What is VIX telling us about where the market is headed?

Years ago I paid a lot of attention to VIX, the CBOE implied volatility index or "market fear gauge/index", but after they changed its composition a few years ago and people began shifting to other techniques for hedging stock positions VIX has lost a significant amount of its value as an "indicator." I only write this post because I just ran into the following misleading claim about what VIX "indicates":

The VIX has indicated correctly over the past few years when the market would decline, particularly after 9/11, the start of the Iraq War and the movements at the beginning of this year on Chinese economic growth fears.

Be clear on one point: VIX is not a leading indicator. VIX does not tell you what the market is going to do days or weeks in advance. It is a coincident indicator of the anxiety of market participants. It tells you how worried people are right now. VIX tends to spike up when people are selling feverishly, not in advance of a sell-off.

If you had sold your stock in early June when VIX spiked from under 13 to 17, you would have missed out on the latest big run-up of the Dow. And if you had not sold on July 19th when VIX had declined to around 15, you would have missed an opprtunity to avoid last week's sell off. Some "indicator."

To reiterate, VIX indicates the current anxiety level, not what the market will do in the days and weeks ahead.

The best use of VIX is to detect times of maximal anxiety, which is when selling peaks, which is precisely the time to jump in and buy the dip.

Alas, there is no indication in VIX that there might not be an even higher spike tomorrow or the day after or next week or next month.

VIX is not a good indicator of precisely when to buy or sell, but you can use it to judge when you should start considering a shift. Even then, I have to advice extreme caution. If you had listened to chatter about VIX being low over the past few years, you would have missed a huge run-up in the bull market. Since VIX was changed a few years ago (September 2003), it has not gone through even a single major crisis and not a single transition to a bear market. It could take another five years before we have a thick enough portfolio of market transitions so that we can calibrate VIX for the kind of markets and the kinds of investors that are active today.

The other answer I can give to the headline question is that the recent spike of VIX up above 24 suggests that the sell-off may be very close to running its course, with an emphasis on the qualifier "may." Based on experience, I wouldn't be surprised either way if the market fell another leg or began a new up-leg immediately.

Timing of market trend changes is very risky business.

-- Jack Krupansky

Were the stock market declines last week a big deal or not?

Should we be concerned by the stock market declines last week? Short answer: Probably not. It is not uncommon in a bull market for the market to occasionally go through "a correction" before continuing upwards, and during a correction people will drag out all manner of anxieties and excuses for why the market "should" go down. By all appearances, that is what we saw last week. But even if that was the case, it doesn't mean that the "bloodletting" is over yet. Corrections can last for days, weeks, or even a couple of months.

As far as the impact of the ongoing slowdown in housing, simply note that back in December non-residential construction exceeded residential construction and since February nonresidential has been growing faster than residential has been skrinking. In other words, housing is no longer a net drag on the economy.

As far as a claim of "contagion" and a "credit crunch" due to problems with subprime mortage-backed securities, note that high-yield bonds and debt for mega leveraged buyouts (e.g., Chrysler) are absolutely not respresentative of the "real" economy. Plenty of credit is available for both consumers and businesses with at least semi-decent credit. According to Freddie Mac, mortgage rates actually dipped a little last week. The fact that some dubious, riskly deals are running into trouble is probably a good sign as far as the health of the financial system.

Some of the market declines may have been an adjustment for the fact that Q3 and Q4 will very likely see slower economic growth than Q2, but the down-shift in growth will most likely not be so big a deal at all. In fact, I strongly suspect that Q3 and Q4 will be a lot stronger than people are currently forecasting or worried about. My guess is that Q3 will come in within the 2.5% to 3.0% range, and Q4 in the 2.75% to 3.25% range. My suspicion is that housing will bottom out fairly soon, with either July or August as the bottom and September and October seeing a little bit of a bounce.

The problem is that a lot of people, including many so-called "professionals" on Wall Street, really don't have a handle on the real economy and let their imaginations and anxieties run away with themselves. Reality tends to turn out a lot better than the forecasts and worries of the doom and gloom crowd.

These dips are rather painful, but on the other hand there are a lot of people like me who are net buyers of stock (and I will be for the next five years), so these dips work out to our financial advantage.

My Roth 401K retirement plan will be buying stock (automatically, twice a month) on Tuesday, so the nice dip will likely at least be a good deal for me. In fact, I'll be annoyed if the markets bounce before Wednesday.

-- Jack Krupansky

Updating definitions of terms related to money, capital, and liquidity

Many terms used in finance and economics have been in use for an extended period of time, but there is also a lot of evolution of our economic and financial systems going on and meanings of terms evolve as well. My motivation for this post is to clarify the common use of the term liquidity, as when people say "the world is awash with liquidity."

My goal here is not to redefine existing banking terms, but rather to focus on how the terms are using in the world outside of banks. My terms basically end where the world inside of the banking system starts.

My definitions here are still in rough draft form. I'm actually not happy with them yet, but I'd rather get them out there for discussion rather than spend a lot more time tweaking them in private. I have consulted a number of sources for existing definitions, but I'm confident that a bit more research will help me identify even tighter and broader definitions.

To summarize this whole post: I would define "liquidity" as the ready availability of capital, regardless of whether that capital is money in the bank, a venture investment, a loan, a credit line, or any other credible "source" for "money."

Traditionally, the term liquidity has been used to refer to a market in which assets (typically securities) can be promptly exchanged for cash at a price which is reasonably stable (or rising.) A liquid market is a market in which owners of assets can feel confident that they can at any time sell those assets promptly and without having to take a substantial "haircut" on the price that they perceived to value those assets well in advance of their decision to sell. A liquid asset is an asset for which there is a liquid market. In other words, a liquid asset can be readily converted into cash. An individual or entity is said to be liquid if they are capable of covering their liabilities with their assets, implying that there is a liquid market for the assets they would need to sell to cover their liabilities.

An illiquid market is a market in which the sale of assets cannot be arranged promptly or if the sale would be at a much lower than expected price. An illiquid asset is an asset for which a liquid market is not readily available. An individual or entity is said to be illiquid if they are not capable of covering their liabilities with their assets, implying that there is not a liquid market for the assets they would need to sell to cover their liabilities, or at least their liabilities which are due promptly (in the very near term.)

In essence, the traditional use of the term liquidity is to refer to non-cash assets and the ease of readily converting them to cash at a decent price.

I do not believe that I am describing or defining anything new there.

But today, people throw around the term liquidity as in "global liquidity" or "the world is awash with liquidity", not in reference to non-cash assets, but in reference to "cash" itself which is readily available to acquire assets.

I suggest that we are stuck with a term that has three alternative definitions:

Liquidity is either: 1) the ease with which a market can be used to readily convert an asset to cash at a price near the price quoted by the market for an extended period of time before the actual sale of the asset, 2) the degree to which an entity could readily convert assets to cash to cover liabilities, and 3) the degree of availability of buyers and investors and lenders with "cash" ready to purchase assets or make investments or make loans.

That's a good rough definition, but some issues remain.

First, what is "cash"? The term is used rather loosely. Well, it certainly isn't simply paper currency in your wallet and the coins in your piggy bank. My third definition for liquidity also needs to cover cases where investors have ready access to credit lines.

I suggest substituting capital for cash in my third definition.

But even to make sense of that definition, we need to get a good handle on the basic terms.

Since most financial transactions are performed electronically, cash has to exist in electronic form as well as its ultimate physical form.

If we are going to talk about cash, then we also need to relate it to or distinguish it from money.

We also have to relate and distinguish cash and cash equivalents.

I would propose the following multi-definition for cash:

Cash is either 1) currency, 2) a loose synonym for money, or 3) extremely liquid assets.

In some contents, cash really does mean money in your pocket, such as paying for a good or service "in cash."

In many contexts, cash and money are used as interchangeable loose synonyms.

Extremely liquid assets are assets for which an extremely liquid market exists.

An extremely liquid market is a market which has extreme liquidity.

Extreme liquidity means that an asset can be so promptly and reliably converted to "cash that most market participants consider such an asset as good as cash. An example of the latter would be short-term U.S. Treasury debt and money market mutual funds.

It is a matter of debate whether commodities such as oil, copper, or even gold, should or shouldn't be considered extremely liquid assets. I would argue that at least in the context of "cash", an asset is extremely liquid only if its nominal value will not decline over a period of time. Sure, inflation and foreign exchange rates can cause the "value" of even currency to decline, but commodities can decline in value even as a deposit in a money market account rises. In the end, my definitions here don't depend on whether commodities are included as extremely liquid assets. I would characterize them as very liquid assets.

