July 31, 2011
Major Asset Classes | July 2011 Performance Update
July was kind to bonds, REITs and commodities, but it was a rough month for stocks, particularly in mature countries. That’s only fitting, considering that the mature markets have been suffering from a toxic blend of cyclical and self-inflicted troubles. The ongoing bailout challenges in Europe a la Greece, et al. roll on, although it’s apparently in remission for the moment. In the U.S., debate about debt ceilings and default roiled the equity market, although here too there seems to be some light at the end of the political tunnel if only temporarily, thanks to last night’s compromise.
In any case, the U.S. stock market (Russell 3000) gave up 2.3% last month—the third straight month of loss and the deepest monthly reversal since August 2010. It wasn’t much better in foreign markets in the developed world: MSCI EAFE dropped 1.6% in July, which also makes three down months in a row. Emerging markets (MSCI EM) fared better by losing less, but sellers have had the upper hand here as well since May.
It’s another story in the land of bonds. U.S. inflation-indexed Treasuries in particular were the darlings of last month. The Barclays Treasury TIPS Index soared 3.9% in July, one of the strongest months on record for broad measures of these bonds. Granted, the historical record for TIPS dates only to 1997, but there’s no denying the extraordinary rise in prices for U.S. inflation-index government bonds last month.
Extraordinary because reported inflation remains relatively low by historical standards. That suggests the crowd expects higher inflation down the road. Or maybe it’s just the weird fiscal debate in Washington these days that inspires rushing into government bonds, although one could argue that the fear of a default would bring the opposite effect.
Regardless, the real yield on the 10-year TIPS has collapsed to a mere 38 basis points. For the 5-year series, the current real yield is negative (as it has been for some time), closing out the month at 72 basis points in the red. Short of a dramatic surge in inflation above the 2% to 3% range in the near term, the expected return for TIPS looks minimal at best.
If it’s yield you’re after, REITs are starting to look attractive again, at least relative to the benchmark 10-year Treasury’s nominal yield, which closed last month at 2.82%, the lowest since last November. The FTSE NAREIT All Equity Index’s trailing yield of roughly 3.4% is alluring by comparison. An extra 60 basis points may not sound like much in the grand scheme of the investment universe, but in a summer riddled with anxiety, the modest premium in REITs is attracting attention. Perhaps that explains why the MSCI REIT Index still leads the year-to-date ledger among the major asset classes with a tidy rise of 12.1%.
July 30, 2011
Book Bits For Saturday: 7.30.2011
● Saving Capitalism From Short-Termism: How to Build Long-Term Value and Take Back Our Financial Future
By Alfred Rappaport
Summary via publisher, McGraw-Hill
Business leaders today obsess over quarterly earnings and the current stock price—and for good reason. Corporate incentives typically focus on short-term profits rather than long-term value creation. Nothing is more harmful to businesses—and to the broader economy. Few business thinkers in recent decades have contributed more to this subject than Alfred Rappaport. As an author and educator, Rappaport is a pioneer in developing the principles of values-based management and is an acknowledged authority on how to make long-term shareholder value the essential driver of corporate strategy. His latest work, Saving Capitalism from Short-Termism, is a clarion call for conquering the addiction to short-term profit—and getting on the path to building long-term value.
● Mr. Speaker!: The Life and Times of Thomas B. Reed The Man Who Broke the Filibuster
By James Grant
Review via The New York Times Book Review
James Grant would not immediately leap out as the logical choice to write a biography of Tom Reed [the late-19th century Speaker of the House]. He is best known as a financial analyst, the editor of the respected Grant’s Interest Rate Observer. But he is also an accomplished biographer, having previously taken on Bernard Baruch and John Adams. I suspect Grant was drawn to Reed in part because his era was rife with pitched battles over monetary policy. The question of whether gold, silver, both metals or none would back up Civil War greenbacks dominated much of the political debate, especially during presidential campaigns. And Grant writes about these issues at great length.
● The Precariat: The New Dangerous Class
By Guy Standing
Essay by the author
For the first time in history, the mainstream left has no progressive agenda. It has forgotten a basic principle. Every progressive political movement has been built on the anger, needs and aspirations of the emerging major class. Today that class is the precariat. So far, the precariat in Europe has been mostly engaged in EuroMayDay parades and loosely organised protests. But this is changing rapidly, as events in Spain and Greece are showing, following on the precariat-led uprisings in the middle-east. Remember that welfare states were built only when the working class mobilised through collective action to demand the relevant policies and institutions. The precariat is busy defining its demands. The precariat has emerged from the liberalisation that underpinned globalisation. Politicians should beware. It is a new dangerous class, not yet what Karl Marx would have described as a class-for-itself, but a class-in-the-making, internally divided into angry and bitter factions.
● Understanding China's Economic Indicators: Translating the Data into Investment Opportunities
By Thomas Orlik
Summary via publisher, FT Press
Understanding China's Economic Indicators is the only guide to what China's statistics say about the state of the economy and how to use them to make more profitable investment decisions. Leading China market analyst Tom Orlik introduces China's 35 most important indicators, explaining why they matter and what they mean, identifying the distortions in the data, and spelling out the impact on equity, commodity, and currency markets.
● Thrift and Thriving in America: Capitalism and Moral Order from the Puritans to the Present
Edited by Joshua Yates and James Davison Hunter
Summary via publisher, Oxford University Press
Thrift is a powerful and evolving moral ideal, disposition, and practice that has indelibly marked the character of American life since its earliest days. Its surprisingly multifaceted character opens a number of expansive vistas for analysis, not only in the American past, but also in its present. Thrift remains, if perhaps in unexpected and counter-intuitive ways, intensely relevant to the complex issues of contemporary moral and economic life. Thrift and Thriving in America is a collection of groundbreaking essays from leading scholars on the seminal importance of thrift to American culture and history. From a rich diversity of disciplinary perspectives, the volume shows that far from the narrow and attenuated rendering of thrift as a synonym of saving and scrimping, thrift possess an astonishing capaciousness and dynamism, and that the idiom of thrift has, in one form or another, served as the primary language for articulating the normative dimensions of economic life throughout much of American history. The essays put thrift in a more expansive light, revealing its compelling etymology-its sense of "thriving." This deeper meaning has always operated as the subtext of thrift and at times has even been invoked to critique its more restricted notions. So understood, thrift moves beyond the instrumentalities of "more or less" and begs the question: what does it mean and take to thrive?
July 29, 2011
Boehner vs. Moody's?
The House finally passed budget legislation this evening that's designed to keep the country from defaulting on its debt. But even if the bill survives the Senate and the President signs it into law (both rather doubtful at this point), there's the question of whether it would save the country's AAA credit rating? Not likely, according to Moody's.
Q2 GDP Rises By A Weak 1.3%
Economic growth remained sluggish in the second quarter, the government reports. Real GDP rose at a 1.3% annualized pace during April through June, the slowest pace since the recession ended. That’s up from the anemic 0.4% rate in Q1, but no one will confuse the latest number as anything other than a weak performance. The best you can say is that the growth rate is once again moving in the right direction. The trick is whether it’ll continue moving higher.
The main drag on economic growth in Q2 was the virtual standstill in consumer spending. Personal consumption expenditures, which represent more than two-thirds of GDP, rose at annual rate of just 0.1% in the three months through June—the slowest pace since the recession was formally declared at an end in June 2009 via NBER. Durable goods in particular took a hit, dropping 4.4%.
None of this is particularly surprising. It’s been clear for some time that the economy slowed in the spring. Today’s GDP report, like all GDP reports, formally restates what was already clear by monitoring the economic news as it arrived. That doesn’t make today's numbers any more palatable, of course.
One bright light is the faster pace in gross private domestic investment, which gained 7.1% in Q2. That’s up from 3.8% in the previous quarter. In addition, exports held up fairly well, rising 6% in Q2, although that’s down slightly from Q1’s 7.9% gain.
Otherwise, today’s report is filled with humbling numbers. “The economy is stuck in a very slow-growth scenario,” says Julia Coronado, chief economist for North America at BNP Paribas. “Consumers are still very cautious and vulnerable. This is a very challenging report for policy makers.”
It’s not so great for the rest of the country either. In any case, it’s all about what happens next. What optimism there is hangs by a thread these days, much of it clinging to yesterday’s relatively encouraging news on jobless claims. But even that thin reed doesn’t mean much until the debt uncertainty in Washington is cleared up. Don’t hold your breath. As CNNMoney reports, “the debt ceiling debate has degenerated into another messy display of congressional dysfunction.”
A Closer Look At The Drop In Jobless Claims
Yesterday’s news that new jobless claims dropped sharply—to under 400,000 for the first time in three months—raises the question of whether the good news will continue? “That’s partly up to Congress,” opines Mark Thoma, professor of economics at the University of Oregon. “If they keep bickering until the time to raise the ceiling passes, or if the deal they agree to imposes substantial cuts to spending too soon, that could put an end to any good news on the recovery for awhile.”
Anthony Chan, chief economist at JPMorgan Private Wealth Management, is cautiously optimistic, albeit with the emphasis on the adverb. He explains:
I would view this number as encouraging -- not as encouraging as the headline would suggest, but certainly encouraging. If the four-week moving average moves below 400,000, that would confirm we're making definitive progress. Right now the best conclusion is this suggests the progress is tentative. I would not jump on the bandwagon suggesting labor market problems are completely healed because there are severe seasonal adjustment problems.
