December 31, 2012
ISM Manufacturing Index: December 2012 Preview
The last entry on The Capital Spectator for the year, and the first look at how manufacturing activity fared in 2012's final month in the ISM report later this week. The stakes are higher than usual, as the nation braces for blowback from the still-unresolved fiscal cliff mess. Much like the political dialog in Washington these days, the December update on the ISM Manufacturing Index (scheduled for release on Wednesday, January 2) is expected to dance on the edge of a knife and remain precariously poised on or near the neutral 50 mark. The Capital Spectator's average econometric forecast anticipates a reading of 49.9, a statistical hair into the terrain of contraction, or moderately below the relatively upbeat 50-plus predictions from economists generally via consensus survey data.
Here's a closer look at the numbers, followed by brief definitions of the methodologies behind The Capital Spectator's projections.
VAR-2: A vector autoregression model that analyzes two economic time series in search of interdependent relationships through history. The forecasts are run in R with the "vars" package using historical data for the following indicators: ISM Manufacturing Index and industrial production.
VAR-9: A second VAR model (see overview above) uses nine indicators: ISM Manufacturing Index, industrial production, private non-farm payrolls, index of weekly hours worked, US stock market (S&P 500), real personal income less current transfer receipts, real personal consumption expenditures, spot oil prices, and the Treasury yield spread (10 year Note less 3-month T-bill).
December 29, 2012
Best of Book Bits 2012 (Part II)
Here's the second installment to last week's recap of The Capital Spectator's short list of titles from 2012 that deserve a second look. Each of the following reviews and summaries appeared earlier in the year on these pages, and here they are once more... an encore presentation.
● The Great Recession: Market Failure or Policy Failure?
By Robert Hetzel
Review via John Taylor's Economics One blog
The debate about the causes of the financial crisis and the great recession will continue for many years, and the facts and analysis that Robert Hetzel put forth in his new book The Great Recession: Market Failure or Policy Failure? should now be part of that debate. As I said in my comments for Cambridge University Press, “Hetzel applies his experience as a central banker and his expertise as a monetary economist to make a compelling case for rules rather than discretion, showing that 'monetary disorder' rather than a fundamental 'market disorder' is the cause of poor macroeconomic performance. At the same time, he acknowledges and discusses disagreements among those who argue for rules rather than discretion.”
● The 7 Most Important Equations for Your Retirement: The Fascinating People and Ideas Behind Planning Your Retirement Income
By Moshe Milevsky
Summary via publisher, Wiley
Physics, Chemistry, Astronomy, Biology; every field has its intellectual giants who made breakthrough discoveries that changed the course of history. What about the topic of retirement planning? Is it a science? Or is retirement income planning just a collection of rules-of-thumb, financial products and sales pitches? In The 7 Most Important Equations for Your Retirement...And the Stories Behind Them Moshe Milevsky argues that twenty first century retirement income planning is indeed a science and has its foundations in the work of great sages who made conceptual and controversial breakthroughs over the last eight centuries. In the book Milevsky highlights the work of seven scholars—summarized by seven equations—who shaped all modern retirement calculations. He tells the stories of Leonardo Fibonnaci the Italian businessman; Benjamin Gompertz the gentleman actuary; Edmund Halley the astronomer; Irving Fisher the stock jock; Paul Samuelson the economic guru; Solomon Heubner the insurance and marketing visionary, and Andrey Kolmogorov the Russian mathematical genius—all giants in their respective fields who collectively laid the foundations for modern retirement income planning.
● The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal
By Ludwig B. Chincarini
Summary via publisher, Wiley
Financial markets are not immune to the human tendency to group together. Investors follow popular trends or latch onto profitable new strategies with herd-like single-mindedness. In The Crisis of Crowding, finance veteran and professor Ludwig Chincarini explores how this dramatic overcrowding has yielded terrifying results and contributed to recent financial crises. “Modern risk-measurement models generally ignore the presence of copycats and the resulting crowded spaces. As a result, a shock to the system can lead to sudden, sometimes large asset price moves, which can cause panic and failure among the institutions involved in that investment space,” explains Chincarini. “In the past 20 years, globalization, technology, and increased leverage have made the effects of overcrowding more apparent and dramatic. In fact, market crashes are happening more regularly than in the past.”
● Automate This: How Algorithms Came to Rule Our World
By Christopher Steiner
Review via USA Today
Christopher Steiner's new book, Automate This: How Algorithms Came to Rule Our World, is a fascinating exploration of how the mathematics behind automated trading revolutionized business worldwide. But it is also a cautionary tale of how automated trading can get completely out of hand. As an example, he points to the "flash crash" of May 6, 2010. "At 2:42 PM on the East Coast, the markets began to shudder before dropping into a free fall. By 2:47 PM -- a mere 300 seconds later -- the Dow was down 998.5 points, easily the largest single-day drop in history. Nearly $1 trillion of wealth fell into the electronic ether." He continues, "Some share prices crashed to one penny -- as in $0.01 -- rendering billion-dollar companies worthless, only to bounce back to $30 or $40 in a few seconds. Other stocks swung wildly up. At one point, Apple traded at $100,000 a share (up from about $250). The market had been gripped with violent turbulence and nobody knew why."
● The Signal and the Noise: Why So Many Predictions Fail--But Some Don't
By Nate SIlver
Review by Burton Malkiel via The Wall Street Journal
It is almost a parlor game, especially as elections approach—not only the little matter of who will win but also: by how much? For Nate Silver, however, prediction is more than a game. It is a science, or something like a science anyway. Mr. Silver is a well-known forecaster and the founder of the New York Times political blog FiveThirtyEight.com, which accurately predicted the outcome of the last presidential election. Before he was a Times blogger, he was known as a careful analyst of (often widely unreliable) public-opinion polls and, not least, as the man who hit upon an innovative system for forecasting the performance of Major League Baseball players. In "The Signal and the Noise," he takes the reader on a whirlwind tour of the success and failure of predictions in a wide variety of fields and offers advice about how we might all improve our forecasting skill.
December 28, 2012
Does Sub-Saharan Africa Deserve A Slice Of Your Portfolio?
"One of the most remarkable features of the global economy over the past fifteen years has been the striking surge of economic growth over much of sub-Saharan Africa," Charles Collyns, assistant secretary for international finance at the US Treasury, advised earlier this month. We've heard this story before, of course, only to discover that the investment results fell short of the headlines. Is it different this time? Possibly. For some perspective, let's spin a few numbers and take a look at an ETF that focuses on investing in the stock markets in this neck of the world.
The economies that comprise Sub-Saharan Africa are expected to post aggregate real GDP growth of 5.3% next year, according to IMF projections. That looks pretty good compared with the U.S., which will see real GDP rise by just 2.1% in 2013, the IMF predicts. China will do much better, with an expected GDP increase of 8.2%. As for the actual growth rates in the recent past, Sub-Saharan Africa's GDP expanded 5.2% last year vs. China's 9.2% rise. Both gains compare favorably with the meager 1.8% increase for the US in 2011.
"Economic conditions in sub-Saharan Africa have remained generally robust against the backdrop of a sluggish global economy," the IMF noted in its October outlook for the region. Not surprisingly, there's a wide variety of conditions within individual nations:
Most low-income countries continue to grow, although drought in many Sahel countries and political instability in Mali and Guinea-Bissau have undermined economic activity. The situation is less favorable for many of the middle-income countries, especially South Africa, that are more closely linked to European markets. Inflation has been slowing, as pressures on food and fuel prices eased following a surge during 2011. The easing of inflation has been particularly noticeable in eastern Africa, helped by monetary tightening.
How does all this translate for equity returns in the region? As a benchmark for performance, consider a Sub-Shaharan Africa ETF: Market Vectors Africa Index ETF (AFK). By several yardsticks, it boasts an impressive track record. Consider how trailing 1- and 3-year returns compare:
Matched against emerging markets generally, AFK has had a good run over the past 12 months. For the year through yesterday, Market Vectors Africa is up a strong 18.5%. That beats equities from many corners of the world, although it's been a good year for stocks generally and so return spreads aren't terribly wide. In fact, European stocks are clearly in the lead for the past 12 months--the euro crisis be damned.
The question is whether Africa's equity markets have finally come of age to the extent that they deserve a dedicated slot in your asset allocation? Possibly, but I'm not yet convinced. You can already juice rebalancing opportunities by breaking foreign equity exposure into several pieces before targeting Africa separately. Does slicing up the foreign stock beta into finer pieces beyond the usual buckets--Europe vs. Asia or developed vs. emerging, for instance—further enhance expected return and offer more control for managing risk?
Definitive answers must remain a gray area, thanks to the standard nemesis: an uncertain future. But as the Sub-Saharan GDP table above suggests, the region has a track record of growth in recent history, and so the projections for more of the same ring a bit truer these days. It doesn't hurt that there's a wider selection of investment products targeting Africa these days, of which AFK is only one. (See ETFdb's Africa ETF guide, for instance.)
Yes, many of Africa's nations are among the more hazardous spots in the world from a geopolitical standpoint. But macro success, such as it is, attracts a crowd and so it's getting easier to rationalize carving out a dedicated allocation to stocks in Sub-Saharan Africa.
Update: An earlier version of this story mislabled the years for GDP growth rates in the 2nd paragraph. The corrections now appear.
December 27, 2012
A Surprisingly Positive Final 2012 Update On Jobless Claims
Jobless claims posted a surprisingly robust decline last week vs. expectations. Today’s update offers more evidence for thinking that the labor market continues to expand and will continue to do so in early 2013, and perhaps with more upward momentum than generally recognized. It all adds up to an encouraging bit of news for thinking positively for jobs growth in early 2013. The fiscal cliff nonsense may throw a wrench into the macro machine, but the final number on the labor market released in 2012 suggests that the case for optimism is very much alive and kicking via the data.
Claims are again trending down, with last week’s figure (along with the four-week average) hovering just over the five-year low set back in early October of this year. New filings for jobless benefits dipped 12,000 last week to a seasonally adjusted 350,000. With only a few exceptions, claims have never been so low since the Great Recession ended in June 2009. This alone is no magic bullet for macro, but it surely speaks rather forcefully about where the labor market seems to be headed.
Far more impressive (and substantially more significant in terms of looking ahead) is the sharp drop in the year-over-year comparison before seasonal adjustments to the data. Unadjusted claims fell more than 11% last week vs. the same period from a year earlier. This is a powerful message that the pre-hurricane trend of progress (i.e., falling claims) is intact. It’s also a strong signal for expecting continued growth in payrolls in the near term.
Even better, today’s claims report is part of a broader narrative of continued improvement in the economic updates. Whether it’s my nowcasts of fourth-quarter GDP, analyzing the broad macro trend across an array of indicators (here and here), or looking at the numbers individually (here, for instance), the theme has more or less favored growth. Modest growth, but growth nonetheless. The first rule of economic analysis is that when a broad cross section of data are speaking with one voice, it's usually a good idea to recognize that the trend is telling you something of value.
I’m amazed that so many analysts have argued otherwise. The constant warnings from some folks, month after month after month, that the US economy is shrinking (or is about to start contracting any day now) have been consistently wrong and, as far as I can see, based largely on speculation about the future rather than examining the hard data as it’s published. Granted, we only have numbers through November at this point, but unless December drives over the edge in fairly dramatic fashion, we’re on track to escape 2012 on a relatively upbeat note in terms of growth.
