August 31, 2011
Redefining Triple-A Credits
Are Springleaf Mortgage Loan Trust 2011-1 bonds safer than U.S. Treasuries? Yes, according to Standard & Poor's. Bloomberg reports: "Standard & Poor’s is giving a higher rating to securities backed by subprime home loans, the same type of investments that led to the worst financial crisis since the Great Depression, than it assigns the U.S. government."
But that can't be right. Let's see, the United States government has the ability to print its own money, a competitive edge that doesn't apply to Springleaf. Assuming inflation doesn't overwhelm this advantage, the odds of a Treasury default are virtually nil. Granted, that's not the impression from recent media reports, but facts are facts.
I'll even go one step further: If inflation rises, and rises substantially, the Treasury won't default. The U.S. may have trouble selling new bonds, but the existing loans will be made whole. There's more to assessing Treasury risk, of course, but that ain't hay.
Meantime, Springleaf's capacity for matching that standard isn't exactly comparable. That's no reflection on Springleaf--the same caveat applies to every corporation. The business of rating bonds, by contrast, is a slightly more subjective topic.
But talk is cheap when it comes to finance. Let's see how the crowd prices Treasuries vs. Springleaf's bonds in question. Any guesses as to how Mr. Market will weigh in on the debate?
Stuck In Neutral
Private nonfarm employment growth slowed in August, according to ADP. “Today’s ADP National Employment Report suggests that the trend in employment moderated somewhat in August at a pace below what would be consistent with a stable unemployment rate.” That’s in keeping with the recent slippage in economic activity generally, and so it’s not terribly surprising. Today’s numbers suggest that we should moderate our expectations for this Friday’s employment report from the government.
"The steady decline in government stimulus is bringing to light an underlying weak economy incapable of generating enough jobs to reduce unemployment," Madeline Schnapp, director of macroeconomic research at TrimTabs, tells TheStreet.com. "Worse still, it appears that the slowdown is accelerating, increasing the risk of recession."
John A. Challenger, CEO of Challenger, Gray & Christmas, tries to put a positive spin on the numbers by reasoning that "July job cuts spiked as a result of a handful of surprisingly large job cut announcements in the private sector. It is too soon to tell whether those cuts were an anomaly, but they appeared to be driven by industry- and company-specific trends, as opposed to larger economic ones.”
We'll know more with Friday's update from the Labor Department. Meanwhile, it's clear that private-sector job growth is slowing once more. It wasn't all that impressive to begin with and it's even less robust now. But assuming we don't sink further in the months ahead, I'm still not convinced that there's a new recession lurking. But it's still touch and go with economic reports and so there's not much confidence that what we see today will hold up. It's easy to get whipsawed if you follow the data closely, but the bigger picture suggests that we're simply not breaking out of the sluggish recovery that's prevailed all along. It could get worse, of course, and eventually it will. Recessions are inevitable... eventually. For the time being, the argument that we're likely to muddle forward is still a reasonable guess. The latest numbers on personal spending and income, for instance, offer some modest hope on this front.
Meantime, the retreat in job growth in the ADP report implies that the more widely followed government data on Friday isn't likely to surprise on the upside. The consensus forecast calls for a net rise of 110,000 private-sector jobs for August via the Labor Department's calculations, according to Briefing.com. That would be a substantial fall from a gain of 154,000 in July. "It seems to me Friday's number from the BLS could be a good deal weaker than the number we're reporting today," Macroeconomic Advisers LLC Chairman Joel Prakken said earlier today.
In short, more of the same is the path of least resistance. The labor market remains weak, but it's still growing. That leaves us (still) in a gray area and waiting for another catalyst to move us out of this neutral zone. A rebound in the housing market would do the trick, but that's not likely in the near future. Exactly how and why we'll move out of this cyclical rut, and in what direction any change will take us, are questions that are still open for debate.
Are Consumer Confidence Indices Useful As Leading Indicators?
Consumer confidence fell to its lowest level in more than two years, the Conference Board reports. That's a discouraging sign for the economy. No one's really surprised, given the various ills weighing on the economy, although some analysts doubt that such measures are all that valuable. "Consumer confidence usually is not a good indicator of spending," Edward Meir, MF Global senior commodities analyst, tells AP. "People may say they don't feel great but they still spend."
Quantifying how consumers think is a fuzzy art under the best of circumstances, but that doesn't stop anyone from trying. There are several confidence measures to consider. A popular alternative to the Conference Board's index is the Thomson Reuters/University of Michigan survey, which has also slumped recently, falling to its lowest level in August since November 2008. Yet another reason for caution.
How much stock should we put in such measures for gauging the future? Consumer confidence benchmarks surely deserve routine monitoring, but the standard caveat applies: Any one predictor is subject to failure at times, and so we need a diversified mix of factors to minimize the potential for error. That said, consumer confidence metrics are a valuable addition to the mix. There are no silver bullets here and so when used in isolation they should be taken with a grain of salt. But there's also a danger if we ignore these metrics because they can tap into a different stream of intelligence about the business cycle. Indeed, there are times when ignoring a slump in consumer confidence has been misguided, to say the least.
A recent study from the European Central Bank, for example, tells us to take these numbers seriously:
…the results show that the consumer confidence index can be in certain circumstances a good predictor of consumption [in the U.S. and Europe]. In particular, out-of-sample evidence shows that the contribution of confidence in explaining consumption expenditures increases when household survey indicators feature large changes, so that confidence indicators can have some increasing predictive power during such episodes.
--"Consumer Confidence as a Predictor of Consumption Spending: Evidence for the United States and the Euro Area"
One of the study's charts compares the historical fluctuations in the University of Michigan Consumer Sentiment Index with real (inflation-adjusted) consumption in the U.S., noting that the correlation between the two series is "rather high." It's far from perfect, but the point is that it's not random either.
The ECB study isn't the first time that researchers have found a productive link between consumer confidence indices and economic activity. A paper from 1994, for instance, found a relationship between confidence measures and economic activity ("Does Consumer Sentiment Forecast Household Spending? If So, Why?"). There also seems to be a connection, as you might expect, between consumer confidence and the stock market. As research from a 2003 issue of The Journal of Portfolio Management advised:
Consumer confidence rises with high stock returns, but high consumer confidence is followed by low stock returns. Sentiments of individual investors about the stock market improve with consumer confidence about the economy, as if individuals were unaware that stock prices are a leading indicator of the economy.
--"Consumer Confidence and Stock Returns"
A 2005 study presents "evidence that both consumer confidence and stock prices have an important role in the United States business cycle, especially at times when a cluster of large shocks to either of them occurs" ("The Influence of Consumer Confidence and Stock Prices on the United States Business Cycle").
It's true that some economists cast aspersions on the idea that consumer confidence indices are helpful for looking ahead. Clearly, there's room for debate, as there is with any one indicator. But to the extent that we try to peel away some of the future's uncertainty, adding consumer confidence gauges to a broad mix of variables is almost certainly worthwhile. That's hardly a guarantee, but no other factor can offer assurances either. Instead, this is a game of minimizing the potential for misleading forecasts. More often than not, using consumer confidence metrics in connection with other indicators, such as the 12-month change in the stock market, initial jobless claims, the yield curve, etc., sheds light on the state of the economy. But caveats abound, including the argument that not all consumer confidence benchmarks are created equal.
Technically, consumer confidence is considered a lagging indicator, or so a number of dismal scientists opine. In that case, these benchmarks are telling us what's happened. But understanding the past can sometimes help with anticipating the future. In fact, some references to these measures are labeled as leading indicators, as in The Economist Guide to Economic Indicators, for instance. Whatever category you prefer for consumer confidence metrics, just don't ignore them.
August 30, 2011
Who Is Alan Krueger?
He's a professor of economics and public affairs at Princeton University and President Obama's choice to lead the White House Council of Economic Advisers. "I have nothing but confidence in Alan as he takes on this important role as one of the leaders of my economic team," the President said yesterday when he announced Krueger's appointment. "I rely on the Council of Economic Advisers to provide unvarnished analysis and recommendations, not based on politics, not based on narrow interests, but based on the best evidence -- based on what’s going to do the most good for the most people in this country."
But that still leave the question: Who Is Alan Krueger? In search of a deeper answer, we can review his track record. "He served as assistant secretary for economic policy at the Treasury Department during the first two years of Obama's administration," reports AP. The article goes on to note:
Gregory Mankiw, a former CEA chairman under President George W. Bush and long-time acquaintance of Krueger, said Obama's new nominee has a reputation as an analytic, data-driven economist, not as a champion for many specific policy initiatives. While Mankiw said he believes Krueger is highly-qualified for the post, he doesn't expect him to push the administration in any new directions when it comes to tackling the nation's economic and unemployment woes.
"This is more of a continuity appointment rather than a move-in-a-new-direction appointment," said Mankiw, now an economics professor at Harvard University. "I don't think the president wanted a change. He's keeping the basic structure of the team in place."
The LA Times advises that "Krueger is best known for his work on minimum wages. Krueger's research with other economists, including David Card at Berkeley, showed that raising the minimum wage doesn't lead to job losses, as is often claimed."
Certain Republicans may beg to differ, and so there's likely to be a fair amount of debate swirling around this dismal scientist inside the Beltway in the weeks to come. There's certainly no shortage of written material to digest. Krueger's paper trail is extensive, although a paper he co-authored in the early 1990s on the minimum wage is likely to receive most of the GOP's attention. According to Krueger and his co-author:
On April 1, 1992, New Jersey's minimum wage rose from $4.25 to $5.05 per hour. To evaluate the impact of the law we surveyed 410 fast-food restaurants in New Jersey and eastern Pennsylvania before and after the rise. Comparisons of employment growth at stores in New Jersey and Pennsylvania (where the minimum wage was constant) provide simple estimates of the effect of the higher minimum wage. We also compare employment changes at stores in New Jersey that were initially paying high wages (above $5) to the changes at lower-wage stores. We find no indication that the rise in the minimum wage reduced employment.
More recently, Krueger has warned that the labor market's wounds aren't likely to heal quickly. As he wrote earlier this year:
Instead of focusing on the unemployment rate, it may be better to look at the employment-to-population ratio, or the share of the population that is employed. This rate isn’t affected by whether someone is counted as in or out of the labor force.
Tellingly, the employment-to-population rate has hardly budged since reaching a low of 58.2 percent in December 2009. Last month it stood at just 58.4 percent. Even in the expansion from 2002 to 2007 the share of the population employed never reached the peak of 64.7 percent it attained before the March- November 2001 recession.
What this indicator tells me is that we weren’t creating enough jobs long before the recession that began in December 2007. If this pattern holds, even in recovery, it points to a much deeper and disturbing problem for the U.S. economy.
Bubble Risk Is A Two-Way Street
Market bubbles are dangerous when they burst, but they're no picnic for investors who make ill-timed bets that the party's over. Just ask Pimco's Bill Gross, manager of the Total Return Fund, the planet's biggest bond fund. In February, he sold all the Treasuries in the fund and compounded the bet with derivatives. He now admits that it was a "mistake," via The Wall Street Journal.
It's easy to see why. Treasury prices have soared since February, which means that yields have dropped sharply. The yield on the benchmark 10-year Treasury Note, for instance, settled at 2.28% yesterday, down from as high as 3.75% at one point in February. As short-term rallies in Treasuries go, that's about as potent as it gets. Thanks to ongoing economic challenges this year, the popularity of safe-haven Treasuries has soared… again.
Don't be too hard on Gross, however. The view that Treasuries were overpriced was widespread earlier this year. Bubble talk was everywhere. And back in February it all sounded reasonable. But reasonable forecasts have a way of turning to dust at times as uncertainty roils the best laid plans of mice and men. One result is that so-called bubbles can roll on for longer than you think, which raises questions about definitions. What exactly is a bubble? No one really knows, or at least no one can provide a working definition in real time. Of course, it's all obvious in hindsight.
Still, Pimco's Total Return Fund got off relatively easy. Why? Gross kept a lid on his active management activity. Some might call that risk management. According to the Journal:
Over the past three months through Friday, the fund had a return of 0.16%, compared with a return of 2.78% for the benchmark Barclays Capital Aggregate Bond Index, according to data from Morningstar Inc.
Over the past month through Friday, the fund lost 0.56%, versus a gain of 2.01% for the benchmark.
The Total Return Fund has been adding to its Treasury positions since March, including a jump in July to 10% of its holdings, up from 8% in June. Overall, the fund now has net positive exposure to Treasurys for the first time in months. Relative to peer bond funds, the Pimco fund is still underweight Treasurys.
To be fair, Gross enjoys one of the best records among fixed-income managers, even after his "mistake." But his ill-timed bet is a reminder that even the smartest of money men can and will stumble at times. The only question is how big the stumble will be?
The answer depends on many factors, starting with a manager's willingness to hold portfolios that differ from the benchmark. In order to beat the benchmark, you have to move away from it. It's also true that for those who mint market-beating results, the advantage is financed exclusively by those who made losing bets. In the middle, as always, is the benchmark. And after adjusting for the relatively higher expense of active management, the benchmark is likely to end up as slightly above average. That's true for individual asset classes and for multi-asset class portfolios as well.
Skeptical? You're not alone. The majority of the planet's investors subscribe to the idea that great success awaits in active management. Nonetheless, you can safely anticipate that half of those who attempt to outguess Mr. Market will end up with below-average results. Why? It's not for lack of opportunity. There are many so-called market anomalies waiting to be exploited, as catalogued in Expected Returns: An Investor's Guide to Harvesting Market Rewards. The trouble, alas, lies with the investors.
No wonder that passive benchmarks remain competitive over time, as you can see in the regular updates posted on this site each month. (Here's the July 31 tally, for instance. On that note, I'll be posting the end-of-August results later this week.)
So, yes, bubbles can be grounds for minting alpha, but they can also be short cuts for trailing the market. As always, the devil's in the details and any shortcomings are due to us. Granted, that's an old story, but it's also forever new.
August 29, 2011
Personal Spending Rises Sharply In July
Today's update on spending and income for July offers more support for thinking that the latest downshift in economic activity won't deteriorate into a recession. Personal consumption expenditures (PCE) surged higher in July, rising by 0.8%--the biggest monthly gain in nearly two years and a sharp reversal from June's slight retreat. If consumption is vulnerable, there's no sign of it in the latest numbers. Even after adjusting for inflation, PCE was up a strong 0.5%. Disposable personal income (DPI) didn't fare as well, but still managed a respectable performance by rising 0.3% last month vs. 0.2% in June. Never say never in macroeconomics, but contractions don't begin with these numbers.
All the challenges that bedevil the U.S. economy remain, of course, but the data du jour look surprisingly resilient, given the current climate. In fact, one might wonder if the numbers on the spending side look at little too good. Consider how PCE and DPI compare on a rolling 12-month basis, as the chart below shows. Note that spending (red line) has been accelerating in recent months (with June the exception) for year-over-year comparisons. Meanwhile, DPI has remained in a flat/declining trend. The divergence can't last forever, although the implications aren't necessarily dire either. At the very least, the gap suggests that consumption's pace will slow.
Meantime, the key driver of personal income—private-sector wages—perked up last month, rising a strong 0.4% in July, more than double June's weak advance. Private wage growth also looks robust on an annual basis too, suggesting that the strength in consumption isn't merely a case of Joe Sixpack going off on another irrational buying binge. ( As of last month, wages were higher by 4.9% vs. a year ago. As the chart below shows, that's a strong pace by historical standards. It may not be strong enough to justify last month's rise in spending, but that's another issue.
Yes, there are still lots of dangers ahead, but consumer spending and income are foundational components for looking ahead. Until (or if) these metrics show more signs of cracking, the odds still look fairly low that a new recession is near.
But even the strength in today's income and spending numbers are suspect, says one analyst. “Income and spending grew at a healthy pace in July, but it was before the confidence shock hit in early August, so it doesn’t tell us much about what spending will look like,” says Michelle Meyer, a senior economist at Bank of America Corp.
So it goes these days. Even good news isn't good news until the next update. But any given outlook is subject to interpretation. "July's U.S. personal income and spending figures significantly alter the outlook for third-quarter GDP growth," advises Paul Dales, Senior U.S. economist at Capital Economics. "Annualized growth may now come in around 2.5%, if not a little bit higher, compared with our previous expectation of around 1.5%."
Research Review | 8.29.2011 | Asset Allocation
Seasonal Asset Allocation: Evidence from Mutual Fund Flows
Mark J. Kamstra, et al. | Working Paper | August 1, 2011
This paper explores U.S. mutual fund flows, finding strong evidence of seasonal reallocation across funds based on fund exposure to risk. We show that substantial money moves from U.S. equity to U.S. money market and government bond mutual funds in the fall, then back to equity funds in the spring, controlling for the influence of past performance, advertising, liquidity needs, capital gains overhang, and year-end influences on fund flows. We find a strong correlation between mutual fund net flows (and within-fund-family exchanges) and the onset of and recovery from seasonal depression, consistent with the hypothesis that investor risk aversion varies with the seasons. Further, we find stronger seasonality in Canadian fund flows (a more northerly location relative to the U.S., where seasonal depression is more severe), and a reverse seasonality in fund flows for Australia (where the seasons are reversed). While prior evidence regarding the influence of seasonal depression on financial markets relies on seasonal patterns in asset returns, we provide the first direct trade-related evidence.
