Saturday, May 8, 2010

Fat Finger Syndrome

From the Desk of Joe Rollins

While sitting in my office between 2:00 and 3:00 yesterday afternoon, I was reminded of those traumatic days during 2007 and 2008 when the stock market was plummeting. Even though I knew perfectly well that the U.S. economy did not support the ridiculous sell-off on Wall Street yesterday, I can’t say I was particularly at ease as I watched the Dow tumble almost 1,000 points in a matter of minutes. But, as we’ve since discovered, the DJIA went from -100 to -980 in less than 15 minutes due to a serious case of broker digit obesity. D’oh!

Suffice it to say that I received emails from clients at the same pace the market was dropping; I actually got a little concerned that my computer would short out from all the email activity! But I do understand why everyone was so concerned, especially since the activity wasn’t making any sense economically.

Just this past Tuesday, I wrote a post stating that the economy was on an even keel with low interest rates and earnings being quite spectacular – the perfect recipe for higher stock prices. Since that post, the Dow Jones Industrial Average has fallen approximately 5% in the intervening three days. And so, I can certainly understand why my clients would question such a large and unexplained move in the national averages yesterday.

According to CNBC, a trader at CitiGroup suffered a serious case of “fat finger syndrome” yesterday when he entered a “b” for billion instead of an “m” for million in a trade involving Procter & Gamble, a component in the Dow. At approximately $60 per share, a $16 billion share trade almost constitutes the entire value of the U.S. stock market combined. This mistake is said to have caused the brief nose-dive in the market – and the DJIA’s largest one-day point drop in its entire history. The market did recover from the nearly 990 low-point drop, with the major indices closing down a little over 3% for the day.

To show just how crazy yesterday’s stock market activity was, Accenture Plc’s stock, which typically sells for approximately $40 a share, could be purchased for a single penny at one point between 2:00 and 3:00 p.m. It certainly seemed like the systems were all going haywire for that hour, but in the end, there should be no major consequences to investors as all of the trades from 2:00 until the closing bell that exceeded a certain threshold will be reversed and never recorded. In spite of that, yesterday’s wild ride left many investors feeling queasy.

Another component of yesterday’s stock market performance concerns the financial crisis in Greece, although I don’t think the situation is as grave as is being reported by the financial news. First, it’s important to understand that Greece essentially has a socialized economy, under which the vast majority of its population is employed by the government. Greece’s retirement program defies any type of logic, providing a full pension to its citizens at retirement age.

Furthermore, about 14% of Greece’s workforce works in job categories that the government deems hazardous enough to retire early – 50-years old for women and 55-years old for men (e.g., radio announcers fall into this category because their microphones expose them to germs). The average retirement age in Greece is 61, the lowest in Europe. Basically, Greece’s economy is totally out of control due to these unsustainable entitlement benefits.

Germany did us all a great favor by telling Greece that in order for the Germans to spend their hard-earned Euros to bail out Greece due to their gross inefficiencies, they will be expected to clean up their act. German Chancellor Angela Merkel has imposed strict conditions that Greece balance its budget and learn to spend only money they have and not money they must borrow. What a novel concept! Washington, are you listening? Germany and France bowed their backs against the socialist Greece concept that the government will provide for all of its citizens’ needs from crib to grave. Greece really had no choice but to agree to Germany’s austerity moves; they would not receive the rescue package until they did.

One of the items that set the sell off on Wall Street in motion was the riots in the streets of Greece concerning their debt woes. Proponents of Greece’s current system demonstrated to make known their dislike that they would actually need to take a reduction in pay and pension benefits. Seemingly, no one wants to be the one to sacrifice, but this is the tough medicine that Greece will need to swallow. An economy where the government provides all the benefits to its citizens must be converted to a more reasonable economy where employees are given incentives to create commerce and not become of ward of their country for years to come.

As for the financial implications of a default by Greece, I think the financial press is suffering from a very slow news week to even make the assertion that it could devastate the world economy. Economically speaking, Greece is not exactly a financial powerhouse. Greece’s entire GDP for 2008 was $341 billion. To put that in perspective, the 2008 GDP for California alone was $1.85 trillion – five times the amount of Greece. Texas had GDP in 2008 of $1.2 trillion, which is four times Greece’s GDP, and the State of Georgia’s GDP is almost exactly that of Greece at $340 billion. To imply that Greece’s economic troubles could become viral worldwide is the mother of all overstatements. Take a deep breath and think about this possibility. Could an almost financially insignificant country like Greece really create a worldwide crisis?

