January 30, 2012
A Troubling Trend For Income & Spending Rolls On
American consumers are spending less and saving more. That's the message in yesterday's personal income and consumption report for December from the Bureau of Economic Analysis. That's a healthy development for household balance sheets and, in the long run, it's a plus for the economy. But if you're looking for a fresh sign that the economy will avoid a recession, it's not clear that these numbers will suffice.
Let's start with the good news. Disposable personal income (DPI) rebounded nicely last month, rising 0.4% in December. That's the biggest monthly gain since March and a clear reversal of the sluggish numbers in recent months. But as the chart below shows, consumption growth has evaporated, with personal consumption expenditures (PCE) posting a slight retreat in December. For an economy that relies heavily on consumer spending, that's a warning sign.
The trend, of course, is the true measure to watch for evaluating the business cycle, and on this front the news continues to look troubling. As you can see in the second chart below, the year-over-year percentage change in both DPI and PCE continues to fall. Even December's relatively strong rise in DPI wasn't enough to slow the decline. PCE's year-over-year change also continues to drop. That's not an encouraging sign for the business cycle.
What force might intervene to keep the forces of contraction at bay for income and spending? A stronger labor market, of course. That may be asking for too much at this point, but the case for hope isn't over yet. Private-sector wages are still growing at a healthy clip, rising 0.5% in December, which translates into an annual rise of 4.6%--the fastest annual rate since last April. Another bit of good news: average weekly hours worked for production and nonsupervisory employees in the private sector is still trending higher, suggesting that the labor market is expanding.
The next question is whether we'll see continued job growth. Alas, the outlook doesn't look particularly robust at the moment, according to the consensus forecast for this Friday's update for private nonfarm payrolls. Economists are predicting private payrolls will add a net 168,000 positions in December, down substantailly from 212,000 in November, according to Briefing.com. If that's an accurate forecast, it'll be a disappointment.
A few analysts argue that a new recession has already started in the U.S. The ongoing deceleration in the annual pace of spending and income supports that diagnosis. Arguing otherwise will require some strongly positive numbers in the next round of economic reports, particularly for the labor market. On that score, the next three days will deliver a trio of readings on the employment trend: tomorrow's ADP Employment Report, Thursday's initial jobless claims, and Friday's nonfarm payrolls update.
A Day In New York...
The personal spending and income report for December is scheduled for release later this morning. The consensus forecast is looking for a rebound after November's tepid rise. The stakes are high, given the recent deterioration in the trend. I'll be reviewing today's numbers from afar, however, as I'm heading off to IMCA's investment consultant conference in New York. I'll have a belated reaction to today's economic news when I return to the normal routine tomorrow.
Another Crossroads For The New Abnormal?
The tight correlation in the last several years between the Treasury market's inflation outlook and the stock market (S&P 500) has been a reliable barometer of macro conditions in a period that I like to call the new abnormal. As I discussed last October, in normal times, there's minimal correlation between equity market prices and inflation expectations. Indeed, higher inflation is generally considered troublesome above a certain level... most of the time. But normality gave way in the wake of the financial crisis in late-2008, which brought us a new paradigm. And so, falling inflation expectations, until further notice, are accompanied by falling stock prices; if the trend persists, it leads to a deterioration in macro conditions. This illness will end one day, but not yet. (For the theory behind this empirical fact, see David Glasner's research paper on the so-called Fisher effect.) Hold that thought as we consider the latest signals from the stock market in the context of inflation expectations and the implications for the economy.
As the chart below shows, the past several weeks have witnessed an unusually large divergence between stock prices and inflation expectations. In particular, the equity market has climbed quite a bit while the market's inflation forecast has remained flat and in recent trading sessions has dropped under 2% for the first time this year. Equity prices have popped in large part because recent economic news has been relatively favorable, including the sharp decline in new jobless claims, which suggests that the labor market will perk up. But the rise in equity prices hasn't been accompanied by an increase in inflation expectations. That's a worrisome sign in the current climate, given what we known about the new abnormal from the last several years--all the more so when you recognize that the economy is still struggling. Either the stock market is set to tumble, which would all but confirm a new round disinflationary expectations; or the market's inflation outlook is poised to rise, which would provide some support for the bulls and expectations for continued economic growth. Why might inflation expectations rise? More encouraging news on the economy would do the trick. It's a virtuous cycle that we need to see right now. On that note, the January numbers will begin arriving this week and so we'll find out if the recent optimism finds support in the data for the new year. But with the stock market's annual change at around 2.7%, we are, it seems, at a new crossroads once again. If equities fall into the red, that would be one more weight in favor of the recession forecasts. A negative annual return for stocks isn't necessarily fate, but history reminds that recessions and the relatively rare sight of losses in the S&P 500 on a year-over-year basis go hand in hand.
The good news is that this time, in contrast to 2010, the annual rate of change in the money supply isn't low or falling. As the next chart shows, M2's pace of growth is around 10% these days vs. the tepid 1%-2% level at this time a year ago. Why does that matter? Money demand is still strong and if that demand isn't satisfied in the current climate of anxiety, the economy is likely to suffer.
The question is whether the current monetary policy will suffice? Yes, compared with this time last year, the Fed is relatively more accommodative, given the pressures of the new abnormal. But as economist David Beckworth reminds, it's not clear that the central bank is doing all it should be doing to offset the macro headwinds. Ultimately, deciding if monetary policy is too tight or too loose can only be answered in the context of money demand. There is no absolute right or wrong with money supply levels; much depends on how it relates with current appetite for liquidity.
In normal times, falling inflation would be a good thing. In the current climate, it can become toxic if inflation is allowed to fall too far. For now, it's not yet clear if inflation is set to fall. The fact that inflation expectations have been relatively stable at around 2% over the last several months has been an encouraging sign, although a higher inflation outlook of 2.5% to 3.0% would have been even better. But all bets are off if inflation expectations trend lower in the weeks and months ahead. If so, the stock market may follow. In that case, the Fed needs to up its game with another round of quantitative easing, i.e., injecting more liquidity into the system to sate higher money demand. History is quite clear on this point: when money demand rises, it must be met with an increase in supply. If not, something has to give, and it's usually prices. If disinflation/deflation is allowed to fester, it eventually infects the broader economy.
Falling stock market prices are usually the canary in this coal mine when the new abnormal prevails, and inflation expectations may precede the early warning of trouble ahead via equity prices. True, recent economic data has been modestly encouraging, as I've been pointing out on these pages recently. It's also clear that last year was recession free. But it's the near-term future that's open for debate... again.
It's not yet obvious, at least to me, what comes next. There are some analysts predicting that a new recession is near, although that forecast isn't confirmed in the latest economic numbers. The situation is quite fluid, and so much depends on the Fed policy decisions in the weeks ahead.
As for this week, the early clues about the economy's strength, or lack thereof, for January will be dispatched in the days ahead. Meanwhile, keep an eye on the divergence between the stock market and inflation expectations. If it continues to widen, there'll be little if any margin for disappointment in the next batch of economic updates.
January 28, 2012
Book Bits For Saturday: 1.28.2012
● The Benefit and The Burden: Tax Reform-Why We Need It and What It Will Take
By Bruce Bartlett
Review via The Financial Times
America’s tax system is a mess. It is unfair, poorly understood and riddled with loopholes. It is ill-equipped to raise the revenues needed to deal with the debt crisis, still less the future needs of an ageing population. It is now over 25 years since it last underwent much reform. An overhaul is long overdue. The case for change is presented in The Benefit and the Burden, a succinct, lucid book by Bruce Bartlett, an economist who spent many years in government working for Republican congressmen and in the administrations of Ronald Reagan and George H.W. Bush. In Mr Bartlett’s view, higher tax revenues are needed to stabilise the US’s finances; one of the goals of tax reform should be to make the higher tax burden more bearable. But it will not happen unless there is a much better public understanding of how the tax system works.
● Paper Promises: Debt, Money, and the New World Order
By Philip Coggan
Lecture by author via London School of Economics
The world is drowning in debt. Greece is on the verge of default. In Britain, the coalition government is pushing through an austerity programme in the face of economic weakness. The US government almost shut down in August because of a dispute over the size of government debt. Our latest crisis may seem to have started in 2007, with the collapse of the American housing market. But as Philip Coggan shows in this new book, Paper Promises: Money, Debt and the new World Order which he will talk about in this lecture, the crisis is part of an age-old battle between creditors and borrowers. And that battle has been fought over the nature of money. Creditors always want sound money to ensure that they are paid back in full; borrowers want easy money to reduce the burden of repaying their debts. Money was once linked to gold, a commodity in limited supply; now central banks can create it with the click of a computer mouse.
● Financial Turmoil in Europe and the United States: Essays
By George Soros
Summary via publisher, Public Affairs
Financial Turmoil in Europe and the United States shows George Soros responding in real time to a rippling earthquake of financial instability. In this collection of essays written since the aftermath of the Crash of 2008, he addresses the urgent need for the U.S. to restructure its banking and financial system. He anticipates the globalization of the crisis and, in particular, its perilous second phase in Europe; and finally he calls for concerted international action.
● The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money
By Carl Richards
Review via Minyanville
In his new book, Richards, also a blogger for the New York Times and Morningstar Advisor, explains why most financial "gurus" on TV can't offer you any meaningful advice because they lack knowledge of your personal situation and cannot forecast the future of the markets. Richards teaches his readers how to think on their own about investing -- ignore the herd, make realistic plans for your own financial future and hire an objective financial advisor, he says... Richards is a certified financial planner and founder of Prasada Capital Management. He works closely with like-minded individuals and families to help them not lose their money and enjoy their lives. Richards himself gained valuable insights about the consequences of listening to the "experts" when he bet too big on a new home -- almost losing his business and putting enormous stress on his family -- during the financial crash of 2008.
● Illicit Trade and the Global Economy
Edited by Cláudia Costa Storti and Paul De Grauwe
Summary via publisher, MIT Press
As international trade has expanded dramatically in the postwar period--an expansion accelerated by the opening of China, Russia, India, and Eastern Europe--illicit international trade has grown in tandem with it. This volume uses the economist's toolkit to examine the economic, political, and social problems resulting from such illicit activities as illegal drug trade, smuggling, and organized crime.
● Too Big to Know: Rethinking Knowledge Now That the Facts Aren't the Facts, Experts Are Everywhere, and the Smartest Person in the Room Is the Room
By David Weinberger
Review via Publisher's Weekly
Weinberger (Everything is Miscellaneous), a senior researcher at Harvard's Berkman Center for the Internet and Society, engagingly examines the production, dissemination, and accessibility of knowledge in the Internet era. The fundamental and pertinent question Weinberger pursues is how the new surplus of knowledge afforded by the Internet affects our "basic strategy of knowing"... While occasionally tending towards the philosophical, Weinberger's book is full of relevant and thought-provoking, insights that make making it a must-read for anyone concerned with knowledge in the digital age.
● Strategic Vision: America and the Crisis of Global Power
By Zbigniew Brzezinski
Excerpt via MSNBC
The world is now interactive and interdependent. It is also, for the ﬁrst time, a world in which the problems of human survival have begun to overshadow more traditional international conﬂicts. Unfortunately, the major powers have yet to undertake globally cooperative responses to the new and increasingly grave challenges to human well-being—environmental, climatic, socioeconomic, nutritional, or demographic. And without basic geopolitical stability, any effort to achieve the necessary global cooperation will falter.
Indeed, the changing distribution of global power and the new phenomenon of massive political awakening intensify, each in its own way, the volatility of contemporary international relations. As China’s inﬂuence grows and as other emerging powers — Russia or India or Brazil for example — compete with each other for resources, security, and economic advantage, the potential for miscalculation and conﬂict increases. Accordingly, the United States must seek to shape a broader geopolitical foundation for constructive cooperation in the global arena, while accommodating the rising aspirations of an increasingly restless global population.
January 27, 2012
US Economic Growth Accelerates Modestly In Fourth Quarter
Another backward-looking economic report dispatched a fresh round of hope today for thinking that a new recession isn't knocking on our collective doorstep. The U.S. economy expanded at an annual real rate of 2.8% in last year's fourth quarter, the Bureau of Economic Analysis reports. That's a respectable bit of improvement over Q3's 1.8% sluggish pace. Granted, the latest number fell short of the consensus forecast, which called for a 3.1% rise .But it's hard not to notice that the Q4 GDP still rose at the fastest rate since the second quarter of 2010. Perhaps it's fair to say we're slumping toward progress.
At any rate, between this morning's advance estimate of GDP and the revival in December's reading of the Chicago Fed National Activity Index, it's safe to say that 2011 was recession free. With that clean break, it's on to debating if 2012 will succumb to the darker forces of the business cycle.
"The economy ended 2011 on a fairly positive note, but the composition of growth in the last quarter is not favorable for growth early this year," warns Ryan Sweet, a senior economist at Moody's Analytics.
Part of the concern is that Q4's rebound in business inventories will slow in early 2012. As MarketWatch advises, "Businesses may have accumulated excess stock on hand and didn’t sell as many products as expected during the holiday season, analysts say." Paul Ashworth of Capital Economics comments that "the pickup in growth doesn't look half as good when you realize that most of it was due to inventory accumulation."
January data has only started to trickle in, of course, so it's going to take some time to see if the acceleration in Q4 GDP has legs. What little data we have so far for 2012, however, offers some mild encouragement. Initial jobless claims this month are still trending lower, although the latest number popped in the wrong direction. Meanwhile, the regional business surveys for January, conducted by the Fed banks of New York, Richmond and Philadelphia, offer an "upbeat" profile, notes economist Ed Yardeni. But he also worries "about the recent weakness in petroleum usage and electricity output in the US." Yardeni explains:
The former fell during the week of January 13 to 18.98 million barrels a day (using the 52-week moving average to smooth out this volatile series). That’s down from a recent peak of 19.31mbd during the week of April 29, and the lowest usage since the week of July 11, 2010. Electricity output (also based on its 52-week average) was remarkably flat over the past year, but then dropped sharply during the first two weeks of this year. Maybe it’s just the weather.
December Economic Activity Improved, Chicago Fed Reports
Yesterday's news that the Chicago Fed National Activity Index (CFNAI) increased last month provides another data point to consider in the debate about recession risk. Looking backward doesn't necessarily tell us what's coming, but it's clear that December's economic momentum strengthened. January and beyond, of course, are still open to interpretation.
"Led by improvements in production- and employment-related indicators, the Chicago Fed National Activity Index increased to +0.17 in December from –0.46 in November," according to an accompanying statement. "The index’s three-month moving average, CFNAI-MA3, increased from –0.19 in November to –0.08 in December—its highest value since March 2011."
CFNAI is a weighted average of 85 indicators of U.S. economic activity. The Chicago Fed recommends reading its 3-month moving average (CFNAI-MA3) as follows: a value below -0.70 after a period of economic expansion "indicates an increasing likelihood that a recession has begun." By that standard, the December CFNAI-MA3 reading of -0.08 suggests that another downturn was nowhere in sight last month.
That's no assurance that the coming months won't deteriorate. There are, as if we needed reminding, plenty of risk scenarios out there that might derail the still-fragile recovery. As I keep mentioning, the weak personal income and spending numbers are high on my list of potential trouble spots. Perhaps we'll learn if this worry is relevant or not when the December update arrives on Monday (Jan. 30).
There's also Europe to consider and the potential for economic blowback as the Continent struggles to keep its own recession risk at bay. The U.K., meantime, has its own problems as it "moves closer to a second recession as economy shrinks 0.2%."
Let's not forget that the festering troubles with Iran may wreak havoc on the global economy. With the European Union set to impose economic sanctions on Iran for its nuclear program, the Iranian parliament is threatening to halt oil exports to Europe. There's no sign of panic in oil trading, at least not yet. But if this crisis rolls on, the possibility for substantially higher energy prices can't be ruled out.
Perhaps the economic outlook isn't as rosy as it appears by looking solely at the data in the rear view mirror. It wouldn't be the first time that focusing on recent history blinds us to what's coming. The problem, of course, is that modeling the future is challenging, to say the least.