James O’Sullivan, global chief economist at MF Global, isn't jumping on bandwagons, but he emphasizes what is arguably the obvious point. “The figures are encouraging, though we need to see a sustained decline in claims,” he tells Bloomberg. “The direction in claims invariably sends the right signal for growth in employment.”
Yes, but it's important to read the fine print on yesterday's numbers. Asha Bangalore at Northern Trust reminds that “it is important to recognize that the spikes of initial jobless claims in April and May were related to the natural disaster in Japan that disrupted supply of auto parts and led to layoffs.” Accordingly,
A resumption of the supply of auto parts has led to hiring again and smaller layoffs in the auto industry. The low for initial jobless claims prior to the earthquake and tsunami in Japan was 375,000 during the week ended February 26. By implication, we will need to see readings below this mark to declare with strong conviction that robust hiring has resumed.
Westpac Banking Corp. agrees:
US initial jobless claims fell 24k to 398k last week - the first sub 400k reading since early April, though we caution that annual auto plant shutdowns for new model retooling usually cause week to week claims volatility in July - and it’s a bigger risk this year given that many plants shut early due to Japanese parts supply issues.
July 28, 2011
Kauffman Foundation: Bloggers Are Gloomy On The Economic Outlook
The Kauffman Foundation’s latest quarterly survey of “leading economics bloggers,” which generously includes yours truly, reports that “optimism is out; pessimism is in,” according to the press release. Tim Kane, the survey’s director and a scholar at the foundation, says: "This quarter's survey provides an unprecedented level of pessimism about the state of the U.S. economy among top bloggers.”
In the wake of this morning’s encouraging news on last week’s initial jobless claims, perhaps the pessimism is already out of date. In any case, you can find the full survey here. As a preview, here’s how bloggers responded to the question: How do you assess the overall condition of the U.S. economy right now?
Is The Rough Patch Over? Lower Jobless Claims Inspire Fresh Hope
Ah, a breath of fresh statistical air. Just when you thought the economic gods had cast us into cyclical hell, today’s update on initial jobless claims delivers a counterpunch. Last week’s tally of new filings for jobless benefits dropped by a hefty 24,000 to a seasonally adjusted 398,000—the first dip below the 400,000 mark since early April. It may or may not last, but let's bask in the glow, if only for a moment.
Let's also ask the obvious question, even if a convincing answer for good or ill will have to wait: Is this a sign that the recent slowdown in economic growth is again giving way to stronger expansionary forces? Perhaps, but it’s premature to declare the rough patch history. We’ll need to see more encouraging news from the initial claims numbers. More importantly, the payrolls numbers have to start cooperating by dispatching stronger figures on net job growth. Rome can’t be rebuilt in a day, but maybe today’s number is the first brick in a new foundation for the fall.
The trend is certainly looking stronger. As the second chart below shows, the unadjusted annual change in jobless claims is 11% lower vs. this time last year. The further below zero, the better since it implies a fresh round of healing in the labor market. And to the extent this trend stays well below zero, it builds a stronger case for arguing that a new recession is a low risk event.
But let’s not loose sight of the obvious caveat: one number, encouraging and timely as it is, doesn’t change much. Indeed, if today's number had brought us in the opposite direction, we might be preparing for the cycle's funeral instead of pondering better days. Yes, we're still that close to the precipice, but for a brief moment, at least, the threat has faded abit.
In any case, it takes weeks if not months of encouraging data to make a convincing case that the latest slowdown is truly behind us. At this early stage, there are still plenty of reasons to be cautious. “Layoffs clearly remain elevated, but the worst part of the adjustment to the first-half slowdown is abating,” says Richard DeKaser, an economist at Parthenon Group. “I still don’t expect relief on the unemployment rate in the next few months.”
The acid test for the economy is remains the creation of jobs, and by that standard there’s a long way to go to reverse the disappointments of late. At the same time, there have been clues that economic growth was holding up surprisingly well in broad terms, as I noted here. An expansive reading of May’s economic numbers reflected continued growth and June’s reports, most of which are in, suggest the expansion continues. That’s not always obvious by cherry picking macro stats, but there’s been a case all along for expecting the economy to muddle through. The summer of 2011, I recently wrote, didn't look like a repeat of 2010, which is to say that the outlook has remained somewhat brighter.
That’s no excuse to minimize the challenges, which are many, including the risk of self-inflicted pain unleashed by the ongoing budget negotiations in Washington.
Politics aside, there’s a new incentive for optimism in town via today’s jobless claims report. Let’s see if it’s the start of a trend or just another head fake.
July 27, 2011
Durable Goods Orders Fall In June, But The Trend Is Still Positive
Today’s durable goods report is disappointing because everyone’s looking for unassailable confirmation that the economy has sufficient wherewithal to forge ahead. The latest numbers out of Washington fall well short of delivering a macro knock-out blow by that standard. The good news is that a close look at the durable goods stats doesn’t look fatal either.
New orders for durable goods slipped by 2.1% on a seasonally adjusted basis in June, reversing May’s 1.9% gain. But the back and forth of late, which feeds into the notion that the economy is stuck in neutral, masks a somewhat rosier trend. In the first half of 2011, for example, durable goods are up by 4.7%. Not too shabby, although it remains to be seen if the pace will continue. Meantime, if we take out the volatile transport sector, however, durable goods rose slightly in June, inching ahead by 0.1%, suggesting that short-term noise may be muddling the numbers as usual.
If we consider the bigger picture, there’s nothing particularly ominous in today’s numbers. The annual rate of change in new orders for durable goods is still encouraging. For the year through last month, this series was higher by 7.6%, as the chart below shows. Yes, the annual pace has been declining for more than a year, but that’s not surprising. After the initial surge from the early stages of the economic rebound fade, it's inevitable that something approaching a normal level of growth is destiny.
For the record, a 7.6% growth rate looks impressive with the pre-crash days. Even if the trend slips further in the months ahead, which is likely, there’s still quite a bit of breathing room for positive thinking. Indeed, anything north of 3% to 4% on an annual basis implies that the broader economy will steer clear of recession. That by itself doesn't solve the problem of low job growth, and that is surely a bigger issue if it rolls on. But that's a topic for another post.
Meanwhile, why should we put so much stock in durable goods orders? Economist Bernard Baumohl explains in his book The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends and Investment Opportunities:
Most economic indicators tell a story about what has already happened in the economy. Only a few provide solid clues about what might occur in the future. The Advance Report on Durable Goods orders is one such statistic, and that’s why it gets center-stage attention from the financial markets and the business community the moment it is released. When we are looking at “orders” for factory goods, it is about production that will take place in the months ahead.
A recent study that analyzes durable goods and asset prices agrees. “Durable orders likely reflect a more forward looking assessment of the economy,” according to professors Chris Jones and Selale Tuzel, both at the University of Southern California. “This is true for several reasons,” they write:
The first is that durable goods are largely comprised of capital spending and inputs to the production of other durables. Thus, orders of durables should reflect the expectations of businesses about the future profitability of capital investment. Second, durable goods are different from most nondurables in that they often require a substantial amount of time to produce. An order for a durable consumption good, for instance, therefore reflects a view of future rather than current demand for that product. An order for durable capital equipment may reflect a view of consumer demand that is even more forward looking if the use of that equipment is in the future production of other durable goods.
By that reckoning, the fact that durable goods are still rising on an annual basis suggests there’s more growth ahead in general. But the enthusiasm by looking backward only goes so far. It’s clear that the economy has recently suffered a slowdown, or rough patch or whatever you want to call it. For the moment, the blowback still looks rather mild by a number of analytical measures, including durable goods.
It’s also true that the recent slowdown has only started to infect the numbers and so it’s premature to estimate the damage. The real question is how the economic reports will look for, say, September on a year-over-year basis. If the annual pace in durable goods can continue to resist the forces of contraction in the months ahead, in concert with other metrics, we may have truly dodged a bullet. It's still an open debate, but that's encouraging, relative to what the crowd was thinking a month ago.
Even so, there’s no shortage of pitfalls lurking, including one rather large potential hazard.
July 26, 2011
Do Gasoline Prices Still Threaten Retail Sales?
Two months ago, I wondered if rising gasoline prices threatened retail sales. At the time, energy costs were rising, taking an increasing bite out of consumer purchases. It looked like a train wreck. Consumer purchases, after all, represent roughly 70% of GDP. But gasoline prices hit a ceiling in early May and have been flat to moderately lower ever since. There’s no assurance that prices won’t resume taking flight, but for the moment there’s been a slight reprieve on the energy-based assault on retail sales.
Gasoline sales as a percentage of total retail sales fell in June to 11.5% from the previous month’s 11.7%, as the chart below shows. That’s the first reduction on a monthly basis in a year. It’s unclear if the decline will roll on, but in the interest of giving the economy a boost it’s a no-brainer to hope that lesser percentages are in the cards.
As economist R. Mark Rogers advises:
The price of gasoline affects dollar volume sales at service station stores. Oddly, higher gasoline prices can make overall retail sales look good, even though consumers have less money to spend on other things after filling the gas tank. Eventually, high gasoline prices hurt retail sales outside of gasoline. Lower gasoline prices boost the real spending power of consumers; this ends up boosting retail sales outside of the service station component.
