July 31, 2012
Reading (And Misreading) Real Consumer Spending In June
A number of pundits today were quick to declare that the business cycle had finally rolled over last month because consumer spending fell slightly in June, as noted in this morning's update via the Bureau of Economic Analysis. One blogger insisted—insisted!—that the 0.1% decline last month in real (inflation-adjusted) personal consumption expenditures (PCE) was a clear and unambiguous death knell for U.S. economic growth. But in the rush to judgment, some analysts are overlooking a few things.
Let's consider June's -0.1% drop in real PCE in terms of history. Although no one at this stage will see last month's retreat as encouraging, it's premature to claim that it's a smoking gun. Monthly declines are hardly unusual in periods of growth. Indeed, as the chart below reminds, looking at monthly changes in real (or nominal) PCE is only slightly more valuable than tossing a coin for insight about what happens next.
Ergo, there's a reason why looking at year-over-year percentage changes are so valuable—essentially, really—for evaluating economic indicators: a lot of the short-term noise is stripped away. Let's consider real PCE again in terms of its annual changes, as shown below. Note that the case for deep, dark pessimism looks a lot less compelling in the second chart. In fact, the 12-month change in real PCE actually ticked up last month, rising 2.0% vs. its year-earlier level—the best pace since last October.
Does the modest improvement in the annual change in real PCE mean that all's well? No, of course not. But neither is it a sign that the cyclical jig was up in June.
Ah-ha, you say! One indicator alone, even on a rolling one-year basis, can be misleading. Agreed, which is why I routinely look at more than a dozen leading and coincident indicators for a diversified read on the otherwise unobservable variable known as the business cycle. On that note, my previous look at the June data a few weeks back suggested that recession risk was quite low. That's not a forecast—rather, it's merely a sober look at what just happened. Today's real PCE data point, which is one of the inputs in my recession risk index, doesn't change the analysis.
If you're focused too closely on the trees, it's hard to see the forest. Granted, if real PCE continues to slip each month for an extended period, it's probably time to put a fork in the expansion. I don't rule out that possibility, although the macro gods are reluctant to give me a heads up on, say, the August updates on jobs and spending. In other words, we're at least several months away from making a call that it's all over now.
Sure, you can make an argument that it's time to expect nothing less than a collapse in consumer spending from here on out. But it's hard to make a persuasive case for the dark outlook based solely on last month's real PCE. In fact, most of the key indicators don't yet add up to a recession call as of June. That's a radical view by some accounts, but the numbers still look convincing for thinking that the cyclical isn't yet toast.
The only thing worse than lowering a coffin into a grave is finding out the next morning that the cadaver hadn't expired. We may be at the end of this rope, but for now it's still early to be calling a mortician.
Personal Income Rebounds In June With Flat Consumer Spending
Disposable personal income (DPI) is rising again, but consumption remains flat. That’s the message in today’s update for the June income and spending report from the Bureau of Economic Analysis. The trend is certainly encouraging on the income front. But the unchanged level of personal consumption expenditures (PCE) is a problem if it continues. Then again, it's not surprising that the public is inclined to save these days. The paradox of thrift may be a bigger problem in the months ahead if the urge to save rolls on and/or accelerates. But the fact that DPI has made an impressive rebound in terms of its growth rate in June suggests that it's still premature to expect the worst. Savings mixed with higher income is hardly a sign of an economic apocalypse. Then again, one month alone never tells us much.
With that caveat in mind, here's how the last 12 months compare for DPI and PCE. The revival in income offers encouragement, or so it appears, but the monthly numbers are subject to lots of volatility and so it's hard to see through the noise.
Rolling one-year percentage changes offer a clearer picture of what's been going on. As the second chart below shows, DPI is looking healthier these days on a year-over-year basis. PCE is merely flat lining in terms of changes in its annual pace, but that's better than the descent that was the norm in previous months. Indeed, PCE stuck at roughly 3.5%, as it has been for the last two months, isn't exactly a danger sign for the business cycle.
The case for modest optimism, it seems, isn't beyond the pale... yet. The expected train wreck for spending and income is still MIA. The future is still uncertain, but based on the numbers reported today through June, the annual rates of change make it a bit harder to argue that income and spending are signaling that a new recession recently started or is imminent in the month ahead.
But let's not minimize the risk linked with the big fade on consumption lately. Joe Sixpack's spending still makes up roughly 70% of U.S. GDP and so it's hard to get excited about economic growth if PCE stays flat. What might induce stronger consumption numbers going forward? Second to none on the list of factors is the labor market. Unfortunately, growth in nonfarm payrolls has been weak lately, as the June jobs report reminds.
Will the labor market's growth rate perk up? The consensus forecast via Briefing.com suggests that we might see slightly better numbers on Friday (Aug 3) for the July payrolls report—a net rise of 100,000 for private-sector jobs vs. 84,000 for June is the crowd's guess.
That's better than a declining rate, but it's still unimpressive. As for a negative surprise of some magnitude, well, let's just say that we're just about out of room for exogenous shocks to the labor market with major repercussions. Yes, it's a precarious existence in macro analysis at the moment, but we still have to take each number as it comes.
On the somewhat brighter side, the growth in personal income seems to be reviving. And not a moment too soon. What's behind DPI's recovery? One rather large clue can be found in private-sector wage growth, which rose 4.2% in June vs. the year-earlier level. That's the highest annual rate since October 2011—one more sign that it's still premature to assume that the economy has already tipped over the edge.
Surprised? You shouldn't be. As I noted a few weeks ago, recession risk for June, based on a broad reading of leading and coincident indicators, was relatively low. Today's update on income and spending supports that view.
July, of course, is another matter. But using the numbers we have so far, there's a strong case for arguing that June wasn't the start of a new recession. Will that narrative hold up once we have a full set of July numbers? For some perspective, your favorite forecaster will be more than happy to give you an earful.
July 30, 2012
Asset Allocation Could Use A Few Good Benchmarks
A pair of analysts at Lyxor Asset Management have a request for index vendors: create a new generation of multi-asset class benchmarks. "The need of such indexes is crucial for all investors that manage multi-asset classes," write Rodolphe Louis and Thierry Roncalli. "Today, it is unthinkable to manage an equity or a fixed-income portfolio without a reference to a benchmark. And this benchmark is generally an index representing the market portfolio." It's time for a renewed focus on stock/bond indexes, they assert. While we're at it, let's develop a suite of multi-asset class indexes beyond a basic equity/fixed-income mix.
Finding good indexes that track passive multi-asset class combinations shouldn't be a chore. Quick, name an asset allocation benchmark from a major index provider... coming up with a blank? You're not alone. Finding a robust, transparent index for asset allocation isn't impossible, but it isn't easy either, which is one reason why I created the Global Market Index (GMI) and update its performance in context with the major asset classes every month. Not surprisingly, GMI's performance is competitive, to say the least, with a broad sample of actively managed multi-asset class funds. Nonetheless, the world needs more GMI-type benchmarks from the usual suspects--and they need to be conspicuous.
That's probably hoping for too much. For the same reason that the design and management of asset allocation too often takes a back seat to sexier investment subjects, building and promoting multi-asset class indexes tends to be an after-thought, if that. Perhaps the marketing opportunities are unattractive. Or could it be that investor demand is minimal? Whatever the reason, investors suffer. Without a clear and transparent yardstick of the broad playing field, it's hard to know if professional fund managers and financial planners are adding value without a fair amount of due diligence. It's also hard to properly frame your investment decisions without first considering the opportunity set in broad, objective terms.
As Andrew Ang of Columbia Business School advises: "The foundation for a long-term investment strategy is rebalancing to fixed asset class positions, which are determined in a one-period portfolio choice problem where the asset weights reflect the investor’s attitude toward risk. Rebalancing is a counter-cyclical strategy that has worked well even during the Great Depression in the 1930s and during the Lost Decade of the 2000s."
This is old news, of course, or at least it should be. It's also news that implies that passive, multi-asset class benchmarks, such as GMI, should be standard fare at this point. The reality, alas, is that it's still hard for the average investor to find robust indexes of even stock/bond mixes. That's a sign that something's amiss in the world of investment analysis and index design.
The problem starts with the overemphasis—an obsession, really—in tracking and analyzing individual asset classes in isolation of their counterparts. Ground zero for this obsession is, of course, all the light and heat about the stock market and where it might be going, or not, next month.
The fact that the world is teeming with indexes that slice and dice equities into broad and narrow pieces is Exhibit A for thinking that the analytical focus that prevails is unhealthy for investors' long-term financial objectives. Yes, there's a genuine need for stock market indexes—and for other individual asset classes as well. But the dearth of obvious benchmarks for asset allocation is a black eye for the cause of developing strategic investment perspective.
Even worse, the opportunity to buy the ETF equivalent of a GMI or equivalent--along with some basic variations such as an equally weighted GMI fund--is an oversight that deserves a solution. Such funds would be ideal as core portfolios, which can form the foundation for a customized investment strategy. We are at a point where virtually all the major asset classes are now available in ETF (or ETN) form. In some cases, the supply greatly exceeds a reasonable menu of choices. It's time to move to the next level in the analysis of combining asset classes and offering simple, clear-headed benchmarks, related analysis and low-cost ETF solutions. Yes, there's been some progress on this front, particularly in the separate account world. But in the wider realm of money management, these topics are rarely treated as a priority.
The fact that the underlying research that inspires managing a mix of asset classes has been around for decades is yet another reminder that there's a big hole in serving the public's best interests in matters of money management. No wonder that several studies (including this 2010 research paper) tell us that relatively few investors exploit market volatility through timely rebalancing strategies. Shocking? Not really. It's hard to optimize something you're not monitoring all that closely.
July 28, 2012
Book Bits | 7.28.2012
● Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street
By Neil Barofsky
Review via The New York Times
Mr. Barofsky justifiably spends time on Treasury’s failure to get banks to stem home foreclosures. But he charges that Treasury helped give birth to the Tea Party “by rolling out a hurried and poorly thought-out mortgage modification program,” when what actually spawned that movement was conservatives’ opposition to the very idea of bailing out troubled homeowners, which Mr. Barofsky so favors. That his book is being released now, amid the presidential campaign, reflects perhaps the biggest contradiction of all: If Treasury has been making policies exclusively “by Wall Street for Wall Street,” as Mr. Barofsky says, why then has a once friendly Wall Street turned so hostile to President Obama’s re-election?
● Fool Me Twice: Obama's Shocking Plans for the Next Four Years Exposed
By Aaron Klein and Brenda Elliott
Essay by co-author (Klein) via Fox News
Months of painstaking research into thousands of documents have enabled Brenda J. Elliott and me to expose the detailed template for Obama’s next four years -- the one actually created by Obama’s own top advisers, strategists and associated progressive groups. This second-term blueprint is laid bare in our upcoming book, “Fool Me Twice: Obama’s Shocking Plans for the Next Four Years Exposed.” We found that, just as in 2008, when Obama concealed his true presidential plans behind bland rhetoric of ending partisan differences and cutting the federal deficit, his 2012 re-election theme of creating jobs conceals far more than it reveals about his true agenda for a second term.
● Who Gets What: Fair Compensation after Tragedy and Financial Upheaval
By Kenneth R. Feinberg
Review via The Washington Post
When bad things happen to good people — the Sept. 11 terrorist attacks, the Virginia Tech shootings, the Deepwater Horizon oil spill — good people want to get paid. In “Who Gets What,” lawyer and master of disaster Kenneth R. Feinberg dissects the complicated business of settling claims after calamity. “To evaluate the value of a life or a livelihood, I must first tackle a set of far bigger philosophical questions,” writes Feinberg, who helped compensate the victims of hijacker Mohamed Atta, Virginia Tech shooter Seung-Hui Cho and polluter British Petroleum without drawn-out litigation. One such questions is “Why should public or private money be used to compensate certain citizens while denying similar generosity to others?”
● The Intention Economy: When Customers Take Charge
By Doc Searls
Essay by author via The Wall Street Journal
This revolution in personal liberation and empowerment won't be complete until we are free to use our computing and networking powers with any device we like, outside the exclusive confines of "providers." This won't be easy. Big companies and old industries are notoriously bad at changing their ways and giving up control, even when obvious opportunities argue for embracing openness and change. There is also big money behind "big data" and supporting the belief that marketing machinery can know people better than people know themselves.
July 27, 2012
Q2 GDP Rises a Sluggish 1.5%
The U.S. economy grew at a real (inflation-adjusted) 1.5% (seasonally adjusted annual rate) in the second quarter of 2012, the Bureau of Economic Analysis reports. That’s roughly in line with consensus forecasts, but it’s disappointing nonetheless. The economy’s tepid 1.5% growth rate represents a slowdown from Q1’s 2.0% pace and a world away from the 4.1% rate posted in last year’s fourth quarter.
The slowdown in growth is due to several factors, starting with the lower rate of personal consumption expenditures. Consumer spending, which accounts for roughly 70% of GDP, decelerated to a 1.5% increase in Q2, down from 2.4% in Q1. Most of the downshift can be blamed on the dramatic decline in the durable goods portion of consumption, which retreated 1.0% in Q2 vs. a strong 11.5% rise in the previous quarter. The fall represents the first negative quarterly reading for durable goods spending since 2011’s Q2.