If the U.S. does slip into a new recession sometime in the near term because of an exogenous shock from Europe, Iran, or some unknown unknown, does that count as a win for the recession forecasters? We all know that there's always another recession lurking in the future. The timing and specific catalysts are usually the great mysteries. As such, should there be a time limit on recession forecasts? Every prediction of is accurate... eventually.
Correction: The next personal spending & income update is for December and is scheduled for release on Monday, Jan. 30. An earlier version of this article incorrectly listed the release date.
January 26, 2012
Mixed Message? Jobless Claims & Durable Goods Orders Rise
Initial jobless claims increased last week, but so did new orders for durable goods in December. It's a mixed bag of news, but a closer look suggests that the economy's capacity for growth continues to bubble.
Let's start with jobless claims. Last week's sizable 21,000 increase to a seasonally adjusted 377,000 is disappointing, but it's not all that surprising. After the previous week's dramatic fall to depths unseen in nearly four years, some backing and filling is normal. New filings for jobless benefits is a valuable leading indicator, but it's quite volatile in the short term and so the longer-run trend is a far-superior measure for this series. By that standard, the decline in new claims appears to be intact, as the chart below shows. For the moment, last week's rise appears to be nothing more than the usual ebb and flow in a generally falling trend.
“The underlying trend is moderately low layoffs," says Scott Brown, chief economist at Raymond James & Associates. "We certainly have seen a lot of volatility in the week-to-week numbers.”
Quite true, although the year-over-year percentage changes in raw claims numbers continue to post sizable declines. The second chart below puts to rest the idea that the recent fall in jobless claims is due to some seasonal glitch. Instead, the numbers tell us that the trend is still our friend. Indeed, new claims last week were nearly 15% below the levels from a year ago on an unadjusted basis. What's more, that pace of annual decline has been fairly consistent for months. Maybe the weeks ahead will reverse this virtuous cycle, but the numbers available at the moment still speak clearly: new claims are falling generally, which suggests that the labor market will continue to heal.
Today's update on new orders for durable goods, another leading indicator, also looks encouraging. Last month's healthy 3% rise for this series builds on November's 4.3% gain. Even better, the rolling 12-month pace for new durable goods orders accelerated in December to 17%--its fastest annual rate of increase in more than a year.
The gain in durable goods orders was broad based last month as well. Indeed, the gains remain comfortably in positive territory even after excluding aircraft and defense orders, which can be misleading at times in the search for the broad trend. Meanwhile, the proxy for business investment—new orders for capital goods less defense and aircraft—rose 2.9% in December.
“Improving economic momentum and diminished angst surrounding the financial crisis has encouraged businesses to take on more risk,” advises Richard DeKaser, deputy chief economist at Parthenon Group. “The factory sector will continue to perform well.”
Sung Won Sohn, an economics professor at California State University, Channel Islands, agrees: "There is more horsepower to this economy than most believe," he opines. "The stars are aligned right for a meaningful economic recovery."
Perhaps, although there's still plenty to worry about. The weak economies in Europe are one large risk factor. Another is the weak trend in personal income and spending. As such, the stakes are high for next week's scheduled update (Monday, Jan. 30) for December's spending and income numbers. But one forecast service suggests that we may dodge a bullet in the next round of releases on this front. Briefing.com predicts that December's spending and income numbers will look a bit better relative to November. Nothing less is needed to keep the momentum going.
Ultimately, the decisive factor will be job growth. Late next week (Friday, Feb. 3) we'll learn how nonfarm payrolls fared in January. Many economists remain confident that we'll see another decent report on par with December's relatively upbeat news. The drop in jobless claims over the past several months suggests that's probably a reasonable forecast.
January 25, 2012
The Long, Long Term View Of Interest Rates
Sometimes a picture really is worth a thousand words... and a couple of centuries. Graphing 222 years of U.S. long-term interest rate history isn't exactly actionable information, but it's damn interesting just the same. You want perspective? Here it is in spades. Heck, it's also a great party favor for your next financial mixer. Thanks to Barry Ritholtz at The Big Picture and the primary source, Bianco Research, for this deep dive data dig. The obvious point is that we're near all-time lows in the long bond. If that doesn't spark a few thoughts, nothing will.
Estimating GMI's Ex Ante Risk Premium
Last week, I updated the Global Market Index’s (GMI) relative performance scorecard vs. actively managed asset allocation products. Now it’s time to look ahead.
For those who don’t know, GMI is an unmanaged index that holds all the major asset classes weighted by their respective market values. As such, GMI is a valuable benchmark because it reflects a broad definition of the opportunity set. Creating benchmarks is the easy part. Modeling expected risk premia is considerably more challenging, but as I noted in my previous analysis of gazing into the future via GMI: the process is "a constructive exercise if only to think through your assumptions and stress test them against history and the alternative methodologies for predicting risk and return."
There are several ways to proceed, but for now I’ll review just one approach. The goal is developing some context for considering how GMI’s expected risk premium changes through time and how it compares with the historical record. Note that I’ve calculated the implied risk premium for GMI and so there’s no attempt to forecast returns directly. (For some background on this technique, which I've modified slightly, see the "Reverse Optimization" section in Thomas Idzorek’s monograph.) Instead, I’m making some assumptions about 1) correlations for the major asset classes relative to GMI; 2) volatility for each asset class; and 3) GMI’s ex ante Sharpe ratio. After calculating expected risk premiums for each asset class, I sum the weighted estimates (weighted by current market values).
Much of what I use as assumptions comes from looking to history. The correlation assumptions are calculated based on the historical relationship between realized risk premia for each asset class and the correlation of that performance with GMI’s return. As for the volatility assumptions, those are drawn from a simple GARCH (1,1) model, which arguably provides a slightly more robust estimate of return volatility vs. standard deviation. Overall, I believe that my numbers are fairly conservative--the aim of this caution is boosting the odds that the inevitable forecasting errors will underestimate the actual return rather than overestimate it.
The graph below compares three measures of GMI’s risk premium. The red line is the rolling annualized three-year return for GMI less the risk-free rate (3-month T-bill). The other two lines are estimates of GMI’s expected risk premium through time. The two forecasts are similar in design; the main difference is the definition of the market price of risk, as proxied by the Sharpe ratio. For the strategic estimate, I’m assuming a fixed 0.2 Sharpe ratio, which history and several research studies recommend as a long-term estimate for a broadly diversified portfolio across asset classes. The tactical estimate, by contrast, uses a more sensitive estimate of the Sharpe ratio based on recent history and measuring return volatility with what’s known as a modified value-at-risk metric.
Note that the trailing 3-year realized risk premium and the tactical estimate fluctuate around the strategic forecast, which is designed to be a more stable prediction for the long run future. This isn’t terribly surprising. In the short term, GMI’s risk premium will rise and fall around a relatively long-run mean. At the moment, my estimates suggest there’s a case for thinking that GMI will generate above-average returns. In the long run, however, the numbers tell us that GMI’s expected risk premium is a relatively modest 2.3%. Remember, that’s the outlook before adding your assumption for the risk-free rate.
A 2.3% expected risk premium for GMI isn’t terribly exciting. But maybe my estimate is wrong and the true risk premium will be much higher. Alternatively, if you accept my estimate but want better results you can adjust Mr. Market's asset allocation. The sky’s the limit for possibilities on this front, but so are the risks. You could, for instance, overweight or underweight certain asset classes. Another strategy is actively managing the mix of asset classes in search of higher performance. You could also tap active managers to round out the asset allocation in a bid to earn alpha over GMI's beta.
Nonetheless, earning above-average results isn’t going to be easy. It never is, of course, as history reminds, but it appears that even stronger headwinds are blowing in the quest to mint risk premia. Unless, of course, you're willing to embrace above-average risk.
The IMF Downgrades Global Growth But Sees No Fallout For The US
Does the International Monetary Fund's diminished outlook for the global economy lay the groundwork for thinking that recession risk is elevated for the U.S.? Perhaps, although the IMF's latest numbers suggest otherwise. Indeed, IMF projections for US GDP remain intact.
"Global growth prospects dimmed and risks sharply escalated during the fourth quarter of 2011," according to the World Economic Outlook report, which was released yesterday. The world economy will expand 3.3% in 2012, the IMF predicts—down from its previous 4.0% forecast. Quite a bit of the downgrade is due to deteriorating conditions in the euro area, which the IMF says will contract by 0.5% this year. But the stronger headwinds in Europe aren't projected to slow the U.S. economy, which is expected to expand by 1.8% in 2012, a rate that's unchanged from the IMF's previous forecast in September.
In fact, the latest numbers from Europe suggest there may more strength than it appears and so the recession in the euro zone may be milder than expected. As Reuters reports:
The euro zone may escape recession thanks to a surprise upturn in the service sector this month but the overall economy is still struggling to gain any traction outside Germany and to a lesser extent France, surveys showed on Tuesday.
Markit's Flash Eurozone Purchasing Managers' Composite Index (PMI), a reliable indicator of overall economic performance, showed the euro zone economy grew in January for the first time since August, confounding forecasts for a contraction.
Survey compiler Markit said that if sustained, the data pointed to no growth in the first quarter - but no contraction either.
Economist Nouriel Roubini, however, isn't taking the bait. "There's a recession throughout Europe, US growth is very anemic. There is a slowdown right now in China," he says.
January 24, 2012
Will December's Economic Momentum Survive The Month's Final Updates?
The full profile of the U.S. economy for December is nearly complete, and so far the numbers continue to look mildly encouraging. It’s hardly a perfect report card, and we’re still waiting for some key numbers. But based on the data released so far, it appears that growth had the upper hand in the last month of 2011.
As the table below shows, 10 of the 14 economic reports for December that are available to date posted gains last month vs. November. Even better, 11 of the 14 were in the black on a year-over-year basis through December. Among the leading indicators, 6 or the 8 currently known reports for last last month are up vs. the year-earlier figures, suggesting that the expansion will roll on.
The next leading indicator update arrives this Thursday: the December reading on new orders for durable goods. In the previous update for November, new orders rose a tidy 3.7%, representing a gain of more than 12% from a year earlier. The consensus forecast for December’s report expects a lower but still positive 2.0% rise in December, according to Briefing.com. Thursday also brings word of the latest weekly initial jobless claims report, another crucial leading indicator. The burning question: Was last week’s sharp drop a statistical quirk? Or is it truly a sign of a stronger labor market? Stay tuned.
Meantime, next week’s scheduled update on consumer spending and income for December tops my list of potential trouble spots. The November numbers on this front looked weak, and more of the same for December could undermine the apparent revival in the labor market. For the moment, however, steady as she goes, but keep an eye out for statistical pirates.
Tactical ETF Review: 1.24.2012
It's been a good year so far for risky assets. Year-to-date returns don't mean much at this point, but the out-of-the-gate start keeps hope alive. Yet the crowd always finds a reason to worry and the "surprisingly tranquil" profile of runnup will do nicely. Nonetheless, U.S. stocks look quite strong on a technical basis these days as domestic equities extend the rally that began in mid-December. Foreign stocks are following suit. Or is it the other way around? But amid a rising appetite for risk, investment-grade bonds are sagging, thanks mostly to lightening up on Treasuries. It's a different story for foreign bonds, which are rising in U.S. dollar terms, in part thanks to fresh weakness in the greenback. Meantime, commodities overall look stuck in neutral, although gold is beginning to percolate again. And after a brief respite, real estate investment trusts are taking wing once more. The question is whether the revival is a sign of things to come for the year ahead? Much depends on how the economic numbers fare in the weeks ahead. We know that recession looks like a done deal in Europe, but the consensus view is more favorable for the U.S. Meantime, here's how the charts stack up for the major asset classes via our usual list of ETF proxies…
US STOCKS • Vanguard Total Market (VTI) • Benchmark: MSCI US Broad Market Index
Off to the races... again
FOREIGN DEVELOPED MARKET STOCKS • Vanguard Europe Pacific (VEA) • Benchmark: MSCI EAFE
Foreign developed stocks are rebounding too...
EMERGING MARKET STOCKS • Vanguard Emerging Markets (VWO) • Benchmark: MSCI Emerging Market
And emerging market equities have also joined the party...
US BONDS • Vanguard Total Bond Market (BND) • Benchmark: Barclays US Aggregate
Some profit-taking in US bonds...
INFLATION-INDEXED US TREASURIES • iShares Barclays TIPS Bond (TIP) • Benchmark: Barclays US TIPS
And second thoughts about inflation-indexed Treasuries too...
HIGH YIELD BONDS • SPDR Barclays High Yield Bond (JNK) • Benchmark: Barclays High Yield Very Liquid
But the relatively high yields in junk bonds draws a crowd...
COMMODITIES • iPath Dow Jones-UBS Commodity (DJP) • Benchmark: DJ-UBS Commodity
Commodities seem to be stuck in neutral lately...
REAL ESTATE INVESTMENT TRUSTS • Vanguard REIT (VNQ) • Benchmark: MSCI US REIT
REITs reach new recent highs ...
FOREIGN DEVELOPED MARKET GOVERNMENT BONDS • SPDR Barclays Int’l Treasury (BWX) •
Benchmark: Barclays Global Treasury ex-US Capped
Foreign bonds are perking up in 2012...
EMERGING MARKET GOVERNMENT BONDS • Van Eck Market Vectors Emg Mkt Local Currency Bond (EMLC) •
Benchmark: J.P. Morgan GBI-EMG Core
Emerging market bonds are on the march again too...
FOREIGN GOVERNMENT INFLATION-LINKED BONDS • SPDR DB International Inflation-Protected Bond (WIP) •
Benchmark: DB Global Government ex-US Inflation-Linked Bond Capped
Ditto for foreign inflation-indexed government bonds...
FOREIGN CORPORATE BONDS • PowerShares International Corporate Bond (PICB) •
Benchmark: S&P International Corporate Bond
Signs of life in foreign corporates...
Charts courtesy of StockCharts.com
January 23, 2012
Delicate Relations: Markets & Macro
Searching for a connection between asset prices and the business cycle is no spring chicken. The economist Irving Fisher, for example, theorized a link between short-term interest rates and economic expectations in his 1907 book The Rate of Interest. This was also the formative period for the Dow Theory. The strategy's chief proponent, William Peter Hamilton, editor of The Wall Street Journal during the early 20th century, outlined the case for using the stock market as a proxy for measuring the ebb and flow of the economy. Reviewing the nexus between the broad trend and the market, Hamilton advised in his 1922 book The Stock Market Barometer: “What we need are soulless barometers, price indexes and averages to tell us where we are going and what we may expect. The best, because the most impartial, the most remorseless of these barometers, is the recorded average of prices in the stock exchange.”
Modern asset pricing theory also looks to financial markets for clues about macroeconomic explanations and vice versa. "The program of understanding the real, macroeconomic risks that drive asset prices (or the proof that they do not do so at all) is not some weird branch of finance; it is the trunk of the tree," writes professor John Cochrane in the textbook Financial Markets and the Real Economy. "As frustratingly slow as progress is, this is the only way to answer the central questions of financial economics, and a crucial and unavoidable set of uncomfortable measurements and predictions for macroeconomics."
Wesley Mitchell and Arthur Burns understood this in 1938, when they decided to include the stock market (S&P 500) in their design of a leading indicator index for assessing the business cycle. But stocks, for all their value for assessing expectations, are but one variable, a point that Mitchell and Burns were careful to emphasize. Good thing too, since the stock market is hardly infallible.
The same can be said for every other predictor, even if some analysts suggest otherwise. Nonetheless, the stock market remains a popular measure of expectations about the business cycle, even though it's been know to predict recessions that never materialize. The market's mixed record tempts some to dismiss it entirely, but that's premature. As I discussed a few months back, there's a connection between equity returns and the business cycle, based on industrial production as a macro proxy via cross correlation analysis. Granted, correlation isn't causation, but theory suggests that we shouldn't ignore the apparent role of stock prices as a leading indicator of the broad trend.
