Month: February 2016

Political Promises

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February 28, 2016

Heaven on Earth

The tax and spending policies proposed by Presidential contender Bernie Sanders were “vetted” by economist Gerald Friedman.  David and Christina Romer review Friedman’s assumptions and methodology,  finding the former unrealistic and the latter flawed. Christina Romer was former chair of the Council of Ecomic Advisors during the Obama administration.

Friedman assumes that Sanders’ income redistribution policies will spur a lot of demand in the next decade, 37% more than the Congressional Budget forecasts.  Real GDP will grow by 5.3% per year (page 7), erasing the effects of the 2008 financial crisis. Friedman also thinks that the productive capacity of this country is far below its optimum.  Therefore, all that extra demand will not lead to increased inflation, which would naturally put a brake on economic growth.  Employment will increase by 26% from the 2007 peak and, magically, all that extra demand for workers will not cause an increase in wages and inflation.

On page 8, the authors provide some historical context:  “Growth above 5% has certainly happened for a few years, such as coming out of the severe 1982 recession. But what Friedman is predicting is 5.3% growth for 10 years straight. The only time in our history when growth averaged over 5% for a decade was during the recovery from the Great Depression and the years of World War II.”

While GDP growth averaged over 5% during the decade after WW2, it was erratic growth spurred on by the inability of many families to buy many household items during the war.  It included one recession as well as phenomenal growth of 13% in 1950, and is unlikely to be replicated.

But we want to believe, don’t we?

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Labor Force Health Report

Yes, we’re busy so who has time to look at a lot of data to understand whether the world will implode tomorrow?  As an indicator, the health of the labor market is pretty good.  To take the temperature of the labor market we can look at the ratio of active job seekers to job openings.  At an ideal level of 100%, seekers = openings.  In the real world, there are always more job seekers than job openings.  When the percentage of seekers to openings is 200%, it is almost certainly a recession.  The economy rarely produces levels below 150%, which means that there are 3 job seekers for every 2 job openings.

Looks pretty good on a historical basis, doesn’t it?

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Women in the Workforce

Fact Check: Women make less than men.  In 2013, the BLS published a survey comparing the full time wages of men and women in the general population and by race.  In 2012, median weekly earnings for women were 81% of men’s.  Black and Hispanic women were higher, at 90% and 88%, but this may be due to the fact that Black and Hispanic men make less than white men.

Education levels have changed dramatically.  In 1970, only 11% of women had a college degree.  In 2012, 38% did, just slightly below the 40% average for the U.S.  A 2010 BLS study found that, in 2009, median weekly earnings of workers with bachelor’s degrees were 1.8 times the average amount earned by those with a high school diploma.  (They are comparing a median to an average to reduce the effect of especially high incomes).

What the BLS notes is that “the comparisons of earnings in this report are on a broad level and do not control for many factors that may be important in explaining earnings differences.”  We will never hear that on the campaign trail.  Academic caveats do not get voters fired up to go out and vote.  If a candidate is running on a platform of fixing income disparity (Democrats), we will hear quoted the report with the most disparity.  Candidates running who claim little disparity (Republicans) will quote a paper whose statistical assumptions minimize income differences.

A more distressing trend is that older women are having to work longer.  8% of women worked beyond retirement age in 1992.  The percentage has almost doubled to 14%.  The BLS estimates that, in ten years, 20% of women will be working past retirement age.

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Oil Rig Count

Almost half of the oil and gas rigs in the U.S. are located in Texas.  The 60% reduction in Texas rigs reflects the decline in total rigs throughout the U.S., according to Baker Hughes.  Rigs pumping oil account for 3/4 of the rigs shut down.

The oil “glut” is only about 1.5 million barrels of oil per day, less than 2% of the 2016 daily demand of 96 million gallons barrels estimated by the IEA.  Fewer rigs reduce downward price pressures and lately we have seen crude prices rise into the mid-$30s. With a long time horizon of several years or more, a diversified mutual fund or ETF like XLE, VDE or VGENX would likely provide an investor with some dividend income and capital gains. Could prices go lower?  Of course. After falling more than 40% in 2008, the SP500 stood at 900 at the end of December.   Investors who bought at those depressed levels might have felt foolish when the index dropped another 25% in the following months.  Those “fools” have more than doubled their investment in the past 7 years, averaging annual gains greater than 12%.

Capitalism and Politics

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February 21, 2016

Capitalism

Growing income inequality, and extreme disparities of wealth in a capitalist economy prompted this 2013 speech by David Simon, the writer of the HBO series “The Wire.”  Mr. Simon attributes the plight of an economic underclass to thirty years of unrestrained capitalism.