The whole point of extremely liquid assets is that "money" can be "stored" in a wide variety of forms just as long as those forms can be converted and consolidated into a "balance" in a financial institution that can be electronically "wired" to another financial institution.

Money is: either: 1) currency, 2) a deposit at a financial institution, 3) special arrangements between financial institutions and central banks which effectively act as if they were real deposits, or 3) a loose synonym for cash.

(I'm not happy with this definition. It needs to be both tightened and broadened.)

A liability is either: 1) a contractual obligation such as a loan or lease, 2) a governmental obligation such as taxes, 3) a court-ordered obligation such as a judgment, or 4) some other form of "commitment" to disburse funds in the future.

An asset is either: 1) property (physical or intellectual) or 2) a financial asset.

A financial asset is either 1) money or 2) a security which can be bought and sold on a financial market

Capital is either: 1) money or 2) credit.

Credit is either: 1) money that is made available to a borrower by a lender in consideration of either their ability to repay the credit or the value of collateral provided by the borrower and held by the lender, 2) a credit line, or 3) a credit card.

A credit line is the prearranged future availability of an agreed upon quantity of credit in advance of the actual access to that credit. The key is that the creditor does not need additional approval from the lender to access the money represented by the credit line.

A credit card is physical object, usually a thin card usually plastic and usually rectangular, use to identify a credit line in a financial or commercial transaction.

Currency is either: 1) the unit of value for financial  and commerce transactions as defined by a governmental entity within an economic community, 2) a quantity of currency, 3) physical currency, 4) electronic currency, .

Physical currency is either paper currency or coin.

Paper currency is either: 1) a type of physical piece of paper printed by a government agency to represent a quantity of currency, 2) a single piece of paper currency which represents a specified quantity of currency value, or 3) a quantity of individual pieces of paper currency.

A coin is either: 1) a type of physical object (other than paper currency) and usually metallic and usually a disk which is manufactured by a government agency to represent a quantity of currency, 2) a single coin which represents a specified quantity of currency value, or 3) a quantity of individual coins.

That about covers it. I think these terms give a detailed enough view for people to understand the interactions between liquidity, money, capital, cash, and credit.

I will continue to research and refine these terms. At least this is a starting point.

I cannot dictate how others should use any of these terms, but at least my readers will have a clue as to what I mean when I use these terms.

-- Jack Krupansky

Nominal GDP continues to recover

Although real GDP growth was rather weak in Q1 (0.6%), nominal GDP growth (which is actual GDP growth before inflation is subtracted) was reasonably decent (4.9%) and in fact greater than nominal GDP growth in Q4 of 2006 (3.8%.) Nominal GDP in Q2 (6.2%) grew at its fastest pace since Q1 of 2006.

The low point of nominal GDP growth was in Q3 (3.4%), last summer, and has been growing at an accelerating pace every quarter since.

Sure, we do have to take inflation into account, but with the high volatility of energy and commodities prices, we do need to start our analysis with nominal growth, since consumers and businesses actually pay nominal prices and real GDP growth is derived from nominal GDP growth, not the other way around.

-- Jack Krupansky

Will China finally let its currency float in 2009?

Liberal politicians like to complain that China is "manipulating" its currency, saying that it "hurts" U.S. manufacturers who are trying to compete with cheap Chinese goods.For the most part this has simply been talk along with meaningless votes in Congress as the business-oriented administration has resisted these liberal efforts to "punish" China in a manner which would punish Americans in an even worse manner. But with the election coming up in 2008, with Hillary poised to win, with Hillary and others passionately committed to fighting China's currency "manipulation" as an election theme, and some stronger action against China and its currency likely from Congress and the new administration when it comes into office in 2009, it becomes very urgent to get a handle on where China is likely to be on foreign exchange rate policy in 2009 as Hillary comes into office and must quickly decide what to really do about the Chinese forex problem.

I do believe that China will eventually float their currency, but the timing is very uncertain. Chinese officials have occasionally stated as much, and I do believe that they understand the necessity of such a move. Right now, their financial system is still much too weak and undeveloped to cope with the "forex wolves" of hedge funds and other traders and speculators who are prepared to deploy vast sums of money to exploit forex arbitrage opportunities. A lot of the calls for a float are simply veiled attempts to open up a new market for speculation rather than a sincere attempt to deal with any alleged harm.

The good news is that China is getting financially stronger and more mature as each year goes by. There is a lot more foreign participation in China's banking system than just two or three years ago. China's stock market is quickly demonstrating an appetite for putting capital at risk.

A float in 2007 is absolutely out of the question.

A float in 2008 is very unlikely, but with the war of words heating up for the 2008 election and even Republican candidates falling all over themselves over who can talk tougher about China on Chinese currency manipulation, I strongly suspect that Chinese officials will really get the message and accelerate the pace of laying the groundwork for a float.

I do not expect China to announce a flotation plan in 2008, but I do expect China to grease the skids for foreign investment and bulking up China's financial system.

Even 2009 might be premature for a smooth floatation, but I do think China will be ready by then and at least be in a position to offer the U.S. a fairly rapid roadmap for a staged flotation over, say, a three year period.

I do expect that the U.S. (most likely led by Hillary) will "demand" that China rapidly end currency "manipulation" in 2009. And I do expect that China will be able to promptly put forward something on the order of a three-year plan that will be at least credible enough and palatable enough to hold off punitive trade sanctions by the U.S.

There will be a lot of foreign investment in China's financial system over the next eighteen months, strengthening it greatly, possibly even bringing it up to a level of robustness that will likely even intimidate all but the largest of forex "wolves."

So, yes, China could be ready to float its currency in 2009, but I think the likely scenario is a partial, staged float with a big first stage in 2009 and with a full float by the end of 2011.

-- Jack Krupansky

PayPal money market fund yield rises to 5.03% as of 7/28/2007

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Here are some recent money market mutual fund yields as of Saturday, July 28, 2007:

• iMoneyNet average taxable money market fund 7-day yield rose from 4.71% to 4.72%
• GMAC Bank Money Market account rate remains at 5.16% or APY of 5.30% (only $500 minimum)  -- Note: This is an FDIC-insured bank account
• Vanguard Prime Money Market Fund (VMMXX) 7-day yield remains at 5.13%
• Vanguard Federal Money Market Fund (VMFXX) 7-day yield remains at 5.08%
• AARP Money Market Fund 7-day yield remains at 5.07%
• TIAA-CREF Money Market (TIRXX) 7-day yield fell from 5.05% to 5.03%
• PayPal Money Market Fund 7-day yield rose from 5.02% to 5.03%
• ShareBuilder money market fund (BDMXX) 7-day yield remains at 4.47%
• Fidelity Money Market Fund (SPRXX) 7-day yield rose from 5.00% to 5.01% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield remains at 4.98%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield rose from 4.45% to 4.46%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield rose from 3.27% to 3.28% or tax equivalent yield of 5.05% (up from 5.03%) for the 35% marginal tax bracket and 4.56% (up from 4.54%) for the 28% marginal tax bracket -- this may be the best rate that most of us can get for "core cash" in a checking-style account
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield rose from 3.22% to 3.23% or tax equivalent yield of 4.97% (up from 4.95%) for the 35% marginal tax bracket and 4.49% (up from 4.47%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate rose from 4.76% to 5.04%
• 13-week (3-month) T-bill investment rate rose from 4.98% to 5.03%
• 26-week (6-month) T-bill investment rate rose from 5.07% to 5.10%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 3.74% (down from 4.52%), with a fixed rate of 1.30% (down from 1.40%) and a semiannual inflation rate of 1.21% (down from 1.55%) -- updated May 1, 2007, next semiannual update on November 1, 2007
• Schwab Bank Investor Checking APY remains at 4.25%
• Schwab Value Advantage Money Fund (SWVXX) 7-day yield rose from 4.91% to 4.92%
• Schwab Investor Money Fund (SW2XX) 7-day yield remains at 4.74%
• Charles Schwab 3-month CD APY remains at 5.10%
• Charles Schwab 6-month CD APY fell from 5.16% to 5.11%
• Charles Schwab 1-year CD APY fell from 5.20% to 5.15%
• NetBank 6-month CD APY fell from 5.40% to 5.35%
• NetBank 1-year CD APY fell from 5.40% to 5.35%

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

PayPal continues to be a fairly interesting place to store cash for both relatively quick access and a well above average yield. There is no minimum for a PayPal account, no fee for a basic account, and it can be linked to your bank checking account or even your brokerage checking account for easy access. Right now I am using PayPal as a savings account, putting a little more money in whenever I get a chance and feel that my budget has some "spare change." The PayPal 7-day yield of 5.03% is equivalent to a bank APY of 5.15%.