The future, of course, is always uncertain, but it would take an unusually large shock at this point to derail the expansion that’s clearly (still) underway. Recessions don't usually drop out of the sky without warning, and so far the warnings remain minimal in terms of expecting the worst.
The December numbers start arriving next week and so we’ll have some early clues on how the final month of the year is shaping up. I’ll also have revisions to my various business cycle indicators early in the new year for additional perspective. For now, it’s still hard to make the case that a new recession is imminent, or that one has recently started. Such talk makes for entertaining interviews with the usual suspects, but a sober, careful analysis of the economy from multiple perspectives still implies that there's forward momentum afoot.
The available numbers across a broad spectrum of the economy and the financial and commodity markets, in the aggregate, simply aren’t dark enough at this point to argue that recession risk is high. That’s been a relatively stable message all along, and it remains clear today. Never say never, but the data to date suggests that 2012 will go into the history books as another recession-free year. Today's jobless claims news certainly puts us one data point closer to confirming that outlook.
Obsessing Over The Trees (And Overlooking The Forest)
With the year nearly complete, what have we learned in 2012 from an investing perspective? The main lesson is a familiar one, but one that is too often trampled under the noise of the moment. Focusing on the portfolio is (still) the primary objective, as Markowitz told us all those years ago. More than half a century later, theory and the empirical record are in rare state of agreement: portfolio design and management take a back seat to nothing as critical factors for engineering investment success.
It's a simple idea and, more importantly, an effective one in terms of improving the odds of achieving your financial goals. But as many studies have documented, relatively few investors (either as individuals or institutions) excel in leveraging asset allocation to its full potential. The stumbling block can't be blamed on technical issues. As the numbers show on a fairly consistent basis, simply diversifying across a broad set of asset classes and routinely rebalancing the mix has a history of generating average-to-above-average returns relative to crowd's efforts overall. That doesn't sound like much, but when you study the data it's clear that average to above-average vs. everything ends up delivering fairly impressive results. All the more so once you recognize that there's a high degree of confidence that you'll earn average-to-above-average returns when you diversify broadly and rebalance regularly.
This isn't rocket science, even if some people treat it as such. That's the message from my own research, and it's a theme that persists in the literature as well, as I noted in my book, Dynamic Asset Allocation.
Sure, there's a sea of studies and quantitative issues to wade through if you're so inclined. But at the end of the day, it's all fairly intuitive and accessible. But success still eludes most folks, and I think I know why: An excessive focus—an obsession, really—on the parts, one at a time, while ignoring or at least minimizing the whole.
Markowitz told us to avoid this pitfall, but it's the norm in the grand scheme of investing. It's easy to see why. Most of the discussion on matters of investing zero in on specific trades and asset classes. A quick example: bonds.
It doesn't take a Ph.D. in finance to recognize that there's far more risk in, say, a 10-year Treasury today vs. 10, 20 or 30 years ago. Why? The current yield on the benchmark 10-year note has fallen to record lows. It's a dramatic decline, particularly when viewed through time. The chart below is dramatic, but it shouldn't be used as an excuse for dramatic changes in asset allocation, at least not all at once.
The reasoning is that if your diversified portfolio included exposure to 10-year Treasuries all along, and you've been practicing a disciplined regimen of rebalancing through the years, the portfolio has been a) routinely capturing a portion of the capital gains thrown off by falling yields; and b) keeping a lid on the 10-year's weight in the overall asset allocation. Prudent risk management, in other words.
So, what's the problem? The trouble starts because the demand for excitement and drama in financial media tends to overshadow the boring narrative of asset allocation and rebalancing. The fundamental lessons for money management don't change much, if at all, through time. That's a problem if you're looking for new story ideas.
Boring doesn't sell magazines, juice traffic on web sites or gin up drama in a TV interview. But unexciting concepts in the cause of strategic investing success work, and so they're not easily dismissed if you're intent on building wealth over medium- to long-term horizons. Keep that in mind the next time you watch an interview with the analyst du jour asserting that a given asset class is a strong buy or sell. The advice may impart useful information, but don't get too worked up about it. First, he could be wrong. Yes, that happens every so often, or so I'm told. Two, if you own a broad mix of assets (and you should), any one slice of the portfolio isn't nearly as important as today's exciting interview implies.
There's nothing wrong with analyzing asset classes in isolation and projecting risk and return. I do a fair amount of it myself, and it's an essential process, although not necessarily for the reasons typically cited. But it's almost always a mistake to analyze a single asset class outside of the context of a broadly diversified portfolio--your portfolio, to be precise. Asset class X may look awful on an ex ante basis, but if it does—and you've owned it all along—it'll probably have a relatively low weight in your portfolio. And if you own a lot of it, well, that's a sign that it's time to rebalance, regardless of the outlook. Why? Because asset classes—we're not talking individual securities here—tend to have low or negative expected returns after a period of the delivering the opposite.
That last point is arguably the single-most important piece of strategic portfolio advice for investors. But it's also worthless without a broadly diversified asset allocation strategy.
December 26, 2012
Weekly Jobless Claims: 22 Dec 2012 Preview
The final report on the US labor market scheduled for release this year is widely expected to be a wash. Several surveys advise that economists see a flat to slightly higher number for tomorrow's update on weekly jobless claims through December 22. The Capital Spectator's average econometric forecast anticipates a rise to 363,000 in new filings for unemployment benefits (seasonally adjusted) vs. the previously reported 361,000. If the forecast holds, jobless claims for December are on track to post an encouraging decline vs. the year-ago monthly total. That outlook implies that the labor market's growth trend, modest though it is, will roll on.
Here's a closer look at the numbers, followed by brief definitions of the methodologies behind The Capital Spectator's projections.
December 25, 2012
A Merry & A Happy To All...
So now is come our joyful feast,
Let every man be jolly;
Each room with ivy leaves is dressed,
And every post with holly.
Though some churls at our mirth repine,
Round your foreheads garlands twine,
Drown sorrow in a cup of wine,
And let us all be merry.
--George Wither, "A Christmas Carol"
December 24, 2012
And To All A Good Night...
A frosty Christmas Eve
when the stars were shining
Fared I forth alone
where westward falls the hill,
And from many a village
in the water'd valley
Distant music reach'd me
peals of bells aringing:
The constellated sounds
ran sprinkling on earth's floor
As the dark vault above
with stars was spangled o'er.
Then sped my thoughts to keep
that first Christmas of all
When the shepherds watching
by their folds ere the dawn
Heard music in the fields
and marveling could not tell
Whether it were angels
or the bright stars singing.
--Robert Bridges, "Noël: Christmas Eve 1913"
A New Business Cycle Indicator
Interpreting the endless stream of macro data points in search of context for analyzing the business cycle confuses and confounds more than a few investors, and even some economists. The Capital Spectator Trend Index (CS-ETI) is one attempt at a solution, or a least a partial solution. The regular updates in recent months on CS-ETI, in fact, have done a decent job of telling us how the economy is faring based on a broad read of the numbers. But there are several ways of interpreting the data, and CS-ETI is only one approach. How can we stress test its signals? One answer is reviewing the same data through a different statistical lens. Enter The Capital Spectator Economic Momentum Index (CS-EMI), a companion to CS-ETI.
As a brief recap, the older CS-ETI is a diffusion index that measures the percentage of 14 leading and coincident indicators that are trending positive for economic growth. Higher readings equate with more indicators signaling that the economy is expanding; lower readings imply a weaker economy, with levels below 50% signaling a high probability that a recession has started.
A diffusion index, however, doesn’t offer much qualitative information about the degree of strength or weakness in the data. As a remedy, CS-EMI looks at the numbers and quantifies the degree of positive or negative momentum for the overall data set. The methodology for CS-EMI is simply the monthly median percentage change for the 14 indicators that comprise the diffusion index that is CS-ETI. Why use the median rather than an average (i.e., the mean?). It’s well known that the mean is subject to outlier numbers, which can mislead us as to the true average. The median, by contrast, is immune to extremes because it reflects the middle point for a batch of numbers.
Here’s how CS-EMI compares through the decades. Note that near-zero and below-zero readings accompany recessions, usually with a slight lead time relative to the start dates, as determined by NBER. Whereas an NBER dating announcement arrives months, even a year, after the fact, CS-EMI is updated much closer to real time, subject only to the timeliness of the economic reports.
For instance, the current update is November 2012, which is nearly complete in terms of initial reports. Last month's CS-EMI reading is a strong 9.4%. The only missing number is real manufacturing and wholesale trade data.
Considering that November was generally a healthy month for growth in most of the economic indicators, it’s likely that the manufacturing and wholesale trade numbers will follow suit. Meantime, the current November profile looks robust in terms of the growth trend--the macro momentum is positive and strong.
In sum, the odds are low that NBER will declare November 2012 as the start of a new recession. That’s also been the message all along in CS-ETI, and it’s a message that’s corroborated in CS-EMI.
December 22, 2012
Best of Book Bits 2012 (Part I)
It's time once more for The Capital Spectator's annual recap of the year's books and your editor's struggle to choose ten titles that, for one reason or another, stand out as worthy releases in 2012. Just ten? Well, it's a round number, and it's easier than 20. It's also a thankless task for an unusually productive year in publishing on matter of macro and money. The sad part is that there's hardly time to read more than a handful of the fascinating works released this year, of which only a few are noted below. Sigh. But if one was limited to only ten books from a year that's nearly complete, what would they be? An unfair question, of course, and all the more so since the list below is drawn exclusively from the Book Bits feature that appears regularly in this space every Saturday morning. What follows is a select remix of items previously published here. But enough with the explaining. Here's my tally of ten, starting with five today and the balance paid off a week hence. Happy reading!
● Misunderstanding Financial Crises: Why We Don't See Them Coming
By Gary Gorton
Summary via publisher, Oxford University Press
Before 2007, economists thought that financial crises would never happen again in the United States, that such upheavals were a thing of the past. Gary B. Gorton, a prominent expert on financial crises, argues that economists fundamentally misunderstand what they are, why they occur, and why there were none in the U.S. from 1934 to 2007. Misunderstanding Financial Crises offers a back-to-basics overview of financial crises, and shows that they are not rare, idiosyncratic events caused by a perfect storm of unconnected factors. Gorton shows how financial crises are, indeed, inherent to our financial system. Economists, Gorton writes, looked from a certain point of view and missed everything that was important: the evolution of capital markets and the banking system, the existence of new financial instruments, and the size of certain money markets like the sale and repurchase market. Comparing the so-called "Quiet Period" of 1934 to 2007, when there were no systemic crises, to the "Panic of 2007-2008," Gorton ties together key issues like bank debt and liquidity, credit booms and manias, moral hazard, and too-big-too-fail--all to illustrate the true causes of financial collapse. He argues that the successful regulation that prevented crises since 1934 did not adequately keep pace with innovation in the financial sector, due in part to the misunderstandings of economists, who assured regulators that all was well.
