May 31, 2012
Slow Growth Still Prevails In The Labor Market
Today’s updates on weekly unemployment claims and ADP’s estimate of private sector payrolls for May suggests that the labor market continues to grow. The expansion is modest and perhaps vulnerable to the ongoing turmoil linked to the euro crisis, and it's not likely to impress analysts, but the growth rolls on.
Let’s start with jobless claims, which jumped last week by 10,000 to a seasonally adjusted 383,000, the Labor Department reports. That’s the highest in five weeks and so the rise is sure to fan worries about the economy’s strength. But if you’re looking for clear-cut signs of trouble, it’s not yet obvious that today’s claims numbers are the smoking gun. As the chart below shows, new filings for jobless benefits remain well below the 400,000 mark. Weekly numbers bounce around a lot and so the jury's still out on whether the falling trend has run its course.
A clearer view of the internal dynamics of weekly claims can be found in the year-over-year change in the unadjusted numbers. By that benchmark, it still appears that the layoffs have downward momentum, as the second chart below reminds. The roughly 10% decline rate remains intact. That's a sign of progress, even if the weekly seasonally adjusted updates run off course at times.
Whatever good news one may take away from the annual decline in new claims is tempered by the fact that job growth has clearly slowed. Today’s ADP estimate of private nonfarm payrolls for May doesn’t offer much evidence for thinking otherwise. “While May’s increase was the twenty-eighth consecutive monthly advance, it nonetheless reflected a notable slowdown in the recent pace of hiring,” says Joel Prakken, Chairman of Macroeconomic Advisers, which generates the ADP report. “The sharpness of the deceleration seems consistent with other incoming data suggesting the economy, weighed down by heightened uncertainty over the European financial crisis and by growing concerns about domestic fiscal policy, slowed early in the year.”
Adding to the pressures on the labor market is today’s news that U.S. employers announced plans this month for the most layoffs since last September, according to Challenger, Gray & Christmas. A large slice of May layoff plans is tied to Hewlett-Packard’s announcement of its anticipated workforce cuts, which comprised 43% of the total layoffs announced this month.
The Hewlett-Packard decision may have temporarily skewed the layoffs trend upward, but today’s ADP report implies that tomorrow’s payrolls update from the government for May will show some improvement over April’s sluggish growth, which was the weakest since August 2011. The consensus forecast calls for something better for May for the private-sector's payrolls: a gain of 168,000 vs. 130,000 in April, according to Briefing.com.
“Businesses are adding workers at a pace that is not very impressive,” says David Sloan, a senior economist at 4Cast Inc. “The unemployment rate is not going to fall rapidly. The numbers are consistent with an economy that is growing modestly.”
“[Today’s ADP employment news is] a little light, but I don't think anyone will be very surprised,” advises Wayne Kaufmann, chief market analyst at John Thomas Financial. “Recent data hasn't been great, and while this isn't a horrible number, it shows we're in a lackluster period in the economy right now. Hopefully the recent negative trends will reverse themselves, but it is hard to see what will cause that."
Strategic Briefing | 5.31.12 | Will Spain Leave The Euro?
Spain bank fears send bond yields to euro-era high
Associated Press | May 30
Investors worried about the viability of Spain's banks sent the country's borrowing costs into the danger zone Wednesday and pummeled European stocks, spooked about whether the Spanish government can pay for a bailout of a banking sector saddled with toxic loans and piles of foreclosed property born from a decade-long building frenzy.
Europe Fears Bailout of Spain Would Strain Its Resources
The New York Times | May 30
In the bond market, the Spanish government’s borrowing costs are approaching the symbolically dangerous level of 7 percent on 10-year bonds. The rise has stoked worries that Spain might need bailouts similar in scope — though many times larger — than those extended to Greece, Portugal and Ireland. Interest rates in that range had pushed them out of the debt markets that governments rely on to finance their operations.
Europe ponders 'banking union' to avert further euro crises
LA Times | May 31
If the Spanish government is left to bail out the nation's banks, the government itself risks becoming insolvent. Its borrowing costs have risen to record highs on fears that Spain could be the next Eurozone member to need a bailout. Spain last week promised troubled lender Bankia nearly $24 billion to keep it afloat in a sea of defaults and foreclosures on properties now worth a fraction of the prices buyers paid.
Spain must tell Europe its plans for Bankia-EC
Reuters | May 31
Spain must lay out plans for nationalised lender Bankia to the European Commission (EC), a spokesman for the Commission said on Thursday, adding a domestic solution to the country's bank crisis would be better than a European rescue. Spain's centre-right government has so far failed to clearly say how it plans to finance a 23.5 billion euro ($29 billion) rescue of the country's fourth-biggest lender, leaving markets confused and driving the country's borrowing costs to levels at which Ireland and Portugal sought international bailouts.
Brussels throws gauntlet down to Berlin
Reuters | May 31
The European Commission leapt off the fence yesterday proposing many of the policies – a bank deposit guarantee fund, longer for Spain to make the cuts demanded of it and allowing the euro zone rescue fund to lend to banks direct (though there were some mixed messages on that) – that would buy a considerable period of time to move towards its ultimate goal: the sort of fiscal union that would make the euro zone a credible bloc much harder for the markets to attack.
6 reasons Spain will leave the euro first
Marketwatch | May 30
Spain is too big too rescue. When it comes to the crunch, the EU will always bail out the Greeks. Its economy is only worth 230 billion euros. It can be subsidized forever. If the Greeks vote for a government that rejects the bailout package, some more money can be thrown at them. Pumping 10% of gross domestic product into the economy only costs 23 billion euros — peanuts. That is not true of Spain. If the economy collapses, it can’t be rescued. It will have to do the hard work by itself.
May 30, 2012
Growth Rates & Government Spending
How fast is the federal government's spending rising? It's a politically charged question these days, of course, and so there's an excess of spin attached to the discussion of government budgets at the moment. Fortunately, the offending numbers are easily located and dissected, courtesy of the Congressional Budget Office's "Budget and Economic Outlook: Fiscal Years 2012 to 2022" report (specifically: the historical data in tables F-1 and F-3). The results may enrage or inspire you, depending on your political persuasion and budgetary assumptions. But the first intelligent step in any debate is to take a sober look at the data, assuming it's available. Oh, yes, one other necessary condition for informed analysis: no screaming, please.
Let's start with total federal outlays on a fiscal year basis. For perspective, the chart below compares a simple one-year percentage change with its annualized (geometric) two- and three-year counterparts. The recent surge in growth rates is due to fiscal year 2009, but there's been a sharp slowdown in the pace of federal spending in the two subsequent years. The future is unclear on this front, but the past is crystal.
As you can see, the latest growth rates for FY2011 don't look radically out of line with recent history. True, it's debatable if we can even afford historically moderate rates any longer. Meanwhile, the annualized three-year rate of 6.5% is near its average pace since the mid-1970s. That's higher than what we saw in the second half of the late-1990s, but one can counter that a 6.5% rate is roughly in line with the trend in the decade before the Great Recession hit. The debate about whether it's too high is a separate question, of course, but if history's a guide it's hard to argue there's been a dramatic surge in the rate of growth. That may not mean much with mounting deficits, but for simplicity let's stick with spending rates. One budgetary challenge at a time, please.
Another relevant point: Most federal outlays fall under the heading of mandatory spending, which includes the entitlement programs, such as Social Security and Medicare. Because mandatory spending is to a degree an automated process, it's reasonable to review the trend in so-called discretionary spending in isolation. These are the programs that receive regular up or down votes. It's interesting to note that discretionary spending rates have dropped in FY2011. Once again, the three-year average of nearly 6% is near the average rate for the past three decades-plus. That looks high compared with the late-1990s, but it's well below the pace set in 2002-2006.
The data above shouldn't be used to dismiss the budgetary challenges that face the U.S. At the same time, the inflammatory language about government spending exploding in a way that's unprecedented looks overblown, based on the historical record. Granted, there's more than one way to look at federal spending. For example, a more troubling comparison can be found via government spending as a percentage of the economy (gross domestic product). As I noted last week, overall federal outlays are running at unusually high levels of late. On the other hand, discretionary spending's growth trend looks less troubling.
The main problem, in sum, is with mandatory spending (i.e., entitlement programs). In 1972, mandatory spending consumed 44% of federal outlays. In subsequent decades, mandatory spending has trended higher to the point that for the past 10 years it routinely accounted for well over 60% of the budget. Given the demographics of the country, that share is on track to rise further. Looking at probable growth rates for the economy, however, it's clear that entitlement spending's expected growth is unsustainable. Budget reform, to state the obvious, is critical.
In short, it's all about entitlement reform. There are no easy solutions to controlling government sprawl. But if there's any hope of resolving the very real financial challenges that await, surely it starts with a sober look at the numbers. That may be asking too much of the political class, but hope springs eternal.
May 29, 2012
A Primer On Minimizing Uncertainty In Retirement Planning
Successful retirement planning requires intelligent investing decisions, but that's just one of several critical factors for managing your assets after you stop working, reminds Moshe Milevsky in his new book The 7 Most Important Equations for Your Retirement: The Fascinating People and Ideas Behind Planning Your Retirement Income. "It's time to have some conversations about retirement income planning, also known as de-accumulation planning," he writes. "The stories in this book should lead you into those conversations."
It's also time to start doing the math. Milevsky, a professor at York University who's written extensively on retirement planning, takes the reader on a brief but revealing tour through seven equations that he argues (persuasively) that are essential for answering such questions as: How long will my nest egg hold out? How long is my retirement likely to last? How should I structure my spending plans in retirement? What is the probability that my retirement plan is sustainable?
Perhaps the main problem in financial planning is that many individuals (and perhaps some financial planners) deal with these questions in an ad-hoc, heuristic fashion. But as Milevsky explains, economists and mathematicians through the centuries have developed quantitative solutions. Definitive answers don't exist in economics, at least not compared with physics or engineering. But as this useful book shows—simply and succinctly—there are powerful methodologies for removing quite a bit of the mystery that normally weighs on retirement planning choices.
Milevsky advises from the start that he's not offering a "how-to" book, at least not in the traditional sense. Rather, The 7 Most Important Equations For Your Retirement outlines the frameworks, the concepts for thinking about how to answer fundamental questions—questions that are at the core for determining whether your retirement will be a success or a flop. The book, he writes,
is a narrative involving seven people, their discoveries and the conceptual innovations that made it possible for you to stop working and enjoy the money you have accumulated, one day. These protagonists--or scientific heroes--didn't achieve their breakthroughs while hunched over a laboratory workbench, peering through a microscope or treking through jungles. They made their discoveries sitting in front of a blank sheet of paper, but while thinking very carefully about life and money.
In some chapters, Milevsky interprets an equation's structure in a modern formulation if its creator had lived in recent history. For example, Leonardo Fibonacci's 800-year-old writings that form the basis of present value analysis don't offer equations per se. Instead, Milevsky interpolates for us, distilling the essence of the concept into a tidy formula.
In other cases, the equations were developed by the original author and survive intact for our review. Chapter 5, for instance, focuses on Paul Samuelson's simple but elegant formula for deciding how much of your portfolio (or financial capital overall) to allocate to stocks.
The seven equations in this book can't guarantee success, a caveat that applies to all quantitative efforts for modeling uncertainty about the future in matters of economics and finance. The old problem of garbage-in-garbage-out applies. If we had full clarity about, say, the path of interest rates or market volatility over the next decade, our ability to model the future would improve considerably. But mere mortals must suffer a certain amount of darkness when it comes to thinking ahead.
That said, some guesstimates are better than others. Milevsky's book lays out what is arguably the foundation for analytically evaluating your retirement future in a thoughtful way, based on the assumptions you provide. The resulting answers are only as good as the estimates you plug in. But with a bit of effort, you can achieve a lot with a spreadsheet and this book.
Milevsky has done us all a great service by condensing and interpreting these seven mathematical concepts into a short, practical-minded overview. The book has lots of competition, of course, but rarely has so much been packed into so few pages and made so accessible. He evaluates the powers of each equation individually and collectively in terms of their value as tools for thinking about retirement planning decisions. Developing intuition about the future is still hard, but this primer shows us that some (most) of the surprises that harass retirement planning can be easily minimized with some basic mathematical modeling.
After reading this book, you'll never think of retirement finance in quite the same way. That's progress for most of us, given how carelessly most folks plan for their financial lives after they retire. There's more to retirement planning than seven equations, of course, as Milevsky admits. But rather than quibble if the true number of equations is eight or 12, of if your list differs, the more-pressing task is to start working on developing robust inputs for the formulas outlined in this book. Retirement is coming for all us, ready or not.
May 26, 2012
Book Bits | 5.26.2012
● The New Geography of Jobs
By Enrico Bonetti
Q&A with author via Forbes
Q: What is the New Geography of Jobs?
A: If you look at the economic map of America today, you do not see just one country. You see three increasingly different countries. On one hand there are cities like Seattle, San Francisco, Raleigh-Durham or Austin, with a strong innovation-based economy and workers who are among the most creative and best paid on the planet. At the other extreme are former manufacturing centers like Detroit, Flint or Cleveland, where jobs and salaries are plummeting. In the middle, there is the rest of America, apparently undecided on which direction to take.The difference between the three Americas was small in the 1980’s and has been growing ever since. My book explores this new geography of jobs, and especially its root causes and what it means for our country.
● The Politics of Poverty Reduction
By Paul Mosley
Summary via publisher, Oxford University Press
Globally, there is a commitment to eliminate poverty; and yet the politics that have caused anti-poverty policies to succeed in some countries and to fail in others have been little studied. The Politics of Poverty Reduction focuses on these political processes. Analysis is based partly on global comparisons and partly on case-studies of nine countries that span the developing world. Where governments are politically weak, they need to make alliances with other groups to stay in power, and where these have been with low-income groups, the result may be a lasting and effective pro-poor strategy. Often pro-poor policies have been brought in not with progressive intentions, but out of fear that the state will fall apart unless pro-poor elements are incorporated into government, and the most effective regimes in reducing poverty have seldom been the kindest and most benevolent.
● The Small Worlds of Corporate Governance
Edited by Bruce Kogut
Summary via publisher, MIT Press
The financial crisis of 2008 laid bare the hidden network of relationships in corporate governance: who owes what to whom, who will stand by whom in times of crisis, what governs the provision of credit when no one seems to have credit. This book maps the influence of these types of economic and social networks--communities of agents (people or firms) and the ties among them--on corporate behavior and governance. The empirically rich studies in the book are largely concerned with mechanisms for the emergence of governance networks rather than with what determines the best outcomes. The chapters identify “structural breaks”--privatization, for example, or globalization--and assess why powerful actors across countries behaved similarly or differently in terms of network properties and corporate governance.