Re-Thinking Target Date Funds
Andrea Malagoli | Buck Consultants | August 2011
There is growing consensus that Target Date Funds (TDFs) represent a "better" solution for retirement investing than traditional strategic portfolios like a 60/40 equities/bonds. While much marketing material hints at the fact that TDFs may provide a "safer" or "less risky" solution for retirement investing, these claims appear to have been contradicted by recent empirical evidence during the 2008 market downturn. In this article we examine the conceptual design behind Target Date Funds (TDFs) in the context of a rigorous modern finance theory framework. In particular, we analyze the risk/return properties of the "glide path", a defining feature of TDFs, and compare them against the various claims singling TDFs out as “the” ideal solution for defined contribution retirement plans. Not surprisingly, it can be formally demonstrated that the deterministic (time based) design of "glide paths" does not necessarily improve the risk/return characteristics of retirement portfolios, and that TDFs are a riskier form of investment than commonly believed. We make the case for a complete and consistent framework to vet the risk-and-return proposition of TDFs. In particular, financial operators and regulators should re-examine the existing TDF solutions and encourage more accurate disclosure of the expected risks and returns of each product in a manner consistent with (a) rigorous analysis based on commonly accepted financial theory and (b) realistic empirical market evidence.
Rebalancing with Spending and Illiquid Allocations
Martin Leibowitz and Anthony Bova | Morgan Stanley | July 13, 2011
Our previous reports that focused on rebalancing liquidity were limited to a discussion of 60/40 portfolios. This report adds both illiquid investments and net flows to the rebalancing equation to provide a more comprehensive analysis of the relationships between rebalancing liquidity, portfolio flows and diversification into illiquid assets. Spending programs and allocations to illiquid assets (non-equity, non-fixed income) naturally reduce a fund’s overall liquidity, but they may also — somewhat surprisingly — lower the cash required for rebalancing. However, over multi-year horizons, spending costs can dominate the rebalancing effect and drive a portfolio’s fixed income reserves down to a level that many investors would find hard to tolerate.
Can Large Pension Funds Beat the Market? Asset Allocation, Market Timing, Security Selection and the Limits of Liquidity
Aleksandar Andonov, et al. | Working Paper | July 14, 2011
We assess the three components of active management (asset allocation, market timing and security selection) in the performance of pension funds. Security selection explains most of return differences. On average, the large pension funds in our sample provide value to their clients using active management, after accounting for all costs, both before and after risk-adjusting, and using all three components of active management: with an annual alpha of 16 basis points from asset allocation changes, 27 basis points from market timing, and 45 basis points from security selection. All three components exhibit significant liquidity limitations, which seem quite important even for asset classes such as equity and fixed income. Security selection outperformance is further driven by momentum trading, which we do not consider as a priced factor and which accounts for about 72 basis points annual alpha. Larger funds realize economies of scale in only in their relatively minor investments in alternative asset classes like private equity and real estate, while thus experiencing liquidity-related diseconomies of scale in equity and fixed income.
Risk Parity Portfolio vs. Other Asset Allocation Heuristic Portfolios
Denis Chaves, et al. | The Journal of Investing | Spring 2011
In this article, the authors conduct a horse race between representative risk parity portfolios and other asset allocation strategies, including equal weighting, minimum variance, mean–variance optimization, and the classic 60/40 equity/ bond portfolio. They find that the traditional risk parity portfolio construction does not consistently outperform (in terms of risk-adjusted return) equal weighting or a model pension fund portfolio anchored to the 60/40 equity/bond portfolio structure. However, it does significantly outperform such optimized allocation strategies as minimum variance and mean–variance efficient portfolios. Over the last 30 years, the Sharpe ratios of the risk parity and the equal-weighting portfolios have been much more stable across decade-long subperiods than either the 60/40 portfolio or the optimized portfolios. Although risk parity performs on par with equal weighting, it does provide better diversification in terms of risk allocation and thus warrants further consideration as an asset allocation strategy. The authors show, however, that the performance of the risk parity strategy can be highly dependent on the investment universe. Thus, to execute risk parity successfully, the careful selection of asset classes is critical, which, for the time being, remains an art rather than a formulaic exercise based on theory.
August 27, 2011
Book Bits For Saturday: 8.27.2011
● The Euro: The Battle for the New Global Currency
By David Marsh
Review via Global Financial Strategy
With the euro saga playing out almost like a Shakespearean tragedy in Brussels, Berlin and Paris, it is good to get a clearer perspective on the origins, miscalculations and inherent problems at the heart of the eurozone's birth. Fortunately enough, the Mutterer is now reading the second edition of a highly insightful account by David Marsh, co-chairman of Official Monetary and Financial Institutions Forum, ex-European editor for the FT, and GFS contributor. Financier George Soros has described the contents as "the stuff of a political thriller" no less. "When David Marsh first wrote his book, I thought that some of his theses were exaggerated. In fact, he foresaw many of the problems that have since befallen the euro," says Soros.
● Breaking the Fear Barrier: How Fear Destroys Companies from the Inside Out, and What to Do About It
By Tom Rieger
Interview with author via The Business Insider
The biggest threat to an organization's success isn't necessarily the competition -- often, it's the fear that lives within its own walls. That fear leads to all sorts of problems and causes people to believe that they need to create walls and barriers to protect themselves, even though those walls and barriers make it harder for others in the organization to succeed. And it's that dynamic -- how fear creates barriers and bureaucracy and how you can get to the root of fear and overcome it -- that the book is meant to address.
● Beauty Pays: Why Attractive People Are More Successful
By Daniel S. Hamermesh
Review via University of Texas at Austin
Good-looking people are generally happier than their plain looking or unattractive counterparts, largely because of the higher salaries, other economic benefits and more successful spouses that come with beauty, according to new research from economists at The University of Texas at Austin.
● The Darwin Economy: Liberty, Competition, and the Common Good
By Robert H. Frank
Summary via publisher, Princeton University Press
Who was the greater economist--Adam Smith or Charles Darwin? The question seems absurd. Darwin, after all, was a naturalist, not an economist. But Robert Frank, New York Times economics columnist and best-selling author of The Economic Naturalist, predicts that within the next century Darwin will unseat Smith as the intellectual founder of economics. The reason, Frank argues, is that Darwin's understanding of competition describes economic reality far more accurately than Smith's. And the consequences of this fact are profound. Indeed, the failure to recognize that we live in Darwin's world rather than Smith's is putting us all at risk by preventing us from seeing that competition alone will not solve our problems.
● Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation
Summary via publisher, University of Pennsylvania Press
One of the lasting legacies of Reaganomics is a deep-seated distrust of government intervention in the markets. Despite this still-popular sentiment, the Basel Accords, a set of international standards for banking supervision and regulation, have been the subject of remarkably little public criticism. While academics and practitioners decry the enforcement of the Sarbanes-Oxley Act on accounting reform or attempts by Congress to regulate executive compensation, the Basel Accords have been quietly accepted. In one of the first studies critically to examine the Basel Accords, Engineering the Financial Crisis reveals the crucial role that bank capital requirements and other government regulations played in the recent financial crisis. Jeffrey Friedman and Wladimir Kraus argue that by encouraging banks to invest in highly rated mortgage-backed bonds, the Basel Accords created an overconcentration of risk in the banking industry. In addition, accounting regulations required banks to reduce lending if the temporary market value of these bonds declined, as they did in 2007 and 2008 during the panic over subprime mortgage defaults.
August 26, 2011
Bernanke Speaks Without Saying Much
Fed Chairman Bernanke says he understands the nation’s economic pain. Speaking earlier at the Fed’s Jackson Hole conference, he also explains that “monetary policy must be responsive to changes in the economy and, in particular, to the outlook for growth and inflation.” But he downplays the prospects for additional stimulus. “Normally, monetary or fiscal policies aimed primarily at promoting a faster pace of economic recovery in the near term would not be expected to significantly affect the longer-term performance of the economy. However, current circumstances may be an exception to that standard view…” This despite his observation that “the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus.” Quite true, but apparently those tools will be kept in the shed for the foreseeable future.
Bernanke’s comments arrived shortly after the government announced that GDP growth in the second quarter was slower than initially estimated. The economy expanded at a real annualized 1.0% rate vs. the earlier 1.3% estimate.
The net result: slower growth and a central bank that’s inclined to let the status quo in monetary affairs roll on. That suits some just fine. But some analysts beg to differ. “Economic performance is clearly subpar, and from that standpoint the case for some sort of further economic-policy assistance is just being made by the poor performance,” says Keith Hembre, chief economist at Nuveen Asset Management.
Economist Mark Thomas notes that "financial markets are likely to be disappointed by the lack of specific news from the Fed, and they may now be looking for additional action at the Fed meeting in September." He goes on to warn:
But I don’t think financial market participants, or anyone else for that matter, should get their hopes up. If the incoming data change substantially, in particular if signs of deflation emerge, the Fed might be prompted to action. But short of that, they will continue in the wait and see mode — a mode that so far has left them behind the emerging economic conditions.
For good or ill, Nicholas Blanchard at Modeled Behavior thinks that the real plans of the Fed (or the lack thereof) will be revealed next month:
We will have to wait until the next Fed meeting to see Bernanke’s “real” intentions on monetary policy. Will he steer the committee into a more aggressive stance? The stock market is very slightly up on the speech, so maybe Wall Street knows something that I don’t…but I just can’t see how an aggressive policy move is in the cards.
Meantime, no one's going to confuse the windup to this summer with last year.
Inflation (And Bernanke) Expectations
The market's inflation outlook is holding steady again, but for how long? The implied inflation forecast, based on the yield spread between the nominal and inflation-indexed 10-year Treasuries, was 2.1% yesterday. That's roughly where it's been for the past week. It's also down from 2.6% in early April. But we're still a long way from the 1.5% at this time last year. What might be the next catalyst that moves the current inflation forecast -- up or down? Fed Chairman Ben Bernanke's speech later today is first on the list.
Meantime, the market's inflation expectations are in a holding pattern, albeit at a relatively low altitude. A drop from current levels would surely be a dark sign, given the weak economy and the high levels of debt. The fall in the inflation outlook in recent months was a warning sign that macro conditions were deteriorating. This indicator also offered an early signal ahead of last year's rough patch. Nonetheless, there's fierce political opposition from Republicans for a new round of monetary stimulus. Will the GOP convince Bernanke not to respond to what appears to be rising money demand in the summer of 2011?
If the Treasury's inflation forecast fades in the weeks ahead, the macro risks may be set to rise further. But not yet. How should the central bank react now? Economist James Hamilton earlier this week counseled:
…the more important and achievable goal for the Fed should be to keep the long-run inflation rate from falling below 2%. The reason I say this is an important goal is that I believe the lesson from the U.S. in the 1930s and Japan in the 1990s is that exceptionally low or negative inflation rates can make economic problems like the ones we're currently experiencing significantly worse. By announcing QE3, the Fed would be sending a clear signal that it's not going to tolerate deflation, and I expect that would be the primary mechanism by which it could have an effect. Perhaps we'd see the effort framed as part of a broader strategy of price level targeting.
August 25, 2011
Bernanke v. Bernanke
How should we judge tomorrow’s speech by Fed Chairman Bernanke? How about Bernanke's previous comments on a similar macroeconomic challenge? Paul Krugman says Bernanke's chat on Japan's malaise are a useful primer for evaluating what we'll hear to tomorrow. Krugman refers to "Bernanke’s 2000 critique of the Bank of Japan for its failure to take strong action in the face of an economy that was actually in much better shape than the US economy right now."
Here's an excerpt from what Bernanke said back in the day…
In the short-to-medium run, however, macroeconomic policy has played, and will continue to play, a major role in Japan’s macroeconomic (mis)fortunes. My focus in this essay will be on monetary policy in particular. Although it is not essential to the arguments I want to make—which concern what monetary policy should do now, not what it has done in the past—I tend to agree with the conventional wisdom that attributes much of Japan’s current dilemma to exceptionally poor monetary policy-making over the past fifteen years… Among the more important monetary-policy mistakes were 1) the failure to tighten policy during 1987-89, despite evidence of growing inflationary pressures, a failure that contributed to the development of the “bubble economy”; 2) the apparent attempt to “prick” the stock market bubble in 1989-91, which helped to induce an asset-price crash; and 3) the failure to ease adequately during the 1991-94 period, as asset prices, the banking system, and the economy declined precipitously. Bernanke and Gertler (1999) argue that if the Japanese monetary policy after 1985 had focused on stabilizing aggregate demand and inflation, rather than being distracted by the exchange rate or asset prices, the results would have been much better.
Bank of Japan officials would not necessarily deny that monetary policy has some culpability for the current situation. But they would also argue that now, at least, the Bank of Japan is doing all it can to promote economic recovery. For example, in his vigorous defense of current Bank of Japan (BOJ) policies, Okina (1999, p. 1) applauds the “BOJ’s historically unprecedented accommodative monetary policy”. He refers, of course, to the fact that the BOJ has for some time now pursued a policy of setting the call rate, its instrument rate, virtually at zero, its practical floor. Having pushed monetary ease to its seeming limit, what more could the BOJ do? Isn’t Japan stuck in what Keynes called a “liquidity trap”?
I will argue here that, to the contrary, there is much that the Bank of Japan, in cooperation with other government agencies, could do to help promote economic recovery in Japan. Most of my arguments will not be new to the policy board and staff of the BOJ, which of course has discussed these questions extensively. However, their responses, when not confused or inconsistent, have generally relied on various technical or legal objections—-objections which, I will argue, could be overcome if the will to do so existed. My objective here is not to score academic debating points. Rather it is to try in a straightforward way to make the case that, far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism.
Jobless Claims: Stalled Again
Initial jobless claims are going nowhere once more. And that's the optimistic view. It’s not the first time that the trend looked like it was turning favorable only to hit a wall. It’s probably not the last time we’ll suffer a headfake, but that doesn’t make it any more frustrating. The good news, in relative terms, is that new jobless claims aren’t moving in a fatal direction, not yet. The main fallout is that the hope of a follow-through to the recent drop hasn’t materialized. In other words, we’re still stuck in the land of neutral. That’s not good, but it’s not a smoking gun for expecting a new recession either--not today, at least, given the numbers in hand.
New filings for unemployment benefits rose again last week by 5,000 to a seasonally adjusted 417,000. That’s puts new claims at the highest level since early July. But a big chunk of the recent rise may be due to a “special factor,” according to the Labor Department:
Even if you accept the explanation at face value, new claims don’t seem to be falling much, if at all. As the chart below reminds, this series remains stuck in an elevated range. The implication: the labor market’s recovery will remain sluggish and prone to setbacks. So, what else is new?
But let’s strip out the noise and look at raw claims data on a year-over-year basis. Here too the trend has suffered a modest reversal of fortunes. Nonetheless, claims remain lower by 11% vs. the year-ago number. That’s encouraging, since it’s still more than a trivial decline. Unfortunately, the margin of comfort seems to be fading. A few more weeks of this and this trend would start to look more ominous.
For now, we’re in a holding pattern. But the good news here is also the bad news. The trend in claims may not be getting any worse, but it’s not improving. Stephen Stanley, chief economist at Pierpont Securities, emphasizes the key challenge by reminding that “the problem over the last 18 months to two years hasn’t been the layoff side. The real problem has been we’re not getting the normal pace of hiring [that comes with a recovery]. For all the talk of impending doom in the economy, there is still not a lot of evidence of that.”
No one’s likely to dispute the point after reading today’s update.
Are We Facing Another Troubling Rise In Money Demand?
Economist John Taylor of Stanford is worried that the appetite for liquidity is rising... again. The source for this concern starts by recognizing that "quantitative Easing (both I and II) has caused the monetary base—the sum of currency and bank reserves—to explode in the past three years, but has not resulted in similarly large increases in the growth of broader measures of the money supply such as M2," he writes. Why hasn't M2 followed suit? Because banks are sitting on the liquidity injected into the system.
The net effect is clear in a graph supplied by Taylor. The sharp rise in the monetary base (right scale) contrasts with the decline in the M2 multiplier (left scale). "But if you look closely at the lower right of the graph, you can see that this pattern may have shifted recently as the M2 multiplier increased," he adds. This could be a sign that inflationary risks are rising. Alternatively, the uptick in the M2 multiplier may reflect a rising demand for money, in which case the risk of inflation is low. "It’s probably too early to tell for sure," Taylor opines, "but the Fed’s weekly Money Stock Measures, released each Thursday afternoon, will be important to monitor in the weeks ahead."
The early clues, Taylor continues, suggest that there's an increase in money demand bubbling. If so, it's a discouraging shift because it signals more trouble for the economy. As David Beckworth (assistant professor of economics at Texas State University) recently observed: "The anemic economic recovery can be tied to the ongoing elevated demand for safe and liquid assets." Beckworth continues:Paul Krugman and Brad DeLong refer to this phenomenon as a liquidity trap; I like to call it an excess money demand problem. Either way the key problem is that there are households, firms, and financial institutions who are sitting on an unusually large share of money and money-like assets and continue to add to them. This elevated demand for such assets keeps aggregate demand low and, in turn, keeps the entire term structure of neutral interest rates depressed too. (Note, that since term structure of neutral interest rates is currently low, it makes no sense to talk about raising interest rates soon. That would push interest rates above their neutral level and further choke off the recovery.)
In a post from earlier this week, Beckworth recommends "paying more attention to the build up of money assets in household balance sheets. Until this development changes, there will be an ongoing drag on nominal spending. One way to address this problem is to introduce a nominal GDP level target."
Excess demand for money, Beckworth and other like-minded economists argue, is at the root of the current economic malaise. The solution can be found in the appropriate monetary policy. If demand for money rises, a central bank should satisfy that demand to stave off deflation and low/negative economic growth. It's debatable if the Fed has effectively satisfied this demand. But if demand is rising once more, as Taylor suggests, the economic headwinds may be set to rise.
