June 25, 2012
The Capital Spectator On The Road...
Your editor will be at various undisclosed locations for the next week or so along the West Coast, traveling with no particular agenda, from LA to San Francisco. Blogging will be light to non-existent during this brief hiatus. What passes for normal around here will resume on Monday, July 2. Meantime, having recently re-read On the Road, I've got Kerouac on the brain. As I make my temporary escape from New Jersey, one of my favorite quotes from the book comes to mind: "Our battered suitcases were piled on the sidewalk again; we had longer ways to go. But no matter, the road is life.”
June 23, 2012
Book Bits | 6.23.2012
● Dark Pools: High-Speed Traders, A.I. Bandits, and the Threat to the Global Financial System
By Scott Patterson
Summary via publisher, Crown Business
A news-breaking account of the global stock market's subterranean battles, Dark Pools portrays the rise of the "bots"- artificially intelligent systems that execute trades in milliseconds and use the cover of darkness to out-maneuver the humans who've created them. In the beginning was Josh Levine, an idealistic programming genius who dreamed of wresting control of the market from the big exchanges that, again and again, gave the giant institutions an advantage over the little guy. Levine created a computerized trading hub named Island where small traders swapped stocks, and over time his invention morphed into a global electronic stock market that sent trillions in capital through a vast jungle of fiber-optic cables. By then, the market that Levine had sought to fix had turned upside down, birthing secretive exchanges called dark pools and a new species of trading machines that could think, and that seemed, ominously, to be slipping the control of their human masters. Dark Pools is the fascinating story of how global markets have been hijacked by trading robots--many so self-directed that humans can't predict what they'll do next.
● Economic Fables
By Ariel Rubinstein
Summary via publisher, Open Book Publishers
Part memoir, part crash-course in economic theory, this deeply engaging book by one of the world's foremost economists looks at economic ideas through a personal lens. Together with an introduction to some of the central concepts in modern economic thought, Ariel Rubinstein offers some powerful and entertaining reflections on his childhood, family and career. In doing so, he challenges many of the central tenets of game theory, and sheds light on the role economics can play in society at large. Economic Fables is as thought-provoking for seasoned economists as it is enlightening for newcomers to the field.
● How Much is Enough?: Money and the Good Life
By Robert Skidelsky and Edward Skidelsky
Review via The Guardian
The Skidelskys resist the idea that growth has a natural limit as some sort of metaphysical fancy, thus distancing themselves from many ecological approaches that regard the planet as a finite resource that cannot sustain continual economic expansion. Technology, the Skidelskys insist, will come to our aid. Moreover, they accuse deep ecological approaches to economics as harbouring a secret puritanism. "Most climate radicals are also passionate haters of greed and luxury, people who in previous ages might have been Cromwells or Savonarolas." The problem, as they see it, is that economic growth has been pursued as an end in itself and not been indexed to any sense of what a good life might look like. Indeed, the very idea of the good life has been so eliminated from public consideration that we are left floundering with the vague rhetoric of happiness, something that has proved insatiable and elusive.
● Peerless and Periled: The Paradox of American Leadership in The World Economic Order
By Kati Suominen
Discussion by author via the German Marshall Fund of the U.S.
In this video GMF Transatlantic Fellow Kati Suominen discusses her new book, "Peerless and Periled: The Paradox of American Leadership in The World Economic Order." She outlines the impact of economic crisis on global powers and why she believe America can continue to lead the world economically.
● Capitalisms and Capitalism in the Twenty-First Century
Summary via publisher, Oxford University Press
Edited by Glenn Morgan and Richard Whitley
The early twenty-first century is witnessing both an increasing internationalization of many markets, firms, and regulatory institutions, and a reinforcement of the key role of nation states in managing economic development, financial crises, and market upheavals in many OECD and developing economies. Drawing on a variety of interdisciplinary perspectives from leading US and European scholars, this book analyses how capitalism and national capitalisms are changing in this context. It focuses on the economic rise of new countries such as the BRICs, the increasing influence of regional organizations such as the EU and NAFTA, and new forms of private and public international regulation. It also considers how states are adapting their economic policies and processes in this new environment, and the consequences of these adaptations for inequality and risk within different societies.
● Africa's Future: Darkness to Destiny
By Duncan Clarke
Review via Business Day
Despite the heady growth on the continent, he notes that half of African states are in economic distress, going on the International Monetary Fund’s lists for those countries judged to be struggling with public debt.
Private investment in sub-Saharan Africa last year remained low — at just 15% of gross domestic product (GDP), compared with 30% in Asia and below the norms of developing countries of between 18% and 19%.
Added to this, the cost of replacing infrastructure on the continent has doubled every five years — today sitting at about $45bn — and more than 30 African countries still experience power shortages. Africa is also vulnerable to health, famine and disease, which cost the continent about $12bn every year.
Clarke points out conflicts in Africa effectively erase 10-15 years of growth in their respective countries. In some it has resulted in a 30%-40% cut in GDP.
● Transformation of the Employment Structure in the EU and USA, 1995-2007
Edited by Enrique Fernandez-Macias, John Hurley and Donald Storrie
Summary via publisher, Palgrave Macmillan
To what extent did European countries create 'more and better jobs' – as the EU's Lisbon agenda targeted - after 1995? And to what extent did employment growth in Europe between 1995-2007 reflect the pattern of growing good and bad jobs and a 'disappearing middle' identified in the US labour market? Addressing these questions, this collection describes the changing structure of jobs during the period of robust employment expansion that preceded the 2008 financial crisis. It also provides analysis of labour market developments in these developed economies in terms of gender, international mobility and debates over the quality of work. All of the contributions in this collection originate from a common jobs-based, structural approach to labour market analysis using the same comprehensive dataset.
● The Economics of Collusion: Cartels and Bidding Rings
By Robert Marshall and Leslie Marx
Summary via publisher, MIT Press
Explicit collusion is an agreement among competitors to suppress rivalry that relies on interfirm communication and/or transfers. Rivalry between competitors erodes profits; the suppression of rivalry through collusion is one avenue by which firms can enhance profits. Many cartels and bidding rings function for years in a stable and peaceful manner despite the illegality of their agreements and incentives for deviation by their members. In The Economics of Collusion, Robert Marshall and Leslie Marx offer an examination of collusive behavior: what it is, why it is profitable, how it is implemented, and how it might be detected.
June 22, 2012
Strategic Briefing | 6.22.12 | Debating Monetary Policy (Still)
Fed's Lacker Says Operation Twist Won't Help Growth, Jobs
Bloomberg | June 22
Federal Reserve Bank of Richmond President Jeffrey Lacker said he dissented from the Fed’s $267 billion extension of its Operation Twist program believing it would spur inflation and not significantly help the economy. “I do not believe that further monetary stimulus would make a substantial difference for economic growth and employment without increasing inflation by more than would be desirable,” Lacker said in a statement today from the Richmond Fed.
What the press should ask Bernanke
Scott Sumner (The Money Illusion) | June 21
Bernanke likes to say monetary policy is “not a panacea.” In one sense that’s true, but it most certainly is a panacea for inadequate NGDP growth, and all the associated problems that flow from inadequate NGDP, such as above natural rate unemployment and that part of financial/banking distress that flows from falling nominal incomes.
Monetary Policy Is about Money, not Interest Rates
Tim Lee (Forbes) | June 20
And when tight money has produced ultra-low interest rates, then thinking about monetary policy in terms of interest rates is misleading. Obviously, it seems unlikely that pushing long-term interest rates even closer to zero will have a big effect on business investment. But the point of monetary easing isn’t lower interest rates, it’s giving people more money to spend.
Indeed, effective monetary easing will likely lead to a rise in interest rates, as businesses anticipate consumers with more money in their pockets will buy more goods and services. That will lead to a virtuous circle: businesses hire more workers in anticipation of increased demand, which puts more money in workers’ pockets, who then spend their earnings on goods and services, further increasing demand. But the idea that the Fed conducts monetary policy by manipulating interest rates makes it impossible to think about this process clearly.
The death of Inflation Targeting
Jeffrey Frankel (Vox) | June 19
The current economic crisis has called into question the role of monetary policy, particularly Inflation Targeting and its oversight of asset bubbles and supply side shocks. This column is an obituary to Inflation Targeting and call for Nominal GDP Targeting to replace it....
Fans of Nominal GDP Targeting point out that it would not, like Inflation Targeting, have the problem of excessive tightening in response to adverse supply shocks. Nominal GDP Targeting stabilises demand, which is really all that can be asked of monetary policy. An adverse supply shock is automatically divided between inflation and real GDP, equally, which is pretty much what a central bank with discretion would do anyway.
In the long term, the advantage of a regime that targets nominal GDP is that it is more robust with respect to shocks than the competitors (gold standard, money target, exchange rate target, or CPI target). But why has it suddenly gained popularity at this point in history, after two decades of living in obscurity? Nominal GDP Targeting might also have another advantage in the current unfortunate economic situation that afflicts much of the world: Its proponents see it as a way of achieving a monetary expansion that is much-needed at the current juncture.
"Inflation Targeting is Dead"
Mark Thoma (Economist's View) | June 14
It's hard to figure out how to fix the world if you don't have a reliable model that can explain what went wrong. The optimal money rule in a model depends upon the the way in which changes in monetary policy are transmitted to the real economy. Is it because of price rigidities? Wage rigidities? Information problems? Credit frictions and rationing? The best response to a negative shock to the economy varies depending upon what type of model the investigator is using.
Thus, for the moment we need robust rules. Inflation targeting works well in models with Calvo type price-rigidities, and a Taylor type rule often emerges from models in this general class, but is this the most robust rule in the face of model uncertainty? We don't know the true model of the macroeconomy, that ought to be clear at this point. Does inflation targeting work well when the underlying problem is a breakdown in financial intermediation or other big problems in the financial sector? I'm not at all convinced that it does - some of the best remedies in this case involve abandoning a strict adherence to an inflation target in the short-run.
So, in the best of all worlds I'd prefer to have a model of the economy that works, find the optimal policy rule for that model, and then execute it. In the world we live in, I want robust rules -- rules that work well in a variety of models and in the face of a variety of different types of shocks (or at least recognize that the rule has to change when the source of the problem switches from, say, price rigidities to a breakdown in financial intermediation). One message that comes out of the description of NGDP targeting above is that this approach does appear to be more robust than inflation targeting. It's not always better, in some models a standard Taylor type rule is the best that can be done. But it's becoming harder and harder to believe that the Great Recession can be adequately described by models of this type, and hence hard to believe that we are well served by policy rules that assume price rigidities are the main source of economic fluctuations.