Simon confuses capitalism with politics. When the politicians and agencies in Washington amass ever more power and draw corporate lobbying money to Washington, that’s politics, not capitalism.  When taxpayers bail out big banks for making stupid bets, that is politics, not capitalism.  When large companies like Archer Daniels Midland and Exxon receive generous subsidies from taxpayers, that is politics, not capitalism.

Cronyism contaminates whatever political or economic system it infects, be it capitalism, socialism, communism or fascism.  Cronyism and factions have infected every human society from the Assyrians of 4500 years ago to the present.  Knowing how destructive these twin human traits were, James Madison, chief constructor of the U.S. Constitution, crafted a system of checks and balances to provide a legal boxing ring for the various factions to punch it out.

Simon sees the economy as a Manichean battle between capital and labor, a model first proposed by Marx.  The battle is more accurately described as a triangle of capital, labor and political power.  Capital and labor are the two productive components of the economy, vying for legal favors from politicians. Capital and labor must push and shove for a more advantageous place in a courtier’s line before the political princes and princesses, kings and queens in the capitols of the world.

With much of the productive capacity of the world weakened or destroyed by World War 2, most of the world’s capital flowed to the U.S., which became the economic engine of the world.  With little global competition, workers in the U.S. had strong bargaining power, able to win pay packages of $200,000 (in 2015 dollars) to install parts on an assembly line.  Public labor unions flexed their legal bargaining and striking power to win pension packages that paid them almost full salary for the rest of their lives.

With few challenges from the rest of the world, management at U.S. companies became undisciplined, unfocused and uncompetitive.  The big three automobile manufacturers influenced politicians who passed tariffs which protected the vehicles produced by those manufacturers.  Tariffs on imported pickups and cargo vans still insulate domestic manufacturers from competion.  Like the automobile manufacturers, aerospace companies like Lockheed cracked under the weight of inept business planning and execution.  The demands of their labor force added to the strains.  Crippled by chronic cronyism, New York slid into bankruptcy and sought a bailout from the Federal government.

In the 1950s and 60s, I grew up in a union family, in a union neighborhood in New York City.  I accepted the nepotism and bribery in the union shops where I worked.  They were a fact of life along with housing segregation and sex discrimination.  The building trades were riddled with union cronyism and “tips” to building inspectors. Repeated strikes by city workers made daily life unpleasant.  Trash piled up in the streets, mass transit didn’t work and it could take an entire day at City Hall to renew a driver’s license.

In the 1960s and 70s, whole sections of New York, Chicago, Detroit and Philadelphia were unsafe to walk in, to live in or to work in. Folks like radio and TV host Tom Hartmann and Senator Bernie Sanders find it convenient to leave out some history when they talk about the 60s and early 70s as a benchmark of fairness for working people.

In the 1970s, the problems of the past two decades were brought to a head by the oil embargo, the recession of 1973-74, wage and price controls, the Watergate scandal, and rising inflation that would near 10% by decade’s end.  In 1971, Lockheed was bailed out by the U.S. government, a precedent that would be followed by others in the coming decades.

As European countries continued to rebuild their manufacturing and financial capacities, Japanese manufacturers took advantage of a new technology, transistors, to build smaller and less expensive electronic TVs and radios.  Their automobiles posed a weak but growing challenge to the dominance of U.S. manufacturers. In 1979, the three cronies of U.S. capitalism – organized labor, capital and politics – renewed their pact when Congress bailed out the automobile manufacturer Chrysler.

In the 1980s, the financial industry, the “bookies” of capitalism, began a decades long courtship of politicians in Washington, competing with organized labor and capital for political favors. The decade began with back to back recessions, 8 – 10% interest paid on savings accounts, 9 – 10% mortgages (a deal!),  and small business loans at 14% (secured), or 21% (unsecured) interest rates.  Small business owners worked extra hard  to compensate for the high interest rates paid on business loans.

Several Social Security tax increases were passed, taking an every bigger bite out of paychecks and profits.  A lot of us muttered about taxes.  There were 10 to 15 tax brackets, none of them indexed for inflation so that most of a raise or some occasional overtime went to Uncle Sam.    For decades, fat cats had been using tax dodges – legally – to escape taxes.

Sensing a growing discontent among voters at the unfairness of the tax system, politicians deliberated for several years before passing a tax reform bill in 1986.  Although tax rates were reduced for the wealthy, they lost many of their tax shelters.  Any change impacts both the incompetent and the dishonest, but especially exposes those who are both incompetent and dishonest.  The loss of tax shelters revealed a large network of scams in the financial and real estate industries that ignited the Savings and Loan Crisis of the late 1980s and early 1990s.