Bruce Bartlett, a former advisor in the Reagan and George H.W. Bush administrations, focused on the problem earlier this month by noting that the velocity of money has fallen and seems to be headed for another drop:One way that the rise and fall of spending can be visualized is by looking at the velocity of money. This is the speed at which money turns over in the economy. When velocity rises, more G.D.P. is produced per dollar of the money supply. When velocity falls, the economic impact is exactly the same as if the money supply shrank by the same percentage.The chart below comes from the Federal Reserve Bank of St. Louis and shows velocity as the ratio of the money supply (M2) to nominal G.D.P. It rose from 1.85 in 2003 to 1.96 in 2006. It has since fallen to a current level of 1.66. Thus one can say that each $1 increase in the money supply produced almost $2 of G.D.P. in 2006 and only $1.66 today.
Bartlett writes that the Fed "could have offset the decline in spending and velocity resulting from the fall in home prices with a sufficient increase in the money supply. And it tried. Since 2006, money supply has increased by about $2 trillion. But velocity fell faster than the money supply increased as households reduced spending and increased saving — the saving rate is now over 5 percent — and banks and businesses hoarded cash."
Will the Fed try again? Some pundits think Ben Bernanke will announce a new round of quantitative easing (QE3) in his speech tomorrow at the Jackson Hole conference. Maybe, but there are plenty of reasons to remain skeptical. Bernanke was attacked for rolling out QE2 last year and some analysts predict that he'll simply let the status quo prevail. In any case, the stakes are high once more.
"The market is treating Bernanke’s speech tomorrow almost like a policy meeting," Steve Barrow, the London-based head of Group-of-10 currency research at Standard Bank Plc, advises via Bloomberg. “If he signals QE3, it could support higher-yielding assets like stocks, the Scandinavian currencies and the Aussie and kiwi dollars at the expense of the U.S. dollar. If the market is disappointed, then it could see a return to risk-off.”
August 24, 2011
New Orders For Durable Goods Rise, But Business Spending Slumps
New orders for durable goods, a widely monitored leading economic indicator, rose 4.0% in July on a seasonally adjusted basis, the U.S. Census Bureau reports. That’s the highest monthly gain since March, although the increase is somewhat tainted because a big chunk of the advance came from a surge in aircraft orders. Excluding transportation, durable goods orders rose by a milder 0.7%. Even so, the gain suggests that while the economy continues to struggle, the risk of an imminent recession remains a low-probability event.
Low, but not zero. It’s debatable just how low is low. In any case, one indicator is hardly the last word on the state of the business cycle. But if you’re trying to make a case for a darker outlook, today’s durable goods report offers a mixed bag. The main threat in the numbers resides with the business-spending component of durable goods (non-defense capital goods ex-aircraft), which slumped in July by a hefty 1.5%--the first drop since April and the biggest monthly setback since January's 4% dive. The implication: sentiment in the business community is deteriorating again.
“It’s going to take time before businesses become comfortable about investing and hiring,” Ryan Sweet, senior economist at Moody’s Analytics, tells Bloomberg. “The improvement in July [for durable goods] appears to be narrowly based.”
There may not be a lot to celebrate in today’s durable goods report, but is it a sign that the economy is set to dive? Not necessarily, as Rudy Narvas, senior economist at Societe Generale, explains via Reuters:It was much better than expected across the board and with the upward revisions you can see upward revisions to Q2 GDP when that report comes out later on this week. When you look at the hard data that has been coming out the past couple of weeks it has been much better than the sentiment surveys that we have been seeing, so there has been a contrast in data between these manufacturing sentiment surveys and the consumer confidence and the hard data. The hard data seems to be holding up pretty well. Whether or not one catches up to the other in subsequent months has yet to be seen.
The case for thinking optimistically, if only marginally so, can also find support by looking beyond the short-term noise with several economic indicators, including today’s updated durable goods numbers. As the chart below shows, the year-over-year changes for new manufacturing orders (red line) and even business spending (black line) are still well above the levels typically associated with recessions.
In short, there's still a good case for thinking that the economy will steer clear of a new recession, if only slightly. That’s not saying much, given that the distinction between growth and recession may be increasingly thin. But for the moment, that’s all we’ve got. There’s not much of a case for arguing that economic growth is set to roar, but forecasting a new downturn isn’t compelling either. We’re still stuck in the land of modest growth. Yes, that means the broad trend remains vulnerable. But it's been vulnerable all along and we're still standing, or at least wobbling forward.
Is Business Spending At The Tipping Point?
"Business spending has been the recovery's bright spot," notes Kelly Evans in today's Wall Street Journal. "Now, it too may be fading." We'll know for sure, one way or the other, later today, when the update on durable goods orders is released. Meantime, it's premature to say this indicator has succumbed to the dark side. But the risk can't be dismissed, given the recent weakness in the overall economy.
"The most important component in the durable goods report is the data on nondefense capital goods orders excluding aircraft, a key gauge of capital spending that correlates with the equipment and software component of the quarterly GDP report," writes Pimco's Anthony Crescenzi in his book The Strategic Bond Investor. "Fluctuations in capital spending tend to coincide with changes in business confidence levels."
The good news is that recent numbers for business spending leave room for optimism. As the chart below shows, the latest report for June pegs business spending at its highest level (on a seasonally adjusted basis) since the recession ended.
But as Evans reminds, the trend is weakening. In the second chart, consider the rolling 12-month change in business spending. Clearly, gravity is taking a toll. The annual pace is still healthy, but the margin of comfort is fading fast.
Unfortunately, economists are expecting more of the same for July. According to Briefing.com's consensus forecast, non-defense capital goods ex-aircraft fell 0.6% last month.
August 23, 2011
Treasuries: Priced For Disaster
Anxiety levels are rising and Treasury yields are falling. The pairing isn't unrelated, but the depth of the fall in government yields is astounding nonetheless.
The benchmark 10-year Treasury Note’s yield is hovering just over the 2% mark, near all-time lows. As recently as early July, it was over 3%. There’s no mystery here. The crowd is anxious about the macro outlook and so the rush to safe harbors is on.
The extraordinary bull market in bonds, Treasuries in particular, has tripped up more than a few analysts over the past year. Indeed, there’s been no shortage of warnings that bonds were in a bubble and set to crash any day now. That forecast will eventually prove accurate, perhaps sooner than we think. But betting against Treasuries has been a losing proposition thus far.
Along the way, relationships between the major asset classes have moved to extremes. Consider how rolling three-year annualized returns compare for stocks (S&P 500), bonds (Barclays Aggregate), REITS (MSCI REIT) and commodities (DJ-UBS Commodity). The relatively steady, positive performance in fixed income looks like nirvana in recent history (see the blue line in the chart below).
The power of bonds appears especially potent when ranked on Sharpe ratio vs. stocks, REITs and commodities. As the second chart below reminds, the risk-adjusted performance for bonds has defied expectations (and gravity).
The diversification value of holding bonds has soared as well, as the third chart suggests. Correlations for REITs and commodities relative to U.S. equities has trended higher in recent years. By contrast, correlations are low and falling for bonds relative to stocks.
In short, bonds are hot, mostly because of Treasuries. It’s unclear how much longer fixed income can shine in relative and absolute terms. But trends continue…until they don’t. The time to think about the dark side is when the light burns brightest. The gravy train in Treasuries may yet roll on, but it can’t last forever. Another global economic calamity might extend the rally, but it takes an especially dark view of the future to rationalize overweighting Treasuries. But what happens if we survive?
Strategic Briefing | 8.23.2011 | Soaring Gold Prices
Gold Tops $1,910 for First Time
Bloomberg | Aug 23
“Gold has continued to blast ahead even with a relatively strengthening U.S. dollar, strongly performing treasuries and other safe havens,” Peter Richardson, chief metals economist at Morgan Stanley Australia Ltd., said by phone from Melbourne. “All of that tells me that this is really all about preserving real purchasing-power.”
Gold futures drop after strong run higher
MarketWatch | Aug 23
Citigroup strategists raised their price forecasts for gold, a move they said was made “to accommodate the impact that global financial tension is having on the metal. Fears about sovereign defaults and currency debasement have left many investors concerned about switching from equities into government bonds, and cash hardly looks an attractive alternative when real rates are negative. Gold has therefore been the main beneficiary of all these concerns,” they said.
Gold hits record high of $1,900 on global growth fears
BBC | Aug 23
Analysts said demand for gold was also being driven by speculation that the US Federal Reserve may announce new stimulus measures in a bid to boost the economy. Central bank governors from across the globe are scheduled to gather for their annual meeting at the Jackson Hole summit later this week. There is growing speculation that Ben Bernanke, the governor of the US central bank, may announce fresh stimulus measures in his speech at the summit. This may include a third round of "quantitative easing" (QE), by which the Fed buys up US government debts, and thereby introduces more dollar cash into the financial system. "The idea for QE2 was conceived during the Jackson Hole summit last year," Ong Yi-Ling of Phillip Futures told the BBC.
Bank of America Tanks; Gold Goes Parabolic, No Telling Where It Stops
Mish's Global Economic Trend Analysis | Aug 22
If this is the start of gold-bugs long awaited extreme move, there is no telling where it stops. Is it? I don't know (and they don't either)... What should be plain to see is that financial stocks, especially banks have been clobbered this year. Banks are under-capitalized, over-leveraged and realistically bankrupt. Mistrust of fiat currencies is high and rising. The entire global financial system is balanced on a mountain of debt, and that debt cannot be paid back. That is the message of gold, not the popularly believed fallacy regarding massive inflation.
Gold Even Reigns On Stock Market
The Wall Street Journal | Aug 23
"Whenever an asset gets securitized, that tends to raise its price level in the short term and lower its expected returns in the long term," says William Bernstein of Efficient Frontier Advisors, an investment manager in Eastford, Conn. The influx of new investors, he explains, gives a quick boost to returns, but the sudden surge of popularity then raises prices so high that future gains are harder to sustain. "The historical return on gold, going back centuries, has been around zero [after inflation]," says Mr. Bernstein. "Going forward, it may be less than zero."
August 21, 2011
Tactical ETF Review: 8.22.2011
Risk is out, safety is in. That's the message in market action this month, as you'll see in the following review of ETF proxies for the major asset classes. Bond prices are generally up (and yields are down) while selling dominates trading in stocks, REITs and commodities. The week ahead may bring more churning as the crowd digests the scheduled economic updates: new home sales (Tuesday), durable goods orders (Wednesday), jobless claims (Thursday), and revisions to Q2 GDP and the Reuters/University of Michigan's consumer sentiment index (Friday). Fed chairman Ben Bernanke also speaks on Friday at the annual Jackson Hole conference. With the recent wave of selling still thick in the air, combined with questions about the economy's strength, the stakes are high. Will the Fed head outline a new round of monetary stimulus? "If the Fed really is going to go down the route of another round of unconventional policy making, I think they've got to go in for, what I called, shock and awe," Russell Jones, Global Head of Fixed Income Strategy at Westpac Institutional Bank, tells CNBC. Meantime, here's how the shock and awe in the major asset classes stacks up.
US STOCKS • Vanguard Total Market (VTI) • Benchmark: MSCI US Broad Market Index
A late-summer slump with ominous tones...
FOREIGN DEVELOPED MARKET STOCKS • Vanguard Europe Pacific (VEA) • Benchmark: MSCI EAFE
The trend looks rather dark in foreign equity markets as well...
EMERGING MARKET STOCKS • Vanguard Emerging Markets (VWO) • Benchmark: MSCI Emerging Market
Ditto for emerging-market stocks...
US BONDS • Vanguard Total Bond Market (BND) • Benchmark: Barclays US Aggregate
Bonds, by contrast, are a different story...
INFLATION-INDEXED US TREASURIES • iShares Barclays TIPS Bond (TIP) • Benchmark: Barclays US TIPS
Inflation-indexed Treasuries aren't hurting either ...
HIGH YIELD BONDS • SPDR Barclays High Yield Bond (JNK) • Benchmark: Barclays High Yield Very Liquid
Junk bonds, however, are suffering along with stocks...
COMMODITIES • iPath Dow Jones-UBS Commodity (DJP) • Benchmark: DJ-UBS Commodity
And broad measures of commodities continue to trend lower...
REAL ESTATE INVESTMENT TRUSTS • Vanguard REIT (VNQ) • Benchmark: MSCI US REIT
REITs aren't immune from the recent flight from risky assets ...
FOREIGN DEVELOPED MARKET GOVERNMENT BONDS • SPDR Barclays Int’l Treasury (BWX) •
Benchmark: Barclays Global Treasury ex-US Capped
But looking to foreign government bonds as a safe harbor, combined with a lower dollar, has been a winning idea recently...
EMERGING MARKET GOVERNMENT BONDS • Van Eck Market Vectors Emg Mkt Local Currency Bond (EMLC) •
Benchmark: J.P. Morgan GBI-EMG Core
The safe-harbor concept looks rather tepid at the moment as it applies to emerging-market debt...
FOREIGN GOVERNMENT INFLATION-LINKED BONDS • SPDR DB International Inflation-Protected Bond (WIP) •
Benchmark: DB Global Government ex-US Inflation-Linked Bond Capped
Foreign inflation-indexed government bonds, on the other hand, are hot once more...
FOREIGN CORPORATE BONDS • PowerShares International Corporate Bond (PICB) •
Benchmark: S&P International Corporate Bond
And foreign corporate bonds are starting to perk up again too...
Charts courtesy of StockCharts.com
August 20, 2011
Book Bits For Saturday: 8.20.2011
● Extreme Money: Masters of the Universe and the Cult of Risk
By Satyajit Das
Review via The Globe and Mail
Forget the hand-wringing over the United States losing its triple-A credit rating. The real threat to the global economy is Europe. That’s the no-nonsense view from Satyajit Das, a global risk expert based in Sydney, Australia, and author of Extreme Money: The Masters of the Universe and the Cult of Risk. Mr. Das is counted among the few who predicted the meltdown of toxic credit derivatives that fuelled the financial crisis of 2008. Now the former financial industry wunderkind is warning of new dangers that are threatening the very future the 17-country euro zone.
● Codes of Finance: Engineering Derivatives in a Global Bank
By Vincent Antonin Lépinay
Excerpt via publisher, Princeton University Press
This book tells the story of a financial innovation from the inside. But one might legitimately ask: Do we really want another insider’s account? Are we not already paying a high price for having left insiders to organize financial markets at their convenience for too long? If financial operators acknowledge that they erred, then the accounts that they give of their inability to control a situation that went out of control are short of illuminating. Threatened as scapegoats of a major financial crisis, those who have attempted to articulate the failure of the financial system usually spend more time shifting the blame over to another group of experts than shedding light on the system’s inherent complexity. When experts are in a bubble, it is safe to burst it open, but not just any tool will reveal its inner complexity. Indeed, who will gain an intellectual grasp of these financial innovations and their ripple effects without a firm grip on the technical mechanisms that triggered the current collapse?
● Time the Markets: Using Technical Analysis to Interpret Economic Data
By Charles D. Kirkpatrick II
Summary via publisher, FT Press
In Time the Market, award-winning technical analyst Charles D. Kirkpatrick uses technical methods to analyze key economic indicators and identify useful buy and sell signals for long-term investors. Uncover these powerful signals based on the technical analysis of corporate, industry, monetary, sentiment, and market data to avoid capital loss and become more profitable.
● Investing in Collectables: An Investor's Guide to Turning Your Passion Into a Portfolio
By Charles Beelaerts
Summary via publisher, Wiley/Wrightbooks
Whether you're looking to make money from your hobby or collection, or you're a serious investor seeking to profit from your passion or diversify your portfolio, Investing in Collectibles contain all you need to know. Inside you'll discover:
* tips for making a profit on your collection
* how to buy and sell through art dealers and private sale, and at auctions
* tax and other legislation governing collectibles as an investment
* how to invest through self managed superannuation funds or trusts
* how to detect fakes and forgeries.
This is the ultimate guide to collecting, investing in and making money from collectables.
● After America: Get Ready for Armageddon
By Mark Steyn
Review via National Post
The news is catching up to Mark Steyn, and the author is catching up to himself. His rollicking new book chronicles the advanced cultural, strategic and economic decline of the United States. It’s called After America: Get Ready for Armageddon, and it picks up the story that Steyn told in his last book, America Alone: The End of the World As We Know It. The earlier book was about how the West outside America was on greased skids to civilizational collapse; in this book he demonstrates that America has more than caught up. The earlier book made much of the demographic collapse in Europe (and Canada) and, on the same grounds, characterized America as the West’s last, best hope. That was rather too rosy a look at his adopted land, and the intervening five years have brought Steyn around to the view that there is plenty of rot in the land of the feckless and the home of the broke.
● Banking and Financial Institutions: A Guide for Directors, Investors, and Borrowers
By Benton E. Gup
Summary via publisher, Wiley
A practical guide to the evolving world of banking and financial institutions. Due to various factors, ranging from the global financial crisis that began in 2007 to new laws such as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, banks and financial institutions have had to alter the way they operate. Understanding how these institutions function in the face of recent challenges is essential for anyone associated with them. That's why Professor Benton Gup has created Banking and Financial Institutions. Opening with a detailed discussion of the causes of the recent financial crisis, as well as a look at some lessons we can learn from it and other crises, this reliable resource quickly moves on to put modern banking in perspective. Filled with in-depth insights and expert advice, Banking and Financial Institutions examines the essential aspects of this discipline and shows you what it takes to make the most informed decisions possible, whether you're a bank director, investor, or borrower.
● The Evolution of Great World Cities: Urban Wealth and Economic Growth
By Christopher Kennedy
Commentary on book via author's blog
One of the basic principles that I set down early in the book is that the wealth of a city should be measured by the net assets of its citizens, which primarily means by the value of residential real estate, business equity and other financial assets. This seems a straight forward measure, although it is complicated in the case of publicly owned housing, as municipal assets are not added in the calculation (as they are already captured through residential property values). Recognizing citizens’ assets to be the basic measure of wealth, it is apparent that establishing property rights and encouraging household savings both directly contribute to urban wealth. Property rights are necessary for real estate to be effectively valued. Despite all the challenges that surround ownership rights in illegal squatter settlements, for example, assigning and enforcing just property rights is fundamental to establishing wealth in cities. Saving is also critical too, and even though it seems tenuous to expect the world’s poorest families to save part of their meagre incomes, successes such as micro-finance schemes of urban poor community associations and savings groups suggest that it is possible
August 17, 2011
One More Summer Fling...