Update: 4-week T-bills are once again looking like an attractive place to park cash that you won't need for a month, but this rate fluctuates significantly from week to week. The rate is locked in for four weeks once you buy the T-bill at the weekly auction, but you can't predict what rate you will get at the next auction since it is based on supply and demand. Simply letting the T-bills automatically roll every four weeks will average out a lot of this volatility. Frankly, the extreme volatility with frequent low yields has turned me off to T-bills in favor of PayPal and Fidelity Cash Reserves, but we'll see how yields evolve over the coming months. I believe that the low yield is due to turmoil in the bond market, with people dumping longer-term bonds and shifting money towards the shorter end of the Treasury yield curve. More money flowing in drives up the price, which lowers the yield.

Check Bankrate.com for the availability of high-rate CDs (5.00% APY to 5.51% APY for 6-month). Alas, there are frequently quite a few caveats, strings, restrictions, requirements, minimums, "introductory specials", and other gotchas, so read the fine print carefully. And some of these banks may have been involved in the subprime lending mess, so you might want to avoid them out of principle even if your principal is protected by the FDIC. CDs work great for some people, but horribly for others. I have no CDs since I do not have any free cash that I can afford to lock up with restrictions for even three months. But, that said, I am considering putting at least a little free cash in short-term CDs (three-month, six-month, or maybe even one-year), in the Fall , especially if the Fed raises interest rates by a quarter-point in that timeframe. My current thinking is that although I can get a moderate increment of yield from a CD (e.g., from NetBank), the additional hassles don't seem worth the effort compared to the simplicity and flexibility I get with PayPal and Fidelity FDRXX. CDs would be worth the effort if I had a lot more cash, but I don't. And if you are up in the 35% tax bracket, a tax-free money market mutual fund (like FTEXX) may be a better deal.

Please note the disclaimer on Fidelity's web site for mutual funds:

Past performance is no guarantee of future results. Yield will vary.

As always, please note that cash placed in money market mutual funds is subject to the disclaimer that:

An investment in the Fund is not insured or guaranteed by the Federal Insurance Deposit Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.

In practice, that is not a problem at all, but it does incline me to spread my money around a bit.

T-bills and the cash in your bank checking and savings accounts or bank CDs are of course "protected", either by "the full faith and credit of the U.S. Treasury" or the FDIC. Please realize that you may not get your full principle back if you attempt to cash out early for Treasury securities since you'll get the price on the open market, which is not guaranteed by the U.S. Treasury. You are only assured of getting your full principle if your Treasury security is held until maturity (or Treasury "calls" the security or issues an offer to repurchase.)

I am not an investment adviser, so my opinions and the data presented here should not be considered as advice for where to invest your money. You should examine this and other available data before deciding how to invest your money. And, seriously, past returns should not be construed as a guarantee or even an "indication" of future returns.

-- Jack Krupansky

Fed on track to keep target rate at 5.25% for the rest of 2007 and probably well into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Despite a rather good Q2 GDP report, there is still a lot of irrational anxiety about subprime mortgage "woes" spreading "contagion" to the "real" economy. These unfounded fears have now caused people to bet on a rate cut in Q4 of this year and a second Fed rate cut in Q2 of 2008. Some people are using a lot of contrived logic to inappropriately argue that the good Q2 GDP report was really a one-off and that the economy will be heading south for the rest of the year. Sure, GDP in H2 of this year will probably average only in the 2.00% to 2.75% range, which is not great and maybe 2.25% to 3.00% in H1 of 2008, but that would absolutely not be down in the range where the Fed would even contemplate cutting interest rates. This sudden surge in negative sentiment was more of a knee-jerk reaction couple with a lot of irresponsible comments by a lot of "professionals" who should know better. I fully expect that the surge will completely unwind within the next couple of weeks as we start getting economic reports for July.

My overall assessment of Fed monetary policy remains:

The Fed will keep the target rate at 5.25% for the rest of 2007, and probably well into 2008.

There will not be a recession this year or next, nor even enough of a growth slump to trigger a Fed rate cut.

The Fed will not cut rates in response to the concern about subprime mortgages.

The Fed will not worry about the health of the economy since it is MUCH healthier than the 0.6% Q1 "real" GDP growth rate "estimate" suggested.

I would suggest that there is a 1 in 3 chance that the Fed will hike rates by a quarter-point before the end of the year.

My current feeling is that the 0.6% Q1 GDP number has frightened so many people (and emboldened so many bears and cynics) that the Fed will likely simply wait until the Q3 GDP number "prints" and demonstrates that the Q2 "recovery" is sustainable before seriously considering a rate hike.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive (approximately 4.25% to 5.75%.) All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer. The odds of such a hike causing a recession are negligible.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• August 7, 2007: 20% chance of a cut -- slam dunk for no change
• September 18, 2007: 34% chance of a cut
• October 30/31, 2007: 56% chance of a cut -- flip a coin, but leaning towards a cut
• December 11, 2007: 90% chance of a cut -- cut is likely
• January 2008: 100% chance of a cut and 26% chance of a second cut
• March 2008: 100% chance of a cut and 50% chance of a cut -- flip a coin, but leaning towards a second cut
• May 2008: 100% chance of a cut and 72% chance of a second cut -- second cut is likely
• June 2008: 100% chance of a cut and 86% chance of a second cut

I personally do not agree with a any of those probabilities, but they are what the market is "saying."

The August FOMC meeting is well within the 45-day window of reliability for fed funds futures to predict Fed action, so it is a virtual "slam dunk" certainty that the Fed will not change the fed funds target rate at the August FOMC meeting. It is too soon for fed funds futures to reliably predict rates for the September or October FOMC meetings.

The futures market is forecasting a cut in Q4, but even October is too far in the future for futures to be a dependable indicator. Also, sometimes the last cut (or hike) forecast by futures is frequently an insurance hedge by vestors rather than an outright bet on the actual outcome.

-- Jack Krupansky

Euro unable to convincingly break out of its trading range

Despite all the recent anxiety over the outlook for the U.S. economy, the euro still wasn't able to convincingly break out of the $1.37 to $1.38 upper end of its $1.33 to $1.38 trading range. Although the euro traded above $1.38 for a little over a week (September futures), it closed at $1.3670 on Friday, a bold 1.77 cents below the prior Friday close of $1.3847. The euro is still poised as if it could break out and march towards $1.40 and beyond, but it may take a couple of more weeks to see for sure whether the euro is now merely taking a breather before charging ahead or has actually reversed and is now trading down in its $1.33 to $1.38 trading range. The reasonably strong Q2 GDP report probably took a bit of the wind out of the euro's sails, but that could have been a transient blip.

There are plenty of traders and speculators who would like to see the euro break $1.40, but whether there is really a net demand for the euro at these levels remains to be seen. I would give the euro bulls and dollar bears a couple of more weeks to see if the euro really wants to stay up at or above $1.37 and $1.38 before concluding that the euro is likely to weaken for the rest of the year.

Euro futures out at December 2008 were only at $1.3768 on Friday (compared to $1.3958 the previous Friday), so there isn't exactly a lot of "slam dunk" enthusiasm for betting on a $1.40 euro, so far.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, a decent Q2 GDP report in July, and a strong hint of a Fed rate hike in the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.38 range as long as there is any superficially bad news or even mere anxiety to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as they begin to deeply grasp the truth that the Fed is very unlikely to cut rates over the coming year.

In short, the dollar is not "plunging." [And I will continue to repeat this line until The New York Times admits that they were wrong for claiming that the dollar is "plunging."] It is certainly fun to chatter about how expensive things are for tourists in Europe, but there are other factors that are more significant as far as keeping prices high in Europe than the minor impact of foreign exchange rates.

-- Jack Krupansky

ECRI Weekly Leading Index indicator down slightly but continues to point to a relatively healthy economy in the months ahead

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell slightly (-0.14% vs. unchanged last week) but the six-month smoothed growth rate rose slightly (from +6.3% to +6.4%), and remains moderately above the flat line, suggesting that the economy continues to retain much of the steam that it had picked up. The smoothed growth rate has been positive for 38 consecutive weeks. We haven't finished the soft landing yet, but we are in great shape, despite the weakness in the housing sector, the misleadingly low GDP report for Q1, and the feverish hand-wringing of the pundits.