The U.S. Energy Information Administration (EIA) isn’t expecting much of a decline in gasoline prices, although the agency doesn’t see a dramatic increase either. “EIA expects regular-grade gasoline prices will average $3.62 per gallon and $3.51 per gallon over the third and fourth quarters of 2011, respectively,” according to the Short Term Energy Outlook published on July 12. That price prediction is down modestly from the heights reached earlier this year, although retail gasoline in the $3.50 range is still near the all-time highs reached in the summer of 2008. The threat to retail sales may have faded a bit, but it remains potent.
Even the EIA’s moderate optimism may be hoping for too much. It's too soon to make bold predictions that the retreat in gas prices has run its course, but there are hints that the decline may be be over. As Consumer Reports notes, gasoline prices have started inching higher once more.
What catalysts might unleash a sustained rise in gasoline prices? The International Business Times ponders three possible scenarios:
a) a U.S. Government default that causes institutional investors to dump U.S. Government bonds, triggering a plunge in the dollar, pushing up oil's price
b) any sustained unrest in another oil producing nation in the Middle East; or
c) stronger growth in Asia/Latin America emerging market economies, most of which are registering large annual percentage increases in oil consumption.
Any one of these factors might be enough to push energy costs higher for months (years?) to come. The really bad news is that it’s not beyond the pale to anticipate all three of these trends unfolding in the near term.
Strategic Briefing | 7.26.2011 | Taxes & The Budget
Our Real Deficit Problem Has Nothing to Do With Traditional Government
The Atlantic | July 25
In 1960, the last full year of the Eisenhower administration, taxes were 17.8 percent of GDP and primary spending (excluding interest) was 16.4 percent. Social Security took in and paid out 2.2 percent. Medicare didn't exist. So Everything Else had a primary surplus, with taxes at 15.6 percent and spending at 14.2 percent.
In 2010, in the supposed age of "big government," spending on Everything Else was only 14.7 percent of GDP, and that was swollen by the recession and stimulus spending. By 2021, according to the CBO's alternative fiscal scenario (the pessimistic one), spending on Everything Else will be 13.0 percent--less than in 1960. Everything Else tax revenues--that is, everything except the Social Security and Medicare payroll taxes--will be 12.5 percent of GDP, for a primary deficit of only 0.5 percent. And that's assuming that all of the 2001, 2003, and 2009 tax cuts are extended indefinitely.
Are the Bush Tax Cuts the Root of Our Fiscal Problem?
Bruce Bartlett (NY Times) | July 26
Whether revenue should play any role in deficit reduction is at the root of the fiscal impasse between Congressional Republicans and President Obama. One factor underlying the hard-line Republican position that taxes must not be increased by even $1 is their assertion that the Bush tax cuts played no role in creating our deficit problem... Federal revenue fell in 2001 from 2000, again in 2002 from 2001 and again in 2003 from 2002. Revenue did not get back to its 2000 level until 2005. More important, revenue as a share of G.D.P. was lower every year of the Bush presidency than it was in 2000.
Editorial: Drop Balanced-Budget Amendment — For Now
Investor's Business Daily | July 25
The balanced-budget amendment has become a major sticking point in deficit talks. We think it's a great idea. But if it gets in the way of a deal that cuts spending with no tax hikes, we say drop it — at least for now. Republicans seem to have won the debate over taxes and spending. Now, even the Democrats are scrambling to create a plan that at least appears to cut spending but not raise taxes. This is a huge victory for the GOP — and for fiscal responsibility. It has also pushed hard to include a balanced-budget amendment in a deficit-reduction deal. Coupled with spending caps, a BBA has obvious appeal. It would require not only a balancing of the federal government's books but a gradual shrinking of the government's size. But while polls show that Americans favor a balanced-budget amendment, Democrats in Congress hate it — and will draw a line in the sand over it.
Call him ‘Drama Obama’
The Hill | July 25
We face a debt crisis largely of Obama’s making. Spending as a percentage of GDP now stands at a startling 25 percent, thanks to Obama’s failed stimulus boondoggle, his healthcare law and just run-of-the-mill spending by Democratic appropriators. Taxes as a percentage of GDP now stand at historic low of 14.4 percent, thanks to a still-sluggish economy made worse by the president signing an extension of the Bush tax cuts. Obama can try to blame Republicans for these tax cuts, but when he had overwhelming majorities in both the House and Senate, he chose to keep those tax cuts in place. Solving this debt crisis requires a math degree, not a degree in drama. It is largely a function of vote-counting (218 in the House, 60 in the Senate) and budget number-crunching (anywhere from $1 trillion to $4 trillion in savings). But instead of looking coldly at the votes and cutting a deal that would pass both chambers, Mr. No-Drama has tried to increase the drama, by putting unnecessary pressure on House Republicans, trying to drive a wedge between John Boehner and Eric Cantor and having dramatic weekend meetings well before the deadline hits.
Norquist: 'We're not raising taxes'
Indy Star | July 26
Anti-tax advocate Grover Norquist, who has been called the most powerful unelected person in the nation, said in Indianapolis on Monday that the federal government needs to avoid default by raising the debt ceiling -- but only by cutting spending. "If you want two-and-a-half trillion in higher debt ceiling, you've got to find two-and-a-half trillion in reduced spending, and we're not raising taxes," he insisted. One reason that tax increases are off the table, Norquist said, is because a majority of the U.S. House has signed the anti-tax pledge that his organization, Americans for Tax Reform, has pushed. Norquist, who formed Americans for Tax Reform in 1986, has succeeded in getting numerous politicians nationwide, including 236 members of the U.S. House and 41 U.S. senators, to sign a pledge promising "to oppose and vote against any and all efforts to increase taxes."
More Data: Debt, and the Origins of Debt
Econobrowser | July 25
I thought it of interest to see the evolution of Federal debt held by the public, and exactly what Administrations were the most spendthrift. Figure 1 highlights the fact that debt-to-GDP began its startling rise in 2008 Q2.
Note that from 2001 Q1 (the beginning of the G.W. Bush Administration) to 2009 Q1 (the beginning of the Obama Administration), debt-to-GDP rose 17 percentage points. From 2009 Q1 to 2011 Q1, a period encompassing the worst recession in the post-War era, that figure rose 13 percentage points.
July 25, 2011
Risk Management & Uncertainty
Predicting is hard—especially about the future, runs the old joke. But there’s no escaping forecasting in finance and economics. Even a passive investor has an assumption—a forecast! If you own an S&P 500 index fund, you’re assuming that you’ll earn an equity risk premium. Where did you get that idea? There are a thousand possibilities for thinking positively, but the key point here is that you’re anticipating a premium will come your way simply by holding risky assets.
Forecasting is unavoidable and hazardous, and so you can’t spend too much time thinking about this challenge. Fortunately, there’s no shortage of literature for helping us improve our efforts on this front. That includes a new series of essays on the topic at Cato Unbound. The current issue asks: What’s Wrong with Expert Predictions? Plenty, as it turns out. But all’s not lost. For investors, Professor John Cochrane’s piece—“In Defense of Hedgehogs”—is worth a read. He reminds that risk management, as opposed to chasing return, is still the only game in town. "Once we recognize that uncertainty will always remain, risk management rather than forecasting is much wiser," he writes, advising:
Just the step of naming the events that could happen is useful. Then, ask yourself, “if this event happens, let’s make sure we have a contingency plan so we’re not really screwed.” Suppose you’re counting on diesel generators to keep cooling water flowing through a reactor. What if someone forgets to fill the tank?
The good use of “forecasting” is to get a better handle on probabilities, so we focus our risk management resources on the most important events. But we must still pay attention to events, and buy insurance against them, based as much on the painfulness of the event as on its probability. (Note to economics techies: what matters is the risk-neutral probability, probability weighted by marginal utility.)
So it’s not really the forecast that’s wrong, it’s what people do with it. If we all understood the essential unpredictability of the world, especially of rare and very costly events, if we got rid of the habit of mind that asks for a forecast and then makes “plans” as if that were the only state of the world that could occur; if we instead focused on laying out all the bad things that could happen and made sure we had insurance or contingency plans, both personal and public policies might be a lot better.
Tactical ETF Review: 7.25.2011
The budget talks in Washington are suffering from "gridlock" and so the risk of default still lurks. Meanwhile, the crisis facing the euro remains an evolving situation. But asset markets around the world don't appear worried, at least as of Friday's close. As our review below of ETF proxies for the major asset classes shows, buyers have had the upper hand recently. That’s a bit unnerving. Even in the best of times, a broad sweep higher in everything suggests there’s a correction brewing somewhere. That certainly looks like the case for U.S. stocks this morning: futures are reportedly “set to drop.” Meanwhile, here’s how the major asset classes stack up via representative ETFs through July 22…
US STOCKS • Vanguard Total Market (VTI) • Benchmark: MSCI US Broad Market Index
US stocks climb a wall of worry... again.
FOREIGN DEVELOPED MARKET STOCKS • Vanguard Europe Pacific (VEA) • Benchmark: MSCI EAFE
Foreign developed market equities also pull another rally out of the hat...
EMERGING MARKET STOCKS • Vanguard Emerging Markets (VWO) • Benchmark: MSCI Emerging Market
And just when it looks like emerging market stocks are poised to succumb, buyers ride to the rescue once more...