I'm taking the rest of the week off (my boss is a generous soul) and so the usual fun may suffer. But I'll be back in the saddle at the world headquarters of The Capital Spectator come Monday morning.
Still Wondering About Recession Risk
The debate about whether the U.S. economy is destined for a new recession remains unsettled, thanks to a mixed bag of numbers in the latest round of updates. The strongest case for thinking positively resides, ironically, in the labor market. Initial jobless claims, a key leading indicator, is moving in the right direction again, albeit from elevated levels. As I noted last week, the annual percentage decline in the raw data isn’t normally associated with broad economic contraction, and that's a good thing. But confidence hangs on a thread these days and so tomorrow’s update will be closely watched. One bad number and the crowd may run for cover once more.
Yet the stronger pace of jobs creation in July implies that we’ll see better reports on jobless claims, but here too the confidence is thin. The labor market continues to grow, but sluggishly, inspiring analysts to hedge their forecasting bets.
Yesterday’s news on industrial production for July keeps hope alive. The surprisingly strong 0.9% rise last month translates into a 3.7% increase over the year-earlier period—comfortably above levels typically associated with the early stages of a fresh contraction.
The latest updates on retail sales and commercial and industrial loans reflect growth as well. But there’s plenty of darkness descending on the numbers elsewhere. The University of Michigan Consumer Sentiment Index’s decline this month to its lowest level since 1980 is distressing. Meanwhile, the housing market remains depressed, as yesterday’s news on housing starts reminds. Housing isn’t necessarily a drag on the broad economy any longer, but it’s also not a positive force yet either.
The stock market’s annual pace remains in positive territory. The S&P 500 is higher by roughly 6% vs. this time a year ago. That’s encouraging in the sense that new recessions are usually linked with year-over-year declines in the equity market. To the extent that Mr. Market can maintain an annual gain, the trend looks encouraging... up to a point. Indeed, there's been a lot of chatter over the recent arrival of the so-called death cross. The S&P’s 50-day moving average has recently slumped under its 200-day average. Technical analysts label this is a bearish development of no small consequence. But history suggests that unless the 50-day average persists under its 200-day counterpart for some period of time, the signal may simply be short-term noise. It’s happened before. The question is whether it describes current conditions?
No wonder that economists are split about what it all means for estimating recession risk. You can certainly find analysts predicting the worst, but optimists (relatively speaking) aren’t unknown either. For example, Steve Leuthold of the Leuthold Group says there’s a one in three risk of a new recession, reports The Chicago Tribune. Goldman Sachs concurs, but adds that the distinction between growth and contraction may be so slight that there’s not much difference one way or the other.
The truth, of course, is that no one really knows if there’s another downturn coming. Based on the information we have at the moment, you can argue either side with some degree of persuasion. Uncertainty keeps us all guessing. Arguably some of the guesses are more informed than others, but figuring out which ones are which is no easier than predicting the economic trend.
"Slow growth doesn't lock in a recession,” advises Dennis Lockhart, president of the Atlanta Fed. “In fact, some recent data we have on hand - retail sales and initial unemployment claims, for example - seem to contradict the direst predictions.”
But you can just as easily argue the opposite with the same reasoning: the arrival of slow growth doesn’t ensure that we’ll avoid a new recession.
So it goes when the macro trend enters a gray area. The only solution is waiting. We know the odds of recession are higher today vs. six months ago, but deciding if that constitutes a tipping point is a piece of information that can only be confirmed after the fact. Some simply refer to it as a familiar four-letter word: RISK.
August 16, 2011
Is Obama The New Hoover?
In the early days after Obama's inauguration, there were many who saw the president as the new FDR. But is the Hoover reference an easier sell in the current climate? It is if you look through the prism of monetary affairs, according to one dismal scientist.
"Hoover wasn’t able to print gold, but can be blamed for supporting the Fed’s tight money policies," writes Scott Sumner. "Obama can’t print dollars, but can be blamed for not moving aggressively to put people at the Fed who understand the need for more dollars."
Alas, the clock is ticking. Bruce Bartlett reminds that the velocity of money supply (the ratio of quarterly nominal G.D.P. to the quarterly average of M2 money stock) is moving in the wrong direction again. The implications?This suggests that the Federal Reserve could have offset the decline in spending and velocity resulting from the fall in home prices with a sufficient increase in the money supply. And it tried. Since 2006, money supply has increased by about $2 trillion. But velocity fell faster than the money supply increased as households reduced spending and increased saving — the saving rate is now over 5 percent — and banks and businesses hoarded cash.
And then Christina Romer, the former chairwoman of President Obama’s Council of Economic Advisers, gives us this bit of history:As I showed in an academic paper years ago, [World War Two] first affected the economy through monetary developments. Starting in the mid-1930s, Hitler’s aggression caused capital flight from Europe. People wanted to invest somewhere safer — particularly in the United States. Under the gold standard of that time, the flight to safety caused large gold flows to America. The Treasury Department under President Franklin D. Roosevelt used that inflow to increase the money supply.The result was an aggressive monetary expansion that effectively ended deflation. Real borrowing costs decreased and interest-sensitive spending rose rapidly. The economy responded strongly. From 1933 to 1937, real gross domestic product grew at an annual rate of almost 10 percent, and unemployment fell from 25 percent to 14. To put that in perspective, G.D.P. growth has averaged just 2.5 percent in the current recovery, and unemployment has barely budged.There is clearly a lesson for modern policy makers. Monetary expansion was very effective in the mid-1930s, even though nominal interest rates were near zero, as they are today. The Federal Reserve’s policy statement last week provided tantalizing hints that it may be taking this lesson to heart and using its available tools more aggressively in coming months.
History doesn't repeat, but does it rhyme? If so, which history? Romer continues:One reason the Depression dragged on so long was that the rapid recovery of the mid-1930s was interrupted by a second severe recession in late 1937. Though many factors had a role in the “recession within a recession,” monetary and fiscal policy retrenchment were central. In monetary policy, the Fed doubled bank reserve requirements and the Treasury stopped monetizing the gold inflow. In fiscal policy, the federal budget swung sharply, from a stimulative deficit of 3.8 percent of G.D.P. in 1936 to a small surplus in 1937.
The Politics Of Economics
Texas Governor Rick Perry is running for president and is eager to take credit for his state's relatively strong economic performance. But just how much accountability should we assign to politicians for economic outcomes? The answer is sure to be warm and fuzzy, reflecting the strange intersection of politics and economics. Rightly or wrongly, politicians usually receive the blame for their cities, states and countries when the economy suffers. Shouldn't they also enjoy some of the glory in the good times?
Depending on your political preferences, your view is likely to wander. President George H.W. Bush's failed bid at re-election in 1992 was widely seen as a referendum on the weak economy at the time. Many Republicans thought that was unfair, in part because the economy entered a long period of growth soon after the election and much of the credit went to Bill Clinton, who defeated Bush (with some ticket-splitting assistance from Ross Perot's third-party run). Fast forward to today's economy, and there's no shortage of Republicans who are quick to blame President Obama and his administration for the ongoing ills.
Rick Perry, by contrast, isn't shy about highlighting the relative strength in Texas these days. As the governor's web site opines:Governor Perry's administration has focused on creating a Texas of unlimited opportunity and prosperity by improving education, securing the border and increasing economic development through classic conservative values.During his tenure, Governor Perry has maintained a strong focus on fiscal discipline, becoming the only Texas governor since World War II to sign budgets that reduced general revenue spending. He has used his line item veto to scrub more than $3 billion in budgeted spending, while encouraging investments in the building blocks of a prosperous state: the economy, education and security.The Texas economy is performing well in the current global economic crisis, thanks to a focused effort to keep taxes low, regulations predictable and legal system fair.
Recognizing that Texas is doing well, or at least better than the U.S. overall in some respects, is no secret. Richard Fisher, president of the Dallas Fed, recently told The Wall Street Journal that 37% of all new jobs in America since the recession ended in mid-2009. The Journal noted too that "Texas is also among the few states that are home to more jobs than when the recession began in December 2007."
But there's no shortage of analysts who question how much of this good news, if any, should be connected with Rick Perry. In fact, some observers go further, arguing that there's really no there there when it comes to the Texas boom. Economist Paul Krugman, for example, claims that the so-called Texas miracle is a "myth."
But other dismal scientists think that's overly harsh and that Perry can rightly claim some responsibility for his state's record. "I am going to have to give some credit back to the state leadership, who’s got us where we are,” says Ted Jones, an economist with Stewart Title Guaranty. “He’s been governor for a long period of time now. And obviously, we have set up a job creating machine and it’s working.”
Perhaps, but as Evan Smith, editor and CEO of the Texas Tribune, reminds:The population of Texas is growing astronomically, and that may be one of the reasons that you're seeing so many jobs created in Texas, particularly in the public sector. Since 2000, according to The Wall Street Journal, 19 percent growth in the public sector versus only 9 percent growth in the private sector, and a lot of that is fueled by population growth because of things like public schools where so many new kids are enrolling over the last 10 years. They've had to create a whole lot of jobs just to keep up with that growth.
In the end, it's probably fair to give Perry some credit for the Texas economy if only because he'd receive quite a bit of the criticism if the state was suffering. Yes, that's a political calculation, but it's unavoidable given the subject matter. But if Perry's great political strength is his economic record in Texas, one might wonder how his latest commentary on monetary policy fits in with this image. Taking aim at Fed Chairman Ben Bernanke yesterday, Perry asserts:If this guy prints more money between now and the election, I don’t know what y’all would do to him in Iowa, but we -- we would treat him pretty ugly down in Texas. Printing more money to play politics at this particular time in American history is almost treacherous -- or treasonous in my opinion. We’ve already tried this. All it’s going to be doing is devaluing the dollar in your pocket and we cannot afford that. We have to learn the lessons of the past three years that they’ve been devastating. The President of the United States has conducted an experiment on the American economy for almost the last three years, and it has gone tragically wrong and we need to send him a clear message in November of 2012 that new leadership is coming.
That's trash talk, according to Tony Fratto, the former deputy press secretary to George W Bush. Writing on Twitter, he complains that Perry's comments about Bernanke and the Fed are "inappropriate and unpresidential."
Meanwhile, it's not difficult to find right-of-center economists who are sure to disagree with Perry's Bernanke bashing as it relates to the policy implications. Scott Sumner and David Beckworth, for example, have written extensively that, if anything, the Fed hasn't done enough to prevent and/or heal the economy.
Clive Crook writes in yesterday's FT that worrying about inflation and long-term debt is still premature in an economy that's still struggling and perhaps on the verge of slipping into a new recession. As such, Crook argues:Rather than targeting inflation, central banks should keep nominal incomes growing on a pre-announced path: say 5 per cent a year. Nominal gross domestic product is the sum of inflation and growth in real output – and is the variable that monetary stimulus directly drives.Samuel Brittan made the case for this approach decades ago on this page. The crucial point – how an increase in nominal GDP breaks down between output and inflation – is not something the Fed can determine, or should have to explain. There are pros and cons to this approach, but that is the decisive political virtue of casting the target this way.When nominal GDP falls below track, monetary stimulus pushes it back. If inflation rises temporarily during catch-up, that is tolerated. In current conditions, this makes all the difference. The new GDP figures showed demand has fallen much further below trend than had been appreciated.
But politics has a habit of trumping economics. At the very least, as Crook reminds, the politics of monetary policy are complicated. And with the presidential debate heating up, clarity is probably going to suffer more in the weeks and months ahead.
August 15, 2011
An Old Debate, A Familiar Response
Is the rebalancing bonus a myth? A number of readers told me so after I briefly mentioned the concept last week. The charge that rebalancing isn't guaranteed to deliver a performance premium over the same portfolio that's left to wander is, of course, true. Much depends on when and how you rebalance, along with the composition of your portfolio. But this caveat isn't terribly surprising, nor is it particularly helpful in the cause of looking for productive strategies in money management. There are no sure things in finance, for the simple reason that the future's uncertain. Even "cash" comes with a sliver of risk.
Recognizing rebalancing's imperfections as an excuse for dismissing the idea is short-sighted in the extreme. To paraphrase Tolstoy, every investment strategy is flawed in its own way. Understanding why rebalancing is flawed is essential, but it's hardly a basis for snubbing the strategy. Indeed, if you're looking for the ideal methodology, you're destined for disappointment. The question, then, is deciding how to prioritize the infinite possibilities for managing the investment challenge?
A growing body of research and real-world track records suggest that the key building blocks of intelligent investment design begin with asset allocation and rebalancing. That's not necessarily the end of the journey, although for many investors it very well could be and, arguably, should be. But regardless of whether this is a stepping stone or a destination, there's a strong case for seeing these twin pillars as money management's foundation. You can amend, revise and adjust these strategies to fit your unique circumstances and talents. But rejecting them outright is almost always a mistake.
I'm defining asset allocation here in simple but broad terms. By purchasing a broad mix of the major asset classes, you're diversifying far and wide. This is a risk-management tool at its core. If we have confidence that stocks will beat bonds over some period going forward, or vice versa, or that REITs will best commodities, etc., then there's a case for leaning heavily on one asset class at the expense of the others. But absent a view, a forecast, a guess--the default asset allocation is simply holding a market-value weighted mix of everything. As it turns out, a simple buy-and-hold strategy that's diversified broadly tends to deliver competitive returns on a risk adjusted basis, as theory advises and market history generally confirms.
Rebalancing a broad mix of assets is no less compelling for a number of reasons, ranging from risk management improvement to the possibility of boosting raw performance numbers. There are no guarantees, of course, but that's no shock, nor should it be a reason to abandon the fundamental proposition that diversifying across asset classes and keeping the allocations from going off the deep end is a reasonable goal with modest benefits. Even better, you don't have to work very hard to reap the rewards.
Critics are quick to point out the limits of asset allocation and rebalancing, charging, for instance, that there are times when either one will deliver subpar results. That's true, of course, and it's important to recognize this possibility. But it could hardly be otherwise. If you stop for a minute and think about it, every strategy faces the hazard that it can and will stumble from time to time. If rebalancing was a sure thing, the world would pile in and the expected return from the strategy would quickly fall to zero, at best.
The reality is that asset allocation and rebalancing are used unevenly in the grand scheme of investing. Many investors ignore or reject these concepts outright. For those who do pay the strategies lip service, the execution is often messy. All of which lays the groundwork for a minority of investors to benefit handsomely from asset allocation and rebalancing. As a number of studies suggest, the failures of the many tend to finance the rewards of the few in matters of investing, and rebalancing is no different.
My post last week was a simple observation that the recent surge in volatility among the major asset classes was a sign that rebalancing opportunities were unusually ripe once again. But as sure as night follows day, the greater opportunities were accompanied with greater risk, some of which is self inflicted by way of inaction.
Ok, asset allocation and rebalancing are flawed, we're told. So, now what? The superior alternative is….? Yes, there are many possibilities. But all paths ultimately come back to the question: What do the numbers tell us?
A simple strategy of holding all the major asset classes in their market weights and rebalancing the mix every December 31 is demonstrably competitive, as I've discussed several times. What's more, this simple strategy, as defined by my Global Market Index (GMI), has proven to be above-average vs. 1000-plus multi-asset class mutual funds, as I noted earlier in the year. Part of the reason is that you replicate GMI for 50 basis points or less via ETFs and ETNs--well below what many actively managed strategies charge. If active managers always delivered big helpings of alpha, the higher costs would be worthwhile. But that's not the case, of course, and so low expenses usually provide a big edge. Another advantage in holding everything and rebalancing the mix every so often is that it minimizes the danger that surprises in the future will trip up the best laid plans of mice and men. Once again, that's proven to be a huge stumbling block for maintaining superior returns by trying to outwit the crowd.
For those who prefer a model-free approach to asset allocation, there's more good news in the sense that equal-weighting everything, and rebalancing to maintain that equality, seems to do even better than cap weighting. But even this boost isn't immune to improvement, or so fans of fundamental weighting assert.
Yes, you can improve upon a simple asset allocation/rebalancing strategy. But you can also do worse. The world is eager to emphasize the former, and to quick to overlook the latter.
August 13, 2011
Book Bits For Saturday: 8.13.2011
● Pinched: How the Great Recession Has Narrowed Our Futures and What We Can Do About It
By Don Peck
Interview with author via Marketplace/NPR
Author Don Peck examines how the Great Recession has affected individual Americans financially and psychologically, and discusses what impact those changes will have on American society overall...
"...the average duration of unemployment now is over nine months. And millions of people have been unemployed for a year or two years or more. And I think that what Gus's story shows is not just the financial loss that results from unemployment, but the psychological loss. Happiness researchers have shown that being out of work for six months or more is really the worst thing that can happen to you psychologically. It's the psychological equivalent of losing a spouse. So today in the U.S. we have millions of people who are in exactly that situation, and millions more with each year that goes by before we find recovery. And one of the big questions for the U.S., I think, is not just how do we recover, but even once we recover, what are we going to do to get these people -- people have become chronically unemployed, whose behaviors have changes, whose skill have eroded -- what are we going to do to get them back into the workplace?"
● One Illness Away: Why People Become Poor and How They Escape Poverty
By Anirudh Krishna
Interview with author via India Real TIme/The Wall Street Journal
Duke public policy professor Anirudh Krishna and a team of researchers spent the last decade talking to over 35,000 families in India, Kenya, Peru, Uganda and the U.S. to answer this question: Why are people poor?
IRT: One of the findings you stress is that many poor people are “first-generation” poor. How many?