But there are many views on how to interpret the equity market's discounting signals and so it's not obvious how to proceed. As a benchmark, we might start by reviewing 12-month price changes to filter out some of the short-term noise. History reveals that recessions are usually associated with 12-month losses in the market. But this is less useful if you're looking for timely investment signals. "The stock market itself is a short-leading indicator of recession, so from an investor's standpoint, coincident or short-lagging recession indicators are not as useful as one would wish," laments John Hussman, portfolio manager at the Hussman Funds. "By the time it's safe to proclaim a recession and close the barn door, the horses are already out." Nonetheless, Hussman recommends watching the S&P 500's six-month performance as an early warning of macro trouble, reminding that "falling stock prices are very important as part of the broader syndrome" for estimating recession risk.
History doesn't disagree. In 1991, Jeremy Siegal reported that 38 or the 41 previous recessions since 1802 "have been preceded by an 8% decline in the stock returns index." That sounds great as a general proposition, but the analytical challenge can be rather intimidating in real time. But here we are, debating the cycle's next move and as of January 19, 2012 the S&P 500 is up 3.2% on a price basis over the past year, according to data from the St. Louis Fed. Is that a sign that the crowd's feeling good about the outlook for the economy?
Maybe, although Bob Dieli of RDLB, Inc.—a.k.a. Mr. Model—advises that there's a gray area when it comes to reading the equity market's tea leaves in a macro context. In his latest research note for clients, he considers the year-over-year change for the S&P 500, based on the month-average values using daily closes. "This makes for a slightly smoother series than what you get if you use month-end data," but in Dieli's view "the series has a perfectly awful record in forecasting recessions," as per his chart below.
The red and green lines go across the page at +10% and -10% [in the chart above], and they are there for two reasons. First, when the blue line goes through those numbers from above and below, those intersections are pretty close to business cycle events, where there are business cycle events. Second, the red and green lines define an area that I call the Zone of Death (ZOD) so named because the blue line does not like to spend much time between the red and green lines. Any time the blue line is in the ZOD I get a lot of calls from my friends in the equity management business (and you know who you are) expressing more than their usual level of anxiety about the trend of the market. I don't make market calls. But I do try and tell them whether the latest venture into the ZOD will be associated with a recession. For the record, there have been more trips into the ZOD than there have been recessions.
In search of a more reliable predictor of the macro cycle, Dieli prefers what he calls the aggregate spread, defined as the arithmetic combination of two other spreads: 1) the Financial spread, or the difference (in basis points) between the long bond and the Federal funds rate; and 2) the difference between the inflation rate and unemployment rate. The aggregate spread is designed as a tool to call turning points in the business cycle, which it "does very well," according to Dieli. The encouraging record inspires Jeff Miller at A Dash of Insight to report that "the Dieli method," which draws a fair amount of context from the aggregate spread, "has worked better than any other method in real time" in the dark art of recession forecasting.
The elevated level of Dieli's aggregate spread at the moment implies that the risk of a recession in the near term is relatively low, a view that claims some support form the Treasury yield curve, falling jobless claims, and some other indicators. Perhaps we can include the stock market in the positive column… perhaps not. The jury may be out on the equity market's forecast, although Scott Grannis notes that market "panic is slowly fading."
There's no shortage of like-minded optimism at the moment. "We think things are setting up to be better than last year," says Brad Sorensen, director of market research at Charles Schwab. "The worst-case scenario is off the table." That may be tempting fate, but there's some fresh quantitative support for thinking positively in the latest reading of the Philadelphia Fed's Aruoba-Diebold-Scotti business conditions index, which is "designed to track real business conditions at high frequency."
But what of the known unknowns? There are plenty of risks out there that could upend the rosy expectations. For some "What If?" scenarios for the year ahead, Simon Constable in the Wall Street Journal reviews several of the suspects du jour.
There are more than vague scenarios that threaten to derail the modest growth trend in the U.S., several cautious analysts warn. In his latest weekly update published today, Hussman continues to insist that "recession risk remains very high based on the leading evidence." Meantime, the Economic Cycle Research Institute (ECRI), which made a recession forecast last September has been sticking to its prediction every since. "ECRI's recession call remains quite controversial in financial circles," notes Doug Short. Fair enough, although what everyone really wants to know is whether it's right… or not.
January 21, 2012
Book Bits For Saturday: 1.21.2012
● First Principles: Five Keys to Restoring America's Prosperity
By John Taylor
Summary via publisher, W.W. Norton
Leading economist John B. Taylor's straightforward plan to rebuild America's economic future by returning to its founding principles. America's economic future is uncertain. Mired in a long crippling economic slump and hamstrung by bitter partisan debate over the growing debt and the role of government, the nation faces substantial challenges, exacerbated by a dearth of vision and common sense among its leaders. Prominent Stanford economist John B. Taylor brings his steady voice of reason to the discussion with a natural solution: start with the country's founding principles of economic and political freedom-limited government, rule of law, strong incentives, reliance on markets, a predictable policy framework-and reconstruct its economic foundation from these proven principles.
● A Nation of Moochers: America's Addiction to Getting Something for Nothing
By Charles J. Sykes
Review via Publishers Weekly
Sykes (A Nation of Victims) argues that hardworking, tax-paying Americans are being turned into the nation’s piggy bank by freeloading “moochers,” both individual and corporate, who have given in to a culture of dependence and free lunch. He lays all this squarely at the feet of “elite” liberals, whose “Assumption of Incompetence”—the default position of assuming that most Americans are incapable and thus must be cared for—has cultivated an atmosphere where people are no longer required to fend for themselves. He points to Katrina victims misusing benefits, homeowners who walk away from underwater mortgages, unemployment benefits fraudsters, adult children living with their parents, big businesses accepting bailouts, and, somewhat less persuasively, food stamps and free school lunches. Though he doesn’t make an especially strong case that “Obamacare” is to blame, his argument is sobering: we’ve set up a system in which dependency begins at birth and extends through people’s entire lives, which has brought us to a tipping point in which more Americans are relying on the efforts of others rather than their own. Interestingly, his cure is less systemic than social: he suggests “dismantling Moocher Nation” by restoring some of the stigma of accepting a handout. Though at times verging on the purely mean-spirited (recall the school lunches), his call for a return to personal responsibility is on point and persuasive.
● Money Well Spent?: The Truth Behind the Trillion-Dollar Stimulus, the Biggest Economic Recovery Plan in History
By Michael Grabell
Review via Kirkus Reviews
ProPublica reporter Grabell began the book after hearing Joe Biden present a speech seven months after Congressional Democrats approved the law without a single Republican vote in the House of Representatives and nearly zero support in the Senate. Because the stimulus involved so much money scattered over so many government programs, Grabell decided to go broad instead of deep in the narrative. He does, however, dig deep in regards to three portions of the stimulus package: providing new jobs in Elkhart, Ind., after the collapse of industry there; the cleanup of an aging nuclear power plant in Aiken, S.C.; and the manufacturing of solar panels in Fremont, Calif., as part of a concerted effort to reduce air pollution across the nation. Some of Grabell's saga is necessarily grounded in previously reported partisan politics, as the newly elected president realized his Republican opposition seemed to be placing his hoped-for election defeat in 2012 above any nonpartisanship that might create new jobs and save existing ones.
● The Age of Austerity: How Scarcity Will Remake American Politics
By Thomas Byrne Edsall
Q&A with author via The American Prospect
Edsall: Scarcity trumps culture, but it would be a mistake to view culture and the economy as inhabiting discrete spheres. Diminishing resources tend to push people in a conservative direction by increasing pressure to protect one’s own interests while simultaneously lessening generosity of spirit. Scarcity sharpens survival instincts, leading to a dog-eat-dog worldview that stresses a distinction between the “undeserving” and “deserving” poor, at the expense of structural analyses of poverty. A belief that the pie is shrinking has led to the conclusion in Washington that the debt and deficit must be reduced. If income is shrinking, cut expenses: It’s a debate inherently favorable to conservatism, which has long held the goal of shrinking the size of government (a commitment that generally ignores defense spending to focus on domestic programs).
● The Psychology of Wealth: Understand Your Relationship with Money and Achieve Prosperity
By Charles Richards
Summary via publisher, McGraw-Hill
Why do some people feel a perpetual state of lack and fear about money, while others feel genuinely prosperous, regardless of the size of their bank accounts? Why do some people shudder with dread when it comes to setting financial goals, while others embrace it with enthusiasm and confidence? What makes the difference? Could it be in their relationship with money itself? People who enjoy a healthy relationship with money share common habits and traits. So, how do they think, and what do they do differently? Are these behaviors hardwired in an individual’s psyche, or can they be learned? In this provocative book, psychotherapist Dr. Charles Richards provides unexpected and encouraging answers to these questions. Based on his research and expert interviews, Dr. Richards shows how each of us can develop a thriving relationship with money and create a rich and rewarding life.
● Birth of a Market: The U.S. Treasury Securities Market from the Great War to the Great Depression
By Kenneth D. Garbade
Summary via publisher, MIT Press
The market for U.S. Treasury securities is a marvel of modern finance. In 2009 the Treasury auctioned $8.2 trillion of new securities, ranging from 4-day bills to 30-year bonds, in 283 offerings on 171 different days. By contrast, in the decade before World War I, there was only about $1 billion of interest-bearing Treasury debt outstanding, spread out over just six issues. New offerings were rare, and the debt was narrowly held, most of it owned by national banks. In Birth of a Market, Kenneth Garbade traces the development of the Treasury market from a financial backwater in the years before World War I to a multibillion dollar market on the eve of World War II. Garbade focuses on Treasury debt management policies, describing the origins of several pillars of modern Treasury practice, including "regular and predictable" auction offerings and the integration of debt and cash management. He recounts the actions of Secretaries of the Treasury, from William McAdoo in the Wilson administration to Henry Morgenthau in the Roosevelt administration, and their responses to economic conditions. Garbade's account covers the Treasury market in the two decades before World War I, how the Treasury financed the Great War, how it managed the postwar refinancing and paydowns, and how it financed the chronic deficits of the Great Depression. He concludes with an examination of aspects of modern Treasury debt management that grew out of developments from 1917 to 1939.
January 20, 2012
The Enduring Power Of Passive Asset Allocation
The dominant theme in the financial economics literature is that most relationships are dynamic. Everything from asset valuations to correlation and volatility fluctuate through time. This empirical fact applies within and across asset classes. Change, in other words, is a constant and it is the primary source of risk and opportunity. But there's always an exception to the rule. Perhaps the leading example in finance is the persistence of average results by a representative index for an asset class or an asset allocation strategy.
One instructive example can be found in my semi-regular updates of how the Global Market Index (GMI) fares against 1,000-plus multi-asset class mutual funds and ETFs through time. In the previous update last September, GMI proved itself competitive in a varied field of actively managed strategies. History continues to repeat on this score. Indeed, GMI—a passive, unmanaged mix of all the major asset classes weighted by market values—has outperformed nearly 90% of more than 1,200 funds for the 10 years through December 31, 2011. It's surprising that GMI's record is so strong against the bulk of actively managed competitors. I doubt that this level of strength will continue for GMI. Nonetheless, I have a high degree of confidence that a decade hence, a broad, unmanaged mix of the major asset classes will remain in the above-average category, if only modestly.
As for the hard numbers from the past decade, GMI returned a 6.0% annualized total return for the 10 years through 2011's close. That puts GMI in the 89th percentile relative to the roughly 1,200 multi-asset class funds with at least 10 years of history. GMI's rebalanced and equal-weighted counterparts did even better, suggesting that there's a case for some forecast-free tweaking.
None of this comes as a surprise. Indeed, similar results are found within asset classes. No wonder that indexing is so popular. On the one hand there's a choice of capturing average to moderately above-average results with a passive strategy—a choice that comes with a relatively high degree of confidence for achieving the expected result. The alternative is opting for an actively managed strategy that, in theory, will beat the average. The critical issue for deciding whether to go with an active strategy boils down to confidence, namely: How confident are you that the manager will deliver superior results relative to an appropriate index? The chart above suggests that the odds for success may be lower than we think. But if you do use an active manager, then by all means do your homework and figure out why the fund has outperformed. Was it really skill instead of luck or just plain beta exposure?
Does this mean that asset allocation should always be passive in design and management? Not necessarily. But GMI's results remind that we should be cautious in expecting to perform miracles. It's hard to beat the markets over time. If your investment horizon is a decade or longer, history suggests that it's going to be difficult to add value over a diversified benchmark without taking a large dose of risk.
January 19, 2012
New Jobless Claims Drop Sharply
The folks expecting a new recession have a new statistical challenge today. Initial jobless claims fell sharply last week, dropping 50,000 to a seasonally adjusted 352,000. The last time new filings for unemployment benefits were this low was nearly four years ago—April 2008. Last week’s large 50,000 tumble is impressive as well relative to history. Indeed, we just saw the largest weekly drop in more than three years.
The good news might be a temporary bout of statistical noise if the latest decline was an isolated event. But as I’ve been discussing recently (here and here, for instance), it appears that new claims have entered a virtuous cycle and today's update strengthens that argument rather forcefully. You can't trust any one indicator for judging the business cycle, even a generally reliable leading indicator like weekly jobless claims. But it's getting increasingly awkward for arguing that the economy's headed for an imminent recession when claims are dropping persistently and substantially.
This much is clear: either we're due to see a major stumble in the value of new claims as a leading indicator—or the analysts who say there's a fresh downturn afoot will be forced to revise their prediction. One way or another, there's a volte-face out there somewhere.
Meantime, the latest fall in claims offer a tidy bit of confirmation for encouraging reports arising elsewhere in the economy, including yesterday's news that industrial production rose a respectable 0.4% in December. As a result, industrial production was higher by 2.9% on a year-over-year basis, or near the best levels posted in the pre-Great Recession glory years. Signs "that manufacturing in the U.S. is gaining global market share appears to be growing, and this could be an important dynamic supporting growth in 2012," says John Ryding of RDQ Economics.
If you're still inclined to worry, there's no shortage of potential trouble spots to choose from. Looking within the U.S., the weak reading lately on disposable personal income is on the short list of negatives to consider. The drop in housing starts last month doesn't look encouraging either. There's also plenty of anxiety about the troubles in Europe, including what now looks like the onset of recession on the Continent.
It's too soon to dismiss the possibility that Europe's woes won't spill over into the U.S. But for the moment, the case for arguing that a recession is fate looks fragile. Unless, of course, initial claims are delivering the mother of all misleading predictions. Never say never in economics, but sometimes the numbers look compelling.
"Over the long run, initial unemployment claims are closely related to monthly employment statistics released by the Labor Department's Bureau of Labor Statistics," notes economist Evelina Tainer in Using Economic Indicators to Improve Investment Analysis. That implies that job growth will accelerate. December's nonfarm payrolls report for the private sector hints at such a possibility. For now, there's only speculation…and a number du jour that's not so easily ignored.
Golden Stump Speeches
Is Newt Gingrich now running on a hard money platform? During campaigning in South Carolina earlier this week for the state's Republican primary on Saturday, January 21, the candidate recommended a "commission on gold to look at the whole concept of how do we get back to hard money," CNNMoney reports. "We need to say to the Federal Reserve: Your only job is to maintain the stability of the dollar because we want a dollar to be worth thirty years from now what it is worth now," he asserted. "Hard money is a discipline. It means you can't inflate away your difficulties."
Gingrich would model his "gold commission" after one put in place after Ronald Reagan was elected, when the nation was battling double-digit inflation. But even then, the commission overwhelmingly rejected the idea of a return to the gold standard.
One of only two members of the 17-member commission to endorse a return to the gold standard was Ron Paul, one of Gingrich's rivals for the GOP nomination.
Reasonable minds might wonder: Why gold now? Inflation has been quite low in recent years. In fact, given what we know about deep recessions, there's a strong empirical case for worrying that inflation is too low and will remain low for some time. Give the large output gap in the nation's economy and the still-high unemployment rate, worrying about inflation as the priority in macro continues to look premature.
The latest reading of U.S. consumer inflation, for example, pegs prices rising at a 3.4% annual rate. Historically speaking, that's near the low end of the range for the past several decades, and compared with the inflationary 1970s the recent levels look, well, almost deflationary.
