The administration is in a tough spot. Interest rates as measured by Fed Funds are almost zero, yet the recovery is stagnating. Unemployment hovers around 10%. In addition, the debt situation is getting worse and worse.

As a president, it’s one thing to know you have a big fiscal problem. It’s quite another when a panel you appointed tells you the policies you have in mind will only make things worse.

That’s what happened Sunday, when leaders of President Obama’s deficit commission offered up the darkest of outlooks for our financial future — calling current trends in U.S. budgets a “cancer” that will “destroy the country from within” unless halted soon. Not exactly encouraging news.
Meanwhile, after a 200 point reversal in stocks yesterday after a weak opening, the market dropped on Bernanke’ remarks. After sitting slightly up for most of the morning, the markets dropped immediately during Bernanke’ testimony to eventually close down over 100 points. As I continue to expect, the equity markets continue to churn in a relatively narrow range. Year to date, the Dow has traded as low as 9686, and as high as 11, 204. However, for most of the year, the range has been less then 1000 points, or around 10%. Just to put this in perspective, in 2008, the Dow traded in a range of over 4000 points. In 2009, the range was over 3500 points.

It is tough for analysts to get a feel for this market. When it rallies like it did between mid-February and early May, sentiment tends to be overwhelmingly positive. When it falls like it did last week, all the nay sayers come out of the woodwork with their doom and gloom. It would seem to me that on a technical basis, S and P 1100 is an important level. I would need to see a solid close above that level to get more positive on the market. We closed Friday at 1065. In the meantime, I expect the market to churn around, driven by earnings and external world events.

Meanwhile, consumer confidence dropped to its’ lowest level in a year, as signs that the recovery is stagnating continue to appear. Two year treasuries dropped below 0.6%. Although very low interest rates tend to lead to stock price increases (as investors figure they can do better in equities as opposed to very low bond yields), the faltering economy is causing great concern everywhere, but especially in Washington. The Obama administration has their work cut out for them.

There are several divergent opinions on this. For example, Doug Kass, who runs a hedge fund called Seabreeze Partners, has stated that he believes that the market has made its’ lows for the year. Kass is famous in my book for called the lows of the market, almost to the day, in March of 2009. Of course, he has been wrong before. However, Kass is known as a short seller, and the fact that he is now bullish has some significance.
On the other extreme, you have Robert Prechter. Prechter follows a form of technical analysis known as the Elliot Wave Theory. Prechter has made rather extreme predictions in the past, with some spectacular successes as well as failures. However, he now believes that the market is at the beginning of a long decline, which could eventually send the Dow down to 1000. Quite a difference of opinion!

I’m in between these two extremes. I think the direction of the market will greatly hinge of several economic factors, but earnings reports will play a big role. As second quarter earnings season begins this week with Alcoa, we should have a better picture of where the market is heading.

1.”Our greatest happiness does not depend on the condition of life in which chance has placed us, but is always the result of a good conscience, good health, occupation and freedom in all just pursuits.”

Thomas Jefferson
2. “Liberty, taking the word in its concrete sense, consists in the ability to choose.”
Simone Weil
3.”Freedom is the oxygen of the soul.”

Moshe Dayan
4. “Those who won our independence believed liberty to be the secret of happiness and courage to be the secret of liberty.”

Louis Brandeis
5. “You can’t separate peace from freedom because no one can be at peace unless he has his freedom.”

Malcolm X
Remember not to take our freedom for granted!

Happy Independence Day!

it seems that many states are finally coming to the realization that their budgets are not close to being balanced. Some states have promised pensions that they cannot afford, and as people retire, these states face a crisis in figuring out what to do. According to Eden Martin of the Commercial Club of Chicago, we are within a few years of several pension funds running out of money. According to federal law, a state is still obligated to make pension payments even if they run out of money. The problem is, where will they get the money? The most obvious choice is from general revenues, i.e. taxes. However, as most of these states are not only in debt but also run continuing yearly deficits, this is sort of like robbing Peter to pay Paul. On Wall Street, we sometimes call it “shuffling the deck chairs on the Titanic”. In other words, you are funding one deficit by adding to another. This is sort of like someone with several credit card bills that he can’t pay. Therefore, he pays off one by increasing the credit line of another.  Of course, the interest charges just get bigger.