June 21, 2012
Jobless Claims Fell Slightly Last Week, But Stagnation Prevails This Year
Initial jobless claims slipped by 2,000 last week to a seasonally adjusted 387,000. That's enough to put a lid on fears that the economy's falling off a cliff now, today, this minute. But today's update also falls well short of inspiring confidence that stronger, sustained growth will quickly resume. Nonetheless, it's still hard to make a case that a new recession is imminent based on the latest numbers.
It's clear, however, that the downward trend in jobless claims has slowed if not stalled. As the chart below shows, new filings for unemployment benefits have stagnated at roughly the 370,000-to-390,000 level. Confirmation arrives via the four-week moving average of new claims, which rose last week to the highest level since last December. We can call it a rough patch, a slowdown in the recovery, or a prelude to another recession. But whatever it's called it's undeniable that the labor market's expansion has slowed. That's old news, of course, to anyone who read the monthly employment report for May. The recent trend in jobless claims suggests that more sluggish jobs reports await.
Figuring out exactly if a sluggish labor market is temporary or the advance warning of a new economic contraction is tricky, but it still appears as though there's a cushion between slow growth and recession. Consider the rolling 12-month percentage change in jobless claims (in unadjusted terms). As you can see from the second chart, new filings are still falling on a year-over-year basis. History tells us that this annual comparison would be rising steadily in the early stages of an economic downturn. Fortunately, new claims are still falling with year-earlier comparisons, which suggests that the economy is still growing, if only modestly.
Even so, analysts are worried. “Momentum is slowing,” advises Ryan Wang, an economist at HSBC Securities USA. “Companies have curtailed demand for labor. This means less income growth. That’s a restraint on consumer spending.”
"This confirms the weak labor market we have," says Sam Bullard, a senior economist at Wells Fargo Securities. "I suspect we would see a modest rebound in payrolls in June but it would still be below 150,000. It's going to be another month of sub-par jobs data."
Will that be enough to tip the economy over the edge? Maybe, maybe not. But if we're headed for another recession soon, it'll soon be obvious in jobless claims and other economic indicators. Based on the numbers in hand to date, however, we're still not at the tipping point. As I discussed earlier this week, a broad ranking of 14 leading and coincident economic indicators (including jobless claims) remain in positive territory by a comfortable margin. Granted, this ranking only reflects the published numbers through May.
Will June's data deliver more ominous readings? Maybe, although today's jobless claims numbers suggest otherwise. Slow growth is a problem, and if it persists it'll deteriorate into a slump. But for the moment, that risk isn't imminent. Looking further out in time is another matter. In any case, let's distinguish between reading the tea leaves that are in front of us vs. forecasting. Each type of analysis is useful, but no one should confuse one with the other.
June 20, 2012
Mr. Market's Estimate Of Expected Stock Returns
Debate over the expected return on the stock market is a hardy perennial for two basic reasons. First, the true ex ante market return can never be known with certainty. Second, the true ex ante return is forever changing. The problem, of course, is that investors must make decisions, even with imperfect information about the future. Where to begin? One possibility is a simple Gordon growth model that equates equity market return with the sum of the growth rate of dividends plus the current dividend yield. It's really an identify rather than a model, but it's useful just the same.
"The long-term increase in stock market value is entirely the result of the sum of long-term dividend growth and dividend yield calculated from the Gordon Equation," writes financial planner Willliam Bernstein in his indispensable book The Four Pillars of Investing: Lessons for Building a Winning Portfolio. Critics will note that this approach to looking ahead isn't perfect (nothing is, of course). For example, Antti Ilmanen warns in Expected Returns: An Investor's Guide to Harvesting Market Rewards that dividend yield "has become too narrow a measure of carry because firms increasingly use means other than dividends to distribute cash to investors, including share repurchases and cash acquisitions."
Nonetheless, dividend yield is still a good place to start, if only as a first stab at developing some context about how the market's pricing assets and what that implies about the return outlook. Just don't confuse a starting point with an end point. In any case, history suggests dividend yield offers valuable information. Consider, for instance, the relationship through the decades between the S&P 500's current yield and the subsequent value of $1 invested after 10 years. (The underlying data, by the way, comes from Professor Robert Shiller's website.)
The chart below tracks how a $1 investment rose (or fell) after a decade and how the initial investment compared with the current dividend yield at the initial purchase point. For example, the latest entry (shown at the right-hand side of the chart) indicates that the current yield in May 2002 was roughly 1.5%. A $1 dollar investment in the S&P that month would have been worth around $1.24 ten years hence.
The larger point is that the previous 50 years suggests that there's a relationship between current yield and the subsequent 10-year investment. It's not a perfect relationship. In the 1990s, in particular, the connection between yield and subsequent 10-year return went a bit crazy, albeit in favor of buy-and-hold investors. As the surge in the red line in the chart above reminds, investment returns were unusually high. Call it market irrationality or inefficiency. Whatever you call it, don't dismiss it—it can and probably will happen again, and not necessarily in favor of investors.
In any case, looking at the connection between current yield and subsequent return is an obvious starting point for deeper analysis in the dark art of projecting the return on the equity market. Suffice to say, analysts have their work cut out for them. Even the simple Gordon growth model raises a number of questions without easy or obvious answers.
For instance, let's assume that the future long-run return on the stock market is the sum of current yield plus the expected dividend growth rate. Okay, but what expected growth rate should we use in the calculation? As a back-of-the-envelope estimate we might look to history as a guide. But how much historical data is optimal? Unsurprisingly, the results vary considerably with different ranges.
Consider that the implied return on the stock market based on the trailing 50-year dividend growth rate plus current yield was 7.3% last month. But if we use the last 10 years as a benchmark for dividend growth the performance outlook falls to 3.1%.
There are various econometric techniques to figure out what's "optimal," or at least what appears to be "optimal." But that's a subject for another day. What's clear from the chart above is that the market is telling us that the expected return for equities generally is much lower at the moment compared with just a few years ago. Notably, the expected return for stocks was unusually high in February 2009. As it turned out, that was an excellent time to buy, given the subsequent rally. In fact, the surge in dividend yield around February 2009 hinted that expected return had taken wing.
You can't blindly accept these implied return clues, but neither can you dismiss them. There's plenty of science (and a lot of models) to consider in developing expected return estimates, but a fair amount of art inevitably comes into play too.
Predicting, in short, is still hard… especially about the future.
June 19, 2012
Housing Starts Retreat In May As New Building Permits Climb
Is the rising economic anxiety taking a toll on the housing industry… again? The answer depends on the data set you’re looking at. Housing starts fell nearly 5% last month vs. April's tally, the Census Bureau reports. But newly issued building permits jumped by almost 8% in May to the highest level since September 2008. That's a sign that housing starts will stay firm if not rise in the months ahead. As economist Richard Yamarone writes in The Trader's Guide to Key Economic Indicators: "Economists have found that privately-owned housing units authorized by building permits generally precede housing starts by about one month and sales by three."
It could be different this time, of course, in which case the retreat in new starts last month may be a sign of things to come. But when we filter out the monthly noise, the record over the last 12 months still looks encouraging. Indeed, both permits and starts have increased substantially vs. the year-earlier levels.
In fact, the annual growth pace for both series remains at relatively high levels of 25% (permits) and 28% (starts). It’s anyone’s guess if those rates can be maintained, but for the moment it’s clear that the housing industry is still expanding (or at least was expanding as of May).
“We saw a very strong number in new permits, indicating builders are seeing improving demand,” Russell Price, senior economist at Ameriprise Financial, tells Bloomberg.
But doesn’t the slump in May in the headline housing starts number suggest otherwise? Not necessarily, according to some analysts. As Reuters reports:
Revisions to data from prior months were more upbeat. April's starts were revised up to a 744,000-unit pace from a previously reported 717,000 unit rate. That was the highest reading since October 2008. America's weak housing market has dragged on growth in the economy for the last six years, but signs of insipient recovery have led many economists to predict a reversal in that trend this year. New permits for building homes jumped 7.9 percent to a 780,000-unit pace. That was the highest since September 2008 and well above analysts' forecasts. "Several aspects of the report paints a somewhat brighter picture than the headline suggests," said Peter Newland, an economist at Barclays in New York.
Back in December I wondered if the housing market was finally poised for a genuine recovery. Six months later, the news from Europe and the potential for macro blowback in the U.S. over the approaching fiscal cliff inspires caution for expecting too much. But if there’s trouble brewing for housing, we’ll soon see it by way of much darker numbers. For now, however, the bias for growth in starts and permits is intact.
Strategic Briefing | 6.19.12 | Staring At The Fiscal Cliff
Fiscal-Cliff Concerns Hurting Economy as Companies Hold Back
Bloomberg | June 19
Companies are starting to delay hiring and spending out of concern that Congress won’t reach a compromise in time to avoid automatic tax increases and budget cuts that would pull billions of dollars of purchasing power out of the economy. Faced with a so-called fiscal cliff of more than $600 billion in higher taxes and reductions in defense and other government programs in 2013, U.S. companies are pulling back, though the deadline for congressional action is more than six months away.
It’s closer than you may think
Irwin Kellner (MarketWatch) | June 19
he fiscal cliff may be six months away, but it is already affecting the United States economy. As I warned at the beginning of last month ( see column ), unless current law is changed, taxes will rise and spending will fall big time, come year-end. Taxes are set to jump by $500 billion, while federal spending is set to decline by more than $130 billion. Combined, this will equal 5% of our gross domestic product. Along with Europe’s debt crisis and the uncertainties over the longevity of the euro, this is enough to turn weak growth into an outright downturn — in other words, a new recession.
Taxmageddon to Hit These States and Congressional Districts Especially Hard
The Heritage Foundation | June 18
axmageddon is getting ready to suffocate the U.S. economy under crushing tax increases on January 1, 2013. These tax hikes include the expiration of the 2001 and 2003 tax reductions and the tax increases from the 2010 health care law. The Heritage Foundation’s Center for Data Analysis (CDA) ran the numbers based on data from the IRS and found how much Taxmageddon will cost the average taxpayers in each state and congressional district. The $494 billion in new tax increases is $4,138 more in taxes for the average family in 2013, but some places will pay more.
Potential Fiscal Cliff Makes Municipal Bonds Even More Attractive: Martiak
Yahoo Breakout | June 14
"I love muni's as an asset class," says Mark Martiak [of Premier Wealth/First Allied Securities], echoing the view of almost no one Breakout has spoken to in its 18 months of existence.... The default issue looms large for muni's, obviously. Ever since Meredith Whitney's controversial and widely misunderstood call on 60-minutes back in 2010 municipal bonds have been thought untouchable by many. Martiak says that works in investors favor by keeping the supply of muni's lower than it otherwise should be, making the bonds trade more dear than they otherwise might. The "day of reckoning" for municipals has yet to arrive. Martiak notes that the market is $3.7 trillion and only $900 million worth of muni's defaulted in the first quarter of this year; a failure rate which would be the envy of most industries.