● Paper Promises: Debt, Money, and the New World Order
By Philip Coggan
Lecture by author via London School of Economics
The world is drowning in debt. Greece is on the verge of default. In Britain, the coalition government is pushing through an austerity programme in the face of economic weakness. The US government almost shut down in August because of a dispute over the size of government debt. Our latest crisis may seem to have started in 2007, with the collapse of the American housing market. But as Philip Coggan shows in this new book, Paper Promises: Money, Debt and the new World Order which he will talk about in this lecture, the crisis is part of an age-old battle between creditors and borrowers. And that battle has been fought over the nature of money. Creditors always want sound money to ensure that they are paid back in full; borrowers want easy money to reduce the burden of repaying their debts. Money was once linked to gold, a commodity in limited supply; now central banks can create it with the click of a computer mouse.
● The Assumptions Economists Make
By Jonathan Schlefer
Summary via publisher, Belknap/Harvard University Press
Economists make confident assertions in op-ed columns and on cable news—so why are their explanations often at odds with equally confident assertions from other economists? And why are all economic predictions so rarely borne out? Harnessing his frustration with these contradictions, Jonathan Schlefer set out to investigate how economists arrive at their opinions. While economists cloak their views in the aura of science, what they actually do is make assumptions about the world, use those assumptions to build imaginary economies (known as models), and from those models generate conclusions. Their models can be useful or dangerous, and it is surprisingly difficult to tell which is which. Schlefer arms us with an understanding of rival assumptions and models reaching back to Adam Smith and forward to cutting-edge theorists today. Although abstract, mathematical thinking characterizes economists’ work, Schlefer reminds us that economists are unavoidably human. They fall prey to fads and enthusiasms and subscribe to ideologies that shape their assumptions, sometimes in problematic ways. Schlefer takes up current controversies such as income inequality and the financial crisis, for which he holds economists in large part accountable.
● Abundance: The Future Is Better Than You Think
By Peter H. Diamandis and Steven Kotler
Review via The New York Times
His thesis rests on a four-legged stool. The first idea is that our technologies in computing, energy, medicine and a host of other areas are improving at such an exponential rate that they will soon enable breakthroughs we now barely think possible. Second, these technologies have empowered do-it-yourself innovators to achieve startling advances — in vehicle engineering, medical care and even synthetic biology — with scant resources and little manpower, so we can stop depending on big corporations or national laboratories. Third, technology has created a generation of techno-philanthropists (think Bill Gates) who are pouring their billions into solving seemingly intractable problems like hunger and disease. And finally, we have what Diamandis calls “the rising billion.” These are the world’s poor, who are now (thanks again to technology) able to lessen their burdens in profound ways. “For the first time ever,” Diamandis says, “the rising billion will have the remarkable power to identify, solve and implement their own abundance solutions.”
● White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You
By Simon Johnson and James Kwak
Blog post by co-author (Johnson) via Economix (NY Times)
Debt has surged, relative to G.D.P., six times in American history, during the War of Independence, the War of 1812, the Civil War, World War I, World War II and since 2000. In the first five instances, debt rose as the government scrambled to raise resources to pay for a war effort. After each of those wars, debt was steadily reduced relative to the size of the economy – over decades, not over months or even years. The debt surge since 2000 is different – a point that James Kwak and I explain in detail in our book, published this week. To be sure, we have the two expensive wars, in Iraq and Afghanistan. But much more of the increase in the deficit was because of tax cuts under George W. Bush, Medicare Part D (which expanded coverage for prescription medicines) and – most of all – the financial crisis that brought down the economy and sharply reduced tax revenue starting in September 2008. Our modern debt surge is much more about declining federal government revenue than it is about runaway spending. If you believe strongly that our fiscal issues are primarily about “runaway spending,” please read our book. The smart approach is to begin the long and not-so-nice work of controlling deficits while allowing the economy to grow.
December 21, 2012
Chicago Fed National Activity Index Pulls Back From The Brink
The Chicago Fed National Activity Index (CFNAI) posted a sharp rise in November, an indication that "economic activity increased" last month, the Chicago Federal Reserve reports. CFNAI's three-month moving average moved higher as well, rising to -0.20 last month. That's close to The Capital Spectator's average econometric forecast for CFNAI of -0.26, which was published yesterday. A reading above -0.70 for CFNAI's three-month average suggests that the economy is growing, which is also the message in today's news on personal income and spending for November.
"Two of the four broad categories of indicators that make up the index increased from October, but only the production and income category made a positive contribution to the index in November," the Chicago Fed notes. Nonetheless, today's rebound is significant because there was no margin for error left after October's update, which left the three-month average of the index just above the recession-level mark of -0.70. The November estimate, by contrast, moves the index well above that danger zone.
Yet the CFNAI's below-zero reading for the three-month-average reading is a reminder that economic activity remains below its historical trend. In other words, the economy is growing, but only modestly. That said, assuming anything darker at the moment isn't supported by the latest CFNAI estimate, which equates with a pace of economic expansion that still looks strong enough to keep the business cycle from falling over the edge. That was the November my projection from earlier this month, via The Capital Spectator Economic Trend Index, a forecast that is more or less confirmed in today's CFNAI update.
Three Aces For November: Income, Spending & Durable Goods Orders
Today's November updates for personal income and spending, along with fresh data on durable goods orders, offer another round of encouraging news on the side of growth. For those who argue that the economy is collapsing, today's numbers offer a sharp rebuke. In fact, similarly robust numbers for November have been published for other indicators in recent weeks. Earlier this month I projected that the broad profile of economic activity in November was on track to improve over October, and today's updates all but seal the deal. The main point is that the risk of a recession, based on the numbers in hand, continues to look like a low-probability event in the here and now. That's been the message all along, and it remains the case today.
Let's take a closer look at today's updates, starting with personal income and spending. Clearly, November was a month for revival in consumption and income. Disposable personal income (DPI) increased by 0.6% last month, the most since February. Personal consumption expenditures also rebounded sharply, rising 0.4%. Both of those gains, by the way, were widely expected, as I noted earlier today, a few hours ahead of the releases.
Far more noteworthy is the upturn in the year-over-year percentage changes for income and spending with today's news. DPI as of last month is higher by nearly 4.0% vs. a year ago—the fastest rate of growth in more than a year. Personal consumption expenditures are looking stronger on an annual basis too, rising 3.5% vs. a year ago. That's well short of the highest rate this year, but the numbers appear to moving higher. The main point is that income and spending are showing signs of improvement. This isn't a sign of an economy that's weakening. It wouldn't mean much if most of the other key indicators were stumbling, but a broad review of the macro reports is also upbeat, as shown by The Capital Spectator Economic Trend Index.
Consider, too, that private-sector wages are now rising at a substantially higher annual rate as of November: +4.3% vs. a year ago. That's the highest pace in more than a year, and sharply higher than October's 3.0% annual increase. The idea that the wages are collapsing, in short, finds no support in today's update.
November's durable goods orders report is encouraging too. Although new orders have been quite weak recently, today's update paints a picture of improvement during the previous month's activity. In fact, new orders for durable goods generally, along with business investment (new orders for nondefense capital goods excluding aircraft) posted back-to-back gains in October and November.
It's still not clear if durable goods orders can pull out of their slump. Indeed, the year-over-year rolling changes for this series look quite gloomy, as the chart below reminds. But are we seeing some light in this tunnel in the November update? Business investment's annual change is positive as of last month for the first since the spring. Is that a signal that the trend for durable goods generally is headed higher in the months ahead?
One reason for answering with a tentative "maybe" is that income and spending are looking stronger, as are several other key economic indicators, including the critical housing market. All of this, by the way, is unfolding despite the worries over the fiscal cliff, which remains uncertain as to the outcome. But if Washington could somehow get its act together, the outlook for 2013 would suddenly turn substantial brighter. Even without a resolution of the fiscal cliff mess there's a good case for expecting that modest growth is still the path of least resistance. That's been true all along, albeit with a few bumps along the way.
Personal Income & Spending: November 2012 Preview
Today's personal income and spending update for November is widely expected to post a rebound after October's disappointing results. The Capital Spectator's average econometric forecasts for these indicators echo the market's outlook: +0.3% for income and +0.4% for spending in today's release. The gains are in line with market's expectations. The release for this data hits the street later today at 8:30am eastern via the Bureau of Economic Analysis.
Here's how the numbers stack up, followed by brief definitions of the methodologies behind The Capital Spectator's projections:
VAR-2: A vector autoregression model that analyzes two economic time series in search of interdependent relationships through history. The forecasts are run in R with the "vars" package using historical data for the following indicators: personal income and personal consumption expenditures (in current $).
VAR-4: A second VAR model (see overview above) uses four indicators: personal income and personal consumption expenditures (in current $), plus private payrolls and industrial production.
December 20, 2012
Chicago Fed Nat'l Activity Index: November 2012 Preview
Is the U.S. economy sinking into a new recession? Or has another downturn already started? Tomorrow's November update of the Chicago Fed National Activity Index (CFNAI) may provide a quantitative answer. In the October reading, CFNAI's three-month moving average slipped to -0.56, the closest to the red line of -0.70 since the Great Recession ended. A fall below -0.70 would be considered a sign of an "increasing likelihood that a recession has begun," according to the Chicago Fed. No one can dismiss the risk, but The Capital Spectator's average econometric forecast anticipates a rebound that moves CFNAI's 3-month average away from the brink: -0.26, or up from -0.56 in October.
Here's how the numbers stack up, followed by brief definitions of the methodologies behind The Capital Spectator's projections:
VAR-4: A vector autoregression model that analyzes four economic time series in search of interdependent relationships through history. The forecasts are run in R with the "vars" package using historical data for the following indicators: the Chicago Fed National Activity Index (3-month averages), the Capital Spectator Economic Trend Index (3-month averages), the Philadelphia Fed US Leading Indicator, and the Philadelphia Fed US Coincident Economic Activity Indicator.
VAR-5: A second VAR model (see overview above) uses five indicators: the Chicago Fed National Activity Index (3-month averages), US private payrolls, real personal income less current transfer receipts, real personal consumption expenditures, and industrial production.
Jobless Claims Rise, But Remain Near 2012 Lows
Jobless claims increased by 17,000 last week to a seasonally adjusted 361,000. The pop isn't surprising, nor is it particularly worrisome at this point. As I noted earlier today, before the report's release, my average econometric forecast called for a gain to 361,000. That's exactly what we got—a freak incident of specificity, no doubt. In any case, the higher level of claims looks like noise within the range that's prevailed for much of this year. As a result, today's number, despite what you might hear otherwise, is mostly a yawn.
New filings for jobless benefits in the neighborhood of 360,000 suggests more of what we've seen in recent months: a labor market that's growing modestly. Last week's four-week average for claims was just under 368,000, or near the lowest levels for this year.
Meanwhile, claims dropped 4.9% last week on an unadjusted basis relative to the year-earlier level. That's a positive sign in that it was a bigger decline than the comparable rate for previous week, although the recent upward bias in this metric looks a bit troubling… if it continues. Before Hurricane Sandy, unadjusted claims were dropping by roughly 10% a year. Post-hurricane data has been falling at a lesser pace. It may simply be blowback from the distorting effects of the storm, in which case we'll see the year-over-year rate move closer to -10% in the weeks ahead. If not, weekly claims may be sending a warning about the labor market for the new year.
The good news is that last week's annual decline of 4.9% is convincingly lower than the previous week's -1.5% drop. It's worth noting too that a ~5% decline rate at the end of 2011 was typical in the final weeks of last year. That didn't derail the primary trend of modest improvement in the labor market in 2012, although we did have a bumpy ride for a time. History doesn't necessarily repeat, but it may rhyme.
