint of prowess in the future will likely induce an earnings “surprise” and engender additional support for their share prices.

Three, they hope investors will respond to both situations favorably and they’re banking on Fed policy as the primer. There’s no question the Fed has run out of bullets given the near-complete lack of response in the markets to QE infinity. And with the fiscal cliff approaching, they’d like to appear protective rather than aggressive, figuring it’s the easier position to defend.

Now let’s talk about the downside.

If you look at a chart below of the S&P 500, the range-bound conditions we’ve seen since this crisis began are evident. So are the much broader ranges since 2000, which is really where this mess started from a technical standpoint.

Chart: Fitz-Gerald Research Publications, Yahoo Finance

Put that against Professor Robert Shiller’s work, and you can see the Fed is clearly trying to engineer a rally even when the natural proclivity is to guide lower to the norms established since the end of WWII.

At 17.7 times earnings, the S&P 500 is still expensive in the big scheme of things.

http://www.ritholtz.com/blog/wp-content/uploads/2012/10/BF-AD687_UPSIDE_NS_20121019171504.jpg

Figure 1: Wall Street Journal, Robert Shiller – Yale University

This isn’t a surprise. Or, at least it shouldn’t be.

As my good friend Barry Ritholtz, CEO of Fusion IQ, recently pointed out so eloquently in his blog, The Big Picture, the “Fed’s liquidity fire hose has forced managers into equities beyond what is normally prudent.”

That’s the key: normally prudent. There’s nothing normally prudent about anything the Fed is doing at the moment.

Sell Your Gold??

And that brings me to what you can do about all of this brewing volatility…prudently…and ahead of time:

  • Hedge your bets by either shorting stocks or picking up shares of my favorite inverse fund, the Rydex Inverse S&P 500 Fund (RYURX), or tapping into an inverse ETF like ProShares Short S&P500 (NYSEArca: SH). Michael Purves, who is the Chief Global Strategist for Weeden & Co, made the case for shorting small caps as an alternative on CNBC, recently noting that the higher financial leverage and lower yields offer better opportunity. I agree, but only if you can stomach the additional risk.
  • Be ready to sell your gold then buy it back again at a lower price. Don’t I mean buy gold then get ready to sell it? Nope. Not this time. Many hedge funds and institutions are using gold to collateralize their marginable assets right now so one of the first things they’re going to sell to raise cash when faced with a margin call is gold. They’re also sitting on large profits that they’ll immediately begin to take off the table in a sell-off. This will end up catching a lot of investors by surprise because they expect gold to take off when the stuff hits the fan. It will…but only after it takes an initial hit.
  • Ratchet up your trailing stops. The markets have risen significantly since the beginning of the year. If you’re using your trailing stops properly (and I hope you are given how frequently we’ve talked about them), that means you should be moving up your stops in near lock step. Or, consider buying put options as an alternative. The last thing you want to do is let a big gainer turn into a loser if things roll over.

And as always, remember that buy-and-hold is a marketing gimmick, not an investment strategy.

Best Regards,

Keith Fitz-Gerald, Chief Investment Strategist

Money Map Press

QE Infinity Won’t Work, But Here’s What Will

By Keith Fitz-Gerald, Chief Investment Strategist

Dallas Federal Reserve President Richard Fisher recently offered a stunning assessment about our policymaking central bankers down in Washington.

They’re winging it.

In a talk before a Harvard Club audience, Fisher presented a candid assessment about all the levers the Fed has been pulling in the aftermath of the 2008 financial crisis. And that includes the recently announced QE3.

“Nobody really knows what will work to get the economy back on course. And nobody-in fact, no central bank anywhere on the planet-has the experience of successfully navigating a return home from the place in which we now find ourselves. No central bank-not, at least, the Federal Reserve-has ever been on this cruise before.”

I don’t know about you, but the idea that four years and trillions of dollars into this quantitative easing voyage we’re still sailing without a compass isn’t just appalling.

It’s terrifying.

The problem is, Fisher is right: QE3 won’t work. QE1 and QE2 didn’t fix this mess. Nor will QE4, QE5, onwards to infinity.

What’s more, there’s a cottage industry of pundits and consultants who’ll agree.

Trouble is, just like Fisher and his colleagues at the Fed, none of them can tell you why it won’t work.

That’s what we’re going to do here today.