Declining union membership coupled with the growing political influence of the financial industry meant that unions could no longer afford to keep up with capital in the scuffle for treats from Washington.  Politicians protest that they too are victims of the “pay to play” system of American politics but efforts to enact a system of public financing of elections have been unsuccessful.  Why?  Because the system fattens the wallets of too many politicians.  If a few do lose their gerrymandered seats, they often find jobs lobbying the very politicians who replaced them.

The task of politicians and partisans of both major parties is to first craft the problem. Is the problem 1) greedy capitalists, 2) the immoral redistribution of income, 3) an overabundance of regulation that is stifling business growth, 4) income inequality, 5) too much power concentrated in the Federal Government, 6) too much money in politics, 7) too much taxes, 8) too little taxes, 9) ineffective or inadequate Federal regulation?  Pick one, or pick several. Make up your own.  The problem is that people can not agree on the problems, much less the solutions.

The essence of capitalism is that it has one metric – the return on capital which directs the flow of capital.To the champions of capitalism, this simplicity of feedback is the virtue of capitalism.  To the detractors of capitalism, this primitive mechanism is a bane.  Socialist and communist planners insist that an elite can direct a society’s capital for the greatest good.  They offer a top-down approach in contrast to the bottom-up solution design that a capitalist system offers.  Because capitalism does not present a unified solution for a society’s problems, some people reach for socialist and communist solutions presented by the few only to find that those solutions benefit mostly the few.

Portfolio Stability

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February 14, 2016

Disturbed by the recent volatility in the stock market, some investors may be tempted to trade in some of their stock holdings for the price stability of a CD or savings account.  After a year of relatively little change, stock prices have oscillated wildly since China began to devalue the yuan at the beginning of the year.

Just this week, the price of JPMorgan Chase (JPM), one of the largest banks in the world, fell almost 5% one day then rose 7% the next.  Such abrupt price moves in a large multi-national company are driven less by fundamentals and more by fear.  As the price of oil fell below $30, hedge fund and investment managers began to doubt the safety of bank loans to energy companies, particularly those smaller companies whose fortunes have risen recently during the fracking boom.  Even if these types of loans were a miniscule portion of JPM’s total loan portfolio, investors remember that the financial crash began in 2007 with growing defaults of home loans that started a financial chain reaction of derivatives that blew up.  Sell, sell, sell, then buy, buy, buy.

Price stability is a term usually associated with measurements of inflation like the Consumer Price Index (CPI). A basket of typical goods is priced each month by the BLS and the changes in those prices are charted.  Each of us has a basket of investment goods that have varying degrees of price stability.  Stock prices vary a lot;  bond prices less so; house prices even less.  Cash type instruments like savings accounts and CDs have no nominal variation.

Each of us desires some degree of stability as we chug through the waters of our lives.  Like a ship we must make a tradeoff between speed and stability.  A stable ship must compromise between the depth and breadth of its keel, that part of the ship which is below water.  A deep keel provides stability but puts the ship at the risk of running aground in shallow water.  A broad keel is stable but increases the water’s drag, slowing the ship. (Cool stuff about ships)

It is no surprise that stocks provide the power to drive our investment ship.  Few investors realize that housing assets provide more power and stability than bonds.  We judge stability by the rate with which the price of an asset changes.  The slower the price change, the more stable the asset.  Over decades, residential housing has better returns and steadier pricing than bonds, although that might surprise readers who remember the housing bubble and its aftermath.

Many investors include the value of their home in their net worth but not necessarily in their investment portfolio and may underestimate the stability of their portfolio. Let’s imagine an investor with $750,000 in stocks, bonds, CDs, savings accounts and the cash value of a life insurance policy.  Let’s say that $375K is invested in stocks, $375K in bonds and cash equivalents.  That appears to be a middle of the road allocation of 50/50 stocks/bonds.  I will use bonds as a stand in for less volatile investments.

Let’s also assume that this investor has a house valued at $215K with no mortgage.  If we add in the $215K value of the house, we have a total portfolio of $965K and a conservative allocation closer to 40/60 stocks/bonds, not the 50/50 allocation using a more standard model.

We arrive at a conservative estimate of a house value based on the income or rental value that the house can generate, not the current market value of the house, which can be more volatile.  In previous posts, I have noted that houses have historically averaged 16x their annual net operating income, which is their gross annual rental income less their non-mortgage operating expenses. For real estate geeks, this multiplier is 1 divided by the cap rate.