For now, it's premature to say there's a change afoot. Indeed, this is a volatile series and it's always dangerous to assume too much from one or two reports. Nonetheless, the next round of numbers deserve careful scrutiny.
Weekly Jobless Claims: 15 Dec 2012 Preview
Today's update on weekly jobless claims (scheduled for release at 8:30am eastern) is widely expected to post an increase after last week's drop to just over a five-year low. The Capital Spectator's average econometric forecast sees a rise to 361,000 new filings for unemployment benefits last week (seasonally adjusted) vs. the previously reported 343,000.
Here's how the numbers stack up, followed by brief definitions of the methodologies behind The Capital Spectator's projections.
December 19, 2012
Housing Starts Fall In November, But Outlook Remains Bright
Housing starts fell 3% last month, the Census Bureau reports. The retreat is the first monthly setback since July, although the drop isn't a big surprise, as I discussed earlier today, before the numbers were released. More importantly, November's red ink doesn't appear particularly troubling in terms of the outlook because it doesn't change the overall momentum profile. The annual trend in new housing construction continues to rise at a strong pace, largely because demographics and demand are again pushing homebuilding activity higher.
Even a growing market for new residential construction doesn't expand each and every month. One reason for thinking optimistically that new starts will reach higher levels in the months ahead is the ongoing increase in newly issued building permits, which increased nearly 4% in November to a four-year high.
Stepping back and looking at the annual trend reveals that both permits and starts continue to advance by a healthy 20%-plus on a year-over-year basis. The November pace for this pair of indicators is at the lower end of annual increases posted in 2012, but short of a recession there's no reason to expect that the housing market's recovery is about to run off the rails.
Is a recession likely? Anything's possible, of course, but for the moment a new downturn continues to look like a low-probability event for the immediate future for at least two reasons. One, my latest GDP nowcast for the fourth quarter anticipates a rise of 1.5% for the economy overall (based on an average of five econometric forecasts). That's a considerable slowdown from Q3's 2.7% increase, although the incoming data lately have been trending higher and so the latest nowcast has turned moderately higher vs. its predecessor. As a result, it's possible that future nowcast updates for Q4 will improve further as more numbers for the current quarter arrive.
Another source of optimism is The Capital Spectator Economic Trend Index (CS-ETI), which continues to exhibit relatively low levels of recession risk, as I noted in last week's update. In fact, since running the numbers for CS-ETI on December 10, several additional data points have been published and the news is positive. Today's year-over-year increase in permits through November (a reasonably good proxy for what to expect with starts) is one upbeat report that will boost CS-ETI in a future update. Another is November's strong rebound in industrial production.
“We’re headed higher and next year is going to be the best year for housing starts that we’ve seen since 2007,” predicts Stuart Hoffman, chief economist at PNC Financial Services Group. “Housing is coming back."
Yes, the fiscal cliff factor may be a joker in the deck for macro, but I expect that a deal that softens the blow in some degree is coming. In that case, the odds will be even higher that the U.S. economy may surprise on the upside in the new year. Sure, there are still plenty of risks lurking, but the fact that the economy has muddled higher this year despite any number of hazards tells you something, namely: growth still has the upper hand.
Housing Starts: November 2012 Preview
The November update on housing starts is scheduled for release today (8:30 am eastern) and a decline is widely expected vs. October's 3.6% rise. The Capital Spectator's average econometric forecast anticipates a 2.5% decrease. Another factor that implies that starts will fall in November is the relatively high level of new housing construction in October vs. the number of building permits issued in that month. The two series tend to track one another fairly closely through time and so any deviations between the pair don't usually persist. In recent years, whenever starts exceeded permits, starts usually declined in the following month. In October, starts rose above the level of permits for the first time since April.
Here's how the numbers stack up, followed by brief definitions for the methodologies behind The Capital Spectator's projections.
VAR-4: A vector autoregression model that analyzes four economic series in search of interdependent relationships through history. The forecasts are run in R using the "vars" package and 40 years of historical data for the following indicators: housing starts, new home sales, newly issued permits for residential construction, and the monthly supply of homes for sale.
December 18, 2012
Barron's Roundtable Vs. Mr. Market's Asset Allocation
Mebane Faber has some fun thinking about an idea for an ETF that tracks the investment results published by the Barron's Roundtable, an annual feature dispenses an array of portfolio recommendations. As Pundit Tracker notes, "following the investment picks of the annual Barron’s Roundtable has been a lucrative approach over the years. Since 2002, the average Roundtable return has been 11.5% versus -0.2% for S&P 500, with all but one of the members outperforming the index."
Of course, much depends on one's definition of "index." The standard answer is the S&P 500, but that's really just one piece of the world's capital and commodity markets. In any case, the roundtable numbers republished by Pundit Tracker inspired some thinking of my own. How, for example, did the Barron's Roundtable data compare with my proprietary Global Market Index, a passive and investable benchmark of all the major asset classes? And what does the comparison tell us about asset allocation vs. favoring star investment managers?
Pundit Tracker (PT) has the numbers on the roundtable and I've have GMI data and so it's easy to compare the results. The S&P 500 is also included, via PT, although it's a bit hard to see in the lower right-hand corner in the chart below because this index's results for the 10-year span under scrutiny (2002-2011) is nearly flat at -0.2%. (Here are the numbers for the roundtable participants in the chart.)
The main message that pops out of the chart above for me is that a passive allocation across the major asset classes (red bar) is just about dead center relative to the performance numbers for the eight roundtable participants (based on the average of returns, as shown in the blue bar). Granted, this isn't a robust analysis, and for a number of reasons, starting with the small sample of returns from the participants. On the other hand, GMI's average performance vs. a pool of active managers is a familiar result in my statistical travels over the years.
For instance, last October I compared GMI's 10-year performance to 1,200-plus actively managed asset allocation mutual funds with at least at decade of history. Once again, GMI ends up looking pretty good vs. the competition. Here's the chart I published last fall:
The lesson is that diversifying across all the major asset classes is a tough act to beat. Rebalancing the mix regularly tends to juice performance a bit higher. Filling the asset class buckets with low-cost ETFs and/or index mutual funds is usually an advantage too.
I'm not saying that trying to pick winners and losers in advance among active managers is a waste of time. But the challenges of trying to figure out which managers will do well, and which ones will stumble, are well known and widely documented. It's fair to say that excelling in this field requires a high degree of talent in its own right—a talent that's relatively rare in terms of publicly available and verifiable track records.
By contrast, building a portfolio with a foundation that holds the major asset classes is easy and it tends to deliver average to above-average results vs. a wide array of strategies that claim to be superior. Why? A complete answer could fill up a book, which is why I wrote Dynamic Asset Allocation: Modern Portfolio Theory Updated for the Smart Investor . But there's also a short answer, and an intuitive one. As Bill Sharpe pointed out a number of years ago, the winning portfolios are financed by the losers. It's a zero sum game when it comes to investment returns. That's not the last word on designing investment strategies, but it's an empirical fact that should inspire some humility about what's probable, what's not, and what it suggests for designing and managing portfolios.
December 17, 2012
Q4:2012 U.S. GDP Nowcast Update | 12.17.2012
Gross domestic product for the U.S. in the fourth-quarter is on track to rise by 1.5%, according to the average of The Capital Spectator's five econometric "nowcasts". That's up slightly from the 1.2% average in our previous update on November 23. The improvement isn’t surprising, considering the recent round of upbeat economic reports, including the revivals in industrial production and retail sales numbers for November. Today's GDP nowcast for Q4 reflects the latest fourth-quarter indicators, and the prevailing wind at the moment is blowing positive, albeit modestly so.
Even if the 1.5% nowcast holds for Q4, it represents a slower rate of growth vs. Q3, which posted a substantially higher 2.7% increase, the Bureau of Economic Analysis reported last month. Looking ahead, the government's official Q4:2012 GDP estimate is scheduled for release on January 30, which means that there's still a long road ahead for new data and nowcast updates. Apart from the usual mystery that surrounds future data releases, there's also an extra layer of macro uncertainty lurking in the weeks ahead due to the ongoing fiscal cliff talks in Washington. Nonetheless, it's encouraging to see our average nowcast rise a bit. Here's how each of the individual nowcasts compare with recent history and The Wall Street Journal's forecasts via a survey of economists from earlier this month:
Next, here's a recap of how our nowcasts for Q4:2012 GDP have evolved so far:
Most of November's indicators are published--the key missing pieces for last month's data profile at this point are personal income and spending, which will be updated this Friday (Dec. 21). Meantime, the trend seems to be moving in the right direction. Is more of the same on tap with Friday's income and spending news? Yes, according to the consensus forecast of economists. Income is expected to rise 0.3% for November, according to Econoday.com, which would compare favorably with October's unchanged reading. Economists also expect a better report on consumer spending: a 0.4% increase for November vs. -0.2% previously.
As for the numbers in hand, here’s a brief review of how they’re sliced and diced to generate The Capital Spectator’s GDP nowcasts:
4-Factor Nowcast. This estimate is based on a multiple regression of quarterly GDP in history relative to quarterly changes for four key economic indicators: real personal consumption expenditures, real personal income less government transfers, industrial production, and private non-farm payrolls. This model compares the data on a quarterly basis, looking for relationships with GDP within each quarter from the early 1970s to the present. The four independent variables are updated monthly and so the nowcast is revised as new data is published. In effect, this model is telling us what the data trends in the current quarter imply for the quarter's GDP growth.
10-Factor Nowcast. This model also uses a multiple regression framework based on historical data from the early 1970s onward and updates the estimates as new numbers arrive. The methodology here is identical to the 4-factor model except that it uses additional factors—10 in all. In addition to the data quartet in the 4-factor model, the 10-factor nowcast also incorporates the following series:
• ISM Manufacturing PMI Composite Index
• housing starts
• initial jobless claims
• the stock market (S&P 500)
• crude oil prices (spot price for West Texas Intermediate)
• the Treasury yield curve spread (10-year Note less 3-month T-bill)
ARIMA Nowcast. The econometric engine for this nowcast is known as an autoregressive integrated moving average. The technique is using only real GDP's history, dating from the early 1970s onward, for anticipating the current quarter's change. As the most recent quarterly GDP number is revised, so too is the ARIMA nowcast, which is calculated in R software via the “forecast” package, which optimizes the prediction model based on the data set's historical record.
ARIMA 4 Nowcast. This model is similar to the ARIMA technique above in terms of the econometric technique, but with a key difference. Instead of using GDP's historical data as a lone input, the ARIMA 4 model analyzes four historical data sets to predict GDP: real personal consumption expenditures, real personal income less government transfers, industrial production, and private non-farm payrolls.
VAR Nowcast. The vector autoregression model looks to several data series in search of interdependent relationships for estimating GDP. The historical data sets in the 4-factor and ARIMA 4 models above are also used to generate VAR nowcasts of GDP. As new data is published, so too is the VAR nowcast. The basic idea here is to let the data specify the model's parameters. The data sets are based on historical records from the early 1970s, using the "vars" package for R to crunch the numbers.