Krishna: Our results show as many as one-third of all poor people were not born poor. They became poor within their lifetimes on account of factors that could have been prevented. It’s ironic that even as governments and donors and others are doing a lot to pull people out of poverty, very little is done to prevent people from falling into poverty so the pool of people in poverty keeps growing even as many people come out.
● Dynamic Economic Decision Making: Strategies for Financial Risk, Capital Markets, and Monetary Policy
By John Silvia
Excerpt via publisher, Wiley
Completion of the first transcontinental railroad across the United States, ably told by Steven Ambrose, is a story of a very imperfect success, with numerous changes in how, where, and by whom the railroad was built. While imperfect, the railroad’s completion is also a study in the flexibility of decision making where the paradigm of how, where, and by whom was always modified to fit the realities of building the road. Choices were constantly made and then modified on issues of where the track would go, how it would be financed, the construction, and, not to be overlooked, what political strings were to be pulled to get the railroad finished at a profit. Other than completing the railroad, there was not a set of proscribed rules; instead, a framework for decision making was set up, modified with new information, then choices were made and a new model put in place.
Successful decision making is a process, not an event, with constant modifications and interactions among the moving parts that evolve over time. In sports, many franchises win a championship once in a while. Yet repeat championships are driven by a model of decision making that generates winners. The focus remains on the correct process that can be replicated over time and across circumstances rather than on a one-off correct decision that is more a matter of luck than skill. Good decision making must be replicable.
● Capital and Affects: The Politics of the Language Economy
Summary via publisher, MIT Press
Communication as work: we have recently experienced a profound transformation in the processes of production. While the assembly line (invented by Henry Ford at the beginning of the last century) excluded any form of linguistic productivity, today, there is no production without communication. The new technologies are linguistic machines. This revolution has produced a new kind of worker who is not a specialist but is versatile and infinitely adaptable. If standardized mass production was dominant in the past, today we produce an array of different goods corresponding to specific consumer niches. This is the post-Fordist model described by Christian Marazzi in Capital and Affects (first published in 1994 as Il posto dei calzini [The place for the socks]). Tracing the development of this new model of labor from Toyota plants in Japan to the most recent innovations, Marazzi’s critique goes beyond political economy to encompass issues related to social life, political engagement, democratic institutions, interpersonal relations, and the role of language in liberal democracies. This translation at long last makes Marazzi’s first book available to English readers. Capital and Affects stands not only as the foundation to Marazzi's subsequent work, but as foundational work in post-Fordist literature, with an analysis startlingly relevant to today’s troubled economic times.
●The Oil Kings: How the U.S., Iran, and Saudi Arabia Changed the Balance of Power in the Middle East
By Andrew Scott Cooper
Review via Publishers Weekly
The petro-politics of the 1970s caused world-historical upheavals--and an international melodrama of statecraft--in this scintillating diplomatic history. Historian Cooper untangles the foreign policy conundrum arising from America's support for the reliably anticommunist Shah of Iran, whom Richard Nixon encouraged to raise oil prices so he could afford to buy U.S. weapons. This dynamic, the author contends, created a monster: to support his wild overspending on arms and pharaonic development projects, the Shah demanded huge OPEC price hikes that crippled the world economy--and provoked an American rapprochement with Saudi Arabia, whose flooding of markets with cheap oil ruined Iran's finances and sped the Shah's downfall. Cooper gives a lucid analysis of shifting oil markets and unearths revelations--including American-Iranian planning for invasions of Arab countries--from meticulous research. But this is a saga of not-so-great men and their wranglings. Its centerpiece is Cooper's superb, lacerating portrait of Henry Kissinger. As the super-diplomat's obsession with great-power rivalries founders in a new world of global economics that he can't fathom, Cooper gives us both a vivid study in sycophancy and backstabbing and a shrewd critique of Kissingerian geo-strategy
August 12, 2011
Retail Sales Continue To Rise In July
Some analysts say there may be a recession coming, but you wouldn’t know by looking at retail sales. Today’s update on consumer purchases for July shows a surprising resilience in the data. Seasonally adjusted retail sales were up 0.5% last month, the U.S. Census Bureau reports. That’s the second monthly increase. In fact, other than May’s modest retreat, retail sales haven't had a down month in more than a year.
The annual trend look even better, and since this is more telling it’s also more encouraging. Retail sales are up 8.5% in July over the year-earlier period, as the chart below shows. That’s about as good as it gets, which is to say that the annual pace of retail sales has rarely been stronger on an annual basis.
Is the strong trend misleading us because of rising gasoline prices? Not really. If we strip out sales at gasoline stations, the 12-month change still looks strong, as the second chart illustrates. Retail sales ex-gasoline were higher on the year through July by 6.9%, which is near the best levels on record. And with gas prices expected to fall, the energy factor isn't likely to be a problem for the immediate future.
The bottom line: the pace of retail sales doesn’t suggest there’s a recession lurking. Granted, retail sales are just one statistic and, as usual, we should look to a broader review for a more reliable assessment. But here too there’s reason for thinking optimistically. For example, my equally weighted index of 18 economic indicators rose again in June (the last full month with updated numbers for all reports), following the gain in May. Yesterday’s encouraging news in jobless claims suggests there’s more growth ahead, as does the surprisingly good report for private-sector jobs in July.
The recent gloom can be traced to the weak report in manufacturing for July via the ISM report. The stock market’s swoon is flashing warning signals too. The political nonsense in Washington recently hasn't helped, and there's serious troubles in Europe to contend with as well. But if you’re looking for bearish confirmation in retail sales, you won’t find it, at least not in today’s update.
"I think the markets have been way too pessimistic on the economy,” advises Bernard Baumohl, chief global economist at the Economic Outlook Group and author of The Secrets of Economic Indicators. “Fundamentals are much better, so we will see in the next few weeks a sling back in the stock market away from these persistent declines. We will see that in continuing strength... You have to write off the summer a little bit because of all the political dust that's kicked up.”
The economy still faces headwinds, a problem that even a surprisingly strong retail sales report can't erase. But the case for thinking a recession is imminent took another hit today. As such, I'm sticking with my forecast that the economy will muddle on. Why? That's what a broad review of the numbers (continue) to tell me.
Strategic Briefing | 8.12.2011 | Rethinking Fed Policy
The Fed Has Not Done Enough and it Has Not Fired Most of its Ammunition
Uneasy Money | Aug 10
We know that QE2 was intended to prevent inflation expectations from falling to dangerously low, even negative, levels, as they seemed about to do last summer. And in this it was successful. The deceleration in growth was associated with a series of unfortunate one-off events: severe winter weather, a spike in oil prices as a result of the Libyan uprising against Colonel Ghaddafi, and the tsunami and nuclear disaster in Japan. But rather than accommodate these supply shocks by allowing prices to rise as would be natural in the face of a supply shock, pressure built to tighten monetary policy to counter the supply-driven rise in prices, with results that are now becoming all too evident: rapidly falling inflation expectations and real interest rates.
Tim Duy's Fed Watch | Aug 9
The story from the Treasury rally is more of a low growth than a deflation story. In what world would anyone foresee that real 5 year yields would be negative, real 10 year yields would be zero, and the real 30 year yield just 1.06 percent? If this really represents annual potential growth over the long run, the next few decades are going to be no fun at all. Now, I think it is perfectly reasonable to argue that low growth will eventually work its way into substantially lower inflation expectations, and it would be better to get ahead of that curve. The Fed doesn't see it that way. They will need to see inflation expectation numbers turn more solidly south to bring out another round of QE3. I think that takes some additional weakness on top of what we are currently experiencing.
The Money Illusion | Aug 9
Over the past few weeks the Fed has reduced NGDP expectations even further below their already dismal levels. Today’s decision reached a new level of futility. The Fed did correctly diagnose the problem, slowing growth and slowing inflation (i.e. slower growth in NGDP.) But they failed to construct any sort of effective policy response. The FOMC doesn’t seem to understand that it’s not the Fed’s responsibility to forecast slower NGDP growth, it’s the Fed’s responsibility to prevent slower NGDP growth.
Yes, there was the decision to promise low interest rates as far as the eye can see; but ultra-low rates are merely a sign that money has been too tight. The bankrupt Keynesian theory (that central banks must target interest rates) is what got us into this mess. Keynesians had no answer for a scenario where rates hit zero. And now the same bankrupt Keynesian model is preventing us from exiting the low spending morass. Zero rates won’t solve the problem as Bernanke ought to understand from his studies of Japan.
And as for the three hawks, who argued that even doing nothing is much too stimulative in a world of collapsing nominal growth expectations, I hardly know what to say. One would have to go back to the 1930s . . .
Yes Virginia, U.S. Back in Deflation; Inflation Scare Ends; Hyperinflationists Wrong Twice Over
Mish's Global Economic Trend Analysis | Aug 12
Hyperinflationits have now blown it twice. First, they insisted hyperinflation would happen before deflation. They were wrong. Then, during the QE2 inspired equities and commodities ramp, they said the same thing. They were wrong again... In the wake of QE II hyperinflationists again started preaching about hyperinflationary crashes. Once again, and with increasing intensity, we heard things like ...
•The US is Zimbabwe
•No food available at any price
•Oil is going to $200, then $400
•Excess reserves will pour into the economy causing massive inflation
•No one will be willing to hold US dollars
•Treasury rates are going to the moon
•The US dollar is going to zero
I could assign names to the above list, but I won't. Two well-known hyperinflationists confidently predicted hyperinflation would start this year. A third said 2011 or 2012 giving himself extra time to be proven wrong. My position all along was that the US would go in and out of deflation over a period of years, just like Japan... The US is now undeniably back in deflation.
A (two volume) history of the Federal Reserve “goes to waste”
Historinhas | Aug 11
This is from Alan Meltzer, the man who wrote it:How can the Fed know now that a zero-rate policy will be required two years from now? It can’t. Yes, economic growth has slowed, and forecasts of future growth decline daily. But the United States does not have the kind of problems that printing more money will cure.Banks currently hold more than $1.6 trillion of idle reserves at the Fed. Banks can use those idle reserves to create enormous amounts of money. Interest rates on federal funds remain near zero. Longer-term interest rates on Treasurys are at record lows. What reason can there be for adding more excess reserves?The main effect would be a further devaluation of the dollar against competing currencies and gold, followed by a rise in the price of oil and other imports. Inflation is now at the edge of the Fed’s comfort range, which is below 2%. Money growth (M2) reached 10% for the past six months, presaging more inflation ahead.
According to him the problems are mainly “structural”!Our problems will not be solved by stop-gaps like QE3 or lower labor taxes, but they are not intractable. What we need most is confidence in our future.
So tell us, please, Professor Meltzer, that the monetary policy “mishap” depicted in the following picture has no implications for the present “problems”!
August 11, 2011
Jobless Claims Fall Below 400k For The First Time Since April
New jobless claims slipped under 400,000 last week on a seasonally adjusted basis for the first time in four months. That’s hardly an all-clear signal for the economy, but at least you can argue that the numbers on this important forward-looking indicator aren’t getting any worse. It’s still open for debate if the trend is getting any better, although as we’ll discuss in a minute there’s some good news to consider.
Meantime, last week’s new filings for unemployment benefits dipped to 395,000 from 402,000 previously. That puts the latest number at its lowest level since the week through April 2. In addition, new claims remain under their four-week moving average for the third week running.
Minds will differ if any of this is meaningful in terms of looking for bits of optimism. Fortunately, there’s a stronger source of encouragement to consider: the unadjusted 12-month change in new jobless claims. As the second chart below shows, there’s substantial movement to the downside here in the latest report and, yes, that's encouraging. New claims last week were more than 17% under their year-earlier level. That’s the biggest drop for the annual change since late-February.
What's the decline in the rolling 12-month percentage for new claims suggesting? The odds of a new recession are still minimal. Economic contractions aren’t normally associated with jobless claims falling by double-digits on an annual basis. And with last week’s relatively encouraging numbers for jobs creation in July offering some positive corroboration, perhaps the labor market isn't set to capitulate after all. Yes, hope may be hanging by this one thread, but it's a rather thick thread. If it gives way, all may be lost, but so far we're hanging on.
But let’s remember too that jobless claims, as valuable as they are for assessing the future path of economic activity, are just one factor. Any one predictor can lead us astray at times. Indeed, you can count on it, although when and where is always uncertain.
The only solution is to review a mix of predictors—a diversified mix, meaning a range of variables that are complementary. There are countless possibilities, although the short list includes the yield curve, the credit spread, the market’s inflation forecast, the 12-month change in the stock market, and several others. Unfortunately, we’re starting to see more mixed/negative messages in a broad review of predictors.
The 12-month change in the S&P 500, for instance, is just about flat at the moment. Considering that it was up by more than 10% recently, well, that’s a discouraging sign. If it goes negative for any length of time, it would cast one more dark shadow over the macro outlook. Every recession in the last 50 years has been accompanied by a 12-month loss of some significance in the stock market. We're not there yet with equities, but it's too close to rest easy.
Yes, there are other signs of hope, including today’s jobless claims report. But make no mistake: the battle is engaged. We’re at the critical juncture, again. The headwinds to growth are the strongest since the recession was officially declared at an end as of mid-2009. It’s not clear if we’ll tip over into a recession or hold the line. Ours is a precarious existence these days with the macro trend. As such, each new data point may bring critical change, for good or ill.
For the moment, at least, the defenses appear to be holding steady in the labor market, which is to say that the weak trend for jobs doesn't seem to be deteriorating. That's not a lot, but it's something. But even one day can make a big difference now.
The Case For Rebalancing Looks Compelling... Again
Market volatility is unnerving, but it usually represents opportunity. Relatively few investors see it that way, of course, which is why so few investors are able to exploit rebalancing opportunities in the long run. On the other hand, the crowd's inability or unwillingness to rebalance in a timely manner is a big reason why a relative handful of investors can cash in on the rebalancing there's a rebalancing bonus. But if you missed it the last time, don't worry: Mr. Market makes it easy to try again, as the recent turmoil reminds.
Consider how the major asset classes stack up on a year-to-date basis through yesterday, based on representative ETFs and ETNs in the table below. Once again, diversity of return is conspicuous. In effect, a new invitation to rebalance has just arrived. There are other ways to earn a profit in the money game, but routinely rebalancing a broad set of asset classes is a strategy that's available to everyone. The fact that it works doesn't hurt, either. It does require a fair amount of emotional discipline, however, which is what trips up most folks. Good thing, too, since the return premium linked with rebalancing would surely dwindle if not vanish entirely if the crowd learned how to become intensely opportunistic on a regular basis. In theory, that's a concern. In practice, well, let's just say that you shouldn't lose any sleep worrying that the rebalancing bonus is set to evaporate.
August 10, 2011
How's That Commodities-Based Inflation Forecast Looking These Days?
Funny how you don’t hear much these days about inflation worries based on rising commodities prices. Mysterious? Well, not really. Commodities prices are down recently--sharply. The cash price of crude oil (West Texas Intermediate) is under $80 a barrel, as I write—off from nearly $115 in late-May. A number of other key commodities have tumbled recently as well. Nothing like a big round of selling to change perceptions. That's the point--commodities prices bounce around a lot, and so we shoud be cautious when it comes to making big decisions based on the price du jour.
A few months ago, however, warning about inflation risk based on elevated prices of raw materials was all the rage. But as I noted at the time, commodities were less than a reliable guide to future inflation (see my post here too). Indeed, one of the prized aspects of commodities prices—high volatility—among traders is also a reason why the asset class is suspect as a variable for estimating the inflation trend. That didn't stop some pundits from screaming for higher interest rates to fend off the perceived surge in inflation. Commodities prices were rising and that alone was enough to pull the trigger. Never mind the wider economic context, or the lack of support in core inflation measures.
Several months later, it's clear that raising interest rates in, say, May would have been exactly the wrong thing to do. The economy is weaker and commodities prices are lower. One might wonder if official readings of inflation will complete the circle in the months ahead. The latest reading on headline consumer price inflation reveals a seasonally adjusted annual rate of 3.4% through June. That's a jump from recent history, although core inflation (which strips out food and energy prices) still looks relatively contained. The fact that the two series weren't in agreement recently is another reason to wonder if commodities prices were giving us reliable information about the future.
Critics still rail against the concept of core inflation, but it's saved us from making rash decisions more than once. In mid-2008, on the eve of the financial crisis and (as it turned out) in the early months of the Great Recession, commodities prices were rising and so headline CPI was too, as the chart below shows (the blue line is headline CPI). But core inflation (red line) remained fairly stable. Core proved to be the more reliable measure of inflation, as indicated by the collapse of headline CPI's annual rate in late-2008 and early 2009.
More recently, headline CPI zipped higher. But this alone wasn't fate, as suggested by the lack of confirmation in core CPI, which remained subdued. All the more reason to think that headline CPI was a head fake once more. The recent downturn in economic expectations all but confirms the suspicion.
Ditto for the market's outlook on inflation these days. The yield spread for the 10-year Treasury less its inflation-indexed counterpart is around 2.2% at the moment. That's down sharply from roughly 2.6% in the spring and more or less unchanged from levels in late-2010.
Meanwhile, there's chatter that the European Central Bank, which had recently warned of rate hikes to fend off perceptions of rising inflation, is having second thoughts. As Kantoos Economics explains,Another commodity boom "tricked" the ECB into raising rates at the worst possible time, even though there were no signs of a pass-through of the currently higher headline inflation to core inflation, and thus, to medium term headline inflation. Now, this step will probably be reversed quickly, too. Why? Because even Germany might be heading for a recession.
Lest anyone think that we ignore commodity prices as a general rule, well, let's nip that in the bud right here. Commodities can't be ignored, nor should they be. But neither can we look at prices in a vacuum. There was too much of that earlier in the year, when commodities were soaring. But they were soaring in the wake of a massive financial crisis and a sluggish recovery. Yes, gold continues to march higher, but that's less about inflation worries vs. solvency fears.