It’s safe to say that no one will find inspiration for thinking positively in today’s GDP report. "The main take away from today's report, the specifics aside, is that the U.S. economy is barely growing," says Dan Greenhaus, BTIG LLC’s chief economic strategist. "Along with a reduction in the actual amount of money companies were able to make, it's no wonder the unemployment rate cannot move lower."
Is today's GDP report a sign that the economy is rolling over and a new recession is near? Perhaps, although it's still debatable if we're suffering from slow growth vs. a period that NBER will eventually label a contraction. That's a subtle distinction for the folks without jobs or working at lesser positions to make ends meet. Meantime, back at the 30,000-foot level of macro analysis, reviewing a broad cross section of economic indicators through June—industrial production, payrolls, newly issued housing permits, jobless claims, etc.—suggests that the cycle hasn't slipped over the edge. The trend has certainly weakened, but it's premature to put a fork in the expansion just yet in the delicate art of defining peaks and troughs. Indeed, the Chicago Fed National Activity Index tells us to reserve judgment for the moment for labeling June as the start of a new downturn.
For another perspective, consider GDP's year-over-year change. Specifically, let's compare each quarter's real, seasonally adjusted estimate of GDP with its year-earlier level, as shown in the second chart below. By that standard, the annual change is more or less on the fence in terms of where recessions have started in the past. The 2.2% annual change in real GDP is no one's idea of a healthy change, but it's also higher than the pace set in each of the first three quarters of 2011—quarters that didn't result in a recession, as defined by NBER.
Yes, we're skating on thin ice and it wouldn't take much of a negative shock (or a series of lesser shocks) at this point to crack the ice. But this much is clear: if our cyclical goose is cooked, it'll become obvious in the numbers. June's data overall didn't descend to that tipping point (at least based on the reports we have so far). July's economic updates, when they start arriving next month, may tell us otherwise.
Strategic Briefing | 7.27.12 | Q2 U.S. GDP Preview
'Subpar' Now Par for the Economic Course
The Wall Street Journal | July 26
Friday's first take on U.S. gross-domestic-product growth for the second quarter is unlikely to improve the mood: forecasters see an annualized increase of just 1.5%. Not only is that lower than a downward-revised 1.9% rate in the first quarter, but it would put the economy even farther off the growth trajectory that it typically would be enjoying three years after a recession's end.
Stock futures up ahead of GDP; Facebook falls
MarketWatch | July 27
Economists surveyed by MarketWatch forecast second-quarter gross domestic product expanded at a 1.3% annualized pace, slowing from 1.9% in the first three months of the year and 3% in the final quarter of 2011.
Economy in U.S. Probably Expanded at Slowest Pace in a Year
Bloomberg | July 27
Gross domestic product, the value of all goods and services produced, rose at a 1.4 percent annual rate after a 1.9 percent gain in the prior quarter, according to the median forecast of 81 economists surveyed by Bloomberg News. Consumer purchases, which account for about 70 percent of the world’s largest economy, may have grown at the weakest pace in a year.
Stocks: Investors await U.S. GDP data
CNNMoney | July 27
On the domestic front, investors await the government's reading of U.S. economic growth during the second quarter. Economists surveyed by CNNMoney predict the economy grew at a 1.4% annual pace, down from 1.9% in the first quarter.
Forex Flash: Expect 1.3% US GDP in Q2, below 1.4% consensus – TD Securities
FXStreet | July 27
TD Securities analysts are expecting the US annualized GDP in Q2 to come in at 1.3%, just below the market consensus of 1.4%: “US GDP may be a weak 1.3%, but we don’t expect deep downward revisions as was the case with last year’s annual revisions”, wrote TD Securities analysts, pointing to risks in case of a modest upward revision as the GDI (gross domestic income) has been running modestly ahead of the “real” GDP series. Upward revisions happened in the boom years of the last decade, while downward revisions are more recent “as income tracked below the expenditure print”.
Wary consumers to weigh on growth in second quarter
Reuters | July 27
The economy probably grew at its slowest pace in a year in the second quarter as consumers spent less, possibly pushing the Federal Reserve closer to pumping more money into the economy. Gross domestic product likely expanded at a 1.5 percent annual rate between April and June, according to a Reuters poll, after rising 1.9 percent in the first three months of the year. That would mark the weakest pace of growth since the second quarter of 2011. "The economy is struggling to maintain altitude," said Robert Dye, chief economist at Comerica in Dallas.
July 26, 2012
The Employed-to-Unemployed Ratio: A Brief Clarification
Earlier today I looked at the history of what appears to be another useful metric for monitoring the business cycle: the ratio of nonfarm payrolls to the unemployment rate in terms of its 12-month percent change. I attributed the “discovery” of this indicator to Bob Dieli, an economist who crunches the numbers at NoSpinForecast.com. But after reading the post, Dieli alerts me that I was mistaken and that he was in fact watching was the ratio of the employed to the unemployed--both in terms of the actual numbers reported each month in the household survey of the employment report. On a 12-month rolling basis, the two signals are virtually identical. Nonetheless, Dieli’s clarification is worth noting because it moves us closer to an apples-to-apples comparison in terms of the underlying data.
But first, let’s look at how the employment/unemployment ratio looks through history. (For those familiar with graphing via the St. Louis Fed’s FRED database, the relevant tickers: CE160V/UNEMPLOY). Here’s how it shakes out for a rolling 1-year percentage change:
Like the ratio I discussed earlier, the recession-warning signals in the ratio above are closely linked with those periods when the ratio falls below zero. It’s not flawless—the indicator suffers several false positives in its history. But the fact that this indicator has a strong history of dispatching early warnings of an approaching recession (or advising us that a downturn has recently started) suggests that we should keep an eye on it. As always, it’s best to look at this ratio (and every other metric) in context with a range of business cycle signals.
What’s the intuition behind this indicator? Simple, really. Imagine that the number of employed workers is rising while the number of unemployed is constant. In that case, the ratio is rising, reflecting the improving conditions in the labor market. In contrast, a decline in the number of employed vs. a constant number of unemployed translates into a declining ratio. The same principle applies if we keep the number of employed constant and compare it with rising or falling numbers of the unemployed. In the worst case scenario, the number of employed people is falling and the total of unemployed is rising. The bottom line: when the labor market is deteriorating, it’s likely to show up in this ratio. When the deterioration is severe enough so that the ratio is retreating on a year-over-year basis, recession risk is above average.
Finally, both the employed and unemployed estimates are found in the household survey of the monthly employment report, and so we’re drawing from the same sample data. In that sense, the design of the ratio is superior to the version I outlined previously. In practice, however, both are in agreement in terms of the timing of their signals through history. Both also tell us that recession risk was low last month.
You still can't get blood out of a stone, or find flawless forecasts of the future in this ratio. But as one more metric for analyzing the business cycle, this one looks pretty good.
A Mixed Bag Of Economic Updates
Today’s updates on initial jobless claims and durable goods orders bring encouraging news, albeit with a caveat: a widely followed subcategory of durable goods—commonly referred to as business investment—looks troubling. Does the weakness in business investment—i.e., new orders for non-defense capital goods less aircraft—overwhelm the brighter numbers in durable goods overall and the sharp drop in new filings for unemployment claims?
In search of some perspective, let’s start with the claims data: last week’s filings dropped a hefty 35,000 to a seasonally adjusted 353,000, or just slightly above a four-year low. Keep in mind that claims data in recent weeks has been buffeted by seasonal noise related to the auto industry (for some background, see here and here). Nonetheless, as the weeks roll on and new claims remain at or near the lowest levels in several years, it’s premature to jettison the case for optimism.
As usual on these pages, I consider the year-over-year percentage change in jobless claims before seasonal adjustments to get a sense of how the true trend may be unfolding. On that front, the numbers continue to look good. As the second chart below shows, the 8.7% annual decline in new claims as of last week is a robust sign that the labor market, for all its troubles, hasn’t imploded and continues to heal. Slowly, but that's still better than deteriorating.
If and when a new recession is upon us, or threatening in no uncertain terms, we’ll likely see a sharp and sustained rise in jobless claims. For the moment, at least, that dire change in the trend was still MIA as of last week.
As for new orders for durable goods, the broad measure for this indicator posted a decent if not terribly impressive month in June: +1.6%. That’s the second straight month of roughly equivalent gains. The trouble spot was in capital goods, which slumped 1.3% last month after a 2.7% rise in May.
You can’t tell much from monthly data, however, and so it’s on to the year-over-year change in search of deeper context. Alas, there’s a mixed bag here. Durable goods overall rose a strong 8% last month vs. the year-earlier level. Even better, the annual pace has been picking up lately.
The annual growth rate for capital goods, however, tells a different and substantially darker story. Indeed, for the first time in more than two years, the year-over-year change in new orders for non-defense durable goods less aircraft was roughly unchanged in June. As the chart above reminds, this indicator's descent to zero has been in the making for several years.
The question is whether business investment trend is a superior measure than the broad indicator of durable goods for assessing the business cycle? The answer depends on the dismal scientist dispensing the advice. Clearly, some analysts say that the trend in capital goods offers a robust look ahead, and one that’s more sensitive to the true state of the economy compared with durable goods overall.
Another way to ask the question given the latest numbers: Is the recent surge in demand for aircraft and military goods—orders that are included in the broad measure of durable goods—distorting the true picture?
Perhaps. Surely no one should dismiss the discouraging news in business investment. But if this indicator’s darkness provides a better read on what's coming, we’ll soon see confirmation in other indicators. So far, we’re still well short of an open-and-shut case that the economy is falling off the cliff. The continued decline year-over-year decline in new jobless claims is one example for arguing otherwise, and there are several others as well.
Granted, the tide could be turning. There are many reasons for thinking so, but relatively few of those reasons are based on hard numbers that have been reported. That may change in the weeks ahead, but for now it’s still hasty to dig a grave for the cycle. I have my shovel ready just in case, but it’s still in the shed. After all, I don't want to scare the neighbors by bringing it out in full view until I'm sure I'll be digging.
Another Business Cycle Indicator Worth Watching
Bob Dieli of NoSpinForecast.com emailed me an intriguing chart earlier this week: the ratio of nonfarm payrolls to the unemployment rate. The ratio, which is based on monthly data, has an especially intriguing relationship with the business cycle, namely: it peaks just ahead of recessions.
Here’s how the ratio plays out over the past 60-plus years:
The trouble with using the ratio as an objective signal for estimating recession risk is that the peak's numerical value fluctuates through time and so it’s unclear how to interpret the latest data point. But that’s a minor problem. Transforming the ratio into year-over-year percentage changes solves the interpretation issue, as the second chart below shows:
Note that the annual percentage change falls below zero either a) just before the onset of a new recession, or b) in the early stages of a downturn. Alas, it’s not perfect—nothing is. But the false positives are relatively rare. The last one arrived in 1996, when the ratio inched ever so slightly into negative territory for a couple of months without a subsequent recession. On the other hand, the ratio hasn’t missed an NBER recession yet.
It's worth emphasizing--again--that perfection doesn’t exist when it comes to looking for a lone indicator for clues about estimating recession risk. Even an intelligently designed combination of predictors, which is essential, won’t be infallible, in part because no one really knows what the optimal mix of indicators will be, or if it's stable or an evolving pool. And then there's the gray area of deciding how to weight the indicators. Oh, well. That’s the nature of macro, and so all the usual caveats apply with this ratio.
That said, it looks like a worthy addition to the quantitative arsenal for evaluating business cycle risk—assuming, of course, it’s used in context with a range of other indicators--along these lines, for instance.
I can’t say that no one’s ever used this ratio before, although I don’t recall reading about it. No doubt I’m not as well-read as I thought on matters of the business cycle literature. In any case, I’m labeling the ratio the Dieli indicator from here on out (thanks, Bob).
Oh, yes, one more thing: the Dieli indicator tells us that the risk of an imminent recession, as defined by NBER, appears relatively low as of June. If it’s wrong, and suffering from a massive, unprecedented breakdown, we’ll soon see the evidence. Never say never in macro. Meantime, cautious optimism has a new statistical friend.
Update: See this post for a clarification on the ratio.
July 25, 2012
Strategic Briefing | 7.25.12 | Is The Fed Set To Roll Out QE3?
Fed Leaning Closer to New Stimulus if No Growth Is Seen
The New York Times | July 24
A growing number of Federal Reserve officials have concluded that the central bank needs to expand its stimulus campaign unless the nation’s economy soon shows signs of improvement, including job growth. The question is expected to dominate the agenda when the Fed’s policy-making committee meets next week, with some members pushing for immediate action while others seek to delay a decision at least until the committee’s next meeting in September, so they can see a few more weeks’ worth of economic data.
Fed Moves Closer to Action
The Wall Street Journal | July 24
Several officials have expressed both frustration with the disappointing recovery and a willingness to act if growth and employment don't pick up. Sandra Pianalto, president of the Cleveland Fed, said in public comments earlier this month she would be prepared to act if weak economic data persisted. Dennis Lockhart, the Atlanta Fed president, said more action could be needed barring a "step-up of output and employment growth."
