June 26, 2016

“Should I Stay Or Should I Go?” was a 1982 song by the Clash.  For months, Brits have debated the question of whether to stay in the European Union (EU) ahead of a referendum vote held just this past week and nicknamed “Brexit,” a mashup of British Exit.  Germany and Britain are the two strongest members of the EU and the loss of either from the union would weaken it’s political and economic ties. In the U.K., the campaigns turned vicious and sparked the murder of an MP (story) earlier this month.  In the British Parliamentary system, an MP is similar to a Congressperson in the U.S. House.

In recent polling the advocates of separation, or Leave, appeared to be gaining momentum so that the outcome of the referendum vote seemed deadlocked at 50-50.  A poll in the last days before Thursday’s vote reassured many that cooler heads would prevail and Britain would remain with the EU. Leaders from both the right and left belonged to this coalition, appropriately named “Remain.”

At about 3-4 AM London time, 11 PM New York City time on Thrusday night, a third of the vote had been counted and it was eerily close, with the Leave group having a teensy-weensy lead.  Then half of the vote was counted and the Leavers were up 1% over the Remainers.  As the vote tally continued, it became apparent that – surprise, surprise – the Remainers had won the vote.

Asian markets were active at that time and responded with a severe sell off of risky assets like stocks and rushed into the safe haven of bonds, cash and gold.  Stocks were down as much as 12% initially on some Asian exchanges.  Gold shot up 6%. Neither the U.S. or European markets were open but the Futures markets in the U.S. sank 6% and European futures plunged 9%.

While most Americans were sleeping European markets opened about 8- 9% down. Market makers in Italy could not establish an opening price for a number of Italian bank stocks, which had already been under pressure in recent weeks.  When they did, these stocks had lost a third of their value.  Everyone was selling, few were buying.

The referendum vote still needs to be codified into law before the Brits formally notify the EU that the country is leaving. After that negotiations begin over the trade and diplomatic terms of exit, a process that could take two years.  A rational person might wonder why the panicked selling?  The worry is that this vote may provoke similar votes in other EU countries, which might lead to the eventual dissolution of the EU.  When in doubt, get out.  Traders did.

Earlier this month the WSJ reported that legendary (and semi-retired) investor and billionaire George Soros had returned to his trading desk to make a series of bearish bets on global markets in anticipation of both political and economic turmoil.  Soros became a household name when he made a $1 billion on a bet against the British pound in 1992.  In several hours Thursday night/Friday morning, the British pound lost 10% of its value.  Was this also another killing for Soros?  Soros thinks the break-up of the EU is inevitable (Story)

What should the long term investor do?  January’s dip of 5% was a good time to make an IRA investment.  This may be an equally good opportunity.

Income Growth

June 19, 2016

A few weeks ago (here) I wrote about trends in income growth and the difficulties of measurement because the growth of employee benefits and insurances are not included.  As a follow up, I thought I would show you a chart of per capita income using a natural log scale, which shows a growth trend more clearly.  In the graph below, we can see three distinct periods of growth:

1) the late 1960s through the mid-1980s, a period of strong growth following WW2;
2) a more moderate period of growth from the mid-1980s to the mid-2000s; and
3) a much more muted cycle of growth after the financial crisis and recession of 2007-2009.

On the right hand scale is the natural log of the Employment Cost Index, an index of total employee costs calculated quarterly by the BLS.  This series is only sixteen years old but it does show the steep growth of these hidden costs.

Our government at all levels chooses to pay for social programs by sliding the costs under the rug.  Politicians could tax everyone for the dozens of social support programs but Americans do not like paying taxes.  As a rule, Europeans are more willing to make sacrifices for programs that benefit the group, although attitudes are changing as European populations become more diversified.  People in general are less willing to pay into the group kitty when a society is less homogenous.

In America, there are fewer protests when politicians add program costs to the total value of a paycheck where employees do not see most of the costs. Workmen’s compensation insurance is a good thing but would voters be willing to pay 5% of their pay for it?  Maybe not.  The law is written so that the employer pays it and the employee never knows the amount.

The cost for workmen’s comp may be 10-20% or more in service and construction trades but only 1% for an office worker.  Some people argue that such a disparity is appropriate; those who work in more dangerous jobs pay more into the insurance system.  Employers are incentivized to create a safe environment for their workers in order to reduce costs.

On the other hand, the health of workers is a public cost.  If all employees were taxed equally, the danger premium would be spread evenly across all employees.