The WLI is now 51 weeks past its low of last summer and the six-month smoothed growth rate is now 48 weeks past its low. Although not signalling an outright boom, this is a fairly dramatic recovery from the somewhat dark times of last summer.

A WLI growth rate of zero (0.0) would indicate an economy that is running at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to be a relatively stable "Goldilocks" economy. We're actually doing somewhat better than that now.

Although the WLI smoothed growth rate remains relatively modest and will likely remain so for the next few months, it isn't showing any signs of the kind of persistent and growing weakness (values more negative than -1.5% over a period of time) that would be seen in an economy that was slowing on its way into recession, but does look a lot like an economy moderating on its way to a relatively stable growth rate.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate. Goldilocks might not be completely happy with the current state of the economy, but she should be. Ditto for NYU Professor Nouriel Roubini. Sorry Nouriel, but Professor Ben Bernanke has it right this time. Anyone expecting a recession or very weak economy (under +1.00% -- average over at last half of the year) this year will be disappointed.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates "clear weather" for the next few months.

-- Jack Krupansky

Really bogus story on high gasoline prices in NY Times

I'm still generally supportive of news coverage by The New York Times, but they do manage to print way too many really misleading and biased stories. The latest was an article by Jad Mouawad entitled "Gas Prices Rise on Refineries' Record Failures" which provides a very misleading account of why retail gasoline prices are so high and overall is more of a mouthpiece for the promoters of energy and commodities speculation and merely repeats the promoters' "story" that high prices are due mostly to refinery outages (and higher crude oil prices.) The story is grossly superficial, not really new news anyway, and does absolutely nothing to dig down and challenge the veracity of the "stories" being touted by Wall Street "analysts" and others who have a financial vested interest and conflict of interest in having people believe the stories.

Rather than pick the story apart line by line, I'll highlight one data point which essentially proves that refinery outages couldn't possibly even come close to explaining the dramatic rise of retail gasoline prices at a national level. Here is what the article says:

As a whole, refining disruptions have been considerably higher than in previous years: they averaged 1.5 million barrels a day in the first quarter, compared with 700,000 to 900,000 barrels a day from 2001 to 2005. In the days after the hurricanes, refiners were forced to briefly halt as many as five million barrels of production.

To anybody who knows nothing about the business, a shortfall of "1.5 million barrels a day" in refining capacity might sound like a really big deal, except for the fact that available inventory levels of retail gasoline (as reported weekly by the Department of Energy's Energy Information Administration (EIA) having been running consistently above 200 million barrels for this entire period, way more than enough to cover even a 1.5 million barrel a day shortfall. If inventories weren't able to cover the shortfall, we would see inventories declining dramatically over time. Yes, inventories are 4.5% below a year ago (but only by a mere 9.5 million barrels), but that further proves that refinery shortfalls are not causing inventories to be drawn down in a dramatic way. Multiply 1.5 million per day by 90 days and you get 135 million barrels. The EIA data proves that gasoline inventories have not been depleted by 135 million barrels. In other words, the loss of production due to outages did not result in a shortfall of available gasoline. In other words, there was no supply shortage. Sure, demand is rising, but only at a low annual rate (the latest EIA report says "Over the last four weeks, motor gasoline demand has averaged over 9.6 million barrels
per day, or 1.3 percent above the same period last year.")

The Times article cavalierly states:

Many factors have led to the rise in gas prices, including disruptions in oil supplies from places like Nigeria and Norway. But analysts say the refining bottleneck in North America has been one of the main drivers of higher energy prices this year.

But they make no mention of the role of speculation on the futures markets. They reference "analysts", failing to mention that the firms employing most of those "analysts" have a vested interest in perpetuating "stories" to incite higher levels of speculation in energy futures.

Curiously they refer to the "refining bottleneck" as only "one of the main drivers." Well, either this so-called "refining bottleneck" is the main driver or it isn't, and if it isn't the main driver, then what is and why doesn't the story focus on it instead? I suspect that when pressed, they would point to higher crude oil prices. But if higher crude oil prices are the main driver, why even bother mentioning secondary or even tertiary drivers that may only account for a few pennies a gallon at most? The bottom line here is that the whole story (both the "analysts" story and the Times story) is rather fishy to say the least.

Even if you buy the story that high crude oil prices are the main driver (which isn't the story being peddled here), that raises the question of what is really going on with regards to both supply and price of crude oil. The quote above does blame part of the rise in gasoline prices on "disruptions in oil supplies from places like Nigeria and Norway", but even that is simply yet another "story" being peddled by "analysts" and others who have a financial vested interest and severe conflict of interest in perpetuating "stories" that even when true paint a very misleading big picture. Once again, we can consult the weekly EIA data and prove that the so-called "disruptions" have had no detectable impact on the overall availability of crude oil as an input to refineries or other uses. The EIA weekly reports have reported domestic crude oil inventory levels of well over 300 million barrels for an extended period of time, way more than enough to cover any Nigerian or Norwegian "shortfall" for an extended period of time. Not to mention the fact that the U.S. has 690 million barrels of crude oil sitting in the Strategic Petroleum Reserve precisely for any significant "supply disruptions." In fact, the current crude inventory level is 5.4% above a year ago, at 352 million barrels. This is very compelling proof that even if there is a shortfall from any number of individual suppliers, there is way more than enough oil sitting in inventories to make up for any shortfall. If the so-called "shortfalls" were truly significant, there would have been a dramatic drawdown of inventory levels, and there has been no such drawdown. This is truly compelling proof that there is no fundamental reason for high crude oil prices and hence no fundamental reason for high gasoline prices.

There is in fact a single "culprit" behind higher energy prices: "the world is awash in liquidity." Put simply, there are too many people with too much money and the stock and bond markets are not providing high enough rates of return, so vast amounts of money are flowing into the commodities markets. Even individual investors are seeing stories chiding them that commodities should be a part of any investor's "portfolio." ("Oil is going to $100! [or is it $200?]) It is that money which is bidding up the price of crude oil and gasoline. And Wall Street and so many of the so-called "analysts" are providing the drumbeat and siren song urging people to put their money into these commodities, exactly as they had done with MBS leading up to the so-called "subprime crisis."

Why the Times does not cover that story is rather baffling. I simply do not know whether they are knowingly participating in the obfuscation of the true story, or merely suffering from incompetence, negligence, and basic laziness. Either way, we readers and consumers suffer the consequences. Ditto for Congress, a Democratic Congress no less, for their turning a blind eye to this sad story.

-- Jack Krupansky

Fed on track to keep target rate at 5.25% for the rest of 2007 and probably well into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

The market continues to flip-flop over whether the Fed will or won't cut rates in 2008, this past week flopping back to expecting a cut in Q1 of 2008. There will probably be enough ambiguity and disagreement over the economic outlook for the next several quarters to keep the market completely on edge and wildly flipping and flopping when looking out six months to a year. The good news is that there is a reasonably strong consensus that the economy will hang in there reasonably well for at least the Q3 and Q4, but until we get a firm reading on Q2 and even Q3, it will be difficult to convince some people that the economy is actually beginning to pick up again. It is unfortunate, but a lot of people seem to be assuming that the economy will weaken towards the end of the year into 2008, even though the Fed is forecasting that the economy will in fact strengthen into 2008.

My overall assessment of Fed monetary policy remains:

The Fed will keep the target rate at 5.25% for the rest of 2007, and probably well into 2008.

There will not be a recession this year or next, nor even enough of a growth slump to trigger a Fed rate cut.

The Fed will not cut rates in response to the concern about subprime mortgages.

The Fed will not worry about the health of the economy since it is MUCH healthier than the 0.7% Q1 "real" GDP growth rate "estimate" suggests.

I would suggest that there is a 1 in 3 chance that the Fed will hike rates by a quarter-point before the end of the year.

My current feeling is that the 0.7% Q1 GDP number has frightened so many people (and emboldened so many bears and cynics) that the Fed will likely simply wait until the Q2 and Q3 GDP numbers "print" before seriously considering a rate hike to make sure that the strength we were seeing in Q2 is really sustainable.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive (approximately 4.25% to 5.75%.) All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer. The odds of such a hike causing a recession are negligible.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• August 7, 2007: 4% chance of a cut -- slam dunk for no change
• September 18, 2007: 10% chance of a cut
• October 30/31, 2007: 16% chance of a cut
• December 11, 2007: 36% chance of a cut
• January 2008: 52% chance of a cut -- flip a coin, but leaning towards a cut
• March 2008: 70% chance of a cut -- cut is likely
• May 2008: 88% chance of a cut
• June 2008: 100% chance of a cut

The August FOMC meeting is well within the 45-day window of reliability for fed funds futures to predict Fed action, so it is a virtual certainty that the Fed will not change the fed funds target rate at the August FOMC meeting. It is too soon for fed funds futures to reliably predict rates for the September or October FOMC meetings.