Those who do not believe that Germany and France – along with the International Monetary Fund’s support (which is ultimately supported by the United States) – can bail out Greece, don’t understand the economic reality of this situation. In spite of the economic realities, we continue to hear that the contagions of Greece will also spread to Portugal and Spain. Reviewing the numbers, however, should give you some insight.

According to the most current data from the Bureau of Economic Analysis, Greece’s GDP in 2008 was $341 billion. For that same year, Spain had a GDP of $1.368 trillion; and Portugal had a very small economy of $233 billion. The entire three countries together are not even the size of California’s GDP. There’s no question that if all three countries defaulted, it would bring financial pain. But would it bring worldwide financial chaos like what was suffered from 2008 through 2009? No way! That’s just ridiculous.

Excellent employment numbers for the month of April were announced this morning. The U.S. economy added 290,000 jobs in April and they revised the March job numbers up an additional 230,000. Therefore, in these two months alone, the U.S. economy created close to 500,000 new jobs for out-of-work Americans.

Let’s put everything into perspective: Interest rates are at extraordinary lows at the current time and no one is forecasting that they’ll increase anytime soon. Corporate earnings are excellent and are, in fact, growing. Cash balances held by American corporations are at record levels and have never been higher in the financial history of the United States. The economy clearly is operating in a positive manner with GDP growth in the 2.5% to 4.0% range forecasted for the remainder of 2010. Employment is starting to pick up, and even though it is very low, it is finally moving in the right direction. Economically speaking, while not spectacular, things in the United States are great. Quite frankly, yesterday’s sell off was not based in economic reality. Rather, it was based on fear, lack of economic knowledge and “fat fingers.”

Once again, I do not write these posts in a vacuum. I completely understand that the U.S. is moving towards the same types of economies that have so often failed in Europe. Greece, Portugal and Spain are the latest examples of how a socialistic economy cannot function successfully. It’s impossible for the government to provide for every need of its citizens and continue to function in a growing economy. When the government is the provider of all financial benefits, then at some point everyone is treated the same. The guy that works hard and the guy that does not work at all receive the same benefits, and there’s something inherently wrong with that philosophy. Therefore, even though socialism is attractive on paper, in reality, it just doesn’t work. If no one has an incentive to do better in life, then everyone will do less. Greece is the most recent example of this. Will Portugal and Spain follow?

As I’ve said before, the U.S. government’s efforts to introduce socialism into our economy will not be successful. For the reasons outlined above, introducing more social services into our economy puts us on a dangerous collision course that we cannot survive.

I’ve been asked by several clients to discuss the states in our country that are on the verge of bankruptcy. California and New York have decided to create their own socialist economies inside the United States. California has a GDP of $1.85 trillion, and New York has a GDP of $1.4 trillion. The combined total of almost $3 trillion is a significant part of the $14 trillion U.S. economy. However, unlike the Euro zone, these states operate financially independent of one another based upon their own ability to run their state finances. In 2009, the federal government, under its economic stabilization plan, essentially provided income to these states to cover their deficits. From 2010 forward, that will not be the case.

It’s true that California is technically already bankrupt. It’s been reported that due to their actuarial earning high interest rate on their state pension plan, the pension plan for California is $500 billion underfunded. At the rate they’re going now, California will have no ability to borrow money, nor will they have the ability to fund their deficits into the next fiscal year which begins in July. It was embarrassing enough to them last year that the state actually had to give out I.O.U.’s to pay their bills. This is just another example of an economy that was once great but by passing out entitlements to virtually all of their citizens, they can no longer afford their operations. California has almost the highest taxes in the United States and the most restrictive business environment. As illustrated many times, neither of these things work in growing an economy. Texas, on the other hand, has a GPD of $1.2 trillion, no state income taxes and a very favorable business environment.

When the day comes that California and New York go to Washington begging for a bail out, we can only hope German Chancellor Merkel’s approach is used by our own federal government and only provide help when those states accept the economic reality that they cannot afford all of the socialistic give-aways that they’ve put into their economies. Once New York and California accept that people must work to receive benefits, then the federal government will help them. Hopefully, Washington will not give either state a dime until those austerities are put in place.

Frankly, it’s not possible for any state in America to default. The U.S. government’s ability to finance even corrupt states like New York and New Jersey is bigger than the financial loss. I don’t think that either of these financially disastrous states will negatively impact our economy anytime in the foreseeable future.

In summary, the U.S. economy is great, earnings are good and interest rates are low. That’s a prescription for higher stock prices regardless of how negative this week has appeared.

As always, the foregoing comments are my opinions, thoughts and personal biases. In all cases, I could be wrong.