In any case, no one's calling for higher rates based on commodities prices. That's sure to change when the next rally ensues. Maybe they'll be right the next time, but maybe not. Context is still king when analyzing the macro climate.
Questions About One Manager’s Prediction Conviction
Bloomberg tells us that “Bill Gross was right after all.” Pimco's celebrated bond fund manager anticipated a lengthy run of sluggish growth in the wake of the Great Recession, an idea that many dismissed:Former White House economic adviser Lawrence Summers and Christina Romer, the former chairman of the U.S. Council of Economic Advisers, were among critics who challenged a view promoted by Gross’s Pacific Investment Management Co. that the U.S. economy may be headed for a long period of below-average growth and high unemployment, a scenario known as “new normal.” Money manager Kenneth Fisher called the concept “idiotic.”Now Gross and co-chief investment officer Mohamed El-Erian, who coined the term more than two years ago, have been vindicated by the U.S. Federal Reserve, which said yesterday that the economic recovery is “considerably slower” than anticipated, following the biggest stock market loss since December 2008. BlackRock Inc. (BLK) co-founder Laurence D. Fink, who in January said he didn’t believe in the “new normal,” is forecasting growth of 1 percent to 2 percent for much of the decade.“A lot of the new normal characteristics have played out,” El-Erian, chief executive officer of Newport Beach, California-based Pimco, said in an interview. “Some people confused new normal with fatalism, but the intention was the opposite. There was the hope that policy makers would recognize that there are structural responses they needed to embark on.”
Fair enough. Major financial crises have a history of dispatching new normals. History tells us as much, as Reinhart and Rogoff remind. But if Gross recognized that history was set to repeat, didn’t he realize that bonds—Treasuries in particular—would benefit? Perhaps not. As the Bloomberg article explains:Gross hasn’t always been right about market calls. Earlier this year, he dumped U.S. Treasuries from his $245 billion Pimco Total Return Fund (PTTRX), only to miss a rally as investors fled to safer assets amid market volatility and the sovereign debt crisis in Europe. His fund has advanced 3.6 percent this year, lagging behind 66 percent of peers, Bloomberg data show.
Making macro calls is one thing. Following through is something else. Or did Gross and company think that the new normal was ending and acted accordingly earlier this year?
Monetary Lessons Learned (And Ignored)
Has the Federal Reserve’s monetary stimulus since 2008 been a failure? Many observers of the economic scene think so, and the evidence, they argue, is overwhelming. The U.S. economy, after all, remains plagued with sluggish growth, high unemployment and dim prospects for something more anytime soon. On its face, this looks like damning evidence. But this is a misreading of what monetary policy has accomplished, or more precisely: what it’s kept from happening.
It’s certainly reasonable to argue that without the Fed’s extraordinary accommodative monetary policy in recent years the economy would be even weaker than it is. Keep in mind too that some economists—Scott Sumner, for instance—assert that even with nominal rates at zero, the Fed continues to run a tight monetary policy. In any case, there are inflation hawks who believe the opposite and that the central bank has erred dramatically on the side of easy money since 2008 and that this easing has been a complete and utter failure. But that's like claiming that spraying water on a burning house, and limiting the damage to the upper floors, was a waste of time because it didn't save the entire structure.
Does any one really think that if the Fed had not acted as it has in recent years that the economy would be stronger? Well, yes, there are quite a few folks who push this line. But based on what evidence? Was there a time in history when a comparable blow to the body economic hit and the Fed was more hawkish? Yes, there was, but the outcome wasn't encouraging.
We know that the Fed's idle monetary hands in the early 1930s enabled a recession to deteriorate into a Great Depression. And, yes, the fact that the U.S. was on the gold standard was a contributing factor, as many studies have shown over the years. Barry Eichengreen and Peter Temin summed up the problem succinctly a few years ago when they wrote:The gold-standard mentality and the institutions it supported limited the ability of governments and central banks to respond to adversity; they led to the adoption of policies that made economic conditions worse instead of better. In response to balance-of-payments deficits and gold losses, governments could only restrict credit with the goal of reducing domestic prices and costs until international balance was restored.
Christina Romer speaks for many economists when she echoes the point in a 2009 speech:In the 1930s, the collapse of production and wealth led to bankruptcies and the disappearance of nearly half of American financial institutions. This, in turn, had two devastating consequences: a collapse of the money supply, as stressed by Milton Friedman and Anna Schwartz, and a collapse in lending, as stressed by Ben Bernanke.
She goes on to remind:The United States was on a gold standard throughout the Depression. Part of the explanation for why the Federal Reserve did so little to counter the financial panics and economic decline was that it was fighting to defend the gold standard and maintain the prevailing fixed exchange rate.13
The more you study economic history, the more you understand that the only reasonable response to a massive financial crisis that triggers a deep recession is satisfying the public's surging demand for liquidity. If you fail on that front, deflation is the inevitable consequence, at which point the game is lost. It's really a no brainer. The footnotes in Romer's speech is a good start if you're looking for details and formal analysis.
Meanwhile, none of this should be surprising at this point. Well before the Great Depression, Walter Bagehot explained why a lender of last resort is essential at times. The lesson has been established and re-established many times over the decades, but the lesson continues to fall on deaf ears in some circles.
Don't misunderstand: I'm not arguing that the Fed's policy in recent years has been perfect. Far from it. And, yes, there's a price tag to keeping a recession from turning into something worse. But there are no free lunches in economics, and so it's always a question of risk-reward tradeoffs. As such, quite a bit of the Bernanke bashing represents a misreading of economic history's lessons, as Greg Mankiw recently argued.
The critics counter that Bernanke's Fed has done too much and that the monetary overreach is hurting the recovery. But the lessons of history beg to differ. Indeed, Fed critics on the other side of this debate say that the central bank still isn't doing enough. Passive monetary tightening, despite nominal rates at zero, was and remains the problem, according to David Beckworth and others.
But this is economics and even lessons of crises long ago don't fully resonate. Perhaps that's the nature of the dismal science, but it's distressing just the same. And to the extent it keeps policy ineffective, it comes with a heavy cost in the real world.
Granted, the Fed's role is primarily one of preventing a financial crisis from turning into a depression. That falls well short of expecting the central bank to engineer robust growth, although the likes of Sumner and Beckworth think that if the Fed had been more proactive in preventing nominal GDP from slipping in the first place, we'd be in better shape now. Maybe, but we'll never really know since we can't replay history with an alternative scenario.
What is clear, or at least what seems clear to this observer, is that the Fed can at least keep the economy from a full meltdown when the forces of contraction surge to unusually potent levels. By that standard, QE1, QE2 and related monetary efforts have been successful. Successful, but forever controversial.
August 9, 2011
Tuesday's Main Event: Economic Uncertainty Vs. Monetary Visibility
There’s been an acute shortage of macro clarity in recent days--yes, more so than usual--and so the Federal Reserve this afternoon made a bold effort to enhance the focus, albeit on the one front it can control. “The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013,” the central bank announced earlier via its FOMC statement. It’s not QE3, which some analysts advocate, but it’s ambitious in the sense that the central bank is telling us what monetary policy will be for the next two years. That’s the equivalent of a politician telling you how he’ll vote in 2013. You want clarity? You’ve got it, at least as Fed machinations go. Whether it’ll help is another question, but there’s no question that’s it’s audacious.
It’s also divisive. Three of the 10 voting FOMC members voted nay on the new level of clarity. “It’s a dramatic commitment on the funds rate that’s clearly extremely dovish and shows clear bias toward more potential purchases” of assets, says James O’Sullivan, chief economist at MF Global Inc. via Bloomberg. “Even this was very controversial -- to have three dissents highlights the real divisions on the Fed right now.”
The rationale here, of course, is that the economy is unacceptably weak and so moving closer to a QE3-type plan without actually touching that rail leaves some political cover. Plausible denial seems to be in vogue at the Fed now that Washington is a town obsessed with chatting up austerity. But just to keep the crowd guessing (and hoping), the FOMC statement hinted at additional tricks up its sleeve that it may roll out in weeks and months ahead:The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.
Apparently there are limits to a new push for clarity, even under the Bernanke Fed.
Meantime, the market votes with its money, as always. Roughly two hours after the Fed announcement hit the streets, the yield on the benchmark 10-year Treasury was 2.16%, or 16 basis points under yesterday’s close. Neither rain nor snow nor Fed announcements nor S&P credit downgrades have dimmed the appetite for U.S. government bonds. Inflation expectations remain nipped in the bud, or so Treasury prices advise.
A Fresh Surge In Uncertainty
Ken Rogoff of Harvard tells Bloomberg that the Fed will likely roll out a new round of quantitative easing. “They certainly should do something right away,” says the co-author of This Time Is Different: Eight Centuries of Financial Folly.
The opportunity to announce QE3 arrives later today, when the central bank is scheduled to dispatch its standard press release in the wake of the scheduled FOMC meeting. “Some market participants will be looking to gauge whether the Fed will give any clues as to the timing of a possible [third round of quantitative easing], given the massive falls in equity markets in recent days,” Michael Hewson, analyst at CMC Markets, advises via MarketWatch. “However, it could well be the only thing the Fed are likely to do is downgrade their growth forecasts for the U.S. economy, while reiterating their intention to keep rates low for an extended period, given that their monetary policy toolbox is starting to look a little depleted."
It's safe to say that there's no shortage of skepticism about the efficacy of additional Fed action. But if the measure of deciding if Fed action is warranted is the risk of new downturn, one economics professor at Stanford lays the foundation for thinking that the macro threat is building. "The U.S. and European debt crisis of the last week have generated massive economic uncertainty," writes Nicholas Bloom. "One measure of the economic uncertainty – the VIX index of stock-market volatility – has jumped to levels not seen since the crash of 2008." Although he's careful to note that no one's really sure what comes next, he goes on to note:I have studied 16 previous uncertainty shocks – events like 9/11, the Cuban Missile Crisis, the Assassination of JFK – and the only certain thing about these is they lead to large short-run recessions (Bloom, 2009).
Surely the double-dip threat is elevated, but it's not yet obvious in the data that another recession is a done deal. Granted, it'll be a fine line for distinguishing in real time between the slow growth of late and a new recession. The old problem that economic reports arrive with a considerable lag is one sticking point. Meantime, it's also true that no one variable has a monopoly on flawlessly predicting recessions. Every predictor is imperfect. The trouble is that you're never quite sure when and where the imperfection will arise. That leads to the reasonable conclusion that reviewing a mix of predictors is the only game in time. On that score, a broad reading of the numbers in hand still presents a mixed bag on the outlook. It's not a particularly encouraging mixed bag, but neither have we fallen off the statistical cliff as of yet.
Does the jump in uncertainty trump the statistical ambiguity? Bloom's work is intriguing and his insights deserve serious attention. But uncertainty, aside from being a rather nebulous concept, is just one factor, if you will and it's not obvious that we should bet the farm on it.
That leaves us with the usual task of focusing on the incoming data and reassessing the macro outlook, day by day. Unfortunately, that's going to take time as we await fresh U.S. numbers.
The next major release comes on Thursday with the update on weekly jobless claims. When we last checked in on this report, the news was ambiguous in terms of whether a fresh bout of good news was brewing. But a bit of salvation came a day later when the government reported that private-sector job growth perked up last month. Yes, that looks like old news in the wake of yesterday's market slide. And the consensus forecast for Thursday's jobless claims calls for an uptick, according to Briefing.com.
This much is clear: the crowd probably has no tolerance at this point for anything other than upside surprises with the labor market. That's a tough standard to satisfy at this point, although not necessarily impossible. Meanwhile, there's that uncertainty thing. Yup, this is going to be a nail biter.
But first up: Does the Fed have anything useful to say? Stay tuned…
Strategic Briefing | 8.9.2011 | The New New Financial Crisis
Why This Crisis Differs From the 2008 Version
The Wall Street Journal | Aug 9
There are three fundamental differences between the financial crisis of three years ago and today's events. Starting from the most obvious: The two crises had completely different origins. The older one spread from the bottom up. It began among over-optimistic home buyers, rose through the Wall Street securitization machine, with more than a little help from credit-rating firms, and ended up infecting the global economy. It was the financial sector's breakdown that caused the recession. The current predicament, by contrast, is a top-down affair. Governments around the world, unable to stimulate their economies and get their houses in order, have gradually lost the trust of the business and financial communities.
Will the FOMC Repeat the Mistake of September 2008?
David Beckworth | Aug 8
I hope not. As you may recall, the FOMC met a day after Lehman collapsed on September 16, 2008 and decided against lowering the federal funds rates. Yes, the Fed decided to keep its targeted interest rate unchanged at 2% just as the financial crisis was reaching its peak. Amazingly, the reason the FOMC acted this way was its concerns about inflation, which at the time were driven by commodity prices and reflected a backward-looking view of inflation. Had the Fed given more weight to forward-looking indicators like the expected inflation rate coming from TIPS and a host of other market indicators, the Fed would have realized the market was pricing in a sharp recession. Even though the Fed intervened more aggressively after this point, it never rose to the point that would restore current dollar spending to a healthy, sustainable level. The Fed, therefore, effectively tightened monetary policy at that time.
Global Bonds Gain $132 Billion Amid Stock Rout
Bloomberg | Aug 9
The worldwide retreat from stocks and commodities following Standard & Poor’s unprecedented cut of the U.S. AAA credit rating has driven the value of the global bond market to a record high. The market value of Bank of America Merrill Lynch’s Global Broad Market Index has increased $132.4 billion since the end of July to $42.1 trillion, the most in data going back to 1996. The index, containing more than 19,000 bonds sold by governments, banks and the world’s biggest companies, returned 1.09 percent this month as yesterday’s stock rout wiped out about $2.5 trillion in global equity values, extending total losses since July 26 to $7.8 trillion. While S&P said the credit worthiness of the U.S. was diminished when it cut the rating to AA+ on Aug. 5, Treasuries have surged. The yield on the benchmark 10-year note dropped today to as low as 2.27 percent, the least since January 2009. Investors are seeking the safest assets amid growing concern that debt crises in the U.S. and Europe and a manufacturing growth slowdown in the world’s two biggest economies may cause the global recovery to falter.
Which Rating Agency Downgraded the U.S. First? Not S&P
Donald Marron | Aug 8
The S&P downgrade of U.S. credit has understandably dominated headlines, but S&P was by no means the first mover. At least three other rating agencies had already downgraded the United States. Egan-Jones was the first Nationally Recognized Statistical Rating Organization (NRSRO) to downgrade. It lowered the U.S. rating from AAA to AA+ in mid-July. NRSROs are the companies that the SEC officially recognizes as credit rating agencies. They number ten in total, with Fitch, Moody’s, and Standard & Poors the most famous (or, in some circles, infamous). Weiss Ratings was the first U.S.-based rating agency to rate the U.S. below AAA. It initiated official coverage in April at the equivalent of BBB and lowered to the equivalent of BBB- in mid-July, just one notch above junk. Back in May 2010, Weiss challenged the three major agencies to downgrade the United States, but hadn’t yet rated the U.S. itself. Weiss is not an NRSRO. And then there’s Dagong, the Chinese rating agency. It initiated coverage with a AA rating in July 2010. It then cut the U.S. to A+ in November and to A last week.
America’s First Debt Crisis
Project Syndicate (Mark Roe, Harvard) | Aug 8
Both Europe and America can learn a lesson hidden in American history, for, lost in the haze of patriotic veneration of America’s founders is the fact that they created a new country during – and largely because of – a crippling debt crisis. Today’s crises, one hopes, could be turned into a similar moment of political creativity. After independence from Britain in 1783, America’s states refused to repay their Revolutionary War debts. Some were unable; others were unwilling. The country as a whole operated as a loose confederation that, like the European Union today, lacked taxing and other authority. It could not solve its financial problems, and eventually those problems – largely recurring defaults – catalyzed the 1787 Philadelphia convention to create a new United States. And then, in 1790-1791, Alexander Hamilton, America’s first treasury secretary, resolved the crisis in one of history’s nation-building successes. Hamilton turned America’s financial wreckage of the 1780’s into prosperity and political coherence in the 1790’s.
Rutgers expert: Credit downgrade will make economy even uglier
Gloucester County Times | Aug 9
John Longo, professor of finance at Rutgers University, said Standard & Poor’s (S&P) first-ever downgrade of U.S. credit from the highest AAA to the next-highest AA+, which caused the Dow Jones to tumble and sent Wall Street into a tizzy, will likely exacerbate an already fragile U.S. economy. Without getting too complicated, here’s why: America sells its debt to investors in the form of Treasury securities. Investors like Treasury securities because for the longest time — at least since the United States first earned its AAA rating in 1917 — they were seen as the most safest, most secure investment there is. By downgrading U.S. credit, S&P shook that belief to its very core. “Everything else looks riskier now,” said Longo. “Every investable asset becomes riskier.” As a result of the additional uncertainty the downgrade has injected into an already uncertain market — whether the uncertainty is real or perceived — Longo said businesses may be less likely to invest in their workforces, causing the unemployment rate to persist at a high level or making it climb even further. If S&P downgrades other U.S.-backed debt, which it’s likely to do, mortgage rates may also go up and pensions and 401Ks may shrink, according to Longo.
The truths behind S&P’s ratings downgrade
The Washington Post | Aug 8
The long-term impact of the downgrade is not yet clear. Yesterday’s market reaction suggested that interest rates could be unaffected as investors shrug off the S&P warning. But over time rates for everything from muncipal bonds to mortgages could be at risk — especially if Congress fails to take more decisive action on the debt. In a few months, the “super-committee” created under the debt ceiling agreement will be tasked with finding another $1.5 trillion to cut from the budget. Failure is not an acceptable outcome, but even success in this short-term goal will not be adequate. More cuts — S&P puts the total savings figure at $4 trillion — must be found, lest the country risk a further downgrade. Adjustments to entitlement programs, including Medicare and Social Security, must be a part of the equation, even in the face of Democratic opposition. New revenue — yes, taxes — must be considered despite Republican vows to resist. The political and market turmoil of the past few weeks will be worth it only if the country’s leaders meet the challenge of coming up with full-fledged solutions.