● The Large-Cap Portfolio: Value Investing and the Hidden Opportunity in Big Company Stocks
By Thomas Villalta
Summary via publisher, Bloomberg Financial/Wiley
Large-Cap is an abbreviation of the term "large market capitalization" and refers to the stock of publicly traded companies with market capitalization values of roughly more than $10 billion, like Walmart, Microsoft, and Ford. Because of their size, the conventional view is that these companies do not present investors with an ability to be opportunistic. The Large-Cap Portfolio + Website argues that, contrary to popular perceptions, significant opportunities exist in these stocks. Written with a fluency that both the savvy amateur and professional investor will understand, the book fills a void in the market by offering the practitioner a methodology to identify and approach the major assumptions that underlie valuation, with an emphasis on issues that are more relevant to the analysis of large-cap stocks.
● Investment Theory and Risk Management
By Steven Peterson
Summary via publisher, Wiley
Investment Theory and Risk Management is a practical guide to today's investment environment. The book's sophisticated quantitative methods are examined by an author who uses these methods at the Virginia Retirement System and teaches them at the Virginia Commonwealth University. In addition to showing how investment performance can be evaluated, using Jensen's Alpha, Sharpe's Ratio, and DDM, he delves into four types of optimal portfolios (one that is fully invested, one with targeted returns, another with no short sales, and one with capped investment allocations). In addition, the book provides valuable insights on risk, and topics such as anomalies, factor models, and active portfolio management. Other chapters focus on private equity, structured credit, optimal rebalancing, data problems, and Monte Carlo simulation.
● Objective Economics: How Ayn Rand's Philosophy Changes Everything About Economics
By M. Northrup Buechner
Review via Capitalism Magazine
To the best of my knowledge, this book represents the first attempt to rewrite economics in the light of Ayn Rand’s philosophy of Objectivism. As such, it is an application of Objectivism to the theory of how a free economy works, that is, to the theory of how men’s independent, self-interested actions to produce and exchange economic values are integrated into an economic system. Ayn Rand did not leave us a new economics, but something much more important—a philosophical foundation for all the special sciences. My purpose is not to present the Objectivist philosophy, but to apply Objectivism to economics. For an authoritative account of Objectivism, there is no substitute for Ayn Rand’s own writings.
May 25, 2012
Federal Spending As A Share Of The Economy
In a previous post, I reviewed Rex Nutting’s report that the “Obama spending binge never happened” by reviewing annual percentage changes in federal spending. The numbers support Nutting's conclusion, but there are several ways of analyzing the federal budget and the results leave plenty of room for debate when it comes to summarizing the government’s fiscal rectitude, or the lack thereof. For example, another method of evaluating federal outlays is by looking at dollar amounts as a percentage of the economy (GDP). By this standard, the Obama administration is open to more criticism vs. comparisons based on the rate of change in spending.
Consider how federal spending compares on an annual basis as a share of nominal GDP over the past four decades. Total outlays as a percentage of the economy have recently been at heights unseen in recent history—roughly 23% to 25%.
Discretionary spending levels, by contrast, are a bit lower, running at roughly 9% in the last three years. That’s up slightly from the pre-recessions levels of 6% to 7%, but still under the 10% mark reached for a time in the 1980s. If you're a fiscal hawk, however, the recent trend is still cause for alarm.
Note that the comparison between calendar-year GDP and fiscal year spending isn’t an exact match (fiscal years for the federal government’s budget run from October 1 through September 30. Nonetheless, the analysis provides a reliable reflection of spending trends in relation to the size of the economy.
What are we to make of the recent rise in overall government spending by this measure? Here’s where the debate begins. Like everything in economics, there’s more than one interpretation. For example, one can argue that the rise in federal spending as a share of the economy is at least partly due to the Great Recession and the sluggish recovery in subsequent years.
Federal spending continued to grow even as the economy shrank, resulting in a higher spending/GDP ratio. If you accept the premise that cutting spending during a deep economic crisis is a bad idea, you’ll cut the government some slack when it comes to the recent rise in outlays relative to economic output. You might even marvel at the recognition that discretionary spending’s share of GDP didn’t surge higher (or that it’s dipped a bit in fiscal year 2011). Indeed, the chart above reminds that the overall rise in spending is due primarily to mandatory spending requirements that are baked into current law.
Nonetheless, the clock is ticking. As the Concord Coalition warns, "Without comprehensive reform, we will leave our children and future generations with huge government debts, higher taxes, lower living standards and a diminished international role for the United States."
The main issue is how we move from here to there. Medium- and long-term spending controls are critical, but doing too much, too fast, may harm the fragile recovery. The main questions are how should the government slow/cut/restructure spending growth and how quickly should it implement the reforms? Everyone has a plan, but consensus is missing in action. But doing nothing will have consequences, and soon. Until further notice, there’s really only one question lurking on the fiscal front: Are You Ready for Taxmaggedon?
Budget Battles & Reality Checks
Earlier this week, MarketWatch's Rex Nutting wrote that the "Obama spending binge never happened" and that federal government outlays have recently been rising at the "slowest pace since 1950s." The claim was quickly attacked by some commentators of the Republican persuasion as a left-wing conspiracy. The motivation for trying to discredit the report is understandable, at least from a raw political perspective. The notion that federal spending hasn't exploded under Obama doesn't jibe with the political playbook these days for the loyal opposition. But facts are still facts and so the frenzy of efforts to dismiss Nutter's column don't stand up based on the numbers.
A simple review of the federal budget data confirms that the rate of spending growth has slowed recently relative to the Bush years. We can debate why that's so, and whether Obama deserves credit or not. But for now, let's just look at the numbers, as published by the Congressional Budget Office here. (In particular, note the historical data in tables F-1 and F-3 in "The Budget and Economic Outlook: Fiscal Years 2012 to 2022".)
The first chart below shows the annual percentage change in federal outlays by fiscal year. The chart speaks for itself.
There's been much discussion about fiscal year 2009. Obama took office in January of that year, and so the naive view is that any spending that immediately followed is solely a reflection of his administration's decisions. But as Nutting correctly reminds, spending for fiscal year 2009 was largely set by the Bush administration and Congress before the election of 2008:
What people forget (or never knew) is that the first year of every presidential term starts with a budget approved by the previous administration and Congress. The president only begins to shape the budget in his second year. It takes time to develop a budget and steer it through Congress — especially in these days of congressional gridlock.
The 2009 fiscal year, which Republicans count as part of Obama’s legacy, began four months before Obama moved into the White House. The major spending decisions in the 2009 fiscal year were made by George W. Bush and the previous Congress.
It's also true that over half of federal spending is automatic, or mandatory, as it's labeled. For example, spending on entitlement programs, such as social security, drift higher without a vote of Congress each year. These programs can be changed or even terminated with an act of Congress, but normally the spending growth on the mandatory side of the budget rolls on, immune to the day-to-day political haggling that otherwise engulfs Washington. That inspires looking at discretionary spending alone to gauge how much more, or less, the government agrees to spend in any given fiscal year. Here too there's been a sharp drop in the rate of spending, albeit only in fiscal year 2011. But the change is dramatic: discretionary federal outlays for fiscal year 2011 dropped slightly relative to the previous fiscal year.
Keep in mind that federal spending is a direct byproduct of Congress, albeit with a heavy hand of influence from the White House. In other words, the idea that federal spending, for good or ill, flows from the decisions of one man, or one branch of government, is misleading, to say the least. Obvious? Yes, but worth repeating in a highly charged political season.
As for the federal budget numbers, they are what they are. You can attack the data as evidence of a government run amuck, or praise the numbers as evidence of enlightened governing. But whatever you do, don't attack the messenger for reviewing the facts.
Update: Here's an excerpt from the aforementioned "Budget and Economic Outlook: Fiscal Years 2012 to 2022" from CBO (pages 4-5):
Federal spending rose by 4 percent in 2011, to $3.6 trillion—a rate of increase that is significantly less than the nearly 7 percent average rate of growth in federal outlays over the previous 10 years. About half of the $142 billion increase from 2010 to 2011 occurred because downward revisions in the estimated net cost of the Troubled Asset Relief Program (TARP) in 2011 were smaller than in 2010; those revisions were recorded as reductions in outlays. Excluding the TARP, total outlays grew by $70 billion, or about 2 percent. In 2012, CBO projects, outlays will increase by just $3 billion (or 0.1 percent). As a percentage of GDP, outlays will fall from 24.1 percent in 2011 to 23.2 percent this year—a level still higher than in any year between 1984 and 2008.
May 24, 2012
April Was Another Weak Month For Durable Goods Orders
New orders for durable goods suffered another sluggish month in April, the Census Bureau reports. Although orders overall edged up last month by a slim 1.5%, the April report follows a sharp 3.7% fall in March. Nonetheless, last month’s slight gain was enough to boost the annual pace of new orders a bit vs. the previous annual reading. That’s hardly a game changer, but the gain at least leaves room for another month of debate about whether durable goods orders--a key leading indicator--are giving way to the dark side of the business cycle.
Looking at the numbers on a monthly basis clearly shows that recent history has roughed up the trend. Is this a smoking gun for the future weakness in the broader economy? Maybe, although some analysts aren’t yet ready to declare that the game is over.
"It looks more and more like businesses are hesitating to invest in the face of worsening uncertainties in the U.S. and global economy," opines Pierre Ellis, a senior economist at Decision Economics.
There's a fine line between hesitating and running up the white flag and so only the next round of data can bring decisive clarity. One small bit of good news today is the substantial rise in the annual rate of change in new orders in April vs. the previous month: 6.7% vs. 1.8%. But the improvement was tarnished somewhat by the continued slump in the year-over-year pace of business investment (new orders ex-aircraft and capital goods). Economists consider this subset of durable goods orders as a benchmark for business investment plans, and so by that standard it seems that corporate sentiment has turned cautious recently.
“These numbers are consistent with a lack of momentum heading into the second quarter,” says Sean Incremona, a senior economist at 4Cast Inc. “The recovery appears resilient but not necessarily strengthening.”
It's easy to be cautious… again. The renewed flare-up of worries about Europe and fears that Greece may leave the euro isn't helping boost confidence. The uncertainty about "Taxmageddon" in the U.S. is another potential negative. On a positive note, energy prices have been trending lower recently, and some analysts predict that even lower prices in the coming months are likely.
Nonetheless, the current climate isn't promoting confidence about the economy. It's premature to cherry pick a few data points and argue that the broad economy's growth in April has suddenly evaporated. The real test will be May's macro reports for deciding if some of the indicators are merely wobbly vs. deteriorating as a reflection of a deeper problem. Tune in a month from now for the answer. In the meantime, there's enough ambiguity to promote or deny your forecast of choice.
Is The Decline In New Jobless Claims Losing Momentum?
For the fourth time in as many weeks, today’s update on initial jobless claims shows that new unemployment filings are hugging the 370,000 neighborhood on a seasonally adjusted basis. The fact that claims aren’t rising is an encouraging sign, of course. But the resistance at the 370,000 level, if it rolls on, will raise more questions about the labor market’s capacity for growth.
For the moment, however, the case for optimism is still stronger. New claims last week remained near the lowest levels since the recession was formally declared null and void as of mid-2009. That’s a sign that suggests job growth continues to forge on. Indeed, one good report and new claims could touch a new post-recession low.
A crucial bit of supporting evidence for the bullish case is the ongoing year-over-year decline in new claims before seasonal adjustment. As the second chart below shows, new claims have been falling by 10% to 20% over last four weeks on an unadjusted basis, with last week’s tally posting a 13% drop vs. the same week a year ago. In other words, nothing seems to have changed--the decline continues.
The weekly seasonally adjusted figures of late appear to be stalled, but that could just be noise. History reminds us that it's usually dangerous to read too much into a few data points on a weekly basis for this series. A more robust analysis comes from analyzing the annual trend, which effectively tells us to think positively until there’s stronger evidence otherwise in the weekly data.
“We haven’t seen very real improvement this year, but claims are not at catastrophic levels,” says David Semmens, a senior U.S. economist at Standard Chartered Bank in London. “They have come down. The labor market is still in a point of flux, but it’s doing OK.”
The Housing Recovery: An Update
Last December I wondered if the housing market was finally poised for a sustainable recovery after years of retreat. There were signs for thinking optimistically then and the latest numbers continue to suggest that mild growth will roll on.
Comparing three key measures of housing activity through April on a year-over-year basis shows that the trend is still up. Housing starts, new one-family houses sold, and newly issued building permits were higher last month by roughly 10% to 30% vs. their year-earlier levels. Even better, the growth rates have been climbing for a year or so. It's not a smooth revival--it never is--but it's hard to miss the general change for the better. In addition, existing home sales rose in April and remain above year-ago levels as home prices continued to rise, the National Association of Realtors reports.
No one will confuse the recent numbers with a healthy market or robust growth. Once you consider the deep and prolonged correction that real estate has endured over the last six years, it's clear that the market is still digging itself out of a very deep hole. And the digging will go on for some time, probably for years. But the light at the end of the tunnel, if we can call it that, is the growing recognition that housing is no longer a negative overall for the broader economy.
The sector's positive contribution may be slight and precarious, but the fact that housing appears to have finally transitioned to a modest net plus is a helpful change that's more than trivial for such a substantial piece of the economy. As much as 18% of GDP is linked to the housing sector, according to the National Association of Home Builders.
"The recent buoyancy in housing market activity has raised hopes that this beleaguered sector may finally be on the verge of a rebound," Millan Mulraine, senior macro strategist at TD Securities, tells Reuters.
Dan Green, a loan officer with Waterstone Mortgage, writes that real estate generally has finally turned the corner:
Since late-2011, the housing market has been improving. Steadily, home sales have moved higher; builder confidence has reached multi-year heights; and, in many U.S. markets, home values have climbed. On a month-to-month basis, it's hard to spot longer-term trends. Beginning this month, it should become easier.
We're only now beginning to see the effects of the government's massive market interventions. As the housing market improves through 2012, 2013 and 2014, we'll look back at Spring 2012 and dub it the "turnaround".
We may still be a long way from witnessing strong growth in real estate on an across-the-board basis. Many regions continue to suffer from a glut of excess inventory. Meanwhile, prices are still soft if not falling in some corners of the country. But the fact that housing is improving, if only slightly, is a big deal for the overall health of the economy. Even a weak and vulnerable run of healing is a substantial change for the better vs. the deep contraction that weighed on growth generally. If nothing else, the ongoing recovery in real estate is one more reason for expecting the expansion in the broader economy to continue.
“It’s very clear now that the housing market has turned a corner,” advises Richard DeKaser, deputy chief economist at Parthenon Group LLC in Boston, via Bloomberg. “The only question is how strong the rebound is going to be. It bodes well for the broader economy.”
May 23, 2012
Staring At The "Fiscal Cliff"
Does the government that governs least also govern best? The famous quote will be put to the test if Congress and the White house don't resolve the "Taxmageddon" train wreck coming our way. What's at stake? Perhaps economic growth, according to a new report from the Congressional Budget Office: "Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013."