Fed "hawks"—who tend to worry more about inflation and have opposed more action to stimulate the economy—have softened their tone and acknowledged the frustration. "I know people feel like we haven't made enough progress," James Bullard, St. Louis Fed president, said in an interview this month. He said he would be prepared to act if inflation falls too low or if a new shock hits the economy.
Fed Focus: Fed strives to replenish depleted toolkit
Reuters | July 25
A recent Reuters poll of U.S. primary dealers, banks that do business directly with the Fed, found that 70 percent expect another round of stimulus via bond buys. But yields on Treasuries are at or near record lows, casting doubt on what good yet more purchases can bring. Little action, if any, is expected at the next policy meeting, July 31-Aug. 1, when some economists think the Fed could push further into the future its conditional pledge to keep rates near zero through late 2014.
Show some real audacity at the Fed
The Financial Times | July 24
Quantitative easing that fails to spark risk-taking could actually make things worse.... And so the Fed faces a dilemma. With inflation below target and unemployment far above the neutral rate, there is a clear case for stimulus. But the familiar tools of stimulus seem unlikely to work. So the markets expect next week’s Fed policy meeting to produce more equivocation. The better way forward would be to come up with new tools. One possible measure is to cancel interest on excess reserves. At present, the Fed pays 25 basis points to banks that deposit cash with it, a perverse reward for keeping money inert. Eliminating that incentive might steer cash into the real economy. But it would also drive cash into the money markets, where returns would soon fall to zero or lower. Money market funds would be hard-pressed to avoid breaking the buck again. Panic might follow. That leaves a second option: the Fed could couple more quantitative easing with a formal announcement of a higher inflation target.
July 24, 2012
Is The Poverty Rate Set To Reach A 40-Year High?
Poverty is a hardy perennial. But while no one will be surprised to learn that eradicating poverty is difficult, perhaps impossible, there was at least some modest progress over the last several decades. But now even that thin reed appears headed for the dustbin of history as the U.S. poverty rate looks set to return to heights last seen in the 1960s.
Decades of progress on lowering the U.S. poverty rate is evaporating before our eyes, or so some analysts say, based on expectations for the scheduled release of the Census data for 2011 later this year. A recent survey of economists by the Associated Press found that a “broad consensus” expects that the 2011 poverty rate may rise to as high as 15.7%, up from 15.1% in 2010. As the chart below shows (via the Census Bureau’s “Income, Poverty and Health Insurance in the United States: 2010 report), the poverty rate rose for three straight years through 2010 and the data for 2011 is on track to make it four in a row.
There’s no great mystery for explaining the reversal of fortunes that may raise the U.S. poverty rate to the highest since the 1960s, when the Johnson administration launched the so-called war on poverty program. The Great Recession, for obvious reasons, has set back the cause of prosperity by, well, years if not decades. It’s disturbing, frustrating and disheartening all at once to realize that the nation, for all the money and effort spent on trying to reduce if not eliminate economic distress, has made no headway in more than 40 years on this front. That’s an exaggeration, of course, but at least one statistic suggests that we’ve gone nowhere since a President with a Texas drawl was working the phones at 1600 Pennsylvania Avenue.
We can debate cause and effect, and dissect the finer points of policy prescriptions—and we should, as a nation. But first things first. According to AP:
Poverty is spreading at record levels across many groups, from underemployed workers and suburban families to the poorest poor. More discouraged workers are giving up on the job market, leaving them vulnerable as unemployment aid begins to run out. Suburbs are seeing increases in poverty, including in such political battlegrounds as Colorado, Florida and Nevada, where voters are coping with a new norm of living hand to mouth.
Considering the big picture inspires rethinking what’s happened over the last several years. Volumes have been written on this vast topic, of course, and no doubt many more books in the years ahead will enlighten us. Meantime, a few thoughts from one observer of the macro scene.
First, President Obama, for all his efforts (informed or otherwise) to respond to the Great Recession, came up short. Maybe that was inevitable—Presidents are mortals, not gods. That said, the focus should have been, from day one, jobs, jobs, jobs. Yes, there was quite a lot of that early on in the Obama presidency, but he became sidetracked. Healthcare, for example. Whatever the pros and cons (and there are many on both sides) of attempting to reform the mess that is healthcare in this country, it should have taken a back seat to jobs, jobs, jobs. When you're faced with the worst economic crisis since the Great Depression, it doesn't take a rocket scientists to figure out where the policy priority lies.
The $787 billion fiscal stimulus enacted in 2009 arguably was a strong response to the economic crisis. But as critics have pointed out, the program's design was less than encouraging if the goal was to maximize job growth.
Beyond that, the White House seems to have lost focus on the jobs-creation topic. Yes, there’s plenty of blame for Congress too--for Republicans and Democrats. In any case, it seems clear that the government’s efforts overall at fostering a pro-growth climate for jobs creation has fallen well short of what’s needed—then and now.
Monetary policy has been lackluster too. Without going into details at this point, let’s just say that the Federal Reserve hasn’t earned any accolades for doing all that it could have done (or could be doing now) to boost the prospects for economic growth and fostering jobs creation. (For some background, you might start with Paul Krugman’s “Earth to Ben Bernanke” article or Scott Sumner’s market monetarist analyses on his blog TheMoneyIllusion.com.
Hashing over the past, and what could have or should have been done, is a job best left to economic historians at this point. In the here and now, a burning question remains of what to do? Everyone has a prescription, and here’s one more. Cut corporate taxes on anything and everything related to jobs creation. Cut it to the bone, if only for a year or two. A tax holiday to stimulate the hell out of private-sector jobs creation. Not on the margins, but boldly so. We need a bombshell jobs-creation program that's on par with taking the country off the gold standard in 1933 to inspire the captains of industry to invest in labor. Something similar should be applied for individual taxes as it relates to investing.
Ditto for monetary stimulus. The Fed should start targeting a higher level of nominal GDP in a very public and clear way. As Scott Sumner argued last fall:
Monetary policy is not an answer to structural policy problems. It cannot make up for a failure to control the growth of public spending or the explosion of entitlement costs. But it can do a great deal to help create a stable environment of consistent growth, and thus make the difficult structural reforms ahead both more effective and easier to tolerate. At the moment, our monetary policy risks making the hard task facing fiscal reformers all the more challenging. A Federal Reserve with its eyes firmly set on the right target would greatly ease their way.
What’s clear is that half-hearted measures that pick around the edges of a very big problem won’t do much. Been there, tried that, with disappointing results. It may seem like fiscal and monetary policies over the last several years have moved heaven and earth to respond to the blowback of the Great Recession. But after closer inspection of the results, it's clear that the nation did a lot less than it could have or should have. Some of this is just politics as usual, but some of it is also misguided thinking.
Meantime, we’re paying the price for policy failure with a sluggish economy that remains vulnerable to any number of risks lurking on the horizon. More importantly, we’re allowing the modest progress in poverty reduction to fade into history. That’s a high price to pay—too high, in fact, particularly for roughly 15.1% (and rising?) of the population.
July 23, 2012
Chicago Fed National Activity Index: No Recession For U.S. As Of June
The Chicago Fed National Activity Index (CFNAI) for June rose modestly, suggesting that recession risk eased. Although the 3-month moving average of the index increased to -0.20 last month from -0.38 in May, the June number was the fourth straight month of below-zero readings, which “suggests that growth in national economic activity was below its historical trend,” the Chicago Fed reports.
The view that the U.S. economy has weakened in recent months is old news at this point. But the idea that recession risk remains relatively low as of June is likely to be greeted with far more skepticism. Nonetheless, the 3-month moving average of the CFNAI has an encouraging record of signaling the arrival of new recessions, albeit with a slight lag. The trigger point for identifying a new period of economic contraction is when the 3-month average of CFNAI drops below -0.7. By that standard, the current -0.38 still affords a decent if not huge cushion between current conditions (as of last month) and another recession.
Economic reports are subject to revisions, of course, and that means CFNAI will be revised too. But reviewing vintage data for CFNAI (i.e., the original data as reported, before revisions) still paints an encouraging picture for this benchmark as an early warning indicator that the U.S. economy has recently slipped into a downturn that will eventually be labeled as a recession by the National Bureau of Economic Research. For example, the first recessionary reading for the 3-month CFNAI was published on March 24, 2008. Many months later, NBER declared that the Great Recession began in January 2008.
Readers of these pages will hardly be shocked to learn that the CFNAI data doesn’t show that the economy had tipped over into recession as of June. Earlier this month, I made the same argument based on a review of 15 economic and financial indicators. The Philadelphia Fed’s ADS Business Conditions Index offers additional statistical support for arguing that recession risk has remained low in recent history.
The future may tell us differently, but the econometric analysis is quite clear in the here and now: the U.S. economy was recession-free as of last month. That’s not a forecast; rather, it’s simply interpreting the numbers overall in a statistical framework informed by the business cycle's history.
Qualitatively, there’s much to criticize when it comes to current economic conditions. There are also plenty of risks lurking as well. No one should consider the empirical fact (based on the numbers in hand) that the U.S. managed to skirt a recession through June 2012 as a sign that all’s well. It’s not.
Barring a massive round of data revisions in the weeks and months ahead, however, the case for thinking that the U.S. dodged a macro bullet through the past month just got a bit stronger with today’s CFNAI update. The burning question now becomes: Will July be able to hold out too? The numbers so far suggest that the forces of darkness may be getting stronger. But the jury’s out until more data arrives. Yes, the mystery of the business cycle for July will soon be resolved, one way or another, one economic update at a time.
Strategic Briefing | 7.23.12 | The Spanish Risk Factor
Spanish Yield Reaches Record on Regional Bailout Concern
Bloomberg | July 23
Spanish bonds slumped, with 10-year yields climbing to a euro-era high, after El Pais said six regions may ask the central government for financial assistance, increasing concern the nation will need additional aid…. “The probable bailouts of some Spanish regions is weighing on markets and pushing up yields,” said Craig Veysey, head of fixed income at Principal Investment Management Ltd. in London, part of Sanlam Group, which manages $72 billion. “There is concern that Spain might be looking for a sovereign bailout sooner rather than later as a result of having to bail out the regions. Yields at current levels aren’t viable for Spain.”
Spain slump deepens as bailout fears grow
Reuters | July 23
The economy contracted by 0.4 percent in the three months from April to June having slumped by 0.3 percent in the first quarter of the year, the central bank said in its monthly report. As Spain's benchmark 10-year debt yields rose further above the 7 percent level that triggered an unsustainable spiral in borrowing costs for the euro's zone existing bailout recipients, Economy Minister Luis de Guindos ruled out a full-scale rescue on top of the 100 billion euros earmarked for the country's banks. Ministers in Madrid insist there is little more they can do to bring the borrowing costs down, but the central bank's deputy governor said more austerity was needed.
Spain on Edge as Focus Shifts from Banks to State’s Finances
The Curious Capitalist (Time) | July 23
Spain got the green light from its E.U. partners last Friday for a $120 billion bailout of its troubled banks.... A rout on the Madrid stock exchange and a big jump in the yields on Spanish government bonds, which soared to over 7%, a crisis level that is unsustainable. What’s going on? The short answer is that the markets are switching their attention from the parlous state of Spanish banks, which have $192 billion in what the Bank of Spain calls “doubtful loans” on their books, or almost 9% of total lending, and are now focusing on the state’s finances, which are showing new signs of deterioration. That’s a worrying development for the euro zone as a whole, since the emergency bailout funds it has agreed on would barely cover a Greek-like sovereign rescue of an economy as big as Spain’s.
German Parliament to vote on Spanish bank rescue
Associated Press | July 23
Germany's finance minister urged lawmakers Thursday to support a rescue package worth up to (EURO)100 billion ($122 billion) for Spain's ailing banks, arguing it was necessary to help the country cope with "excessive" market fears and prevent the eurozone's debt crisis spreading further. Germany's Parliament has to endorse all decisions to use money from the eurozone's rescue fund. The country is Europe's biggest economy and the biggest single contributor to the bailout fund; it will guarantee loans to the tune of up to (EURO)29 billion under the Spanish package.
IMF Calls on Eurozone to Take Determined Action in Response to Crisis
Int'l Monetary Fund | July 18
The euro area crisis has reached a critical stage, as financial markets in parts of the region face acute stress. In its latest assessment of economic developments in the eurozone, the IMF calls for determined action towards establishing banking and fiscal unions in the euro area to bolster monetary union. GDP growth in the euro area is expected to come in at -0.3 percent in 2012 and 0.9 percent in 2013. The pace of fiscal adjustment is particularly fast in the hard-hit periphery countries, and this is weighing on the growth outlook. Projected consolidation for 2012-13 ranges from more than 4 percentage points of GDP in Cyprus, Portugal, Greece, and Spain, to 0.5 percentage points or less in Germany, Austria, Finland and Luxembourg. The rate of unemployment is expected to continue to vary widely across the region—from 5 percent in Germany to about 24 percent in Spain this year.