The futures market is forecasting a cut in Q1, but even January is too far in the future for futures to be a dependable indicator. Also, sometimes the last cut (or hike) forecast by futures is frequently an insurance hedge by vestors rather than an outright bet on the actual outcome.

-- Jack Krupansky

PayPal money market fund yield remains at 5.02% as of 7/21/2007

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Here are some recent money market mutual fund yields as of Saturday, July 21, 2007:

• iMoneyNet average taxable money market fund 7-day yield rose from 4.70% to 4.71%
• GMAC Bank Money Market account rate is at 5.16% or APY of 5.30% (only $500 minimum)
• Vanguard Prime Money Market Fund (VMMXX) 7-day yield remains at 5.13%
• Vanguard Federal Money Market Fund (VMFXX) 7-day yield rose from 5.07% to 5.08%
• AARP Money Market Fund 7-day yield is at 5.07%
• TIAA-CREF Money Market (TIRXX) 7-day yield rose from 5.04% to 5.05%
• PayPal Money Market Fund 7-day yield remains at 5.02%
• ShareBuilder money market fund (BDMXX) 7-day yield rose from 4.47% to 4.48%
• Fidelity Money Market Fund (SPRXX) 7-day yield rose from 4.99% to 5.00% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield remains at 4.98%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield remains at 4.45%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield remains at 3.27% or tax equivalent yield of 5.03% for the 35% marginal tax bracket and 4.54% for the 28% marginal tax bracket -- this may be the best rate that most of us can get for "core cash" in a checking-style account
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield remains at 3.22% or tax equivalent yield of 4.95% for the 35% marginal tax bracket and 4.47% for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate rose from 4.75% to 4.76%
• 13-week (3-month) T-bill investment rate rose from 4.96% to 4.98%
• 26-week (6-month) T-bill investment rate rose from 5.06% to 5.07%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 3.74% (down from 4.52%), with a fixed rate of 1.30% (down from 1.40%) and a semiannual inflation rate of 1.21% (down from 1.55%) -- updated May 1, 2007, next semiannual update on November 1, 2007
• Schwab Bank Investor Checking APY remains at 4.25%
• Schwab Value Advantage Money Fund (SWVXX) 7-day yield fell from 4.92% to 4.91%
• Schwab Investor Money Fund (SW2XX) 7-day yield fell from 4.75% to 4.74%
• Charles Schwab 3-month CD APY fell from 5.11% to 5.10%
• Charles Schwab 6-month CD APY remains at 5.16%
• Charles Schwab 1-year CD APY remains at 5.20%
• NetBank 6-month CD APY remains at 5.40%
• NetBank 1-year CD APY remains at 5.40%

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

PayPal continues to be a fairly interesting place to store cash for both relatively quick access and a well above average yield. There is no minimum for a PayPal account, no fee for a basic account, and it can be linked to your bank checking account or even your brokerage checking account for easy access. Right now I am using PayPal as a savings account, putting a little more money in whenever I get a chance and feel that my budget has some "spare change." The PayPal 7-day yield of 5.02% is equivalent to a bank APY of 5.14%.

New: I just ran across GMAC Bank's money market account paying a rate of 5.16% or an APY of 5.30%. That looks very appealing and I was tempted to open an account. This doesn't appear to be an introductory rate, but since I haven't seen it before and it doesn't show up on the iMoneyNet list of top yields, I'd like to watch it a bit before jumping on it.

No longer current: I wasn't aware of the high-yield TAA-CREF and Vanguard money market mutual funds before and I don't know much about them, but they are the highest yielding money market mutual funds out there for us retail investors, so I'll follow them and look into them a bit more closely. At this stage, it is still unclear if they really are available to all of us individual retail investors or if there are restrictions or fees that might reduce their attractiveness, but they do seem rather attractive, especially as an alternative to CDs.

Update from a previous week: The TIAA-CREF yield recovered a bit last week after plunging the week before. Who knows whether that was a fluke or whether the original high yield was a fluke. Stay tuned.

Latest Update: The TIAA-CREF yield is now right about at the same level as the PayPal yield. The yield appears to have roughly stabilized, but we'll have to watch it and see how it evolves.

4-week T-bills continue to not look as attractive a place for cash that you won't need for a month, since the new issue yield remains well below the yield of PayPal and Fidelity Cash Reserves, but this rate fluctuates significantly from week to week. The rate is locked in for four weeks once you buy the T-bill at the weekly auction, but you can't predict what rate you will get at the next auction since it is based on supply and demand. Simply letting the T-bills automatically roll every four weeks will average out a lot of this volatility. Frankly, the extreme volatility with frequent low yields has turned me off to T-bills in favor of PayPal and Fidelity Cash Reserves, but we'll see how yields evolve over the coming months. I believe that the low yield is due to turmoil in the bond market, with people dumping longer-term bonds and shifting money towards the shorter end of the Treasury yield curve. More money flowing in drives up the price, which lowers the yield.

Check Bankrate.com for the availability of high-rate CDs (5.00% APY to 5.51% APY for 6-month). Alas, there are frequently quite a few caveats, strings, restrictions, requirements, minimums, "introductory specials", and other gotchas, so read the fine print carefully. And some of these banks may have been involved in the subprime lending mess, so you might want to avoid them out of principle even if your principal is protected by the FDIC. CDs work great for some people, but horribly for others. I have no CDs since I do not have any free cash that I can afford to lock up with restrictions for even three months. But, that said, I am considering putting at least a little free cash in short-term CDs (three-month, six-month, or maybe even one-year), in the Fall , especially if the Fed raises interest rates by a quarter-point in that timeframe. My current thinking is that although I can get a moderate increment of yield from a CD (e.g., from NetBank), the additional hassles don't seem worth the effort compared to the simplicity and flexibility I get with PayPal and Fidelity FDRXX. CDs would be worth the effort if I had a lot more cash, but I don't. And if you are up in the 35% tax bracket, a tax-free money market mutual fund (like FTEXX) may be a better deal.

Please note the disclaimer on Fidelity's web site for mutual funds:

Past performance is no guarantee of future results. Yield will vary.

As always, please note that cash placed in money market mutual funds is subject to the disclaimer that:

An investment in the Fund is not insured or guaranteed by the Federal Insurance Deposit Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.

In practice, that is not a problem at all, but it does incline me to spread my money around a bit.

T-bills and the cash in your bank checking and savings accounts or bank CDs are of course "protected", either by "the full faith and credit of the U.S. Treasury" or the FDIC. Please realize that you may not get your full principle back if you attempt to cash out early for Treasury securities since you'll get the price on the open market, which is not guaranteed by the U.S. Treasury. You are only assured of getting your full principle if your Treasury security is held until maturity (or Treasury "calls" the security or issues an offer to repurchase.)

I am not an investment adviser, so my opinions and the data presented here should not be considered as advice for where to invest your money. You should examine this and other available data before deciding how to invest your money. And, seriously, past returns should not be construed as a guarantee or even an "indication" of future returns.

-- Jack Krupansky

Euro still struggling to decide whether to break out of its trading range

Although the euro has traded above $1.38 for a week (September futures), it hasn't moved convincingly above that $1.38 trading range bound. It did pop up to $1.3870 on Friday, but then fell back to close at $1.3847, a mere 0.3 cents above the prior Friday close of $1.3817. The euro is certainly still poised as if it could break out and march towards $1.40 and beyond, but it may take a couple of more weeks to see for sure whether the euro has indeed broken out or simply expanded its trading range by another cent.

There are plenty of traders and speculators who would like to see the euro break $1.40, but whether there is really a net demand for the euro at these levels remains to be seen. I would give the euro bulls and dollar bears a couple of more weeks to see if the euro really wants to stay up at or above $1.37 and $1.38 before concluding that the euro is likely to weaken for the rest of the year.

Euro futures out at December 2008 were only at $1.3958 on Friday (compared to $1.3928 the previous Friday), so there isn't exactly a lot of "slam dunk" enthusiasm for betting on a $1.40 euro, so far.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, a decent Q2 GDP report in July, and a strong hint of a rate hike in August or the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.38 range as long as there is any superficially bad news to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as they begin to deeply grasp the truth that the Fed is very unlikely to cut rates over the coming year.