Unless the government acts between now and the end of the year, a combination of expiring tax cuts and broad reductions in spending will kick in automatically. It doesn't take a genius to recognize that this wave of fiscal change, if implemented overnight in one fell swoop, could be toxic for a fragile economic recovery. The CBO report says as much:
If current law is allowed to unfold unchanged, the CBO expects that the economy will retreat at an annual real (inflation-adjusted) rate of 1.3% in the first half of 2013—a decline that "would probably be judged to be a recession" by the National Bureau of Economic Research. In that case, overall growth for 2012 is expected to be a shallow 0.5%.The CBO engages in a bit of scenario analysis:
What would happen if lawmakers changed fiscal policy in late 2012 to remove or offset all of the policies that are scheduled to reduce the federal budget deficit by 5.1 percent of GDP between calendar years 2012 and 2013? In that case, CBO estimates, the growth of real GDP in calendar year 2013 would lie in a broad range around 4.4 percent, well above the 0.5 percent projected for 2013 under current law.
Ultimately, there's the fine line between balancing short-term economic challenges and promoting long-term fiscal rectitude. As the CBO advises:
However, eliminating or reducing the fiscal restraint scheduled to occur next year without imposing comparable restraint in future years would reduce output and income in the longer run relative to what would occur if the scheduled fiscal restraint remained in place. If all current policies were extended for a prolonged period, federal debt held by the public—currently about 70 percent of GDP, its highest mark since 1950—would continue to rise much faster than GDP. Such a path for federal debt could not be sustained indefinitely, and policy changes would be required at some point.
Forecasting how all this plays out is especially tricky at a time of dysfunctional government and an unusually contentious election season. Meantime, the macro stakes are rising. There's an assumption that economic policy is focused on favoring growth and keeping the nation out of recession. The track record is, of course, littered with mistakes and failure, although one can argue that those were honest errors and/or the fallout from "normal" political affairs. The danger that awaits now, however, may be the first time that government actively plays a role in tipping the economy into recession. Is Washington really going to let that risk rise?
"You can call this a fiscal cliff. You can call it Taxmageddon as others have done," says Sen. Orrin Hatch, a Republican from Utah. "Whatever you call it, it will be a disaster for the middle class. And it will be a disaster for the small businesses that will be the engine of our economic recovery."
For the moment, at least, the public is unconcerned (or unaware?). Economic confidence hit a new post-Great Recession high last week, according to Gallup. That's not surprising, given the ongoing expansion in the broad economy, according to the April reading on the Chicago National Fed Activity Index.
The question before the house: Will events in Washington derail whatever positive momentum bubbles in the economy?
May 22, 2012
Bubbles, Rebalancing and Asset Allocation
Remember the bond bubble? This is the prediction that bonds are subject to irrational exuberance and so they’re vulnerable to a crash any day now. Analysts have been warning that the end is near for several years. Meantime, the rally rolls on.
The Vanguard Total Bond Market ETF (BND), for instance, is comfortably in the black for the past year through May 21, posting a 7.2% total return. For the past three years, BND is up 6.7%.
Bonds may be in a bubble, of course… or not. It’s hard to know for sure until after the fact. That’s no excuse for ignoring valuation or going through the critical process of projecting expected return and risk. But much of the way the bubble talk is presented is impractical if not dangerous from a strategic-minded investing perspective.
It’s easy to get worked up about dramatic talk of bubbles and the potential for crashes. But it's far from easy to exploit these types of forecasts. That's obvious by reviewing the audited performance numbers of investment portfolios generally. One example that’s a regular topic on these pages is the persistence of above-average returns with passive asset allocation strategies. As I discussed last week, history shows that it’s hard to beat a portfolio that mindlessly holds all the major asset classes. A bit of simple, periodic rebalancing has a habit of juicing returns a bit more. The result: most of the mutual funds that engage in multi-asset class investing of one form or another have trailed simple asset allocation benchmarks over the past 10 years.
Hold on, say the critics, haven't we learned that bubbles are a fact of life in the markets? Haven't we learned the hard lesson from 2008 that markets crash and that buy and hold is for suckers? Whether you think the answers to these and related questions are "yes" or "no" doesn't change the fact that broad diversification across asset classes and regular (or semi-regular) rebalancing exploits the lion's share of what you need to know about investing. That includes dealing with the potential for bubbles.
Rebalancing, after all, is a tool for hedging bubble risk in a world where the timing of bubble bursting is a perennial mystery. For instance, let's say you ignored the bubble forecasts of recent years and continued to hold a portion of your portfolio in bonds. In that case, your bond allocation is probably above the target weight for the portfolio—perhaps substantially above the target. In other words, it's time to rebalance: sell some of the bond holdings and rebalance into other asset classes that haven't performed as strongly.
It's all quite simple, of course. More importantly, it works. Granted, there's no guarantee that the underlying markets you own will earn a positive return, particularly in the short term. But that variable is beyond the control of mortal investors. Asset allocation and rebalancing, by contrast, are within our grasp.
Even so, relatively few investors (even among professionals) do a good job of exploiting the rebalancing bonus, as the chart I posted last week reminds. There are many theories about why so few investors cash in on this simple but effective strategy. Some of the explanation is related to a bias for poorly designed asset allocation strategies. In order to earn a rebalancing bonus, you need to hold a broad array of asset classes, perhaps to the point of dividing up the major pieces into a number of subcategories. You'll also need to adopt an aggressive contrarian mindset to fully take advantage of the opportunities. Think buying equities in December 2008, for instance, or paring bond allocations now.
It's also likely that many investors suffer from managing overly complicated investment strategies. Simple is often better when it comes to harvesting risk premia through time. Unfortunately, that's a lesson that's too often ignored or dismissed, despite decades of research that tell us otherwise.
Don't despair, however. Although most investors do a poor job of exploiting the rebalancing bonus, that means that the expected returns from this task are that much higher for everyone else who focuses like a laser beam of optimizing the decisions here.
Rebalancing alpha, like all alphas, inevitably sums to zero and so the winners are financed by the losers. This simple but powerful point isn't widely understood, but it ends up driving quite a bit of the performance results for investment portfolios the world over. For the minority of investors who are taking advantage of this insight, there's probably a secret hope that the rest of the crowd doesn't catch on. If history's a guide, there's no reason to fear. A relatively small share of investors will probably earn most of the rebalancing bonus over the long haul. The only question is whether you want to be in the minority?
May 21, 2012
Chicago Fed National Activity Index Rose In April
A broad reading on economic activity turned higher last month. “Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) rose to +0.11 in April from –0.44 in March,” the Chicago Fed reports. Meanwhile, the index’s three-month moving average slipped a bit to -0.06 from March’s +0.02. But that’s still far above the -0.70 value that the Chicago Fed advises is an early warning sign of a new recession. By that standard, we’ll need to see a dramatic deterioration in economic reports in the weeks ahead to argue convincingly that a new recession is fate. Some analysts already say the jig is up. Perhaps, but for the moment a dismal outlook from dismal scientists is still more of a forecast that a recognition of current conditions.
Based on the numbers in hand, it doesn’t appear that the economy is poised to fall off the cyclical cliff. Nonetheless, there's room for doubt about what comes next. “Of the four broad categories of indicators that make up the index, only the production and income category and sales, orders, and inventories category improved from March and made a positive contribution in April,” the Chicago Fed noted in a press release.
A week ago I wrote: “We don’t yet have a full reading on the April reports, but what is available to date doesn’t look dark enough to expect that NBER will date last month as the start of a slump either.” Today’s update on the CFNAI strengthens the case for optimism, at least for April.
It’s too soon to say much of anything for May, at least with a high degree of confidence. Forecasting, as always, is wide open to interpretation. But given what we know about April based on the numbers published to date, it’ll take a radical shift to the dark side in this month’s economic news to tip the scales heavily toward a contractionary outlook. Anything’s possible, but it doesn’t look likely.
Bob Dieli, an independent economist who crunches the numbers at RDLB, Inc., recognizes that another slump is coming, but it’s not yet a clear and present danger. In a new report for clients, he writes:
We are going to have another recession. That, my friends, is always true. And that, my friends, is why the easiest forecast in the world is that we are going to have another recession. But the real question is: “when”? And I wish there was a law that said that queries regarding the phases of the business cycle always have to include the word “when”. So, to answer the question properly posed: "when are we going to have another recession?” my answer is: not soon.
Why? Several reasons, which he discusses in some detail for subscribers. To take one of several benchmarks he evaluates in the May edition of his “Prospects and Perspectives” report, industrial production looks quite buoyant. “In front of the last three recessions, and indeed in front of every recession since 1955, this number [on a one-year percentage-change basis] has been running at or near zero when the recessions have gotten under way,” he notes. “While times have changed,” he quips, industrial production's 5.2% annual growth rate through April “is not the new zero.”
Not every economic indicator appears as strong. Employment growth, to cite the leading example, has been slowing lately. But initial jobless claims of late tell us not to jump the gun here either.
It's folly to ignore all the macro risks swirling about at the moment, some of which may be bubbling higher--Europe in particular. The euro factor may be our downfall, but it's not yet obvious in the U.S. numbers. Tomorrow, of course, is another day.
Strategic Briefing | 5.21.12 | Taxmageddon & The Economy
How ‘Taxmageddon’ would affect the U.S. economy
The Washington Post | May 17
What will the economy look like in 2013? A great deal depends on what Congress decides to do at the end of this year. Remember, the Bush tax cuts are expiring, the payroll tax holiday will sunset, and a bunch of new spending cuts under the debt-deal “sequester” are scheduled to kick in. Coming all at once, that’s a potentially big drag on growth.
Three Views of the 'Fiscal Cliff'
Ed Lazear (The Wall Street Journal) | May 20
It's the tax increases we have to fear. Spending cuts won't hurt the economy.
Why America Should Stop Worrying and Love Taxmageddon
James Kwak (The Atlantic) | May 10
A decade ago, President Bush passed temporary tax cuts, betting that they would have to be made permanent to avoid an unpopular tax "increase." Everything is going according to schedule.
The Economy’s Ailments and the Best Fiscal Policy Prescriptions
The Concord Coalition | May 15
The latest economic news and the CBO analysis serve as a reminder that any deficit reduction efforts over the next year need to be designed so as to not stifle personal consumption too much in the short term and yet substantially and credibly increase public saving over the longer term. The President’s budget proposals seem to be appropriately mindful of the short-term fragility of the economy. But in the longer term, their deficit financing becomes the most significant feature in terms of their (adverse) economic effects, causing their costs to outweigh any of the economic benefits associated with the finer structure of the policies. The best way to turn the longer-term numbers around is to keep the basic structure of the policies but change their financing -- i.e., offset their cost without offsetting their good incentive effects.
Speaker Boehner pledges to hijack the debt ceiling and jeopardize recovery again
Economic Policy Institute | May 17
There are only two theoretical ways in which long-term deficit reduction can accelerate economic recovery. First (and actually plausible), a long-term deficit reduction “grand bargain” could include substantial near-term fiscal stimulus and gradually phase-in deficit reduction after some macroeconomic trigger is met (e.g., EPI proposed a “6-for-6” trigger: unemployment at or below 6 percent for six consecutive months). Second, deficit reduction could lower the premium on government borrowing, and thus private interest rates. This second channel actually has no hope of actually working today, as longer-term Treasury yields are already at historically low levels. Making all future increases in the debt ceiling completely uncertain and chaotic, however, will almost certainly impede both channels in the future.
Dems Return Fire on Boehner over Fiscal Crisis
The Fiscal Times | May 17
“If you try to restore fiscal balance without a penny of additional revenue, then you have to cut deeply—too deeply—into critical functions of government,” he said. “Just one example—the cost of extending the Bush tax cuts for the top 2 percent of earners for the next decade is about one trillion dollars. Tax cuts do not pay for themselves. You have to pay for them. We can’t afford to borrow the money to extend those tax cuts, and we won’t agree to cut benefits for seniors or cut investments in education to pay for those tax cuts.”
The 2012 Tax Policy Two-Step: Taxmageddon, Then Tax Reform
The Heritage Foundation | May 9
The nation faces an unprecedented tidal wave of tax hikes on January 1, 2013. Aptly called “Taxmageddon,” at nearly $500 billion the tax hike is so massive that it has accomplished what many regarded as impossible: consensus. There is broad agreement that at least most of this tax hike must be prevented. The debate is really only about how much and when.
At the same time, there is a growing consensus in favor of tax reform. Both President Obama and the presumptive Republican presidential nominee Mitt Romney have called for reducing corporate income tax rates substantially. With such an obvious need, many Members of Congress, echoing their constituents’ views, are frustrated with the lack of progress on tax reform. Many also express a reluctance to prevent Taxmageddon without tax reform, suggesting that doing so smacks of once again “kicking the can down the road.” While these frustrations are understandable, nevertheless as matters stand, the correct two-step sequencing Members should embrace is to prevent all tax hikes now while working on and for tax reform in 2013.
May 19, 2012
Book Bits | 5.19.2012
● The 7 Most Important Equations for Your Retirement: The Fascinating People and Ideas Behind Planning Your Retirement Income
By Moshe Milevsky
Summary via publisher, Wiley
Physics, Chemistry, Astronomy, Biology; every field has its intellectual giants who made breakthrough discoveries that changed the course of history. What about the topic of retirement planning? Is it a science? Or is retirement income planning just a collection of rules-of-thumb, financial products and sales pitches? In The 7 Most Important Equations for Your Retirement...And the Stories Behind Them Moshe Milevsky argues that twenty first century retirement income planning is indeed a science and has its foundations in the work of great sages who made conceptual and controversial breakthroughs over the last eight centuries. In the book Milevsky highlights the work of seven scholars—summarized by seven equations—who shaped all modern retirement calculations. He tells the stories of Leonardo Fibonnaci the Italian businessman; Benjamin Gompertz the gentleman actuary; Edmund Halley the astronomer; Irving Fisher the stock jock; Paul Samuelson the economic guru; Solomon Heubner the insurance and marketing visionary, and Andrey Kolmogorov the Russian mathematical genius—all giants in their respective fields who collectively laid the foundations for modern retirement income planning.
● Hedge Fund Market Wizards
By Jack Schwager
Excerpt via publisher, Wiley
When I asked Colm O’Shea to recall mistakes that were learning experiences, he struggled to come up with an example. At last, the best he was able to do was describe a trade that was a missed profit opportunity. It is not that O’Shea doesn’t make mistakes. He makes lots of them. As he freely acknowledges, he is wrong on at least 50 percent of his trades. However, he never lets a mistake get remotely close to the point where it would provide a good story. Large trading losses are simply incompatible with his methodology.
● China's Remarkable Economic Growth
By John Knight and Sai Ding
Summary via publisher, Oxford University Press
How has the Chinese economy managed to grow at such a remarkable rate--no less than ten per cent per annum--for over three decades? This well-integrated book combines economic theory, empirical estimation, and institutional analysis to address one of the most important questions facing contemporary economists. A common thread that runs throughout the book is the underlying political economy: why China became a "developmental state," and how it has maintained itself as a "developmental state".
● Climate Wars: What People Will Be Killed For in the 21st Century
By Harald Welzer
Review via The Irish Times
Harald Welzer’s new book, translated from German, considers the issue of climate change from the perspective of a social scientist. Welzer is profoundly concerned with the potential for violence and for the breakdown of world order inherent in the pressures that climate change will generate. He sees Sudan as the first case of a war-torn country where climate change is unquestionably one cause of violence and civil war. Over the past 40 years, the desert in northern Sudan has moved 100km towards the once-fertile south. The causes are, on the one hand, steadily decreasing rainfall linked with global climate change and, on the other, the overgrazing of grassland, deforestation and ensuing soil erosion that makes the land infertile.