December 15, 2012
Book Bits | 12.15.12
● Practical Risk-Adjusted Performance Measurement
By Carl Bacon
Summary via publisher, Wiley
Risk within asset management firms has an undeserved reputation for being an overly complex, mathematical subject. This book simplifies the subject and demonstrates with practical examples that risk is perfectly straightforward and not as complicated as it might seem. Unlike most books written on portfolio risk, which generally focus on ex-ante risk from an academic perspective using complicated language and no worked examples, this book focuses on ex-post risk from a buy side, asset management, risk practitioners perspective, including a number of practical worked examples for risk measures and their interpretation.
● Petropoly: The Collapse of America's Energy Security Paradigm
By Gal Luft and Anne Korin
Video of author discussing US energy policy via Milken Institute
Is energy self-sufficiency a realistic goal for the United States? In his latest book, expert Gal Luft argues that energy independence is a pipedream that will have little or no effect on the price Americans pay at the pump. Luft and co-author Anne Korin point to the fact that, over the past seven years, domestic oil production has expanded, vehicle fuel-efficiency has increased and oil imports have fallen. Yet the amount Americans spend on oil imports has skyrocketed. True energy security requires an uninterrupted energy supply and affordable prices, he argues, and energy self-sufficiency guarantees neither. At this Milken Institute Forum, Luft, the co-director of the Institute for the Analysis of Global Security, will explain the reason for the collapse in the energy security paradigm and how the U.S. can avoid the pitfalls of today's cartel-dominated oil market.
● Mastering the Stock Market: High Probability Market Timing and Stock Selection Tools
By John L. Person
Reference via Tom Aspray/MoneyShow.com
In the mid-1990s, I published weekly and daily pivot levels for the cash forex markets to my institutional clients. At that time the formula was not widely distributed. I even recall that there were a few services that sold the pivot levels for a price. I concluded that the weekly levels were often not reliable enough for me and the pivot levels were not available in most technical analysis programs.
That changed in 2004 with the publication of John Person’s book Complete Guide to Technical Trading Tactics: How to Profit Using Pivot Points, Candlesticks & Other Indicators. In the following years, he gave numerous presentations of his methods at The Traders Expos, and by 2007 pivot points were a common feature of pretty much every trading or technical analysis program.
I had never thought about doing monthly pivot analysis until I read John’s books and later found out that he had been using pivot point analysis for over 20 years. I was even more fascinated a couple of years ago when he let me in on the secret of quarterly pivot point analysis. It was something that he had never revealed publicly, and therefore I did not incorporate them into my analysis.
John now discusses them in his latest book, Mastering the Stock Market: High Probability Market Timing and Stock Selection Tools, published this month by Wiley. Therefore, I now plan on referring to them in my analysis.
● The Evolving Role of China in the Global Economy
Edited by Yin-Wong Cheung and Jakob de de Haan
Summary via publisher, MIT Press
China is now the world’s second largest economy and may soon overtake the United States as the world’s largest. Despite its adoption of some free-market principles, China considers itself a “socialist-market economy,” suggesting that the government still plays a major role in the country’s economic development. This book offers a systematic analysis of four factors in China’s rapid economic growth: exchange rate policy, savings and investment, monetary policy and capital controls, and foreign direct investment (FDI).
● Inflation, Unemployment and Government Deficits: End Them: A professional's readable explanation of the current recession and how to quickly end it.
By John Lindauer
Summary via Amazon.com
This is a professional's explanation of how the economy of the United States went wrong in 2008 as the result of poor political appointments. More importantly, it explains how the recession can be quickly ended without further congressional action. It was written because people, investors, and politicians have been badly misled by unqualified journalists and political appointees who merely repeat the inaccurate common knowledge they gleaned from a few undergraduate courses and luncheon speakers. The results have been horrific: massive unemployment, bankruptcies, foreclosures, business failures, and low tax collections that have resulted in severe and unnecessary deficits.
December 14, 2012
Industrial Production Rebounds Sharply In November
Industrial production mounted a surprisingly strong comeback last month. The 1.1% surge in the Fed's industrial production index—the biggest monthly gain in nearly two years—surprised many analysts, including yours truly. Surprising or not, it's clear that October's dreadful decline in this indicator (a decline that was revised further into the red in today's update) was a temporary setback rather than a sign that the trend was slipping over the edge. Indeed, the cyclically sensitive manufacturing component in today's report also registered a strong 1.1% increase in November.
The strength of last month's rebound is almost certainly overstated due to the distorting effects of Hurricane Sandy, albeit for positive reasons this time. As the Federal Reserve notes in today's release: "The gain in November is estimated to have largely resulted from a recovery in production for industries that had been negatively affected by Hurricane Sandy, which hit the Northeast region in late October."
Whatever the source of last month's rebound, the positive effects on the year-over-year trend is anything but subtle. Industrial production increased 2.5% for the year through November. That's a sharp turn higher from October's 1.6% annual gain. It's also one more reason for assuming that the broad economic profile for November 2012 will eventually be marked as one of growth generally in the macro history books.
As I discussed on Monday, the overall picture for November is leaning towards one of expansion based on the incoming data. Several economic reports after I made that observation, that view is even stronger. Today's industrial production news is certainly another batch of data on the side of growth; yesterday's encouraging updates on jobless claims and retail sales are two more.
The speculation by some analysts that a new recession is overtaking the U.S. economy has been a stretch all along. The data in total never offered a compelling case for making such a claim. Yes, certain indicators have looked wobbly at times, and we're sure to see more signs of unsteady economic reports in the weeks ahead. It's also easy to think negatively if you spend too much time reading headlines about politics in Washington. All the more reason that clear, objective analysis of the broad trend is essential these days. That's the primary goal of The Capital Spectator Economic Trend Index, which continues to estimate recession risk as a low probability event.
That could change, of course, and rest assured that one day we will have a recession. But based on the data through November, which is only missing a handful of numbers at this point, it's becoming clear that the economy wasn't contracting last month.
Industrial Production: November 2012 Preview
The November update on industrial production is scheduled for release today (9:15am eastern) and most analysts are expecting a rebound from October's 0.4% slump. The Capital Spectator's econometric forecasts are mixed, however, although the average of these predictions leans modestly into positive territory with a slight 0.1% increase. That's a sign for thinking that industrial production will post a gain in today's report, but probably not as much as the consensus outlook anticipates.
Here's how the numbers stack up, followed by brief definitions for the methodologies behind The Capital Spectator's projections.
VAR-11: A vector autoregression model that analyzes eleven economic series in search of interdependent relationships through history. The forecasts are run in R using the "vars" package using 30 years of historical data for the following indicators: industrial production, private non-farm payrolls, index of weekly hours worked, US stock market (S&P 500), real personal income less current transfer receipts, ISM Manufacturing Index, spot oil prices, real personal consumption expenditures, Treasury yield spread (10 year Note less 3-month T-bill), University of Michigan Consumer Sentiment Index, and housing starts.
VAR-2: A vector autoregression model that's identical to VAR-11 with the exception that the inputs are restricted to industrial production and ISM Manufacturing Index. Several studies find that the ISM data is especially valuable for anticipating industrial production and this parsimonious VAR model focuses on exploiting the historical relationship between these indicators as a forecasting tool.
December 13, 2012
A Pair Of Winners: Jobless Claims Fall, Retail Sales Rise
Jobless claims dropped substantially last week, near the lowest level in almost five years. Meanwhile, retail sales rebounded in November. In short, we have two more economic updates that support the case for expecting modest economic growth in the near future.
Let’s look at both reports in more detail, start with consumer spending. Retail sales rose 0.3% last month, modestly below the rate projected by economists overall. Nonetheless, today’s report shows a) there’s a post-Hurricane Sandy rebound factor juicing the numbers; and b) retail spending isn’t collapsing, as some of the more pessimistic analysts have been predicting. In sum, a decent report and one that continues to support the case for expecting modest growth in the economy overall.
Stripping out gasoline sales, which tumbled 4.0% in November, puts retail ex-gas up by a much-stronger 0.8% last month. That's a reminder that consumers are spending on discretionary items. A strong month for auto sales is one reason, and the holiday shopping season doesn't hurt either.
More importantly, the annual trend is holding up as well. Retail sales rose 3.7% last month vs. the year-earlier level. A drop below this rate into the low-3% range would be a warning sign for the business cycle, but there’s still a comfortable margin in today's numbers over that zone.
“The details look pretty solid,” says Ryan Sweet, a senior economist at Moody’s Analytics. “The consumer is continuing to support the recovery, which is important because identifying the sources of growth is becoming increasingly difficult. The burden is really starting to fall on the consumer.”
For now, the beast is holding up his share of the burden, which means that another data point for the November profile of the economy remains on the side of growth.
Jobless claims certainly look better these days too. Last week’s tally of new filings for unemployment benefits dropped by 29,000 to a seasonally adjusted 343,000. That’s just a hair over the 342,000 mark set for the week through October 6, the lowest since early 2008. For four weeks running, claims have retreated, all but confirming that the early November surge was a storm-related distortion.
If there’s a reason to be cautious in today’s jobless claims report it can be found in the annual change for the unadjusted data. In contrast with the weekly numbers, claims fell a slight 1.6% last week vs. the level from a year ago. That’s a bit too close to zero for comfort, although one data point doesn’t mean much. A series of repeat performances in the weeks ahead, however, would be another matter.
For now, however, the data continues to support a forecast for slow growth in the economy overall. I said as much on Monday, with the update of The Capital Spectator Economic Trend Index, and today’s numbers strengthen the econometric case for arguing that recession risk is still low, based on the available numbers. December and beyond are wide open for debate, of course, but the odds are rising for expecting that November will go into the history books as another month of expansion.
December 12, 2012
More Of The Same... With "Thresholds"
Fed Chairman Ben Bernanke made it clear... again. Interest rates will remain low, even when the labor market shows stronger signs of growth. He said that if inflation doesn't exceed an annual rate of 2.5%, and unemployment stays above 6.5%, the Fed would keep its target rate near zero percent. Laying out "thresholds" is something new, but the basic message remains the same: low rates and no plans to change the status quo any time soon.
As Bernanke explained at yesterday's press conference:
First, as the statement notes, the committee reviews policy as likely to be appropriate at least until a specified threshold is met, reaching one of those thresholds will not automatically trigger immediate reduction in policy accommodation.
If unemployment was to decline at a time inflation and expectations were subdued... the committee might judge an increase in target for the federal funds rate to be inappropriate and ultimately in deciding when and how quickly to reduce policy accommodation the committee will follow a balanced approach in seeking to mitigate deviations of inflation from the longer run 2% goal and deviations of employment from estimated maximum level.
The 2.5% ceiling for pricing pressure is a "conditional inflation targeting," as Menzie Chinn labels it. As it happens, the market appears to have been anticipating that level in recent days. Yesterday's inflation forecast via the 10-year Treasury yield less its inflation-indexed counterpart was 2.51%, about where it's been all week. It's also interesting to note that the Treasury market's assumption for future inflation has been inching higher this month after bottoming out at around 2.4%.late last month.
It's also clear that inflation expectations and the stock market remain tightly bound. The new abnormal, as I like to call it, is still with us. Expecting higher inflation, in short, is still considered bullish, as this month's dual rally in equities and inflation expectations through yesterday remind.