July 21, 2012
Book Bits | 7.21.2012
● Moods and Markets: A New Way to Invest in Good Times and in Bad (Minyanville Media)
By Peter Atwater
Summary via publisher, FT Press
Leading consultant and Minyanville contributor Peter Atwater has helped institutional investors, corporations and policymakers map changing social moods to emerging market shifts, and use that knowledge to identify huge new market opportunities. Now, Atwater shows you how to use the same powerful Horizon PreferenceTM approach to select your own high-performance investments. Utilizing what is often in plain sight, but overlooked and underestimated, Horizon Preference helps you understand how we narrow our physical, time and relationship horizons to the "local" in bad times, and widen them to the "global" in better times — and then translate that knowledge into better investment decisions. Atwater’s Moods and Markets offers powerful new insights into everything from market bubbles to the real challenges of making mergers work… why "farm to table" and "locavore" movements are booming now, and what’s likely to happen next… why Americans now want to rent homes even though it’s become far more affordable to buy them… why the "Arab Spring" is bullish, and higher education is in deep trouble… which businesses prosper in a downturn, which prosper most in an upturn — and why.
● Bloomberg Financial Series Visual Guide to Financial Markets
By David Wilson
Summary via publisher, Wiley/Bloomberg Financial
Financial markets are supposed to be complicated. Otherwise, there wouldn’t be as much money to go around and individual investors wouldn’t need to pay brokers and financial advisers as much to manage their nest eggs. The Bloomberg Financial Series Visual Guide to Financial Markets makes them easier to understand. This essential guide provides key information about the forces underlying market structure, instruments, and dynamics and the ways to capitalize on them. Written by Bloomberg Reporter-at-Large David Wilson, the book covers the three basic types of investments and the markets tied to them directly and indirectly.
● The 4% Solution: Unleashing the Economic Growth America Needs
Edited by Brendan MiniterAuthor
Reference via the Associated Press
Former President George W. Bush said he wants his institute, which Tuesday released a book featuring experts weighing in on ways for the U.S. to jumpstart the economy toward 4 percent gross domestic product growth, to be an "action-oriented" place. "We're very much involved in action-oriented programs," Bush told the about 200 people gathered for the release event for the George W. Bush Institute's first book. Bush's brief speech was followed by a panel discussion with several of those who contributed to "The 4 Percent Solution: Unleashing the Economic Growth America Needs." "We believe that we can do better in growing our economy," said Bush, who wrote the book's foreword.He added, "My view is that we'll never fix the deficit without growing the private sector."... James K. Glassman, executive director of the Bush Institute, has said that the book — which includes entries by five Nobel Prize winners — is part of "The 4 Percent Growth Project" launched last year with a goal to "change the conversation in America so that it focuses on the goal of sustainable, strong growth. We think that the way to solve the economic problems that America faces can be summed up in 4 percent growth. Right now we're growing about at 2 percent. We've grown an average of about 3 percent since the end of World War II," said Glassman, who wrote the book's introduction.
● The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton
By Colin Read
Summary via publisher, Macmillan
The third book in the Great Minds in Finance series examines the pricing of securities and the risk/reward trade off through the legends, contribution, and legacies of Jacob Marschak, William Sharpe, Fischer Black and Myron Scholes, and Robert Merton, influencing both theory and practice, enabling the question of how do we measure risk?
● Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income
By Triet Nguyen
Summary via publisher, Wiley/Bloomberg Financial
This unique guide to the high yield municipal bond market sheds some much-needed light on this esoteric but profitable corner of the fixed-income world. It fills the void between the general reference handbooks on municipal bonds and the superficial treatment of do-it-yourself bond guides, with an emphasis on practical trading applications. Having witnessed the beginning of the modern high yield tax-exempt institutional market, author Triet Nguyen documents its historical evolution, outlines a conceptual framework for high yield tax-free investing, one that takes into account both interest rate and credit cycles, and reviews the latest historical data on municipal defaults, including for the first time the non-rated sector.
● The Money Trap: Escaping the Grip of Global Finance
By Robert Pringle
Summary via publisher, Palgrave Macmillan
Why have the efforts of governments and central banks to revive economic growth and solve the problems left by the global financial crisis met with such limited success? Why have markets been periodically paralysed by fear and uncertainty? This book argues that governments have been using the wrong policy weapons. They have relied on the traditional tools of low interest rates and monetary ease, plus tighter bank regulation and new macro-prudential toolkits. The Money Trap discusses how governments have failed to understand the roots of the rolling crisis and recession of 2007-12 and argue that these roots lie in the interaction of an elastic credit supply, dysfunctional banking systems and an unreformed international monetary system. Historically, the advanced countries enjoyed long periods of economic growth with stable money and without systemic banking crises - and minimal bank supervision. We can learn from the historical experience, and from the teaching of great economists. They point to a clear conclusion.
July 20, 2012
What’s Next For The Link Between Stocks & The Inflation Outlook?
The stock market and the Treasury market’s inflation forecast seem to be going their separate ways. We haven’t seen this movie in quite some time. Is that significant? It may be. To understand why, a brief history lesson.
In the grand scheme of the equity market and the inflation outlook, there’s usually minimal correlation. In fact, it’s not unusual to see the stock market move in the opposite direction to inflation forecasts when the latter moves to relative extremes on the upside. Higher inflation, at some point, goes over like a lead balloon in the stock market. But it’s been several years since that negative link has been the rule.
The relationship changed with the financial crisis in late-2008 and the Great Recession. The weak recovery and the burden of working off excess levels of debt created what I like to call the new abnormal. Equity prices and the market’s inflation outlook have become tightly and positively bound. That’s abnormal, but it’s become typical in recent years because the debt-deflation threat trumps the usual worries about nexus between inflation and the economy. (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.)
In short, higher inflation is greeted favorably by the stock market. That, at least, has been the prevailing theme in recent years as the economy struggled to overcome unusually strong macro headwinds and keep the red ink from sinking the ship. But as you can see in the chart below, the relationship seems to be changing, which is to say inching back toward the standard of decades past.
Consider the latest leg down in inflation expectations (the 10-year Treasury Note yield less its inflation-indexed counterpart, indicated by the black line in the chart above). This decline, which started in the spring, offered an early clue that economic growth was slowing. It remains to be seen if it will end up as another rough patch or a new recession. Economists, not surprisingly, are all over the map on where we're going. In any case, the Treasury market has recently been predicting a lesser level of inflation compared with the outlook during the early months of 2012. That’s a bearish sign in the new abnormal and for a time the stock market reacted in the usual way for the post-2008 era: falling, in sympathy with the lower inflation prediction.
But starting in June, the inflation forecast stabilized at roughly 2.1% and the stock market began trending up. As a result, stocks and the inflation outlook appear to be decoupling. It’s anyone’s guess if it will continue, but for now let’s ponder the implications of this divergence.
The optimistic view is that the new abnormal is in retreat. In other words, the macro outlook is returning to something approximating normality. If so, the positive correlation between the stock market and the inflation forecast will fade as a general rule. That would be a sign of progress generally, if the trend holds.
The alternative view is that the equity market is making one of its periodic mistakes and so stocks are overbought and the new abnormal will persist across the macro landscape. In that case, the stock market is headed for a correction. A kinder, gentler interpretation of this scenario is that inflation is set to rise, in which case the stock market may avoid a nasty selloff. In either case, the growing divergence between stocks and the inflation outlook will reverse if the new abnormal will be with us for a while longer. The only question: how much will it cost equity investors?
One thing’s for sure: Only one of these scenarios awaits.
July 19, 2012
Seasonal Distortion In Jobless Claims: The Sequel
Last week’s sharp rise in new jobless claims looks ominous, but there’s a good reason to reserve judgment at this point. Recall that the previous weekly update in new filings for unemployment benefits tumbled dramatically to a new four-year low. But as several analysts warned, the fall was probably due to a seasonal factor linked to summer shutdowns of auto plants. Fast forward a week and it appears that the seasonal distortion has been effectively corrected. In sum: the latest reading on jobless claims (for the week through July 14) is more or less unchanged from the late-June figures, which implies that the roller coaster ride in the interim was a lot of noise about nothing.
As the first chart below shows, weekly claims have been unusually volatile lately—even by the standards of what is inherently a volatile data series. Taken at face value, new claims on a seasonally adjusted basis have generally remained flat through last week’s tally of 386,000. In other words, there’s not much progress to report on this leading indicator for the labor market. That’s bad.
On the other hand, if we look for deeper clarity in the raw figures, and compare the numbers on a year-over-year basis, the trend looks brighter. As the second chart reminds, the annual pace of unadjusted claims continues to decline relative to its year-earlier level. That’s good.
But, wait—even the annual pace of claims has suddenly moved closer to zero. Is that a sign of trouble? Perhaps. If and when the annual pace of claims is flat (it hasn’t been for more than a year) or, even worse, begins rising on a sustained basis, we’ll have a strong signal that we’re in trouble (much deeper trouble) with regards to the labor market and, by extension, the economy overall.
For now, however, it’s premature to say what all the back and forth means. As you’ve read on these pages many times, it’s usually a mistake to read too much into any one data point when it comes to claims, as last week’s head fake reminds.
Yes, there’s darkness on the edge of town via the latest batch of monthly numbers for June (retail sales, the ISM Manufacturing Index, and payrolls). But optimists can also point to yesterday’s encouraging numbers on housing starts and the resilience in the June update for industrial production. Feeling a bit whipsawed? Welcome to the club. But if we’re looking for clarity on estimating recession risk, based on the full set of numbers available so far through May, it’s not yet obvious that the cycle is destined to crumble. My recession risk index for the preliminary June profile is holding up quite well too (I’ll have an update soon).
But let’s be clear: there’s plenty of weakness all around to inspire worries about what comes next. We may be at the tipping point... or is the trouble merely a batch of statistical noise that's temporarily infecting the numbers? In any case, all will be sorted out soon. Meanwhile, it’s premature to rush to judgment that the cycle is doomed. In short, don’t let emotion, driven by the latest numbers, overwhelm strategic perspective.
"The snapback in the pace of claims should not be particularly surprising as last week's favorable seasonal unwinds," says Millan Mulraine, senior macro strategist at TD Securities, via Reuters. "However, we believe that the current level of initial jobless filings overestimates the true pace of jobless claims, and should see claims fall back to around 370,000 in the coming weeks."
If he’s wrong, and there’s more pain to come, the evidence will become clearer in the near term. For now, assuming the worst still relies heavily on speculating rather than interpreting the data in hand. Itchy trigger fingers play well on the big screen, but the habit of shooting first and asking questions later isn't helpful for dissecting the cross currents that typically swirl in the seas of macro.
July 18, 2012
A Four-Year High For Housing Starts In June
Today’s update on housing starts and new building permits for June delivers another day of upbeat economic news, following yesterday’s encouraging report on industrial production for last month. June overall is still a mixed bag of economic data (retail sales, ISM Manufacturing Index, and payrolls in particular were disappointing). But it’s hardly trivial that the housing market continues to grow—a trend that appears intact, based on today's news for permits and starts.
As the first chart below shows, new housing starts rose last month to a new post-recession high of an annualized 760,000. The last time starts were this high was October 2008. Permits retreated slightly in June, but this isn't cause for alarm since the year-over-year trend continues to look quite healthy for both of these leading indicators.
Indeed, as the second chart illustrates, the revival in starts and permits still looks encouraging on an annual basis. Both indicators are advancing at roughly 20% a year. That's a sign that the housing sector has a fair amount of growth momentum. Yes, it could all disappear tomorrow, but let's remember that the rebound in housing didn't suddenly drop out of the sky. Last December, I noted that it appeared as though the housing market had finally turned a corner in favor of growth. More than six months later, the data offer persuasive corroboration that the sector's growth is the real deal this time. If so, the revival will continue to bestow considerable benefits on the overall economy at a critical (and, yes, still-dangerous) period. Housing's share of the U.S. economy may be as high as 18%, according to the National Association of Home Builders, and so growth--any growth--is a considerably hefty net plus for the broad trend.
One recent study goes so far as to claim that Housing Is The Business Cycle. An exaggeration? Perhaps, although this much is clear: a housing market that's no longer a huge negative influence on the broader economy is a substantial change for the better. No, housing can't save the business cycle if certain other risk factors continue to deteriorate in the months ahead. But for now, there's one more factor in the plus column to consider.
On that note, the full set of June economic and financial market indicators is nearly complete for nowcasting recession risk. The May profile in this effort suggested that the economy wasn't in recession territory as of that month, and it's looking like more of the same applies for June. The future, of course, may tell us otherwise, but for now there's still a case for modest if anxious optimism, based on the numbers in hand. (I'll have a detailed update on my recession risk estimate as of June in the days ahead.)
Today's housing update "was a good report overall," Martin Schwerdtfeger, an economist at TD Bank, says via AP. That fact that new permits continue to remain high "suggests that the momentum in building activity observed in recent months should carry forward."
“Demand has bottomed out and we expect continued improvement,” notes Yelena Shulyatyeva, a U.S. economist at BNP Paribas. “We’re in a recovery, a very slow one,” she tells Bloomberg.