● The New Economics of Sovereign Wealth Funds
By Massimiliano Castelli and Fabio Scacciavillani
Summary via publisher, Wiley
Sovereign wealth funds (SWFs) aren't new, but they are often misunderstood. As they've attracted more attention over the last decade and grown greatly in size, the need for a new and thorough resource on SWFs has never been greater. These funds will only grow more important over the coming years. In this book, expert authors who work in the industry present a comprehensive look at SWFs from the perspective of western investors.
● The Eskimo and The Oil Man: The Battle at the Top of the World for America's Future
By Bob Reiss
Review via Publishers Weekly
Despite the slightly deceptive title, Reiss offers a nuanced evaluation of the necessity of offshore drilling and ecological preservation. Tracing almost a year in the lives of Edward Itta, the Eskimo mayor of the North Slope of Alaska, and Pete Slaiby, a powerful Shell executive, the engrossing narrative depicts the struggle to reach a drilling decision that will benefit Shell while protecting the native Iñupiat community’s way of life. In light of the 2010 BP oil spill, the North Slope community is especially wary of the detriments of offshore drilling. Meanwhile, Shell spends billions on leases and equipment only to find itself unable to drill year after year. Striking a balance that benefits both the community and the corporation requires outreach, education, understanding, and trust, as well as careful navigation of native culture to arrive at a sensitive medium.
● Handbook of Volatility Models and Their Applications
Edited by Luc Bauwens, Christian Hafner, and Sebastien Laurent
Summary via publisher, Wiley
Volatility has become a hot topic in this era of instant communications, spawning a great deal of research in empirical finance and time series econometrics. Providing an overview of the most recent advances, Handbook of Volatility Models and Their Applications explores key concepts and topics essential for modeling the volatility of financial time series, both univariate and multivariate, parametric and non-parametric, high-frequency and low-frequency.
May 18, 2012
Passive Asset Allocation Strategies Are Still Tough To Beat
Brett Arends of SmartMoney skewers the simple stock/bond balanced fund strategy, and rightly so. There's no reason to rely on a basic equity/fixed income mix in a world where a wider array of asset classes are available through low-cost ETFs.
Recognizing that the average investor has a rich menu of betas at his disposal brings us to the critical issues for portfolio management: a) choosing asset classes; and b) managing the mix through time. There's plenty to say on these topics (see my book Dynamic Asset Allocation, for instance), although it's useful to start by considering a good benchmark, which is the inspiration on these pages for the Global Market Index. This index is a passive allocation to all the major asset classes and it comes in three primary flavors:
1) unmanaged, market-value-weighted (GMI)
2) a year-end rebalanced version of the market-valued weighted index (GMI-R)
3) an equally weighted allocation to the major asset classes that's rebalanced back to equal weights at the end of every year (GMI-E)
One reason why passively owning everything is a strong benchmark is that it makes no assumptions about what's hot or what's not. As such, it's a fully transparent strategy that requires no skills or talent. The straight GMI, in fact, requires no decisions at all once it's initially launched. Market-value weighting takes care of itself. But if you're skeptical of the underlying theory for such a system—a.k.a. the capital asset pricing model—you might consider a model-free allocation to the major asset classes: GMI-E. In order to keep the weights equal, periodic rebalancing is necessary; in this case, I arbitrarily chose the end of each calendar year. As for the rebalanced version of the market-value weighted index (GMI-R), it's something of a hybrid of the other two.
How have these indices performed? Rather well, at least in comparison with a broad sampling of actively managed asset allocation mutual funds. In my previous update in January, GMI was a strong competitor. In fact, GMI has continued to outperform nearly 90% of roughly 1,200 funds for the 10 years through April 30, 2012 (based on funds with at least 10 years of history through the end of last month via Morningstar Principia software). The rebalanced version of GMI fared even better, and the equal-weighted strategy did better still, as you can see in the chart below.
Here's the 10-year annualized total return figures for the chart above:
Does GMI's strong relative performance mean that everyone should abandon their asset allocation strategy and go passive? No, probably not, although you should think twice before straying too far from the GMI allocations. In any case, there are other factors to consider for building portfolios, such as your investment horizon and how your finances and career differ from the average investor's profile.
Meantime, the simple GMI strategies tell us once again that mindless diversification across asset classes and basic rebalancing captures quite a lot of what's otherwise billed as enlightened investing techniques. You can pay a lot more for investment advice, or spend a lot more time analyzing expected return and risk. Assuming you'll do a lot better, however, is probably asking too much for most of us.
May 17, 2012
Jobless Claims Were Unchanged Last Week
No news is still good news for jobless claims. The risk that the labor market’s revival has stalled is still on everyone’s mind, but there’s nothing ominous in today’s update on new filings for unemployment benefits. Claims were flat last week, holding steady at a revised 370,000 on a seasonally adjusted basis. The number du jour is a yawn, and for the time being that’s ok. Treading water has a short shelf life for inspiring confidence, but for the moment a broader review of the numbers continue to suggest that job growth will roll on.
One reason for thinking positively is that the four-week moving average of new claims fell for the second straight week and is near its post-recession low. That’s a sign that the downward momentum for this series remains intact. You can't tell much from any one report for this series, but the trend is more reliable and for the time being the trend still appears inclined to be friendly.
The year-over-year decline in new claims on an unadjusted basis still looks encouraging too. This is a valuable metric because it strips out seasonal adjustment and provides a clearer picture of the trend in new claims. The good news is that there's still a robust bias for declines. If and when the year-over-year profile turns sharply higher for a sustained period, the party is likely to be over. But for the moment, at least, we're still comfortably below zero.
Skepticism abounds, however, in part because the weak growth in April’s payrolls report, which followed a disappointing update for March. But yesterday's strong industrial production reading for April implies that job growth will improve in May. The fact jobless claims aren't rising strengthens the case for thinking that the labor market won't surrender to the cycle's darker forces.
"Over the past two weeks is the first time that there was evidence that claims had come back down from the troubling increase that we saw over April," advises Ellen Zentner, senior U.S. economist at Nomura Securities. "This is the third straight week that claims have remained lower, definitely proving that April was an anomaly."
"Definitely" isn't a word I'd use, although I understand Zentner's point. But stagnation in weekly claims won't get a pass for much longer. Some dismal scientists are already uneasy about the implications. “This is just a steady moving along, claims are not getting worse at least,” says Yelena Shulyatyeva, an economist at BNP Paribas. “We need to see more hiring. We don’t see that happening yet.”
The Economic Implications Of Quantifying Policy Uncertainty
Is policy uncertainty holding back the economic recovery? Stanford economics professor John Taylor says it is and writes that "recent research by Ellen McGrattan and Ed Prescott (on increased regulations) and by Scott Baker, Nick Bloom, and Steve Davis (on policy uncertainty) supports this view." The U.S. Chamber of Commerce also advises via its recent small business survey that "concerns about over-regulation are the highest we’ve seen in the past year, with 42% of small businesses citing it as a major concern and 52% citing regulations as the top threat to their business."
Other lines of research find a connection between corporate investment and political uncertainty. For instance, a study in a recent issue of the Journal of Finance finds that "during election years, firms reduce investment expenditures by an average of 4.8% relative to nonelection years." Meanwhile, higher uncertainty about government policy is expected to have a negative impact on stock prices, according to a model in forthcoming paper in the Journal of Finance. And a recent NBER paper warns that political procrastination in resolving the long-term fiscal challenge for the U.S. "perpetuates uncertainty," which can be thought of as an "excess burden of government indecision."
The future, of course, is always uncertain. Deciding if there's an unusually high level of ambiguity harassing decisions in the here and now is tricky. In an effort to bring some clarity to the topic, three economics professors—Baker, Bloom and Davis (BBD), as noted above—have created an index of economic policy uncertainty in a recent paper and they update the benchmark monthly at PolicyUncertainty.com. The index reflects three data sets:
1. Monthly news stories that cite various references to uncertainty
2. A measure of tax code uncertainty based on tax code provisions set to expire each year
3. Macro uncertainty as defined by the dispersion of individual forecasts for several economic indicators via the database of Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters
BBD's policy uncertainty index has soared in recent years, giving ammunition to analysts who argue that an excess of doubt about the future is weighing on the economy. (For a good overview of the debate about the pace of the post-recession recovery, see John Cochrane's post here.) The question is whether BBD's definition of uncertainty truly captures the lion's share of this factor. For now, let's accept their index as a representative benchmark. By that standard, it's interesting to note that this policy uncertainty benchmark has dropped sharply in recent months and is now at the lowest level since just before the financial crisis exploded in the autumn of 2008. Should we now conclude that uncertainty is no longer a problem? If so, is the economy poised for stronger growth? Does anyone think that the drop in BBD's index will translate into more support for Obama's re-election prospects?
Clear answers are in short supply when you consider that rate of growth in private-sector payrolls, industrial production and other economic indicators have already rebounded to pre-recession levels in recent history despite the formerly elevated levels in BBD's policy uncertainty index. Is this a signal that an even stronger phase of growth awaits in the wake of BBD's fallen benchmark? Or is there a disconnect between this index and the real economy?
It seems that BBD's index raises more questions than it answers. The drop in BBD's index isn't likely to change anyone's mind, at least not until after November 6. Political uncertainty and economic uncertainty are connected, of course. The upcoming election will wipe away part of the doubt, although it's unclear if post-election clarity will clear up the rest of the misgivings.
The lesson in all of this? Uncertainty is uncertain.
May 16, 2012
Industrial Production Rebounds Sharply In April
If you’re looking for evidence that recession risk is rising, you won’t find it in today’s update on industrial production, which surged 1.1% in April—the biggest monthly rise since December 2010. The cycle may be drag us down in the months ahead, but industrial production is putting up a pretty good imitation of swimming against the tide.
The other big economic news today comes from housing, which suggests that the modest mending rolls on. Housing starts rose a bit last month, although newly issued building permits retreated. The trend in both cases still looks favorable, albeit mildly. But slow healing has been the narrative all along for housing and the numbers du jour don’t change that view.
Today’s drama, however, is clearly in industrial production, and for all the right reasons. Let’s start by looking at the monthly percentage changes. As you can see, April witnessed a strong revival in this series, which is considered to be on the short list of proxies for the broad economy. The caveat is that the revisions lately have been relatively large and so today’s good news may evaporate next month. But given the numbers in hand, it’s a bit tougher to argue that the economy is headed for trouble.
The stronger evidence for seeing the macro glass half full comes from looking at industrial production’s one-year percentage change, which moved up to a robust 5.2% increase. If and when a new recession is imminent, history suggests we'll see a much lower growth rate. To the extent that some analysts have been using industrial production’s weakening annual pace of late to warn of a new slump ahead, today’s stats throw a wrench into that machine.
Any one number must be taken with a grain of salt, of course. Indeed, there are still several reasons to remain cautious about the business cycle, including the slowdown in payrolls growth last month and the ongoing deceleration in the growth rate for personal income.
But today’s industrial production news suggests it’s still too early to give up on growth, a message we heard two weeks ago in April’s IMN Manufacturing report.
This is a good time to emphasize that no one should confuse predicting a new recession at this point with making the case that a new downturn has started based on a preponderance of smoking guns in real time. There may be a downturn lurking in the near-term future, but that’s still a debatable forecast, and one with slightly less statistical support in the wake of the industrial production update. Everything may change tomorrow, but in the meantime you can’t rush the future. It's all a matter of how much confidence you're comfortable with when perusing the numbers. As such, the question I posed earlier in the week is still very much alive and kicking: Is That A Recession Or Just More Slow-Growth Turbulence?
Today's industrial production report brings "more positive U.S. economic news pointing to continued moderate growth," Jennifer Lee, a senior economist at BOMB Capital Markets, tells Reuters.
“Things are looking brighter than they were a few months ago,” opines Millan Mulraine, senior U.S. strategist at TD Securities via Bloomberg. “Auto production is doing well because consumers are buying vehicles, and consumers are buying vehicles because they feel more positive about their job prospects.”
If there’s a good reason to think otherwise, it’ll be conspicuous in the numbers. Until then, gloom is still a forecast. It may be an informed forecast, and it may even be right. No harm done, assuming you distinguish forecasting from profiling the economy with the data as it arrives.
May 15, 2012
Retail Sales Growth Turns Sluggish In April
Retail sales rose a meager 0.1% last month on a seasonally adjusted basis, the smallest monthly gain since December, the Census Bureau reports. The retreat in the growth rate isn’t terribly surprising, given the relatively strong pace in each month during the first quarter. Nonetheless, today's sales news won't inspire confidence amid all the renewed worries about the potential blowback for the global ecoomy if Greece leaves the euro and the possibility of rising recession risk in the U.S.
Some economists say there's still a weather factor at play in the latest retail sales numbers and so it's not obvious that April's data is all that damning. “The consumer is holding up,” says Neil Dutta , a Bank of America economist. “The key thing here is to determine to what extent the weather had an effect, and it’s pretty clear if you look at the components there was some weather impact.”
Last month's fade in consumption may be a harbinger of things to come, or not, but the trend doesn't look ominous in terms of the year-over-year change. Retail sales jumped 6.4% in April vs. 12 months earlier. That's down moderately from the pace in recent months, but no one will confuse this rate of growth with a recession.
The concern is that the annual rate of retail sales has been falling, albeit gently, for a year. That may be nothing more than a natural migration to sustainable (i.e., lower) levels after the dramatic rebound from the depths of the Great Recession. Nonetheless, some analysts worry that the downshift has legs and so the outlook is clouded for the consumer-dependent economy.
"Growth is there, but it's not that convincing," notes David Sloan, senior economist at 4CAST.
Before we throw in the towel on consumption, let's consider the possible effects from falling gasoline prices. There's a lot of chatter this morning about the minimal impact from lower fuel prices on April's retail sales. Fair enough, but if gasoline continues to trend lower it may boost consumer confidence, which was flat last week but still higher than April's readings, according to Gallup. Does that suggest that May economic news will be brighter too?
The answer partly depends on how much green consumers spend at the pump. The national average retail price of regular gasoline fell again in the week through Monday to the lowest level since early February, according to the Energy Information Administration. Granted, prices are still high by historical standards and so a mild fall from extremes is hardly a game-changer. But if more declines are coming, there's a possibility that Joe Sixpack's consumption may hold up through the summer. On that note, today's news that the nuclear talks between the United Nations and Iran are "constructive" implies that energy prices may fall further as the geopolitical risk premium in oil retreats.
Lower energy prices generally last month kept consumer inflation flat in April, the Labor Department reports. Meanwhile, retail sales on a real (inflation-adjusted) basis rose on an annual basis last month to a 4.0% rate, the highest since last October.