In short, the dollar is not "plunging." [And I will continue to repeat this line until The New York Times admits that they were wrong for claiming that the dollar is "plunging."] It is certainly fun to chatter about how expensive things are for tourists in Europe, but there are other factors that are more significant as far as keeping prices high in Europe than the minor impact of foreign exchange rates.

-- Jack Krupansky

ECRI Weekly Leading Index indicator steady and continues to point to a relatively healthy economy in the months ahead

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose very slightly (+0.057% vs. +0.72% last week) and the six-month smoothed growth rate rose modestly (from +6.1% to +6.3%), and remains moderately above the flat line, suggesting that the economy continues to retain much of the steam that it had picked up. The smoothed growth rate has been positive for 37 consecutive weeks. We haven't finished the soft landing yet, but we are in great shape, despite the weakness in the housing sector, the misleadingly low GDP report for Q1, and the feverish hand-wringing of the pundits.

The WLI is now 50 weeks past its low of last summer and the six-month smoothed growth rate is now 47 weeks past its low. Although not signalling an outright boom, this is a fairly dramatic recovery from the somewhat dark times of last summer.

A WLI growth rate of zero (0.0) would indicate an economy that is running at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to be a relatively stable "Goldilocks" economy. We're actually doing somewhat better than that now.

Although the WLI smoothed growth rate remains relatively modest and will likely remain so for the next few months, it isn't showing any signs of the kind of persistent and growing weakness (values more negative than -1.5% over a period of time) that would be seen in an economy that was slowing on its way into recession, but does look a lot like an economy moderating on its way to a relatively stable growth rate.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate. Goldilocks might not be completely happy with the current state of the economy, but she should be. Ditto for NYU Professor Nouriel Roubini. Sorry Nouriel, but Professor Ben Bernanke has it right this time. Anyone expecting a recession or very weak economy (under +1.00% -- average over at last half of the year) this year will be disappointed.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates "clear weather" for the next few months.

-- Jack Krupansky

What about Fannie Mae and its mortgage business?

Talk about the elephant standing in the middle of the room that nobody wants to talk about, what about mortgage giant Fannie Mae? Just a couple of years ago all of the talk was about how Fannie posed a "systemic threat" to the financial system. I never bought any of that crap. Sure, Fannie's accounting needed some rationalization, but basically they were a sound and conservatively run operation. The real motivation was that Fannie was doing incredibly well and greedy Wall Street wanted a piece of the action. What was the action? Simple: Buying and securitizing mortgages (MBS), exactly the kind of thing that Wall Street has made such a mash of in the past two years. Meanwhile, as far as I can tell, Fannie is still doing quite well and may in fact do even better by buying up MBS debt that Wall Street is now trying to shed. The difference is that Fannie always stayed true to its mission and never sold its soul and dove down the sub-prime rat hole.

The reason nobody talks about Fannie these days is that Fannie is a huge reminder that Fannie and its supporters were absolutely right and Fannie's critics were dead wrong, both about the so-called "systemic risk" posed by Fannie and the ability of Wall Street to successfully handle Fannie's type of business.

Three and a half years ago I recall listening to a speech by Franklin Raines, head of Fannie Mae, at the American Enterprise Institute in Washington, D.C. at which he defended Fannie and its ability to not only avoid systemic risk, but to even be able to help out if there was a financial crisis, simply because it has the financial resources, including the ability to borrow from the government at below market rates that would allow it to step in and buy up mortgage debt when investors might be seeking to dump assets in a crisis. Guess what? He was absolutely right, and we are now seeing on a small scale what Fannie is capable of doing if a true systemic crisis were to occur (which, thankfully, is not going to happen despite the chatter from some pundits.)

The whole Fannie regulation and financial stability "scandal" of just a few years ago is now just as big a black eye for Wall Street and the rest of Fannie's detractors as the so-called "Subprime Crisis" is for Wall Street today. The last thing any of these people are going to do is stand up and admit that they were wrong and that Fannie is one of the pillars of our financial system. Shame on them all.

Note: Freddie Mac has been in basically the same boat as Fannie Mae, but Fannie took most of the heat.

-- Jack Krupansky

Analysts and numbers

I've never been a Herb Greenberg fan since I simply find his general tone offensive and holier-than-thou, but he did make a good point at the end of his latest column entitled "Nautilus muscles out analyst - Commentary: Says company hasn't talked him since he issued sell rating" about an analyst who was "cut off" from access to management after he issued a "sell" recommendation and was still able to make a good call on the company:

In looking back, the lack of access forced Wold to rely only on publicly disclosed numbers and outside resources for his analysis, and in doing so he got it right. Maybe that is the moral of this story: Let the numbers do the talking, not the company.

Well, duh, yeah! I've always believed this. The fact that it is some kind of revelation to Greenberg boggles the mind.

It has been quite a number of years since I "followed" any so-called sell-side analysts. Sure, back shortly before the heyday of "The Boom" there was some value for analysts able to pick out up and coming companies from all of the chaff, but even that "stock picking" had its limits. I personally haven't read a single stock research report in the past five years.

Since I've never had a bearish, short-selling mentality, I've never been interested in so-called "sell" recommendations either. Truth be told, most analyst "recommendations" are usually self-serving. Although there is in theory a "wall" between "research" and the investment banking side of the business there is no such wall between research and so-called "execution services" and access to high-value "clients." So, whether an analyst initiates coverage, terminates coverage, issues a "Strong Buy" or issues a "Strong Sell", none of these so-called "recommendations" means much at all to the normal, average individual investor, but can help inspire changes in short-term trading patterns that can boost profits from transactions handled by the "execution services" side of the house which can include facilitating trades by hedge funds and other high-value clients. This is true at all investment banks and brokerage firms, but especially true at "boutique" firms such as Greenberg mentioned. Their web site says that the company "provides investment research, capital markets services, corporate and venture services, investment banking, asset management and primary research" and are "focused on providing a full range of specialized and integrated services to institutional investors and corporate clients." Hmmm... "integrated"... so much for the idea of a wall between research and non-research operations. Oh, and "to institutional investors and corporate clients" makes it clear that normal, average, individual investors are unlikely to benefit from the firm's research. Sigh.

At its core, the very idea that normal, average, individual investors will have a net benefit from most of this so-called "research" is a myth which should simply no longer be tolerated. Much better to simply judge companies by their numbers. That is still no guarantee of success, but at least investors will know that they need to use their own wits to achieve success.

-- Jack Krupansky

Does Microsoft really no longer matter as a technology company?

It wasn't that many years ago when Microsoft was considered one of the top technology companies. Now, not only has Microsoft been eclipsed by Google as far as media attention, but it has gotten to the point where Microsoft tends to not even get mentioned in passing other than to disparage their "attempts" to compete with Google. I write this after reading an article in The New York Times by Conrad De Aenlle entitled "A Peek at Tech's Strength" which focuses on "two pairs of high-profile tech companies announce second-quarter earnings." Yes, Intel, AMD, Google, and Yahoo are indeed important technology companies that are reporting earnings this coming week, but it seems rather mind-boggling that one could consider Intel "high-profile" and not even give a passing reference to Microsoft reporting earnings this coming week as well (Thursday afternoon.) How did we get to this sorry state of affairs?

Granted, Microsoft's performance over the past few years has been somewhat "uneven", but the company is still quite a powerhouse in terms of raw revenue and earnings and delivery of new products and services, and Windows-based personal computers continue to deliver vast legions of "eyeballs" that drive all of those "hot" Web 2.0 sites, including blogs, social networking, and search engines.

Personally, I do think that there is a certain amount of anti-Microsoft bias in the media. I'm not prepared to speculate at length why that is, but simply note that it is there and is a real problem when trying to get a clear picture of the technology sector from the media.

For the media to act as if Microsoft hardly even existed anymore is rather bizarre. I can't imagine any better explanation other than that the media has some deep bias. The media has an obligation to its readers and viewers to at least make an attempt to be "fair", "unbiased", and "objective", and to paint a complete, full, and honest picture of the technology sector, but for whatever reasons, those criteria don't seem to apply anymore to media coverage of Microsoft.

The referenced story is not the first time I have seen evidence of such a bias, only the latest.

I am only speaking "in general"; certainly I have seen any number of stories mentioning Microsoft that were reasonably fair, unbiased, and objective, but the problem is that in the past couple of years the apparent ratio of biased to unbiased coverage has grown alarmingly high.