US BONDS • Vanguard Total Bond Market (BND) • Benchmark: Barclays US Aggregate
Have US bond prices hit a ceiling?
INFLATION-INDEXED US TREASURIES • iShares Barclays TIPS Bond (TIP) • Benchmark: Barclays US TIPS
TIPS: the gift that keeps on giving on the expectation of higher inflation ...
HIGH YIELD BONDS • SPDR Barclays High Yield Bond (JNK) • Benchmark: Barclays High Yield Very Liquid
Is the third attempt at breaking to new highs the charm?
COMMODITIES • iPath Dow Jones-UBS Commodity (DJP) • Benchmark: DJ-UBS Commodity
Commodities bulls look tired...
REAL ESTATE INVESTMENT TRUSTS • Vanguard REIT (VNQ) • Benchmark: MSCI US REIT
Up, up and away for REITs...
FOREIGN DEVELOPED MARKET GOVERNMENT BONDS • SPDR Barclays Int’l Treasury (BWX) •
Benchmark: Barclays Global Treasury ex-US Capped
Is there a new rally brewing?
EMERGING MARKET GOVERNMENT BONDS • Van Eck Market Vectors Emg Mkt Local Currency Bond (EMLC) •
Benchmark: J.P. Morgan GBI-EMG Core
Emerging market bonds continue to hold up as an alternative to developed-market "safety."
FOREIGN GOVERNMENT INFLATION-LINKED BONDS • SPDR DB International Inflation-Protected Bond (WIP) •
Benchmark: DB Global Government ex-US Inflation-Linked Bond Capped
Worries of future inflation around the world keep inflation-indexed bonds bubbling...
FOREIGN CORPORATE BONDS • PowerShares International Corporate Bond (PICB) •
Benchmark: S&P International Corporate Bond
Are investors having second thoughts about foreign corporate bonds?
Charts courtesy of StockCharts.com
July 23, 2011
Book Bits For Saturday: 7.23.2011
● The Man and the Statesman: The Correspondence and Articles on Politics
By Frédéric Bastiat
Review via The Wall Street Journal
Bastiat's short essays, which he grouped under the title "Economic Sophisms," are beloved by friends of laissez-faire. Late in the 19th century, small-government Democrats quoted him on the floor of the House against the high-tariff schemes of the GOP. The Republicans groaned when they heard Bastiat's name. Unable to answer his arguments against government economic intervention, they charged him with being French. Familiar though Bastiat's economic writings may be, his letters, until now, have been available only in their original language. "The Man and the Statesman," the first in a projected English-language edition of Bastiat's collected works, encompasses 209 letters as well as a sampler of his political essays and notes and a helpful glossary from the editors (Jacques de Guenin, Jean-Claude Paul-Dejean and David M. Hart). But the letters are the thing. Through them shines the most charming economist you have ever met.
● The Role of Policymakers in Business Cycle Fluctuations
By Jim Granato and M. C. Sunny Wong
Summary via publisher, Cambridge University Press
This book's central theme is that a policymaker's role is to enhance the public's ability to coordinate their price information, price expectations, and economic activities. This role is fulfilled when policymakers maintain inflation stability. Inflation persists less when an implicit or explicit inflation target is met. Granato and Wong argue that inflation persistence is reduced when the public substitutes the prespecified inflation target for past inflation. A by-product of this co-ordination process is greater economic stability. In particular, inflation stability contributes to greater economic output stability, including the potential for the simultaneous reduction of both inflation and output variability - inflation-output co-stabilization (IOCS). Granato and Wong use historical, formal, and applied statistical analysis of business-cycle performance in the United States for the 1960 to 2000 period. They find that during periods when policymakers emphasize inflation stability, inflation uncertainty and persistence were reduced.
● Invisible Wealth: The Hidden Story of How Markets Work
By Arnold Kling and Nick Schulz
Summary via Amazon
The discipline of economics is not what it used to be. Over the last few decades, economists have begun a revolutionary reorientation in how we look at the world, and this has major implications for politics, policy, and our everyday lives. For years, conventional economists told us an incomplete story that leaned on the comfortable precision of mathematical abstraction and ignored the complexity of the real world with all of its uncertainties, unknowns, and ongoing evolution. What economists left out of the story were the positive forces of creativity, innovation, and advancing technology that propel economies forward. Economists did not describe the dynamic process that leads to new pharmaceuticals, cell phones, Web-based information services-forces that fundamentally alter how we live our daily lives. Economists also left out the negative forces that can hold economies back: bad governance, counterproductive social practices, and patterns of taking wealth instead of creating it. They took for granted secure property rights, honest public servants, and the willingness of individuals to experiment and adapt to novelty.
●Modern Political Economics: Making Sense of the Post-2008 World
By By Yanis Varoufakis, Joseph Halevi, Nicholas J. Theocarakis
Summary via publisher, Routledge
Once in a while the world astonishes itself. Anxious incredulity replaces intellectual torpor and a puzzled public strains its antennae in every possible direction, desperately seeking explanations for the causes and nature of what just hit it. 2008 was such a moment. Not only did the financial system collapse, and send the real economy into a tailspin, but it also revealed the great gulf separating economics from a very real capitalism. Modern Political Economics has a single aim: To help readers make sense of how 2008 came about and what the post-2008 world has in store.
● The History of the Future: The Shape of the World to Come Is Visible Today
By Max Singer
Summary via The Hudson Institute
Human character has always been shaped by struggles against poverty, tyranny, and war. Hudson Institute co-founder and Senior Fellow Max Singer's new book, The History of the Future: The Shape of the World to Come Is Visible Today (Lexington Books), argues that poverty, tyranny, and war will be largely eliminated in the future. Without the struggles that have plagued humanity throughout history, Singer says we will have to find new ways to shape character. In this work which continues the research into the future that Singer began with Herman Kahn a half-century ago, Singer asks the important question: will people really be better off when the whole world has become wealthy, free, and peaceful? Professor Bruce Bueno de Mesquita of New York University praises The History of the Future by stating that “anyone who wants to understand where the world of politics, economics, and freedom is headed must read this book.”
● Debt: The First 5,000 Years
By David Graeber
Summary via publisher, Melville House Publishing
Every economics textbook says the same thing: Money was invented to replace onerous and complicated barter system--to relieve ancient people from having to haul their goods to market. The problem with this version of history? There's not a shred of evidence to support it. Here anthropologist David Graeber presents a stunning reversal of conventional wisdom. He shows that for more than 5,000 years, since the beginning of the agrarian empires, humans have used elaborate credit systems. It is in this era, Graeber shows, that we also first encounter a society divided into debtors and creditors.
July 22, 2011
Will Commercial Lending's Revival Survive The Summer Slump?
The rebound in commercial and industrial (C&I) lending rolls on, but for how long? Recent history suggests a case for thinking positively. The value of C&I loans has risen in each of the last eight months through June. That’s the longest stretch of monthly increases since the recession formally ended in June 2009 and so it’s an encouraging sign that lending—a key indicator of future economic activity—has entered a period of sustained growth.
True, C&I loan growth has slowed recently but it has yet to reverse course. “Even with the economy stuck in neutral, three of the nation's biggest lenders—Bank of America Corp., Wells Fargo & Co. and KeyCorp—are sounding more hopeful that businesses are accelerating their borrowing,” The Wall Street Journal reports.
Then again, looking backward can be dangerous in these precarious economic times. Indeed, there are some worrisome cracks forming in C&I’s momentum. It’s too soon to say if the recent burst of higher lending has run its course, but it’s hard to dismiss the risk given the downshift in economic activity overall in recent months.
Taking a closer look at C&I loans doesn’t offer much comfort. Although total loan value is still growing, the rate of growth slowed considerably in June, rising just 0.3% last month vs. the 1.0% rate posted in each of the previous three months.
Weekly data for C&I loans at large commercial banks so far in July also suggests that the trend is rolling over, as the second chart below suggests.
It’s premature to declare the revival in lending as another victim of the recent slump, but it’s not too soon to start worrying. Lending tends to be a lagging indicator, which is to say that it recovers well after a recession has ended. That’s certainly been true in the latest cycle. But it’s also true that once lending revives, the growth is persistent and robust for an extended period. If the narrative doesn’t hold this time, that would a dark sign for the wider economy at this stage.
Lending, after all, is a critical part of economic growth. It’s no surprise to see the pace of lending fall sharply in times of economic stress if not fall outright. As such, if loan growth starts to falter in the weeks and months ahead--so soon after it began to expand--well, that would be another sign of trouble for the broader economy.
But let’s not jump to conclusions just yet. There are still reasons to be optimistic. One obvious example: the stock market is still firmly in the black on a year-over-year basis, which suggests that the crowd still thinks the risk of a new recession is low. You can find some corroboration for that view by looking at the annual trend in various economic metrics. Even private-sector job growth, although battered in recent months, remains comfortably in the black relative to year-earlier comparisons.
Much depends on what happens next, however. The wrangling over the budget in Washington surely leaves lots of room for debate over the risks that lie ahead. Meantime, if loan activity continues to decline, keeping the faith isn’t going to get any easier.
For the moment, there’s still a good argument for remaining cautiously optimistic and expecting the economy to muddle through. But even this thin reed is subject to revision on a moment’s notice these days.