None of this wipes away the concern that the consumer is wary, but it's a reminder that it's premature to yell fire in macro's theater just yet. There are a lot of moving parts at work these days and it's not at all clear how key events around the world (and within the U.S.) will play out.
"Greece is peanuts as far as the United States is concerned," says Uri Dadush, former economic policy chief at the World Bank. "But if Greece leads to the contagion of Spain and Italy, the euro could implode. This is big business for the U.S. We're talking trillions of dollars in direct and indirect exposure to the European banking sector."
While the world waits for clarity, let's see what the rest of the week's economic reports say before we pass judgment on April. Next up is tomorrow's update on housing starts and new building permits issued last month, along with April's read on industrial production. There's also Thursday's weekly update on jobless claims and Friday brings word of the Conference Board's leading index.
Strategic Briefing | 5.15.12 | Will Greece Leave The Euro?
European leaders and financial markets braced for Greece exit from euro
The Guardian | May 15
With attempts in Athens to form a government after last week's election looking increasingly doomed, European leaders abandoned their taboo on talking about the possibility that Greece might have to leave the euro.Shares, oil, and the euro were all sold heavily on Monday in anticipation that anti-austerity parties would garner support in a second Greek election likely to be held next month, bringing the row between Greece and its European creditors to a climax.
Greece Gets Hint of Leeway From Euro Officials
Bloomberg | May 14
European governments hinted at giving Greece extra time to meet budget-cut targets, as long as the financially stricken country’s feuding politicians put together a ruling coalition committed to austerity. Calling talk of a Greek pullout from the euro “nonsense” and “propaganda,” Luxembourg Prime Minister Jean-Claude Juncker said only a “fully functioning” Greek government would be entitled to tinker with the conditions attached to 240 billion euros ($308 billion) of rescue aid.
Fears of Greece EU exit rattle markets
MarketWatch | May 14
“It is generally accepted that the euro zone is better positioned now for a Greek exit than it was a year ago,” said Jane Foley, senior currency strategist at Rabobank International, in a note. “That said, it is widely accepted that any sign that Greece could be preparing to exit the system would still trigger contagion in the more vulnerable euro-zone bond markets.” The greatest uncertainty surrounds how much collateral damage a Greek exit would wreak on other vulnerable—and much larger—sovereigns, particularly given the already-weakened position of Spain, Foley said.
Greek coalition talks drag on as stocks tank on fears over fresh vote
Associated Press | May 14
For the ninth straight day, Greek party leaders were struggling to form a coalition government, riven by differences over the harsh austerity measures demanded by international creditors in return for rescue loans. The impasse means the debt-stricken country is facing the prospect of another national election next month after holding an inconclusive ballot May 6.
Greece and the euro: What's next?
CNNMoney | May 14
"The threat from Greece remains real, and Greece exiting the euro area would likely have contagion effects that cannot easily be addressed in the current set-up," said Bank of America Merrill Lynch analysts in a note Monday. "The next weeks are crucial."
Risk of Greek Euro Exit Rattles Markets, but Hints of More Talks Emerge
The New York Times | May 14
As gridlock among Greece’s political parties made new elections and another month of uncertainty there all but inevitable, European markets dropped significantly on Monday amid concerns that Greece’s departure from the euro was near, and right behind it a new round of financial instability for Europe and the outside world. Yet there were also indications emerging on Monday that the latest turmoil could as easily signify the beginning of a new phase of bargaining between Greece and its European lenders as it could a sudden Greek exit from the euro zone.
If Greece has to leave the euro, it will be because of the reckless decision to bail it out in the first place
Andrew Lilico (The Telegraph) | May 15
The reason Greece is likely to leave the euro is precisely because it was (or, more specifically, those that had lent money to it were) bailed out in 2010. Under the scenario above, official creditors (the IMF, the Germans, etc) would have lent money to Greece only after it had defaulted, much as a classic IMF package involves the IMF lending money to countries after they devalue. But what actually happened was that the official creditors lent money to Greece to try to stop it from defaulting.
A Greek default, a euro collapse?
Gwynne Dyer (The Spec) | May 15
The Greeks will probably be using new drachmas before long. The Spanish may also be back to pesetas and the Italians to liras before we are much older. Perhaps the euro will survive as the common currency of the rich and efficient economies of northern Europe, and perhaps not. But the demise of the euro would not mean the end of the EU or of peace in Europe.
May 14, 2012
Is That A Recession Or Just More Slow-Growth Turbulence?
The Economic Cycle Research Institute last week repeated its forecast that the U.S. is headed for a new recession, a prediction that the consultancy has been emphasizing since last September. There is some damning evidence to consider, starting with the slumping rate of growth in personal income, a danger sign that’s been with us for months.
Last December, for instance, I wrote that the deceleration in the pace of disposable personal income growth was "troubling… if it continues." And it has, as ECRI notes in its May 9 commentary:
For the last three months, year-over-year growth in real personal income has stayed lower than it was at the beginning of each of the last ten recessions. In other words, this is what personal income growth typically looks like early in a recession.
Has personal income growth ever remained this low for three months without the economy going into recession? The answer is no.
There’s a fine line between declaring that a new recession is a done deal, a certainty, and arguing that a trend will continue and unleash a fresh round of contraction in the future. If ECRI’s recession forecast is correct, and it may be, then we will soon see clear evidence that all but confirms the prediction.
I’ve been looking for that evidence ever since ECRI first made its forecast back in September. So far, the confirmation in the data hasn't risen to the critical level, a point I've been making all along. In January, for instance, I said that there was still enough forward momentum in the economic data to expect that recession risk in the immediate future was relatively low.
Has this basic outlook changed? Yes, but only on the margins, based on the numbers in hand. Trouble may be brewing, but there’s a strong case for arguing that the data through March still aren’t weak enough to compel the National Bureau of Economic Research at some point to declare that a new recession began in that month. We don’t yet have a full reading on the April reports, but what is available to date doesn’t look dark enough to expect that NBER will date last month as the start of a slump either.
When the next recession does arrive, what signs will provide unambiguous confirmation? Professor Ed Leamer of UCLA, in an NBER research paper from 2008, outlined a simple gauge for judging the major turning points in the business cycle: "Monthly US data on payroll employment, civilian employment, industrial production and the unemployment rate are used to define a recession-dating algorithm that nearly perfectly reproduces the NBER official peak and trough dates." By that standard, the economy isn't likely to be in a recession as of April. As the chart below shows, each of the three indicators continued to post year-over-year percentage changes at levels that are associated with economic expansion.
You can find a degree of confirmation for the chart above in various business cycle indexes. The Conference Board’s Leading Economic Index, for example, continued to anticipate growth through March. And while the Chicago National Fed National Activity Index weakened in March, its three-month moving average was still "above trend," which suggests that a new recession isn’t imminent. The Philadelphia Fed’s Aruoba-Diebold-Scotti Business Conditions Index also looks sufficiently buoyant to raise doubts about expecting a new slump in the immediate future.
Another reason for keeping an open mind on the cyclical outlook until the data convince us otherwise is the message embedded in the output gap, or the ratio of real GDP to potential GDP (using a definition of potential GDP that's estimated by the Congressional Budget Office). "It is not a technical ceiling on output that cannot be exceeded," CBO explains. "Rather, it is a measure of maximum sustainable output—the level of real GDP in a given year that is consistent with a stable rate of inflation. If actual output rises above its potential level, then constraints on capacity begin to bind and inflationary pressures build; if output falls below potential, then resources are lying idle and inflationary pressures abate."
As such, when the ratio of real to potential GDP is above 1.0, that’s a sign that the economy is bumping up against its growth limit for the near term. On the flip side, readings below 1.0 are a signal that the economy has spare capacity. In the first quarter of this year, the ratio was far below 1.0, as the chart below shows. It’s also worth noting that nine of the last 10 recessions have started with readings above 1.0. A reading under 1.0 by itself doesn’t insure that the economy will remain recession-free. But a reading so far below 1.0, as it currently is, raises questions about anticipating a new downturn when the economy appears to have so much capacity sitting idle.
Ultimately, predicting a new recession and finding overwhelming statistical support for the onset of the event are two different things. This much is clear: if ECRI’s forecast is correct, we’ll soon see much clearer warning signs in the numbers scheduled for release in the days and weeks ahead, including tomorrow’s April update on retail sales, Wednesday’s release of industrial production for last month, and the Conference Board’s Leading Economic Index update for April.
The jury, it seems fair to say, is still out on what happens next for the economy. There are danger signs, but it’s not yet clear that the cycle is destined to succumb in the near term to contraction. Then again, maybe the data updates for the week ahead will disabuse us of this optimism.
May 12, 2012
Book Bits | 5.12.2012
● Better, Stronger, Faster: The Myth of American Decline... and the Rise of a New Economy
By Daniel Gross
Q&A with author via Kai Ryssdal (Marketplace)
Ryssdal: All right, so here comes the put-up-or-shut-up: You say early in this book that the ingredients are already here. You say 'it's tough to see what exactly is going to propel the United States forward, but the ingredients are already here.' Like what?
Gross: Well exports is obviously one of them. The fact that the world has been growing more rapidly than the U.S. is a big source of this declinist thinking. An author like Tom Friedman goes to China and says, 'Oh boy, they're building high-speed rails and look at us, we can't build infrastructure; we're finished.' Exports started turning up in April 2009, before the economy at large did. In the last two years, they're up 35 percent. When the rest of the world gets rich, or gets middle-class, they buy what we make. That includes Boeing jets, gas turbines. I found a family-controlled, little company in suburban Pennsylvania that makes wallpaper. 2007, 2008 -- 80 percent of this business was at home; now 70 percent is overseas.
● The Little Book of Bull's Eye Investing: Finding Value, Generating Absolute Returns, and Controlling Risk in Turbulent Markets
By John Maudlin
Summary via publisher, Wiley
To make money in this troubled economy you need to understand where the markets are headed, not where they ve been. Clinging to outdated strategies and played out market trends are sure ways to miss out on new investments, and in The Little Book of Bull s Eye Investing, acclaimed investment expert John Mauldin teaches you how to read the direction of the markets to make decisions that capitalize on today s investment opportunities. A practical road map to what s in store for the markets to help you stay ahead of the curve, the book debunks many of the myths that have come to govern investment logic, particularly the buy-and-hold, relative return vehicles that Wall Street peddles to unsuspecting investors. Giving you a clear view of the trends shaping the markets right now which are likely to provide investment options for the decade ahead, The Little Book of Bull s Eye Investing teaches the value of careful research before you put your money to work.
● The Little Book of the Shrinking Dollar: What You Can Do to Protect Your Money Now
By Addison Wiggin
Summary via publisher, Wiley
The United States dollar is losing value at an alarming rate. According to the Organisation for Economic Co-operation and Development (OECD) index, the U.S. currency is 37 percent below fair value against the Australian dollar and 20 percent versus the Canadian dollar. The decline of the U.S. dollar is one of the biggest threats facing American investors today, but with the Little Book of the Shrinking Dollar: What You Can do to Protect Your Money Now in hand, you have the knowledge and the expertise you need to fight back.
● Quantitative Risk Management: A Practical Guide to Financial Risk
By Thomas S. Coleman
Excerpt via publisher, Wiley
The distinction I draw between risk management and risk measurement argues for a subtle but important change in focus from the standard risk management approach: a focus on understanding and managing risk in addition to the independent measurement of risk. The term risk management, unfortunately, has been appropriated to describe what should be termed risk measurement: the measuring and quantifying of risk. Risk measurement requires specialized expertise and should generally be organized into a department separate from the main risk-taking units within the organization. Managing risk, in contrast, must be treated as a core competence of a financial firm and of those charged with managing the firm. Appropriating the term risk management in this way can mislead one to think that the risk takers’ responsibility to manage risk is somehow lessened, diluting their responsibility to make the decisions necessary to effectively manage risk. Managers cannot delegate their responsibilities to manage risk, and there should no more be a separate risk management department than there should be a separate profit management department.
● The Road to Freedom: How to Win the Fight for Free Enterprise
By Arthur C. Brooks
Review via The Washington Times
In his revolutionary book “The Road to Serfdom,” German economist F.A. Hayek observed: “No sensible person should have doubted that the crude rules in which the principles of economic policy of the nineteenth century were expressed were only a beginning - that we had yet much to learn and that there were still immense possibilities of advancement on the lines on which we had moved.” Indeed, in the nearly 70 years since that book, scholars and “sensible” people alike have learned much about how a country can prosper and falter within the frame of a free-market economy. Arthur Brooks has learned a few things and, with a nod to Hayek, describes them in his new book, “The Road to Freedom.”
● The Taylor Rule and the Transformation of Monetary Policy
Edited by Evan Koening, Robert Leeson, and George Kahn
Summary via publisher, Hoover Institution Press
Twenty years ago, John Taylor proposed a simple idea to guide monetary policy. Quickly the idea spread, not only through academia, but also to the trading floors of Wall Street and the Federal Reserve's boardroom in Washington. Now, two decades later, the Taylor rule remains a focal point for discussions of monetary policy around the world. In The Taylor Rule and the Transformation of Monetary Policy, a veritable contributors' "who's who" from the academic and policy communities explain and provide perspectives on John Taylor's revolutionary thinking about monetary policy. From the Great Inflation of the 1970s through the Great Moderation of the 1980s and 1990s to the Great Deviation following the 2001 recession, the contributors analyze Taylor's influences on monetary theory and policy around the world. They explore some of the literature that Taylor inspired and help us understand how the new ways of thinking that he pioneered have influenced actual policy here and abroad.
● The Submerged State: How Invisible Government Policies Undermine American Democracy
By Suzanne Mettler
Review via Foreign Affairs
Over the course of the past century, the American state -- the sum of all government programs and policies -- has grown dramatically larger and more complex.... All this activity has generally improved and become intricately embedded in citizens' lives -- which is why attempts to cut the government back tend to be unpopular and unsuccessful. Yet many also feel that the government has started to overreach and that its costs and burdens are becoming unsustainable -- which is why bemoaning the extent and growth of the American state is also a perennial feature of political debate. This tension between the fact of a large, active state and doubts about its value is a distinctive feature of the American political scene. One consequence and driver of the contested legitimacy of the American state is the degree to which so much government work has gone underground in recent decades, far more than in other advanced industrial countries, which is the subject of the political scientist Suzanne Mettler's important new book, The Submerged State.
● Restoring Trust in Organizations and Leaders: Enduring Challenges and Emerging Answers
Edited by Roderick M. Kramer and Todd L. Pittinsky
Summary via publisher, Oxford University Press
The sinking public trust in contemporary institutions is a multifaceted phenomenon with political, sociological, economic, and psychological antecedents and consequences. Restoring Trust in Organizations and Leaders is the first volume to adopt the multidisciplinary approach required to understand this decline and to propose and assess remedies. Editors Roderick M. Kramer and Todd L. Pittinsky have assembled contributions from leading psychologists, sociologists, economists, and organizational theorists. In response to such blows to public confidence as the scandals in the Roman Catholic Church, numerous corporate accounting frauds, widespread retirement insecurity, the inadequacy of many school systems, and the failure of politicians in the United States and Europe to come to grips with the economic crisis, Restoring Trust offers a compelling and mind-opening mix of theory, examples, and practical prescription for the critical social problem of restoring public trust in organizations, institutions, and their leaders.