That doesn't mean that economy is home free. Indeed, as Fed chairman Ben Bernanke predicted in Congressional testimony yesterday, the decline in the unemployment rate will continue to be “frustratingly slow.” Nonetheless, if the housing market was still suffering, the odds would be a lot lower for expecting even slow progress.
* * *
Correction: An earlier version of this story incorrectly stated that both starts and permits were growing well in excess of 20% a year. Also, the chart of annual data that was initially published didn't show the latest data through June. In fact, starts rose at well over 20% while permits through June were up just under 20% vs. a year earlier. The text and chart have been changed to reflect the corrections. Sorry for any inconvenience.
July 17, 2012
Industrial Production Rebounds In June
Several of the June updates on the economy to date have brought discouraging news (retail sales, the ISM Manufacturing Index, and payrolls). Today’s report on industrial production offers a refreshing change for the better. The Federal Reserve advises that industrial production rose 0.4% last month, a respectable rebound from May’s 0.2% decline. Even better, the year-over-year change through June perked up slightly to 4.7% vs. 4.4% through May. Is the moderately better news for industrial production enough to blow away the worries dispatched by less-encouraging news from elsewhere in the economy? No, but it’s enough to keep the debate open about what happens next.
Nonetheless, reviewing the last several months reminds that industrial production activity has turned choppy lately. The June report, which is subject to revision, is certainly welcome after May’s slump. But it’s unclear if the economy has hit a temporary rough patch, or if there are more ominous clouds on the cyclical horizon.
This much, however, is obvious: the trend in industrial production, as defined by the annual pace, offers no clear sign of trouble. The 4.7% rise for June vs. the year-earlier month is near the best levels over the past 12 months. That's a healthy pace and it seems to be holding. In short, there’s no sign that industrial production is rolling over and signaling an imminent recession.
Any one indicator may be misleading, of course, which is why it’s crucial to look at a broad range of economic reports and their trends. On that score, the available June numbers continue to signal that recession risk is low (for an analysis for the numbers through May, see this post). That's not a forecast; rather, it's a simple but powerful profile of where we've been. What does it tell us? When the NBER gets around to dating the start of the next recession, it’s looking increasingly likely that it won’t be June 2012.
Beyond that, the future is wide open for debate, as always. For insight, feel free to turn to your favorite forecaster. Meantime, once we have the full spectrum of July data in hand we may discover that everything fell apart... or not. But for the moment, what we do know, based on the numbers dispensed so far, keeps hope alive, and by more than a thread.
“Manufacturing looked decent in June,” opines Harm Bandholz, chief U.S. economist at UniCredit Group via Bloomberg. “The risk is from the uncertainty over the global economic outlook and, more recently, the fiscal situation in the U.S., which means companies will meet demand more and more by drawing down inventories.”
If the economy is slipping over the edge, we’ll soon see convincing evidence across a range of indicators. When and if that happens, I'll be among the first to report the change in the cyclical weather on these digital pages. For the moment, however, there are only cracks in the expansion’s trend. It could be noise, or a sign of something deeper creeping up on us. Granted, the expansion isn’t all that strong to begin with and there are plenty of threats swirling in the U.S. and abroad that could potentially derail the modest growth trajectory of late. This is no time to fall asleep at the switch for monitoring macro signals. But industrial production’s resilience, backed up by some other metrics, including initial jobless claims, suggest that it’s still premature to dig a grave for the business cycle.
July 16, 2012
Retail Sales Retreat In June For 3rd Straight Month
Retail sales unexpectedly fell 0.5% last month, the Census Bureau reports. Economists had generally predicted an increase for the month. In contrast, the revised numbers now show that June’s retreat was the third monthly loss in a row—the first trio of consecutive decreases since 2008. Not an encouraging sign, but not a smoking gun either.
The standard caveat applies, namely, monthly data is volatile and not necessarily indicative of the broader trend. Then again, it’s not often that volatility on the downside persists for three months running if the economy has a head of steam.
For a clearer look at the trend, let’s consider the year-over-year percentage change. The good news is that retail sales are still growing at a healthy pace on this score. The bad news is that the deceleration in the annual rate of growth rolls on, posting a 4% rise for the year through last month—the slowest increase since August 2010.
Is this a sign that a recession has started? Possibly, but the jury’s still out until we have a broader reading on the June data. There’s still a case for making a distinction between forecasting and diagnosing the trend based on the numbers in hand. We’ll know more in the days and weeks ahead.
What we’ve seen so far, however, has been a mixed bag, at best. The ISM Manufacturing report is warning of economic trouble. So too is the employment report for June, although the annual pace of private-sector job growth continues to hold up in moderately positive territory and initial jobless claims have yet to take a sharp turn upward. Nonetheless, it’s hard to dismiss the possibility that the cycle has turned.
If we have slipped over the edge, we’ll soon see a number of convincing signs of the change. For example, the June update of the Chicago Fed National Activity Index (scheduled for release on July 23) will tell us if the May weakness in this benchmark deteriorated further. Meantime, I’ll be updating my 15-indicator reading on the economy for additional clues on where we stand as of last month as the numbers come in.
For the moment, it’s getting easier to see darkness approaching. It may still be a head fake, but that’s a harder argument to make today. "Evidence is increasingly clear that the U.S. economy is slowing," says Jim Baird, an investment strategist at Plante Moran Financial Advisors.
“People are just pulling back, and you’re not likely to see a significant pickup from here,” notes Michael Carey, chief economist for North America at Credit Agricole CIB. “This was certainly a slowdown from the first quarter.”
The next big clue: industrial production for June, which will be released tomorrow. The consensus forecast among economists sees a 0.3% rise for last month, according to Briefing.com. Suffice to say, the crowd's just about out of patience for another round of negative surprises.
Windows Of Opportunity In Business Cycle Analysis
Amid all the recession talk of late, there's a lot of chatter about the value of predicting these events. One line of reasoning advises that unless you're capable of anticipating recessions with a fair amount of lead time, the situation is hopeless. Actually, no—reality is far more nuanced than this one-dimensional claim lets on. Different recessions dispatch different degrees of pain on different time schedules. As a result, there can be value in simply recognizing when recessions begin, as early as possible.
Life would be much easier, of course, if we could reliably forecast recessions well in advance and take defensive actions before the storm hits. But history is littered with failure here. What's more, it's never really clear if the claimed forecasting successes relied completely on a methodology vs. a bit of luck. In any case, the debate about predicting inspires looking for the telltale signs of economic slumps once the process has started and once the negative trend is clearly terminal. Designed properly, this approach can be quite effective, in part because it's not subject to the higher error rates of pure forecasting. I outlined a test on this front last week, and the results come with an encouraging record. It's not rocket science, but it's effective, as I discuss in a book I'm writing on the topic. In any case, the world is awash in predictions; what's missing is a robust model for recognizing that a recession is already upon us. That alone can't solve all our troubles with macro, but it's not worthless either.
Waiting for a recession to declare itself in convincing terms may seem like a pointless exercise, but in fact there's often a chance to prepare for the worst—even after the storm has recently started pummeling us. Consider the Great Recession. By NBER's estimate, January 2008 was the economy's first full month of broad decline. My research suggests that by the spring of that year, the data was clearly revealing, in real time, that the economy was in trouble. But wasn't the jig up in January? Hadn't the window of opportunity already closed by the first of the year? Not necessarily.
As one test, let's compare the stock market's one-year rolling return for the first 12 months of Great Recession with its 3-, 5-, and 10-year annualized counterparts. One-year returns were already negative by the time the recession started in January. But a roughly 4% loss at the end of the year's first month deteriorated dramatically as the recession unfolded. Meanwhile, the 3-, 5- and 10-year annualized returns for the S&P 500 remained positive through August 2008, offering investors a chance to preserve quite a bit of the gains earned previously before all hell broke loose in September 2008 and beyond.
Looking at a variety of economic indicators also reminds that the Great Recession's pain didn't arrive as an across-the-board bolt out of the blue early on. For instance, retail sales and new orders for durable goods held up surprisingly well during the first half of 2008. Although both series weakened as the year progressed, it was hardly the case that the worst of the contraction had struck in these corners at the beginning of the recession.
To be fair, the window of opportunity for defensive action, once a recession begins, can and does vary considerably through history. But it's misleading to argue that all of the damage is always dispatched up front. That may be true for some financial indicators and/or economic series in some recessions, but it's far from an iron rule.
In other words, developing a relatively reliable methodology for recognizing when a contraction has started can offer a surprisingly powerful bit of strategic information. But there's a catch: You have to be looking for it, and the search requires an analytical lens that's somewhat different than the usual suspects that are deployed for predicting recessions.
July 14, 2012
Book Bits | 7.14.2012
● Affluence and Influence: Economic Inequality and Political Power in America
By Martin Gilens
Summary via publisher, Princeton University Press
Can a country be a democracy if its government only responds to the preferences of the rich? In an ideal democracy, all citizens should have equal influence on government policy--but as this book demonstrates, America's policymakers respond almost exclusively to the preferences of the economically advantaged. Affluence and Influence definitively explores how political inequality in the United States has evolved over the last several decades and how this growing disparity has been shaped by interest groups, parties, and elections. With sharp analysis and an impressive range of data, Martin Gilens looks at thousands of proposed policy changes, and the degree of support for each among poor, middle-class, and affluent Americans. His findings are staggering: when preferences of low- or middle-income Americans diverge from those of the affluent, there is virtually no relationship between policy outcomes and the desires of less advantaged groups.
● Octopus: Sam Israel, the Secret Market, and Wall Street's Wildest Con
By Guy Lawson
Q&A with author via Jeff Glor/CBS News
Jeff Glor: What inspired you to write the book?
Guy Lawson: When I first talked to Sam Israel in prison I thought I was working on a story about a Wall Street fraudster--at the time the biggest ever. But Israel started to tell me this entirely different story about a secret bond market and the CIA and how the Federal Reserve is running a Ponzi scheme. It was literally incredible--as in unbelievable. But those are the kinds of stories I'm drawn to--stories that prove how much stranger fact is than fiction.
● Resilience: Why Things Bounce Back
By Andrew Zolli and Ann Marie Healy
Review via Publishers Weekly
This intriguing, wide-ranging probe ponders the underlying principles behind whether complex systems of every sort—government, business, social, natural—function or fail. Zolli, director of the global innovation network PopTech, and financial and technology journalist Healy ask: since “[v]olatility of all sorts has become the new normal,” is it even possible to isolate causal factors in an ever more complex world? Their findings emphasize the importance of examining the importance of elemental interconnectedness in contrast to isolating and addressing features individually. To demonstrate deep linkages between apparently unrelated events, they cite the role Hurricane Katrina played leading up to the 2007 Mexican food riots. This is followed by analyses of international terrorism, the 2008 financial crisis, and the ad hoc international effort to assist Haiti following its catastrophic 2010 earthquakes.
● The Fiscal Cliff: How America Can Avoid a Fall And Stay On Top
By Ayse Imrohoroglu and Selahattin Imrohoroglu
Reference in The New York Times
When news broke last week that the billionaire investor Joe Ricketts had considered financing a $10 million advertising effort linking President Obama with the fiery race-based rhetoric of his former spiritual adviser, the Rev. Jeremiah A. Wright Jr., Mr. Ricketts quickly distanced himself from the proposal and Mitt Romney’s campaign denounced it.... His political action group Ending Spending is financing a book by the husband and wife economists Ayse and Selahattin Imrohoroglu that in effect argues for an embrace of the bipartisan Bowles-Simpson debt reduction plan. (Called “The Fiscal Cliff: How America Can Avoid a Fall and Stay On Top” and due out late next month, it has a clinical, academic approach.)
● The Consequences of the Global Financial Crisis: The Rhetoric of Reform and Regulation
Edited by Wyn Grant and Graham K. Wilson
Summary via publisher, Oxford University Press
The Global Financial Crisis is the most serious economic crisis since the Great Depression, and although many have explored its causes, relatively few have focused on its consequences. Unlike earlier crises, no new paradigm seems yet to have come forward to challenge existing ways of thinking and neo-liberalism has emerged relatively unscathed. This crisis, characterized by a remarkable policy stability, has lacked a coherent and innovative intellectual response. This book, however, systematically explores the consequences of the crisis, focusing primarily on its impact on policy and politics. It asks how governments responded to the challenges that the crisis has posed, and the policy and political impact of the combination of both the Global Financial Crisis itself and these responses.
● The Biobased Economy: Biofuels, Materials and Chemicals in the Post-oil Era
Edited by Hans Langeveld, Johan Sanders, and Marieke Meeusen
Summary via publisher, Routledge
The impending threats of catastrophic climate change and peak oil are driving our society towards increased use of biomass for energy, chemical compounds and other materials – the beginnings of a biobased economy. As alternative development models for the biobased economy emerge, we need to determine potential applications, their perspectives and possible impacts as well as policies that can steer technological and market development in such a way that our objectives are met. Currently, it is still far from clear what will be the most sustainable routes to follow, which technologies should be included, and how their development will affect, and be affected by, research, public opinion and policy and market forces.