July 21, 2011
Jobless Claims Rise 10k: Biggest Jump In 8 Weeks
The message in today’s update on initial jobless claims is that the labor market recovery has stalled. The crowd has more or less suspected as much these last several months, but today’s numbers drive home the point. It’s clear from looking at the trend that we’re stuck in an elevated range. It could be worse, of course. New weekly claims could be rising. Instead, they’re treading water, albeit at levels that leave little room for comfort in thinking positively about what happens next for job creation and therefore the economy. True, overall growth still has the upper hand and there's a number of reasons to expect more of the same. But the economy's flying closer to stall speed.
New filings for unemployment benefits rose by 10,000 to a seasonally adjusted 418,000 for the week through July 16. That’s the biggest weekly jump since late May. More troubling: jobless claims have remained north of the 400k mark for 15 consecutive weeks. "We're just stuck in this trend between 410,000 and 430,000, Jeffrey Greenberg, an economist with Nomura Securities, tells Reuters. "Generally we're just really not seeing any improvement but also not much worsening."
The optimistic view is that job growth has slowed considerably, which finds easy corroboration in the June employment report, but with minimal consequences. The darker outlook is that the sluggishness in the labor market will spread--is spreading--to other corners of the economy and will reduce the modest growth that otherwise prevails.
It’s always useful to step back from the short-term noise in jobless claims and consider the big picture for this volatile series. As it turns out, the profile on this front is more encouraging. But there’s also a clear warning sign. The unadjusted annual pace of change for new jobless filings is still falling, but the rate of decline is fading, as the second chart below shows. That’s not unexpected. After recessions end, the annual rate of decrease in new jobless claims moves slips away, eventually moving to zero and above. That's the natural course of the business cycle. The biggest improvement comes right after the worst of the recession. The trouble this time is that absolute job growth has been weak in the rebound and so the natural cyclical forces are poised to inflict pain that wouldn’t normally be present if the labor market had been minting higher levels of new jobs over the past several years.
In sum, the economy remains unusually vulnerable to shocks. Two potential negative catalysts at the moment: the uncertainty surrounding the budget negotiations in Washington, which could trigger a default on Treasuries. There’s also the default risk in Europe, which threatens another front of uncertainty.
The trouble is that there's not enough growth in the labor market to offset any new affronts to the economy. “The labor market is still quite fragile,” advises Tom Porcelli, chief U.S. economist at RBC Capital Markets Corp., via Bloomberg. “The pace of firings continues to move sideways and it’s obvious there is not a lot of hiring going on. There is not a lot of demand right now.”
Until the precarious state of the labor market changes for the better, there's a fair amount of macro risk hanging over our collective heads. Some of it is self inflicted by way of politics. As a report from Goldman Sachs notes, the budget wrangling in Washington is a “contributing factor” in the sharp drop in the latest reading for consumer confidence.
But the case for salvation isn't lost. If the politicians work out a deal and avert a default, a collective sigh of relief is likely. It's unclear if that would translate into better numbers for the labor market, but hope springs eternal.
July 20, 2011
A Long US Holiday For The Bond Vigilantes
Bond vigilantes are driving yields higher for certain European countries, but there’s little sign of stress in the U.S. Treasury market. The dollar is hardly perfect, but it's still the world's reserve currency and it claims a number of benefits over the euro. Even so, the low yields on Treasuries is surprising to some considering the surge of predictions that the fiscal and monetary stimulus in recent years would eventually drive yields skyward. In 2009, for instance, The Wall Street Journal argued that the vigilantes “appear to be returning with a vengeance now that Congress and the Federal Reserve have flooded the world with dollars to beat the recession.” Two years on, the benchmark 10-year Treasury yield is roughly 2.9% as of yesterday, or about 50 basis points lower than when the Journal expressed its concerns about the blowback from vigilantes on May 29, 2009.
According to some analysts, these are still ripe times for soaring Treasury yields. The Federal Reserve’s program of buying government debt (QE2) ended last month, thereby removing some of the downward pressure on yields. There's also worries over whether Congress will raise the debt ceiling in early August and avert a technical default on Treasury debt, an event that, if it happens, could trigger a new financial and economic crisis, according to some economists. But despite these dark clouds, Treasury yields remain relatively subdued.
It’s the same story for the Treasury market’s inflation forecast, based on the yield spread between the nominal 10-year Note less its 10-year inflation-indexed counterpart. By that measure, the crowd’s expecting inflation of around 2.4% a year for the decade ahead, which is more or less the average reported over the last decade.
Is any of this surprising? Not really. Yields and inflation expectations are low in the U.S. because of the ongoing fallout from the massive financial crisis of 2008 and the lingering economic ills that followed. The unemployment rate remains high, job creation is still tepid, and the demand for safe havens, such as gold and Treasuries, is above average. Paying down the excesses of debt accumulation in years past is now a priority, which means consumption and economic growth are on the defensive. It's an old story at this point, but it's still the main narrative.
Some analysts are confused by these events, arguing that higher yields are just around the corner. That's true for Greece and Spain, for example, but it's wrong to assume that the conditions in those countries have a direct analogy with the U.S. A more telling analysis for America is the history of financial crises, which suggests that slow and middling recovery will roll on for some time.
The market seems to anticipate no less. Indeed, the demand for money is still robust. “U.S. Treasury bill yields not far above zero were no deterrent on Tuesday to demand in an auction of $28 billion of four week bills which was underpinned by tight supply and safe-haven buying,” Reuters reports. “The U.S. Treasury on Tuesday auctioned the bills at a high rate of 0.005 percent, down from 0.02 percent in a similar auction last week, but up marginally from a high rate of zero in a four-week bill auction two weeks ago.”
The same demand for a safe haven (as opposed to a fear of higher inflation) is probably driving gold prices skyward as well. Not everyone agrees. One theory is that gold prices reached $1600 an ounce for the first time in recent days because, as one writer opined, of worries over U.S. fiscal and monetary policies. Perhaps, but then why is demand for Treasuries so strong at this late date?
The answer seems to be that we’re still suffering from the after-effects of a huge debt crisis. As David Leonhardt reminds, balance sheet recessions and their aftermaths are especially persistent and pernicious beasts and so it takes an unusually long period of time for something approaching a normal recovery to take root. The latest reading on consumer confidence, which just hit a 2-1/2 year low, surely doesn’t change the historical perspective.
Yes, a more aggressive monetary policy might be able to speed the recovery process, although that hope is fading, i.e., a potent QE3 is off the table, at least for now. Ditto for thinking that a new fiscal stimulus will bring salvation.
Meantime, the case for arguing that the bond vigilantes are poised to return in the near future in the U.S. Treasury market still looks like a long shot. The history of financial crises doesn’t repeat, but it does rhyme.
July 12, 2011
One More For The Road...
Just as I'm heading out the door for a week-long holiday, I see that Financial Advisor has published my latest piece on a new generation of research focused on the eternal search for excess returns born of skilled trading, a.k.a. alpha. As per the article's title, it's an old debate with some new twists. For the details, read on here...
The Capital Spectator Takes A Holiday...
I'll be traveling for the next week and so posting will be light to nonexistent until I return to the usual affairs on July 20 or thereabouts. To wit, man cannot live by economics and finance alone.
July 11, 2011
The Final Frontier Of Investing
Financial researchers have had great success over the years in deciphering some of the mysteries of asset pricing. Much of it boils down to recognizing that the source of excess returns—risk premiums—can be traced to various betas, or specific types of market risks, or factors or investment anomalies or whatever term you prefer. As productive as this effort has been, it's only half the battle. The next phase of deciphering Mr. Market’s secrets—indeed, the critical phase—has only just begun. Figuring out how to efficiently manage risk factors--dynamic asset allocation—is still in its infancy. Nonetheless, this is the holy grail of investment strategy.
That’s old news, of course. Financial economists are already in hot pursuit of this strategic quarry. A recent study, for instance, surveys a broad array of return predictors and considers how they compare for managing portfolios. In fact, if we look back over recent decades, it's clear that the possibilities are extensive for forecasting risk premiums across the major asset classes. There's lots of hazards, of course, but we're not quite so blind as it appeared in years past.
“Expected returns are now commonly seen as driven by multiple factors,” writes Antti Ilmanen in the recently published Expected Returns: An Investor's Guide to Harvesting Market Rewards. Dissecting these factors is the first step to building better models and making superior forecasts. It's hard work, but success never comes easy. The big change in finance is that there's a reliable map to follow.
Having identified a rich array of factors linked to risk premiums, the challenge of how to manage these sources of excess returns is receiving more attention—in academia and in the general investing community. “Investing success does not come in one flavor,” notes financial writer Lawrence Light in his new book Taming the Beast: Wall Street's Imperfect Answers to Making Money "Many strategies must be explored to get to that blessed state where you can say, 'I've got plenty of money to sustain me, thank God'" He goes on to explain,
The new approaches to investing that have sprung up each have devoted adherents. The trick is to be sufficiently flexible to dip into any or all of them, but by the same token know their limitations.
Indeed, there's a rainbow of risk factors at our collective fingertips, as the exploding menu of ETFs and ETNs reminds. Some betas that were once considered the sole province of active managers are now repackaged as investable indexes.