May 11, 2012
Strategic Briefing | 5.11.12 | The Outlook For Oil Prices
Oil: A Temporary Selloff?
BCA Research | May 10
Oil prices may stay under downward pressure in the near term and are particularly vulnerable to euro volatility. Nonetheless, our cyclical bias is still positive.... Moreover, many of the headwinds for oil prices should prove temporary even if a washout in the euro does develop. Generous Fed liquidity reduces the odds of sustained U.S. equity weakness at a time when the U.S. economy is on a stable, albeit slow growth path. In this environment, lower oil and product prices have a self-stabilizing aspect by supporting consumer and business confidence, suggesting that without a major exogenous shock, the downside in oil prices from current levels is lmiited. Bottom line: Our Commodity & Energy Strategy service maintains that oil prices should be higher by year-end.
Iran Oil Exports Fall as Sanctions Tighten
The Wall Street Journal | May 11
Iranian crude oil exports fell sharply again in April and could be down by as much as one million barrels a day this quarter as many countries reduce imports ahead of sanctions that come into effect on July 1, the International Energy Agency said Friday.
OPEC Says ‘Plentiful’ Global Oil Supplies Outpace Demand
Bloomberg | May 10
The Organization of Petroleum Exporting Countries said that global oil supplies are outpacing demand levels, keeping its forecast for world consumption this year unchanged. OPEC, scheduled to meet next month, is producing 8.3 percent more crude than it considers necessary this quarter, data released today by the Vienna-based group show. This has helped inventories in developed nations to reach “comfortable levels,” equivalent to about 59 days worth of consumption, according to an e-mailed report.
Oil futures fall in electronic trading
Marketwatch | May 11
“With Chinese gross domestic product set to improve over the coming months, as the government continues to ease lending requirements, we would expect oil demand growth to pick up, although the apparent consumption figures may remain depressed in the short term due to lower runs in the second quarter,” said commodity strategists at Barclays Capital.
CBO study examines policy options to reduce oil price volatility
Oil & Gas Journal | May 10
Policies that reduce the US transportation system’s heavy reliance on petroleum products would more effectively shield consumers from volatile prices and supply interruptions in the long term than simply increasing US production, a new Congressional Budget Office study concluded. Higher vehicle fuel efficiency requirements and increased motor fuel taxes might be easier to implement than developing alternative fuels and their necessary distribution systems, it suggested.... Increasing US production would put downward pressure on global oil prices once projects were operating, but several overseas producers, particularly members of the Organization of Petroleum Exporting Countries, likely would respond by trying to reduce their exports, the study said. More US production also would take pressure off consumers to move away from petroleum products for motor fuels, it added. A study by the Energy Security Leadership Council at Securing America’s Future Energy, which was released on May 8, reached a similar conclusion.
Domestic Oil Production Is Irrelevant To Oil Prices
Matthew Yglesias (Slate) | May 10
Gasoline is made of oil, so it sounds to a lot of people like if the United States produced more oil domestically that gasoline would get a lot chaper. But a new CBO report on gasoline prices contains this nice chart which shows that it's not so. Canada is a net oil exporter, Japan produces no oil, and the United States is a middle case. But it's Canada, not the US, that's in the middle case for retail gasoline prices. Why? The issue is that oil is a globally traded commodity, so oil isn't really any more expensive in importing countries than in exporting countries.
May 10, 2012
Jobless Claims Fall (Just Barely) Last Week
There’s good news and bad news in today’s weekly update of initial jobless claims. The good news is that new filings for jobless benefits fell last week, albeit by a slim 1,000 to a seasonally adjusted 368,000. That’s also the bad news. A more convincing drop--ideally to new post-recession lows--is what's needed to boost confidence. Instead, we seem to be stuck in neutral, and so there's no resolution yet for the main question weighing on the economic outlook: Are the last two months of weak growth in private payrolls signs of deeper troubles for the U.S. economy?
It’s surely encouraging that claims have remained relatively low in recent weeks. The outlook for the labor market would be considerably darker if new filings for unemployment had jumped sharply in the wake of the March and April slowdown in jobs creation. Actually, it was easy to think that the economy’s goose had been cooked when new claims surged to nearly 400,000 last month. But the danger quickly passed and claims have since fallen back to near four-year lows.
It’s also encouraging that the unadjusted year-over-year change in jobless claims continues to fall at a strong pace. Using last week’s numbers, claims are roughly 15% below the level from 12 months earlier. That’s near the biggest decline rate for the past year. The fact that the annual retreat continues at a robust pace implies that the labor market will continue to heal and so there's a case for arguing that the latest seasonally adjusted number can be dismissed as short-term noise.
“Part of the reason we’ve seen consumer spending hold up is because we’ve stopped seeing a large amount of layoffs,” Drew Matus, senior U.S. economist at UBS Securities, tells Bloomberg. “The general trend in jobless claims is lower.”
There's some reason to argue the point based on today's update, but the year-over-year decline rates largely trumps those worries. Nonetheless, the recent inability of the weekly seasonally adjusted numbers to poke down to new lows feeds concerns that the labor market's healing process is slowing.
Meanwhile, two large risk factors of late offer mixed messages these days as well. Oil (West Texas Intermediate) has fallen under $100 a barrel for the first time since February and that's helping to pull gasoline prices down. All things equal, lower fuel costs are always helpful for juicing the economy. The question is whether all things are equal these days. In particular, are the growth-boosting benefits of lower energy prices offset by the revival of euro risk.
One step forward, one step back.
“The initial-claims numbers are consistent with the notion that while the labor market is not as robust as December-February data suggested, neither does it appear to be in the process of falling apart,” says Joshua Shapiro, MFR's chief U.S. economist.
Does History Support NGDP Targeting Now?
The debate about targeting a higher rate of growth for nominal gross domestic product (NGDP) keeps the blogosphere humming, but the discussion doesn’t mean much if Fed Chairman Ben Bernanke doesn't embrace the idea. Don't hold your breath. Last month he said the idea is "reckless." That's monetary-speak for: Don't even think about it. But if NGDP targeting is considered a radical notion by some, including those at the pinnacle of monetary power, the empirical record suggests otherwise.
Consider how nominal and real GDP compare through the decades when measured in terms of their rolling one-year percentage changes. As the chart below shows, there's a relationship here that isn't terribly surprising. Higher levels of NGDP tend to be associated with higher levels of real GDP (RGDP).
This relationship is clearer in a scatterplot graph of the two sets of GDP changes. The next chart illustrates how one-year percentage changes for NGDP fare against RGDP. It's not a perfect fit, but you'd be hard pressed to dismiss the connection as random.
For another perspective, the third chart looks at quarterly changes in the two series and the result shows that the connection is even stronger, as indicated by a slightly higher R-squared reading vs. the one-year comparison.
The message in history is that higher (lower) levels of NGDP are linked with higher (lower) levels of RGDP. On its face, this relationship appears quite robust. Why the debate? In a word, inflation, which determines the difference between NGDP and RGDP. Everyone recognizes the relationship between nominal and real growth, but there are questions about whether a central bank can push NGDP higher and what that means for RGDP. Actually, there's little doubt that the Fed's ability to engineer a higher NGDP. Thinking otherwise is to question a central bank's powers to raise inflation. Presumably, that point isn't in doubt. What is unclear, at least in the minds of some (most?) economists is the connection between a central bank's overt policy to push inflation higher for the express purpose of raising RDGP. The fear is that with a policy to raise NGDP, the Fed will unleash a permanently higher level of inflation.
There are also questions about whether NGDP that's "artificially" raised can meaningfully lift RGDP in the short term. David Andolfatto, a vice president at the St. Louis Federal Reserve, recently asked on his blog Macromania: "What is the theoretical underpinning for NGDP targeting? And what is the empirical evidence that leads them to believe that an NGDP target right now is a cure for whatever ails us right now?" Economist David Beckworth responds that "David Andolfatto Can Feel More Confident About NGDP Targeting" by reviewing the case in favor of the policy as outlined by Beckworth and others of his persuasion.
Meanwhile, James Hamilton considers the possibilities with targeting a higher NGDP, but is still worried about the "logistics" and so he is "convinced that it is a mistake to ask too much from monetary policy." Scott Sumner counters that Hamilton's concerns are misguided.
And so it goes. But it's all academic unless Bernanke and company undergo an attitude adjustment. On the surface, it seems like the Fed chief would be a natural supporter of NGDP targeting. As Paul Krugman recently reminded, Bernanke wrote papers in favor of the idea. Of course, it's one thing to explore monetary policy as a professor and quite another to weigh the pros and cons of a given policy as the head of the central bank for the planet's largest economy. Noah Smith explains:
I think Bernanke is dealing with a severe case of model uncertainty. Think about it. A professor's job is to say "Here is a way the world might work." A policymaker has to say "OK, I am going to act as if the world works this way." The latter requires a LOT more faith in the model's correctness than the former. It seems highly likely to me that Fed Chairman Bernanke does not believe in Professor Bernanke's theories enough to make big bets on them.
Empirical facts, it seems, only go so far in monetary affairs. "The more I read about monetary policy," Smith writes, "the more convinced I become that humankind does not really understand it very well." Smith continues:
The fact is, we just don't know what monetary policy is the best. Maybe QE is a good idea (I think it is!). Maybe a rule like NGDP level forecast targeting is a good idea (I am skeptical but it doesn't sound too bad). Or maybe the amount of QE needed to produce a noticeable movement in employment is so huge that it really would cause serious inflation. Maybe monetary policy operates with "long and variable lags," as Milton Friedman suggested, meaning that it's very difficult for the Fed to know the consequences of its actions. I am not economically illiterate. I can easily find, read, understand, and explain a paper supporting any of these contentions. But at the end of the day I'm willing to bet you that I won't really know how right the paper is. At best, my opinions will probably only have shifted slightly. I am guessing this because I've never read a monetary policy paper that convinced me that "OK, this has got to be how the world works."
So I think that Ben Bernanke has been paralyzed into inaction by the realization that, his academic papers aside, he doesn't really know if QE would be good or bad.
That may or may not be true, but until (if) Bernanke changes his mind about policy, it's (still) all academic.
May 9, 2012
Is The Recent Fall In Inflation Expectations A New Warning Sign?
The new abnormal is still with is, and that means that the recent fall in inflation expectations could be signaling trouble ahead… again. Implied inflation, based on the yield spread between the nominal and inflation-indexed 10-year Treasuries, remains tightly linked with the ebb and flow of the stock market and, by implication, the broader economy. That’s an unusual relationship in the grand scheme of financial and economic history, but it’s a relationship that rolls on in the wake of the Great Recession. It’s also a relationship that in recent weeks seems to be anticipating a new round of problems for the economy. (For the theory behind this empirical fact, see David Glasner's research paper on the so-called Fisher effect.)
Recall that the market’s inflation outlook has been a reliable early warning indicator of macro trouble in recent years. In the new abnormal, a fall in inflation expectations is linked with a falling stock market and a general decline in economic activity. Given that history, the fall in inflation expectations to 2.16% as of yesterday from the previous peak of 2.42% in late-March can’t be dismissed. It may be noise, of course, but the change bears watching until the true trend reveals itself.
Optimists will say that the stock market has yet to confirm the recent drop in inflation expectations. Although the S&P 500 has fallen from its recent highs, there’s nothing particularly ominous about the mild retreat, at least so far. But viewed through the prism of rolling one-year percentage changes, the market’s behavior looks less reassuring.
As a quick digression, negative returns in the stock market on an annual basis tend to be associated with recessions. It’s a flawless relationship in the sense that the onset of every recession in the past 50 years has been a) preceded by a negative annual return or b) the market’s return sinks into the red early on in the economy’s downfall. The problem is that the market sometimes goes negative on an annual basis without a new recession.
In any case, the market is still positive relative to its year-earlier level, but not by much. No one will be encouraged by the sharp descent of late in the S&P’s annual performance. As the second chart below shows, the market is moving dangerously close to the zero mark. For the first time since January, the S&P 500’s year-over-year price change is under 2%.
The antidote is stronger economic news. Unfortunately, that’s been in short supply lately, judging by last week’s update on U.S. jobs growth. But the case for thinking positively isn’t doomed yet. The sharp drop in jobless claims at the end of April holds open the possibility that the labor market will strengthen this month. We’ll know soon enough, but for the moment there’s a bit more doubt about what comes next.
May 8, 2012
Investing In A G-Zero World
The planet is ripe with investment opportunity, according to most of the speakers at an ETF conference I attended yesterday in Boston. From emerging markets to sector rotation to alternative betas, optimism abounds, attendees were told.
As usual at these type of events, focusing on what could go wrong was minimized, although in fairness I did moderate a session on risk management. In any case, it was hard to miss the penchant for seeing the investment outlook as flush with possibility. That's a worthwhile perspective, up to a point, although as I listened to the speakers I kept thinking about Every Nation for Itself: Winners and Losers in a G-Zero World, Ian Bremmer's new book that I read (most of it) on the train ride to Beantown.
Bremmer is the president of the Eurasia Group and a keen geopolitical analyst. In his latest book, he argues that the world is headed for a period for a "tumultuous transition" that's bereft of the leadership that used to prevail when the U.S.-centric club of nations—the so-called G7, which evolved into the G20—kept the international system humming and put out the fires, or at least kept them from burning free. But those days are gone and "we have entered a period of transition from the world we know toward one we can't yet map." He writes that
This is not a story of the decline of the West or the rise of the rest. In years to come, none of these players will have the power to bring about needed change. The G20 doesn't work, the G7 is history, the G3 is a pipe dream, and the G2 will have to wait.
Welcome to the G-Zero
What's the G-Zero? "A world order in which no single country or durable alliance of countries can meet the global leadership."
Bremmer's argument is laid out in breezy fashion, covering the waterfront of macroeconomics, politics and international relations. It reads like an extended op-ed than with footnotes. But his view is certainly persuasive, in part because he provides numerous examples of how the geopolitical world order is evolving and what it means for the future.
For instance, the prediction by some that the rise of emerging markets will fill the vacuum left by a debt-laden U.S.-Europe-Japan power system may be expecting too much. As Bremmer explains, "the BRICS [Brazil, Russia, India, China, South Africa] countries now hold summits and talk publicly of shared interests, but there is much less to their partnership than meets the eye."
These countries don't have much in common beyond a shared desire to increase their international influence and to limit the ability of established powers to impose their will on everyone else. China and India are among the largest energy importers. Brazil and Russia are among the world's most important energy exporters, giving them a very different view of policies and events that push crude oil prices higher. China and Russia are authoritarian countries that face internal ethic and religious challenges to their territorial integrity, while India and Brazil are genuine multiparty democracies with governments that must weigh the need for sometimes painful reforms against frequent fluctuations in public opinion. China and India are rivals for influence in South Asia. China and Russia compete for influence in Central Asia—and in Russia's Far East. Brazil is the only BRICS country that lives in a relatively stable region. China, India, and Brazil each have far more trade with Europe and the United States than with Russia. South Africa, admitted to the group in December 2010, has virtually nothing important in common with any of them.