Another observation: inflation expectations seem to have some upward momentum. Progress, one might say, from the central bank's perspective: convince the crowd that higher inflation is destiny. The market is inclined to agree, albeit on the margins, and only relative to a low base in recent years.
There are, of course, limits to everything, including the market's perception that more inflation is productive. Exactly when that limit will be reached is unknown, of course, but Bernanke is eager to reach that state of mind sooner rather than later. But the road for getting from here to there is still riddled with potholes. The Fed's new GDP growth projection is a bit lower for next year compared with its September outlook: a 2.3%-to2.5% projection via the "central tendency" forecast, or down from 2.5%-to-3.0% range previously published. The Fed also sees slightly lower inflation and unemployment in the new year.
The struggle to juice the economy goes on, with mixed results. One can make an argument that Bernanke and company are winning, but not enough to convince the man on the street. Perhaps a better way to see the big picture is that the Fed isn't losing, at least not any more so than in recent months. We are, it seems, still stuck somewhere in a macro never-never land, floating between a genuine recovery and a shrinking economy.
Stress-Testing Forecasts For Tomorrow's November Retail Sales Report
Will tomorrow's retail sales update for November bring pain or pleasure for the increasingly delicate and high-stakes art/science of deciding where the business cycle's headed? October's report was somewhat sobering, thanks to a 0.3% drop in consumption—the first since June. Some of the weakness was blamed on Hurricane Sandy. If so, will November's numbers bounce back after a month of relatively clear skies? Yes, according to the consensus forecast, which projects a handsome 0.4% rise, according to Briefing.com. Sounds good, but that's a bit high relative to a pair of econometric models I routinely use for additional context when considering where the data's headed.
I crunched the numbers in two ways, using vector autoregression (VAR) and autoregressive integrated moving-average (ARIMA) models, both of which also show up in my work with modeling the business cycle and nowcasting US GDP. As for today's retail sales projections, I'm using R software by way of the "forecast" and "vars" packages. These tools optimize the parameters based on the historical data records and so in some degree the resulting projections represent benchmarks for evaluating forecasts from other sources.
For the VAR projection of retail sales, I've chosen four data series to search for interdependent relationships: US private sector employment, personal consumption expenditures, disposable personal income, and the University of Michigan Consumer Sentiment Index. By contrast, the ARIMA projection uses only the historical data for retail sales as the basis for looking ahead. Here's how the two estimates compare for estimating the monthly change for November retail sales (in nominal dollar terms):
Averaging the two forecasts gives us a +0.1% estimate. Keep in mind that the confidence intervals for each of these point forecasts is, as usual, wide enough to keep us humble for thinking that the future is clear enough to put a high degree of confidence in one number. The potential for fairly large negative or positive surprises, econometrically speaking, remains substantial.
Nonetheless, my take on the these two forecasts is that we should be a bit more cautious in expecting a strong rise in tomorrow's report compared with the consensus outlook. November is likely to show a modest rebound from October, but I'm not expecting a large upside surprise.
December 11, 2012
Research Review | 12.11.2012 | Dividend Yield & Equity Returns
Dividend Yields, Dividend Growth, and Return Predictability in the Cross-Section of Stocks
Paulo Maio and Pedro Santa-Clara | Nov 2012
There is a generalized conviction that variation in dividend yields is exclusively related to expected returns and not to expected dividend growth --- e.g. Cochrane's presidential address (Cochrane, 2011). We show that this pattern, although valid for the stock market as a whole, is not true for small and value stocks portfolios where dividend yields are related mainly to future dividend changes. Thus, the variance decomposition associated with aggregate dividend yields (commonly used in the literature) has important heterogeneity in the cross-section of equities. Our results are robust for different forecasting horizons, econometric methodology used (direct long-horizon regressions or first-order VAR), and also confirmed by a Monte-Carlo simulation.
Drained by DRIPS: The Hidden Cost of Buying on the Dividend Pay Date
Henk Berkman and Paul D. Koch | Nov 2012
On the day that dividends are paid we find a significant positive mean abnormal return, followed by a reversal that negates most of this price appreciation. This temporary dividend pay date effect has grown in magnitude since the 1970’s, and is concentrated among high dividend yield stocks that offer dividend reinvestment plans (DRIPs). Since the mid-1990s, these stocks yield a mean abnormal return close to 0.5% on the dividend pay date. This temporary inflation is larger in magnitude for stocks subject to greater limits to arbitrage. Quarterly profits from a trading strategy to exploit this anomaly are economically significant, and related to time series movements in market sentiment, transaction costs, the dividend premium, and the VIX. For investors who reinvest their dividends on the pay date, this temporary inflation represents a substantial implicit transaction cost.
Do Firm-Level Fundamentals Still Matter? - A Re-Examination of Market Anomalies
Samuel Xin Liang | Oct 2012
We re-examine market anomalies over the 1990-2011 period and find that the book-to-market and cash flow-to-price ratios predict higher future short-, medium- and long-term returns and alphas whereas size, price, momentum, short-term reversal, beta, volatility, the earnings-to-price ratio and dividend yield do not. Meanwhile, volatile stocks have higher future six-, nine-, and 12-month returns, contradicting the volatility puzzle of one-month returns. These findings suggest that the U.S. market has become weak-form market efficient which supports the assumption of many classical finance theories. We also find that conservatism and representativeness cannot explain the driving force behind firm-level fundamental information on stock returns. We also discover that monetary policy does not make a market efficient since both past returns and fundamentals predict higher future returns and alphas in Hong Kong which shares the same monetary policy with the U.S. However, firm-level fundamentals also drive the aggregate return differences between these two markets.
Modelling Time-Variation in the Stock Return-Dividend Yield Predictive Equation
David G. McMillan | Oct 2012
Using data for forty markets, this paper examines the nature and possible causes of time-variation within the stock return-dividend yield predictive regression. The results in this paper show that there is significant time-variation in the predictive equation for returns and that such variation is linked to economic and market factors. Furthermore, the strength and nature of those links are themselves time-varying. The inclusion of this time-variation in the predictive equation increases the predictive power compared to the standard constant parameter predictive model. Evidence is also reported for time-varying dividend growth predictability. Long-horizon predictability is also examined with evidence reported that the nature of the factors affecting time-varying predictability changes with horizon. The results here, while directly contributing to the returns predictability debate, in particular regarding its existence and source, may also inform the discussion that links time-varying expected returns (and risk premium) to economic factors.
Effects of Dividend Ratios and Other Fundamentals on Forward P/Es - Some Evidences from a Worldwide Cross-Sectional Multivariate Analysis
Marco Taliento | Nov 2012
This study seeks to regress the forward P/Es on firms’ fundamentals as measured on global market basis. Starting from theoretical premises (DDM), the paper develops a linear multivariate model in order to capture (for US, Australia / New Zeland / Canada, Europe, Japan and Emerging Markets quoted companies) the underlying value-drivers. The regression is cross-sectional with annual data referred to 2010, a financial year – immediately after the explosion of the GFC [global financial crisis]– which exhibits signals of both slight recovery and persisting uncertainty. Results about the dividend yield confirm the hypotheses whilst the association with payouts appears surprisingly negative. Other control financial variables are tested.
December 10, 2012
U.S. Economic Trend Update | 12.10.12
Thinking positively about the economy isn't getting any easier these days. From worries about fiscal uncertainty in Washington to fears that America's long-run growth prospects have been impaired, the case for pessimism is in full swing in the final days of the year. The rear view mirror for economic data, however, suggests that the game isn't over yet, as today's update of The Capital Spectator Economic Trend Index (CS-ETI) reminds.
November's economic profile, based on the data published so far, reveals minimal signs of deterioration. The one exception is the latest return to a state of contraction in manufacturing via the ISM data. For now, however, that's an outlier and the broad trend remains positive. There's a lot of debate about whether the business cycle has taken a turn for the worse, but arguing in the affirmative still doesn't come with much econometric support, as this broad review of CS-ETI's indicators reminds:
Plugging the data into a diffusion index shows that the economy's overall momentum remains positive in the sense that a recession hasn't started in the recent past. The majority of indicators are still trending positive. That's not a qualitative statement about the economy per se; rather, it's a quantitative summary of how the data is behaving, primarily on a year-over-year basis, albeit with a few exceptions (as noted in the "Transformation" column in the table above). Boiling it all down to one metric gives us the following chart, which advises that the current batch of numbers isn't currently signaling a new economic downturn:
Converting the data in the diffusion index into probabilities via a probit model tells us more directly that recession has been a low-risk event recently:
Finally, let's consider what the data's telling us about the near-term future by way of a sophisticated econometric technique that's applied in a relatively straightforward way here. In particular, I've generated forecasts for each of CS-ETI's indicators, independently of one another, using an ARIMA model. I then aggregate the results to estimate CS-ETI for the next several months.1 The process starts by filling in the missing numbers as a bridge to estimating each of the monthly data sets. It's safe to assume that a fair amount of error infects any one forecast, although aggregating the individual estimates can minimize the risk a bit if some of the errors cancel each other out. One source for cautious optimism on this front is the recent record in estimating CS-ETI's future path, an exercise that's produced fairly reliable results lately. With that in mind, the near-term outlook is encouraging for thinking that CS-ETI will continue to post readings that are associated with economic growth.
A separate set of forecasts for CS-ETI using a vector autoregression technique dispenses a similar set of estimates for expecting that the next month or two won't bring a dramatic reversal of fortune for this index.
All of this comes with the usual caveats, of course. Indeed, the range of outcomes implied by the confidence intervals associated with CS-ETI's projections inspires a fair amount of humility. But there's another factor that's considerably more worrisome at the moment. The big risk for the economy may be a threat that's immune to econometric modeling and forecasting: the U.S. government. "Time running out on ‘fiscal cliff’ deal," according to The Washington Post.
It's unclear as to exactly what failure on this matter means for the economy. But on the topic of the economy's trend so far, a subject that comes with a touch more clarity, the numbers still look encouraging overall. That's no assurance that the various macro hazards won't derail the trend in the weeks and months ahead, but for now it's still premature to argue that growth has hit a wall.
The bottom line: as we go into the economy's year-end finale, there's quite a bit more positive momentum in the macro trend than some analysts recognize. That may not be enough to keep us out of trouble going forward, but for now the case for cautious optimism is still reasonable--particularly if Washington finds a way to deliver a pro-growth compromise in the current fiscal debate.
December 8, 2012
Book Bits | 12.8.12
● Do You Need a Financial Adviser?
By Mark Nind
Summary via publisher, Memoir Publishing
While most financial advisers offer a valuable service to their clients, many people have stories about those who failed to understand their needs or were ignorant of useful products or important legislation. Yet blundering on without seeking the right advice can prove extremely costly. Mark Nind has worked in financial services for most of his working life and has seen the perils and pitfalls of investment planning from the points of view of the bank, the independent adviser and the customer. In this book he explains the financial adviser’s role clearly and objectively and gives valuable tips about when you should seek advice about what to do with your money, where you should go for it and how you should use
● The Janus Factor: Trend Follower's Guide to Market Dialectics
By Gary Edwin Anderson
Summary via publisher, Bloomberg/Wiley
The Janus Factor presents an innovative theory that describes how feedback loops determine market behavior. The book clearly shows how the theory can be applied to make trading more profitable. The metaphor of the two-faced god Janus is used to reflect alternating market environments, one dominated by trend followers and the other by contrarian bargain hunters. In this book, author Gary Anderson puts forth a systematic view of how positive and negative feedback drive capital flows in the stock market and how those flows tend to favor either sector leaders or sector laggards at different times.