The fiscal cliff in America. Why so much uncertainty?
The Economist | June 14
Our correspondents discuss whether it's policy, or a lack of it, that is causing so much uncertainty in business and markets.
June 18, 2012
Estimating Recession Risk (One Monthly Data Set At A Time)
There are two basic ways to wrestle with recession risk. One is to forecast it, the other is to develop a high-confidence assessment of whether it's stepping on the business cycle's throat based on the data published so far. The world is awash with the former, and it comes with all the usual caveats, including a fair amount of error. That's the nature of forecasting: accuracy is all over the place, and it's up to the consumers of the outlooks to figure out who has the better prediction methodology. By contrast, calling the start of major downturns in the economy in the here and now, by using what we know rather than what we think will happen, is far less precarious (if the process is designed reasonably well).
Eventually, all is clear… if you wait long enough. The gold standard on this front is the NBER's official announcements on the dating of new recessions. Because NBER is striving for a very high level of accuracy—perfection, really—these announcements come well after the fact. The cyclical peak of December 2007, for instance, was identified a year after the recession started.
The advantage of the slow-moving NBER process is that you don't have to worry about retractions. When they say the cycle peaked, you can be virtually sure that they're right. But must we wait so long for clarity? The tradeoff in the pursuit of less ancient signals is that earlier calls on cyclical peaks must be paid for with accuracy. The earlier you attempt to declare peaks, the higher the possibility that you could be wrong.
The challenge is figuring out how to maximize accuracy and minimize the signal lags. It wouldn't hurt if the process is transparent, calculated with free, publicly available data, and is relatively simple and intuitive. High parameterized models may wow 'em at the next academic conference, but the record on complex systems isn't encouraging.
One possible solution that seeks to find a reasonable compromise is to focus on the key economic variables that are published in a timely manner. That's an inherently subjective task, but it's par for the course in business cycle analysis—the economic gods have left mere mortals with the unpleasant work of conducting trial-and-error tests to figure out what is, or isn't, relevant.
With that in mind, I've created a list of 14 monthly leading and coincident indicators that have both empirical traction and academic support for assessing the ebb and flow of the business cycle (see the bottom of this post for a list). Each of these indicators has a productive record as it relates to capturing the broad fluctuations in the otherwise unobservable business cycle. The problem is that no one indicator is flawless—even for so-called leading indicators. On the assumption that it's always unclear which indicator will stumble, it's safer to look at an array of numbers to diversify this potential problem.
In most cases, I'm looking at year-over-year percentage changes, calculated monthly. The two exceptions are the Treasury yield curve spread (used as an input based on its currently monthly average) and ISM Manufacturing Index (calculated as its current percentage difference relative to a neutral level of 50). There's also some minor tweaking required for some numbers, such as inverting the signal from jobless claims (i.e., lower is better).
The intuition is that annual changes in the key economic variables will capture most of the otherwise unobservable business cycle patterns. By looking at a broad mix of indicators, we'll limit the potential for false signals about recession risk.
The bottom line: plugging all this into a broad reading on the economy by way of a diffusion index (the percentage of indicators trending positive or negative) reveals a useful history, as the chart below shows. The record suggests that when this index falls below the 50% mark, the odds are reliably high that a new recession has started or will commence in the near future. (On that note, the latest numbers show that recession risk is quite low, as implied by the near-90% reading—more about that later in this post.)
Critics will say that this method for calling business cycle peaks may look accurate in retrospect, but in real time going forward (the so-called out-of-sample test) may falter. The world is littered with econometric evaluations that look promising on paper but disappoint later on. That's always an appropriate caveat and it applies here. Indeed, the problem of data revisions is always lurking. Suffice to say, 100% accuracy is always elusive, no matter what you do (short of waiting for NBER press releases).
Nonetheless, the revisions for the 14 indicators in the chart above may not be fatal. One reason is that the indicators are a wide-ranging lot and so the updates may cancel each other out through time, or at least keep the short-term noise to a minimum. Indeed, revisions aren't uniformly positive or negative, particularly for a broad data set.
A stronger reason for thinking positively that this index of 14 indicators can survive the revision challenge is that analyzing its record using vintage data holds up quite well. By "vintage" I'm referring to a number that was initially released for a given indicator—that is, before the data was revised. Finding vintage data isn't easy, although the St. Louis Fed's Archival Federal Reserve Economic Data (ALFRED) certainly lessens the burden. But ALFRED is missing a fair amount of the vintage numbers and so it's necessary to dig through many press releases and other sources to fill in the missing pieces. A tedious task, to be sure, and one that revealed vintage data for all indicators in my index going back to only 1998. In any case, the effort is quite revealing. As you can see in the next chart, the diffusion index of our 14 indicators that's calculated with vintage data tracks rather closely with the index based on revised numbers for the periods surrounding last two recessions.
By the way, the analysis using vintage data runs as follows. In all cases, I used the current vintage numbers for each point in time. In those cases where the indicator is compared with its year-earlier reading, I used the revised data for the 12-month previous number (on the assumption that revised data is available a year later).
As for the latest numbers, my diffusion index is effectively saying that a new recession didn't start as of last month. Granted, that's based on data only through May. What's more, three of the inputs for last month (personal income and spending, along with housing permits) aren't yet published and so I'm using April numbers as naïve estimates for May.
In sum, don't confuse this evaluation with a forecast. Rather, the 14-indicator diffusion index is advising that the business cycle didn't turn, based on the numbers reported to date. Maybe the full set of June numbers will tell us differently. In any case, the future is unclear, but the recent past is quite a bit less murky.
As for reading the numbers in real time, as released, it seems safe to say that the economy overall was growing as of last month, courtesy of my 14-indicator diffusion index. (A qualitative assessment is something else entirely.) In any case, reading the May data points overall implies that the Chicago Fed National Activity Index (a much broader measure of economy that will be updated on June 25) will also show that recession risk was minimal last month.
Meanwhile, keep an eye on the Philly Fed's ADS Business Conditions Index for a "high frequency" reading of recession risk. Not surprisingly, the latest update for this benchmark also suggests that the economy's still outside of the red zone.
No one should use these numbers as an excuse to ignore the very real threats that exist. A certain currency, for instance, that seems to be teetering on the brink comes to mind as a conspicuous problem for the global economy.
Yes, another recession may be coming, perhaps for reasons that are obvious now. If the economy is destined for a fresh round of contraction, we'll soon see clearer signs that we've slipped off the ledge. But for the moment, that's still a forecast.
* * *
June 16, 2012
Book Bits | 6.16.2012
● 2052: A Global Forecast for the Next Forty Years
By Jorgen Randers
Summary via publisher, Chelsea Green
Forty years ago, The Limits to Growth study addressed the grand question of how humans would adapt to the physical limitations of planet Earth. It predicted that during the first half of the 21st century the ongoing growth in the human ecological footprint would stop—either through catastrophic "overshoot and collapse"—or through well-managed "peak and decline." So, where are we now? And what does our future look like? In the book 2052, Jorgen Randers, one of the co-authors of Limits to Growth, issues a progress report and makes a forecast for the next forty years. To do this, he asked dozens of experts to weigh in with their best predictions on how our economies, energy supplies, natural resources, climate, food, fisheries, militaries, political divisions, cities, psyches, and more will take shape in the coming decades.... The good news: we will see impressive advances in resource efficiency, and an increasing focus on human well-being rather than on per capita income growth. But this change might not come as we expect.
● The Capitalism Papers: Fatal Flaws of an Obsolete System
By Jerry Mander
Review via IFG Oligarchy Blog
“What may have worked in 1850 and 1900 is calamitous in 2012,” says Jerry Mander, in “The Capitalism Papers”. A former advertising executive, Mander was Founder and is now Distinguished Fellow of the International Forum on Globalization. He argues that “the system is killing the planet, dismantling democracy, promoting wars and making people less happy, not more.” In a departure from most previous writings about our two centuries’ old economic system, “The Capitalism Papers” presents a series of point by point arguments that capitalism is increasingly non-viable, and obsolete. The book makes the case that the problems are intrinsic to the model, and are not reformable.
● Betting on China: Chinese Stocks, American Stock Markets, and the Wagers on a New Dynamic in Global Capitalism
By Robert Koepp
Summary via publisher, Wiley
Betting on China takes readers on an illuminating journey into the often confusing and poorly understood world of Chinese stock issuances in America. With insightful qualitative and quantitative analysis, it looks at the phenomenon of equity and capital exchanged between the world's two largest economies and the implications for global finance. Written in an accessible narrative style and amply supported by hard data, the book examines the context and underpinnings of the Sino-American equity relationship, revealing its core dynamics through real-world case studies that range from the precedent-setting blockbuster IPO of China Mobile to the near breakdown of the U.S.-China equity exchange mechanism brought about by short seller attacks on Chinese concept stocks.
● The Lost Bank: The Story of Washington Mutual--The Biggest Bank Failure in American History
By Kirsten Grind
Review via Publishers Weekly
Hubris and greed break the bank in this absorbing saga of the housing bubble. In her first book, Wall Street Journal reporter Grind chronicles the rise of Washington Mutual from a sleepy Seattle-based thrift to America’s biggest savings and loan bank, its reckless plunge into the can’t-lose subprime mortgage market, and its 2008 failure. As the honest, avowedly “nice” WaMu succumbs to the lure of easy money, an almost Shakespearean boardroom melodrama unfolds, featuring vivid personalities like Kerry Killinger, WaMu’s conquering hero-turned-vacillating nebbishy CEO, and Jamie Dimon, the ruthless JPMorgan leader who swallowed WaMu.
● They Play, You Pay: Why Taxpayers Build Ballparks, Stadiums, and Arenas for Billionaire Owners and Millionaire Players
By James T. Bennett
Summary via publisher, Springer
They Play, You Pay is a detailed, sometimes irreverent look at a political conundrum: despite evidence that publicly funded ballparks, stadiums, and arenas do not generate net economic growth, governments keep on taxing sales, restaurant patrons, renters of automobiles, and hotel visitors in order to build ever more elaborate cathedrals of professional sport—often in order to satisfy an owner who has threatened to move his team to greener, more subsidy happy, pastures. This book is a sweeping survey of the literature in the field, the history of such subsidies, the politics of stadium construction and franchise movement, and the prospects for a re priva¬ti¬zation of ballpark and stadium financing. It ties together disparate strands in a fascinating story, examining the often colorful cases through which governments became involved in sports. These range from the well known to the obscure—from Yankee Stadium and the Astrodome to the Brooklyn Dodgers’ move to Los Angeles (to a privately built ballpark constructed upon land that had been seized via eminent domain from a mostly Mexican American population) to such arrant giveaways as Cowboys Stadium.