Skeptics of the government's inflation estimates cry foul and warn that price pressures are actually much higher than the official numbers reveal. Perhaps, but alternative measures of inflation suggest otherwise. For example, MIT's Billion Prices Project generally tracks the government's CPI numbers. Meanwhile, the yield on the 30-year Treasury, currently at 2.9% or so, betrays minimal worries over future inflation. Indeed, the 30-year yield, which is highly sensitive to expected inflation, is near all-time lows. If the crowd expects inflation, there's a surprisingly cavalier reaction to the threat when it comes to deploying capital.
What about seeing gold as a general solution for calming economic turmoil and promoting macro stability? History reminds that we should be cautious in thinking that tying the money supply to gold is a magical elixir. For example, it's a myth that in the absence of a central bank while hugging the gold standard frees us from financial panics. For the ugly details, take a look at The Panic of 1907: Lessons Learned from the Market's Perfect Storm.
Meantime, economist David Beckworth advises "there is no need for a new commission on the gold standard. It has been extensively studied and there is a huge literature on it." He recommends starting with Barry Eichengreen's Golden Fetters: The Gold Standard and the Great Depression, 1919-1939.
Sure, the Fed is at risk of letting the inflationary cat out of the bag at some point. But there are other challenges as well, and it's not exclusively about inflation. It's all about discipline and making the right policy decisions. That's never easy, although it's certainly possible. In fact, it's reasonable to argue that the drop in inflation over the last generation (even before 2008) was at least partly due to progress in central banking. In any case, history strongly suggests caution in expecting that the adoption of a gold standard will provide a quick and easily solution to all our monetary and macro challenges. Nonetheless, the allure of fairy tales is powerful, particularly in an election year. In truth, there's only hard work and tough decisions. There's no substitute for leadership for managing the money supply.
Update: The December report on consumer prices suggests that inflation remains tame with a flat performance last month. On an annual basis as of last month, CPI rose 3.0%, or down from the 3.4% year-over-year rate through November.
January 18, 2012
Data Check: The Small-Cap & Value Factors
The academic case for using a multi-factor model to maximize the realized equity risk premium is old news, but documenting the empirical evidence is forever new. It's been known since the 1970s that the single-factor model of CAPM doesn't fully explain the risk-return relationship for stocks. The limitation of the one-beta model has inspired a range of nuanced approaches for modeling returns and looking for Mr. Market's silver lining. The most popular framework is still the Fama-French 3-factor model that taps the broad market beta along with the small-cap and value factors. It's useful every once in a while to ask: How's the 3-factor recipe working out for 'ya. As it turns out, quite well, or so recent history suggests.
There's always some doubt if the small-cap and value factors will deliver a risk premium through time. Why? Limited capacity. There's only so much room in these slices of the equity market and if too many investors pile in the expected return will fade if not evaporate entirely. Indeed, there have been stretches when holding small cap and/or value has been a dog--the late-1990s, for instance. The optimistic view is that if you're patient, and can tolerate higher risk, you'll be rewarded eventually. More ambitious types recommend some market-timing and adjusting the small-cap and value asset allocations through time based on changing expectations.
So, what does history tell us? It's clear that over multi-decade periods the evidence supports the small-cap and value strategies. But what about recent history? The last 10 years suggest that the small-cap and value factors are still alive and kicking, as the table below shows:
Note that the small-cap value (Russell 2000 Value) and microcap value (Russell Microcap Value) indices are comfortably in the lead for the past 10 years through January 17, 2012. The Russell 2000 Value has generated a 6.7% annualized total return for that decade, or nearly twice the 3.7% gain for the broad large-cap equity market (Russell 1000). It's also notable that within large-cap, value beat growth.
You can't count on the small-cap and value factors in the short term, and perhaps not even in the long run. The future's always uncertain and the associated risk premiums are empirical "facts." But for the moment, those "facts" look persuasive. Deciding if they'll remain persuasive is closely related to how many investors agree and decide to hold above-market-weight allocations in these equity groups.
January 17, 2012
An Optimist's Optimist On The Economy
If you’re looking for a cheerleader on the outlook for the U.S. economy, Ed Yardeni’s your man. "The US economy may be on the verge of a big comeback," this economist and founder of Yardeni Research predicts. "It could experience an unusual second recovery over the next three years following the weak initial recovery of the past three years. In the past, recessions were followed by one broad-based recovery in economic activity. The Naysayers have been predicting a 'double dip' recession for the US economy since it started to recover in 2009. I’m suggesting that a more likely scenario might be a double back-to-back recovery."
The foundation for his optimism is an expectation that employment growth will accelerate. He reasons that the rebound in corporate profits since the Great Recession ended has been "unusually strong" and that "profitable companies expand." As everyone knows, of course, companies have been reluctant to hire. "That could change now that they don't have as much room to expand by stretching the workweek and boosting productivity." In sum, Yardeni thinks that the pace of hiring will improve in the coming months.
The statistical evidence that his forecast is on track will find confirmation in initial jobless claims in the year ahead. He sees new weekly filings for jobless benefits dropping to around 300,000 over the next 12 to 18 months, down sharply from the latest four-week average of 381,750 through January 7.
If Yardeni's outlook is accurate, we should also see a convincing increase in consumer confidence. In fact, that's already underway, he points out. "In this scenario, consumer spending would grow at a faster clip, leading the second recovery," he opines. "It too has been subpar so far compared to the previous seven cyclical upturns."
One potential wrench in this machine is the recent weakness in the growth of personal disposable income (DPI), as I discussed last month. If the consumer is set to up his game on spending, eventually we'll see more encouraging numbers on DPI. For now, however, the jury's still out. Meantime, there are several influential analysts warning that the business cycle will turn darker before we see the dawn.
But perhaps the revival in consumer confidence of late heralds better days and so the recession forecasts are in need of an update. The latest reading on consumer sentiment reflects the highest reading in eight months with January's pop. Consumer Reports also notes that its benchmark on sentiment is looking up these days too. Yardeni puts the resurgence in consumer sentiment into historical perspective with this graph:
Should we take the rebound in consumer confidence surveys seriously for evaluating the business cycle? Yes, according to a 2011 study from the European Central Bank ("Consumer Confidence as a Predictor of Consumption Spending: Evidence for the United States and the Euro Area"):
Overall, the results show that the consumer confidence index can be in certain circumstances a good predictor of consumption. 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.
But like everything else in macro, there's always room for doubt. "The idea that changes in consumer and business confidence can be important business cycle drivers is an old but controversial idea in macroeconomics," Sylvain Leduc, a researcher at the San Francisco Fed, reminds.
The role of confidence as a source of business cycle fluctuations remains controversial partly because it is difficult to measure its importance empirically. Clearly, confidence reacts to a host of economic developments. Identifying a causal link between confidence and economic performance is therefore challenging. Is confidence higher because the economy is booming or vice versa?
Nonetheless, it's premature to dismiss the link between consumer sentiment and economic activity. "Recent empirical work indicates that these sentiments contribute significantly to economic ups and downs," Leduc concludes.
By that standard, the latest rise in consumer confidence is encouraging, if only marginally. If there's a crack in this source of optimism, Yardeni writes, we'll likely see signs of trouble with rising jobless claims data in the weeks and months ahead. For the moment, the claims numbers still look good, although the latest report was a bit shaky.
Was that just the usual short-term volatility? Yes, according to the consensus forecast for the next update. New jobless claims are expected to fall slightly in this Thursday's release, according to Briefing.com. And not a moment too soon, assuming the prediction holds. With last week's claims total at just under the psychologically perilous 400,000 mark, the margin for optimism is uncomfortably tight at the moment for this series.
Strategic Briefing | 1.17.2012 | Iran & The Proposed Oil Embargo
Oil Rises to Three-Day High as Saudi Arabia Is Seen Targeting $100 Crude
Bloomberg | Jan 17
Oil rose to the highest level in three days on speculation that China will intensify monetary stimulus, supporting fuel demand, and as France pushed for a ban on Iranian imports. France wants a European Union embargo delayed by no more than three months as members seek alternative supplies, an official with knowledge of the matter said yesterday. China’s economy expanded at the slowest pace in 10 quarters, sustaining pressure on Premier Wen Jiabao to ease monetary policy. Saudi Arabia aims to stabilize the average of crude prices worldwide at $100 a barrel in 2012, Oil Minister Ali al-Naimi said in an interview with CNN yesterday. “Everything is rising because of China,” said Carsten Fritsch, an analyst at Commerzbank AG in Frankfurt. “It’s general market sentiment.”
Iran Face-Off Testing Obama the Candidate
NY Times | Jan 17
The escalating American confrontation with Iran poses a major new political threat to President Obama as he heads into his campaign for re-election, presenting him with choices that could harm either the economic recovery or his image as a firm leader. Sanctions against Iran’s oil exports that the president signed into law on New Year’s Eve started a fateful clock ticking. In late June, when the campaign is in full swing, Mr. Obama will have to decide whether to take action against countries, including some staunch allies, if they continue to buy Iranian oil through its central bank.
US presses Seoul to cut Iranian oil
Korea Times | Jan 17
A senior U.S. official urged Korea to reduce its crude oil imports from Iran, Tuesday, as part of a U.S.-led sanctions campaign over Tehran’s alleged nuclear weapons program, saying Washington would work closely to minimize adverse effects on the local economy.
Tensions rise between Iran, Arab states over possible oil embargo
LA Times | Jan 16
The deepening economic and diplomatic pressure against Iran is sharpening tensions between Tehran and oil-producing Arab states that have long relied on the West to counter Iran's nuclear program and its regional ambitions. Iran's growing isolation has agitated sectarian mistrust in the Persian Gulf between Tehran's Shiite Muslim-run government and Sunni-controlled states including Saudi Arabia and Bahrain. In a provocative move over the weekend, Iran warned Arab regimes not to join a possible Western-backed oil embargo to further weaken its economy.
Iran tops agenda as Chinese chief visits gulf
The Jerusalem Post | Jan 17
China hasn’t joined the Western sanctions effort – indeed, Beijing gave US Treasury Secretary Timothy Geithner a “No” when he visited last week to try to recruit China into the sanctions campaign – but it realizes that its supplies of Iranian oil are no longer as secure as they once were. Analysts say it wants to make sure the Saudis will be able to open the taps if needed.
China weighs 'right side of history' in Gulf
Asia Times | Jan 18
Rebuff the United States' entreaties regarding sanctions against Iran, then nonchalantly cross the Sunni-Shi'ite divide in the Persian Gulf while sidestepping the Arab Spring altogether and vaguely greeting Islamism, and all this as solo acts - Chinese diplomacy is on a roll in the Middle East. Premier Wen Jiabao's current six-day visit to Saudi Arabia, the United Arab Emirates (UAE) and Qatar is a display of masterly diplomacy. China is probably the only big power today among the permanent members of the United Nations Security Council that can claim a strong partnership with Syria and Iran on the one hand and Saudi Arabia and Qatar on the other.
History Suggests Europe’s Iran Oil Ban Could Fail
The Source/The Wall Street Journal | Jan 16
U.K. Foreign Secretary William Hague reportedly confirmed over the weekend that the European Union will slam an oil embargo on Iran when it meets later this month. U.K. Foreign Secretary William Hague reportedly confirmed over the weekend that the European Union will slam an oil embargo on Iran when it meets later this month. But in a freshly released report, Chatham House, the U.K.’s most authoritative foreign affairs think-tank, begs to differ. “Oil embargoes simply do not work,” it said. Its conclusion is based largely on a previous embargo against Iran—when foreign powers banned Iranian exports after Prime Minister Mohammad Mossadegh nationalized the country’s oil industry.">report, Chatham House, the U.K.’s most authoritative foreign affairs think-tank, begs to differ. “Oil embargoes simply do not work,” it said. Its conclusion is based largely on a previous embargo against Iran—when foreign powers banned Iranian exports after Prime Minister Mohammad Mossadegh nationalized the country’s oil industry.
Closure of Hormuz Strait: An Actual Threat or Diplomacy?
Sara Vakhshouri, Fmr. advisor to the director of the National Iranian Oil Co (lHuffington Post) | Jan 16
Closing the Straight, albeit temporarily, is their way of signaling that there are some bargaining chips that it cannot tolerate being deprived of. Since there is no ongoing dialogue between the US and Iran, the threat to close the Straight of Hormuz should be seen as an act of subtle diplomacy in the absence of ambassadors and embassies. It is not a desire to disrupt global energy markets, which would destroy any support Iran has from other countries (such as Russia and China) opposed to sanctions. Thus, it is a rhetorical device, a warning rather than a promise. It is a massage to remind the US and Europe that Iran plays a major role in global oil security and energy markets, and also to counter the convenient idea that Saudi spare capacity would simply replace Iranian oil and leave markets in tact. These warnings should not be seen as 'bluster' by an irrational regime, but as an expression of Iran's rubric of national security.
Iran Warns Riyadh, An Increase In Exports Is 'Unfriendly'
AGI | Jan 17
Tehran- Iran warned Saudi Arabia "reflect" on its commitment to increase oil production to offset any fall due to sanctions. A move of this kind, warned foreign minister, Ali Akbar Salehi, in an interview with Iran's Arabic language television channel, Al-Alam, does not show a "friendly" attitude. "We urge the Saudi authorities to further reflect and reconsider" their offer to compensate for decreased Iranian exports, added Salehi.
January 16, 2012
Is The Yield Curve Still A Reliable Signal Of Recession Risk?
In the current debate about recession risk, some commentators have rolled out the yield curve argument or variations thereof. On first glance, this line of analysis looks like a slam-dunk refutation of the forecast by some that another economic contraction is now fate. But such arguments based heavily (or exclusively) on the yield curve risk overplaying their hand. It’s true that the yield curve has been a reliable predictor of recessions for half a century, as many studies assert. Indeed, the literature on this topic is now quite extensive and persuasive. But in the dark art of developing macro forecasts, one can never assume that a predictor’s track record—even one as strong as the yield curve’s—seals its fate for repeat performances. It'd be wonderful if we could point to one indicator as a dependable predictor, but macro's just not that simple.
But let’s back up for a minute and recognize the yield curve’s allure. It’s well known that when short rates rise above long rates, that’s been a strong signal that the economy was headed for a recession in the near term. This track record is quite clear by reviewing the yield spread for, say, the 10-year Treasury less the 3-month T-bill. For additional clarity, this signal can be transformed with a probit model so that the spread is converted into a probability estimate of future recession risk.
For example, using the procedure for parameter estimates outlined in a 2006 New York Fed paper ("The Yield Curve as a Leading Indicator: Some Practical Issues"), I calculated recession risk in an Excel spreadsheet for the 12-month-ahead time horizon based on monthly yield data history for the 10-year Note and 3-month T-bill (see "The Probability Model" sidebar on p. 3). Here's the resulting chart, which is updated through the end of 2011:
Clearly, the history of the yield curve as a predictor of recessions is quite good. No wonder, then, that if you create a model that piggybacks off of the yield curve in some degree you're going to generate similarly favorable results these days. There's virtually no recession risk via the yield curve model at the moment given that the spread was positive by 186 basis points as of January 13 (i.e., the 10-year yield was 1.89% and the 3-month T-bill was just 0.03%). That's a relatively high reading in the context of the last 50 years and it suggests that a new recession is nowhere in sight.
The problem is that it's unclear if the yield spread indicator has been compromised by the unusual run of monetary policy in recent years. The Federal Reserve has reduced short rates to virtually zero since late-2008 and it appears that zero will prevail for the foreseeable future. Under those conditions, an inverted yield curve isn't possible.
It's an open debate if the yield curve remains a viable predictor of the business cycle under the current conditions. In particular, the question is whether the economy can still contract when short rates are at zero? Only time will tell. Meanwhile, a simple reading of history suggests the odds are quite low. But even under the best of circumstances, relying on one indicator is dangerous. At some point, every predictor fails. So far, the yield curve appears to have sidestepped that fate, but it's unlikely that it will shine indefinitely. Whether it's failing now is unclear. In any case, it's folly to put too much weight into the yield curve (or any other predictor) for estimating recession risk.