Let’s use an example to see how this multiplier works.  Let’s say that the going rent for a modest sized house is $1600 per month and we guesstimate an average 30% operating expense, leaving a net monthly income of $1120.  Multiplying that amount by 12 months = $13,440 annual net operating income.  Multiply that by our 16x multiplier and we get a valuation of $215K.  Depending on location, this house might have a market value of $260K but we use  historic income multiples to calculate a conservative evaluation.

Our revised portfolio provides a more comprehensive perpective on our investment allocation and the stability of our “buckets.” During the past year, we may have seen a 5 – 10% increase in the value of our home, offsetting some of the apparent riskiness of a 10% or 20% move in the stock market.  Adjusting our portfolio assessment to allow for a home’s value might reveal that our stock allocation is actually a bit on the low side after the recent market decline and – quelle horreur! – we should be selling safer assets and buying stocks to maintain our target portfolio balance.  But OMG, what if stocks fall further?!  Then we might have to buy even more stocks to meet our target allocation percentages!  This is the essential strategy of buying low and selling high, yet it is so counterintuitive to our natural impulses.  We buy some assets when we are fearful of them.  We sell other assets when we think they are doing well.

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For anyone interested in housing as a business, the Wall St. Journal published a comprehensive guide, Wall St. Journal Complete Real Estate Investing Guidebook by David Crook in 2006. Recently, Moody’s noted that apartment building cap rates had declined to 5.5%, resulting in a multiplier of 18x that is above historical norms.

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Income Distributions

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February 7th, 2016

Updates on January’s employment report and CWPI are at the end of this post.  Get out your snowboards ’cause we’re going to carve the political half-pipe! (*v*)
(X-Game enthusiasts can click here)

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To Be Rich or Not To Be Rich

Every year the IRS takes a statistical snapshot of the almost 150,000,000 (150M) personal tax returns it receives.  There are some interesting tidbits contained in these tables that will put the lie to many a politician’s claim in this election season.  The IRS lists the number of returns for each of some twenty income brackets.  They also list the exemptions claimed for each of these income brackets and let’s turn to that for some interesting insights.

From Table 1.4 we learn that there were 290M exemptions claimed in the 147M tax returns filed in 2013, or almost two exemptions per return.  In 1995 (Table 1, same link as above) the number of exemptions claimed was 237M for 118M returns, exactly two exemptions per return. Exemptions are people that need to be fed, clothed, and housed.

Census Bureau surveys (CPS) over the past few decades show that households are shrinking.  Conservatives assert that median household income has stagnated simply because there are fewer people and workers in households today compared to the past.  If this were true, IRS data would show a greater decrease in exemptions over an 18 year period. We can’t say that one or the other data source is “true,” but that averaging data from the two sources probably gives a more accurate composite of income trends in the data.  Census data probably overcounts households while the IRS undercounts them.  Conservatives who advocate less government support will ignore IRS data that conflicts with their beliefs.

30% of the exemptions were claimed by tax returns with adjusted gross incomes (AGI) of less than $25,000, or less than half the median household income. (AGI is earned income and does not include much of the income received from government social programs.)  Only 2M exemptions, or 2/3 of 1%, were claimed by tax returns with an AGI of $1M or more.  Out of 315 million people in the U.S., there are only two million “fat cats” with incomes above $1,000,000.

Presidential contender Bernie Sanders tells his supporters that he is going to tax the rich to help pay for his programs.  IRS data shows just how few there are to tax to generate money for ambitious social programs. Mr. Sanders says he will get money from the big corporations.  Corporations with lots of well paid lawyers are not going to give up their money peacefully.

Instead, Mr. Sanders’ plans will rely on taxing individuals who can not erect the legal or accounting barricades employed by big corporations.  11% of exemptions were claimed by those making more than $200,000, a larger pool of potential tax money. Doctors, lawyers and other professionals will “Feel the Bern.”  It is not unusual for a middle class married couple in a high cost of living city like New York or Los Angeles to make $200K.  Mr. Sanders has his sights on you.  You are now reclassified as rich.

Here is a well-sourced analysis of the net cost to families.  Most will save money.  Unfortunately, Mr. Sanders made the political mistake of admitting that he would raise taxes, but…  No one paid attention to the “but.”  Should he win the Democratic nomination, Mr. Sanders will “feel the Bern” as Republicans use the phrase against him.  He might have used a phrase like “my plan will lower mandatory payments” to describe the combined effect of higher income taxes and no healthcare insurance payments.