We’ll start by giving you the lowdown on how this nation’s central bankers view “Quantitative Easing.” Then we’ll show you how the Fed thinks QE is supposed to work.

Finally, we’ll punch some (actually, many) holes in in the Fed’s hull by discussing why it’s not working.

We’ll even demonstrate what could still be done to fix this wretched mess.

Quantitative Easing (QE) is a Great Theory, But …

The latest version of QE calls for the New York Fed (the central bank’s trading arm) to buy $45 billion of U.S. Treasuries and $40 billion of mortgage- backed securities a month from dealers and banks .

The Fed then intends to “sterilize” these purchases by selling 1- to 3- year bonds through the end of the year – until it runs out of short- term paper to sell. A “sterilized” intervention is one that doesn’t increase the money supply.

But beginning in 2013, the Fed plans to continue doing the same thing – effectively continuing “Operation Twist,” but without the sterilization, because it has no more short- term paper to sell.

In plain terms, this means the Fed will monetize nearly 50% of the entire U.S. budget deficit in 2013. That will boost its balance sheet from the current $2.8 trillion to approximately $4 trillion – or 24% of U.S. GDP – by the end of the new year.

There isn’t a big list of players here. And that’s extremely important to understand.

Even the Fed’s own Website tells us there are only 21 counterparties – including U.S., Canadian, British, French, German, Japanese, and Swiss banks.

The upshot: The risks are highly concentrated – in just this list of financial institutions:

  • Bank of Nova Scotia, New York Agency.
  • Barclays Capital Inc.
  • BMO Capital Markets Corp.
  • BNP Paribas Securities Corp.
  • Cantor Fitzgerald & Co.
  • Citigroup Global Markets Inc.
  • Credit Suisse Securities (USA) LLC.
  • Daiwa Capital Markets America Inc.
  • Deutsche Bank Securities Inc.
  • Goldman, Sachs & Co.
  • HSBC Securities (USA) Inc.
  • J.P. Morgan Securities LLC.
  • Jefferies & Company Inc.
  • Merrill Lynch, Pierce, Fenner & Smith Incorporated Mizuho Securities USA Inc.
  • Morgan Stanley & Co. LLC.
  • Nomura Securities International Inc.
  • RBC Capital Markets LLC
  • RBS Securities Inc.
  • SG Americas Securities LLC
  • UBS Securities LLC.

In theory, the Fed expects these actions to push bond yields down while removing “safer” investments from the market. To be fair, Treasuries and other forms of government debt will always be available – but at higher prices because there aren’t as many offered for sale.

This is not unlike buying the last egg at the grocery store…if nobody wants it the price will be low, but if everybody wants it, you can bet you’ll have to pay a premium.

The idea is that, flush with cash and with fewer opportunities for higher returns, the banks will take on more risk and boost their lending to businesses and consumers.

With more money available – and at cheaper “prices” (lower rates) – that money will then work its way through the economy.

Businesses would use the cheap money to expand their operations, make capital purchases, produce more and hire workers to make it all happen. Firms are expected, according to the model, to build inventory in anticipation of the higher demand to come.

Then there are the consumers, who in good times account for 70% of what makes the U.S. economy go. Those folks, too, will borrow more of this abundant, cheap money to pay for products and services. That, of course, bolsters demand, boosts corporate profits, and spurs hiring. That hiring, in turn , puts additional money in consumer wallets, which accelerates spending, and starts the whole cycle anew.

Consumers are also expected to invest in housing. The Fed presumes both are the result of more or better wages ahead.

The Fed’s grand plan is also supposed to benefit the stock and bond markets. The yield-starved, zero-interest-rate environment the Fed is deliberately creating will force businesses and consumers to turn to stocks, bonds, capital purchases, and other assets in pursuit of higher returns. At least according to the Fed.

Over time, Team Bernanke hopes this will reflate everything from stocks to housing. It believes that increased demand creates jobs, stimulates new capital creation, raises housing values and leads to higher prices.

The hope is that there’s enough capital injected into the banking system to create a self-sustaining cycle of “capital creation.”

The Fed's Vision- How Quantitative Easing Is Supposed to Work

It’s a great theory.

But that’s the problem.

It’s a theory.

The central bank’s master plan is constructed mostly by academics and policy wonks with a decidedly political agenda – all of whom appear to believe in the fallacy of perfect information as part of their decision making.