July 13, 2012
Major Asset Classes: Ex Ante Risk Premia | June 2012
Earlier this week I reviewed how the Global Market Index’s risk premium stacked up in historical terms vs. looking ahead. Or in the jargon of the investment industry, I profiled the ex post and ex ante risk premia for GMI, a passive benchmark of all the major asset classes. Today I’ll perform a similar round of quantitative surgery on the individual asset classes to round out the analysis.
But first, let’s summarize where we’ve been. The first table below lists the risk premia for each of the major asset classes, along with the comparable numbers for GMI. Remember, we’re talking of risk premiums throughout—total returns less the risk-free rate, which I’m defining as the total return on a 3-month Treasury bill. Not surprisingly, the gap has narrowed substantially in recent years between total return and risk premia, thanks to persistence of near-zero yields on T-bills. The further back in time you look, however, the T-bill return rises and so the difference between risk premia and total return widens.
For another statistical trip down memory lane, consider how the major asset classes and GMI compare in recent history in terms of their respective Sharpe ratios, a popular risk metric that measures the ratio of excess return (risk premium) to volatility (standard deviation). The idea here is that the Sharpe ratio quantifies an asset’s earned risk premium per unit of risk taken. Higher Sharpe ratios equate with higher risk-adjusted return. Yes, like every other risk metric, the Sharpe ratio is flawed, as I discussed in an article in Financial Advisor: “Building A Better Sharpe Ratio.” There are, of course, a number of alternatives risk measures, but considering the popularity of the Sharpe ratio it’s a reasonable starting point for comparing risk-adjusted performance.
With the history lesson out of the way, let’s take a stab at estimating ex ante risk premia for the major asset classes and GMI. From here on out, the standard caveat applies, namely: We’re no longer in Kansas, Dorothy. No one should confuse forecasts with the hard data of the past. But we need a foundation for looking forward. There are many ways to proceed, but as a starting point I offer the following ballpark estimates.
The summary of this exercise is listed in the third table below. I generated two sets of forecasts, listed in the next table below. One is based on averaging the inputs over the 36 months through June 2012. The second set of forecasts uses only the June 2012 data points. Again, keep in mind that the estimates in the table below are risk premia. To calculate the total return estimates, simply add your outlook for the risk free rate. The basic formula: GMI's Sharpe ratio * the volatility of the asset class * the correlation of the asset class vis-a-vis GMI.
How exactly did I come up with the forecasts above? Briefly, I'm using a slightly adjusted framework originally laid out by Professor Bill Sharpe in a 1974 paper in the Journal of Financial and Quantitative Analysis: "Imputing Expected Returns From Portfolio Composition." For a slightly less-geeky overview, see the "Reverse Optimization" section in Thomas Idzorek’s monograph or Chapter 3 by Gary Brinson in The Portable MBA in Investment I also discuss the basic process in Chapter 9 of my book Dynamic Asset Allocation
It all boils down to what's known as equilibrium estimates of expected return, or forecasts that assume that the markets clear in the long run. Estimating risk premia this way has pros and cons. On the plus side, the forecasts don't attempt to estimate returns directly, which is quite difficult compared with the slightly easier task of estimating risk. Rather, the returns are implied by way of estimating risk, namely: ex ante numbers for volatility, correlations, and GMI's Sharpe ratio. (By the way, for the risk premia forecasts, I use a simple GARCH (1,1) model to calculate volatility. I make some basic assumptions about future correlations with GMI from these estimates on vol. I also calculate what's known as a modified Sharpe ratio for the forecasts. By contrast, for the historical data in the first two tables above, I'm using a standard definition of Sharpe ratio and volatility is defined in those cases as standard deviation.)
The flaws of equilibrium estimates of risk premia (everything has flaws, of course) is that the markets don't always clear in the short term, and perhaps not at all. To the extent that we can use the forecasts derived from this methodology, it's for looking well down the line. In other words, day traders and speculators should avert their eyes.
So, what's the value here? As Bob Litterman advised a few years back in Modern Investment Management: An Equilibrium Approach,
We need not assume that markets are always in equilibrium to find an equilibrium approach useful. Rather, we view the world as a complex, highly random system in which there is a constant barrage of new data and shocks to existing valuations that as often as not knock the system away from equilibrium. However, although we anticipate that these shocks constantly create deviations from equilibrium in financial markets, and we recognize that frictions prevent those deviations from disappearing immediately, we also assume that these deviations represent opportunities.
In other words, volatility can be our friend by way of exploiting rebalancing opportunities in a multi-asset class portfolio. If we make some reasonable, conservative assumptions about risk premia, and stand at the ready to rebalance when volatility rises to something more than average, we may be in the sweet spot for taking advantage of Mr. Market's bi-polar personality.
Granted, the estimates above aren't likely to be perfect. In fact, they're sure to be wrong to some degree. That's the nature of forecasting--lots of uncertainty. But we have to start somewhere, and the above process has lots of appeal as the first step on a thousand-mile-journey.
More generally, why should we seriously consider GMI's risk premia as strategic information, either in historical or ex ante terms? One reason is that GMI's passive asset allocation has a history of competitive performance relative to a broad set of actively managed multi-asset class funds. That doesn't mean that GMI is a prudent strategy for everyone, or even anyone. But it does suggest that GMI is a valuable benchmark for considering how to design and manage an investment strategy and analyze actively managed portfolios.
The first question that arises from all of this: Should your customize GMI for building an investment portfolio? There are many reasons why we should answer "yes." Then again, if you're responding "yes" because you think it's easy to beat GMI in the long run or even medium term, here's a bit of unsolicited advice: Think again.
July 12, 2012
Jobless Claims Drop To 4-Year Low... Due To Seasonal Distortion?
Yesterday I profiled the trend for a broad mix of economic and market indicators and reasoned that the case for expecting a new recession was still weak. Today’s weekly update on initial jobless claims supports that view: new claims dropped a hefty 26,000 last week to a seasonally adjusted 350,000—a new four-year low. Taken at face value, this looks like extraordinary news. The reality, however, may be far less encouraging. Last week's decline is of questionable relevance because of a rather large seasonal adjustment that’s built into the calculation due to routine July shutdowns of auto plants for retooling.
“You can never take claims at face value because of the July shutdowns,” warns Jonathan Basile, an economist at Credit Suisse. David Sloan, a senior economist at 4Cast Inc., bluntly advised ahead of the release that today’s claims numbers will be “misleading.”
If the seasonal factor is distorting the claims data by more than usual, perhaps we can see a clearer picture in the raw, unadjusted numbers on a year-over-year basis. On that score, the ongoing annual drop is still encouraging, although the pace of decline eased last week vs. the previous week's drop from its year-earlier level. Nonetheless, as you can see from second chart below, new claims are still falling on an annual basis within the range of recent history. That suggests that modest growth in the labor market will roll on for the near term, regardless of what's going on in auto production.
Some analysts disagree and predict that the business cycle is crumbling. But if a new recession is imminent, it’s highly unlikely that jobless claims data would be insensitive to the darkening macro clouds. History tells us the exact opposite, namely: when the economy begins to tip over into a new round of contraction, jobless claims rise sharply and consistently. For the moment, there’s no sign of such darkness on the horizon.
In fact, there’s minimal sign of cyclical trouble across a broad spectrum of economic and financial market indicators, as I discussed at length yesterday. That's not the same as saying that all's well--it isn't--or that there are no serious risks lurking--there are. But if we're trying to gauge recession risk, it's still reasonable to expect more of the same--moderate growth.
Let’s see how the revisions on claims fare and what other economic reports in the days and weeks ahead reveal. Meantime, one thing is clear: It’s still premature to argue, based on the numbers published so far, that the economy has already slipped into a new recession or is in high danger of tumbling in the immediate future.
July 11, 2012
Recession Risk In Perspective
Lakshman Achuthan of the Economic Cycle Research Institute (ECRI) said that the U.S. is in a recession now. Speaking on Bloomberg TV yesterday, he argued that “I think we're in recession already.” He may be right, but it’s impossible to know for sure at the moment. May is the latest full month of published economic data, and those numbers overall reflect growth. There are also a handful of June reports to review—payrolls and the ISM Manufacturing Index, in particular--and they aren’t particularly encouraging. But those two data points alone aren't smoking guns either for arguing that a recession has started, as I discussed earlier via the links above. As for what the July data will tell us, we'll have to wait until the reports begin to arrive in a few weeks.
ECRI’s warning can’t be dismissed, of course. There are no shortage of reasons to wonder about where the economy goes from here. But it’s important to recognize a critical distinction between forecasting a recession and recognizing a new downturn’s onset as early as possible based on the numbers in hand. ECRI’s analysis falls into the former category. There's nothing wrong with forecasting the business cycle. It's a productive exercise. But all the usual caveats apply. For instance, ECRI has been forecasting a recession since last September.
The forecast will be proven accurate… eventually. There's always another recession lurking out there somewhere. Exactly when is always open for debate. But if we’re looking for confirmation today, using the most recent numbers available through May, the case for arguing that a recession has started is weak, for reasons I'll briefly discuss. Granted, that’s no assurance that the economy didn't succumb last month, or that it’s in the process of doing so now or in the near future. But we’ll need to see an unusually dramatic and rapid decline from the broad profile available as of May. Alternatively, it's possible that revisions to the numbers already reported will deliver extraordinarily dire updates. Anything's possible, but it's useful to consider what we know (given the current data set), if only for some perspective. And perspective on the business cycle, as usual, is in short supply.
How can I make such a claim? It’s all based on the numbers. Not just one or two, but a broad spectrum of economic and financial indicators that, in the aggregate, define the business cycle. In particular, I’m referring to a list of 14 key leading and coincident indicators, including private-sector payrolls, industrial production, credit spreads, and others (see the full list at the bottom of this post). It’s also essential to look at the trend in these reports, meaning the year-over-year percentage change for most indicators, with a few exceptions as noted below. By contrast, the popular habit of looking at the monthly changes over a recent period typically distorts the analysis by introducing a high degree of short-term statistical and seasonal noise.
Plugging the 14 indicators listed below into what’s called a diffusion index and ranking them based on whether they’re trending positive or negative delivers the following profile of economic conditions for the past four decades (plotted monthly for a 3-month average to smooth over the volatility) through May 2012:
Note that recessions are accompanied by 1) a sharp, rapid decline in the number of indicators trending positive; and 2) readings below the 50% mark, which indicates that less than half of the indicators are trending positive. As of May 2012, however, neither of those conditions applied—not even close. All hell could break loose with the June and July numbers, or perhaps even for May once the data revisions apply. But we're not likely to see a massive change, in part because the chart above uses several market price indicators that are immune to revisions.
It’s worth mentioning that there’s a 15th indicator that deserves to be included in the chart above but is missing: manufacturing and trade sales (MTS) for the U.S., as calculated by the Bureau of Economic Analysis. I leave it out of my 14-indicator set is because the updates for this data series arrive with a monthly lag relative to all the other indicators and so it's always out of date for calculating the latest monthly profile. For example, the latest MTS number available as I write is as of April 2012, whereas everything else is available through May 2012. Nonetheless, MTS is a critical variable for monitoring the broad sweep of manufacturing, wholesale, and retail sales data and so it requires close attention. Given its one-month lag relative to everything else, however, I follow it separately.
So, how does MTS stack up? If we look at this data series in real (inflation-adjusted) terms on a year-over-year basis, it’s not obvious that it’s warning of an imminent recession. As the second chart below shows, MTS increased 3.8% for the 12 months through this past April (the latest month available as of today). Historically speaking, that’s fairly robust and well above levels normally associated with recessions.
Overall, there’s a lot of confusion in the wider world when it comes to interpreting the economic and financial numbers vis-à-vis recession risk. Many pundits focus on a handful of numbers that, in isolation, can be misleading. Another mistake is to emphasize month-to-month trends, which is usually far too volatile for making broad assumptions about the overall economic trend.
The bottom line: recession risk remains low based on the latest set of monthly economic and financial numbers measured primarily on a year-over-year basis. That’s no assurance that a recession won’t start this month, of course, or that all's well when it comes qualitative assessments of the economy. Indeed, statistics don't mean much if you're unemployed or forced to take a lesser job to pay the rent. But the focus here is on macro and if we leave forecasting and speculation aside for a moment, and instead consider the strategic context, the numbers paint a fairly encouraging picture.
I use the word “encouraging” in a specific sense, namely, that the National Bureau of Economic Research—when it gets around to updating the business cycle calendar—won’t designate May 2012 as the start of a recession. June 2012 and beyond, meanwhile, is open for debate.
Update: An earlier version of the table of indicators above mistakenly listed the transformation of the ISM Index as a 1 year % change. In fact, for purposes of calculating the diffusion index (see first chart above) this indicator is calculated in terms of its % difference each month to a neutral reading of 50. Readings above 50 are considered to be associated with growth; below 50 suggests a contracting economy. The correction now appears in the table above.