● Lawless Capitalism: The Subprime Crisis and the Case for an Economic Rule of Law
By Steven A. Ramirez
Summary via publisher, NYU Press
The subprime mortgage crisis has been blamed on many: the Bush Administration, Bernie Madoff, the financial industry, overzealous housing developers. Yet little scrutiny has been placed on the American legal system as a whole, even though parts of that system, such as the laws that regulate high-risk lending, have been dissected to bits and pieces. In this innovative and exhaustive study, Steven A. Ramirez posits that the subprime mortgage crisis, as well as the global macroeconomic catastrophe it spawned, is traceable to a gross failure of law.
● After the Great Recession: The Struggle for Economic Recovery and Growth
Edited by Barry Cynamon, Steven Fazzari, Mark Setterfield
Summary via publisher, Cambridge University Press
The severity of the Great Recession and the subsequent stagnation caught many economists by surprise. But a group of Keynesian scholars warned for some years that strong forces were leading the U.S. toward a deep, persistent downturn. This book collects essays about these events from prominent macroeconomists who developed a perspective that predicted the broad outline and many specific aspects of the crisis. From this point of view, the recovery of employment and revival of strong growth requires more than short-term monetary easing and temporary fiscal stimulus. Economists and policy makers need to explore how the process of demand formation failed after 2007, and where demand will come from going forward. Successive chapters address the sources and dynamics of demand, the distribution and growth of wages, the structure of finance, and challenges from globalization, and inform recommendations for monetary and fiscal policies to achieve a more efficient and equitable society.
● The Global Economic Crisis and the Future of Migration: Issues and Prospects: What will migration look like in 2045?
By Bimal Ghosh
Summary via publisher, Palgrave Macmillan
A ground-breaking and sharply insightful book revealing the wide-ranging effects of the global economic crisis, the Arab Spring and the ongoing rebalancing of the world economy on international migration and its configuration. It debunks 'the business as usual' approach to the future challenge of migration and argues for a new approach to the issue. Following a critical discussion of the recession-led changes in migration patterns, practices and policies, the book depicts in some detail the changing landscape of South–North and South–South migration and presages how migration might look in 2045. In addition to presenting a carefully crafted set of policy prescriptions and practical measures to address the post-recession migration issues, the author shows how nations can turn the present crisis into an opportunity to lay an enduring basis for better management of human mobility and puts forward a bold proposal indicating exactly how this can be done.
December 7, 2012
Private Payrolls Rise More Than Forecast In November
Private payrolls increased by 147,000 last month on a seasonally adjusted basis, the Labor Department reports. That represents a considerably slower rate of growth from October's revised 189,000 jump, but today's number beat expectations by a comfortable margin. The consensus forecast compiled by Briefing.com, for instance, projected a lesser gain of 120,000. Meanwhile, the jobless rate reportedly fell to 7.7%. I don't pay much attention to this number—payrolls data is more informative for business cycle analysis. Nonetheless, it's hard not to notice that unemployment slipped to the lowest level in nearly four years. There's a lot of debate about the relevance of the unemployment numbers, but to the extent that this data tells us anything it's the direction of the trend, and for now that seems to be moving in a productive direction: down.
Meanwhile, the relatively upbeat news for payrolls isn't a total surprise after yesterday's favorable update on weekly jobless claims. Any one employment report, of course, is suspect and so it's wise not to read too much into today's data. But when we look at November's jobs picture in historical context, the trend continues to look encouraging.
The net gain in private payrolls last month represents a 1.8% rise from a year ago. That tells us that the economy's capacity to mint new jobs remains more or less unchanged vs. recent history. Since April, the annual rate of growth in private payrolls has closely hugged the 1.7%-to-1.8% range. That's mediocre compared with the glory days in the 1990s, when annual increases of 2.5% to 3.0% were common. But relative to the five years just before the Great Recession hit, 1.7%-plus looks decent.
In fact, it's the stability of the annual pace that is most encouraging. Everyone would like to see much faster job growth, of course. But the fact that private payrolls continue to grow at a steady rate that compares favorably with recent history is a strong clue for thinking that the labor market still has forward momentum. That's not everything when it comes to business cycle analysis, but it's a lot. Yes, next month may bring calamity, but today's number at least is dispatching a familiar refrain: slow growth.
“We’re making progress in the labor market,” says Michael Gapen, a Barclays economist. “We expect a return to a pace of hiring that suggests we’re moving in the right direction. It’s not as fast as policy makers would like, but employment is growing.”
There's nothing in today's jobs report that challenges that notion. Yes, the overall macro environment remains precarious for several reasons, starting with the present danger otherwise known as politicians in Washington who continue to argue over you know what. It wouldn't be difficult to come up with a lengthy list of things that could go wrong and derail the slow-growth train we're on. But for the moment, the incoming data hasn't surrendered to the darker angels of risk.
There are still a few numbers yet to come to complete the November economic profile, but it appears that we dodged a bullet last month once again. Is that a surprise? Actually, no--the numbers overall have been telling us for some time that recession risk is still low, as shown in the regular updates of The Capital Spectator Economic Trend Index, including this one from last month. How does the big picture stack up with the latest numbers through November? I'll have an update on Monday, but today's employment report gives us more number for the positive column.
December 6, 2012
Technical Analysis & Financial Advisors
More financial advisors are using technical analysis in their money management travels these days, including asset allocation. In the new issue of Financial Advisor, I profile the trend and ask some wealth managers why and how they're using TA: (Re)Discovering Technical Analysis.
Jobless Claims Fall To Pre-Hurricane Levels
New filings for jobless benefits fell again last week, offering another statistical talking point to argue that the dramatic surge in new claims for the week through November 11 was a temporary effect from Hurricane Sandy. Since then, claims have dropped for three consecutive weeks. The overall decline in the last three reports is substantial, pushing last week's claims data down to the range that prevailed before the storm hit, albeit on the high side of the pre-storm range. But for now, there's quite a bit more confidence for asserting that the claims numbers again suggest that slow growth for the labor market remains a reasonable outlook.
Exhibit A is last week's drop in new filings for unemployment benefits, which retreated by 25,000 to a seasonally adjusted 370,000, or slightly below the four-week average for the week ahead of the sharp increase in claims due to the storm. As today's press release notes, the biggest drop last week among the states was a 24,000 slide in New Jersey, which—according to the Labor Department—reported "fewer storm related claims, primarily from the construction, transportation and warehousing, manufacturing, trade, and accommodation and food service industries." By comparison, the biggest state increase was 5,000 in Wisconsin.
Turning to the unadjusted numbers on a year-over-year basis—a more robust measure of the trend for this leading indicator—we find that new claims across the U.S. generally continue to drop relative to year-earlier levels. For the third week in a row, weekly filings are falling on an annual basis, which amounts to a return to the prevailing pre-hurricane trend of the past three years. That's a strong signal on the side of optimism for thinking that the economy will continue to create new jobs on a net basis.
What's not to like? The unadjusted annual decline remains modest, with claims falling by roughly 6% last week vs. a year ago. The pre-storm trend was closer to a 10% drop. Nonetheless, the fact that new claims are again trending lower, albeit at a slower pace, is encouraging.
It's still too soon to argue that the claims data has returned to "normal." But the speculative cries of recent weeks from some corners that the early November surge in new filings was a sure sign that the labor market is collapsing is all but dead with today's report. Yes, there are other demons to worry about when it comes to assessing jobs growth, starting with the low pace of new hires. But arguing that the claims numbers clearly point to trouble continues to fade as a compelling narrative. That's no guarantee that we won't run into trouble in the weeks ahead, but based on the numbers in hand there's no smoking revolver here.
Dueling Forecasts: ISM Manufacturing & Services Indexes
Yesterday's update on the ISM Services Index delivered a positive counterpoint in the November estimate vs. the discouraging slide in the ISM Manufacturing Index. One of the indicators is feeding us misleading signals about the business cycle. The manufacturing index is warning, albeit mildly, that the economy is weakening. But the services data begs to differ.
“The consumer is carrying a lot more of the economic momentum into the end of the year, given the cautiousness of business leaders,” says Joel Naroff, president of Naroff Economic Advisors, via Bloomberg. "That bodes well for next year.”
For some recent perspective on the data, the chart below tracks the non-manufacturing (services) composite index (red line) and its manufacturing counterpart (black line). Note that the services composite index only dates to early 2008 and so I've included a related services metric—non-manufacturing business activity index (blue line)—that goes back to 1997. The main point is that the services sector data is trending higher while the manufacturing index has again slipped under 50, a sign that the sector is contracting.
It's quite possible that the manufacturing's darker message is genuine, in which case the relatively upbeat services trend is wrong and will soon dive south. For the moment, however, I'm inclined to give the services numbers the benefit of the doubt. Here's why. First, a rival purchasing managers index from Markit Economics also reports stronger data for November for the manufacturing sector. As the press release from earlier this week noted: "Manufacturing growth strengthens to five-month high in November."
A broad review of economic and financial indicators beyond purchasing managers indexes also suggests that the economy hasn't yet fallen victim to recession, as tracked by The Capital Spectator Economic Trend Index (CS-ETI), which I'll update soon.
It would be foolish, of course, to conclude that all's well and that the economy is sure to avoid a recession. That's obviously a risk, and for a number of reasons, ranging from the ongoing threat via the unresolved fiscal cliff factor to the general backdrop of slow growth that could deteriorate into outright contraction if another large negative shock strikes. But the numbers overall don't yet send a clear and unambiguous warning that a recession has started. That may be coming and we should be open to the possibility in the current climate. Certainly a number of metrics look wobbly, although it's unclear how much of this is temporary due to distortions from Hurricane Sandy.
History suggests that it'll take at least three or four months, at the earliest, before a high-confidence recession alert is signaled--if a downturn is in fact in progress. If we're moving toward such a turning point in the business cycle, the statistical evidence will begin piling up in the weeks ahead. If so, the ISM Manufacturing Index is a sign of things to come. But for now, it still looks like an outlier. When and if that changes, you'll read about it here.
December 5, 2012
November Job Growth Slows... Because Of Hurricane Sandy?
Private payrolls in the U.S. increased by 118,000 last month, according to the ADP Employment Report. As expected, that’s a slowdown from October’s 157,000 rise (on a seasonally adjusted basis). Many economists will chalk up the slower rate of growth to Hurricane Sandy’s negative influence. Maybe. For now, it’s a plausible argument. Nonetheless, today’s ADP number tells us to remain cautious on expecting anything other than a comparably lower rate of jobs growth when the Labor Department publishes the official November payrolls report on Friday.
"Superstorm Sandy wreaked havoc on the job market in November, slicing an estimated 86,000 jobs from payrolls," says Mark Zandi, chief economist of Moody's Analytics, the firm that crunches the ADP numbers. "The manufacturing, retailing, leisure and hospitality, and temporary help industries were hit particularly hard by the storm."