Buy stocks, sell bonds
Felix Salmon (Reuters) | Aug 8
From a market-dynamics perspective, we’re now in the world of momentum trades and falling knives. This isn’t a repricing of risk based on new information: it’s a trader’s market, which will move in the direction of inflicting the maximum amount of pain on the maximum number of people. I’m not saying that this is an overreaction — the US downgrade is a legitimately momentous event, and will have a large number of unknowable repercussions. A world which highly values predictability and certainty has become significantly less predictable and certain than it was last week. Does that mean that US stocks are worth 20% less than they were at the market highs around 1,370 on the S&P? No — and that’s one reason I’m looking at this move more like a 20%-off-sale than a sign of incipient economic Armageddon.
August 8, 2011
David Levey Begs To Differ
Standard & Poor's thinks the U.S. no longer deserves a triple-A credit rating. The Treasury market disagrees and so does David Levey, former managing director, sovereign ratings, at Moody's (1985-2004). Rajiv Sethi, professor of economics at Columbia, has the details.
The Market Can't Get Enough Of Those Downgraded Treasuries
The stock market was crushed today, with the S&P 500 falling nearly 7%. The proximate cause of the mayhem: Standard & Poor's downgrade of the U.S. government credit rating. But a funny thing happened on the path to demoting Treasuries: prices of these tarnished securities soared.
Accordingly, the yield on the benchmark 10-year Note went south by a comparable amount, falling 22 basis points to 2.34% as of 3pm today, according to Bloomberg. That's the lowest yield since January 2009, when the Great Recession was raging and the world was rushing into safe harbors.
The message seems to be that the market took no notice of S&P's warning about U.S. credit, at least in terms of the bonds in question. Fear is still a bigger motivator than credit reports. Prices on Treasuries are now higher (and yields lower) than they were at Friday's close, before the world learned of S&P's report. The U.S. isn't likely to regain its AAA credit any time soon, S&P advises. But if lowering the country's rating to AA+ has any downside for prices, the burden falls primarily on equities.
Treasuries, by contrast, are more popular than ever. There's no mystery here. The S&P downgrade has heightened fears of macroeconomic risk. The crowd was already worried about a new recession and, well, you don't have to be a genius to figure out what's happened. In short, there's a new rush into Treasuries, and gold, which closed above $1,700 an ounce today for the first time.
Some pundits continue to say that inflation is the main threat. But if that were true, would Treasury prices soar (and yields tumble)? Unlikely.
Higher inflation at this point would, in fact, be welcome. For the moment, however, there's little sign that inflation is even stable, much less rising. That's a problem at this juncture. The only question is whether it'll become a bigger problem in the days and weeks ahead? Much depends on what the Fed decides at tomorrow's FOMC meeting. No pressure, though.
“There is a one-in-three chance that we’re going to go into recession,” says Larry Summers, former director of the President's National Economic Council and now a professor at Harvard. “Although it’s not clear how much impact the Fed can have, the risks are much more on the side of them doing too little than on the side of them doing too much.”
Is Battling Deflation The New New Thing Again?
The week ahead will surely be a stress test. Friday’s downgrade of the U.S. credit rating, although hardly a surprise, seems to have unleashed a higher round of risk aversion in world markets. Equity prices are tumbling around the globe, and early indicators suggest that no less is in store for stocks in the U.S. today. What's the economic logic behind the selling? The main worry is deflation. Yes, it looked like that problem was solved. Many analysts have continued to scream that inflation was the main challenge ahead. But the one-two punch of deleveraging and slow growth that has plagued the U.S. and mature economies never really went away. These risks were always lurking in the background, waiting to re-emerge, if and when there was a new catalyst.
It’s no accident that the market’s inflation forecast is falling again amid the new turmoil of confidence. As of Friday’s close, the yield spread between the nominal and inflation-indexed 10-year Treasuries is 2.26%. That’s not threatening per se. If it remained in that neighborhood it would be fine. The trouble is the trend, which lately has been down. It’s too soon to say if this new decline has legs, but it would be a dire signal if the inflation outlook continues to sink given the current climate.
As I’ve written many times over the years, inflation worries are credible—but not now. In a world still battling excess debt and a subpar economic rebound triggered by an unusually large financial crisis and a global recession, worrying about inflation was and remains premature.
Nonetheless, pundits see what they want to see. The surge in gold’s price is considered prima facie evidence in some circles that inflation is the pressing issue. But that’s only partially accurate, at best. The main reason that gold prices have been rising since 2008 is the metal’s historic role as a safe monetary haven. In that regard, gold competes with U.S. Treasuries. As such, Friday’s credit downgrade of Treasuries to AA+ from AAA by S&P will likely drive gold higher in the days to come. But if gold's rise is accompanied by a fall in yield in the 10-year Note, you can bet that inflation fears aren't driving the metal higher.
Keep in mind that the U.S. has no trouble borrowing money, as the low and falling yield on the benchmark 10-year Note reminds. In late-June, the 10-year traded above 3% vs. under 2.6% as of Friday. Inflation fears look rather subdued.
Meantime, falling prices generally threaten the economy…again. "What the U.S. can ill-afford is the decline in equity prices in view of how home prices have continued to fall," says John Lonski, chief economist at Moody's Investors Service. "It will reduce household wealth."
Make no mistake: if deflationary forces continue to gain momentum, the front line in the battle to keep a new recession at bay will be one of engineering higher inflation. This can only be achieved if the Federal Reserve is willing and able to mount a credible plan to elevate prices, or at least keep them stable. In short, QE3 will be required.
The mere mention of the idea will send some observers of the economic scene into a rage. But if the outlook continues to deteriorate (i.e., inflation expectations continue descending), there’s really only one policy prescription: more quantitative easing. Granted, this is no silver bullet. But as a last effort at keeping deflation from returning, it’s the only game in town.
Yes, it's a game with limited powers. The practical goal of QE3 would be quite modest: keep the economy from suffering deflation via buying time. In other words, keep the macro trend stable until organic economic growth is stronger.
By that standard, QE1 and QE2 have been successful. Did those program give us roaring growth that solved all our problems? No, of course not. On the other hand, we didn’t have another recession (a.k.a. a new bout of deflation). Can the Fed pull this monetary rabbit out of its hat again? There’s reason to wonder, given all the criticism of QE2.
Perhaps Bernanke and company will tell us otherwise via tomorrow’s FOMC meeting. “It won’t be a boring meeting,” notes Lawrence Creatura of Federated Clover Investment Advisers. “We’re in an entirely different orbit today than we were two weeks ago.”
In short, it's all about growth, growth, growth, and a key part of that equation is keeping inflation above zero. This isn't universally understood. But the truth will out, but there's no assurance that acquiring wisdom will be painless.
August 6, 2011
Book Bits For Saturday: 8.6.2011
● The Era of Uncertainty: Global Investment Strategies for Inflation, Deflation, and the Middle Ground
By Francois Trahan and Katherine Krantz
Summary via publisher, Wiley
The recent credit crisis in the United States ushered in a new era of uncertainty. Like other bubbles, it was born out of an extended period of easy money that fueled prosperity and engendered speculation, but it was not the same as a euphoric run up and crash of technology stocks; it was an assault on two pillars holding up middle-class America: homes and credit. The remaining two pillars—employment income and investments—were collateral damage. People can no longer count on ample access to credit, increasing home values, and abundant job opportunities to propel them into a better lifestyle. In The Era of Uncertainty: Global Investment Strategies for Inflation, Deflation, and the Middle Ground, François Trahan, Vice Chairman and Chief Investment Strategist of Wolfe Trahan & Co, and Katherine Krantz, Managing Director and Founding Partner of Miracle Mile Advisors, LLC, present a new framework for investing in a dynamic, macro-driven world. The book addresses the creation and aftermath of bubbles from a top-down perspective and shows how applying the macro framework can help investors profit from the interwoven inflationary and deflationary scenarios likely to evolve in the next several years. It also examines the role of macro analysis in the markets: how top-down forces influence the direction of financial markets; how including macro analysis in research improves the odds of investment profits; and the potential pitfalls of ignoring macro trends in the investment process.
● The Little Book of Trading: Trend Following Strategy for Big Winnings
By Michael W. Covel
Summary via publisher, Wiley
The last decade has left people terrified of even the safest investment opportunities. This fear is not helping would-be investors who could be making money if they had a solid plan. The Little Book of Trading teaches the average person rules and philosophies that winners use to beat the market, regardless of the financial climate. The market has always fluctuated, but savvy traders know how to make money in good times and bad. Drawing on author Michael Covel's own trading experience, as well as insights from legendary traders, the book offers sound, practical advice in an easy to understand, readily digestible way.
● Government versus Markets: The Changing Economic Role of the State
By Vito Tanzi
Summary via publisher, Cambridge University Press
Vito Tanzi offers a truly comprehensive treatment available of the economic role of the state in the twentieth and twenty-first centuries from a historical and world perspective. The book addresses the fundamental question of what governments should do, or have attempted to do, in economic activities in past and recent periods. It also speculates on what they are likely or may be forced to do in future years. Although other recent titles in economics deal with normative theories, public choice theories, welfare state analysis, social protection, and the like, no other book has the same breadth or depth specifically on the state's viable economic role. The author occupies a unique position in global public finance, having served for nearly three decades as a leading fiscal administrator for the International Monetary Fund, financial adviser to 80 countries, and active economic theorist. The investigation assembles a large set of statistical information that should prove useful to policy-makers and scholars in the perennial discussion of government's optimal economic roles. It will become an essential reference work on the analytical borders between the market and the state, and on what a reasonable "exit strategy" from the current fiscal crises should be.
● Beyond Price: Value in Culture, Economics
Edited by: Michael Hutter and David Throsby
Review via Grantmakers In The Arts
Now comes Beyond Price: Value in Culture, Economics, and the Arts, a new volume edited by economists Michael Hutter and David Throsby, which makes significant contributions to the conversation on value in the arts. It speaks to practitioners and scholars (humanists and economists). Specifically, the book examines the nature of the twin concepts of cultural value and economic value; how they are formed; and how they do (or do not) relate to one another. This work is distinguished from other studies on the topic by its scope (it approaches value in the arts from diverse theoretical and historical perspectives and across a range of artistic disciplines); its commitment to moving beyond the rigid disciplinary confines within which scholars often work; and its encouragement of interdisciplinary communication and dialogue.
● Chipping Away at Public Debt: Sources of Failure and Keys to Success in Fiscal Adjustment
Edited by Paolo Mauro
Review via IMF
Until recently, developments in public debt and deficits were seldom the stuff of high drama in the world’s advanced economies. However, things have changed dramatically in the aftermath of the “Great Recession” of 2008–09. Public debt and deficits have skyrocketed. Intense negotiations between parties with different views on how to restore public finances to sustainability make front-page news in several of the largest countries on a daily basis. Investors’ concerns about fiscal sustainability in some advanced economies are reflected in major increases in funding costs. Thus, the design and implementation of credible fiscal adjustment plans in advanced economies is critical now and will remain so for many years to come. Although the fiscal challenges facing policymakers today are greater than in the past, there is much to be learned from previous experience with large fiscal adjustment plans, including both those that achieved their objectives and those that ended up wide of the mark. This motivates a new book from the IMF’s Fiscal Affairs Department (FAD): Chipping Away at Public Debt—Sources of Failure and Keys to Success in Fiscal Adjustment, edited by Paolo Mauro, with a foreword by FAD’s Director, Carlo Cottarelli; published by Wiley; available in hardback and e-book.
● Economics Evolving: A History of Economic Thought
By Agnar Sandmo
Review via The Enlightened Economist
I’ve just finished reading Economics Evolving: A history of economic thought by Agnar Sandmo, and commend it to every economist and student of economics. It’s a clear and fair account of the contribution to the subject by the key figures in its intellectual history, with a focus on Adam Smith and his immediate predecessors to the 1970s. The book would make an ideal text for a history of thought module in a degree course, but is also an accessible general read for an economist seeking some perspective on the state of economics today. I particularly appreciated not being able to tell the author’s own opinions; the book simply gives a straightforward account of both sides of the various controversies... Anyway, Economics Evolving is a highly commended book, which completely defied my initial impression that it was going to be worthy but dull. Heilbronner’s The Worldly Philosophers is still a terrific introductory read but is nothing like as substantial as this book, which is the best overview I’ve come across of the history of thought in economics.
August 5, 2011
Private-Sector Job Creation Accelerates In July
Today’s jobs report isn’t great, but it’s better. For the moment, that’s good news--great news, if you consider the alternative outcome implied by yesterday's steep market loss. Private-sector payrolls rose by 154,000 in July, nearly double June’s revised 80,000 gain. Although government jobs overall decreased 37,000 last month, the momentum in the private sector was enough to bring the unemployment rate down ever so slightly to 9.1%. In short, we dodged another bullet. There are still plenty of challenges ahead, as there have been all along, but today’s payrolls report for the private sector is strong enough to keep the recession risk at bay, if only on the margins and just long enough until the next data point arrives.
Last month’s net gain in private-sector jobs was the highest since April’s 241,000 rise. We’re still well below that figure, but it’s also obvious that we’re comfortably above the below-100k reports for May and June. Is the two-month slump over? Hard to say, and there are lots of reasons for staying skeptical. It’s still going to take time to figure out how much the economy has slowed, and what it implies for the fall. But at least today’s update extends the rationale for optimism, albeit an optimism that’s simply looking for evidence that there’s no recession lurking around the next bend.
"While I do not think this sounds the all-clear signal, it does quell some of the conversation that the U.S. is falling back into a recession, says Tom Porcelli, chief U.S. economist at RBC Capital Markets. "There are still plenty of headwinds, like Europe. This report pulls us back from the ledge a little bit."
Strategic Briefing | 8.5.2011 | Recession Risk
Odds of double-dip recession grow
MercuryNews | Aug 4
In a report titled "Markets tumble, recession alarm bells ring," consulting firm IHS Global Insight Thursday put the odds of a new recession at 40 percent. Vanguard economists are estimating the odds of a double-dip recession at around 35 percent to 40 percent, up from 30 percent last year, [Roger] Aliaga-Diaz [Vanguard Fund senior economist] said. Economists still consider the most likely scenario to be a very slow-growing economy that feels like a recession, but isn't one officially.
NY Fed Model: 1-in-125 Chance of 2012 Double-Dip
Carpe Diem (Professor Mark Perry) | Aug 4
The New York Federal Reserve updated its "Probability of U.S. Recession Predicted by Treasury Spread" this week with treasury yield data through July 2011, and the Fed's recession probability forecast through July 2012. The NY Fed's Treasury model uses the spread between the yields on 10-year Treasury notes (3.00% in July) and 3-month Treasury bills (0.04%) to calculate the probability of a U.S. recession up to twelve months ahead (see details here) using the spread between those two yields (2.96% in July).
Bernanke to the rescue?
The Economist | Aug 4
The good news is this: the Fed can't help but act. On Tuesday, I worried that the Fed would stand pat at its meeting next week, leaving the economy to dip into recession before it finally reacted in late August or following its September meeting. That no longer seems like the most likely outcome to me; events are moving too fast. Ben Bernanke may not announce a new policy next week, but I believe he will hint at new Fed easing—potentially at new purchases, but perhaps also at other available tools. The drop in inflation expectations should force the Fed's hand. Ideally, it will also shake Congress out of its destructive state. Extension of the payroll tax cut and emergency unemployment benefits would improve confidence, reduce projected fiscal tightening over the next year, and ease the suffering of the unemployed. The double-dip is at the door. Only quick action can send it packing now.
Strategists See 17% S&P 500 Rally on Earnings
Bloomberg | Aug 5
Wall Street has never been more sure that the Standard & Poor’s 500 Index will rally in 2011, even after speculation the U.S. economy is heading for a recession prompted the biggest plunge since the bull market began. Chief strategists at 13 banks from Barclays Plc (BARC) to UBS AG (UBSN) see the benchmark measure of American equity surging 17 percent through Dec. 31, the average estimate in a Bloomberg survey. Their projection that the index will reach 1,401 hasn’t budged in four weeks, while mounting concern U.S. growth is slowing drove the S&P 500 down 11 percent since July 22, including yesterday’s 4.8 percent tumble.
Time to Say It: Double Dip Recession May Be Happening
The New York Times | Aug 5
If this is the beginning of a new double dip, it will have two significant things in common with the dual recessions of 1980 and 1981-82. In each case the first recession was caused in large part by a sudden withdrawal of credit from the economy. The recovery came when credit conditions recovered. And in each case the second recession began at a time when the usual government policies to fight economic weakness were deemed unavailable. Then, the need to fight inflation ruled out an easier monetary policy. Now, the perceived need to reduce government spending rules out a more accommodating fiscal policy.
Insight: Debt relief replaced with recession fear
Reuters | Aug 3
Former Treasury Secretary Lawrence Summers said in a Reuters column there is a one in three chance of a U.S. recession. According to number crunching by Goldman Sachs, history suggests the economy is perilously close to tipping over the edge. Signs are little better elsewhere. Italy and Spain are edging closer to the euro area debt danger zone, China's economy is slowing and Japan is mired in recession after the March earthquake. The gloom is hitting the corporate world as analysts cut earnings forecasts globally, especially in export-led economies, and big banks have announced tens of thousands of job cuts.