July 10, 2012
GMI's Ex Ante Risk Premium | June 2012 Update
The Global Market Index (a passive benchmark of all the major asset classes) has a history of delivering competitive returns against its actively managed competitors over the past decade. Surprising? Not really. It’s tough to beat the market generally, and the lesson applies to asset allocation too. A minority of skillful (lucky?) portfolio managers will, of course, outperform the averages when it comes to running multi-asset class portfolios. The mistake is thinking that the superior results will be widespread and easy to identify in advance. History suggests otherwise, which is one reason why a broadly defined strategy such as GMI is such a valuable benchmark. As an unbiased measure of return and risk for the global opportunity set, GMI tells us what’s available to every investor for minimal effort and at low cost via replicating this index via ETFs.
GMI’s power as benchmark inspires calculating its expected return for additional insight. Ideally, we’re looking for an unbiased estimate of future performance. That’s a high standard and difficult (impossible, really) to achieve. One way to get close to this ideal is by calculating GMI's implied risk premium (total return less an estimate for the “risk free” rate).
In contrast to the standard methodology of forecasting returns directly, this technique reverses engineers expected return based on several assumptions about risk. In particular, I’m making assumptions about 1) correlations for the major asset classes relative to GMI; 2) volatility for each asset class; and 3) GMI’s ex ante Sharpe ratio. After calculating expected risk premiums for each asset class, I sum the weighted estimates (weighted by current market values). For some background on this technique, which I've modified slightly, see the "Reverse Optimization" section in Thomas Idzorek’s monograph or Chapter 3 in The Portable MBA in Investment
The results are illustrated in the graph below, which compares GMI’s historical risk premium on a rolling three-year annualized basis (red line) with two estimates of the benchmark’s expected premium.
The green line is the estimated “tactical” premium for the near term—roughly the next three to five years. This estimate is based on predicting volatilities for each of the major asset classes using a simple a simple GARCH (1,1) model. In turn, I make some basic assumptions about correlations with GMI from these estimates on vol. I also calculate what's known as a modified Sharpe ratio for GMI. All of these estimates are computed monthly.
The "strategic" estimate of GMI's future risk premium, represented by the blue line in the chart above, assumes a stable Sharpe ratio of 0.2 for the portfolio. Why a 0.2 Sharpe ratio? The short answer: history suggests that this is a reasonable long-term guesstimate for a multi-asset class portfolio. Otherwise, the methodology for the "strategic" forecast of GMI's risk premium is identical to the tactical calculation.
Note that both the "tactical" projection and the actual real world record of GMI's risk premium bounce around the "strategic" estimate. That's what we would expect to see since the "strategic" estimate reflects a long-term outlook under the key assumption that the markets clear in the long run. Accordingly, the short-term realized and "tactical" estimate of GMI's premium fluctuate quite a bit. We can think of the wider fluctuations as a type of error relative to the trend. In that case, the deviations from the trend provide clues about the magnitude of GMI's premium in the near-term future.
Not surprisingly, GMI's risk premium was relatively high after the financial crisis of 2008 and Great Recession. Meantime, it's no shock to see that the implied risk premium for the near term has fallen recently.
In the short term, my estimates say that GMI's risk premium will be roughly 4.7% a year (plus whatever you expect for a risk-free rate to calculate the total return). But that's double the expected risk premium for GMI using the "strategic" methodology, which suggests that performance surprises are for multi-asset classes are likely to be negative for the foreseeable future.
Yes, a risk premium under 5%--perhaps well under 5%--is quite low. How could you boost expected return? You could start by considering an asset allocation that deviates significantly relative to GMI's passive mix. Or you could engage in a relatively aggressive strategy of tactical asset allocation. Or both. But keep in mind that relatively few professionals end up beating GMI over the medium- and long-term horizons. Those that do usually embrace a fair amount of risk, one way or another. There are still no free lunches in the money game. The good news is that it's relatively easy to enhance the odds of ending up in the upper half of the performance rankings. How? By keeping radical bets on asset allocation to a minimum.
July 9, 2012
Strategic Briefing | 7.9.12 | Deflation Risk In China
Price Data Suggest Specter of Deflation in China
The New York Times | July 9
Prices are tumbling across the Chinese economy, according to government data released on Monday, as a flood of goods pouring out of the nation’s vast and ever-expanding factory cities exceeds anemic demand from Chinese households and businesses.
China Official: 2012 CPI To Below 4%, Small Risk Deflation
Market News International | July 9
China's consumer price inflation will stay below 4% for 2012, a senior official with the powerful National Development and Reform Commission told state television, playing down worries about deflation. Headline consumer inflation rose at the slowest pace since January 2010 at 2.2% y/y in June, lower than the expected 2.3% in a median survey by MNI. CPI rose 3.3% y/y in the first half of the year. Zhou Wangjun, deputy chief of the NDRC's price department, said the CPI, though falling fast in June, has not exceeded expectations.
China’s Stocks Drop Most in Month on Economy, Deflation Concern
Bloomberg BusinessWeek | July 9
China’s benchmark price for power-station coal fell for a ninth week, the longest period of losses since at least 2008, as slowing economic growth and increased use of hydropower crimped electricity demand.
Chinese inflation slows to lowest in two years
The Telegraph | July 9
The inflation figures were the latest in a series of data in recent weeks showing China's economy is slowing, and analysts said they would allow the government to act more aggressively in trying to revive growth. "The softening CPI will give the central bank more room to stabilise the economy," Tang Jianwei, a Shanghai-based economist with the Bank of Communications, told AFP. "Before the central bank had to balance between inflationary pressures and softening demand."
China inflation cools, with more easing likely
MarketWatch | July 9
“While an economy-wide generalized deflation is yet to be seen, the deflationary spiral looks to have started in some industrial sectors, attesting to considerable stress with the economy,” IHS Global Insight economist Xianfang Ren said in Beijing in a note following the data release.
China inflation signals demand falling as prices ease
Reuters | July 9
China's annual consumer inflation cooled to a 29-month low of 2.2 percent in June versus May's 3.0 percent, data from the National Bureau of Statistics showed, with a month-on-month CPI fall of 0.6 percent twice the rate of decline expected. Producer prices eased even faster, falling 0.7 percent on the month and 2.1 percent on the year, marking the fourth straight month of outright deflation in factory gate prices and pushing the PPI to a 31-month trough. "The PPI figure last month further confirmed the economy continued to cool down, which means the industrial output and other economic activity data could not be upbeat," said Wang Jin, a Shanghai-based analyst with Guotai Junan Securities. China last suffered a bout of deflation between February and October of 2009. By the end of 2009, consumer prices had fallen 0.7 percent on the year.
July 7, 2012
Book Bits | 7.7.2012
● Behavioral Finance and Investor Types: Managing Behavior to Make Better Investment Decisions
By Michael Pompian
Excerpt via publisher, Wiley
Why are somany people across the United States and other developed (and currently developing countries) in a position to accumulate wealth but have such a difficult time doing so? More often than not, the reason for this failure is that one’s own financial choices and behaviors sabotage otherwise well-intentioned efforts to achieve stated financial goals—assuming one’s goals are stated. For the purposes of this book, we will leave aside any discussion of the current outlook for the global economy, take no notice of the wealth distribution or wage levels, and stick primarily to the subject of personal financial management.
● Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham
By Joe Carlen
Review via The Economist
Before Benjamin Graham started to work on Wall Street, investment analysis was a hit-and-miss affair, focusing more on recent price movements than on the merits of individual companies. Graham, a brilliant mathematician, took the process to a much higher level. By doing so, he inspired a generation of investors, including Warren Buffett, one of the world’s richest men, who studied under him. Graham showed it was possible to find companies that were underpriced by the market, often because investors were too focused on short-term bad news. This “value” approach, based on careful analysis of a company’s cashflows and balance-sheet, is still popular today.
● Genesis of the Financial Crisis
By Roderick Macdonald
Summary via publisher, Palgrave Macmillan
A complete and accessible explanation of the factors contributing to the onset of the 2007 financial and economic crisis. The myriad factors are explained in an orderly way with simple terms. The anticipation (or not) and reception of the crisis by mainstream economists and by Austrian economics leads to reflection on the state of economic theory.
● Delusions of Power: New Explorations of the State, War, and Economy
By Robert Higgs
Summary via publisher, Independent Institute
Why has the U.S. government become a growing threat to the civil and economic liberties of ordinary Americans? Does the nation suffer from a lack of democracy or have we deluded ourselves into believing that democratic institutions can deliver more than they actually can? Is contemporary democracy the best political system for securing the blessings of liberty—or should we search for better alternatives to government as we know it? In Delusions of Power: New Explorations of the State, War, and Economy, economist and historian Robert Higgs offers penetrating insights about fundamental issues surrounding democracy and the legitimacy of the state, as well as fresh observations about the turning points in American history during the past century: the world wars and the Cold War; the post-9/11 national-security state; and major economic calamities, including the financial crisis of the 2000s.
● The Economists' Voice 2.0: The Financial Crisis, Health Care Reform, and More
Edited by Aaron Edlin and Joseph Stiglitz
Summary via publisher, Columbia University Press
This collection contains thirty-two essays written by academics, economists, presidential advisors, legal specialists, researchers, consultants, and policy makers. They tackle the plain economics and architecture of health care reform, its implications for society and the future of the health insurance industry, and the value of the health insurance subsidies and exchanges built into the law. They consider the effects of financial regulatory reform, the possibilities for ratings reform, and the issue of limiting bankers’ pay.
● Rethinking the Keynesian Revolution: Keynes, Hayek, and the Wicksell Connection
By Tyler Beck Goodspeed
Summary via publisher, Oxford University Press
While standard accounts of the 1930s debates surrounding economic thought pit John Maynard Keynes against Friedrich von Hayek in a clash of ideology, this reflexive dichotomy is in many respects superficial. It is the argument of this book that both Keynes and Hayek developed their respective theories of the business cycle within the tradition of Swedish economist Knut Wicksell, and that this shared genealogy manifested itself in significant theoretical affinities between the two supposed antagonists. The salient features of Wicksell's work, namely the importance of money, the role of uncertainty, coordination failures, and the element of time in capital accumulation, all motivated the Keynesian and Hayekian theories of economic fluctuations.
July 6, 2012
Another Disappointing Payrolls Report For June
Private-sector payrolls grew by a sluggish 84,000 on a net basis in June, the Labor Department reports. That’s down from the revised growth of 105,000 in May. It’s a disappointing report in absolute terms, and it doesn’t help that yesterday’s far-more encouraging ADP estimate inspired expectations that we’d see something better. But while no one can deny that the jobs growth is s-l-o-w, according to the government’s figures, it’s still premature to argue that it signals a new recession.
Most of the commentary today is likely to focus on the June payrolls number and how unimpressive it looks compared with May and earlier months this year. I don’t want to dismiss that line of worry, but there’s a danger in letting it dominate the analysis. There are plenty of reasons to be concerned about the labor market and the economy overall, but let’s also maintain some perspective on what’s been unfolding.
Let’s start by reminding everyone that revisions to payroll estimates can and do swing wildly through time. For example, the initial report for May's private-sector payrolls was a tepid 82,000, as I discussed a month ago. That number has since been revised up to a rise of 105,000 net new jobs for May. Hardly a game changer, but it's one more reminder that what you see today isn't necessarily what you'll find tomorrow.
In fact, if you look at revisions since 2000, monthly estimates for the total number of people on private-sector payrolls have varied far and wide. Indeed, over the past decade, revisions for the monthly total of payrolls have been as high as nearly 800,000, and cut by more than 1.6 million, according to the St. Louis Fed. Revisions aren’t generally so extreme, but it’s safe to say that it’s always wise to remain skeptical for thinking that the first estimate is the last word on labor market’s trend.
There's also some risk in looking solely at the absolute monthly figures and comparing it to the previous estimate. One way to look for deeper perspective is to consider how the year-over-year change compares. For several reasons, we’re likely to find a more robust reading on the labor market by watching the annual percentage changes. With that in mind, consider how the two metrics compare. Although June’s tepid rise in private-sector employment looks quite weak (the red line in the chart below) in absolute numbers vs. the month before, the trend looks considerably better in terms of the year-over-year comparison in percentage terms (the black line).
The 1.78% rise in the private-sector employment tally as of last month vs. a year ago is near the 2.09% jump for January 2012—the best year-over-year comparison since the Great Recession ended. Clearly, the pace of payrolls growth has slowed since January, but it’s a stretch to say that the trend has collapsed. Analysts were quite giddy in January; today, they're feeling quite sullen. A 31-basis-point retreat in the annual pace of job growth certainly has a big impact on sentiment, but it's debatable if it's also a death cross for the economy.
Meantime, the fact that initial jobless claims continue to trend lower on a year-over-year basis, as I noted yesterday, suggests that we’re suffering from slow growth rather than a descent into a new recession, at least for the immediate future.
That’s still a long way from arguing that all’s well. With unemployment stuck at an elevated 8.2% for last month, it’s clear that the economy continues to face substantial headwinds. That’s a huge problem on numerous fronts, starting with the negative impact it brings to so many individuals who can’t find work or must take lesser jobs to make ends meet.
That said, there’s still no smoking gun in today’s jobs report in broad macro terms. It’s discouraging and well below what’s needed to move closer to the pre-recession levels of prosperity experienced before the economy crumbled in 2007-2009. But slow growth, for all its problems, shouldn’t be confused with the onset of a new recession—at least not yet.
