State Budgets, the VIX, and the Stock Market

On the surface, the stock market looks OK - going up slowly but surely, with the Dow closing in on the 12,000 mark. I'm a little wary because this week the Volatility Index (also known as the VIX), went up from 15.5 to 18.5 - about 20% from Tuesday through Friday.

There's an old saying when it comes to the VIX: "When it's high, you buy - when it's low, you go (sell)." It's been low and dormant for a long time, but it looks like it's waking from its slumber... and ready to go much higher.

I don't see ANY fundamentals holding the stock market up at current levels, other than High-Frequency Trading from investment banks and maybe some help from the Fed. State budgets around the country are bleeding red ink from deficits and debt - and in Illinois, their only remedy seems to be a financial transfusion of money from taxpayers.

When the New York Times runs a story about states looking to possibly file bankruptcy, the economy is not as rosy as economists like Brian Wesbury would have you believe.

Just like in 2007 when the Dow reached its peak of over 14,000, that didn't mean the economy was fundamentally sound. It was heavily laden with debt, and at the climax of the biggest misallocation of money in the history of the world. The biggest problem I have with Wesbury's hypothesis is that because Republicans have control of the House of Representatives, this will magically improve the economy.

I want to be optimistic about the overall American economy, but when I look at the mountains of debt at the federal, state, corporate and household levels, I seriously doubt we'll ever repay these obligations. Default is the more likely option for municipal bonds and defined-benefit pension plans. Until these debts are paid back or defaulted upon, we won't see Honest-to-Pete savings and investment for a very long time.

And I don't believe that enough Republicans in Washington (or most state capitols) have the gumption to make the necessary cuts. Almost all politicians care about what's best for them, and getting re-elected. If they make these needed cuts, they'll piss off a key campaign donor or special-interest group... and they can kiss their office goodbye. So they'll tinker around the edges, and find solutions that will try to "kick the can" down the road and further postpone the day of financial reckoning.

What does this all mean for the stock market? Unless the investment banks and powers that be can keep levitating the market at current levels, I believe it's headed for another leg down. State pension funds will sell the most liquid assets in their portfolio (probably stocks and mutual funds) to shore up deficits, and keep making payments in the short-term.

I do see opportunities for short-term traders who are nimble enough to get in and get out of the markets, and take their profits. And a few for long-term investors who know the right industries and companies to pick. But over that long-term horizon, we could see a roller-coaster ride of volatility that could shake you to your core.

If you still want to invest in the stock market, you need to have a high risk tolerance... strict money management rules in place... and stick to those rules consistently. Tray tables and seats in the locked and upright position, folks - it's gonna be an interesting ride.

Thoughts on Commodities...

I've thought about my prediction for the price of wheat, which is... we'll see Hard Red Winter Wheat at $10.00/bushel or higher by Labor Day. As they say in the NFL: "After further review..." I think it's entirely possible we could see this occur by Memorial Day, or even May Day. Here's why:

Floods in Australia, drought in Russia, and dry conditions in the U.S. Central Plains - plus the Federal Reserve's insane "Quantitative Easing II" policy (aka, money printing on steroids) all look like rocket fuel ready to explode the price of wheat higher.

The Fed's insanity has increased and will continue to increase the price of other commodities, such as crude oil, natural gas, gold and silver. I've been considering what factors could prevent this explosion in commodity prices. The only things I can think of are sharp cuts in government spending, and a Paul Volcker-style interest rate shock treatment. Watching what Ben Bernanke says - and more importantly, what he's done - it's pretty obvious that Ben is no Paul Volcker.

He seems hell-bent on printing money, while the Congress is hell-bent on spending it. Even with Republicans taking control of the House, I don't see politicians at the federal (and most state) levels having the gumption to seriously address government spending, entitlements, and most importantly... state and municipal pension plans, which have huge unfunded liabilities.

Not to mention Social Security and Medicare at the federal level.

Could we see some downward corrections in the short term? Absolutely.

Markets can - and usually do - act in irrational ways in the shorter term... but always trend according to the fundamentals in the long-term. Easy money, tighter supplies and crazy government spending are why I'm bullish on commodities for the foreseeable future.

Dot.Com Fever, Part II?

Karl Denninger has an interesting post about Facebook receiving $500 million in cash for part ownership in the company. I'm not as negative on the company as Karl is, because they have several streams of revenue (games and applications such as Farmville), in addition to ads they sell on a per-click or CPM (per thousand views) basis.

He poses a good question about how good an investment Facebook really is, when it's a privately-held company that doesn't release its financial results: If the company is doing so well, why did they take the $500 million from Goldman Sachs and the Russian investor?

In September 2009, Facebook announced they were cash flow positive, which is good. The next question savvy investors should ask: "Is Facebook STILL cash flow positive?"

Time will tell how good a financial investment Facebook will be. I do like it better than the over-hyped Twitter for a number of reasons. Before I list those reasons, in fairness, I will give the positive side of this social media site: Twitter (if used correctly) can help you build a marketing list, and broadcast your marketing message to a large audience.

However, too many business owners seem to think that Twitter is a business "cure-all" that will cover up a flawed business model, or a bad product or service. You have to "tweet" and "re-tweet" your messages multiple times to get people's attention.

If any of your followers follow more than several hundred people, it's pretty easy to get lost in the shuffle. And to send these multiple messages daily, it takes valuable time that may be better spent on other tasks or marketing media.

Facebook is easier to navigate, allows more conversations and interactivity between users than the Re-Tweets on Twitter. 160 characters just isn't enough to have a decent conversation.

And I hated all the hype about Twitter, because anytime something is hyped up so much... it can almost never live up to that hype, and most of the time, the underlying fundamentals aren't that impressive.

When looking at a business to invest in as a shareholder or owner, you need to ask difficult questions to make sure you're making a wise purchase.

And when a supposedly intelligent business owner says something stupid, I won't hesitate to criticize them for it. Last November, one of Twitter's co-founders announced they were "exploring different business models."

Huh?!

OK... call me crazy, but shouldn't you decide on a business model before you start the company? I believe Mark Twain said: "History doesn't repeat itself, but it often rhymes." These business tunes sound a lot like the "one-hit wonders" of the late '90s dot.com era, when people were buying stocks of companies who had never made a dollar of profit - much less had a realistic, viable business model.

Twitter also raised $200 million in new funding, along with the $100 million in venture capital that T. Rowe Price and other investors ponied up in 2009.

Along with Twitter, we're seeing companies like Four Square raise venture capital - just like the dot.com days. It raised $20 million last June, and the investing company claimed that Four Square was worth $95 million.

Opinions on company valuations are a dime-a-dozen, and I don't believe these estimates are based on any solid financial or accounting data.

It seems like venture capital firms and Wall Street want to blow up another investment bubble to cash in on, and investors want to get in on "the next big thing." And both want to see some signs of growth and good news in the economy.

If you've spent any time on Facebook or Twitter, and connected with family, friends or business contacts, there are intangible benefits you receive from interacting on these sites. Such as re-connected with old friends and family - and sometimes the tangible benefits of finding a new client, or making a sale.

But for investors who want to put their hard-earned money into Facebook, Twitter or similar companies, and expecting a great return on that money - remember this: Caveat Emptor, or "buyer beware."