● Counting the Poor: New Thinking About European Poverty Measures and Lessons for the United States
Edited by by Douglas Besharov and Kenneth Couch
Summary via publisher, Oxford University Press
The poverty rate is one of the most visible ways in which nations measure the economic well-being of their low-income citizens. To gauge whether a person is poor, European states often focus on a person's relative position in the income distribution to measure poverty while the United States looks at a fixed-income threshold that represents a lower relative standing in the overall distribution to gauge. In Europe, low income is perceived as only one aspect of being socially excluded, so that examining other relative dimensions of family and individual welfare is important. This broad emphasis on relative measures of well-being that extend into non-pecuniary aspects of people's lives does not always imply that more people would ultimately be counted as poor. This is particularly true if one must be considered poor in multiple dimensions to be considered poor, in sharp contrast to the American emphasis on income as the sole dimension.
Previous Book Bits columns are available here
June 15, 2012
Industrial Production Weakens In May, But Annual Pace Remains Firm
Industrial production posted a slight loss in May, the Federal Reserve reports. That’s one more reason to worry about the business cycle in the wake of slower job growth and a deepening euro crisis in Europe. Nonetheless, today’s industrial production update falls well short of a fatal blow for thinking positively. Although industrial production declined last month, the retreat was marginal. In fact, one could argue that economic activity has held up surprisingly well so far in the face of so much bad news coming out of Europe.
Looking at industrial production on a monthly basis, last month’s slight 0.1% drop looks quite modest after April’s strong 1.0% increase. As far as this indicator goes, May doesn’t look like a major turning point to the dark side of the cycle. The future may bring calamity, or not, but there's minimal sign of trouble by this data point.
As usual, it’s hard to tell much about the bigger-picture trend from monthly data, an obstacle that’s partly minimized by looking at rolling one-year percentage changes. On this front, the numbers du jour continue to reflect a fair amount of strength. Industrial production rose 4.7% for the year through last month. That’s down a bit from April’s 5.1% year-over-year pace, but it’s hard to argue that the change amounts to much more than the usual statistical noise.
To be honest, I was expecting a far worse report for May. The fact that industrial production has effectively held its ground after such a potent increase in April is encouraging. None of this wipes away the very real risks that hang over the global economy if the euro implodes, but if we’re headed over a macro cliff there’s no overwhelmingly clear sign of that in today’s industrial production news.
This indicator doesn’t typically lead the business cycle and there’s no reason to think otherwise. Nonetheless, if a recession is imminent, history suggests that the year-over-year change in industrial production will 1) be far lower than 4.7% and 2) show clear signs of deceleration on an annual basis. Neither of those conditions apply at the moment. That alone doesn’t guarantee that the economy’s not headed for trouble, but it’s one more positive in the optimism column.
Even so, today’s industrial production news, and the sharp slowdown in growth via the June reading of the Empire State Manufacturing Survey for New York state, show “that the U.S. factory sector is struggling to cope with the impact of the renewed recession in Europe and the slowdown in many key emerging markets,” says Paul Ashworth, chief U.S. economist at Capital Economics via RTT News. "This supports our long-held view that U.S. economic growth will be no better than 2.0% this year and, given the financial instability in the euro-zone, the risks to that forecast lie mainly on the downside.”
If so, that implies that U.S. industrial production’s update for June (scheduled for release on July 17) will bring far more negative news. Pessimism, you could say, springs eternal these days. But for the moment, the numbers don’t quite jibe with the worst fears of analysts.
June 14, 2012
Jobless Claims Rise Last Week. A Warning Sign Of Things To Come?
Today’s update on initial jobless claims doesn’t look good, but it isn’t a death blow either. In “normal” times, one might dismiss the latest numbers as noise. But in the current climate, with the potential for a deepening of the euro crisis, it’s hard to overlook even small bits of deterioration in economic news.
The main issue is that claims are creeping higher (again). The drift so far falls well short of convincing evidence that the cycle has turned. Indeed, it's not yet obvious that the latest numbers reflect anything more than the usual volatility. But with worries about what happens next on the Continent, it’s hard to put a positive spin on today’s data. New filings for unemployment benefits rose last week by 6,000 to a seasonally adjusted 386,000. The increase itself isn’t the problem so much as the appearance of a bottoming out in the downward trend over the past year.
Caution is always required when interpreting weekly numbers for this volatile series, which inspires looking at unadjusted year-over-year percentage changes for a more reliable profile of the trend. Unfortunately, this measure is looking weaker in the wake of the latest numbers. As the second chart below shows, the annual decline in new claims was a modest 6.8% through last week—the slowest rate of retreat since April.
Does this all add up to a nail in the coffin for the labor market in the weeks and months ahead? No, not yet. These numbers bounce around a lot in the short term and so it’s premature to say that the cyclical jig is up for this series. However, if the year-over-year decline rate continues to move closer to zero in the weeks ahead, it’s going to be a lot tougher to refrain from adopting a darker view for job growth and the economy generally.
“This is a bit of a notch-shift higher with jobless claims,” says Bricklin Dwyer, a BNP Paribas economist. “We’ve seen some disappointing employment reports in May. The labor market is just kind of mediocre right now, not gaining much traction.”
If a more ominous outlook is warranted, we’ll soon see more convincing signs in the weekly claims numbers, and in other data too. On that note, the latest full month of economic data (April) shows minimal sign of recession risk. In particular, 13 economic and financial indicators on a rolling 12-month-change basis that I’m tracking/analyzing for a new study on the business cycle show no sign that the economy’s on the cusp of a new downturn (I’ll have more to say on this study soon). In particular, virtually all the indicators are comfortably in positive territory through April vs. a year earlier.
What’s more, the May numbers that have been released so far continue to give growth the benefit of the doubt. Will tomorrow’s update on industrial production for May tell a different story? Yes, according to the consensus forecast via Briefing.com, which expects a dramatic slowdown in industrial production: a slight 0.2% rise for May vs. April’s 1.1% increase.
We are, it seems, at a critical juncture once more. The available data published to date suggests that the economy a) wasn’t in recession in April and b) there’s encouraging odds for thinking that May won't succumb when the final reports are updated. But even May data may be irrelevant at this point. In a world that’s holding its breath over the potential fallout from a deepening euro crisis, it’s only natural to wonder if the economy’s modest momentum in the past two months will last through the summer. Meantime, if there was any hope that Germany--Europe's strongest economy and the last, best hope for macro salvation on euro-related matters--would up its game at building a hire fire wall, Chancellor Angela Merkel managed those expectations down earlier today in a rather big way:
In a speech to lawmakers ahead of the meeting of G20 leaders in Los Cabos, Mexico on June 18-19, Merkel warned Europe could not take the easy way out with solutions based on "mediocrity" that failed to address core problems. "All those looking to Germany again in these days in Los Cabos, who are expecting a drumroll and the answer... I say to them Germany is strong, Germany is an engine of economic growth and a stability anchor in Europe," Merkel said. "But Germany's powers are not unlimited," she said, cautioning against counting too much on Germany as the sole crisis fighter in Europe. "All the (aid) packages will ring hollow if you overestimate Germany's strength," she said.
Strategic Briefing | 6.14.12 | Falling Oil Prices & The Economy
Economy’s Mixed Blessing: Commodity Prices Fall
The New York Times | June 13
“The world economy is in risk of a recession and on that possibility, commodity prices weaken,” said Allen L. Sinai, chief global economist for Decision Economics, a consulting firm. “Lower inflation comes with weakening economies.”
Oil is among the commodities that have fallen in price the fastest despite continuing tensions in the Middle East and the tightening sanctions on Iran. OPEC production has been soaring in recent months because of mushrooming crude exports from Iraq, an almost total resumption of exports from Libya since the fall of the Qaddafi dictatorship, and a concerted drive by Saudi Arabia to push up production. At a meeting in Vienna on Thursday, OPEC is expected to decide to keep production steady despite weakening prices.
Why Saudi Arabia wants to bathe the world in affordable oil
FT Alphaville | June 13
Oil watcher and economist Phil Verleger has some reasons why Saudi Arabia’s insistence on raising production quotas is a sincere bid to keep prices under control, and would willingly risk prices falling below its own “break even” price. He summarised his reasons this way:
The economy. Saudi Arabia recognizes that lower prices in 1999 were a great helping solving the Asian debt crisis.
Russia: The Saudis are very upset with the situation in Syria. Lower oil prices will convince Putin to cooperate
Iran: Lower oil prices will increase pressure on Iran.
Canada and the US: Lower prices will slow development of shale oil and tar sands.
Conservation: lower price might just slow the move of the US to efficiency. (might)
G20: Saudi Arabia likes to be considered part of the club. Lower prices would help renew their membership.
Oil steady ahead of OPEC meeting, Greek polls
Reuters | June 14
Top oil exporter Saudi Arabia is now under pressure from fellow OPEC producers to cut oil output. Price hawks in OPEC are fretting that slower economic growth will send crude, already off $30 since March, sliding further.
"We think that given the economic situation, above all in Europe, there is a serious threat that prices might fall drastically and so our policy is to defend the production ceiling agreed in December," said Venezuelan Oil Minister Rafael Ramirez ahead of the OPEC meeting in Vienna.
Oil Trades Near Eight-Month Low Before OPEC Meeting
Bloomberg | June 14
OPEC, which convenes in Vienna today, will probably maintain its output ceiling as concern that global growth is shrinking outweighs calls for supply cuts to stem sliding crude prices, three of the group’s ministers said. Oil advanced after approaching a technical support level, data compiled by Bloomberg showed.
“The market is in a distinctive wait-and-see mode,” Ole Hansen, senior manager of trading advisory at Saxo Bank A/S in Copenhagen, said by phone. After the results of the OPEC meeting the “immediate focus will switch to Greece elections this weekend because that’s really where demand side questions will be answered,” he said.
Short-Term Energy Outlook
U.S. Energy Information Administration | June 12
West Texas Intermediate (WTI) crude oil spot prices averaged more than $100 per barrel over the first 4 months of 2012. The WTI spot price then fell from $106 per barrel on May 1 to $83 per barrel on June 1, reflecting market concerns about world economic and oil demand growth. EIA projects the price of WTI crude oil to average about $95 per barrel over the second half of 2012 and the U.S. refiner acquisition cost of crude (RAC) to average $100 per barrel, both almost $11 per barrel lower than last month’s Outlook.
June 13, 2012
Retail Sales Slump In May, Mostly Because Of Falling Gasoline Sales
U.S. retail sales slipped 0.2% in May. That’s the biggest monthly fall in two years, although quite a bit of the drop last month was due to a sharp decline in gasoline sales. Nonetheless, the revised data tell us that retail sales have fallen for two months in a row—the first back-to-back monthly declines since 2010. Looking at retail sales on a year-over-year basis is more encouraging, but the trend is still slipping on this front too.