A more robust model is one of combining multiple predictors and generating probit models for each to estimate the outlook for the economy. Ideally, the pool of predictors will represent a diversified mix of economic dynamics to minimize redundancy and the risk of failure. It's reasonable to anticipate that one or two predictors will stumble at some point, but it's unlikely that all will fail simultaneously (assuming you choose a truly diversified mix). Over time, it's likely that we'll see different predictors fail at different times. Fortunately, there's no shortage of useful factors to consider to manage this hazard. If anything, there's too many predictors, which is why empirical testing keeps econometricians busy.
The good news is that there's a fair amount of corroboration from other predictors for the yield curve's current prediction that economic growth will continue. Nonetheless, some analysts disagree. But any forecaster who's relying on the spread alone for expecting that the modest expansion will roll on may be courting trouble. It's premature to conclude that the economy is doomed for another round of contraction, but the odds that we'll muddle through are well below the near-certainty levels implied by the yield curve alone.
January 14, 2012
Book Bits For Saturday: 1.14.2012
● Broke: How Debt Bankrupts the Middle Class
Edited by Katherine Porter
Summary via publisher, Stanford University Press
While the recession that began in mid-2007 has widened the scope of the financial pain caused by over-indebtedness, the problem predated that large-scale economic meltdown. And by all indicators, consumer debt will be a defining feature of middle-class families for years to come. The staples of middle-class life—going to college, buying a house, starting a small business—carry with them more financial risk than ever before, requiring more borrowing and new riskier forms of borrowing. This book reveals the people behind the statistics, looking closely at how people get to the point of serious financial distress, the hardships of dealing with overwhelming debt, and the difficulty of righting one's financial life. In telling the stories of financial failures, this book exposes an all-too-real part of middle-class life that is often lost in the success stories that dominate the American economic narrative. Authored by experts in several disciplines, including economics, law, political science, psychology, and sociology, Broke presents analyses from an original, proprietary data set of unprecedented scope and detail, the 2007 Consumer Bankruptcy Project. Topics include class status, home ownership, educational attainment, impacts of self-employment, gender differences, economic security, and the emotional costs of bankruptcy. The book makes judicious use of illustrations to present key findings and concludes with a discussion of the implications of the data for contemporary policy debates.
● Financing Failure: A Century of Bailouts
By Vern McKinley
Summary via publisher, The Independent Institute
During the recent financial crisis no issue has aroused more passion than financial institution bailouts. The standard rationale for the bailouts has been one of necessity and fear: federal regulatory agencies must have more authority in order to respond to the crisis, or else the public will face terrible consequences. But does this rationale hold up to close inspection? In Financing Failure, Vern McKinley approaches the topic by examining the policy decisions behind the bailouts and by showing their connection to previous government interventions. He brings under scrutiny the policy decisions made by the Treasury Department, the Federal Reserve, and the FDIC during the crisis of the 2000s and links them to policies that go back as far as the 1930s. This history of bailouts reveals that the genesis of financial crisis is government policy, be it the mismanagement of monetary policy during the 1930s or the political push to expand homeownership that helped cause the 2000s crisis.
● Behavioral Investment Management: An Efficient Alternative to Modern Portfolio Theory
By Greg B. Davies and Arnaud de Servigny
Summary via publisher, McGraw-Hill
Written by leading money managers with expertise in both quantitative and behavioral finance, this cutting-edge guide shows institutional investment managers, retail investors, and investment advisors how to use the latest theories and techniques from the field of behavioral finance to construct better-performing portfolios. After systematically deconstructing MPT to illustrate why it does not work empirically, this one-of-a-kind book presents a reasonable framework for improving your ability to generate high-performing portfolios. The applicability and strategic consequences of this book’s approach set a new standard for portfolio development that will put you far ahead of the industry curve.
● Behavioral Finance and Wealth Management: How to Build Optimal Portfolios That Account for Investor Biases
By Michael Pompian
Excerpt via publisher, Wiley
At its core, behavioral finance attempts to understand and explain actual investor and market behaviors versus theories of investor behavior. This idea differs from traditional (or standard) finance, which is based on assumptions of how investors and markets should behave. Wealth managers from around the world who want to better serve their clients have begun to realize that they cannot rely solely on theories or mathematical models to explain individual investor and market behavior. As Meir Statman’s quote puts it, standard finance people are modeled as “rational,” whereas behavioral finance people are modeled as “normal.” This can be interpreted to mean that “normal” people may behave irrationally—but the reality is that almost no one (actually, I will go so far as to say absolutely no one) behaves perfectly rationally, and dealing with normal people is what this book is all about. We will delve into the topic of the irrational behaviors of markets at times; however, the focus of the book is on individual investor behavior.
● Macroeconomics Beyond the NAIRU
Servaas Storm and C. W. M. Naastepad
Summary via publisher, Harvard University Press
Economists and the governments they advise have based their macroeconomic policies on the idea of a natural rate of unemployment. Government policy that pushes the rate below this point—about 6 percent—is apt to trigger an accelerating rate of inflation that is hard to reverse, or so the argument goes. In this book, Servaas Storm and C.W.M. Naastepad make a strong case that this concept is flawed: that a stable Non-Accelerating Inflation Rate of Unemployment (NAIRU), independent of macroeconomic policy, does not exist. Consequently, government decisions based on the NAIRU are not only misguided but have huge and avoidable social costs, namely, high unemployment and sustained inequality.
January 13, 2012
The Fed's Undistinguished Macro Discussions Circa Jan 2006
Anticipating recessions is hard, especially the ones in the future. Just ask the Fed officials who attended the January 2006 FOMC meeting to discuss the outlook for the economy. The newly released transcripts from this meeting have attracted attention far and wide about Fed's ability, or lack thereof, to see macro changes. Unfortunately for the central bank, the reviews are in and most pundits aren’t impressed (see news reports here and here, for example.) The Atlantic's Derek Thompson finds the transcript "damning" in light of the "blithe ignorance in the face of impending doom."
At issue is whether there was sufficient warning in the stumbling housing market to alert policy makers of the turmoil that lay ahead in early 2006. It's all obvious in hindsight, of course, prompting comments like this one from Slate's Matthew Yglesias:
Some people sat around looking at the US economy from 2002-2006 and thought all was well. But many people looked at it and could see clearly that all was not well. That we were on an unsustainable path and that we were primed for a crash. The main feature of the unsustainable path was huge inflows of foreign capital into AAA-rated American financial instruments, including US government debt, mortgage-backed securities, etc. These unsustainable flows were distorting employment patterns and sustaining unsustainable living standards. Americans were maintaining broad-based consumption growth only through excessive household indebtedness and underpayment of taxes relative to the quantity of services being received. Someday soon, the capital flows would come to an end and we'd have a version of a classic developing economy sudden stop of "hot money," except it would be happening to a rich industrialized nation. The value of the dollar would crash, restraining inflation would require high interest rates, and the US economy would feature a period of painful restructuring.
Some analysts argue that the Fed's monetary policy was overly accommodative, which unleashed a housing bubble. But Scott Sumner disagrees, in part because the housing market was correcting for several years before we reached the oh-my-god-it's-all-going-to-end-NOW moment in September and October of 2008.
One interesting discussion point to consider amid all the chatter about the 2006 minutes and what should have been done is the fact that the Treasury yield curve looked rather ominous when the FOMC convened six years ago. The spread between the 10-year Note and the 3-month Treasury bill was unusually low as of the January 31 meeting: less than 20 basis points, or down from nearly 400 basis points in mid-2004. Even in 2006, there was a large amount of research advising that the yield curve was a powerful signal for assessing recession risk. In particular, when the yield curve inverts, a contraction in the economy almost always follows.
To be fair, the curve hadn't inverted as of January 31, 2006, but it was close, and it was obvious that the spread had been falling sharply in recent history. Later in 2006, the yield spread would go negative, sending a shot across the bow for the business cycle—a warning that would be proven timely once again when a new recession arrived at the close of 2007. Many dismissed it at the time, but now we know better.
A 2008 study by the San Francisco Fed notes:
… forecasters appear to have generally placed too little weight on the yield spread when projecting declines in the aggregate economy. Indeed, we show that professional forecasters appear worse at predicting recessions a few quarters ahead than a simple real-time forecasting model that is based on the yield spread. This relative forecast power of the yield curve remains a puzzle.
These days, as analysts again struggle with deciding if a new recession is near, probably can't rely on the yield curve this time, thanks to the Fed's unusually efforts at keeping the short end of the curve at roughly zero. Does that distort the value of the curve for predicting recessions? It's debatable and only time has the answer. For the moment, the 10-year/3-month T-bill spread is positive at around 200 basis points. Historically, that tells us that there's a recession isn't imminent, although that doesn't stop some analysts from predicting that a new downturn is near.
Relying on predictor is dangerous, of course. On that note, if we have another recession soon, the value of the yield curve will be tarnished. So it goes in forecasting the business cycle. Expecting what worked before to be a reliable guide now and forever more is expecting too much. Still, it's hard to read the 2006 transcripts and see the Fed officials as distinguished in the art/science of macro forecasting. Of course, the central bank can redeem itself when it meets later this month (January 25-26). We're not looking for much, just a simple prediction about the risk of a new downturn for the year ahead. An accurate prediction would be nice. But, hey, no pressure.
Update: David Beckworth argues that Fed's action pre-2008 weren't all about failure:
Yes, the Fed like most observers did not understand all the linkages between housing, the financial system, and the broader economy at the time, but this fact does not really matter. What matters--and is missed by these observers--is that the Fed was fairly successful in preventing the housing recession from spreading to the broader economy for almost two years! From the peak of the housing market in the spring of 2006 to about mid-2008, the Fed was able to keep aggregate nominal spending growing with minimal slowdown from the housing recession. It did so by keeping nominal spending (and by implication inflation) expectations stable over this time... Now, ultimately the Fed did make a historically large policy blunder in mid-2008 by allowing the largest peacetime collapse in nominal GDP since the late 1930s. The collapse is evident in the figure above. But that was mid-2008, not 2006, and it is something the Fed could have been minimized, if not prevented, with something like a nominal GDP level target. But that is an another story. The main point here is that all the excitement over the 2006 FOMC transcripts completely ignores the success of the Fed in 2006 and 2007.
January 12, 2012
Jobless Claims Rise As Retail Sales Slow
There are two ways to interpret today’s economic updates on weekly jobless claims and retail sales for December. If you’re inclined to see a recession coming, a view that appeals to some analysts, the numbers du jour offer some marginally stronger support for expecting trouble. But the latest reports are hardly game changers and so it’s not obvious that a moderately optimistic outlook is suddenly indefensible.
Let’s begin with jobless claims, which rose a hefty 24,000 last week to a seasonally adjusted 399,000—the highest since late-November. The latest jump brings us just under the psychologically distressing benchmark of 400k. Suddenly there’s a new question of whether the progress in recent weeks was another head fake? You can’t dismiss anything these days, but thinking that we're doomed (again) is still premature.
The standard caveat is worth repeating: jobless claims data is quite noisy in the short term and so drawing hard-and-fast conclusions from one report is risky. Far more important is the trend for this leading indicator, including its four-week moving average, which remains near its lowest level for new claims since the recession was formerly declared over as of mid-2009. The persistent decline in the four-week average since last spring has signaled a stronger labor market, and so far that's prediction looks good. Deciding if the latest rise in jobs creation rolls on is the subject of some speculation, but for now there’s no smoking gun in today's claims number one way or another.
Meantime, consider the unadjusted year-over-year change in jobless claims. As of last week, new filings for jobless benefits are lower by roughly 17%. In other words, the general trend in the labor market is still getting better, not worse.
Still, there’s plenty to worry about, and at the top of my list is the slowing growth rate in disposable personal income (DPI), as I discussed yesterday. My concern is that if the pace of increase for DPI continues to fade, it raises questions about the outlook for consumption, which in turn will influence the next phase of the business cycle. Today’s retail sales report isn't terrible (December sales are virtually unchanged at a 0.1% seasonally adjusted rise over November), but it doesn’t ease my anxiety for DPI's future either. Indeed, last month's retail sales rise was the slowest month for this series since last May’s modest decline.
The overall trend in retail sales offers a truer profile of where we may be headed, but here too there appears to be the potential for problems. Retail sales are up 6.5% for the year through last month. That’s actually quite good, but as the chart below shows the rate of increase has been descending steadily over the last three months. Is this a sign that the weakening trend in income growth for consumers has momentum and is taking a toll on consumption? That’s the fear and at the moment it can’t be dismissed as a potential trouble spot for the foreseeable future.
"The retail sales (data) suggests that spending isn't really picking up any momentum," says Sean Incremona, an economist at 4Cast Ltd. tells Reuters. Tim Quinlan, an economist at Wells Fargo Securities, agrees, telling Bloomberg: "Consumers pulled out all the stops to have a decent holiday season, but we’re seeing the momentum from that dropping off."
If the recent recovery in the job market also starts to fold, the business cycle’s goose may be cooked. But it’s too early to say for sure what comes next. Nonetheless, fresh seeds of doubt have been planted with today’s updates. The next question in the wake of this news is whether there’s any fallout in consumer sentiment? Tune in tomorrow for the January release of the University of Michigan Consumer Sentiment Index. Briefing.com reports that the consensus forecast calls for a moderate rise.
Research Review | 1.12.2012 | Austerity Economics
The "Austerity Myth": Gain without Pain?
Roberto Perotti (University of Bocconi) | November 2011
As governments around the world contemplate slashing budget deficits, the "expansionary fiscal consolidation hypothesis" is back in vogue. I argue that, as a statement about the short run, it should be taken with caution. Alesina and Perotti (1995) and Alesina and Ardagna (2010) (AAP) show that fiscal consolidations may be expansionary if implemented mainly by cutting government spending. IMF (2010) criticizes the data and methodology used by AAP, and reach opposite conclusions. I argue that because of the multi-year nature of the large fiscal consolidations, which are precisely the most informative ones, using yearly panels of fiscal policy is limiting. I present four detailed case studies, two -- Denmark and Ireland -- undertaken under fixed exchange rates (the most relevant case for many Eurozone countries today) and two -- Finland and Sweden -- after floating the currency. All four episodes were associated with an expansion; but only in Denmark the driver of growth was internal demand. However, after three years a long slump set in as the economy lost competitiveness. In all the others for a long time the main driver of growth was exports. In Ireland this occurred because the sterling coincidentally appreciated. In Finland and Sweden the currency experienced an extremely large depreciation after floating. In all consolidations interest rate fell fast, and wage moderation played a key role in generating a gain in competitiveness and a decline in interest rates. Wage moderation was facilitated by the direct intervention of the government in the wage negotiation process. In Finland and Sweden, the adoption of inflation targeting at the same time of the consolidation helped the decline in interest rates. These results cast doubt on at least some versions of the expansionary fiscal consolidations hypothesis, and on its applicability to many countries in the present circumstances. A depreciation is not available to EMU members today (except vis à vis countries outside the Eurozone). A net export boom is not feasible for the world as a whole. A further decline in interest rates is unlikely in the current situation. And incomes policies are not popular nowadays; moreover, international experience, and the Danish case, suggest that they are ineffective after a few years.
Is the Recovery Sustainable?
Dimitri Papadimitriou (Bard College), et al. | December 2011
Fiscal austerity is now a worldwide phenomenon, and the global growth slowdown is highly unfavorable for policymakers at the national level. According to our Macro Modeling Team's baseline forecast, fears of prolonged stagnation and a moribund employment market are well justified. Assuming no change in the value of the dollar or interest rates, and deficit levels consistent with the Congressional Budget Office’s most recent “no-change” scenario, growth will remain very weak through 2016 and unemployment will exceed 9 percent. In an alternate scenario, the authors simulate the effect of new austerity measures that are commensurate with the implementation of large federal budget cuts. Here, growth falls to 0.06 percent in the second quarter of 2014 before leveling off at approximately 1 percent and unemployment rises to 10.7 percent by the end of 2016. In their fiscal stimulus scenario, real GDP growth increases very quickly, unemployment declines to 7.2 percent, and the US current account balance reaches 1.9 percent by the end of 2016—with a debt-to-GDP ratio that, at 97.4 percent, is only slightly higher than in the baseline scenario. An export-led growth strategy may accomplish little more than drawing a small number of scarce customers away from other exporting nations, and the authors expect no net contribution to aggregate demand growth from the financial sector. A further fiscal stimulus is clearly in order, they say, but an ill-timed round of fiscal austerity could result in a perilous situation for Washington.