Savings Glut

Interest rates are near zero.  One year CDs from major banks pay 1% or less.  Interest rates have been falling since the early 1980s when savings accounts were earning an astronomical 12% or so. Interest rates are a price of sorts, the price a bank is willing to pay for someone’s savings.  Lower interest rates = lower price = less demand for savings.  So, people will respond to that lowered demand by putting less money in savings accounts and CDs, right?  Wrong.

As interest rates decline, people actually increase the supply of savings they want to give to banks. Why?  It seems counterintuitive till we take into account that the population is aging, and older people tend to get more conservative with their savings.  Secondly, a larger pool of savings is needed to earn the same interest income.

So we would expect that “safe money” savings would increase somewhat in the past decade.  However, the difference in the amount of savings is dramatically higher.  In the 15 year period from 1980 to 1995,  Money Market, savings accounts, and CDs grew by 50% per person.  In the subsequent 15 year period from 1995 to 2010, safe savings grew by 150%, triple the increase of the previous fifteen year period.

By keeping interest rates low, the Federal Reserve is trying to force the public to take more chances with their money.  Like the mule who resists going down a steep path in soft dirt, the American public stubbornly refuses to go where the Fed wants.  It may take at least another ten years before Americans forget the financial crisis and are willing to take on more risk.  The slow growth of this seven year recovery will persist until Americans lose their aversion to risk.

Caution: Under Construction

June 12, 2016

As we travel the highways this summer we are likely to encounter many construction zones as crews repair wear and tear, and the damage that results from the temperature cycle of freeze and thaw. There are a few hitches on the economic road as well.


I look to the Purchasing Manager’s (PM) Survey each month for some advance clues about the direction of the economy.  Like the employment report, this month’s survey contains some troubling signs.  I had my doubts about the low numbers in the employment report until I saw the results from this survey.  PMs in the services sectors reported a 3.3% contraction in employment growth so that it is now neutral, matching the lack of growth in manufacturing employment.

New orders in both manufacturing and services are still growing but slowed considerably in the services sectors.  The slowdown in both employment and new orders in the services sectors is apparent from the graph below.  While this composite is still growing (above 50), it has been below the five year average for four out of five months.

This recovery has been marked by, and hampered by, a familiar peak and trough pattern of growth. Last month I wrote:

 “A break in this pattern would indicate some concern about a recession in the following six months. What is a break in the pattern? An extended trough or a continued decline toward the contraction zone below 50.”

The CWPI, a custom blend of the various parts of the ISM surveys, shows a continued weakening that is more than just the periodic trough.  If there are further indications of weakness this summer, get concerned.



A few years ago the Federal Reserve introduced the Labor Market Conditions Index, or LMCI, a composite analysis of the labor market based on about twenty indicators published each month by several agencies. Because the report is released a week after the headline employment report, this composite does not receive much attention from policy makers, which is a bit of puzzle.  Janet Yellen, chair of the Fed, has indicated that she and others on the rate setting committee of the Fed, the FOMC, rely on this index when determining interest rate policy.

One business day after the release of this month’s unexpectedly weak employment report, the LMCI showed an almost 5% decrease and is the 5th consecutive monthly decrease in the index.

Although this composite is fairly new, many of the underlying indicators have long histories and enable the Fed to provide several decades of this index.  As a recession indicator, the monthly changes in this index tend to produce a number of false positives.  However, if we shift the graph upwards by adding 7 points to the changes, we see a familiar 0 line boundary.  When the monthly change in the index drops below 0 on this adjusted basis (actually -7), a recession has followed shortly.

We are not at the zero boundary yet, but we are getting close and the pattern looks ominously familiar.  Don’t play the Jaws music yet, though.

Housing Heats Up

June 5, 2016

In parts of the country, particularly in the west, demand for housing is strong, causing higher housing prices and lower rental vacancy rates.  For the first quarter of 2016, the Census Bureau reports that vacancy rates in the western U.S. are 20% below the national average of 7.1%.  At $1100 per month, the median asking rent in the west is about 25% above the national average of $870 (spreadsheet link).

With a younger and more mobile population, home ownership rates in the west are below the national average (Census Bureau graph). Housing prices in San Francisco have surprassed their 2006 peaks while those in L.A.are near their peak.  Heavy population migration to Denver has spurred 10% annual home price gains and an apartment vacancy rate of 6% (metro area stats).