The investment theory for managing these betas is still very much a work in progress, however. It's fair to say that while cataloguing the broad spectrum of risk factors has become quite sophisticated and routine, the equivalent for dynamic asset allocation is comparatively undeveloped.
That's not surprising since recognizing, classifying and evaluating risk in all its variations is the first step in this process. With a fair amount of progress under the industry's belt, it's only natural that financial economics as well as practical-minded investors are turning to the final frontier: asset allocation.
Unfortunately, this obvious research focus isn't going to give up its secrets easily or quickly. In contrast with looking for the drivers of risk premia, asset allocation revelations are problematic because the solutions, such as they are, tend to be investor specific. My optimal asset allocation may be irrelevant or even dangerous for you. That's not fatal for analyzing portfolio strategy, but it surely makes life more difficult.
Difficult or not, the research on asset allocation is essential. The good news is that this thorny but fundamental topic is being analyzed from multiple angles by a growing number of researchers and investment practitioners. (For example, see this recent survey of literature on the connection between asset allocation and systemic risk; also, consider this intriguing study on tactical asset allocation and a complementary analysis here.)
It was probably inevitable that asset allocation would become the prime focus ever since Markowitz established the framework of modern finance in his celebrated 1952 paper "Portfolio Selection." Markowitz's seminal work, and his elaborate follow-up book, has guided financial economics over the years. The revelations inspired by this research to date are nothing short of extraordinary, as Ilmanen's book reminds. But the grandest discoveries for investing are yet to come.
It's hard to overestimate the importance of developing intuition for anticipating risk premia. This, after all, is at the core of investing. But peeling away some of the mystery about how risk premiums interact, and what that implies for blending them to generate a more efficient risk-return tradeoff, is a much-bigger prize. What we really need is a general theory for asset allocation. Unfortunately, all we have at the moment is an awkward mix of rough rules of thumb and a patchwork of theory. Meanwhile, the world awaits the Markowitz of asset allocation. He or she is out there somewhere.
July 9, 2011
Book Bits For Saturday: 7.9.2011
● The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . and Are Ready to Do It Again
By Nicholas Dunbar
Summary via publisher, Harvard Business Press
"The Devil's Derivatives" charts the untold story of modern financial innovation--how investment banks invented new financial products, how investors across the world were wooed into buying them, how regulators were seduced by the political rewards of easy credit, and how speculators made a killing from the near-meltdown of the financial system. Author Nicholas Dunbar demystifies the revolution that briefly gave finance the same intellectual respectability as theoretical physics. He explains how bankers created a secret trillion-dollar machine that delivered cheap mortgages to the masses and riches beyond dreams to the financial innovators. Fundamental to this saga is how "the people who hated to lose" were persuaded to accept risk by "the people who loved to win." Why did people come to trust and respect arcane financial tools? Who were the bankers competing to assemble the basic components into increasingly intricate machines? How did this process achieve its own unstoppable momentum, ending in collapse, bailouts, and a public outcry against the stars of finance? Provocative and intriguing, "The Devil's Derivatives" sheds much-needed light on the forces that fueled the most brutal economic downturn since the Great Depression.
● Minding the Markets: An Emotional Finance View of Financial Instability
By David Tuckett
Review via The Guardian
In Minding the Markets Prof David Tuckett, from University College London, argues that contemporary economics, with its neat mathematical models and fully rational robot-like decision-makers, fatally under-estimates the importance of emotions. There is plenty of economic research – by George Akerlof and Robert Shiller, for example – on the psychology of market bubbles. But Tuckett's insight, based on in-depth interviews with more than 50 investors, each managing more than $1bn, is that stocks, shares and derivatives are a special kind of asset, and decisions about whether to buy and sell them are particularly subject to stories and emotions.
● Financial Statement Analysis: A Practitioner's Guide (4th ed.)
By Martin S. Fridson and Fernando Alvarez
Summary via publisher, Wiley
In Financial Statement Analysis, Fourth Edition, leading investment authority Martin Fridson returns with Fernando Alvarez to provide the analytical framework you need to scrutinize financial statements, whether you're evaluating a company's stock price or determining valuations for a merger or acquisition. This fully revised and up-to-date Fourth Edition offers fresh information that will help you to evaluate financial statements in today's volatile markets and uncertain economy, and allow you to get past the sometimes biased portrait of a company's performance.
● Sacred Economics: Money, Gift, and Society in the Age of Transition
By Charles Eisenstein
Summary via publisher, North Atlantic Books
Sacred Economics traces the history of money from ancient gift economies to modern capitalism, revealing how the money system has contributed to alienation, competition, and scarcity, destroyed community, and necessitated endless growth. Today, these trends have reached their extreme—but in the wake of their collapse, we may find great opportunity to transition to a more connected, ecological, and sustainable way of being. This book is about how the money system will have to change—and is already changing—to embody this transition. A broadly integrated synthesis of theory, policy, and practice, Sacred Economics explores avant-garde concepts of the New Economics, including negative-interest currencies, local currencies, resource-based economics, gift economies, and the restoration of the commons. Author Charles Eisenstein also considers the personal dimensions of this transition, speaking to those concerned with "right livelihood" and how to live according to their ideals in a world seemingly ruled by money. Tapping into a rich lineage of conventional and unconventional economic thought, Sacred Economics presents a vision that is original yet commonsense, radical yet gentle, and increasingly relevant as the crises of our civilization deepen.
● Barbarians of Oil: How the World's Oil Addiction Threatens Global Prosperity and Four Investments to Protect Your Wealth
By Sandy Franks and Sara Nunnally
Summary via publisher, Wiley
An engaging look at the global oil industry and how to navigate the price volatility and new policies associated with it. Oil is a constantly changing industry, and with the recent BP oil spill in the Gulf of Mexico, more changes are expected. From extra equipment, higher-cost insurance, and expensive technology to mandatory third-party inspections, costly delays, and shifting investments, analysts say the price tag of regulation will be stiff and not confined to the Gulf. The oil industry affects everyone, and the machinations of a few industry heads, the "Barbarians of Oil," can drastically change the lives of investors and consumers. In Barbarians of Oil author Sandy Franks offers the tips needed to avoid future market dips and dives as well as safeguard your investments and profit in the future.
● The Man of Numbers: Fibonacci's Arithmetic Revolution
By By Keith Devlin
Review via The Wall Street Journal
Before the 13th century, European businessmen recorded figures in Roman numerals and computed with their fingers or a counting board. But these creaky accounting systems began to buckle under the growing complexity of regional and international finance. In 1202, Leonardo of Pisa—better known by his family name, Fibonacci—published the "Liber Abbaci," or "Book of Calculation," a 600-page tome detailing the rules of Hindu-Arabic arithmetic and algebra. Fibonacci's volume was directed not to scholars but to merchants, the first work in the West to demonstrate the commercial utility of Eastern mathematics. The book was an instant success and propelled the Pisan maestro d'abbaco to fame. The "Liber Abbaci" inspired a flood of regionally produced (and lesser) primers on the subject. Arithmetic schools sprang up throughout Italy and would eventually count among their pupils da Vinci and Machiavelli. German merchants flocked to Venice during the 1300s to learn the new accounting practices. In "The Man of Numbers," mathematician Keith Devlin makes the case that Fibonacci's book spearheaded the decline and fall of the Roman numeral and transformed scientific, technological and commercial calculation in the West.
July 8, 2011
Job Growth Weakens Again In June
The number we've all been waiting for is a disappointment. Net private-sector job creation was a slim 57,000 in June, below even May's dismal 73,000 rise, which was revised down from the initially reported 83,000, the Labor Department reports. There had been hope that May was an anomaly, a one-off affair that would quickly return to the stronger levels of job growth witnessed in February, March and April. Yesterday's modestly encouraging employment report via ADP certainly inspired that optimism. But today's update is a sobering reminder that the economy will continue to struggle through the summer. Granted, the employment report, grim as it is, isn't fatal. But it's a sign that the pace of growth has slowed considerably and, even worse, it suggests that a revival in economic momentum faces stronger headwinds.
As the chart below shows, job creation in the nation's private sector last month was near the weakest since the Great Recession technically ended in June 2009. The comfort margin between growth and contraction is dangerously thin. Looking at the jobs report by sector reveals a mixed bag of modest growth and mild retreats. Job growth in durable goods was a rare bright light, adding 15,000 positions. But there was plenty of offsetting mediocrity and declines, including construction's 9,000 retreat and 15,000 fewer financial activities jobs in June. Even the category of temporary positions tumbled 12,000 last month. If companies are relucant to hire temps, what does that say about expectations? And while the services sector, which employs the bulk of the nation's labor force, managed a familiar gain last month, it was slight: higher by just 53,000—one of the smallest increases in the post-recession period.
Optimism, in sum, has suffered a hefty blow today. Indeed, the unemployment rate inched higher again, reaching 9.2% in June--the third straight monthly increase from March's 8.8%, the lowest point since the recession began. It seems that we're moving in the wrong direction again, albeit slowly. It's likely that there's enough forward momentum in other corners of the economy to keep us out of a recession proper for the immediate future. But for how long? Without a return to higher levels of job creation, it's hard to muster anything more than vague hope that better days lie ahead.