Austerity and Anarchy: Budget Cuts and Social Unrest in Europe, 1919-2008
Jacopo Ponticelli and Hans-Joachim Voth (Universitat Pompeu Fabra) | August 2011
Does fiscal consolidation lead to social unrest? Using cross-country evidence for the period 1919 to 2008, we examine the extent to which societies become unstable after budget cuts. The results show a clear correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the case. While autocracies and democracies show a broadly similar responses to budget cuts, countries with more constraints on the executive are less likely to see unrest after austerity measures. Growing media penetration does not strengthen the effect of cut-backs on the level of unrest.
Is Ireland Really the Role Model for Austerity?
Stephen Kinsella (University of Limerick) | September 2011
This paper describes the causes and consequences of Ireland’s economic crisis in the context of the policy solution implemented to contain that crisis: protracted fiscal austerity. I describe the causes of the recent crisis in Ireland, and look at the logic of austerity with a simple model. I compare the current crisis to the crisis of the 1980s, when fiscal austerity was touted as the trigger for the Celtic Tiger. I discuss the measures implemented to date in the current crisis, tracing their effects on sectors of Ireland’s macroeconomy, and, finally, ask whether Ireland is, indeed, the role model for fiscal austerity in the Eurozone and beyond.
Expansionary Austerity New International Evidence
Jaime Guajardo (IMF), et al. | July 2011
This paper investigates the short-term effects of fiscal consolidation on economic activity in OECD economies. We examine the historical record, including Budget Speeches and IMFdocuments, to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to prospective economic conditions. Using this new dataset, our estimates suggest fiscal consolidation has contractionary effects on private domestic demand and GDP. By contrast, estimates based on conventional measures of the fiscal policy stance used in the literature support the expansionary fiscal contractions hypothesis but appear to be biased toward overstating expansionary effects.
Fiscal Policy in an Era of Austerity
David Schizer (Columbia Law School) | October 2011
We face a time of stagnant economic growth, severe unemployment, massive budget deficits, and an increasingly competitive global economy. Monetary policy is tapped out, and there is a great deal of uncertainty about the effectiveness of a traditional Keynesian stimulus – and, not surprisingly, a heated debate among economists. One thing we do know is that a stimulus is quite difficult to execute effectively. For example, it is a challenge to identify “shovel ready” projects that contribute to long-term economic growth, particularly on short notice. There is no uncertainty, though, about the need to address a broad range of specific problems contributing to our economic woes. As an illustrative example, this Article emphasizes the perils of having the highest corporate tax rate in the Organisation for Economic Co-operation and Development (“OECD”) in a competitive global economy. Cutting our corporate tax rate will encourage businesses to invest and hire more employees, while also reducing incentives to engage in wasteful tax planning and to shift taxable income and jobs overseas.
Let Them Eat Cake: Socio-Economic Rights in an Age of Austerity
Paul O'Connell (University of Leicester) | August 2011
The argument advanced here, in a nutshell, is that this current age of austerity should not be viewed, as it is often cast, as exceptional, but should instead be understood as the natural order with respect to government attitudes to socio-economic rights. To put it slightly differently: in the context of an economic and social system which invariably privileges numerically small, elite groups within society, both at the domestic and global level, commitments to socio-economic rights are only ever formal, and honoured in the most grudging and limited of ways. Or, returning to the title of this chapter, in an economic and political order premised on the privileging of the few at the expense of the many, governments are happy to agree to allow everyone to “eat cake”, so long as each atomistic market actor is ready to secure it for his or herself. One important consequence of this, is that the language of socio-economic rights, and consequently the various interests related to and protected by them, tends not to feature in decision-making processes about the size and share of the national resources cake. Therefore, in seeking to take what silver lining their may be from the current crisis, we need to look at ways of democratising such decision-making processes, to provide at least the possibility that socio-economic rights, and the interests associated with them, will figure in the calculus.
Eurozone Sovereign Debt Crisis
Serge L. Wind (NY University) | November 2011
The eurozone, composed of 17 countries which have adopted the euro as their currency, has been struggling with an apparently-intractable crisis over the enormous debts faced by its weakest economies and by countries impacted by the bursting of the housing boom in the past global recession of 2007-09. “Fiscally-distressed” countries now include Italy and Spain, both too big to bail out, along with Greece, Ireland and Portugal. Major contributing factors are the sizes of net government debt, primary budget deficits and negative current account (trade) balances, each expressed as a percent of GDP. With potential loss of access to bond markets, inability to devalue and failure of the European Central Bank (ECB) to intervene, stern demands by Germany for adoption of severe austerity programs and reform could lead to a deeper recession, bond restructurings, bailouts, and even defaults on sovereign debt. The only resolution now apparently demanded by bond markets and deficit hawks is unequivocal confirmation of the ECB as lender-of-last-resort for Italy and Spain. However, Germany’s leaders are firmly opposed to expansion of ECB’s role due to concerns of inflation, devaluation of its assets, and moral hazard (rewarding risky behavior’s losses). Quickly-moving bond markets may provide a stern test of the slowly-unfolding, “just-in-time” crisis management led by Germany, which currently is proposing a “fiscal union” with enforceable deficit limits. Underlying structural factors associated with peripheral eurozone countries – overspending, imports exceeding exports, higher real labor costs, lower productivity, real appreciation, tax avoidance and the reluctance to radically reform – reflect national traits and behavior which may be difficult to change quickly. Over 40 charts support paper’s observations.
January 11, 2012
Crunch Time For The Business Cycle
If there's one corner of the economy that concerns me more than others, it's the recent trend in disposable personal income (DPI). As I discussed last month with the update of the November data, the falling pace of annual growth is starting to look troubling on this front.
DPI is a crucial factor generally for the consumption-dependent U.S. economy. Any one month isn't all that important, but the trend is another matter. As the authors of Conquering the Divide: How to Use Economic Indicators to Catch Stock Market Trends advise, DPI is "the amount of money consumers have available to spend after paying income taxes." As a result,
The rate of change in disposable income offers insight into the balance sheet of the consumer. As income increases, spending should follow and economic growth should be healthy. Decreasing incomes are signs of potential recessions.
Analysts expecting a new recession in 2012 are still in the minority, but they're a persistent lot, as I noted yesterday. One of the stronger arguments for worrying surely resides with the diminishing growth rate of DPI. The annual change was a modest 2.4% as of November, the latest update. A year earlier, in November 2010, DPI was advancing twice as fast at a 4.8% pace on a year-over-year basis. Other than during the Great Recession and its aftermath in 2008 and 2009, the current rate is near the lowest levels on record, which starts in 1959. Not a good sign for looking to the year ahead.
The speed of the decline in the annual rate of growth in DPI is the primary concern. It's been unfolding for some time and so it's hard to dismiss the weakening trend as statistical noise. The slowdown has obvious implications for consumption. Speaking of which, on Thursday the government releases the December reading for retail sales, which are expected to post a handsome rise of 0.5%, according to the consensus forecast via Briefing.com. The optimism seems warranted, at least for the moment, given the generally favorable increase in holiday sales.
But there's a sizable and growing gap between DPI and retail sales, with the latter rising at a much faster pace. If the squeeze on disposable income rolls on, there will be repercussions for consumption, which inevitably will spill over into the broader economy. The question is whether the recent strength in the labor market will save us from this train wreck? A stronger rate of job growth is the critical tonic that's needed to keep DPI's trend from sinking further if not mounting a revival.
On that note, Thursday also brings word of the latest on the weekly report on initial jobless claims, which have been falling recently. The hope is that the drop in claims is a reliable signal of stronger job growth in the months ahead. Nothing less is needed to offset the deterioration in DPI. The folks telling us that there's a new recession approaching are effectively saying that initial jobless claims aren't a dependable harbinger of things to come. They may be right, but if there's any hope for avoiding a downturn, a stronger labor market is surely on the short list of potential saviors.
The good news is that it's too soon to throw in the towel on seeing a way out of this mess. Private nonfarm payrolls rose 1.8% in December vs. a year earlier. That's a decent increase by the standard of the last several decades. More importantly, the annual pace has been rising. At the end of 2010, the year-over-year increase was just 1.1%. If there's another recession coming, we'll probably see the private sector labor market's current 1.8% year-over-year growth rate take a dive lower in the months ahead.
For now, however, the latest numbers tell us the labor market is improving, a trend—if we can keep it—that will go a long way in putting the recession forecasts on the defensive. But we're at a point where there's minimal, if any, room for bad news.
January 10, 2012
The Great Debate About Recession Risk Rolls On
The economy appears to be on the mend, but the great debate about recession risk in 2012 is in no danger of fading. The labor market may be reviving, but that’s not enough—at least not yet—to convince some analysts that the danger has passed.
Let’s start with the Economic Cycle Research Institute, which bills itself as “the world's leading authority on business cycles.” The firm continues to stand by its late-September recession forecast, There’s a robust discussion about whether a dark outlook for the U.S. economy is still warranted in the wake of what economist James Hamilton calls a “favorable turn” in the recent update of leading indicators, albeit with some considerable caveats, he adds.
In any case, ECRI’s recession call is at odds with the consensus forecast these days. Leading the charge of the optimists is the Conference Board’s Leading Economic Index, which continues to signal expansion. “November’s increase in the LEI for the U.S. was widespread among the leading indicators and continues to suggest that the risk of an economic downturn in the near term has receded,” says Ataman Ozyildirim, an economist at the consultancy. Dwaine van Vuuren of PowerStocks Investment Research also offers an “opposing view” of the recession-is-fate forecast based on analysis of nine coincident and leading economic benchmarks.
Such optimism contrasts sharply with recent calls by others that a new recession this year is destiny. Last month, for instance, Van Hoisington of the fixed-income manager Hoisington Investment Management told Barron’s:
We are going to enter another recession next year, when we haven't really fully recovered from the previous one. We think we are in what Niall Ferguson, a Harvard historian, recently termed a slight depression. This isn't a normal business cycle. So long as there is downward pressure on prices, bond yields will either continue to go down or bottom out around the real rate, assuming that the inflation rate stops at zero. We aren't there yet, obviously, but are headed in that direction. That's why we've had a bull market and why it will continue until such time as inflationary expectations start to rise.
John Hussman of Hussman Funds weighs in by warning that the recent optimism arising from the economic news leans too heavily on anecdotal evaluations:
I can understand this view in the sense that the data points are correct - economic data has come in above expectations for several weeks, the Chinese, European and U.S. PMI's have all ticked higher in the latest reports, new unemployment claims have declined, and December payrolls grew by 200,000.
Unfortunately, in all of these cases, the inference being drawn from these data points is not supported by the data set of economic evidence that is presently available, which is instead historically associated with a much more difficult outcome. Specifically, the data set continues to imply a nearly immediate global economic downturn. Lakshman Achuthan of the Economic Cycle Research Institute (ECRI) has noted if the U.S. gets through the second quarter of this year without falling into recession, "then, we're wrong." Frankly, I'll be surprised if the U.S. gets through the first quarter without a downturn.
That's a strong forecast and given Hussman's background and record no one should dismiss it lightly. But if the recession forecasts are indeed accurate, we should start to see some clear signals of deterioration in the labor market, which is especially critical at this stage for the economy's health, or lack thereof.
It's true that employment indicators aren't leading indicators per se, with the exception of weekly initial jobless claims, which Hussman notes have "very slight short-leading usefulness." Indeed, initial claims have a history of rising in advance of, or during the early stages of each of the last seven recessions, as the chart below shows. But the trend in new claims is down for this series since last spring, and the momentum appears to be stronger over the past month or so. There's always a danger of reading too much into any one series, of course. But if there's a recession brewing surely it'll start showing up relatively soon in new claims. In other words, initial claims are on my short list as the statistical equivalent of the canary in the cyclical coalmine. In particular, there's likely to be a general change in direction in new claims if economic conditions take a turn for the worse in the weeks and months ahead.
In that case I also expect to see the stock market's annual return dip into negative territory if the forces of recession grow stronger. For the moment, the S&P 500 remains moderately higher vs. this time last year. Although the stock market has been known to see recessions that never materialize, new contractions are almost always accompanied by persistent and deep year-over-year declines in the S&P. The market flirted with some annual red ink briefly in recent months, but the flirtation evaporated quickly. Like many of us, stocks seem to be on the fence for deciding what comes next. As such, a sharp selloff at this stage would be rather ominous.
As for the conflicting signals between the Conference Board's leading indicator and the likes of ECRI and Hussman, some of the difference—perhaps all of it—may be related to the declining relevance of monetary factors as a reliable guide for the future path of the economy. Indeed, the Conference Board is scheduled to adjust the design of its leading indicator at the end of this month. For the details, see the research paper: "Using a Leading Credit Index to Predict Turning Points in the U.S. Business Cycle."
Meantime, don't forget about the risk of a foreign shock--Europe in particular. The crisis on the Continent is still playing out and, well, predicting is still hard, especially about the future.
January 9, 2012
Equal Weighting: A Timely Antidote For Uncertainty?
Are investors irrational or just cautious when it comes to the fundamental stock/bond asset allocation decision? It’s a topical question in light of MarketWatch’s Jonathan Burton article that reviews the case for “Why stocks will beat bonds over the next 20 years." The basic outline is by now familiar: bonds have done well in recent years while stocks have performed poorly. For example, over the past five years, the stock market (Russell 3000) is flat while bonds (Barclays Aggregate Bond) are up an annualized 6.5% through the end of 2011 (for a summary of recent returns, see my latest update of the major asset classes). Assuming a dose of mean reversion, the outlook for equities is favorable and prospective returns for bonds look relatively mediocre if not negative.
“Using history as their guide, and weighing current stock valuations and interest rates, various investment pros believe stocks have a much better chance than bonds to beat inflation in the long run,” Burton reports. He cites several analysts who forecast equity returns ranging from 5% to 9% for the long run. Meanwhile, the benchmark 10-year Treasury yield is roughly 2%, which doubles as the expected return.
In short, the gap in favor of equities looks compelling. Meantime, history suggests that rebalancing a mix of broadly defined asset classes in favor of the laggard and cutting back on the leader tends to boost portfolio returns. By contrast, allowing the winner to dominate the asset allocation has a habit of delivering meager results. This is all familiar terrain, of course, as I discuss at length in my book, Dynamic Asset Allocation. The implication in the current climate: investors should dump bonds and load up on stocks… NOW!
If that is in fact the rational thing to do, it follows that those who don’t jump on the equity bandwagon are irrational. Maybe, but since the future’s uncertain it’s hard to say for sure if an equity-heavy allocation will be optimal. But doesn’t history tell us that it’s always wise to buy stocks when they’ve underperformed bonds? Yes, but history isn’t guaranteed to repeat.
Nonetheless, I think that a healthy dose of equities is compelling for investors with long-term horizons. But there’s always room for doubt. On that note, consider a recent study by professors Robert Weigand (Washburn University School of Business) and Robert Irons (Dominican University): “The Relative Valuation of US Equities at Bear Market Bottoms: A Perspective on the Equity Risk Premium." Part of the paper documents a widely recognized relationship between equity returns and market values. That is, buy cheap and sell dear. But the authors also find that the crowd’s habits evolve in pricing assets, and not necessarily for the better in terms of anticipating stock market returns these days.