From 1982 through 2008, the Census Bureau estimates that the number of homeowners under age 35 was about 10 million. These were the “baby bust” Generation X’ers who numbered only 70% of the so-called Boomer generation that preceded them.

Shortly before the financial crisis in 2008, a new generation came of age, the Millenials, born between 1982 and 2000, and now the largest age group alive in the U.S. (Census Bureau). Based on demographics, homeownership should have increased to about 13 million in this younger age group, but the financial crisis was particularly hard on them.  Starting in 2008, homeownership in this younger demographic began to decline, reaching a historic low of 8.8 million in 2015, a 15% decline over seven years, and a gap of almost 33% from expected homeownership based on demographics.

In response to lower homeownership rates, builders cut back and built fewer homes.  I’ll repost a graph I put up last week showing the number of new homes sold each year for the past few decades.

Look at the period of overbuilding during the 2000s, what economists would euphemistically call an overinvestment in residential construction.  Then, financial crisis, Great Recession and kerplooey!, another technical term for the precipitous decline in new homes built and sold. As the economy has improved for the past two years, the demand for housing by the millennial generation, supressed for several years by the recession, has shifted upwards.  More demand, less supply = higher prices.  This younger generation prefers living closer to city amenities, culture and transportation, causing a revitalization of older neighborhoods.  In Denver, developers are buying older homes, scrapping them off, and building two housing units where there was one. Gentrification influences the rental market as well as affordable single family homes and pushes out families of more modest means in some parts of town.

The housing market really overheats when rentals and home prices escalate at the same time. During the housing boom of the 2000s, many tenants left their apartments to buy homes and cash in on the housing bonanza.  Rising vacancies put downward pressure on monthly rents.  Move-in specials abounded, announcing “No Deposit!”, “First Month Free!” or “Free cable!” to attract renters. This time it’s different.

Rising rents and home prices put extraordinary pressure on working families who find they can barely afford to live in central city neighborhoods which offered low rents and affordable transportation.  They consider moving to a satellite city with lower costs but face longer commute times and additonal transportation costs to get to work.  Demographic trends shift more slowly than building trends but neither moves quickly so we can expect that housing pressures will not abate soon until the supply of multi-family rental units and single family homes increases to meet demand.



For the past four decades, household income has declined, as Presidential contender Bernie Sanders is quick to point out.  Some economists also note that household size has declined greatly during that time as well so that comparisons should take into account the smaller household size.  A recent analysis  by Pew Research has made that adjustment and found that middle class incomes had shrunk from 62% of total income in 1970 to 43% in 2015.

But, again, comparisons are made more difficult because some categories of income, which have risen sharply in the past few decades, are not included.  Among the many items not included are “the value of income ‘in kind’ from food stamps, public housing subsidies, medical care, employer contributions for individuals (ACS data sheet).  Generally, any form of non-cash or lump sum income like inheritances or insurance payments are excluded.  There is little dispute with the exclusion of lump sum income but the exclusion of non-cash benefits is suspect.  An employer who spends $1000 a month on an employee health benefit is paying for labor services, whether it is cash to the employee or not.

The lack of valid comparison provokes debate among economists, confusion and contenton among voters.  The political class and the media that live off them thrive on confusion. Those who want the data to show a decline in middle class income cling to the current methodology regardless of its shortcomings.



The BLS reported job gains of only 38,000 in May, far below the gain of 173,000 private jobs reported by the payroll processor ADP and below all – yes, all – the estimates of 82 labor economists. The weak report caused traders to reverse bets on a small rate increase from the Fed later this month.

Almost 40,000 Verizon employees have been on strike since mid-April and just returned to work this past week. On the presumption that a company will hire temporary workers to replace striking workers, the BLS does not adjust their employment numbers for striking workers.  However, most employers of striking employees hire only as many employees as they need to, relying on salaried employees to fill in.  Do strikes contribute to the spikes in the BLS numbers?  A difficult answer to tease out of the data. In the graph below we notice the erratic data set of the BLS private job gains (blue line; spikes circled in red) compared to the ADP numbers (red line; spike circled in blue).

Each month I average the BLS and ADP estimates of job gains to get a less erratic data swing.  The 112,000 average for May follows an average of 140,000 job gains in April – two months of gains below the 150,000 new jobs needed to keep up with population growth.  Let’s put this one in the wait and see column.  If June is weak, then I will start to worry.