Only a handful of economic reports for May have been released so far and so it’s premature to comment on last month’s macro profile overall. Perhaps the tumble in gasoline sales—a plus for the economy to the extent that it reflects lower gas prices—is skewing the top-line number. But if the overall retail consumption number is the more reliable indicator, it looks like the spring slowdown has legs.
Whatever the cause, the strength in the first quarter is clearly history for now. Short of a dramatic revision in the numbers (or a magnificent June report), retail sales for Q2 are on track for a reversal of fortune relative to the first three months of 2012.
The annual pace of retail sales looks quite a bit better. The 5.5% rise for the 12 months through May is a strong number in historical terms. The worry is that the decelerating rate of growth that’s prevailed for some time will roll on.
It’s debatable if the softer side of the economy of late is due to temporary effects born of the euro crisis vs. internal cyclical troubles. The distinction will be lost, of course, if a recession arrives. But some analysts say that the blowback from Europe is the main impediment to U.S. growth at the moment and so the sluggish economic numbers in recent months are only temporary—assuming the euro disease ends, or at least lessens soon. That may be expecting too much, but that’s the best offer available at the moment if you’re searching for optimism. Unless you buy into the argument that the recent weakness is all about slumping gasoline sales courtesy of falling fuel prices.
"It's basically all about cautious spending,” advises Peter Cardillo, chief market economist at Rockwell Global Capital. “A little disappointing but it's something that the market was expecting, that consumers remain quite cautious. It's all due to the decline in energy sales. Other components show modest spending."
Quite true. Retail sales less gasoline station sales rose a bit in May: +0.1%, comfortably better than the -0.2% loss in the top-line number. Is that a critical distinction? Perhaps we’ll find out tomorrow with the weekly update on initial jobless claims. If the economy is truly slowing, the deterioration will soon reveal itself in no uncertain terms by way of an increase in new filings for unemployment benefits. So far, however, the claims numbers suggest that the labor market is still expanding, or so last week’s report implies. Is it time to revise that outlook? Stay tuned….
June 12, 2012
Searching For Macro Clues On Google
Will Internet search trends offer early signals about the timing of the next recession? No one really knows, but the possibilities are intriguing. Several researchers in recent years have considered the idea that tracking Internet activity offers a window into the future.
A 2009 paper from two Google researchers considered the prospects, asking: "Can Google queries help predict economic activity?"
Economists, investors, and journalists avidly follow monthly government data releases on economic conditions. However, these reports are only available with a lag: the data for a given month is generally released about halfway through the next month, and are typically revised several months later.
Google Trends provides daily and weekly reports on the volume of queries related to various industries. We hypothesize that this query data may be correlated with the current level of economic activity in given industries and thus may be helpful in predicting the subsequent data releases.
We are not claiming that Google Trends data help predict the future. Rather we are claiming that Google Trends may help in predicting the present. For example, the volume of queries on a particular brand of automobile during the second week in June may be helpful in predicting the June sales report for that brand, when it is released in July.
Earlier this year, a pair of New York Fed economists wrote:
Internet search counts possess useful information, not available in other variables, to now-cast or forecast the trajectory of some financial market data. While this predictive power is by no means universal—as we observe above, for a number of markets, Internet search data do not provide explanatory power beyond that of more traditional forecasting methods—the basic message is of a useful addition to the economist’s toolkit.
A related line of research also considers the possibilities of using Internet search data to analyze/predict investment returns. For example, a study published last year in The Journal of Finance finds a connection between Google searches and equity prices (here's a working-paper version of the analysis). Another recent study reports that "asset prices are positively related to the growth rate of Google’s search, trading volume and the level of Google search clicks."
Given this small but growing corner of research, perhaps it's no surprise to find that Google searches on the word "recession" spiked in late-2007 and early 2008—right about the time that the Great Recession began, according to the NBER. The NBER didn't formally announce the onset of the recession until 12 months after the fact. More timely warnings were available, however, although all came with the usual caveats that harass real-time analysis of the business cycle. But that's a topic for another day.
Meantime, the recession-search indicator via Google Trends looks quite tame at the moment. You can find support for thinking positively from more traditional economic indicators, such as the Chicago Fed National Activity Index. Based on CFNAI's update through April, recession risk appears quite low.
Some analysts argue otherwise, and with the euro crisis still raging and perhaps worsening--again--it's easy to imagine a less accommodating future. But if the outlook for the U.S. economy is set to turn darker, one might expect that we'll get wind of the change relatively early via selected word-search queries at Google Trends.
Should we take Internet searches seriously as an early warning sign of changes in the business cycle. Yes, according to the latest study on this intriguing research topic:
In this paper, we propose a novel business cycle surveillance system that utilizes the query logs of search engines for business cycle modeling. The system employs an effective feature selection technique to identify query terms that are representative of business cycles…. Experimental results based on a five-year dataset show that the proposed system can classify the status of business cycles accurately, and the selected query terms reveal interesting human behavior patterns in different business cycles. Unlike economic variables, query logs are readily available through online Web services, so our system can provide business cycle information in a timely manner.
The challenge, of course, is matching in-sample methodologies with out-of-sample results. Studying business cycles in search of superior forecasting techniques is littered with systems that worked well in the past but stumbled when applied afterward in real time with data as it's released.
The true test for Internet searches as an early warning indicator, in short, starts… now. The results won't be known for several months (or years, if the U.S. economy avoids a recession). Meantime, the sky's the limit for the (in-sample) possibilities.
June 11, 2012
A Year Later, Core Inflation Doesn't Look So Rotten
Remember the attack on core inflation? Right about this time a year ago there was a wave of criticism aimed at the idea that core inflation—headline inflation less food and energy prices—is a useful predictor of overall pricing pressures. But a funny thing happened on the way to the lynching of core: the much-maligned concept for looking ahead turned out to be reliable… again.
Consider the rolling one-year percentage changes for headline and core CPI through this past April. Each is higher by 2.3% over the previous 12 months. But the path to equality has been a volatile trek, as it always is. That’s not surprising. But while core and headline are once again running neck and neck, it won’t last. But when the next round of divergence comes, and you’re looking for some perspective on the outlook for inflation, history suggests we should start by considering core inflation.
That's a radical notion in some circles. A year ago, the idea that core could tell us anything useful about the inflation outlook generally had fallen on hard times. For example, St. Louis Fed President James Bullard publicly rejected a fair amount of research when he asserted in May 2011:
One popular argument for focusing on core inflation is that core inflation is a good predictor of future headline inflation. I think this is wrongheaded, as well as wrong.
A year later, core doesn't look quite so rotten. In fact, it looks pretty good. A year ago, if you had looked to core as a guide for where headline would be, you'd have done quite well in the forecasting game. By contrast, some pundits we're telling us that the then-rising 12-month pace of headline inflation was a harbinger of things to come and so the increasing inflation rate would roll on. Low inflation was history, they said—we were on the cusp of surge in headline inflation. But core inflation's lower rate of increase suggested otherwise, and a year on we now know that core was the better predictor.
What changed? Energy prices are no longer skyrocketing. In fact, crude oil has fallen rather dramatically in recent months. After reaching nearly $110 a barrel earlier this year, the benchmark West Texas Intermediate has sunk to the mid-$80s.
It's no surprise that most of the folks who were projecting higher headline inflation a year ago were also warning that $200-a-barrel-oil was just around the corner. Yes, those risks can't be dismissed, even today. But if there's an imminent danger of those outcomes, we'll likely see an early warning in a steadily rising pace of core inflation. For the moment, those potential risks look rather minimal.
Looking to inflation less energy and food prices is, in fact, an old idea, and one that starts with Irving Fisher's debt-deflation theory. As I wrote a year ago, "the focus on core has evolved via years of research that suggests that this narrower gauge inflation is a better predictor of headline inflation for the medium- to long-term future." You can find a few examples of the research from recent years in that post.
Why, then, do so many analysts effectively ignore this body of analysis, and the empirical record? Part of it is probably related to the pressures of the moment. When you're watching oil and gasoline prices rise over, say, the previous six months, it's hard to dismiss the trend and argue that a lower core inflation rate may be a better measure of where prices generally are headed. The basic concept of core inflation, in other words, is counterintuitive in real time. So many people fall into the trap of deciding that core can't be right tomorrow because they see energy and food prices rising today. But looking in the rearview mirror isn't necessarily the best way to project trends beyond a few months. That may be obvious now, but the insight will again go out the window the next time oil prices surge.
June 9, 2012
Book Bits | 6.9.2012
● The Price of Inequality: How Today's Divided Society Endangers Our Future
By Joseph Stiglitz
Review via NPR
In his latest book, The Price of Inequality, Stiglitz argues that widely unequal societies don't function effectively or have stable economies and that even the rich will pay a steep price if economic inequalities continue to worsen. In the current system, top income earners who make their money through capital gains and stock dividends pay lower effective tax rates than the average person. Those capital gains tax rates were first lowered during the Clinton administration, when Stiglitz led the Council of Economic Advisers.
● A Capitalism for the People: Recapturing the Lost Genius of American Prosperity
By Luigi Zingales
Summary via publisher, Basic Books
In A Capitalism for the People, Zingales makes a forceful, philosophical, and at times personal argument that the roots of American capitalism are dying, and that the result is a drift toward the more corrupt systems found throughout Europe and much of the rest of the world. American capitalism, according to Zingales, grew in a unique incubator that provided it with a distinct flavor of competitiveness, a meritocratic nature that fostered trust in markets and a faith in mobility. Lately, however, that trust has been eroded by a betrayal of our pro-business elites, whose lobbying has come to dictate the market rather than be subject to it, and this betrayal has taken place with the complicity of our intellectual class.Because of this trend, much of the country is questioning—often with great anger—whether the system that has for so long buoyed their hopes has now betrayed them once and for all. What we are left with is either anti-market pitchfork populism or pro-business technocratic insularity. Neither of these options presents a way to preserve what the author calls “the lighthouse” of American capitalism. Zingales argues that the way forward is pro-market populism, a fostering of truly free and open competition for the good of the people—not for the good of big business.
● Winner Take All: China's Race for Resources and What It Means for the World
By Dambisa Moyo
Review via Kirkus Reviews
Though she is concerned that “the world…remains largely ill-prepared for the challenges of resource scarcity and the evolving dynamics around China's central role,” the author sharply disagrees with those who assert that China is making an imperial-style grab for raw materials. She asserts that China's policy is different and compares statements of leaders and partners from different countries as proof. China is obtaining access to resources to maintain the growth of its own economy, writes the author, who shows how the country's leaders are prepared to offer money, roads, railways, schools and hospitals in exchange. Moyo contrasts what the Chinese call a “win for all involved” approach with the colonialist approach. She writes that if Western countries “are to have any semblance of standing in the emerging world,” they must cease depending on their traditional policy tools.
● Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio
By Sal Arnuk and Joseph Saluzzi
Summary via publisher, FT Press
The markets have evolved at breakneck speed during the past decade, and change has accelerated dramatically since 2007's disastrous regulatory "reforms." An unrelenting focus on technology, hyper-short-term trading, speed, and volume has eclipsed sanity: markets have been hijacked by high-powered interests at the expense of investors and the entire capital-raising process. A small consortium of players is making billions by skimming and scalping unaware investors -- and, in so doing, they've transformed our markets from the world's envy into a barren wasteland of terror. Since these events began, Themis Trading's Joe Saluzzi and Sal Arnuk have offered an unwavering voice of reasoned dissent. Their small brokerage has stood up against the hijackers in every venue: their daily writings are now followed by investors, regulators, the media, and "Main Street" investors worldwide. Saluzzi and Arnuk don't take prisoners! Now, in Broken Markets, they explain how all this happened, who did it, what it means, and what's coming next.
● Oracles: How Prediction Markets Turn Employees into Visionaries
By Donald Thompson
Summary via publisher, Harvard Business Review Press
From selecting the lead actress in a Broadway musical, to predicting a crucial delay in the delivery of Boeing's 787 Dreamliner months before the CEO knew about it, to accurately forecasting US presidential elections--prediction markets have realized some amazing successes by aggregating the wisdom of crowds. Until now, the potential for this unique approach has remained merely an interesting curiosity. But a handful of innovative organizations--GE, Google, Motorola, Microsoft, Eli Lily, even the CIA--has successfully tapped employee insights to change how business gets done. In "Oracles," Don Thompson explains how these and other firms use prediction markets to make better decisions, describing what could be the origins of a social revolution. Thompson shows how prediction markets can: (1) draw on the hidden knowledge of every employee, (2) tap the "intellectual bandwidth" of retired employees, (3) replace surveys, and (4) substitute for endless meetings.
● Regulating Competition in Stock Markets: Antitrust Measures to Promote Fairness and Transparency through Investor Protection and Crisis Prevention
Edited by Lawrence Klein, Viktoria Dalko, and Michael Wang
Summary via publisher, Wiley
Engaging and informative, Regulating Competition in Stock Markets skillfully analyzes the impact of the recent global financial crisis on health and happiness, and uses this opportunity to put regulatory systems in perspective. Happiness is lost because of emotional and physical health deterioration resulting from the crisis. Therefore, the authors conclude that financial crisis prevention should be the focus of public policy. This book is the most comprehensive study so far on potential risks to the stock market, especially various forms of market manipulation that lead to mania and eventual crisis.
June 8, 2012
Can The U.S. Economy Continue To Fend Off Euro Risk?
The U.S. economy is struggling on a number of fronts, but it’s also encouraging (and surprising?) that the economic turmoil in Europe hasn’t taken a deeper bite out of America’s moderate growth path of late. That could change, of course, but for now there’s still optimism that we’ll sidestep a new recession.
Consider, for instance, yesterday’s update of the Livingston Survey, the oldest continuous polling of dismal scientists on the economic outlook:
The 32 participants in the June Livingston Survey have raised their estimates of output growth for 2012. The forecasters, who are surveyed by the Federal Reserve Bank of Philadelphia twice a year, project that the economy’s output (real GDP) will grow at an annual rate of 2.2 percent during the first half of 2012 and 2.6 percent during the second half of 2012, followed by growth of 2.3 percent (annual rate) in the first half of 2013.
Forecasters can be wrong, of course. In fact, you should count on no less to some degree. But the same applies to those who are predicting a new recession any day now. But if we’re analyzing the numbers reported so far, arguing on behalf of a new slump in the near term requires anticipating the economic news in the weeks and months ahead will deteriorate substantially relative to what’s known in the here and now.
For example, many of the usual suspects that tell us when recession risk is high and rising are still signaling that contraction danger remains minimal. To cherry pick a few benchmarks, the latest numbers on industrial production, private nonfarm payrolls, jobless claims, and real personal income excluding current transfer receipts remain encouraging vs. year-earlier levels. One notable exception that looks troubling is the St. Louis Financial Stress Index, which has been rising recently. No doubt some of this is related to financial pressures in Europe.
Those pressures are spilling over into the real economy on the Continent, as this chart posted earlier this week by Dr. Ed Yardeni reminds:
The recent drop in the euro area’s manufacturing purchasing managers index to 45.1 (a reading under 50 implies a contracting economy) “confirmed that the region has fallen into a recession that is worsening,” Yardeni observed on Tuesday. That’s a problem, he wrote, because
manufacturing has been the leading source of growth during the latest global economic recovery, including in the US. The concern is that neither the US nor China can continue to grow for very long if the European recession continues to deepen. I think they can. However, there has always been a very strong correlation among the various [manufacturing indices] over the business cycle. So it’s not surprising that the stock market’s reaction on Friday [June 1] suggests that investors are skeptical and questioning whether the [manufacturing indicators] can decouple.
If the blowback from Europe gets worse before it gets better, there’s a possibility that the Federal Reserve may roll out a new round of monetary stimulus. As always (especially at this late date) there’s debate about the efficacy of new monetary action. In any case, Janet Yellen (the Fed’s vice chair) wants everyone to know that monetary stimulus is an option that’s very much on the table. As she explained on Wednesday:
I am convinced that scope remains for the FOMC to provide further policy accommodation either through its forward guidance or through additional balance-sheet actions.
Meantime, the waiting game goes on. The big macro question in the states is deciding if the euro dangers will derail the U.S. economy. It’s reasonable to think that if Europe’s problems could be contained, U.S. growth expectations would improve considerably. But there’s the opposite side of that equation to ponder as well.
“If Europe implodes, Obama probably won’t be re-elected,” says Gary Smith, executive director of the American Academy.
Reading between the lines, Obama’s re-election risk vis-à-vis Europe is clearly bound up with the calculation that a euro implosion will sink the U.S. economy and, by association, the President’s political fortunes.
But all of this is speculative. Given the numbers in hand, the U.S. economy is forging ahead. The growth is precarious, to be sure. If momentum stumbles and the outlook darkens, we’ll soon see the hard evidence in the economic updates. Yup, it’s still touch and go, with every new data point scrutinized intensely for fresh clues. Then again, we should all be familiar with the routine by now. The new abnormal is approaching its fourth anniversary, and no one’s predicting that a stronger, broader recovery in the global economy will usher in a regime shift any time soon.
June 7, 2012
Jobless Claims Data (Still) Suggest Modest Job Growth Ahead
Today’s weekly jobless claims report seems to be telling us that the labor market isn’t fatally wounded. New filings for unemployment benefits fell 12,000 last week to a seasonally adjusted 377,000. That’s not far from the post-recession low of 361,000 in mid-February, when optimism was considerably stronger about the economy's prospects. One good report in the weeks ahead could take us to a new low and revive expectations that the future looks okay after all. Analysts are inclined to think otherwise, however, courtesy of the disappointing employment report for May. But today’s claims update suggests that maybe, just maybe, it’s too soon to write the obituary for economic growth.
The operative question: If recession risk is high and rising, would the danger be conspicuous in jobless claims? If the answer is “yes” (and it probably is), then there’s at least one good reason for thinking that the business cycle may not be destined to turn dark just yet. You can’t rely on one indicator for reading the broad economic trend, but in the grand scheme of looking for major turning points in the business cycle there’s a strong case for expecting jobless claims to drop early clues about what’s coming. History tells us that jobless claims are usually rising sharply either just ahead of or in the early stages of NBER-dated recessions. The good news is that it’s hard to make that case with the latest numbers. As the chart below shows, the worst you can say about jobless claims is that they’ve been going sideways. That may bring trouble later in the year, but in the here and now the claims numbers are effectively saying that recession risk is still relatively low.
What about the recent pop in claims numbers in April? That was an early warning sign that the labor market’s growth rate hit a rough patch. Is the slowdown in job growth temporary? The jury’s still out on a definitive answers, but it’s certainly encouraging to see that jobless claims have fallen again since the rise in April. If a recession was imminent, it’s likely that the April increase would have kept on going.
Skeptics may argue that the seasonal adjustment in the claims data masks a much darker picture. But that argument doesn’t hold up if we look at unadjusted numbers on a year-over-year basis. As the second chart reminds, claims continue to drop at a healthy pace of around 10% a year. If and when the economy stumbles to the point that a recession is near, the unadjusted annual change rate will quickly rise to zero and above on a sustained basis. For now, we're still well under that danger zone.
Yes, it could all suddenly change next week, next month. And to be fair, there are other indicators that are flashing warnings. But if we take the claims data at face value, it’s telling us that employment growth has only slowed. If deeper trouble is just around the next bend, the claims numbers will almost certainly deteriorate substantially in the weeks ahead. For now, there’s relatively good news in the data.
“It’s pretty clear claims are stabilizing,” says Michael Englund, chief economist at Action Economics. At the same time, “it’s hard to make the case that there’s any upward tilt to growth.”
Growth is weak, but so is the argument that we’re falling off a cliff. "This is a generally encouraging report,” advises Carl Riccadonna, senior U.S. economist at Deutsche Bank. “The fact that the number didn't back up is a strong sign that the economy is holding in. If the economy were really swooning because of events in Europe, it should be accompanied by a backup in jobless claims.”
June 6, 2012
The New Abnormal Returns...
Actually, it never left. A month ago I wondered: "Is The Recent Fall In Inflation Expectations A New Warning Sign?" The answer, we now know, is "yes."
The new abnormal, as I call it, is alive and kicking… again. The expected inflation rate, based on the yield spread between the nominal and inflation-indexed 10-year Treasuries, hit its recent peak back in March at roughly 2.4%. These days it's down to around 2.1%, and it seems headed lower still. Why? Lots of reasons, although one word probably suffices as an explanation these days: Europe.
Whatever the cause, in keeping with the trend of the last several years the stock market has fallen along with the drop in inflation expectations. That's atypical in the grand scheme of the market's relationship with the inflation outlook. But we are in the new abnormal (still) and so equity prices and inflation expectations are positively correlated. That's unusual, but not surprising, given the debt-deflation climate that continues to prevail. (For the theory behind the empirical fact of late that ties the equity market with the inflation forecast, see David Glasner's research paper on the so-called Fisher effect.)
This relationship confounds some observers, who still can't shake the habit of calling for contained and/or lower inflation. But the key issue is recognizing that demand for money fluctuates and so the central bank must satisfy the changing appetite for liquidity accordingly or else the economy suffers the consequences. One way to track the changes in money demand is to look to the inverse M2 money stock's velocity. In the next chart below, it's clear that M2 velocity (the ratio of nominal GDP to a measure of the money supply) has been falling dramatically in recent years. In other words, money demand has soared.