After studying stock returns, earnings, interest rates and relative valuation in the U.S. in the context of bear markets and subsequent trends, Weigand and Irons discover that “bear market bottoms since 1950 have been associated with shorter bear markets, lower average market earnings yields and slower real earnings growth following the market bottom, but higher real stock returns over the next decade.” In other words, the market’s been pricing equities at higher levels and this increase in valuing corporations has been advancing at a faster pace than the underlying growth rate of earnings—a trend that’s been unfolding for decades. As for the implications, Wiegand and Irons advise:
Equity values growing faster than earnings for an extended period of time means that the stock return/earnings relation is significantly different pre- and post-1950. Before 1950, the market earnings yield predictably reverted to the mean (often overshooting at bear bottoms), and future equity returns were related to expansion and contraction of this key ratio. Post-1950, we find that the stock return/earnings relation becomes strained as stock prices grow faster than the long-term trend in earnings, eventually resulting in stock prices and earnings losing the cointegrating relation that drove mean reversion in the ratio. In the period following World War II, stock returns have become gradually disconnected from earnings to the point that the earnings yield is no longer reliably mean-reverting, and thus no longer predictive of future equity returns. US stocks' earnings yield and trailing earnings growth are unrelated to future long-term returns post-1950.
The bottom line:
Despite all the anxiety about the "lost decade" in stocks, US equity values in 2011 remain inflated compared with the fundamental earnings US companies will most likely be capable of producing, and long-term future expected returns remain low. Although we estimate the real equity risk premium to be only 0.5% below its post-1950 average, in a low inflation, low bond yield environment, our forecast is that US equities are priced to deliver real returns of approximately 3.5% per year for the coming decade.
None of this convinces me that equities should be shunned. But the paper suggests that the jury’s still out on deciding if bonds are in a bubble, or if stocks will be a slam-dunk winner in the years ahead. So, what’s an investor to do? If you have a high degree of confidence that stocks are indeed a great buy, or that bonds are priced for disaster, well, you’ve already made your decision. But if you’re not quite sure who’s right, it may be time to consider the model-free antidote to uncertainty: equal weighting.
As I wrote recently for Financial Advisor, “equal weighting looks good on paper and it performs handsomely in practice.” Why? It’s arguably the ultimate risk management technique, or at least after adjusting for the required effort/analysis for implementation. First, by diversifying equally across assets without making a judgment about prospective returns, you’re hedging your bets in the extreme. As such, you’re pre-emptively giving up big returns but you’re also minimizing the risk of suffering big losses. Second, maintaining the equal weighting insures that you’ll capture the mean-reversion effect, assuming it rolls on, via rebalancing. If mean reversion weakens, or evaporates entirely, the need for rebalancing will be muted, of course, in which case no harm done since you won't be trading much because relative weights are somewhat static.
An equally weighted portfolio of all the major asset classes returned roughly 4.3% a year over the last five years, by my calculation. That’s hardly spectacular, although it’s probably competitive in the grand scheme of clever managers trying to outsmart the markets. Naïve strategies that deliver decent returns sounds counterintuitive, but this is finance and so the risk of trying too hard should be considered.
In any case, here’s a prediction: Five years from now, an equal weighting of a broad mix of asset classes will look pretty good, just as it does now. This too requires a bit of faith, as does every other investment strategy. The difference is that equal weighting demands a substantially lower leap of faith than most if not all of the competing strategies. That’s no small selling point these days.
January 7, 2012
Book Bits For Saturday: 1.7.2012
● American Gridlock: Why the Right and Left Are Both Wrong - Commonsense 101 Solutions to the Economic Crises
By H. Woody Brock
Summary via publisher, Wiley
Pessimism is ubiquitous throughout the Western World as the pressing issues of massive debt, high unemployment, and anemic economic growth divide the populace into warring political camps. Right-and Left-wing ideologues talk past each other, with neither side admitting the other has any good ideas. In American Gridlock, leading economist and political theorist H. Woody Brock bridges the Left/Right divide, illuminating a clear path out of our economic quagmire. Arguing from first principles and with rigorous logic, Brock demonstrates that the choice before us is not between free market capitalism and a government-driven economy. Rather, the solution to our problems will require enactment of constructive policies that allow "true" capitalism to flourish even as they incorporate social policies that help those who truly need it.
● After the Fall: The End of the European Dream and the Decline of a Continent
By Walter Laqueur
Review via The Wall Street Journal
When the West found itself lacking for serious rivals after the collapse of the Soviet Union, an era of optimism dawned on both sides of the Atlantic. In the U.S., political scientist Francis Fukuyama dreamed about the "end of history," an inexorable convergence toward liberal democracy. Meanwhile, in Europe, a few philosophers and Eurocrats entertained a similar dream of their own: the comforting idea that their continent was a natural blueprint for the rest of humanity. Going even further than Mr. Fukuyama, they predicted that the world wouldn't just converge on some generic form of liberal democracy—but rather on its European incarnation, complete with an aversion to military force, a generous welfare state and the post-national form of sovereignty embodied by the European Union.
But as Walter Laqueur argues in "After the Fall: The End of the European Dream and the Decline of a Continent," this dream was delusional from the start. Mr. Laqueur's case seems easy to make in these times. We have all become well-acquainted with Europe's woes, from the sovereign-debt crisis to the danger that disagreements about how to handle it might tear the political institutions of the EU apart.
● Slow Finance: Why Investment Miles Matter
By Gervais Williams
Summary via publisher, A & C Black Publishers
Thought-provoking and provocative, Slow Finance anticipates a profound change in public attitudes. It outlines how credit growth and globalisation have contributed to the excessive scale of the financial sector. Just as the Slow Food movement represents a reaction to the food industry losing sight of its ultimate purpose, Slow Finance explores how parallel trends will soon be reflected in the investment world. At once think-piece, potted history and call-to-action, the ideas in Slow Finance is an essential read for professionals, academics, business leaders and private investors alike, as well as policy-makers seeking a more sustainable approach to investing.
● The Restructuring of Capitalism in Our Time
By William K. Tabb
Summary via publisher, Columbia University Press
Actions taken by the United States and other countries during the Great Recession focused on restoring the viability of major financial institutions while guaranteeing debt and stimulating growth. Once the markets stabilized, the United States enacted regulatory reforms that ultimately left basic economic structures unchanged. At the same time, the political class pursued austerity measures to curb the growing national debt. Drawing on the economic theories of Keynes and Minsky and applying them to the modern evolution of American banking and finance, William K. Tabb offers a chilling prediction about future crises and the structural factors inhibiting true reform.
● Mastering Hurst Cycle Analysis: A modern treatment of Hurst's original system of financial market analysis
By Christopher Grafton
Summary via publisher, Harriman House
This book offers a modern treatment of Hurst's original system of market cycle analysis. It will teach you how to get to the point where you can isolate cycles in any freely-traded financial instrument and make an assessment of their likely future course. Although Hurst's methodology can seem outwardly complex, the logic underpinning it is straightforward. With practice the skill needed to conduct a full cycle analysis quickly and effectively will become second nature. The rewards for becoming adept are high conviction trades, tight risk management and mastery of a largely non-correlated system of analysis. In this extensive step-by-step guide you will find a full description of the principal tools and techniques taught by Hurst as well as over 120 colour charts, together with tables and diagrams. The Updata and TradeStation code for all of the indicators shown is also included.
● Gurus and Oracles: The Marketing of Information
By Miklos Sarvary
Summary via publisher, MIT Press
We live in an “Information Age” of overabundant data and lightning-fast transmission. Yet although information and knowledge represent key factors in most economic decisions, we often forget that data, information, and knowledge are products created and traded within the knowledge economy. In Gurus and Oracles, Miklos Sarvary describes the information industry--the far-flung universe of companies whose core business is to sell information to decision makers. These companies include such long-established firms as Thomson Reuters (which began in 1850 with carrier pigeons relaying stock market news) as well as newer, dominant players like Google and Facebook. Sarvary highlights the special characteristics of information and knowledge and analyzes the unusual behaviors of the markets for them. He shows how technology contributes to the spectacular growth of this sector and how new markets for information change our economic environment.
January 6, 2012
Private Payrolls Rise 212k In December
Private payrolls rose by a net 212,000 in December as the overall jobless rate fell to 8.5%, the lowest in nearly three years, the Labor Department reports. Still, the pace of job creation last month is a bit of a letdown after yesterday's stellar rise via ADP's estimate. But let's not quibble too much. Today's report is still quite respectable in the current climate. Indeed, a gain of 212,000 jobs is a decent showing after November's tepid 120,000 gain. If nothing else, today's number du jour puts more pressure on the folks who argue there's a recession in the offing.
Never say never, but economic contractions don’t have a history of arriving when the labor market is expanding at the current pace. And if job creation is strengthening, as it seems to be, pessimism about the macro trend may out of style for a stretch. Sure, there may be a recession off in the distance and next month may bring dismal news. But there's no sign of darkness in today's employment report. Job growth is hardly the only data point to consider when reviewing macro trends, but it's certainly a fair slice of the total package. And when you consider some of the other encouraging reports of late, it's tempting to see the proverbial glass as half full.
Another cause for optimism is the fact that the December rise in private payrolls is the strongest showing for the final month on the calendar since 1999. In addition, quite a bit of the stronger job growth in December is due to a pop in employment from cyclically sensitive areas of the economy, namely, the goods-producing industries, including manufacturing and construction. Yet the crucial services sector, which accounts for the lion's share of private employment, also rebounded smartly with employment growth in December.
It's fair to say that the labor market is firing on all cylinders at a moderately faster pace than we've seen for several months. That's hardly a cure for all the macro ailments that plague us, but it's a sign that maybe, just maybe, the labor market is healing.
Today's jobs report "highlights that the U.S. economy is on its way to recovery even as strains in Europe persist," David Watt, senior currency strategist at RBC Capital, tells Reuters.
There was also encouraging news for wages too. Average hourly earnings for private-sector employees gained 0.2%, which translates into a rise of 2.1% over the past year. Average hours worked also rose a bit last month. “You got the trifecta -- more people working, wages up and the average work week up,” says Stuart Hoffman, chief economist at PNC Financial Services Group. “You can’t really argue that that isn’t a sign of significant improvement in the job market.”
While We're Waiting For Today's Jobs Report Update...
The Labor Department is scheduled to release its December payrolls report in a few hours and expectations are high that we'll see a strong number. Yesterday's potent update from ADP on jobs creation in the private sector last month certainly strengthened the outlook. The consensus forecast for private jobs creation for today's release: +170,000, according to Briefing.com. Meanwhile, running a simple linear regression model on the historical data set of ADP numbers vs. the Labor Department's private payrolls since 2000 implies that today's update will post a rise of 249,000. Statistical models should be taken with a grain of salt, of course, but there you have it. As for the actual figure, the answer is….
January 5, 2012
Cause & Consequence?
Princeton professor Burton Malkiel predicts that “U.S. stocks should produce returns of about 7%, five points higher than the yield on safe bonds” for the long-run future. Writing in today’s Wall Street Journal, the author of the best selling A Random Walk Down Wall Street advises that “stocks were losers to bonds in 2011. But don't invest with a rear-view mirror. U.S. stocks, available in a broad-based index fund or ETF, are more attractive than bonds today."
Meantime, money management shop MFS reports in a new survey that “investors' wall of worry continued to rise throughout 2011.” The MFS report goes on to note:
Pessimism, as measured by investors' risk tolerance, continued to grow during the year as well. Furthermore, investors' positive perceptions of financial products waned considerably during the year as well.
ADP: Job Creation Surged In December
Job creation accelerated sharply last month, according to the ADP Employment Report. U.S. nonfarm private employment rose a seasonally adjusted 325,000 in December--up dramatically from November’s 204,000 net gain. December’s advance is the strongest monthly gain in the history of this series, which dates to 2000. ADP’s estimate for job growth is coupled with news that initial jobless claims fell a healthy 15,000 last week to a seasonally adjusted 372,000, or the lowest level since May 2008. It’s starting to look like there’s a tailwind in the labor market. The recent drop in jobless claims has been anticipating as much and the forecast appears to be turning into reality.
The next test is whether the ADP report finds support in tomorrow’s far-more influential jobs report from the U.S. Labor Department for December. Judging by the ADP data, there’s reason for optimism. As the chart below shows, there’s a fairly tight relationship between the ADP and Labor Department date through time. The two data series fall out of line in the short run, but the gap doesn't often linger. The fact that the latest ADP number is relatively elevated vs. the last data point from the government implies that tomorrow’s update will be favorable.
The consensus forecast anticipates a 170,000 gain in the government’s update for private payrolls, according to Briefing.com. But if today’s ADP news is an indication, tomorrow’s report may bring a sizable upside surprise. Some analysts are leaning in that direction. Briefing.com’s forecast, for instance, calls for a 200,000 gain for tomorrow’s report.
Preliminary estimates are vulnerable to revisions, of course, and so today's ADP number should be viewed with some suspicion. As Bloomberg explains:
The December ADP number may have reflected the so-called purge effect. Workers, regardless of when they are dismissed or quit, sometimes remain on company records until December, when businesses update, or purge, their figures with ADP.
The paycheck processor estimates this change when adjusting its data for seasonal variations and, because there were fewer firings at the end of 2011 than in previous years, ADP may find it more difficult to formulate a projection, according to economists like Peter D’Antonio.
“This huge purge of workers is beyond the scope of normal seasonal adjustment,” D’Antonio, an economist at Citigroup Global Markets Inc. in New York, said in a research note before the report. “So the ADP folks have to make huge assumptions for December that often widely miss the mark.”
ADP’s initial figures for November showed a 206,000 gain, while the Labor Department’s data two days later registered an increase of 140,000 in private payrolls for the month.
But there’s no denying that initial jobless claims have been falling steadily since last spring. History suggests this is a strong signal that job creation is on the upswing. Today’s ADP news falls in line with that outlook. Let’s see what tomorrow’s payrolls report from Washington brings.
Research Review | 1.5.2012 | The Role Of Risk In Portfolio Design
Financial Advice and Individual Investor Portfolio Performance
Marc Kramer (University of Groningen) | December 2011
This paper investigates whether financial advisers add value to individual investors’ portfolio decisions by comparing portfolios of advised and self-directed (execution-only) Dutch individual investors. The results indicate significant differences in characteristics and portfolios between these investor groups, but no evidence of differences in risk-adjusted performance. The findings indicate that portfolios of advised investors are better diversified and carry significantly less idiosyncratic risk. In addition, evidence from an analysis of investors who switch to advice taking indicates that these findings (at least in part) reflect the effect of advisory intervention.
Diversifying Risk Parity
Harald Lohre (Deka Investment GmbH), et al. | December 2011
Striving for maximum diversification we follow Meucci (2009) in measuring and managing a multi-asset class portfolio. Under this paradigm the maximum diversification portfolio is equivalent to a risk parity strategy with respect to the uncorrelated risk sources embedded in the underlying portfolio assets. Our paper characterizes the mechanics and properties of this diversified risk parity strategy. Moreover, we explore the risk and diversification characteristics of traditional risk-based asset allocation techniques like 1/N, minimum-variance, risk parity, or the most-diversified portfolio and demonstrate the diversified risk parity strategy to be quite meaningful when benchmarked against these alternatives.
The Puzzling Countercyclicality of the Value Premium: Empirics and a Theory
Maurizio Montone (University of Cassino) | December 2011
A portfolio made up of a long position in value stocks and a short position in growth stocks yields countercyclical returns. Despite this insurance property, however, unconditional expected returns on value stocks are higher than those on growth stocks. Since these findings are not accounted for by systematic risk, they are at odds with standard finance models and constitute what I call the value premium puzzle. Drawing from Thaler’s (1999) mental accounting theory, I propose a behavioral intertemporal asset pricing model that accounts for the puzzle. The model is also consistent with other well-known empirical phenomena such as imperfect portfolio diversification, momentum trading and participation in lotteries and bets. Overall, the results suggest a new interpretation of the book-to-market ratio as a risk-factor.
Minimum Variance, Maximum Diversification, and Risk Parity: An Analytic Perspective
Roger Clarke (Analytic Investors), et al. | December 2011.
Analytic solutions to Minimum Variance, Maximum Diversification, and Risk Parity portfolios provide helpful intuition about their properties and construction. Individual asset weights depend on systematic and idiosyncratic risk in all three risk-based portfolios, but systematic risk eliminates many investable assets in long-only constrained Minimum Variance and Maximum Diversification portfolios. On the other hand, all investable assets are included in Risk Parity portfolios, and idiosyncratic risk has little impact on the magnitude of the weights. The algebraic forms for optimal asset weights derived in this paper provide generalizable perspectives on portfolio risk-based construction, in contrast to empirical simulations that employ a specific set of historical returns, proprietary risk models, and multiple constraints.