So what are they missing? Let’s take a look.

What the Banks Are Really Afraid Of …

A key reason the Fed can’t clear away the financial-crisis fallout is that it doesn’t understand why the banks engaged in the risky behavior that caused the crisis in the first place. As Fisher’s comments suggest, it also doesn’t understand the implications of the moves it’s making now.

Given that, it’s no surprise our central bankers are so ill-prepared to deal with the witch’s brew they’ve now created.

Let’s start with FDIC insurance. When the Glass-Steagall Act was repealed in 1999, the protective wall that separated the more-staid commercial banking world from its risk-taking investment-banking counterparts was demolished.

The new “bank holding companies” could now reach through the proverbial firewall and finance their high- risk trading activities using FDIC- insured deposits as the anchor.

Some would say fuel.

Then, as part of the Commodity Modernization Act of 2000, derivatives and other exotic investments were specifically exempted from reporting and public- exchange requirements in a move that further incentivized and even encouraged risk-taking.

Taken together, it was as if Washington had dumped a barrel of jet fuel on an open campfire: It started a blaze that just about burned the whole forest down.

With access to an entirely new pool of capital and an implicit government guarantee, big banks moved rapidly out on the risk curve as CEOs like Dick Fuld (Lehman Brothers), Martin J. Sullivan (AIG), Charles Prince (Citi), and James Cayne (Bear Stearns) realized that trading – and not banking – provided a direct pathway to obscene profits.

Some experts don’t believe this could have happened in private markets, where risk is directly a function of capital on hand rather than the implicit guarantee of the U.S. federal government.

I agree. Banks would have had to quintuple their capital before anybody in their right mind thought about taking on that much risk. The markets would have made that impossible.

That brings us back to the present.

The Fed believes that it has to provide liquidity to these very same banks under the misguided assumption that the banks will turn around and release it to the public.

But not having enough money to lend was never the issue. It was the implicit federal backing and destruction of protective regulations that made too much money available the first time around.

Here’s the real issue – the one thing that terrifies these massive institutions.

They’re afraid of each other.

That’s right … they’re so afraid of each other, and of the potential implosion of the $648 trillion derivatives playground that they created and have now handcuffed themselves to that they’re forced to forever watch one another, and to hoard capital for that future “what if” day of reckoning.

And they need to be that afraid.

Thanks to the unholy combination of a fractional reserve system, leverage that at one point approached 100-1 on some instruments and the almost-total lack of supervision of unregulated trading activities for the last 12 years, estimates suggest there’s only one “real” dollar in the system for every $10 they’ve created .

And nobody knows who’s got it.

Practically speaking, the world of high finance has become murkier than ever. And traditional banking customers have become all but irrelevant.

Not surprisingly, this lack of clarity in the financial system translates directly into uncertainty in the business community. CEOs are responding in the only ways they can and, like banks, are hoarding cash.

Apple Inc., for example, is sitting on more than $117 billion in cash, 63% of which is offshore. Berkshire Hathaway is sitting on $162 billion. General Electric Co. has $122 billion tucked away.

The nation’s chief job-creation engine – the small business sector – is also adrift and listing. Small ventures don’t have the luxury of building up huge cash stockpiles, so they depend on various forms of revolving debt. Many can’t get the loans they need despite flawless credit because banks obsessed with their own survival have tightened up their external lending standards so much that no money escapes.

The nation’s banks once went out of their way to find reasons to give money out. No longer. And America’s entrepreneurial spirit is being crushed in the process.

Companies of all sizes are holding down costs, delaying investments as long as possible, and are hiring only when absolutely necessary.

And, as the controversies over recent jobs reports underscore, that lack of hiring is the most damaging reality of all.

Until that changes, the economy isn’t going to get well again.

Having been badly burned by an orgy of easy credit and profligate spending, consumers have had enough, too . They’re deleveraging. Many don’t want debt – even if it’s free.

Unlike the government and the banks, which exist in some sort of fantasy land, consumers have to live within their means.

So growth slows to a crawl, or grinds to a halt . This results in balance sheet destruction once productive assets go into decline.

Ultimately, demand craters.

Once that happens, it’s only a short drop into a managed depression that lasts for decades – as we see in Japan, where an entire generation has lived its whole life in a functional depression, no-growth malaise.