Do you see the obvious implications that flow from that multi-dimensional matrix of incentives, conflicts and challenges? Neither do I, and I suspect that it's going to be hard for most folks to figure out what's relevant, what's not, and how to tell the difference. In fact, real-time events only strengthen Bremmer's argument. For example, the latest political upset in the "revolt against austerity, cuts" in Europe is yet another sign that the rise of G-Zero world has momentum. Indeed, the triumph of Francois Hollande in the French presidential election threatens to complicate the tension between Paris and Berlin as the Continent struggles to solve its ongoing euro crisis and balance Germany's preference for austerity with France's new-found preference for fiscal stimulus. A similar conflict looks set to roll on for policymakers in the U.S., where divided already government reigns supreme and the possibility (likelihood?) of an extended run awaits after the November elections.
To the extent that geopolitics influences markets (and it does), investing isn't going to get any easier in the years ahead. Geopolitical risk is almost certainly on the rise, and for lots of different reasons. True, it's a different type of risk compared with the Cold War, but it's a risk nonetheless. More importantly, it's much more of a multi-faceted risk, which means that there are probably a lot more unknown unknowns out there.
The fact we live in a multi-polar world is no surprise at this late date. But as Bremmer's book reminds, the multi-polarity may be even more nuanced and byzantine than we thought just a few years ago.
It's easy to see a G-Zero world as favorable for investment opportunities, but it's also a world filled with new and uncertain risks. That's good news for talented managers who have the brains and the resources to navigate the shifting landscape. Well-run global macro strategies, for instance, may be well-positioned to exploit the world ahead. But history suggests that most investors (and institutions) will still have a tough time beating a benchmark of all the major asset classes. That's been true for the past decade, as my recent review of the Global Market Index vs. multi-asset class mutual funds shows. Bremmer's books implies that we should expect more of the same. In fact, if his worldview is correct, and I think it's largely on the money, then the competitive profile of broad-minded asset allocation with simple rebalancing rules is going to remain a tough act to beat. Perhaps that's the only constant you can count on when it comes to investment strategy.
May 7, 2012
Strategic Briefing | 5.7.12 | Fed Governors & Monetary Policy Under Pressure
The Most Important Economic Story Nobody Is Talking About
The Atlantic | May 3
By failing to appoint new members to the Federal Reserve, Obama has failed the economy.... Behind every great central banker stands a great central banking committee. Or at least a pliant one. It's this latter reality that President Obama still has not quite recognized. And this malign neglect of most matters monetary has added a wholly unnecessary degree-of-difficulty to the economic recovery.... As Greg Ip of The Economist has pointed out, most of Bernanke's colleagues now want to raise rates before he does. He increasingly looks isolated.... It's worth remembering that even the hawks project inflation to remain below target and unemployment to remain above target for the next few years. If the Fed believes its own forecasts, it should be doing more.... There are two unfilled seats on the FOMC. President Obama's picks for those positions have been among the victims of the endless Republican obstruction in the world's greatest deliberative body. There's a simple solution. Obama could just bypass the Senate with recess appointments. That's what he did for the Consumer Financial Protection Bureau (CFPB) and National Labor Relations Board (NLRB). Why not do the same for the Federal Reserve (or the Federal Housing Finance Agency)?
Missing Federal Reserve Board Members, Hawks and Weak Leadership
Marcus Nunes (Historinhas) | May 5
I wholeheartedly agree that Obama´s failure to make good board appointments has made life harder for Bernanke. But there´s another reason for what many view as Fed ‘passivity’ and that is Bernanke´s weak leadership qualities. After all, during Greenspan´s years at the Fed´s helm, the FOMC had its usual assortment of “hawks”.... Maybe Greenspan, not being an academic, was pragmatic. He didn´t appear to have “obsessions”, saying phrases such as: “with the ‘appropriate monetary policy’ we will keep risks to inflation and growth balanced”. What the heck does ‘appropriate monetary policy’ mean? That was for the ‘Fed Watchers’ to figure out! But Bernanke is obsessed with inflation – in particular with its negative manifestation deflation. He´s not a natural leader, so he could not bring the hawks to see things his way – as he had long ago figured out for Japan – especially during critical junctures.
Occupy the Philly Fed!
Keystone Politics | May 2
[Charles Plosser] is the President of the Philly Fed, and he has used this position to stop the Federal Reserve from taking more action to get the economy back to full employment. The good news is that Plosser’s 5-year term is up at the end of 2012, so there’s *some* chance his replacement will care more about full employment. The bad news is this chance is very small, since the new President will be appointed by a Board whose members are mostly selected by the banks in the district.
Federal Reserve draws legislative fire from both sides of the aisle
The Hill | May 6
Along with Paul’s bill to eliminate the Fed, two other Republican measures to be discussed are being offered by Reps. Brady and Mike Pence (Ind.). Pence’s bill, which he also introduced in the last Congress, would cut the Fed’s mission in half. Since 1977, Congress has handed the Fed a dual mandate of maximizing employment while controlling inflation. Recent steps taken by the Fed in pursuit of the former goal, like near-zero interest rates and two rounds of “quantitative easing,” have earned recriminations from Republicans, who worry the moves could be encouraging inflation.
How the Next President will get to Re-Shape The FED
LearnBonds | April 2012
If Mitt Romney is elected President, his appointments to the Federal Reserve Board will likely be far more hawkish than Obama’s. Two of his leading economic advisers, Glenn Hubbard and Greg Mankiw are both seen as hawks. Mr. Mankiw wrote an academic paper in 2001 which laid out a formula for an ideal fed funds rate. According to RBS, his formula would indicate that the Fed Funds rate should rise to 0.8% by the end of 2014. This would be an increase of ⅔ percent from the current target of 0.0 to 0.25%.
May 5, 2012
Book Bits | 5.5.2012
● The Clash of Generations: Saving Ourselves, Our Kids, and Our Economy
By Laurence Kotlikoff and Scott Burns
Summary via publisher, MIT Press
The United States is bankrupt, flat broke. Thanks to accounting that would make Enron blush, America’s insolvency goes far beyond what our leaders are disclosing. The United States is a fiscal basket case, in worse shape than the notoriously bailed-out countries of Greece, Ireland, and others. How did this happen? In The Clash of Generations, experts Laurence Kotlikoff and Scott Burns document our six-decade, off-balance-sheet, unsustainable financing scheme. They explain how we have balanced our longer lives on the backs of our (relatively few) children. At the same time, we've been on a consumption spree, saving and investing less than nothing. And that’s not to mention the evisceration of the middle class and a financial system that has proven it can’t be trusted. Kotlikoff and Burns outline grassroots strategies for saving ourselves--and especially our children--from what could be a truly catastrophic financial collapse.
● The Little Book of Hedge Funds
By Anthony Scaramucci
Review via The Huffington Post
Most of the books I've read on investing are about as appealing as chewing on a cinder block. Fortunately, Anthony Scaramucci has written The Little Book of Hedge Funds, an entertaining and informative book without the typical Wall Street bombast, and it's nearly small enough to fit into my back pocket. Scaramucci is a regular contributor to CNBC's Fast Money, so he knows how to deliver a cogent message when he explains "the history and evolution of hedge funds and how they operate." The Little Book of Hedge Funds has everything from interviews with industry giants (Leon Cooperman) to a Due Diligence Questionnaire for potential investors.
● Every Nation for Itself: Winners and Losers in a G-Zero World
By Ian Bremmer
Adapted excerpt via The Wall Street Journal
We have entered what I like to call a "G-Zero" world: one in which no single nation (not even the U.S.) or alliance of governments (certainly not the G-7 or G-20) possesses the political and economic muscle to drive an international agenda. In this new decentralized global order, growth isn't enough. A country also must have resilience—the power to pivot. Which countries are best positioned to pivot deftly in this emerging world order? Brazil, which recently surpassed Britain to become the world's sixth-largest economy, has many promising advantages. With a middle class of more than 100 million, it is home to Latin America's largest consumer market. Its government, led by a party of the left, has established a national consensus in favor of market- and investor-friendly economic policies. Though huge offshore oil discoveries in 2007 ensure that the country will become a leading energy exporter, its economy is well diversified.
● MoneyShift: How to Prosper from What You Can't Control
By Jerry Webman
Excerpt via publisher, Wiley
What has changed? What was so aberrant about the Great Moderation that today we can understand it as an anomaly and be pretty sure that it will not come back—at least not where and how it once resided? What went on in that quarter century that made it so very easy for so very many people to become financially successful in a way that was simply not possible before or since? The answer is that there was a financial vaccine that kept the Great Moderation going, and now, like an antibiotic up against a resistant strain of bacteria, that vaccine has lost its potency. The vaccine’s name? Debt. The doctor administering the vaccine? The Federal Reserve.
● The Big Win: Learning from the Legends to Become a More Successful Investor
By Stephen Weiss
Summary via publisher, Wiley
In his first book, The Billion Dollar Mistake, author Stephen L. Weiss showcased the biggest blunders of some of the world's legendary investors—which lost them billions of dollars on a single investment. Incredibly, the mistakes they made were the same mistakes made by everyday investors but for the magnitude of the loss. Weiss's second book, The Big Win: Learning from the Legends to Become a More Successful Investor, highlights financial successes, explaining how the world's most successful investors make a fortune and how you can do the same. As with the missteps Weiss profiled in his first book, the strategies used by these legendary investors are available to all, regardless of size or sophistication.
May 4, 2012
Is April's Slow/Low Payroll Growth Signaling The New Normal Or A New Recession?
Economists were expecting a relatively weak month for job growth in April, but today’s payrolls report from the Labor Department managed to disappoint the crowd even by the downsized standards of late. Employment in the private sector rose by a thin 130,000 on a seasonally adjusted basis, down from March’s modest 166,000 gain. April’s increase was the lowest since last August. The unemployment rate, surprisingly, managed to slip a bit to 8.1%, but that's irrelevant given today's meager gain in the working population.
Most of the job growth last month, what there was of if, came from the services sector, as usual. The cyclically sensitive goods-producing sector eked out a gain of 14,000, but no one will be impressed with that slight increase.
"It’s a pretty sluggish report over all," Andrew Tilton, a senior economist at Goldman Sachs, tells The New York Times. Julia Coronado, chief economist for North America at BNP Paribas, opines that “the labor market is gradually improving, but I wouldn’t want to call it strong by any stretch. I don’t think this is reassuring for the Fed, though it’s not catastrophic either."
Meanwhile, government employment continued to decline, shrinking by 15,000 after March’s 12,000 retreat. Some analysts worry that the ongoing contraction in the public-sector workforce is becoming a substantial economic headwind.
As for the trend in private payrolls, today's update offers no reason for celebration but there's nothing unusual in today's report relative to recent history either. Granted, payrolls growth is at the lower end of the range for the past year or so. That may be a sign that the economy is weakening, although it's not beyond the pale for arguing that the last two months are just statistical noise and that better news is coming. Indeed, yesterday's large drop in new jobless claims feeds hope on that front.
In any case, analyzing the labor market requires a sober dose of managing expectations these days. It's crucial to distinguish between an unrealistic outlook that disappoints and recognizing that the economic recovery is mild relative to recoveries in decades past. It's hard to tell the difference sometimes, but clarity is coming.
“People say the economy is broken,” James Paulsen, chief investment strategist at Wells Capital Management, tells Bloomberg BusinessWeek's Peter Coy. “It’s not. This is the New Normal. And the New Normal is 25 years old.”
Strategic Briefing | 5.4.12 | Gov't Spending & The Economy
What stimulus? Government is holding us back
Rex Nutting (MarketWatch) | May 4
Everyone’s worried that the economy may go over a “fiscal cliff” next year, but they’re missing something essential: We’ve been falling down a “fiscal hill” for two years already. After giving the economy a huge boost in 2009 and 2010, fiscal policy has become contractionary. Now that the private sector is on the mend, the lack of government spending is the biggest factor holding back the economy. And it could get worse.
Government cutbacks slice into economy's growth
McClatchy Newspapers via Miami Herald | April 27
The U.S. economy's weaker-than-expected growth in the first three months of this year renewed concerns Friday that the nation's fragile recovery might stall. Much of the drag against growth reported Friday came from falling government spending, which raises the stakes in the difficult political fight ahead over narrowing federal budget deficits and lowering the national debt.
Economy's Biggest Drag Right Now Is Government
Eileen Appelbaum (CEPR) via US News | April 27
The economy needs to grow by at least 2.5 percent just to keep unemployment from rising. Thus this latest figure on GDP growth does not auger well for the job market, which has seen a steady rise over the last few weeks in initial unemployment claims. In the face of weaker demand, Investment spending by business is slowing. Cutbacks in government spending at the federal as well as state and local levels are already hurting GDP growth. In the absence of federal revenue sharing with the states--the first time the federal government has not had such a program when unemployment is above 7 percent--state and local government expenditures have fallen for seven consecutive quarters.
Economy's Biggest Drag Right Now Is Government
CNBC | April 27
Government has become its own worst enemy when it comes to the economy, with public spending putting a damper on growth that otherwise continues at a steady if unspectacular pace.... Before anyone starts thinking that Washington suddenly has gotten religion on spending, the bulk of the federal government cuts came from defense spending, which plunged 8.1 percent.... Government policymakers, then, face a dicey dilemma: Continue spending and risk falling further into the fiscal abyss, or cut back and deal with a prolonged future of uninspiring GDP numbers. "The dagger (from the GDP letdown) came from a second straight steep drop in federal government spending due to plunging defense outlays," observed Pierpont economist Stephen Stanley. "Boy, wait until these budget cuts start to kick in."
Defense Spending Plummets under Obama’s Budget
Heritage Foundation | May 2
Last night, President Obama visited Afghanistan and stood on the shoulders of the U.S. military to trumpet his foreign policy. But that military is being eviscerated under the president’s budget cuts, creating a hollow force and exacerbating today’s readiness crisis. Since President Obama took office, more than 50 major weapons programs at a value of more than $300 billion were cut or delayed. On top of this, the Administration told the military to cut almost $600 billion more over the next 15 years. And that’s before any cuts under the Budget Control Act take place.
Economy in U.S. Grew Less Than Forecast in First Quarter
Bloomberg | April 28
Gross domestic product, the value of all goods and services produced in the U.S., rose at a 2.2 percent annual rate [in the first quarter] after a 3 percent pace, Commerce Department figures showed yesterday in Washington... Government spending fell for a sixth straight quarter.
Economy slowed to 2.2% growth rate in Q1
USA Today | April 27
The economy grew at a 2.2% annual rate in the first quarter, the government said today, as a pickup in consumer spending was partly offset by shrinking government spending and sluggish private investment... If government spending had been unchanged in the quarter, the economy would have grown at a 2.8% rate, [said Joel Naroff, president of Naroff Economic Advisors] said.