For the moment, the labor market appears to be stalling. That implies that the path of unemployment will drift higher. The possibility of slow strangulation can't be ruled out. If the labor market is more or less treading water, there's no imminent danger of an outright contraction in the macro trend, thanks to the support from elsewhere in the economy. But if job creation crawls along at May and June's pace, the battle to keep the economy moving is going to get tougher, perhaps a lot tougher.
It's true that the job market stalled last year for three months before reviving in the fall. A similar rebound can't be ruled out, although the question is what will be the catalyst? Arguably the much-anticipated roll out of the Fed's QE2 was part of last year's salvation. This time, the central bank has recently ruled out a repeat performance, although maybe today's jobs report will change that view.
Meantime, the anxiety over the budget talks in Washington and the potential for a technical default on Treasuries looms in early August. With each passing day, that's the big issue until we see resolution. Otherwise, corporate America has one more reason to refrain from hiring.
This much is clear: Whatever ails the labor market is still with us and so reviving job creation is job one, more so than ever. But the path of getting from here to there is a mystery at the moment. The solution, of course, is spurring higher demand in the economy. There's a fierce debate about the best way to proceed. Cut the deficit? Roll out a new stimulus (monetary and/or fiscal)? And a thousand other variations drive the discussion. In the wake of a financial crisis, however, easy solutions are in short supply.
The only fact we have this morning is a rather dark one. "The message on the economy is ongoing stagnation," Pierre Ellis, senior economist at Decision Economics, tells Reuters. "Income growth is marginal so there's no indication of momentum."
July 7, 2011
Is The Labor Market Reviving?
Have we dodged a macro bullet? Today's employment news offers two data points for thinking positively. New claims for jobless benefits dropped again last week and the ADP Employment Report for June reports a revival in private sector job growth after the sharp downshift in May. The numbers aren't particularly impressive per se, especially for the new claims tally. But there's enough juice in the latest updates for arguing that the recent stumble in the macro trend isn't getting worse and may very well be giving way to a stronger rate of growth.
Let's start by taking a closer look at initial jobless claims. As the chart below shows, seasonally adjusted claims fell 14,000 to 418,000. That's still elevated, suggesting that the economy is still under stress. But it's also true that last week's claims are the lowest in more than a month and well below the spike that reached nearly 480,000 back in late April.
Looking at unadjusted weekly claims numbers on a 12-month rolling basis offers even stronger encouragement. This calculation cuts out a fair amount of the short term noise for this volatile series and based on the latest reading it appears that the storm is passing. The 12-month change in raw claims numbers is lower by more than 11%, the best rate of annual decline since mid-May.
The question is whether the fall in new filings for unemployment benefits has legs? Today's ADP Employment Report suggests thinking in the affirmative. As the third chart below indicates, private sector job growth rebounded sharply last month, with the labor market expanding by a net 157,000, up from a dismal 36,000 reading in May and more than double what economists were expecting. Whatever affliction the economy suffered in April and May appears to be receding, or so the ADP update suggests.
If tomorrow's jobs report from the government confirms the revival implied in today's numbers, a huge collective sigh of relief will echo through the crowd. But we're not there yet. Tune in tomorrow at 8:30 a.m. Washington time.
July 6, 2011
Early Economic Indicators For June Are Moderately Encouraging
The first clues about June's economic activity are in and the numbers leave room for optimism, but not nearly enough to eliminate worry entirely. Today's reading on the services sector via the ISM Non-Manufacturing Report reveals a slower rate of growth last month. Meanwhile, the June reading on manufacturing shows that a slight increase in activity. The good news is that in both cases growth still has the upper hand, albeit at a lesser pace for services companies, which constitute the lion's share of the private sector. Nonetheless, the idea that the summer of 2011 isn't destined to follow the previous year's dismal downturn remains alive and kicking. But the week's ahead will surely test this faith.
Much depends on how the rest of the month's numbers look. First up is tomorrow's update on weekly jobless claims. Economists aren't expecting much of a change, which means that elevated claims will continue to haunt the outlook for growth. The big number arrives on Friday, when the June employment report is released. The consensus forecast calls for a net gain of 110,000 private sector jobs, up from May's disappointing 83,000. That's an improvement, but if the forecast holds true it's still too low to provide much confidence that the rough patch is over.
"The start-and-stop recovery we have experienced over the last year and a half is stifling the momentum necessary for business confidence to rise materially and hiring to gain traction," Russell Price, senior economist at Ameriprise Financial, tells CNNMoney.
Nonetheless, the stock market's optimism remains intact. That's no guarantee, of course, but when we pair the rolling 12-month percentage change for equities with some other economic metrics, the trend still appears to have forward momentum. In the chart below, the annual change in the S&P 500 (red line) and the ISM Manufacturing Index (black) is updated through June. The latest numbers for durable goods orders (blue) and industrial production (green) are as of May.
Clearly, the stock market sees better times ahead. The ISM reading on manufacturing is suffering, but it's perked up courtesy of the June report. The big mystery is whether industrial production, durable goods orders and other metrics will hold their ground in June. The stock market is inclined to think that we'll muddle through. But before we pin our hopes on the crowd's expectations as expressed through equities, we have to survive the next two days of employment statistics.
In short, we're at a precarious point in the economic cycle…again. The real danger is arguably less about a new recession vs. a lesser level of growth that endures and thereby slowly strangles the economy. Deciding if that risk is more than a passing threat may get easier by the end of this week.
The hope is that the rough patch ends and brighter skies emerge. Is that feasible? Absolutely, says one strategist. "We've got this idea that we've really slowed down, but the actual inherent growth rate of the economy has sped up," says Jim Paulsen, chief investment strategist at Wells Capital Management via US News & World Report. "It's just being covered up by temporary forces."
Perhaps, but if that's true it's not unreasonable to expect some inspiration in the next batch of employment numbers.
July 5, 2011
Running The Numbers On A Strong Asset Allocation Fund
Human nature being what it is, investors are forever looking for a magic mix of investments that will soar in good times and offer a safe harbor amid turmoil. Nirvana doesn’t exist, of course. If it did, the world would figure out the secret and pile in, arbitraging away any future value in the process. Different asset allocations do generate different results over time, of course, and so we should spend time thinking how to design and manage our portfolios. But there are limits to even the best-laid plans of mice and men. The question, then, is figuring out a prudent framework for considering out options and evaluating the potential rewards. What follows is an example of how we might proceed by looking at one asset allocation fund that's actively managed and boasts a handsome record.
The inspiration for kicking the tires comes via The Wall Street Journal, which reviews several mutual funds with encouraging track records for weathering rough seas. BlackRock Global Allocation (MDLOX), for instance, is listed as one of several mutual funds that "beat the market during the last big downturn." Fair enough. But it's also important to recognize what's possible in the art of self defense in money management with minimal effort, skill or expense.
As always on these pages, I start with the Global Market Index (GMI), a passive mix of all the major asset classes weighted by market values. It's useful to consider how GMI fared against the BlackRock fund during the worst stretch of the last downturn, as per the period noted by The Journal. I've adjusted the dates slightly, since The Journal picks specific intra-month days whereas I calculate GMI monthly. That said, the BlackRock fund retreated by a cumulative 26.6% from the end of September 2007 through February 2009's close. The S&P 500 suffered a deeper loss over that span, shedding roughly 50% on a total return basis, based on data from Morningstar Principia. But that comparision's not really fair since the S&P represents large U.S. stocks and the BlackRock fund has a broad mandate to invest across asset classes on a global basis.
For a somewhat fairer comparison, GMI was lighter by 34.3% over that span. Of course, that's not quite realistic, since that's reference to a paper index. That real world performance using ETFs to replicate GMI (as per the investable version of GMI, a.k.a. GMI-F) shows a modestly deeper loss of 35.8% over those 17 months through February 2009's close.
The BlackRock fund, in short, delivered superior performance. But it's not obvious that we've found strategic nirvana. Let's play devil's advocate for a minute and consider some facts. For starters, there's no guarantee that what's unfolded in the past will repeat in the future. That's true for GMI too. But the warning is doubly relevant for actively managed portfolios with moving parts, such as MDLOX. The management team for the fund surely is a talented bunch, but there's always an element of simple risk exposure that explains results, for good or ill. Beta, in other words, is always a factor.
Exactly how much a factor beta plays is debatable. Depending on the strategy and the manager, it's a factor that can vary considerably. For most conventional investment strategies, however, beta's usually a fairly large presence. The fact that GMI's results are within shouting distance of the BlackRock fund's performance suggests that beta—even for a broadly diversified, active asset allocation fund such as MDLOX—is more than a trivial variable.
Nonetheless, the BlackRock fund has delivered an impressive run when we look back over the good times and bad. For the five years through the end of June 2011, MDLOX posts an annualized 7% total return, according to Morningstar.com. That's a handsome premium over GMI's 5.1% performance, or GMI-F's 4.8%.
On the other hand, the performance gap closes further if we consider a mindless, end-of-year rebalancing strategy for GMI that returns the mix back to its previous year's profile: GMI-R earned an annualized 6.3% return for the five years through last month. Alternatively, an equally weighted version of GMI fared even better with a 7.4% return over that span. In fact, that's slightly better than MDLOX's 7% gain.
What are we to make of these numbers? There's beta in them 'thar performance hills, and some of the alpha can be replicated with simple rebalancing and/or minimizing hefty allocations to any one asset class.