Demystifying Equity Risk-Based Strategies: A Simple Alpha Plus Beta Description
Raul Leote de Carvalho (BNP Paribas), et al. | September 2011
We considered five risk-based strategies: equally-weighted, equal-risk budget, equal-risk contribution, minimum variance and maximum diversification. All five can be well described by exposure to the market-cap index and to four simple factors: low-beta, small-cap, low-residual volatility and value. This is, in our view, a major contribution to the understanding of such strategies and provides a simple framework to compare them. All except equally-weighted are defensive with lower volatility than the market-cap index. Equally-weighted is exposed to small-cap stocks. Equal-risk budget and equal-risk contribution are exposed to small-cap and to low-beta stocks. These three have a high correlation of excess returns and their portfolio largely overlap. They invest in all stocks available and have both a low turnover and low tracking error relative to market-cap index. Minimum variance and maximum diversification are essentially exposed to low-beta stocks. They are the most defensive, invest in much the same stocks and have high tracking error and turnover.
January 4, 2012
The January Effect & The Year Ahead
The so-called January effect for the stock market (S&P 500) looks quite weak when measured on a monthly basis, and it doesn't offer much more encouragement as a signal for the 1-year-ahead return horizon either.
To understand why, let's compute average returns for each month for the past 20 years. Next, let's plot those monthly average returns against the average of subsequent 1-year returns, measured from the end of the month in question. The result is the chart below. As you can see, the average January return is virtually nil over the past two decades. Yes, subsequent 1-year returns measured from January's close are near the highest compared with the other months. But the comparable 1-year average performance from the end of February is equally high and March's results are slightly better. In addition, the average 12-month return after April's close is nearly as strong as January's. The question is whether there's a strong relationship between January's returns and the year ahead? If there is, it's not obvious in recent history.
The relationship between monthly return and subsequent 1-year performance looks more or less random in the chart above. That's certainly the message in the R-squared of roughly zero for these plots. It's hard to see the logic in basing investment decisions on the January effect. The first month of the year appears to be related to above-average returns in the year ahead, but the same can be said of three other months in the early part of the calendar. But all's not lost. Maybe we can re-title the January effect as the January-through-April effect.
January Effect Update (And Mea Culpa)
In an earlier post today, I reviewed the thin evidence for the January effect as defined as a month that's expected to shine with above-average returns. Debunking this idea still looks good based on the past 10 or 20 years, but it turns out that the numbers are even worse than I initially reported. In the previous post I mistakenly reported the sum of monthly returns for each monthly period—my apologies to readers. After correcting the error by computing the standard average of monthly returns (see the new chart below), I find that the January effect is even more elusive.
Here’s the updated chart showing the true average returns for the respective months over the trailing 10- and 20-year periods. There may be a January effect, but it’s not necessarily the one you’ve been expecting.
Some analysts say that the true value of the January effect is that it sets the tone for the year-ahead performance in the stock market. That argument is on stronger statistical ground, although it’s hardly a slam dunk. Details to follow shortly....
Looking For The January Effect
Once upon a time investors believed in the January effect. The story is that there's gold in them 'thar hills for equity returns during the first month of the year. The idea that January dispenses richer results than the other months dates to economist Sidney Wachtel's 1942 study on seasonality effects in the market. It's been a winning idea ever since, judging by all the attention it receives. As an investment concept, however, it looks distinctly unimpressive, or so recent history suggests.
The average return in January for the S&P 500 since 1992 is zero. The best month: April, with an average return of 2.1%.
If we restrict our analysis to the last 10 years, the January effect slips into negative territory, with the month posting an average decline of 1.7%. Once again, April is the leader for the 2001-2010 period, boasting a 2.2% average gain. April, of course, is the dreaded month when taxes are due—is there an IRS effect? Intrepid researchers will want to jump on this one—heck, it seems we're in need of a new calendar-based anomaly.
Indeed, the January effect seems to have lost its shine. Or has it? SmartMoney ventures a guess as to "What a January Jump Says About 2012" while Mark Hulbert advises that "only the smallest stocks tend to shine in January." Another analyst confidently asserts that "the January effect is in play" in the wake of yesterday's pop in the first trading session of the new year.
Maybe, although the record looks conspicuously unappealing for expecting much more than random results in January. That doesn't mean this month won't deliver stellar results, but ascribing it to a systematic calendar effect may be pushing your luck. Then again, there are mitigating circumstances these days, we're told. The January effect is "less sure because of nervousness," according to one news story. Even anomalies need a vacation at times. Trying to live up to elevated expectations is exhausting work.
Update: An earlier version of this story overstated the January effect. In other words, the January effect is even more elusive than initially reported. For details on what's changed, see my post here.
January 3, 2012
An Encouraging Start For 2012 Economic Releases
The first major economic release of the December economic profile suggests that momentum continues to bubble. The ISM’s factory index rose 1.2 percentage points to 53.9 last month, the highest since April and an acceleration from the pace of November's gain. If the first reading on the windup to 2011 is any indication, the statistical case is a bit stronger today for expecting the economy to muddle forward, perhaps at a slightly faster clip, in the months ahead.
Reviewing the ISM index with the annual change in the stock market (S&P 500) implies that equity prices will trend higher. As the chart below shows, the ISM benchmark has been turning higher recently as the S&P has remained flat on a year-over-year basis.
The bullish ISM report found support in today's other data release: construction spending for November, which rose an annualized 1.2% and is now at the highest level since June 2010. This report adds another data point to the argument that that the housing sector is finally reviving.
Today's numbers also suggest that the upbeat reading of consumer confidence for December isn't a fluke. "After two months of considerable gains, the Consumer Confidence Index is now back to levels seen last spring," says Lynn Franco, Director of The Conference Board Consumer Research Center, in a press release from last week.
The question, of course, is whether the rest of the week's scheduled economic releases will confirm (or deny) today's buoyant numbers? Thursday brings word of the December update on the ISM Services Index and the weekly jobless claims report. The big news comes on Friday, when the December payrolls report hits the street. For the moment, economists are moderately optimistic that more good news is on tap on all three counts, according to Briefing.com. The consensus forecast for private non-farm payrolls, for instance, is anticipating a net gain of 170,000 for December vs. November's 140,000. Nothing less than growth in employment is required to quell worries linked to weak income growth. A gain of 170k in private jobs may not suffice, but it's probably the bare minimum required to keep hope alive.
Meantime, it's been a good year so far for economic news.
Major Asset Classes | Dec 31, 2011 | Performance Update
It was a tough year in 2011 for minting risk premiums if you held a broadly diversified portfolio. Bonds and REITs were the big winners among the major asset classes last year. If you didn't hold generous helpings in those corners, your results for the year just passed are probably modest at best. Stocks were mixed, if we can call it that, with U.S. equities generally rising by a lackluster 1% on the year on a total return basis, but it was ugly for overseas markets in dollar-based terms. Broad measures of commodities suffered too, although gold and oil each climbed around 10%.
Unsurprisingly, a broadly diversified portfolio delivered a distinctly uninspiring performance in 2011. The Global Market Index (GMI) shed 1.4% in 2011, a big change from the 10%-plus rise for 2010. Equally weighting all the major asset classes managed to eke out a small gain on the year, but even this usually reliable methodology wasn't much help for the past 12 months.
For a bit of historical context, consider how trailing annualized 5-year returns stack up, one of the most stress-tested runs in modern market history. GMI posted a modest 1.8% annualized gain over that volatile stretch. Not very impressive, although its equal weighted counterpart compares favorably with an annualized 4.3%.
It's hardly surprising that equal weighting is competitive if not superior (for some thoughts on why, see my profile of the strategy here) to weighting assets by market value. Granted, 4% or so a year over the last 5 years is a yawn. But it's also a reminder that turning a profit hasn't been easy in recent history. For those investors who beat the odds the table above suggests that they've done so with generous helpings of bonds. The question is whether the past is still prologue?
January 2, 2012
Prediction Addiction: 2012 Edition
A new year has arrived and that can only mean one thing: forecasts. Lots of 'em. There's something about a fresh calendar that promotes prognostication in ample quantities. Predicting is still hard, even if supply exceeds demand. But like a highway accident, we can't avert our eyes. Adjust your expectations accordingly. "In the end the only certainty is that the forecast will either be wrong or lucky," advises the Colorado-based Business and Economic Research's warning in its economic outlook for the year ahead. "Either way, the value of the forecast is not in the numbers, but in the forecast story." It's a long and winding story, of course, and one that has no end. Where to start? How about right here, with an assorted list of predictions that caught my eye for one reason or another. Who knows? Some of them may actually be accurate.
Let's consider the big picture for some context. The bidding starts with the Conference Board's recent forecast of 3.2% growth this year for global GDP. That's a respectable rise, although there are lots of reasons for wondering if such optimism can survive the year ahead. As Morgan Stanley warned a few weeks back:
We expect upcoming policy decisions in the US and Europe to hold the key to the global growth outlook. With a recession in Europe, anaemic growth in the US and a further dimming of emerging market economies' growth prospects as our base case, we see global growth falling below its long-term average.
Our bear case is a full-blown recession, and it won't take much to tip the balance. Our base case assumes that European governments make a big step towards fiscal integration soon that stabilises confidence, and that US Congress extends most of this year's stimulus. Against the backdrop of recent policy mistakes, these assumptions may seem heroic. Failure on these fronts would risk a full-blown recession in the US and Europe, with global GDP growth falling below the 2.5% recession threshold.
Meantime, it's a new year and anything seems possible. For example…
AP survey: Growth will pick up in 2012, but US economy is vulnerable to turmoil in Europe
The U.S. economy will grow faster in 2012 — if it isn't knocked off track by upheavals in Europe, according to an Associated Press survey of leading economists. Unemployment will barely fall from the current 8.6 percent rate, though, by the time President Barack Obama runs for re-election in November, the economists say. The three dozen private, corporate and academic economists expect the economy to grow 2.4 percent next year. In 2011, it likely grew less than 2 percent.
3 Experts Weigh In On 2012
Last month the well-known mutual fund manager Bill Miller announced his retirement as portfolio manager for the Legg Mason Value Trust, a mutual fund that made history by beating the S.& P. 500 for a record 15 consecutive years. He was named fund manager of the decade by Morningstar in 1999. But no one is infallible, and Mr. Miller stumbled in 2008 by betting on a recovery in United States financial stocks that never happened. His fund has now trailed the S.& P. 500 for five of the last six years.... Like many contrarians right now, Mr. Miller is bullish on stocks. “A great deal of pessimism is already built into the U.S. equity market,” Mr. Miller said when I caught up with him. “The market is trading at 12.5 times earnings. Basically, the market is expecting no growth in corporate profits from here indefinitely. The S.& P. 500 dividend yield is higher than the 10-year Treasury yield. This only happened at the bottom of the financial crisis, and before that you have to go back 50 years. “After two years of headlines on Europe, beginning with Greece, my view is, everything about Europe is discounted except the complete collapse and disintegration of the European Union,” Mr. Miller continued. “Everything but the worst-case scenario is baked in. Recession? Yes. Political dysfunction? Yes. Bad austerity policies when they need to promote growth? Yes. Those are in the headlines every day and it’s priced into U.S. stocks. I’m not so sure about European stocks.”
Bond mutual funds could defy gravity again in 2012
Clearly, investors and fund managers are jittery and their wait-and-see stance looks to be mildly supportive for stretching the 2011 government bond rally into at least the early part of 2012. “The economic toll for this uncertainty in Europe and the rest of the globe will become clearer over the next few quarters,” said Don Quigley, manager of Artio Total Return Bond Fund, which added 7.8% in 2011. “We see Europe moving into recession. U.S. Treasury rates should remain well behaved due to slow growth prospects.”
N. American oil output could top 40-year-old peak
North America appears headed for an oil renaissance, with crude production expected to hit an all-time high by 2016, given the current pace of drilling in the U.S. and Canada, according to a study released by an energy research firm this week. U.S. oil production in areas including West Texas' Permian Basin, South Texas' Eagle Ford shale, and North Dakota's Bakken shale will record a rise of a little over 2 million barrels per day from 2010 to 2016, according to data compiled by Bentek Energy, a Colorado firm that tracks energy infrastructure and production projects.
Houston Chronicle | Dec 30
A China Daily survey finds growth is likely to slow down
China Daily surveyed numerous economists - all opinion leaders in Chinese economic studies - and while they differ on many topics, they seem to agree on one thing: The Chinese economy is set to slow down. No one is sure how serious that slowdown might be, just as few anticipated that GDP growth in China, in the first quarter of 2009, would drop to slightly more than 6 percent (from its usual 10-plus percent) in the wake of the global financial crisis. As one economist says, China risks a hard landing if the economies of the European Union and the United States are worse than expected and the country's property market slumps too fast.
China Daily | Dec 30
BlackRock's Bob Doll sees hopeful signs in 2012
Q: And what about the big drag on the economy: housing. Is there a turnaround on the horizon?
A: My view is that we are probably in a long-term bottoming process in real estate. According to the Case-Shiller index, the cataclysmic decline in home prices has long ended and prices bottomed out in May 2009. But we've continued to bounce along. Banks are unwilling to make mortgage loans and many loans are higher in value than the homes. All that's kept the real estate recovery very slow. New construction is taking place at just half the pace of population growth. At some point those things will have to balance out.
Refinancing Gets Even More Attractive
The average interest rate on a 30-year mortgage fell to 4.05% for the week ended Dec. 23, the lowest in 60 years, according to HSH Associates, a mortgage-data firm. And rates on jumbo mortgages—private loans that in most parts of the country are larger than $417,000—also have hit new lows, averaging 4.61%. "It's hard to argue rates will get much lower than they are today," says Stuart Gabriel, director of the Ziman Center for Real Estate at the University of California, Los Angeles.
The Wall Street Journal
Commercial Real Estate
2011 Review & 2012 Outlook
Real estate investments should become increasingly attractive in 2012, in our opinion. Gradually improving supply conditions, coupled with moderate growth in demand from the U.S. economy, may produce attractive returns for many areas of commercial real estate. In addition, with the potential for higher inflation on the horizon, real estate investments should be emphasized as appropriate because, as an asset class, real estate has historically generated positive performance during periods when costs rise more dramatically.
Gold Set For 11th Straight Annual Gain; Prospects Seen Rising In 2012
Morgan Stanley has cited gold as its top commodity play for 2012. And VTB Capital analyst Andrey Kryuchenkov Friday advised investors to remain long on gold entering a new year. ”Longer-term players and physical buyers are likely to return to the market in the first half, while the latest price retreat could serve as a good encouragement for hesitant market participants,” he said. Kryuchenkov suggested that investors be realistic in 2012. ”There is little alternative to gold in times of economic uncertainty, despite the recent rush for the dollar,” he said.”Gold stands on its own in terms of safe haven buying and bullion allocations are only likely to gain with currency protectionism still at large.” Economist Dennis Gartman, who has been neutral on the market since mid-November, said he is “about to become bullish once again” on the yellow metal. ”Commodities prices generally are weaker, but as the year ends the precious metals are rather sharply firmer and we are impressed with that strength,” he told clients today.
Outlook for Currency Markets in 2012
Given the current level of volatility and uncertainty it is extremely difficult to call the direction of forex markets as we head into 2012. The trend will be very much determined by how markets react to ongoing events in Europe, as well as the tone of Q4-2011 and Q1-2012 economic data. At the same time though, while there are some underlying concerns about the US (sub trend growth as well as a high fiscal and current account deficits), sentiment appears to be generally favouring the dollar right now. The eurozone debt crisis remains the central focus for markets, suggesting downside risks for the euro. The outcome of the EU Summit in early December outlining plans to work towards greater fiscal integration in the eurozone failed to provide any real comfort to the market, with the $1.30 level coming under threat as rating agencies talk of sovereign downgrades. Despite numerous summits and eurozone finance minister meetings aimed at resolving the issue, if anything the stakes in Europe are now even higher and this will be a key theme for markets in 2012.
Allied Irish Banks Global Treasury Service