The author calculates that the top 4% will spend a net $21K in extra taxes less savings on health care premiums.  The author probably overstates the effect on those at the top because he uses an average instead of a median, but we could conservatively estimate an additional $10K for those with AGIs in the $200K-$300K range.

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Earned Income Tax Credit

The Earned Income Tax Credit (EITC) is  a reverse income tax for low income workers, who get a check from the federal goverment.  For the 2014 tax year, over 27 million returns received about $67 billion from the government for an average of $2400 per receipient (IRS).  In inflation adjusted dollars, this is up 50% from the 2000 average of $1600.  The number of receipients has expanded 50% as well, growing from 18 million to 27 million.  Although Democrats often tout their support for the poor, it is Republican congresses that are largely responsible for expanding this support for low income families.  Republicans may talk tough but are more than willing to reach out a helping hand to those who are giving it their best effort.  There is a practical political consideration as well.  An analysis of IRS data by the Brookings Institute found that, in the past fourteen years, the poor have shifted from urban areas largely controlled by Democrats to the outlying suburbs of metropolitan areas, where Republicans have more support. In short, Republicans are taking care of their voter base.

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Constant Weighted Purchasing Index (CWPI)

The manufacturing sector, about 15% of the economy, continues to contract slightly, according to the latest Purchasing Manager’s Survey from ISM.  The strong dollar and a slowdown in China have dragged exports down.   Extremely low oil prices have impacted the pricing component of the manufacturing survey, which has reached levels normally seen during a recession.

 

For some industries, like chemical products, the low oil prices have boosted their profit margins.  Most industries are reporting strong growth or at least staying busy.  Wood, food, beverage and tobacco manufacturers and producers report a sluggish start to the year, as reported to ISM.

The services sectors have weakened somewhat in the latest survey of Purchasing Managers, but are still growing, with a PMI index reading of 53.5.  Above 50 is growing; below 50 is contracting.  The weighted composite of the entire economy, the CWPI, is still growing strongly but the familiar up and down cycle of the recovery is changing.  Both exports and imports are contracting

The composite of employment and new orders in the non-manufacturing sectors has broken  below the 5 year trend.  It may turn back up again as it did in the winter of 2014, but it bears watching.

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Employment

Each month theBureau of Labor Statistics  (BLS) surveys thousands of businesses and government agencies to compute the number of private and public jobs gained or lost during the month.  The payroll processing firm ADP also tallies a change in private jobs based on paychecks generated from thousands of its client businesses.  If we subtract government jobs from the BLS total, we should get a total number of jobs that is close to what ADP tallies.  As we see in the graph below, that is the case.

Economists, policy makers and the media look at the monthly change in that total number of jobs.  This change is miniscule compared to the 121 million private jobs in the U.S.  A historical chart of that monthly change shows that BLS survey numbers are more volatile than ADP.

I find an averaging method reduces the monthly volatility.  I take the change in jobs as reported by the BLS, subtract the  change in government employment, average that result with the ADP report of jobs gained or lost, then add back in the BLS estimate of the change in government employment.  This method produces a resulting monthly change that proves more accurate in time, after the data is subsequently revised by the BLS.  Based on that methodology, jobs gains were close to 175K in January, not the 151K reported by the BLS or the 205K reported by ADP.

There was a lot to like in January’s survey.  The unemployment rate fell below 5%.  Average hourly earnings increased by 1/2%.  Manufacturing jobs added 29,000 jobs, the most since the summer of 2013.  This helped offset the far below average job gains in professional and business services.  Year-over-year growth in the core work force aged 25-54 increased further above 1%.

The bad, or not so good, news: job gains in the retail trade sector accounted for 1/3 of total job gains and were more than twice the past year’s average of retail jobs gained.  Considering that job growth in retail was near zero in December, this may turn out to be a survey glootch.  Food services were another big gainer this past month.  Neither of these sectors pays particularly well.  The jump in manufacturing jobs probably contributed the most to lift the average hourly wage.

The Labor Market Conditions Index (LMCI) is a cluster of twenty or so employment indicators compiled by the Federal Reserve.  December’s change in the monthly index was almost 3%.  In the forty year history of this index, there has NEVER been a recession when this index was positive.

We are innately poor at judging risk.  We derive indicators and other statistical tools to help us balance that innate human weakness with the strength of mathematical logic.  Still, people do not make money by NOT talking about recession.  NOT talking does not pay commissions, does not generate the buying of put options, expensive annuities, and other financial products designed to make money on the natural gut fears of investors.  Next week I’ll look at the price stability of our portfolios.