The Path We Don’t Want to Travel

Indeed, Japan is now entering the third decade of what was supposed to be a single “Lost Decade.” The Nikkei is off 80% and that nation’s combined private, corporate and public debt is now over 500% of GDP.

And that brings me to where I believe the Fed’s plans are so badly flawed.

Money created in a vacuum that is not backed by real savings and real assets creates false economic signals. These false signals, in turn, lead directly to additional economic misallocations.

Yet this ship of fools sails on.

What I mean by that is the money gets diverted into areas of our economy that have marginal value (like the banking system) instead of being funneled to where it can do the most good (job-creating technology or manufacturing) to help those who need it most (America’s hard-working-but-still-

struggling middle class households ).

So yes, the stock market will rally in the short term, but as the weight of these debt burdens becomes greater, the cumulative effect of each new round of stimulus lessens.

And that’s precisely what’s happening now.

Take a look. With each successive round of QE, the gains become smaller in magnitude and shorter in duration.

At some point in the future – a point that Fisher and his Fed colleagues readily admit they can’t identify – quantitative easing will fail to have any impact whatsoever.

But rest assured: Everyone is Washington is focusing their energies on making sure it happens on someone else’s “watch.”

Three Steps the Fed Can Take Now To Fix the Problem

To keep that from happening, we need to do what a long-winning sports team does when it falls on hard times – get back to the basics, to the fundamentals that made it great.

In this case, those “fundamentals” are the Fed’s basic mandate. According to that mandate, as amended in 1977, “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” [emphasis mine].

And this kind of a long-run focus doesn’t include propping up a banking system with liquidity it neither needs nor deserves.

In fact, here are the three steps Fed leaders can take right now if they are truly interested in acting in accordance with their mandate:

    1. Force banks to choose: Either you’re an investment bank or a commercial bank – but you can’t be both. If you’re lending to consumers and businesses, you get the FDIC insurance and the implicit backing of the U.S. federal government. If you’re trading derivatives, you’re on your own.
    1. Reintroduce risk: All gain, no pain doesn’t work. It’s never worked. Success, by its very definition, includes the potential for failure. The Fed has to let failure happen. History, as legendary investor Jim Rogers pointed out to me years ago, “is littered with the bones of failed financial institutions.” Why should this time be any different? Printing money is a short- term fix that only digs us into a deeper hole.
  1. Require capitalization: Lasting economic development is driven by real savings, not fiat money and financial engineering. Responsible parties assume the risks and deserve the profits. Today’s Wall Street robber barons aren’t responsible, and they aren’t deserving.

Of course, we can always continue on our current path. But as Fisher says, that will only take us even “deeper into uncharted waters.”

Along with Fisher, I think this country needs to “sober up” and get its act together.

More of the same isn’t a solution that will work this time.

Best Regards,

Keith Fitz-Gerald, Chief Investment Strategist

Money Map Press

This Buying Spree Dwarfs The One That Shook the World in the 80s

By Keith Fitz-Gerald, Chief Investment Strategist

They’re baaaaack. While the Chinese are busy grabbing all of the headlines, it’s really the Japanese who are making the biggest moves.

So far this year, they’ve very quietly spent $101 billion on overseas acquisitions in a global buying spree that now dwarfs the one undertaken in the late 1980s and early 1990s according to Edward Jones of Dealogic.

S&P Capital IQ reports 45 deals with a value of $18.7 billion year-to-date involving a Japanese investor or buyer and U.S. assets alone. That’s a 50% increase in the number of deals and a 64% increase in the valuation versus last year at this time.

To put this binge into perspective, not only is this the highest year on record, but it is on a pace that’s three times the acquisition rate that had everybody quaking in their boots 30 years ago.

I think that’s very telling on a couple of levels.

First, Japan’s economy is faced with a triple disaster. When you add up private, corporate and government debt, it’s nearly 500% of GDP according to numbers from Goldman Sachs earlier this year, which makes the Greeks look positively miserly. Even our own fiscal cliff pales in comparison.

Second, fully 25% of their population is going to die off by 2050, according to the Japanese Health Ministry, further exacerbating the near-complete shutdown in domestic demand that repeatedly plagues any attempt to jump-start the Japanese industrial machine.