One excuse I've heard anecdotally is that a lot of journalists prefer "the Mac" and supposedly that is a big source of their disinterest if not bias in anything to do with Microsoft. That could be one factor and it could be a significant factor, but I personally do not know it for a fact. I only know the effect that I see in the media.

On the off chance that I am completely wrong and mistaken, does anybody have any evidence or rationale or even speculation for what reasons the media might have for considering Microsoft to be effectively no longer relevant to media coverage of the technology sector?

Disclosure: I am in fact an employee of The Evil Empire. I joined Microsoft in May 2006 in a software development test role, but my views aren't significantly different than before I joined when I was independent for about 20 years.

-- Jack Krupansky

Euro struggling to decide whether to break out of its trading range

The euro may or may not be on the verge of breaking out of its $1.33 to $1.38 trading range. It will take another few weeks to tell. The euro did close modestly above the $1.38 upper bound of the range on Friday, but not by enough to call it a convincing breakout. Euro futures (September) closed on Friday at $1.3817, 1.64 cents above the $1.3653 level of a week ago. There are plenty of traders and speculators who would like to see the euro break $1.40, but whether there is really a net demand for the euro at these levels remains to be seen. I would give the euro bulls and dollar bears a couple of more weeks to see if the euro really wants to stay up at or above $1.37 and $1.38 before concluding that the euro is likely to weaken for the rest of the year.

Euro futures out at December 2008 were only at 1.3928 on Friday, so there isn't exactly a lot of enthusiasm for betting on a $1.40 euro, so far.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, a decent Q2 GDP report in July, and a strong hint of a rate hike in August or the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.38 range as long as there is any superficially bad news to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as they begin to deeply grasp the truth that the Fed is very unlikely to cut rates over the coming year.

In short, the dollar is not "plunging." [And I will continue to repeat this line until The New York Times admits that they were wrong for claiming that the dollar is "plunging."]

-- Jack Krupansky

Fed remains likely to stay on course at 5.25% for all of 2007 and probably well into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

The market continues to be very non-commital as to how confident people are that the Fed will or won't cut rates in 2008. The market almost flip-flopped again this past week, but still narrowing forecasts no rate cut out to June 2008. There will probably be enough wiggle room concerning the economic outlook for the next several quarters to keep the market completely on edge when looking out nine months to a year. The good news is that there is a reasonably strong consensus that the economy will hang in there reasonably well for at least the next two quarters. Until we get a firm reading on Q2 and even Q3, it will be difficult to convince some people that the economy is actually beginning to pick up again.

For now, my overall assessment of Fed monetary policy remains:

My view is that the Fed will keep the Fed funds target rate paused at 5.25% for all of 2007, and probably well into 2008.

There will not be a recession this year, nor even enough of a growth slump to trigger a Fed rate cut.

The Fed will not cut rates in response to the concern about subprime mortgages.

The Fed will not worry about the health of the economy since it is MUCH healthier than the 0.7% Q1 "real" GDP growth rate "estimate" suggests.

I would suggest that there is a 1 in 3 chance that the Fed will hike rates by a quarter-point before the end of the year.

I tentatively say "for now" because I remain partially convinced that the Fed may in fact feel the need to make another hike before the end of the year to 5.50%. To my way of thinking, it all depends on what happens with energy commodities. Prices of oil and gasoline futures are still quite elevated, albeit modestly off their Summer 2007 peaks, and this constitutes an ongoing source of inflationary pressure that continues to propagate throughout the economy. If prices of energy commodities resume their decline, the Fed will be able to remain paused for all of 2007. But if energy commodities prices do not continue to fall, the Fed may have little choice but to hike to 5.50% before the end of the year. Based on economic fundamentals, we should see the prices of energy commodities come back down to Earth, but unfortunately there is simply so much free cash sloshing around seeking "some action" and a lot of speculators are simply unable to resist the urge to try to run commodities prices back up since "it worked before." My view is that there is a fairly good chance that prices of energy commodities will recede in the coming months, but it may be too soon to bet too heavily against the speculators. My finger is on the trigger, but for now I'll retain my belief that the Fed will remain paused for at least another year.

My current feeling is that the 0.7% Q1 GDP number has frightened so many people (and emboldened so many bears and cynics) that the Fed will likely simply wait until the Q2 and Q3 GDP numbers "print" before seriously considering a rate hike to make sure that the strength we were seeing in Q2 is really sustainable.

I am not suggesting that the Fed will "target" commodities prices such as crude oil and gasoline, but that the Fed will be noticing the degree to which elevated commodities prices are influencing the rest of the economy and pushing up even core prices over time. The price of crude oil remains up at $73.93 (up moderately from $72.81 a week ago), which has to concern the Fed. The Fed is usally quite tolerant of short-term energy and food price spikes because they tend to quickly recede, but oil and gasoline and other energy prices have remained persistently high for a prolonged period of time, which results in at least modest upwards pressure on core, non-energy prices. Wholesale gasoline remains well above $2, and at $2.2248 last week (down very sharply from $2.3096 a week ago) indicates an equilibrium retail level of $2.82 to $2.87, which is too far above $2 to give the Fed any comfort that inflationary pressures are "subdued."

The point here is not the price of crude oil and gasoline per se, but the fact that elevated prices means that either real demand is overly strong, or there is too much monetary liquidity in the financial system that inspires speculators to throw too much money around because it is relatively too cheap and the Fed will feel some pressure to "mop up" such excess liquidity to the extent that it causes higher core inflation in the real economy.

Although the moderation of the housing boom will indeed hold back the economy over the next couple of quarters, the Fed seems to agree with me that this is to be expected and not an indicator of a coming recession. A lot of people have been desperately funneling money into bond funds in response to an expectation of well below-par economic growth, and this has depressed Treasury yields and caused an partially inverted yield curve (on some days), but this is ultimately indicating only below-par growth (e.g., 2.25% to 3.25% rather than 3.00% to 4.00%) for the coming six months. Yes, there is a lot of anxiety, but anxiety itself is not a reliable indicator of a particular outcome.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive (approximately 4.25% to 5.75%.) All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer. The odds of such a hike causing a recession are negligible.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• August 7, 2007: 4% chance of a cut -- slam dunk for no change
• September 18, 2007: 8% chance of a cut
• October 30/31, 2007: 12% chance of a cut
• December 11, 2007: 12% chance of a cut
• January 2008: 20% chance of a cut
• March 2008: 32% chance of a cut
• May 2008: 42% chance of a cut
• June 2008: 48% chance of a cut

The August FOMC meeting is well within the 45-day window of reliability for fed funds futures to predict Fed action, so it is a virtual certainty that the Fed will not change the fed funds target rate at the August FOMC meeting. It is too soon for fed funds futures to reliably predict rates for the September or October FOMC meetings. A lot can and will transpire during the run-up to the August, September, and October meetings to whipsaw the odds for a rate change at those meetings, although in recent months the rate outlook in the near months has been quite stable. My belief is that we will begin to see rising odds for a hike later in the year.

I would note that such betting can change on a moment's notice as economic and financial data, not to mention commentary and sentiment, unfolds and evolves. Like it or not, the economy proceeds more through Darwinian evolution than "intelligent design." Emergent phenomena and evolution are the norms for the economy. The Fed (and Wall Street) can influence the evolution, of the economy, but not control it as if it were a clockwork machine. Predicting the precise or even general impact of any Fed action or inaction is quite literally a fool's errand. Further, the "betting" on any last Fed move is usually more of an insurance hedge than an outright bet, more of a "just in case I'm wrong" kind of "bet." Finally, studies have shown that Fed funds futures are not a very reliable indicator more than 45 days into the future.

What the fed funds futures market tells us clearly is that the Fed will most likely leave rates unchanged through Q2 of 2008.

My feeling is that since the housing retrenchment and so-called subprime "crisis" didn't cause a Fed cut at the January (or March) FOMC meeting, it is unlikely that housing or the so-called subprime "crisis" will be enough of a problem to cause a Fed cut for the rest of the year either.

In the July 13, 2007 edition of the UBS As We See It - Market Viewpoint report, UBS Wealth Management Research suddenly dropped all commentary about the Fed but simply kept their recent forecast for a Fed funds rate of 5.00% by the end of 2007and a total of three quarter-point cuts (versus a forecast of 4.50% and six cuts just a month ago.) Two weeks ago they told us that "The healthier US economy prompts us to delay the first Fed cut to December from September 2007 and to expect less total easing of 75 basis points instead of 150." They now forecast a Fed funds rate of 4.50% by the end of 2008 compared to their forecast of 3.75% just a month ago. They continue to forecast 2% GDP growth for 2007. Obviously I do not concur, although I welcome their alternative perspective. It sounds to me that their commitment to their "call" is rapidly crumbling and that they themselves are on the verge of admitting that they are clueless.