Real Government Consumption Expenditures & Gross Investment
St. Louis Fed/U.S. Department of Commerce: Bureau of Economic Analysis
May 3, 2012
Jobless Claims Fell Sharply Last Week
Suddenly the sun came out… again. New filings for jobless benefits dropped a hefty 27,000 last week to a seasonally adjusted 365,000. It appears that the downward trend in new claims is intact after all. The last several weeks had raised new doubts, courtesy of a modest rise in new claims, but today's news takes the edge off the worst fears. As always, caution is required for reading too much into any one number for this volatile series. But the trend is far less prone to short-term noise and on that score there’s cheery news in today’s update, as the following charts show.
New claims for unemployment have once again turned down and are near a four-year low. Last week’s 27,000 descent is the biggest weekly fall in a year, which suggests that the labor market healing process, moderate and vulnerable as it still is, continues to roll on.
The fact that exactly one year ago there was a similarly outsized decline in new claims implies that the seasonal adjustment factor for the series may be misleading us. But this charge is softened considerably when we look at the raw, unadjusted figures on a year-over-year basis.
As the second chart below shows, new claims fell last week by more than 20% compared with the year-earlier week--the steepest retreat since February 2011.
The overall message is that the labor market isn’t on the precipice of disaster. The slowdown in job growth reported in the March payrolls report, and a repeat performance in ADP’s estimate of employment changes in April, can’t be dismissed. But today’s jobless claims news is a reminder that it’s premature to say that the labor market is doomed.
The encouragement is timely as it will help us interpret tomorrow’s payrolls report for April from the government. Analysts are expecting a relatively weak rate of growth, which isn’t terribly surprising after yesterday’s ADP estimate for last month. But the jobless claims news holds out the promise that the May payrolls report will show stronger growth.
“The [jobless claims] numbers allay some concern that the labor market is deteriorating,” says Brian Jones, a senior U.S. economist at Societe Generale.
"This offsets the concerns from yesterday's ADP number," advises Phil Flynn, a senior market analyst at PFG. "You're getting mixed signals...It might not be as bad as we were thinking after ADP."
Overall, the case for expecting moderate growth still stands. The trend has been a bit wobbly lately, and it wouldn't be a shock to see more of the same in limited doses via the economic news in the weeks ahead. But the weaker-than-expected data was never broad enough, or deep enough to throw optimism out the window.
"The question is where is the trend going forward?" notes Brett Ryan, U.S. economist at Deutsche Bank. "We think the labor market continues to remain healthy and we expect claims to edge lower."
The bottom line: we've yet to see widespread, sustained deterioration in the economic data generally, which suggests that Ryan's moderately bright outlook sounds about right. The numbers may eventually tell us otherwise, but for the moment there's no overwhelming case for thinking that moderate growth has been hijacked.
A New Old Explanation For Recessions & Financial Crises
Edward Conard, a retired executive of Bain Capital and a major donor to Mitt Romney's presidential campaign, tells us that the precipitating cause of the 2008 financial crisis was a surge in demand for liquidity. He's right, of course. The appetite for safety went into overdrive in the final months of that fateful year. This may be a controversial explanation in some circles, but it shouldn't be. Divisive or not, Conard's accounting of how the economy nearly melted down is an excuse to consider how far we've come (or not) in dissecting the business cycle when it goes negative in the extreme. It's also an opportunity for a refresher course on considering the practical policy responses.
“A lot of people don’t realize that what happened in 2008 was nearly identical to what happened in 1929,” Conard tells The New York Times Magazine. “Depositors ran to the bank to withdraw their money only to discover, like the citizens of Bedford Falls [in the movie It’s a Wonderful Life] that there was no money in the vault. All that money had been lent.”
Conard's views would be of minimal interest if he was just another voice in the black hole of economic opinion these days. But as a wealthy individual who's contributed at least $1 million to help Romney reach the White House, his thoughts on the dismal science are destined to attract more than casual scrutiny. In fact, Conard welcomes the attention, considering that he's the author of a new book slated for publication next month--a book that's sure to inflame debate about the nature and role of wealth in America: Unintended Consequences: Why Everything You've Been Told About the Economy Is Wrong.
As for Conard's views on 2008's meltdown, his argument that the economy was blindsided by a bank run, albeit a 21st century version with lots of moving parts, is largely correct. Granted, the definition of "bank" has expanded dramatically since the days of FDR, but the underlying concept still holds. The details on why everyone suddenly demanded safe assets in late-2008 is a frenzy of debate, however. The explanations via the book trade in this niche, for instance, run the gamut, from Richard Posner's A Failure of Capitalism to Robert Hetzel's explanation of "monetary disorder" in The Great Recession to Bethany McLean and Joe Nocera's narrative that financial securitization via Wall Street unleashed the recession, as they report in All the Devils Are Here, to name but a few of the titles.
The truth is that no one's really sure what sets off recessions, i.e., why liquidity demand surges. The smoking gun for thinking so is the reality that the recessions keep coming. But the presumption for thinking that it's all clear is a constant. Take the argument that it was the housing bubble that crashed and killed the boom. Sounds plausible, and for some it's the last word on what went wrong. To some extent, it's a reasonable assessment. But as you dig into the details, it becomes clear that the bull market in housing had started deflating several years before the financial system went into freefall in the fall of 2008. What changed to make 2008 the straw that broke the economy's back? There are a host of theories on this point alone. Indeed, the recession officially began in January 2008, according to NBER, but the calamity didn't arrive until September. Unsurprisingly, there's precious little consensus here either. Was letting Lehman Brothers go under the crucial event? The answer varies, depending on who's at the podium.
Even if we could definitively figure out cause and effect, it's not likely that the details will hold lessons for preventing/responding to the next recession. Recessions, like murder and fingerprints, are unique. There are common traits, but it's not obvious that this information provides us with clear solutions for responding to future downturns. But if there's rarely agreement on what triggers slumps (economists are still debating what's behind the Great Depression of the 1930s), there's at least a fair amount of harmony on how to keep the whole system from collapsing when disaster strikes. In a recent paper presented at the Russell Sage Foundation's "Rethinking Finance" conference, professor Brad DeLong reminds that Walter Bagehot 1873 book Lombard Street still offers advice on how to respond to financial crises that's "remarkably close to the best we can do, even today."
The lender of last resort theory will remain the state-of-the-art response as long as the crises keep coming. It's tempting to think that This Time Is Different in macro, but it never is, at least not when it comes to the fundamentals. The reason why Bagehot's advice remains practical is because the recessions keep coming and no one's sure how to stop this ebb and flow (or even tame it). That doesn't stop anyone from trying, or arguing that the business cycle has finally been deciphered. Perhaps, but I'll keep a copy of Lombard Street handy just in case.
May 2, 2012
ADP Reports Sharply Slower Job Growth In April
The April update of the ADP Employment Report is a clear signal for keeping expectations low for Friday’s influential payrolls report from the U.S. Labor Department. Employment in the private sector grew by only 119,000 last month, according to ADP’s estimate. That’s a 41% drop in the pace of job growth vs. March’s 201,000 gain and is the slowest rate of increase since last September.
Virtually all of last month’s net gains in employment came from the services sector. Most of the cyclically sensitive goods-producing and manufacturing corners of the economy shed jobs in April, ADP reports.
The question is whether ADP’s reading of April's labor market activity is leading or lagging the government’s payrolls report. For some perspective, consider the chart below, which compares the Labor Department’s estimate of private-sector non-farm payrolls (red line) with ADP’s numbers (blue line). The two series generally track one another closely, although in any given month or two there can and will be relatively large divergences. The issue now is deciding if the latest downturn in the ADP number for April is following the March decline in the Labor Department’s update. If so, one could reason that the ADP number is merely a delayed confirmation of what we already knew a month ago, when the Labor Department reported that March job growth suffered a considerable slowdown. In that case, Friday's report may bring better news.
The darker interpretation is that ADP’s April number is telling us that more weakness is coming in the Labor Department’s figures. We’ll know more on Friday, but for now there’s enough room for doubt to keep the crowd guessing. Indeed, economists don’t seem especially eager to predict a big upturn in Friday’s report. The consensus forecast sees modest improvement in the government's report: a gain of 167,000 for April's private payrolls, according to Briefing.com. That’s higher than the Labor Department's March estimate of a 120,000 gain. But anything well below 200,000 isn't likely to inspire confidence about the sustainability of economic growth.
Meantime, there seems to be a disconnect between today's ADP update and yesterday’s news from the Institute for Supply Management, which reports that manufacturing activity, including employment and new orders, strengthened in April. The ADP numbers beg to differ.
“Employment growth is slowing,” notes David Sloan, an economist at 4Cast Inc. But that's not necessarily a death sentence for the business cycle, he adds. “The economy is growing at a fairly slow pace, though it’s sustainable.”
But not everyone is happy with today's news. "This is an upsetting report," complains David Carter, chief investment officer at Lenox Advisors. "The strength of the U.S. economic rebound is clearly still uncertain. Hopefully we don't get a third consecutive summer of weaker growth."
May 1, 2012
Manufacturing Activity Strengthens In April
The first major economic report for April brings encouraging news. Economic activity in the manufacturing sector expanded last month, the Institute for Supply Management reports. One update must be taken in context with the broader trend, of course. Indeed, a single report can't wipe away the recent worries about another spring slowdown. Still, today's ISM news offers a timely burst of optimism that promotes the idea that the weak economic news in some corners over the past several weeks isn't necessarily the last word on what's ahead.
"This month's increase [in the ISM index] is yet another sign that the U.S. manufacturing sector has been one of the most reliable sources of growth in the U.S. economy since the Great Recession ended," says Alistair Bentley, a TD Bank economist. Scott Brown, chief economist at Raymond James & Associates, agrees. As he tells Bloomberg: "Manufacturing is still in pretty good shape. U.S. manufacturing will outperform its counterparts in Europe. At the points, we’re in a steady-state [economic] expansion."
Indeed, the rise in ISM's overall manufacturing index to 54.8 last month—up from 53.4 in March—elevates this gauge to its highest since last June. (Any reading above 50 indicates growth.) The pop was accompanied by gains last month in ISM's employment and new orders indices for manufacturing, suggesting that there's broad improvement in the sector.
Is manufacturing's continued growth in April a sign that the broader economy will perk up too? The deluge of economic data in the days and weeks ahead will bring an answer soon enough. Meantime, there's a new reason to think positively.
"ISM suggests there's no real reason to get too concerned about the path of the U.S. economy at this point," counsels Nick Bennenbroek, head of FX Strategy at Wells Fargo for North America.
Major Asset Classes | April 2012 | Performance Review
REITs and bonds stole the performance show last month among the major asset classes. As stocks around the world retreated slightly in April, REITs forged ahead for the second straight month, rising 2.9%, according to MSCI REIT. Meanwhile, the crowd resumed its love affair with bonds. U.S. fixed income gained 1.1% last month, based on the Barclays Aggregate Bond Index (its best month since last August), while inflation-indexed Treasuries surged 2.0% as per Barclays Treasuries Tips Index.
Fixed income wasn't able to overcome the headwinds in equities, however. The net result was a slight drag on our market-value weighted benchmark of all the major asset classes. The Global Market Index (GMI) slipped 0.1% in April, it’s first monthly loss this year.
Equal weighting everything once again demonstrated its competitive advantage in April. Our equal-weighted GMI rose 0.5%. For the year through last month, however, the equal-weighted version of GMI trails its market-value-weighted counterpart: 6.7% to 7.1%.
Strategic Briefing | 5.1.12 | The Macro Pain In Spain
Europe, in Slump, Rethinks Austerity
The Wall Street Journal | May 1
Spain has joined seven other euro-zone nations in recession, according to data released Monday, providing new evidence that austerity policies are failing to spark confidence in the region's economies ahead of a week of expected anti-austerity protests and a string of important national elections.
Spain in recession as austerity bites deep
Reuters | April 30
Spain sank into recession in the first quarter and economists said spending cuts aimed at meeting strict EU deficit limits, together with a reeling bank sector, would delay any return to growth until late this year or beyond. It is the second recession in just over two years for the euro zone's fourth largest economy and comes as the government tries to convince investors it will not need outside aid to put its house in order. The country is caught between pressure from its European peers to fix public finances and growing domestic resistance to austerity measures that have helped push unemployment to more than double the EU average.
Spain slides back into recession
The Telegraph | April 30
Germany continued to heap pressure on Spain. Speaking alongside his Spanish counterpart in Santiago de Compostela, German finance minister Wolfgang Schäuble said there should be no easing of austerity in Spain. He said: "The first condition is economic and fiscal consolidation. If now we talk about growth, it shouldn't be understood as a change of direction. That would be a mistake. The focus [on austerity] needs to remain."
Recession in Spain Breeds Pessimism in Global Markets
Associated Press | April 30
The contraction in Spain's economy is dimming hopes that the government will be able to cut its budget deficit as predicted and raises the specter that the country might be locked into a downward financial spiral. A recession makes it more difficult to lower the deficit, and as investors lose confidence in the country, borrowing rates rise, adding to the financial pressure. Ratings agency Standard & Poor's on Friday downgraded Spain to just three notches above junk, following up the move on Monday by lowering its rating for 11 Spanish banks. Investors are worried that Spain will not be able to support its banks, which are burdened with massive amounts of bad loans from an imploded property market. But rescuing Spain, the fourth-largest economy in the 17-country eurozone, might prove too expensive for the continent's bailout funds.
Why We Should Worry about Spain’s Economic Pain
Time | May 1
We should all be very worried about what’s going on in Spain. Because Spain isn’t Greece. The Greek crisis was most likely not a direct threat to the survival of the monetary union. Its economy was simply too small. The danger was in the possible contagion effect Greece might present if it outright defaulted or bolted from the union. Spain, the zone’s fourth-largest economy (after Germany, France and Italy) can do a lot of damage all by itself. If Spain ultimately requires a bailout, it would strain the resources available in the zone’s rescue fund (the European portion of which was recently boosted to a total of $925 billion) and put pressure on the zone to fatten up the fund even more, which Germany and others have been reluctant to do. Such an event would also be the biggest blow to the future of the euro yet, likely reigniting the crisis in Italy and making other bailouts more likely (especially for Portugal). With emerging markets slowing down, Europe in the toilet, the U.S. recovery uncertain, and energy prices high, a Spanish meltdown is exactly what the global economy doesn’t need right now.
Fiscal consolidation: Too much of a good thing?
John Van Reenen (London School of Economics) via Vox | April 27
Germany is rightly concerned about past and future fiscal profligacy by countries like Greece undermining the euro. But the problems of Spain and Ireland, for example, stem not from public borrowing but rather high private debts due to the aftermath of the construction bubble. Forcing Spain down to a deficit of 3% of GDP by 2013 when the 2011 level is 8.5% is, as my colleague Luis Garicano describes it, “Mission Impossible”. Or as the Economist (2012) puts it “The misguidedness of today’s austerity obsession is clearest in Spain…Relying on austerity alone, in a shrinking economy after a huge private debt burst, is a recipe for deflation and depression that could easily end up worsening the underlying fiscal position”