This is the same scenario the US government has with social security. Many people misunderstand this system. They think that the money deducted from their paychecks is being held in reserve for them till retirement. The reality is quite different. To understand this, think of when social security first became a law in 1935. Retirees received money immediately, without ever having to pay into the system. Where did this money come from? From the then current worker pool. Who paid those workers? The new workers, and so on and so forth. Now, this system only works if the social security tax rises at least as people retire. In 2009, over 50 million American received over $650 billion in benefits. Even though social security taxes are now over 15% (equally split between employers and employees), the system has not kept pace. This is especially due to the beginning of the “baby boomers” retirement age. Some people, like Thomas Sowell, refer to this as just a pyramid scheme. How this will play out over the next decade may prove to be a challenge.

On that day, an explosion on a oil rig led to 11 deaths and a massive oil spill in the Gulf of Mexico. Since that date, estimates of the amount of oil released and the potential clean up costs have increased constantly. As such, BP stock lost about half of their value. The devastation has effected the shipping industry and negatively effected a huge portion of the US marine environment. In a bid to show leadership, you even had President Obama involved in castigating the company on national television.

Today, BP finally announced that they were setting up a $20BB fund. This may not be enough. In addition, they suspended their dividend, which will save them another $10BB. The question is, what’s next? I can see three possible scenarios:

1. BP finally gets a handle on the problem and takes steps to resolve it. The stock will probably increase under this scenario, depending on the eventual cost.

2. BP gets taken over by one of its’ competitors. There are rumors of Exxon and Shell being interested, but these are only rumors. A takeover could mean a $50+ stock price.

3. The costs and political pressure become so great that BP decides to seek protection under the bankruptcy code. This would have the biggest negative effect on the stock price.

Although the situation is still ongoing, I think scenario 1 is most likely. Bankruptcy is a final resort, and even Obama would not like to see this, as it will limit BO’s ability to pay claims. As far as scenario 2, a takeover is always tough to predict. Even if someone was interested, it would be an incredibly complex deal subject to heavy regulatory approval. Therefore, I believe BP will finally get a handle on the costs. However, this situation is still changing every day, and as such, anything could happen.

The main issue, of course, is debt. It is rather outrageous that almost every industrialized nation has spent more than they take in. If a sovereign country were a corporation, they would realize that you cannot continually spend three dollars for every two dollars in revenue. Sooner or later, you are to have to turn a “profit”. In the case of most European countries, they haven’t turned that profit in years. Their solution has been to borrow ever increasing sums in order to finance their yearly shortages, as well as buying the interest on their debt. This is true in the United States as well. OK, then why did the market react so negatively to a seemingly benign jobs number on Friday?

In order to stimulate the economy, the US government has been spending huge amounts of money (via treasury bond sales).Interest rates are already around zero. They have already bailed out the banks and the auto industry. Now, all this might have been worth it if the economy was truly improving. However, based on the latest unemployment numbers (which are currently 9.7% nationally),it is apparent that it is not. Most of the new hires have come from the government incentives, and not from private industry. How long can the US continue to spend without bringing the Euro crisis here? I don’t know, but one thing I learned in business school was that if you borrow money, you have to repay it sooner or later. Unfortunately, the US, like most countries, really have no idea how they are going to repay this. You want to know what their plan is?

1. Leave it to the next guy

2. Hope that investors will continue to buy bonds forever

3.Pray

There is only one real way to address this, and that is to balance the budget. One would accomplish by either cutting expenses (meaning unemployment, bailouts, subsidies, etc.) or by increasing revenues (meaning taxes). Needless to say, neither path is politically popular. The one thing every elected official understands is that you remain popular in order to get reelected. As such, there are very few people who will be willing to sacrifice their political career for the sake of balancing the budget. Until this happens, we will constantly be behind the eight ball.