Not everyone agrees, but for the moment there’s not much to do but wait for the next number. If Friday’s Labor Department update is considerably weaker than expected, the business cycle outlook will darken further. Actually, the consensus forecast is already discounting a sizable slowdown in the government figures: a gain of around 95,000 for private payrolls in November, or half as much as October’s 184,000 pop. If that estimate holds up, Friday’s update will bend but not yet break the argument that payrolls have succumbed to the darker angels of the cycle.
What might change the dynamic to something more agreeable? A resolution of the fiscal cliff nonsense would help. Indeed, by some accounts, the economy still has a fundamental capacity for growth. “Outside of Sandy, I think businesses are still hiring,” opines Gus Faucher, an economist with PNC Financial Services. “There’s underlying job growth that’s strong enough to employ new entrants into the labor force as well as some of those who lost their jobs going into the recession.”
That’s an intriguing theory, but one that will take time to prove, or not. The next clue comes in tomorrow’s weekly jobless claims report. The consensus outlook sees more repair and recovery after the hurricane-related surge in new filings from a few weeks back. But the R&R is expected to be mild, with only a slight drop to 380,000 from the previous week’s 393,000. Better, but still sluggish enough to keep everyone guessing.
Will The Housing Recovery Survive The Fiscal Follies?
What are the arguments for thinking that the U.S. economy will remain on a slow-growth course and avoid a new recession? Unfortunately, there are fewer sources of statistical support these days, but the strongest ones—relatively speaking—remain payrolls and real estate. Today's estimate from ADP (scheduled for release at 8:15 am ET) is expected to post a slower rate of jobs growth for November, but not enough to challenge the notion that the economy is still growing. The nascent real estate revival is the other conspicuous point of optimism… if we can keep it.
Several studies over the years assert that quite a lot of the ebb and flow of the business cycle is closely linked to fluctuations in the residential housing market. For example, Ed Leamer a few years back asserted that Housing IS the Business Cycle and before that Richard Green demonstrated in econometric tests that housing is a strong predictor of GDP. The good news, then, is that a number of housing metrics are showing signs of positive momentum.
Several indicators tell the story, including rising housing starts and increased home sales. Even prices for houses have perked up. The median sales price of new homes sold recently rose above the $250,000 mark for the first time since 2007 before slipping back under that line in September and October. All of this comes from a low base, of course, but even modest progress on housing can pack a punch for the economy. Green wrote that "residential investment has a significant and positive effect on personal consumption." If so, that wasn't obvious in last week's update on personal income and spending numbers for October. But if the housing recovery rolls on, Green's research suggests that spending will find support.
It would be unusual to see a recession start during a housing recovery. Of course, that's assuming we still have a housing recovery. Everything's precarious, again, as the latest update on new home sales reminds. Maybe the current bout of tremors is only temporary. But before we can feel comfortable about housing's recuperative powers, there's a certain political logjam to resolve. Assuming Washington gets its act together, attention can turn once more to the numbers, including the big question: Will the housing recovery survive the attack on sentiment that's currently waged on the economy by our representatives in government?
December 4, 2012
A Long, Strange Season For Macro Analysis
Analyzing the business cycle in real time is a task that's always threatening to lead us astray, but in the current climate the hazard may go into overdrive. All the usual gremlins are with us, but there are additional complicating factors to consider these days, including: the uncertainty and high-stakes poker of the fiscal cliff negotiations in Washington; a recession in Europe that coincides with a (dormant?) fiscal crisis on the Continent; and deciding how, or if, Hurricane Sandy's lingering effects are distorting the incoming data.
Consider yesterday's auto sales news for November, which rose sharply to the highest annual rate in nearly five years. Is that a sign that the U.S. economy is chugging along? Or is the demand surge a one-time response to the hurricane, which unexpectedly cut short the working lives of thousands of autos in one fell swoop.
"Vehicle sales are one of the encouraging spots of our economy," notes Gary Bradshaw of Hodges Capital Management. But will the party last? That depends on how much of the demand surge is storm related. “November was a very good month, but December has the potential to be even better,” predicts Jesse Toprak, chief analyst for TrueCar.com.
Consider, too, the conflicting news on manufacturing for November. As I noted yesterday, the ISM Manufacturing Index delivered a warning to optimists with a below-50 reading, a signal that economic activity in the sector is contracting, albeit only slightly. But a rival benchmark from Markit Economics tells us that growth in the manufacturing sector strengthened last month.
Separating the legitimate signals from the anomalous ones is always a challenge, and it's not going to get any easier in the months ahead. I expect that we're going to see an unusually wide range of numbers as the economic updates roll in through the end of the year and into January. Prepare yourself for equally dramatic forecasts that purport to know what it all means with absolute certainty.
Don't misunderstand: There's plenty to worry about. But the numbers aren't uniformly awful, at least not yet. Meantime, there's another large uncertainty that may bring relief. Imagine that the fiscal follies in Washington ends and a reasonable deal is engineered. Would that unleash a wave of positive sentiment across America? Would it translate into a new round of positive economic momentum? Or is that merely wishful thinking? Again, hard to say until—if?—we see the details of any deal.
Expectations for the U.S. economy seem to be quite low—again. But we are in a strange period with little precedent. There's still only one solution: study a broad data set to make informed decisions. That's a terrible way to evaluate the economy… except when compared to the alternatives.
December 3, 2012
ISM: Manufacturing Activity Contracts In November
An early peek at economic activity for November tells us to keep our optimism in check. The ISM Manufacturing Index dropped to 49.5 last month, the first dip under the neutral 50 mark since August. In short, we have a new data point that turned negative for profiling the economy. Is it a robust sign that the economy’s tanking, or is this another head fake courtesy of Hurricane Sandy’s distortions on the economic trend? The answer—not to be confused with the speculation in the here and now—is waiting for us in the near-term future.
That won’t stop any one from worrying now, of course. No explanation needed. The ISM index slipped to its lowest level in three years by inching below August's reading by the smallest of margins. As dips under 50 go for this metric, last month’s swoon is modest. But in the current climate of recession in Europe and the potential for something similar in the U.S. (courtesy of Washington’s fiscal follies), no one needs an excuse to wonder how it all plays out.
"There are two ways of looking at this," Christopher Low, chief economist at FTN Financial, advises. "We had two months of growth and now we are back to contraction, that is one way. The other, which is a little more realistic is that since May the index has been very close to 50 and I think what we are seeing is that manufacturing has stalled and has yet to recover."
Deciding which fork in the road we're on will take time and data. For now, November’s economic profile is still mostly a blank slate, other than today’s disappointing number. The critical question: how does the incoming data compare? If we receive deeper confirmation that the trend in November is cracking, can we believe it? If so, will there be a snap-back effect from post-hurricane rebuilding and (dare we say it?) a resolution to the fiscal cliff follies in Washington? Or might sanity in government come too late to save the cycle?
There are several reasons to reserve judgment on stating outcomes at this point, including a rival benchmark’s conflicting message for the November read on manufacturing. “The expansion of the U.S. manufacturing sector gained traction in November, with the final Markit U.S. Manufacturing Purchasing Managers’ Index (PMI) rising to its highest level in six months,” Markit Economics also reports today.
One of these reports is misleading us. Which one? Stay tuned for the answer….
Major Asset Classes | November 2012 | Performance Review
The fiscal cliff is drawing closer in the US as the recession in Europe rolls on, but the major asset classes overall posted a modest gain for November. The Global Market Index (GMI) earned 0.8% last month and is up 9.8% on the year. The big winner in November: foreign stocks in developed markets as tracked by MSCI EAFE, which climbed 2.4% last month. But EAFE's fixed-income counterpart (Citigroup World Government Bond Index ex-US) was on the leading edge of losses, closely followed by REITS—each posting 0.4% declines. Otherwise, the month-to-date numbers were red-ink free.
For the year so far, the performance ledger has remained comfortably in the black for all the major asset classes. Cash, of course, continues to go nowhere fast, but risky assets have delivered varying shades of gain so far this year. By some accounts, it's an odd sight—broadly distributed profits for all the primary markets amid so much anxiety over what happens next for the big picture.
"Washington brinkmanship and a delay in reaching an agreement on the 'fiscal cliff' are likely to rattle markets," says John Praveen, chief investment strategist at Prudential International Investments Advisers. "These risks and uncertainties are likely to keep markets volatile."
The volatility so far in 2012 hasn’t been a problem. But if there's a price to pay for so much uncertainty, will December become the weak link in an otherwise profitable year?
December 1, 2012
Book Bits | 12.1.12
● Hedge Fund Analysis: An In-Depth Guide to Evaluating Return Potential and Assessing Risks
By Frank Travers
Excerpt via publisher, Wiley
I recently read an article printed in the financial press that questioned the viability of hedge funds as an asset class. Following the bear market decline and the corresponding volatile market environment, the article suggested that investors had begun to question whether or not hedge funds actually hedge and whether or not the asset class was doomed. Managers responded that it had become too hard to find profitable shorts, as all the best shorts quickly become crowded trades—which can lead to short squeezes.
The author of the article suggested that many hedge fund managers had become overconfident going into the market decline and had begun to invest outside of their core mandates and, even worse, did not do a good job of matching the liquidity of their fund’s underlying investments with that of their underlying investors....
What is most striking about the article (titled ‘‘Hard Times Come to the Hedge Funds’’) is that it was written by Carol Loomis and was published by Fortune magazine in June 1970.
● 3 Steps to Investment Sucess: How to Obtain the Returns, While Controlling Risk
By Rory Gillen
Excerpt via author's web site
Building an asset base from which you can earn income gives you choices later in life. My aim is that, when you close this book, you should be able to implement an easy-to-follow approach to investing in the stock markets, whilst minimising risk. No matter what level of experience you are starting from, this book is aimed at assisting you to obtain the returns on offer from the markets over time.
● Rethinking Valuation and Pricing Models: Lessons Learned from the Crisis and Future Challenges
Edited by Carsten Wehn, Christian Hoppe, and Greg Gregoriou
Summary via publisher, Academic Press/Elsevier
It is widely acknowledged that many financial modelling techniques failed during the financial crisis, and in our post-crisis environment many techniques are being reconsidered. This single volume provides a guide to lessons learned for practitioners and a reference for academics. Including reviews of traditional approaches, real examples, and case studies, contributors consider portfolio theory; methods for valuing equities and equity derivatives, interest rate derivatives, and hybrid products; and techniques for calculating risks and implementing investment strategies. Describing new approaches without losing sight of their classical antecedents, this collection of original articles presents a timely perspective on our post-crisis paradigm.
● Understanding the Culture of Markets
By Virgil Storr
Summary via publsher, Routledge
Although most social scientists recognize that culture shapes economic behavior and outcomes, the majority of economists are not very interested in culture. Understanding the Culture of Markets begins with a discussion of the reasons why economists are reluctant to incorporate culture into economic analysis. It then goes on to describe how culture shapes economic life, and critiques those few efforts by economists to discuss the relationship between culture and markets. Finally, building on the work of Max Weber, it outlines and defends an approach to understanding the culture of markets.
● The Handbook of Organizational Economics
Edited by Robert Gibbons and John Roberts
Summary via publisher, Princeton University Press
In even the most market-oriented economies, most economic transactions occur not in markets but inside managed organizations, particularly business firms. Organizational economics seeks to understand the nature and workings of such organizations and their impact on economic performance. This landmark book assembles the leading figures in organizational economics to present the first comprehensive view of both the current state of research in this fast-emerging field and where it might be headed.