Let's go a step further and run a factor analysis test to evaluate beta's influence. This is simply performing a multiple regression on the numbers by comparing the monthly risk premium for MDLOX vs. the equivalent for the proxy indices of the major asset classes (see the list here) and GMI. I chose to review the 10 years of monthly data through May 2011. The results show that roughly 97% of MDLOX's monthly risk premium (total return less the performance of a 3-month T-bill) is driven by GMI.
Yet that small difference on average was used intelligently and efficiently by the fund's managers. MDLOX's alpha (statistically labeled as intercept of coefficient) is roughly 2.5% a year. In other words, the BlackRock fund over the last decade has beat GMI by around 2.5% in risk premium terms.
How did MDLOX manage that feat? In part by veering away from GMI's passive allocation, according to factor analysis. Relative to a passive mix, MDLOX appears to have made relatively heavy bets on U.S. stocks, foreign equities in developed markets, and foreign government bonds issued by mature countries over time.
Overall, MDLOX has done a handsome job in adding value. Perhaps the record is strong enough to consider owning the fund for the future. But the managers have a high bar to overcome. MDLOX's net expense ratio is 1.17% plus a steep one-time front end load of 5.25%, according to Morningstar Principia. That compares with GMI-F's load-free 0.5% expense ratio.
Keep in mind too that GMI tends to fare competitively against asset allocation funds generally, as I discussed earlier this year. On average, GMI does quite well, especially after adjusting for its simplicity and low expense.
The basic message is that if we compare GMI to a broad measure of funds intent on adding value, there tends to be a handful of winners, a handful of losers and a large supply of mediocre results. MDLOX is one of the winners over the last 10 years. An impressive achievement, and one that doesn't come easily or often to funds. Nonetheless, the issue to consider before buying this fund, or any actively managed fund, is whether you have a high degree of confidence that the past will continue to endure for positive alpha. The analysis above offers some reason for hope, although the costly fees raise some questions. In any case, additional research is required.
The broader point is that it's important to know what risk premium is available at low cost for everyone regardless of skill. GMI is no silver bullet, but it's a competitive benchmark and it can be transformed into an investable strategy at minimal expense. Given the transparency and simple strategy, it's also an investment portfolio with a relatively encouraging level of reliability for delivering a modest risk premium. GMI or something similar is where the analysis should always begin.
You can do better, of course, but you should have a clear understanding of why you expect you won't do worse. Or perhaps the better question: Why do you expect that you won't suffer the fate of roughly half the investment community and underperform GMI?
July 2, 2011
Book Bits For Saturday: 7.2.2011
● Economics of Good and Evil: The Quest for Economic Meaning from Gilgamesh to Wall Street
By Tomas Sedlacek
Summary via publisher, Oxford University Press
In The Economics of Good and Evil, Sedlacek radically rethinks his field, challenging our assumptions about the world. Economics is touted as a science, a value-free mathematical inquiry, he writes, but it's actually a cultural phenomenon, a product of our civilization. It began within philosophy--Adam Smith himself not only wrote The Wealth of Nations, but also The Theory of Moral Sentiments--and economics, as Sedlacek shows, is woven out of history, myth, religion, and ethics. "Even the most sophisticated mathematical model," Sedlacek writes, "is, de facto, a story, a parable, our effort to (rationally) grasp the world around us." Economics not only describes the world, but establishes normative standards, identifying ideal conditions. Science, he claims, is a system of beliefs to which we are committed. To grasp the beliefs underlying economics, he breaks out of the field's confines with a tour de force exploration of economic thinking, broadly defined, over the millennia. He ranges from the epic of Gilgamesh and the Old Testament to the emergence of Christianity, from Descartes and Adam Smith to the consumerism in Fight Club. Throughout, he asks searching meta-economic questions: What is the meaning and the point of economics? Can we do ethically all that we can do technically? Does it pay to be good?
● Banker to the World: Leadership Lessons From the Front Lines of Global Finance
By William Rhodes
Review via The Economist
“Everyone knows Bill. Everyone trusts Bill.” Rupert Murdoch’s 2007 tribute to William Rhodes on the 50th anniversary of his joining Citigroup hints at how interesting this retrospective on a stellar career in finance could have been. Unfortunately, nobody had the heart to tell Bill to do a rewrite. Mr Rhodes is a former vice-chairman of Citigroup, with the ear of a series of the bank’s chief executives. He is a veteran of debt-restructuring negotiations in Latin America in the 1980s and 1990s. He headed a series of advisory committees (a term he insisted on over the previous, high-handed label of “restructuring committees”) representing international banks in talks with the governments of Argentina, Brazil, Mexico and others. He is an éminence grise of Wall Street, as a very long list of extra-curricular positions attests.
● Reluctant Regulators: How the West Created and How China Survived the Global Financial Crisis
By Leo F. Goodstadt
Summary via publisher, Hong Kong University Press
The 2007-09 global financial crisis was predictable and avoidable but American and British regulators chose not to intervene. They failed to enforce legislation or implement their own policies because of an Anglo-American "regulatory culture" of non-intervention that came to dominate financial regulation worldwide. Hong Kong — the international financial centre of an increasingly prosperous China — defied world opinion and made stability its priority, even where that meant extensive government intervention. This policy ensured Hong Kong's robust performance during the 1997-8 Asian financial crisis and the latest global crisis. More significantly, it made possible Hong Kong’s impressive contributions to financing China's economic take-off and to the modernization of its financial institutions. Reluctant Regulators is a scathing indictment of regulatory inertia in the West. It provides important and original insights into the causes of financial crises and pays special attention to China's attempts at reform and Hong Kong's place in China's financial modernization.
● A 'Short Treatise' on the Wealth and Poverty of Nations (1613)
By Antonio Serra, edited by Sophus A. Reinert
Summary via publisher.
Although no less an authority than Joseph A. Schumpeter proclaimed that Antonio Serra was the world’s first economist, he remains something of a dark horse of economic historiography. Nearly nothing is known about Serra except that he wrote and died in jail, and his ‘Short Treatise’ is so rare that only nine original copies are known to have survived the ravages of time. What, then, can a book written nearly four centuries ago tell us about the problems we now face? Serra’s key insight, studying the economies of Venice and Naples, was that wealth was not the result of climate or providence but of policies to develop economic activities subject to increasing returns to scale and a large division of labour. Through a very systematic taxonomy of economic life, Serra then went on from this insight to theorize the causes of the wealth of nations and the measures through which a weak, dependent economy could achieve worldly melioration. At a time when leading economists return to biological explanations for the failure of their theories, the ‘Short Treatise’ can remind us that there are elements of history which numbers and graphs cannot convey or encompass, and that there are less despondent lessons to be learned from our past. Serra’s remarkable tract is introduced by a lengthy and illuminating study of his historical context and legacy for the theoretical and cultural history of economics.
● Debtor Nation: The History of America in Red Ink
By Louis Hyman
Summary via publisher, Princeton University Press
Before the twentieth century, personal debt resided on the fringes of the American economy, the province of small-time criminals and struggling merchants. By the end of the century, however, the most profitable corporations and banks in the country lent money to millions of American debtors. How did this happen? The first book to follow the history of personal debt in modern America, Debtor Nation traces the evolution of debt over the course of the twentieth century, following its transformation from fringe to mainstream--thanks to federal policy, financial innovation, and retail competition.
July 1, 2011
Major Asset Classes | June 2011 Performance Update
June was a mixed bag of investment results. Emerging market bonds (Citigroup ESBI-C) led the pack among the major asset classes, advancing 1.1% last month. Commodities (DJ-UBS Commodity) were the big loser for the second straight month, shedding 5.0% in broad terms. Our passive market-value weighted mix of everything—the Global Market Index—suffered under the strain of the widespread selling. GMI fell 1.0% in June. GMI was off in May as well and so the index just had its first run of two straight monthly losses in a year.
Given the recent economic uncertainty, red ink isn’t surprising. Even so, the losses for June are modest. In fact, when we look at year-to-date returns through June 30, the tally still looks quite decent, as the table below shows. GMI, for example, is up 4.8% as of this year's midway point. Not too shabby for a broadly diversified index over six months. In fact, it's quite good, relative to the historical record.
As another example, consider U.S. stocks (Russell 3000), which retreated 1.8% last month. But domestic equities for the first half of 2011 are still up a respectable 6.3%. Even if the stock market stayed flat for the second half of the year, a 6.3% annual return is only moderately below the long-term average performance of roughly 9% since 1926.
Some of last month’s losses can be chalked up to gravity. REITs (MSCI REIT), for instance, gave up more than 3% in June, but this asset class is still higher on the year by more than 10%--the best showing among the major asset classes so far in 2011. Back in mid-May, I wondered if REITs were due for a correction, as implied by the evaporation of the traditional yield premium for real estate securities at the time.
Looking forward, it’s not unreasonable to expect more churning in the markets until the crowd develops more confidence about the next phase for the economic cycle. Are we in “rough patch” or is there something darker lurking? If it’s a rough patch, how will that play out in the all-important labor market? Questions, questions, as always, but the stakes are bit higher than usual.
As I’ve been discussing all week, the next big clue arrives in a week, with the release of the June employment report on July 8. The crucial question: Was the big fade in job growth in May a one-time stumble? We’ll know more in a week. Stay tuned…