The question is whether the central bank has satisfied the changing demand for liquidity? The chart above suggests rather convincingly that it's failed, as does the persistence of the new abnormal. Even worse, Scott Sumner worries that Bernanke and company are in no rush to change their strategy:
The Fed seems content to wait until our recovery is off the rails, and then pull out still another QE, each one less stimulative than the last, because they mostly work via signalling. Every time the Fed fails to carry through it losses a little more credibility. And the biggest irony is that the credibility loss they are worried about is too much inflation! That’d be like Mitt Romney worrying that people will regard him as too spontaneous and reckless.
Some Fed members are in no rush to change the wait-and-see game plan, as Marcus Nunes reminds. In other words, there's more abnormality coming, and arguably of the self-inflicted variety.
June 5, 2012
A Fine Balance: Core Funds & Rebalancing
"Maybe it's time for world-stock funds, rather than ones that focus separately on the U.S. and overseas," advises a story in The Wall Street Journal. It's a good idea—up to a point. The strategy of using core funds, perhaps even a super core for the entire asset allocation process, has merit. But there's a danger of going too far. The problem is that if you put too much in a core fund, rebalancing opportunities are limited if not short-circuited completely, depending on the core fund you hold and how much it represents of your allocation in that asset class.
There are valid concerns about how to divide, say, an equity allocation. One common strategy for stocks for U.S.-based investors is defining the world markets by domestic, foreign-developed and emerging-market equities. Sophisticated investors may prefer more granular slicing and dicing via sectors or countries, or perhaps dividing regions into pieces.
By contrast, you can now find ETFs and actively managed funds that cover the world in one ticker. Two examples: Vanguard Total World Stock (VT) and iShares MSCI ACWI (ACWI). These broadly defined equity funds serve a useful role for establishing a core allocation. But putting the entire stock allocation into such portfolios effectively ties your hands when it comes to rebalancing.
Let's say that 100% of your equity allocation is in Vanguard Total World Stock, which is a cap-weighted ETF. In that case, the rebalancing process is fully run by the market/fund. By contrast, holding an equivalent portfolio in, say, three pieces—U.S., foreign developed and emerging markets—leaves you in control of rebalancing for deciding when and how to adjust the relative weights.
Why is rebalancing important? It may not be—if you have a very long-term time horizon. But for most folks (and even most institutions) it's hard to think (much less act) in 30-year slices. The short-term, in other words, matters. That's where rebalancing comes in. It's unclear what constitutes optimal rebalancing strategies. But for broadly diversified portfolios, there's persuasive empirical evidence that basic rebalancing rules are productive for boosting return, lowering risk, and perhaps a bit of both. That's been true within asset classes and for asset allocation strategies as well.
Rebalancing is essentially a system for exploiting volatility. The strategy comes in a variety of flavors, but simple, forecast-free rules can be quite effective for broad asset allocation strategies, as I discussed last month. At the same time, holding core positions can help anchor asset allocation strategies by providing a foundation. As with most investing strategies, finding a prudent balance between extremes works best for most of us. Without full clarity about what's coming, it's often a good idea to apply some hedging vs. embracing the radical outer limits of portfolio possibilities.
For instance, it's reasonable to hold Vanguard Total World Stock as, say, 50% of an equity allocation and put the other half of the allocation into various funds that target specific pieces of the global stock market. In that case, the core holding might be left alone, other than to buy or sell to keep it at a roughly 50% weighting. Meantime, the rebalancing activity would be pursued with the remaining funds that represent components of global equities. A similar strategy can also be applied to the other asset classes.
This much is clear: If you hold one broadly defined fund to represent an asset class, you're betting that rebalancing won't be productive in the years ahead. Anything's possible in finance because the future's always uncertain. But history strongly suggests we should be cautious in expecting rebalancing to be worthless from here on out.
June 4, 2012
Chart Chatter: Wage Growth & The Business Cycle
The relationship between real (inflation-adjusted) wages and the business cycle is “inconclusive,” a recent study reminds. For example, the empirical literature “finds that the wages of newly hired workers are more cyclical than wages of workers in ongoing employment relationships,” notes a 2010 paper from the Federal Reserve Bank of Richmond. But if you’re inclined to see a procyclical link between wage growth and the economy generally, Friday’s income and spending update for April holds out the possibility that all’s not yet lost for expecting growth.
Private-sector wage growth inched higher in April, enough at least to raise the year-over-year percentage change to 4.1%, or slightly above the 3.9% annual pace in March in nominal terms. The annual pace of real wage growth also perked higher in April. Is this a sign of economic strength that will help carry us through what looks set to be a turbulent summer? Or is April's pop in wage growth the last gasp of an economy that's struggling (and failing?) to digest a world full of hazards?
If real wages have any influence on recession risk, perhaps it’s no small advantage that inflation-adjusted wage growth was 1.8% for the year through April. That’s a bit more than twice the rate in December 2007, when the economy peaked just ahead of the Great Recession. A small edge, perhaps, but if rising wages can help keep a new contraction at bay, the April numbers are a small bright spot.
Nonetheless, there are plenty of reasons to be cautious. For one thing, April data now looks ancient in the wake of Friday’s discouraging employment report for May. We'll have to wait a month to find out how wages fared in May. Of course, by that time there's a good chance that there'll be a lot less cyclical mystery otherwise, for good or ill.
Strategic Briefing | 6.4.12 | Jobs & The Economy
Growth Slowdown Seen for Third Year in U.S. Dodging a Recession
Bloomberg | June 4
The U.S. economy looks set to deliver a repeat performance in 2012: for the third straight year, it may suffer a swoon yet not slip into a recession.
“I don’t think the slowdown will be any more consequential than the past two years,” said John Ryding, a former Federal Reserve researcher who is chief economist at RDQ Economics LLC in New York. “There are positives out there in the economy. We’ll avoid a recession.”
Another lousy jobs report -- is a second recession on the way?
Peter Morici (Fox News) | June 1
The May jobs report indicates growth could be even slower in the second quarter, and the economy is dangerously close to stalling and falling into recession.... Without prompt efforts to produce more domestic oil, redress the trade imbalance with China, relax burdensome business regulations, and curb health care mandates and costs, the US economy simply cannot grow and create enough jobs.
Recession storm clouds threaten global economy
June 1 | MSNBC
"Wow, this is ugly,” said Malcolm Polley, president of Stewart Capital Advisors, in response to Friday’s jobs data. “Some had believed that we had decoupled from China slowing and all the problems in Europe, but that seems to be shortsighted. We're slowing alongside the rest of the world."
Investors Brace for Slowdown
The Wall Street Journal | June 3
"We are not robust enough to withstand a real European recession," said market strategist Edgar Peters, who helps oversee $18 billion at money-management firm First Quadrant in Pasadena, Calif. "I am getting less and less optimistic about this."
Some economists and strategists believe the setbacks, in the U.S. at least, may be short-lived. Michael Darda, chief economist at brokerage firm MKM Partners in Stamford, Conn., told clients last week that the U.S. economy was still growing. Others said the prospect of more help from the Fed may limit declines. Those arguments didn't lure many bargain hunters back to stocks last week.
Contrary to Popular Belief, the Recovery is not Stalling
Wells Fargo Economics Group | June 1
Nonfarm employment came in well below expectations in May, adding only 69K jobs with the unemployment rate drifting a notch higher to 8.2 percent. The details of the nonfarm payroll report suggest that weather could have been a driver for the weaker-than-expected outturn.
The ISM manufacturing survey weakened a bit, sliding 1.3 points to 53.5; however, the forward-looking new orders component jumped to 60.1, the highest level in 13 months, showing the continued resilience of the manufacturing sector.
Why the U.S. economy is stuck in the slow lane
USA Today | June 3
Economists initially blamed the slowdown on warm winter weather that pulled forward construction and other activity to early this year, damping spring sales and hiring. Mark Zandi, chief economist of Moody's Analytics, says some weather-related payback was still at work in May, contributing to a loss of 37,000 jobs in construction and hospitality.
But many economists say the darker jobs picture can no longer be chalked up to weather. Zandi points to worries by U.S. corporations about Europe's worsening financial crisis and says businesses' uncertainty has held back hiring. IHS' [Nigel] Gault says the stronger gains early in the year "were clearly out of line with the (weak) underlying pace of (economic) growth."
Bleak U.S. jobs report a danger to global economy
Associated Press | June 3
“The U.S. is not an island, and what happens abroad matters here,” said Diane Swonk, chief economist at Mesirow Financial. “The weakness in Europe, in particular, has a global reach and is affecting us.”
June 2, 2012
Book Bits | 6.2.2012
● The Unfair Trade: How Our Broken Global Financial System Destroys the Middle Class
By Michael J. Casey
Summary via publisher, Random House
A wake-up call for middle class Americans who feel trapped in a post-crisis economic slump, The Unfair Trade is a riveting exposé of the vast global financial system whose flaws are the source of our economic malaise. Our livelihoods are now, more than ever, beholden to the workings of its imbalances and inequities. The trillions of dollars that make up the flow of international finance—money that is often steered away from the people who deserve it the most—have not just undermined the lives of working and middle class Americans. It is a world-wide phenomenon that is changing the culture of Argentina; destroying the factory system in Northern Mexico, enabling drug cartels to recruit thousands of young men into their gangs; that has taken down the economies of Iceland, Ireland, Spain, Greece, and possibly Italy; and is driving American companies such as a 60-year-old family owned manufacturer of printed circuit boards to shutter all but one of its factories. Veteran journalist Michael Casey has traveled the world—from China to Iceland, Spain to Argentina, Indonesia to Australia—recounting extraordinary stories about ordinary people from one continent to another whose lives are inextricably linked.
● Living Economics: Yesterday, Today, and Tomorrow
By Peter Boettke
Review via Laissez-Faire Books
The phrase “living economics” means two things: 1) economics is part of life whether we recognize it or not, and 2) economics is a living discipline, rooted in universal principles but always changing in nuance and application.Professor Boettke’s purpose is to provide a guided tour through the profession as it is now and how he would like to see it changed. He does this by first explaining what got him interested in the science. It turns out that he remembers the gas lines of the 1970s and recalls being amazed to discover that they were wholly manufactured by Washington policy. It was the price control of oil combined with inflationary pressures from bad monetary policy. Contrary to what the media mavens and politicians were saying at the time, it had nothing to do with producer greed, secret price manipulation or financial speculation. That’s what did it for him. He realized that economics is woven into every aspect of our lives. It is inescapable. When the market is allowed to work, beauty and growth results. Humanity flourishes. When markets are truncated and hobbled, people suffer. Then he realized how little public understanding there is of economics. And he realized that he could play a role in changing this. He has. His students are now teaching other students in six different Ph.D.-granting institutions, among dozens more institutions.