August 4, 2011
Dipping Closer To The Tipping Point
The digital ink was barely dry on this morning’s post, which discussed the relationship between the S&P 500’s rolling one-year price return and the onset of recessions, when Mr. Market went into one of rare but far-from-unprecedented hissy fits. By the end of the day’s trading, the S&P had a new haircut with a price tag that pinched the numbers by 4.8%. What does it mean for the market’s forecast on the macro outlook? The good news is that even after today’s rout, the S&P 500 is still up roughly 6.5% vs. a year ago on a price basis. The bad news is that the margin of comfort is fading—fast, at least by today’s standard.
A bit of history: Every recession in the past 50 years has been associated with year-over-year declines in the equity market. Samuelson’s famous warning that the stock market had forecast nine of the last five recessions is still relevant. But this particular defect in prognosticating isn’t worrisome at this point. Indeed, the risk in looking to the market is that it may see an approaching recession (as implied by a one-year decline in price) when in fact there’s no such beast on the horizon. Perhaps the most infamous example is the 1987 stock market crash, which led to double-digit annual market losses well into 1988 but without a corresponding recession.
Given recent conditions, ours is a different problem in the current climate, namely: There’s never been a recession in the modern era without the market suffering an annual loss. As we move closer to a loss, no one's losing any sleep over the possibility that the market's wrong. We should be so lucky.
The notion that the market is a pretty good judge of the macro trend, albeit a flawed judge, has been discussed for years. Geoffrey Moore wrote about the dance between the market and macro back in 1975 and Jeremy Siegel penned an intriguing essay on the topic in 1991, for instance.
As for the latest round of selling, the market trend hasn’t rolled over in annual terms, but we’re a lot closer to zero than we were yesterday. One indicator is hardly fate, which is why it's usually hazardous to evaluate one factor--any factor--in a vacuum. But if the broad market gauges keep falling to the point that one-year performances sinks below zero, it would surely be one more dark sign.
What's Up (And Down) With The Economy?
Is there a new recession looming? That’s the burning question (again) these days, and understandably so. The slowdown in job creation is reason enough to worry. As troubling as that is, there’s discouraging news on consumer spending and weak July reports for the manufacturing and services sectors. Adding to the anxiety is the fear that the push in Washington to cut spending at a time of weak economic growth will only exacerbate the problem, although the pro-austerity crowd argues otherwise. All of which sets us up for the latest update on initial jobless claims. Unfortunately, the number du jour doesn’t tell us much.
New filings for unemployment benefits slipped a scant 1,000 last week to a seasonally adjusted 400,000, the Labor Department reports. That’s the lowest in nearly four months, but it's also ambiguous at a time when the crowd’s desperate for strong signals about what comes next. But as the chart below suggests, it's unclear if we're set to resume the fall in new jobless claims or stuck at an elevated level.
By comparison, the raw year-over-year change in jobless claims looks more encouraging. New filings were nearly 16% lower last week vs. the same period a year ago on an unadjusted basis, as the second chart shows. It's too soon to say if this marks a period of renewed decline for fresh claims, but on its face it looks promising. At the very least, the latest annual change in unadjusted claims doesn't suggest a recession is imminent.
Jobless claims are just one statistic and so we should look to other indicators too. Unsurprisingly, a number of pundits are quick to suggest that the outlook is still quite bleak. For example, Peter Coy of Bloomberg BusinessWeek writes:It’s widely accepted that a slowly growing economy is more likely to tip into recession, for the obvious reason that it’s already too close to the line; any shock can knock it into negative territory. And today’s slow growth is at least in part a symptom of underlying problems such as consumer indebtedness, high energy prices, and the jitters induced by debt ceiling brinkmanship.
David Callaway of MarketWatch opines that "stocks are pricing in a new recession."
Surely the risk of recession is higher today vs. six months ago. Indeed, I was writing about warning signs in May and it's clear that the danger hasn't passed. But it's also debatable if a double dip is a done deal. There are still positive signs out there and so it's still debatable if the forces of growth will hold the line against the demons of contraction.
Economist Larry Kudlow, for instance, writes that strong corporate earnings imply that there'll be no recession. "Profits are at record highs as a share of GDP," he writes. "Second-quarter earnings are coming in much stronger than expected. For some reason investors have chosen to ignore profits. But they’re still the mother’s milk of stocks and the economy. Stocks may well be undervalued right now."
Speaking of the stock market, one of the metrics I watch is the 12-month percentage change for the S&P 500. It's not perfect (nothing is), but it has a decent record of anticipating a new recession by tumbling to a loss vs. the previous year. Every recession in the past 50 years has been accompanied by an annual loss in the stock market. By that standard, there's still a healthy comfort margin: the S&P remains up by well over 10% compared with its year-earlier price.
There are other encouraging signs too, including a positively sloped yield curve. History suggests that a new recession is near when short Treasury rates rise above long rates. But with the 3-month T-bills near zero and the 10-year Note at roughly 2.6%, there's minimal risk of an inverted yield curve in the near term according to this measure.
There are dozens of other indicators to evaluate, of course, although the key factor remains the labor market at this point. But here too the trend, while battered, still looks mildly favorable. Recessions invariably are linked with declines in private sector job creation. Although the numbers have been weak on this front, there'll still positive, as ADP advised yesterday. Economists are also predicting growth in tomorrow's update on July employment from the Labor Department.
There are still no guarantees. Lots of risk resides on the macro landscape. But considering the numbers in hand, it's not yet clear that another recession is fate. That outlook is subject to revision with the arrival of each new data point, of course, but that's par for the course in the dismal science. Predicting is still hard, especially about the future.
August 3, 2011
ADP: Economy Adds 114,000 Private-Sector Jobs In July
Today’s ADP Employment Report for July isn't really encouraging but it does tell us that there's still job growth. It's modest at best, but the fact that the labor market is still expanding at this point suggests that the economy will sidestep a new recession. There's no assurance that the labor market won't suffer in the months ahead, but the latest numbers don't look like recession figures.
Private nonfarm payrolls added a net 114,000 positions last month, ADP advises. That's down slightly from June's 145,000 gain and so there's nothing much has changed in the labor market. Growth is still sluggish. But 100,000-plus new jobs implies that there's still enough forward momentum in the broad trend to keep the economy bubbling, if only slightly. The margin for error is thin, but it could be a lot worse.
Today's ADP number also suggests that Friday's employment report for July from the Labor Department will be an improvement over the government's June estimate, which was unusually disappointing, even by the diminished standards of recent history. As the second chart below shows, the last two ADP monthly figures have printed comfortably above the government's numbers. The two series wander quite a bit relative to each other on a monthly basis, but there's a fairly tight correlation through time and so the Labor Department's estimate may be set to play catch-up with the ADP report.
The consensus forecast for Friday's jobs report expects as much with a prediction of 100,000 new private-sector jobs for July vs. June's 57,000 gain, according to Briefing.com.
Even so, some analysts warn that the risk of a new recession is rising. “This economy is really balanced on the edge,” Harvard University economics professor Martin Feldstein, a member of the Business Cycle Dating Committee of the National Bureau of Economic Research, tells Bloomberg. “There’s now a 50 percent chance that we could slide into a new recession. Nothing has given us much growth.”
Morningstar economist Francisco Torralba puts a slightly more nuanced spin on the risk, telling TheStreet.com: "We are in a process of discovery over whether the slowdown we have seen since March in the U.S. is over and we are entering a new phase of faster growth or that we are in a slump."
The discovery process remains fluid, but at least the ADP number keeps hope alive. Next up: Let's see if tomorrow's jobless claims report can build on last week's encouraging news.
The Big Squeeze
The new austerity is underway, but it’s not clear that the bond market is optimistic about the implications for growth. The benchmark 10-year Treasury yield dropped to 2.66% yesterday, the lowest since last November. The sight of the crowd rushing into bonds at this stage isn’t encouraging. Meanwhile, the stock market cast its own vote yesterday via a hefty 2.6% tumble.
What can be done? The Federal Reserve seems to be the only lever left to pull. It’s no silver bullet, but policy could be more accommodative, as a number of economists advise. Here’s David Beckworth, who criticizes the Fed’s “passive tightening” policy:A key problem behind this passive tightening of monetary policy is that money demand has been and remains elevated and the Fed has yet to successfully address it. What is frustrating is that the Fed could meaningfully undo this three-year passive tightening cycle by adopting something like a nominal GDP level target. For many reasons--its political capital is spent, internal Fed divisions, the popularity of hard-money views, etc--it won't and so the U.S. economy remains mired in an anemic recovery.
And Scott Sumner observes:Five year yields are 1.26% and falling almost every day. One need to look no further than the market for 5 year T-notes to see the increasing tightness of monetary policy. NGDP growth expectations are now falling rapidly.
August 2, 2011
Consumer Spending Retreats In June
For the first time in a year, monthly consumer spending dropped, the U.S. Bureau of Economic Analysis reports. Personal consumption expenditures (PCE) fell 0.2% in June as disposable personal income rose by a slight 0.1%. Joe Sixpack’s inclination to spend, it seems, is drying up. Indeed, PCE’s monthly pace has been descending non-stop since March and the latest number reflects outright decline. (Some news outlets are reporting that consumer spending, as per today's revised numbers for PCE, fell in June for the first time in nearly two years. In fact, there was a slight 0.04% drop in June 2010, although rounding changes this to zero.)
Suffice to say that the trend in PCE isn’t encouraging. There’s no shortage of incentives for consumers to save more and spend less these days, but that won’t diminish the macro pain for an economy that relies primarily on Joe Sixpack’s consumption habits.
On the other hand, there’s nothing particularly new in today’s numbers. We already knew that second-quarter GDP growth was weak. After reading today’s income and spending report for June, we have more detail on why it was weak.
An optimist might say that with the threat of a Treasury default no longer looming, consumer confidence may pick up in the months ahead. Perhaps, but one could just as easily counter that the budget deal spells trouble for the economy because of the anticipated cuts in government spending at a time when economic growth is subpar.
In other words, it seems we’ve solved one source of uncertainty and replaced it with another. Is the emphasis on fiscal austerity good news for the economy in the short term? Or are we facing a fresh hurdle? Only time will tell, although depending on your dismal scientist of preference, you can find almost any prediction you’re looking for. History, however, suggests we should worry as the record on imposing fiscal austerity in periods of weak growth triggered by a financial crisis isn't encouraging. Or perhaps the Fed will offset the fiscal cutting with QE3? Questions, questions, always more questions.
Meantime, the trend continues to hold its ground, based on the numbers in hand. As the chart below shows, the rolling one-year percentage changes for spending and income, although off their recent highs, still suggest growth will prevail. Nonetheless, the margin of comfort is slim. If June’s income and spending report is a harbinger of things to come, the trend will suffer.
The good news is that private-sector wages are still growing at an encouraging pace vs. the year-earlier period. That implies that consumer spending isn’t headed for the skids. And while industrial production’s annual pace has slowed considerably, it’s still well above stall speed. Even the sharp slowdown in jobs creation has yet to put stress on the labor market trend. Private nonfarm payrolls were higher in June by roughly 1.6% over the past year, or near the best levels since the recession formally ended two years ago.
None of this is a guarantee that a recession will be averted, but there’s not yet a smoking gun for the dark side either. "The recent run of weak economic news has made us more concerned that any rebound will be more modest than previously looked likely," opines Paul Dales, senior U.S. economist at Capital Economics. Deciding if there’s more, or less, to this reasonable outlook will take time.
It’s still going to be a long, hot August.
Strategic Briefing | 8.2.2011 | The Debt Deal In Washington
Debt battle set to draw to close, for now
MSNBC | Aug 2
The United States was poised to step back from the brink of economic disaster Tuesday as a bitterly fought deal to cut the budget deficit was expected to clear the Senate and President Barack Obama's desk.
Budget fight on health care cuts just beginning
AP | Aug 2
When it comes to Medicare and Medicaid, the debt deal raises more questions than it answers. The giant health care programs serving some 100 million elderly, low-income and disabled Americans were spared from the first round of cuts in the agreement between President Barack Obama and congressional leaders. But everything's on the chopping block for a powerful new congressional committee that will be created under the deal to scour the budget for savings.
US debt deal: how Washington lost the plot
The Guardian (Dean Baker) | Aug 2
While many in the media and around the country had been panicking over the possibility that no deal would be reached and the government would actually default on its debt, those who understand American politics knew that this is not a concern. The reason is that Wall Street is on the frontline in this battle.
If there were a default on US debt so that it could no longer be held on bank books as being a riskless asset, most of the major banks would likely be insolvent. It would not be just US debt that must written down, but also debt implicitly guaranteed by the government, such as mortgage-backed securities issued by Fannie Mae and Freddie Mac, as well as a wide range of other assets held by the banks.
The loss of value of on a wide range of assets could easily wipe out the capital of the Wall Street banks, putting them on the road to Lehman land. Since JP Morgan, Citigroup and the rest have enormous power in Congress, it was a safe bet that they would force their allies to find a way to keep them in business. Therefore, there was never any reason to worry about the default story.
What we should be worrying about is all the news that Washington has ignored while it was doing the debt ceiling shuffle. Most importantly, the economy has almost stopped growing and unemployment is again on the rise.
Why Much Was Accomplished in the Debt/Budget Negotiations
Economics One (John B. Taylor) | Aug 1
Many are still debating how much was accomplished in the debt/budget agreement approved by the House today with the Senate to vote and the president to sign tomorrow. In my view, much was accomplished, and credit goes to all those who have been laying out the arguments and fighting hard for a return to sound fiscal policy as part of a pro-growth program to get the economy moving again.
The Coming Double Dip
Slate | Aug 1
What does the last-minute deal to raise the debt ceiling do to aid the flagging, faltering economy? Nothing.
The economy is in appalling shape. Last week, the Commerce Department's latest estimate of economic growth left many economists agog. In the second quarter, the economy grew at an annual rate of 1.3 percent. In the first, it grew at an annual rate of just 0.4 percent, a figure revised down sharply from previous estimates. Based on the first six months of 2011, the economy is growing less than 1 percent per year, about one-third of the speed we would expect during a normal expansion. In short, the recovery has completely stalled and the economy is perilously close to double dipping back into recession.
Those horrid growth figures are magnified by horrible jobs figures. Currently, 14.1 million Americans are out of work. Millions more are underemployed, discouraged from hunting for jobs, or "missing" workers who have elected not to enter the labor market. Even if the economy suddenly starts growing at the pace of the 2002-07 expansion, the unemployment rate would not drop to its prerecession level of 5 percent until 2018.
But the debt deal pays no attention to the unfolding catastrophe in the real economy. The deal's major accomplishment, as touted by the White House, is hardly an accomplishment at all—merely an admission that Congress has probably avoided doing too much damage during this idiotic debate.
On the debt-ceiling deal
The Economist | Aug 1
To Democrats I would like to say relax, guys. The debt-ceiling got raised. Yay! And the debt-ceiling deal is not going to destroy the recovery, if there has been a recovery. While the deal does rule out further fiscal stimulus, the bulk of the putative cuts in the deal are so far in the future that their contractionary effects are likely to be small to nil.
August 1, 2011
US Manufacturing Activity Slows Sharply In July
Today’s ISM Manufacturing report—the first economic data point for July—reflects a sharp slowdown. Although the ISM index is still above 50, indicating growth, it fell to its lowest level in two years.
Given the current climate, no one can dismiss this as a statistical quirk. There are simply too many risks lurking. But neither should we jump to conclusions. Was the sharp deceleration in manufacturing activity last month a victim of fears over a potential default on Treasuries? If so, will the 11th hour deal to avert default revive the trend in the weeks and months ahead? No one really knows, of course, and so that leaves us to consider the numbers so far.
Based on the current data, it’s a mixed bag. For instance, consider how the ISM Manufacturing Index compares with the trend in three other metrics, as shown in the chart below. Clearly, the ISM has suffered a slowdown. Nonetheless, it still reflects growth by virtue of the above-50 reading, albeit by a hair at 50.9 for July. Somewhat more encouragingly, the stock market (S&P 500) still isn’t pricing in a new recession, as implied by equities' trailing one-year return that’s still in positive territory. Recessions tend to be associated with negative year-over-year equity market performance and for the moment there’s still a tidy margin of comfort here via the S&P’s 17% gain vs. this time last year. Mr. Market, of course, makes mistakes at times and so that possibility can't be ruled out.
Industrial production and new orders for durable goods are also higher on the year, although that doesn’t help much since both of these numbers are currenly updated only through June. As a result, the economic news in the days and weeks ahead deserve careful scrutiny for clues about the macro outlook.
Meantime, the latest point of statistical optimism remains last week’s drop in jobless claims. Today’s ISM report takes some of the shine off of any related hope that the next employment report will bail us out, but it’s not yet clear that the broad trend will succumb the full nine yards.
If the threat of a Treasury default is now off the table, if only temporarily, there’s hope that the uptick in clarity will bring a reprieve of sorts. Then again, expecting anything more than muddling through is probably expecting too much.
"These are the types of numbers that are consistent with what we saw with the GDP numbers,” Keith Hembre, chief economist at Nuveen Asset Management, says of this morning’s ISM update. "Absent a governmental shock, we would dredge forward with this stagnant economic performance. We'll be mired in this 1 to 2 percent (growth) environment we have been in."
In effect, we’re now suffering from a new slowdown in slow growth. "Manufacturing was really the one sector that was moving along quite nicely and now it’s decelerating," notes John Silvia, chief economist at Wells Fargo Securities via Bloomberg. "Businesses have cut back on orders and employment because they are just not seeing the demand that they expected. The economy is just not picking up momentum in the second half."
The question is whether the trend in the ISM report will find corroboration in the rest of July's economic numbers. The first big clue arrives this Friday with the government's employment report for July. According to Briefing.com, private sector job growth is due to pick up to a net rise of 100,000, or nearly double June's sluggish pace. And the actual number is...