Why would the UBS outlook be so far off from my own view or even from the pessimistic market view? The wide divergence of these views doesn't make sense, right? Well, that's true if one were considering only economic fundamentals, but we do need to take into account that UBS has a customer base that they want to preserve and that the "research" document I referenced is really marketing literature, most likely designed to make the existing UBS customer base feel that UBS is "in touch" with their customers and their "needs." That is par for the course with the big financial firms. Step 1 is to understand the hopes and fears and anxieties of your customers and step 2 is to directly tap into those hopes and fears and anxieties. Right now, a lot of people hear so many desperate and gloomy stories in the media and internalize that desperation and gloom, and the result is that firms like UBS have no choice but to send out a message of "we understand and share your fears and anxieties." Better to be wrong and keep your customer base than be right and lose your customers. The bottom line is that individual investors cannot look to the research and economic outlooks peddled by Wall Street for a balanced accurate view of how the conomy and businesses will likely unfold in the coming months or year or over any period of time.

Why are so many smart people so confused about the future? It is simply the fact that the conservative thing for them to do is to assume that economic events such as housing booms always play out in the same pattern every single time. For a bureaucrat, that is always the safe approach. Alas, every economic episode has its own idiosyncratic pattern and the real issue is how to forecast the interactions between the many sectors and regions of the economy, and that is a really hard problem that is absolutely not amenable to the cookie-cutter application of historical patterns.

The current "herd mentality" on Wall Street is basically sending so many speculators and even investors off on a truly wild goose chase, after which Wall Street will quietly acknowledge its error ("the data changed in an unexpected manner") and then chase those same speculators and investors back in the opposite direction, making sure to collect transaction fees and spreads on both legs of the roundtrip "chase." Expect to see a reversal of the trend of the past week within a month.

The Weekly Leading Index of the Economic Cycle Research Institute is telling us, according to Lakshman Achuthan, managing director at ECRI, that "With WLI growth at its highest reading in over three years, U.S. economic growth is bound to pick up in the months ahead."

I'll continue with this post series as long as I continue to see evolution in how people view the outlook for Fed rate action.

-- Jack Krupansky

PayPal money market fund yield falls to 5.02% as of 7/14/2007

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Here are some recent money market mutual fund yields as of Saturday, July 14, 2007:

• iMoneyNet average taxable money market fund 7-day yield rose from 4.68% to 4.70%
• TIAA-CREF Money Market (TIRXX) 7-day yield rose from 4.94% to 5.04%
• Vanguard Prime Money Market Fund (VMMXX) 7-day yield remains at 5.13%
• Vanguard Federal Money Market Fund (VMFXX) 7-day yield fell from 5.08% to 5.07%
• PayPal Money Market Fund 7-day yield fell from 5.06% to 5.02%
• ShareBuilder money market fund (BDMXX) 7-day yield rose from 4.46% to 4.47%
• Fidelity Money Market Fund (SPRXX) 7-day yield fell from 5.01% to 4.99% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield fell from 4.99% to 4.98%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield fell from 4.47% to 4.45%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield fell from 3.34% to 3.27% or tax equivalent yield of 5.03% (down from 5.14%) for the 35% marginal tax bracket and 4.54% (down from 4.64%) for the 28% marginal tax bracket -- this may be the best rate that most of us can get for "core cash" in a checking-style account
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield fell from 3.31% to 3.22% or tax equivalent yield of 4.95% (down from 5.09%) for the 35% marginal tax bracket and 4.47% (down from 4.60%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate fell from 4.76% to 4.75%
• 13-week (3-month) T-bill investment rate rose from 4.93% to 4.96%
• 26-week (6-month) T-bill investment rate rose from 5.01% to 5.06%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 3.74% (down from 4.52%), with a fixed rate of 1.30% (down from 1.40%) and a semiannual inflation rate of 1.21% (down from 1.55%) -- updated May 1, 2007, next semiannual update on November 1, 2007
• Schwab Bank Investor Checking APY remains at 4.25%
• Schwab Value Advantage Money Fund (SWVXX) 7-day yield rose from 4.91% to 4.92%
• Schwab Investor Money Fund (SW2XX) 7-day yield rose from 4.74% to 4.75%
• Charles Schwab 3-month CD APY fell from 5.15% to 5.11%
• Charles Schwab 6-month CD APY remains at 5.16%
• Charles Schwab 1-year CD APY remains at 5.20%
• NetBank 6-month CD APY remains at 5.40%
• NetBank 1-year CD APY remains at 5.40%

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

PayPal continues to be a fairly interesting place to store cash for both relatively quick access and a well above average yield. There is no minimum for a PayPal account, no fee for a basic account, and it can be linked to your bank checking account or even your brokerage checking account for easy access. Right now I am using PayPal as a savings account, putting a little more money in whenever I get a chance and feel that my budget has some "spare change." The PayPal 7-day yield of 5.02% is equivalent to a bank APY of 5.14%.

No longer current: I wasn't aware of the high-yield TAA-CREF and Vanguard money market mutual funds before and I don't know much about them, but they are the highest yielding money market mutual funds out there for us retail investors, so I'll follow them and look into them a bit more closely. At this stage, it is still unclear if they really are available to all of us individual retail investors or if there are restrictions or fees that might reduce their attractiveness, but they do seem rather attractive, especially as an alternative to CDs.

Update: The TIAA-CREF yield recovered a bit last week after plunging the week before. Who knows whether that was a fluke or whether the original high yield was a fluke. Stay tuned.

4-week T-bills continue to not look as attractive a place for cash that you won't need for a month, since the new issue yield remains well below the yield of PayPal and Fidelity Cash Reserves, but this rate fluctuates significantly from week to week. The rate is locked in for four weeks once you buy the T-bill at the weekly auction, but you can't predict what rate you will get at the next auction since it is based on supply and demand. Simply letting the T-bills automatically roll every four weeks will average out a lot of this volatility. Frankly, the extreme volatility with frequent low yields has turned me off to T-bills in favor of PayPal and Fidelity Cash Reserves, but we'll see how yields evolve over the coming months. I believe that the low yield is due to turmoil in the bond market, with people dumping longer-term bonds and shifting money towards the shorter end of the Treasury yield curve. More money flowing in drives up the price, which lowers the yield.

Check Bankrate.com for the availability of high-rate CDs (5.00% APY to 5.46% APY for 6-month). Alas, there are frequently quite a few caveats, strings, restrictions, requirements, minimums, "introductory specials", and other gotchas, so read the fine print carefully. And some of these banks may have been involved in the subprime lending mess, so you might want to avoid them out of principle even if your principal is protected by the FDIC. CDs work great for some people, but horribly for others. I have no CDs since I do not have any free cash that I can afford to lock up with restrictions for even three months. But, that said, I am considering putting at least a little free cash in short-term CDs (three-month, six-month, or maybe even one-year), in the Fall , especially if the Fed raises interest rates by a quarter-point in that timeframe. My current thinking is that although I can get a moderate increment of yield from a CD (e.g., from NetBank), the additional hassles don't seem worth the effort compared to the simplicity and flexibility I get with PayPal and Fidelity FDRXX. CDs would be worth the effort if I had a lot more cash, but I don't. And if you are up in the 35% tax bracket, a tax-free money market mutual fund (like FTEXX) may be a better deal.

Please note the disclaimer on Fidelity's web site for mutual funds:

Past performance is no guarantee of future results. Yield will vary.

As always, please note that cash placed in money market mutual funds is subject to the disclaimer that:

An investment in the Fund is not insured or guaranteed by the Federal Insurance Deposit Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.

In practice, that is not a problem at all, but it does incline me to spread my money around a bit.

T-bills and the cash in your bank checking and savings accounts or bank CDs are of course "protected", either by "the full faith and credit of the U.S. Treasury" or the FDIC. Please realize that you may not get your full principle back if you attempt to cash out early for Treasury securities since you'll get the price on the open market, which is not guaranteed by the U.S. Treasury. You are only assured of getting your full principle if your Treasury security is held until maturity (or Treasury "calls" the security or issues an offer to repurchase.)

I am not an investment adviser, so my opinions and the data presented here should not be considered as advice for where to invest your money. You should examine this and other available data before deciding how to invest your money. And, seriously, past returns should not be construed as a guarantee or even an "indication" of future returns.

-- Jack Krupansky