● The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds
By Maneet Ahuja
Excerpt via CNNMoney/Fortune
Maneet Ahuja, also known as "Wall Street Maneet" on Twitter, has one of the most powerful Rolodexes in business. The 27-year-old CNBC producer regularly coaxes the world's most successful and reclusive investing stars on the network's flagship show, Squawk Box. She also got them to talk for a series of extended interviews that she has turned into a new book of profiles, The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds. As the title implies, the book is hardly critical of her subjects (most of whom Ahuja was also able to draw to her star-studded book party, held last week in midtown Manhattan). But it offers their stories from their own perspective and some entertaining unvarnished comments.
● The Fundamental Rules of Risk Management
By Nigel Da Costa Lewis
Summary via publisher, CRC Press
The consequences of taking on risk can be ruinous to personal finances, professional careers, corporate survivability, and even nation states. Yet many risk managers do not have a clear understanding of the basics. Requiring no statistical or mathematical background, The Fundamental Rules of Risk Management gives you the knowledge to successfully handle risk in your organization. The book begins with a deep investigation into the behavioral roots of risk. Using both historical and contemporary contexts, author Nigel Da Costa Lewis carefully details the indisputable truths surrounding many of the behavioral biases that induce risk. He exposes the fallacy of the wisdom of experts, explains why you cannot rely on regulators, outlines the characteristics of the "glad game," and demonstrates how high intelligence or lack thereof can lead to loss of hard-earned wealth. He also discusses the weaknesses and failures of modern risk management.
● Cognitive Capitalism
By Yann Moulier-Boutang
Summary via publisher, Wiley/Polity
We live in a time of transition, argues Yann Moulier Boutang. But the irony is that this is not a transition to a new type of society called ‘socialism’, as many on the Left had assumed; rather, it is a transition to a new type of capitalism. Socialism has been left behind by a new revolution in our midst. ‘Globalization’ effectively corresponds to the emergence, since 1975, of a third kind of capitalism. It does not have much to do with the industrial capitalism which, at the point of its birth (1750-1820), broke with earlier forms of mercantile capitalism. The aim of this book is to describe and explain the characteristics of this third age of capitalism.
● So Rich, So Poor: Why It's So Hard to End Poverty in America
By Peter Edelman
Interview with author via The Takeaway/Public Radio International/WNYC
Poverty is one of the most pressing and divisive issues of our day, and Democrats and Republicans have staked out largely different approaches to the increasing divide between the poorest members of the United States and the richest. With the economy central to the November elections, the wealth gap will likely only become even more talked about in the months to come. Peter Edelman is one of the most outspoken antipoverty advocates in the country. Edelman became a household name in 1996 after resigning from his post at the Department of Health and Human Services in protest of President Clinton's signing of the welfare reform bill.
● Wars of Plunder: Conflicts, Profits and the Politics of Resources
By Philippe le Billon
Summary via publisher, Columbia University Press
From Iraq and Angola to Liberia and the Democratic Republic of Congo, resource-rich countries with high incidences of poverty are prone to devastating outbreaks of war. These conflicts are highly idiosyncratic, and the response of the international community to their occurrences is fascinatingly complex. Philippe Le Billon traces the specific burden of owning the world’s most precious resources and the effects of resource politics on the development of war. He focuses on three key resources––oil, diamonds, and timber––and the circumstances linking their abundance to war. He discusses the role of resource revenue in financing belligerent forces, a trend that has grown more conspicuous with the withdrawal of Cold War foreign sponsorship.
● The Land Grabbers: The New Fight over Who Owns the Earth
By Fred Pearce
Excerpt via The Guardian
Vast swaths of Africa are being bought up by oligarchs, sheikhs and agribusiness corporations. But, as this extract from The Land Grabbers explains, centuries of history are being destroyed.
● How to Think Seriously About the Planet: The Case for an Environmental Conservatism
By Roger Scruton
Summary via publisher, Oxford University Press
The environment has long been the undisputed territory of the political Left, which casts international capitalism, consumerism, and the over-exploitation of natural resources as the principle threats to the planet, and sees top-down interventions as the most effective solution. In How to Think Seriously About the Planet, Roger Scruton rejects this view and offers a fresh approach to tackling the most important political problem of our time. The environmental movement, he contends, is philosophically confused and has unrealistic agendas. Its sights are directed at the largescale events and the confrontation between international politics and multinational business. But Scruton argues that no large-scale environmental project, however well-intentioned, will succeed if it is not rooted in small-scale practical reasoning.
June 1, 2012
A (Partial) Antidote For Today’s Disappointing Jobs Report
Employment growth remained weak in May, the government advised earlier today, but the day’s other economic news offers more encouraging fare. Personal income and spending for April were strong enough to stabilize the year-over-year pace of growth. Meanwhile, the ISM factory index for May continues to signal growth--wobbly, perhaps, but growth just the same. Taken together with disappointing jobs report, it all adds up to a mixed bag, but that's better than definitive, across-the-board evidence that the cycle has taken a turn for the worse.
The monthly view on income and spending for April doesn’t look all that impressive, although we can certainly breath a sigh of relief that consumption rose a bit after swooning so dramatically in March relative to the previous month’s surge. Disposable personal income, unfortunately, still looks mediocre.
But the monthly data masks far more encouraging news: the stabilizing of the year-over-year percentage changes for income and spending. A month ago I wondered if personal income growth’s decelerating rate of annual growth through much of 2011 had finally ended. The April data suggests we should answer in the affirmative. Does that mean that recession risk has fallen? History shows that new recessions are usually preceded by sharp declines in disposable personal income’s annual rate of change—declines that typically roll on through the duration of the recessionary months. As such, it’s encouraging to see the year-over-year rate for income hold steady in the last three months at about 2.45%.
In fact, the improvement is even more pronounced in real terms. The inflation-adjusted disposable income tally for April was roughly 0.6% higher than its year-earlier level—that's considerably stronger than the 0.3% annual pace logged for March.
Meanwhile, today’s ISM numbers look healthy enough to argue that the economy’s ailments aren’t necessarily fatal, at least not yet. As the third chart below shows, there’s still a fair amount of forward momentum in the manufacturing sector. New orders in particular imply that factory activity will continue to bubble in the near term.
The big risk is that Europe spins out of control and takes a toll on the U.S. Based on what’s been reported in recent days, it’s hard to be optimistic that the worst will be avoided. Traders are certainly placing their bets on where it appears to be headed. As Reuters reports:
Hedge funds are piling into bets against the bonds of core euro zone countries like Germany and France, signaling a growing fear that nations once considered safe havens could be dragged down by the crisis in peripheral states like Greece and Spain.
It’s unclear how much of the worries about Europe are infecting economic conditions in the U.S. But until the Continent’s crisis calms down (again), things will probably get worse before they get better. The good news is that there’s still not an open-and-shut case that the U.S. has hit a macro wall. The margin of safety on this front may be thin, but it’s all we have at the moment.
Another Month Of Slow Job Growth In May
Job growth remained sluggish in May, the Labor Department reports. Nonfarm private-sector payrolls rose by a slim 82,000 on a seasonally adjusted basis last month. That’s the smallest increase since last August. It’s also a sign—confirmation!—that economic growth overall slowed in the spring.
For two months running, the labor market’s growth has been mild, at best. The 200,000-plus growth in private payrolls in each of the three months through this past February now looks like ancient history. Pessimists will cite today’s news as clear evidence that the economy is destined for more trouble, and perhaps a new recession. It would be foolish to dismiss that possibility in the wake of today’s employment news. The ongoing and apparently deepening economic woes in Europe via the euro crisis only strengthen the case. But it's still premature to argue that the tipping point for the business cycle in the U.S. has been reached and that it's all downhill from here.
For starters, two months of sluggish payrolls growth is hardly definitive. It's not encouraging, and it may be a smoking gun if the weakness rolls on. Statistically speaking, however, it's still quite unimpressive. The difference in net job growth of 80,000 and 200,000 in a labor force of 155 million is a rounding error, at least for the span of a month or two. Keep in mind too that the annual percentage change in the labor force, even after May's weak performance, is near the best pace in the last three years. Private-sector payrolls increased by 1.78% on a year-over-year basis through last month, or only moderately lower than the post-recession high of 2.09% for this past January.
If there is a new recession approaching, the annual rate of growth for private payrolls will start falling dramatically, and soon, month after month. For the moment, the pace in May is virtually unchanged from April's year-over-year rate.
That's no excuse to dismiss today's news, or discount the higher risk that macro turbulence awaits the U.S. economy. But if you're looking ahead based on the numbers in hand (as opposed to speculating how future economic reports will play out), there's still reason to expect that growth will prevail for the foreseeable future.
Indeed, one can point to a number of recent reports that inspire some confidence about the future. April's industrial production, for instance, was quite strong. Perhaps May's update on industrial production will tell us differently when it's released on June 15, but not yet.
Nonetheless, sentiment has clearly taken a hit today. “The robust employment growth at the start of the year has clearly waned,” says Ellen Zentner, a senior U.S. economist at Nomura Securities. “Hiring plans may have been put on hold amidst an increasingly uncertain outlook.”
“There’s no positive spin that can be put on the May Employment report,” says Jim Baird, chief investment strategist for Plante Moran Financial Advisors. “It was a disappointment, pure and simple.”
In that respect, the jig may be up. If the business cycle has gone over to the dark side, we'll soon see clearer evidence.
Major Asset Classes | May 2012 | Performance Review
May was a rough month for financial and commodity markets—the worst, in fact, since September 2011. Most of the major asset classes slumped last month. The main exception: U.S. Treasuries, which buoyed the Barclays Aggregate Bond Index. Inflation-indexed Treasuries in particular performed handsomely, jumping 1.7% in May. Otherwise, red ink in varying degrees dominated.
Thanks to a surge in the dollar last month, foreign stocks and bonds in unhedged dollar terms took an usually big hit. The euro crisis inflicted heavy damage on the European-company laden MSCI EAFE, which suffered it’s worst monthly decline in two years in May: -11.5%.
The market-weighted Global Market Index (a passively allocated benchmark of all the major asset classes) retreated by 5.3% last month—it’s worst month since last September. GMI is still up for the year so far, ahead by 1.5% through the end of May. But in a world worried about the end game for the euro, it’s rank speculation at this point to assume how the numbers will wind up for the full year.
Meantime, the sharp decline in oil prices takes some of the sting out of all the red ink in terms of looking ahead in economic terms. Crude oil (West Texas Intermediate) fell a hefty 17.5% in May—its biggest monthly drop since the financial crisis was raging in December 2008. Mark Hulbert considers the upside for the economy, advising that lower energy prices may translate into a defacto stimulus for growth.
Perhaps, but if the price decline in oil reflects a drop in demand, that’s a sign of weakness. Meantime, another month like May for asset prices and the damage to consumer sentiment may offset any payoff from lower energy prices.