“The job market is soft, as is the overall economy,” says David Resler, chief economic adviser at Nomura Securities via Bloomberg. “I’d characterize our reaction as much the same way the Fed will react -- not surprised but disappointed. It’s just not the kind of growth we need to see at this stage in the business cycle.”
The main risk factor now is that we’re out of room for further disappointment. On that point, everyone agrees. More disturbing economic reports may be coming. When (or if) that happens, the warning will be conspicuous in the numbers, including a substantial drop in the year-over-year percentage change in private payrolls. But for the moment, it’s not obvious that the end is near, even if it's easier to imagine such a future. In sum, let’s not start the funeral proceedings just yet.
July 5, 2012
Jobless Claims Drop & The June ADP Employment Tally Perks Up
There’s still no sign of an imminent recession in the latest numbers for initial jobless claims. New filings for unemployment benefits last week dropped to a two-month low of 374,000 on a seasonally adjusted basis. Meanwhile, the year-over-year change in unadjusted terms posted a roughly 14% decline. There’s a lot of chatter about a slowing economy these days, based on certain indicators. Some pundits have already declared that another recession is fate. But fears that growth has hit a wall appear overblown based on today's claims figures.
It’s true that new claims have been stuck in neutral in recent months, as the chart below shows. But if the economy was tipping over into a full-blown contraction, jobless claims would be rising consistently. Instead, claims have been treading water.
Looking at seasonally adjusted numbers on a weekly basis may be distorting the true trend, which is why it’s helpful to look at unadjusted claims relative to the their year-earlier levels in search of deeper clarity. By that standard, the trend looks substantially more encouraging. Indeed, as the second chart below shows, new filings continue to fall in the range of roughly 10% a year, with last week’s change logging in at a decline of 13.7%. That's a sign that recession risk is low, at least for assessing conditions right now.
It’s possible that the claims data is anomalous this time. Heck, you can never really be sure of anything in macro, which no one should confuse with physics. Leaving that caveat aside, it’s noteworthy that the last full month of economic numbers published—May—signals growth. The next chart tracks 14 key leading and coincident indicators (see the bottom of this post for a list), primarily on a year-over-year percentage basis. As you can see, the latest ranking is nowhere near levels historically associated with the onset of recession.
Don’t confuse any of this with looking down the road. But if we’re talking about the majority of key indicators in terms of the latest numbers, and evaluating their signals in an historically relevant context, the odds that we’re in a recession right now, today, this minute are quite low. That implies that the next month of yet-to-be published economic numbers—June—won’t be labeled as the start of a new recession either. Beyond that, the speculative factor increases substantially, which means that all the usual caveats apply. For instance, it's devilishly difficult to predict how the euro crisis or the U.S. fiscal troubles will fare in, say, September, and how those yet-to-be-determined variables will influence the economy at that point. Considering what might happen is a productive exercise, of course, but it’s also a different kettle of fish than the analysis above.
True, the June ISM manufacturing report was weak, and it may signal trouble down the road for the economy. But as valuable as this indicator is, it’s only one number. And as we all know, any one number can be misleading at times. In fact, you can count on it. There's no flawless metric. That’s why it’s far more valuable to look at a range of indicators. Even looking at a diversified mix of indicators is never a sure thing, but it's quite a bit more reliable than making assumptions based on one or two numbers.
On that front, the June data has only started rolling in, and the overall picture so far is arguably mixed at worst. On the negative side is the ISM manufacturing report. But the services counterpart, updated today, shows a more encouraging picture for last month. As the ISM advised in a press release, “economic activity in the non-manufacturing sector grew in June for the 30th consecutive month.”
Meantime, today’s update of the ADP Employment Report for June also suggests that the economy is still expanding. Private sector nonfarm payrolls rose by 176,000 last month, the strongest rise since March and a moderate amount of progress from May's discouraging number. That implies that Friday’s employment report for June from the Labor Department may surprise on the upside too.
"Jobless claims are a move in the right direction,” Omer Esiner, chief market analyst at Commonwealth Foreign Exchange, tells Reuters. “The drop, combined with the ADP report earlier, suggests the jobs market is not as weak as recent data has suggested,"
Granted, that may be wishful thinking. There’s certainly no shortage of risk factors lurking in the world to keep optimism in check. But if the economy is truly deteriorating, we’ll see it in the numbers. So far, however, there’s no smoking gun.
The Challenges Of Benchmarking Your Financial Adviser
Jason Zweig at The Wall Street Journal reminds us that analyzing an investment adviser’s performance record is still a complicated and convoluted affair. Performance alone shouldn’t be the only measure of an adviser’s value, but it’s not chopped liver either. So, how can we judge an adviser’s record? There are no short cuts, as Zweig points out. Although several consultancies have taken a stab at developing transparent and relevant adviser benchmarks—Brightscope and the Spaulding Group, for instance, according to Zweig—it’s debatable if the challenge has been solved.
To be fair, it’s not obvious that a workable solution is available if we’re looking for one benchmark (or even several benchmarks) that can be used to assess a wide variety of adviser-run portfolios. The problem is that there are many strategies focused on achieving different goals. It’s inevitable that building customized benchmarks comes into play.
Generic benchmarks are still useful, of course, assuming they’re designed properly. What are the attributes of a good benchmark overall? The investment software firm Zephyr Associates cites the CFA Institute’s standards:
• Reflective of current investment opinions
• Specified in advance
Where to begin? With a passive index that captures a broad spectrum of the major asset classes. Ideally, such a benchmark represents the investment opportunity set for everyone and so it provides an estimate of what the average investor earns with broad exposure to risky assets. Because this benchmark is passively weighted and owns everything (i.e., the major asset classes), and requires no investing or forecasting skills, it’s a representative portfolio. True, such a benchmark is the optimal strategy only for the average investor with an infinite time horizon, which means that it’s impractical for most of us. But as a robust starting point for evaluating investment strategies, it’s an obvious place to begin.
What’s the logic behind such a benchmark? The answer can be summed up as a mix of common sense and decades of research from financial economists, as I discuss in more detail in my book Dynamic Asset Allocation. Where can you find such a benchmark? You can start with the Global Market Index (GMI), a proprietary gauge that’s updated monthly on these pages, including the latest tally through the end of June 2012. And, yes, GMI meets the CFA standards listed above.
This may come as a shock to some investors, but GMI has performed competitively with a broad sampling of multi-asset class mutual funds through the years. For instance, looking at returns for funds with at least 10 years of history through this past April (according to data from Morningstar Principia software) shows that GMI has given more than 1,000 actively managed asset allocation portfolios a run for their money. A simple regimen of rebalancing GMI’s components tends to earn slightly higher returns; equally weighting the asset classes (and rebalancing back to equal weights every December 31) does even better, or so history shows.
GMI and similarly designed benchmarks are hardly a silver bullet. That said, everyone needs a strong reference point for analyzing portfolio returns. Think of GMI as the investment equivalent of the North Star—a fixed point on the investment horizon that offers a reliable landmark. What can you do with GMI when it comes analyzing your adviser’s record? At your next meeting, you might consider asking him how he plans to add value relative to GMI or a comparable benchmark. Listening closely to the answer may be revealing in itself.
July 3, 2012
Pondering The Rest Of The Summer
A month ago, it looked like the new abnormal was going to roll over the economy and the stock market and unleash a fresh round of general havoc. But the big squeeze never arrived. Is that the calm before the storm? Or is real mending unfolding in macro and markets?
The source of this line of questioning comes by way of the market's inflation forecast—the yield spread between the nominal and inflation-indexed 10-year Treasuries—and its relationship with the stock market (S&P 500). Normally, Mr. Market has a contentious reaction to rising inflation expectations. But the last several years have turned that relationship on its head and so equities prices and the inflation outlook are positively correlated—the new abnormal. That relationship appears to have stabilized in recent weeks. As the chart below shows, the market's inflation forecast has remained in a range of roughly 2.1% for the past month. Meantime, the stock market's spring sell-off has reversed course.
It's tempting to think that this combination is setting us up for a new new virtuous cycle where inflation expectations gradually rise and the stock market follows. That future would look a lot more plausible if 1) the euro crisis was truly resolved rather than merely in remission; 2) the potential for a conflict with Iran was fading rather than rising; 3) and there were clear signals in the latest economic numbers that the U.S. economy was improving as opposed to stumbling.
But hope springs eternal. "If the ECB offers loud support this Thursday with a rate cut and a signal of more to follow in the face of lower growth and inflation, there may be enough fuel for a summer rally in stock markets," Bill O'Neill, EMEA Chief Investment Officer for Merrill Lynch Wealth Management, tells Reuters. Maybe, but let's not forget that the June employment report for the U.S., scheduled for release on Friday, awaits. Some economists are already managing expectations down on this front. “The recent weakness in hiring is a combination of seasonal issues and the underlying slowdown in U.S. and global economies,” warns Yelena Shulyatyeva, a BNP economist, via MarketWatch. “This week should bring more disappointing news.”
Then again, the consensus forecast for private-sector employment calls for a modest improvement: a gain of 100,000 jobs for June vs. the 82,000 previously reported for May, according to Bloomberg. Assuming that the 100,000 forecast is accurate, will that suffice to encourage the crowd? Stay tuned....
July 2, 2012
Is The June Slowdown In Manufacturing Activity A Sign Of Things To Come?
Manufacturing activity contracted in June, according to the Institute for Supply Management’s manufacturing index. For the first time since July 2009, the ISM Index slipped under 50, dropping to 49.7 last month. A reading below 50 indicates a contracting manufacturing sector.
Is this an early warning of a new recession? Perhaps, but we're still a long way from declaring the current growth phase of the business cycle dead. Like any one economic indicator, the ISM Index is far from flawless when it comes to using it as a benchmark for anticipating major turning points in the economy. To be precise, a below-50 reading for this indicator doesn't always correspond with recession. The history of this index is littered with periods when below-50 levels didn't equate with a new downturn in the broad economy.
Then again, it's also clear that every recession in the post-World War II era has been accompanied by sub-50 readings in the ISM index. Sometimes a dip is relevant, sometimes not. It's too soon to say if today's today is an early warning or another false signal. Nonetheless, it's hard to overlook the latest reading for new orders, which tumbled sharply last month relative to May. On the other hand, manufacturing employment is holding steady.
What we know for sure is that the key economic indicators for May—the most recent full set of monthly numbers published so far—are trending positive. Fourteen crucial leading and coincident indicators through May tell us that recession risk was quite low (for an overview of these indicators, see this post).
Will June tell us differently? Today's ISM report certainly implies that incoming data will be weaker relative to May. But forecasting and reading the numbers in hand are two different tasks. For the moment, growth rolls on, based on a broad set of numbers. We may suffer an attitude adjustment in the weeks ahead, but for now a darker future is still the stuff of speculation.
“Clearly [today's ISM report] is the biggest sign yet that the U.S. is catching the slowdown that is well underway in Europe and China,” writes Paul Dales, senior U.S. economist at Capital Economics, in a note to clients, according to MarketWatch. “But it is worth remembering that a reading of below 47.0 is required to be consistent with another recession. This means the index is still consistent with a growing economy, albeit at an annualized rate of a little below 1%.”
If June proves to be a turning point for bigger problems, we may find stronger evidence in the government's employment report scheduled for release this Friday (June 6). At the moment, the consensus forecast still calls modest improvement for June vs. May. Private-sector jobs are expected to rise by a net 105,000, up from May's sluggish 82,000 gain, according to Briefing.com.
The employment index shows that employment increased by 0.3 percent in June, for an annualized rate of 4.1 percent -- the strongest rate of growth that small businesses have seen in the past three months. This equates to approximately 70,000 new jobs created, although Intuit is recalibrating the index and expects these numbers to change.
Let's see if the broad national report on employment confirms the trend... or not.
Major Asset Classes | June 2012 | Performance Review
June was a month of revival for most of the major asset classes. The hefty, wide-ranging losses in May gave way to handsome gains last month. Alas, the pop in June wasn't strong enough to wipe away May's red ink, but there's no mistaking the rebound in the month just passed. Whether it'll roll on in July is anyone's guess, but for the moment the bulls have something to cheer about.
The big winner among the major asset classes: stock markets in foreign developed markets, in dollar terms. The MSCI EAFE index rose 7.0% last month. REITs, commodities and stocks generally posted respectable gains in June too. The main loser: inflation-indexed Treasuries, which shed 0.6% in June.
Meanwhile, our market-weighted Global Market Index (a passively allocated benchmark of all the major asset classes) posted a strong 2.9% increase in June—its best monthly gain since January. For the first half of 2012, GMI is higher by 4.4% and over the past three years the index has climbed 9.7% on an annualized total return basis. Passive, no-brainer asset allocation, in other words, is (still) earning competitive returns.
The second half of 2012, of course, is wide open for debate. With the euro crisis still bubbling, an oil embargo targeting Iran about to kick in, and the high season of Presidential politics in the U.S. approaching, there are lots of moving parts to digest for looking ahead. Judging by returns at the midway mark for 2012, however, recent history has rewarded buy-and-hold diversification, much to the chagrin of traders, who warned that this form of investing had gone the way of the Edsel.