And third, Japanese corporations themselves are struggling on every level. Decades of low and no growth have paralyzed even the best companies.

That’s why so many Japanese companies are now turning their attention to global markets. They have to – it’s the only way they’re going to survive.

The Japanese Hunt For Growth

Japan’s economy is not growing at 7% a year; instead it’s fighting to maintain any kind of positive momentum whatsoever.

Its executives are struggling to cope with highly competitive markets that move faster and more decisively than they are prepared to accept. According to McKinsey, productivity per worker is one of the lowest of any developed country.

In short, the Japanese economy is vulnerable rather than in a position of strength.

This changes the game significantly and gives the Japanese a new sense of urgency. Japanese companies literally have no alternative. Almost every market they’ve dominated for years is failing.

Case in point, Japan is well known for its electronics prowess. In 1990 Japanese products represented nearly 30% of the world’s total export value. Now that figure is closer to 14%.

That’s why, in contrast to the 1980s when Japanese companies were primarily interested in top-tier assets, now they’re interested in businesses that will result in accretive growth or further control over their supply chain.

They aren’t as interested in any one geographic area, either, as they were in the 1980s when the majority of Japanese companies engaged in overseas expansion focused mainly on the United States. Now, they’re on the hunt for growth anywhere they can find it and in any sector that appears promising.

The big banks, trading houses and pharma companies are particularly aggressive, and with good reason – they’ve got everything to lose. Generally speaking, they’re the only companies with any sort of growth momentum left and, more importantly, the cash to exploit it.

In that sense, Japanese companies are positioned like Germany is in the EU. They’ve got to move or risk having the very life sucked out of them by ineffective debt-plagued competitors and a government that’s determined to “help.”

Take Takeda Pharmaceutical, for instance. Their recent buying spree includes:

  • $13.7 billion for Swiss drug maker Nycomed
  • $800 million in cash for Philly-based URL Pharma Inc.
  • $248 million to gobble up Brazilian company Multilab Industria e Comercio de Productos Farmaceuticos Ltda.
  • And $60 million paid in a lump sum up front to purchase Montana based LigoCyte Pharmaceuticals

All of them allow Takeda to pursue global vaccines while offering the kind of diversification and cash flow not possible in Japan itself.

Or Daikin Industries, which agreed to fork over $3.7 billion for U.S. HVAC maker Goodman Global, Inc. in August. Daikin lacks the technology needed to compete globally in markets like the U.S. that is dominated by air duct systems. This acquisition gives Daikin the ability to funnel the newly-purchased product line though a dealer network that’s 90-plus countries strong.

On Monday Softbank, a leading Japanese mobile carrier, announced that it will purchase a 70% interest in Sprint Nextel in a transaction that is the single-most expensive yet this year at $20 billion.

Mitsubishi UFJ Lease and Finance Co, LTD is purchasing Jackson Square Aviation for $1.3 billion and change. According to S&P Capital IQ, that’s the largest acquisition of a U.S. financial services provider this year and second only to that of Tokio Marine & Nichido Fire Insurance Co. Ltd’s purchase of Delphi Financial Group last year for $2.7 billion.

And the list goes on, getting bigger and more valuable by the day.

According to S&P Capital IQ, the average purchase this year falls into a range that defies belief at 20-25 times trailing 12 month earnings before interest, taxes, depreciation, and amortization — or EBITDA for short.

Putting a Higher Value on Intellectual Capital

Here’s another change from the 1980s that’s also worth considering.

In contrast to the acquisition wave of the 1980s and 1990s, the vast majority of Japanese companies are leaving local management in place. In fact, they’re requiring they stay as part of specific terms included in the transaction.

This is a radical departure from what happened last time around when Japanese companies couldn’t swap out local management fast enough.

If you recall, movies like Michael Keaton’s Gung Ho and Sean Connery’s Rising Sun hit the theaters in 1986 and 1993 respectively in response to the rise in social angst that accompanied the flood of Japanese capital.

At the time, business schools were falling all over themselves to offer courses in Japanese management and “textbooks” like the Book of Five Rings written by Miyamoto Musashi, a legendary samurai, became instant best-sellers.

I remember that almost every Japanese acquisition I worked on at the time came with a flood of “interns” ostensibly there to learn, but in reality were there to report nightly to the home office.

Takeda, for instance, not only plans to leave senior managers in place at these companies, but is taking its cues from global experts like Rajeeve Venkayya, a former White House Special Assistant for Biodefence, who was hired specifically for the purpose of guiding international expansion as reported by the Wall Street Journal.

Goodman’s executives will likely stay on, too, given that the U.S. is the largest air-duct dominated HVAC market in the world, and Daikin has very little experience selling into this important retail channel. The loss of intellectual capital which once went unnoticed by the Japanese supermen of the 1980s is now highly valued by the present generation.

As for what’s driving this, it’s the Yen.

Since 2008, the Yen has appreciated 28.8% against the dollar. This year it’s backed off a bit after repeated Bank of Japan intervention.

Nonetheless, at 78.44 to the dollar, it’s still super strong even if it remains below the postwar record of 75.35 per dollar hit a year ago October. Next to the Swiss Franc, the Yen is undeniably one of the strongest currencies on the planet.

Practically speaking, “it’s as if everything we Japanese have ever wanted to buy overseas got put on sale at a huge discount” noted a colleague of mine who wishes to remain anonymous from Tokyo who works in the M&A department of a top tier bank.

People who are focused on Europe’s debt crisis or slowing Chinese growth don’t realize that this can continue for some time to come. Japanese companies have more than $2 trillion in cash on their balance sheets and some very powerful motivation.

And they’ll be all too happy to quietly build key competitive positions worldwide at a time when the rest of the world is looking the other way.

Whether or not they can keep them moving forward remains unknown.

Best Regards,

Keith Fitz-Gerald, Chief Investment Strategist
Money Map Press

Why Most Stock Market Systems Fail… And This One Doesn’t

by Alexander Green, Investment U Chief Investment Strategist
Monday, October 15, 2012

Alexander Green

Most investors realize they need a successful, battle-tested system to increase their returns in the stock market.

But which system? There are so many. And every guru claims his or her system is the best. They can’t all be, of course. And, truth be told, many of them are no good at all. Turns out some folks aren’t so great at calculating their own numbers. (That’s the reason golfers are required to have their opponents attest the card.)

The least you should expect when evaluating a stock-picking system is that it passes the common sense test. That means it should be a) easily understandable and b) intuitively believable. (In my experience, if an investment system involves things like Fibonacci numbers or Japanese candlestick formations, it’s best to give it a miss.)

That’s why I’m surprised more investors don’t use one of the most intuitive and successful stock market indicators of all: heavy insider buying.

Many years ago, insiders could buy or sell at any time for any reason and just pocket the gains. Needless to say, this infuriated most investors who rightly saw the game as rigged in favor of those holding material, non-public information. And so the federal government began requiring corporate insiders to file a Form 4 with the SEC any time they transacted in their own company’s shares, detailing how much they bought or sold, at what price, and when.

If you don’t think the smart money is watching insider activity like a red-tailed hawk, you don’t know the smart money. Corporate insiders have a treasure trove of information available to them and they can hardly forget this knowledge when they go into the market to trade. They know, for instance, the direction of sales since the last quarterly report, what new products and services are in development, whether pending litigation is about to be settled, and plenty of other stuff those of us on the outside looking in couldn’t possibly know.

The insiders have an enormous unfair advantage in trading their own company’s shares. That’s why the government requires them to file that Form 4 within 48 hours of any transaction. And I can tell you from looking at these filings almost every day that most insiders file the same day they buy or sell. And you should take advantage of it by buying the same things they are.

Numerous studies have shown that stocks with heavy insider buying substantially outperform the market. (How could it really be otherwise?) That’s why it makes sense to ride the coattails of knowledgeable officers and directors. Yet I often find that ordinary investors have no idea which companies have corporate chiefs who are loading up on the stock.

There is still due diligence required, of course. You need to know how many insiders are buying, for example, and what their track records are. Have they bought shares in the past? If so, did they buy low and sell high? And if they sit on the boards of other companies, did they buy low and sell high there, too? If so, you should score their buying higher than you would otherwise.

In essence, insiders vote with their wallets. Every time they pile into a stock, they are in effect saying that with everything they know about the company – including all sorts of material, non-public information – they believe it is selling for less than it’s worth.

That’s an excellent signal. So if you’re looking for a stock market system that is easy to understand, intuitive and effective, insider buying is a great place to start.

Good Investing,

Alex