The Coming Boom or Not

November 27, 2016

For most of Obama’s time in the White House, the Republican led House has fought more borrowing to repair the nation’s decaying infrastructure.  The incoming Trump administration has promised to fulfill a campaign pledge to spend $500 billion or more on these repairs. Funding this spending while reducing taxes may prove to be improbable.  A lack of available labor in parts of the country may stress the economies of some states.

In 2010, economists Robert Frank and Paul Krugman recommended additional infrastructure spending to take care of much needed repairs at low interest rates and an idle construction workforce.  In February 2010, the unemployment rate among construction workers was 27% (FRED).

Since early 2010 construction spending has increased by 42% (FRED).  As older workers in the field retire, the severe downturn in the housing industry dissuaded many young workers from entering the profession in the past decade.  Following the housing bust and the 2008 crisis, many workers native to Mexico left the U.S. to find lower paying work in their home country. Continuing high unemployment did not attact new migrant workers who would contribute to the productivity of the U.S. economy. A mood of hostility towards foreigners has furthered dampened the appeal of work in the U.S.  Only the desperate now risk the dangers of crossing the border.

While roofing companies struggle to find workers at $20 an hour, farmers are simply leaving crops to rot for lack of available workers to pick the vegetables and fruits.  Automated picking machines still can not tell ripe from unripe produce. As job openings go unfilled, employers cut back on plans for expansion.  After six years of paralysis and debate, fiscal stimulus may be achievable under a Trump regime.  Irony may have the final curtain if the extra spending is too much too late. Readers with a WSJ subscription can read more here.


Existing Home Sales

Sales of existing homes in October notched a recovery high at 5.6 million.  Home prices are rising fastest in the western states at a 7.8% clip.  Prices are now 50% higher than the country’s median. (NAR)  Volume increases of 10% are far outpacing the national yearly increase of 5.9%. Expect continuing price increases in the western states.

Mortgage interest rates have risen 1/2% but are still low by comparison with past decades.  The increase has prompted an uptick in refinances.  Higher rates will put homes in some neighborhoods out of reach for first time buyers as well as current owners who were hoping to trade up.

In the early part of 2008, the delinquency rate on single family mortgages rose above 5%.  During the 90s and 00s, the rate averaged a little over 2%.  Despite seven years of recovery, escalating home prices and extremely low mortgage rates, the delinquency rate just fell below 5% earlier this year.  In short, there is still a lot of pain out there.

On the other hand, credit card delinquency is at an all time low.  So are consumer loan delinquency. Consumer credit continues to grow but at a slower pace since the financial crisis.


Commercial Loans

Tightening lending standards for large and mid-size companies has proven to be a reliable recession indicator.   When the percentage of cautious banks grows above 25%, recession has followed within the year.

We can also see periods of doubt in this chart.  In late 2011 to early 2012 a short rising spike indicates a growing caution following the budget standoff in the summer of 2011.  In response to an economic dip in the beginning of this year, banks again grew more cautious.


Stocks make new highs

Stocks continue to rise modestly on hopes of greater economic growth, future profits, lower taxes and tax policy changes.  After more than a year of declining profits, price levels are a bit rich but may be justified if…  After spiking up on election night, volatility has fallen near year to date lows.   Traders have priced in the likelihood that the Fed will raise rates in mid-December.

Electoral College

November 20, 2016

Did you know that the U.S. has the highest Presidential voting record in the world?  100%.  No other country comes close.  How do we achieve this extraordinary participation rate?  The Electoral College (EC).

What the heck is the Electoral College and why doesn’t any other democracy use this system?  Firstly, the U.S. is not strictly a Democracy, in which people vote directly for their leader.  It is a democratic (small ‘d’) republic.  Within this republic, the states are semi-autonomous regions in a Federal alliance.  It is the states, not the people, who elect the President.

Each Prez election is a survey conducted by the state asking its citizens: who do you want the state to vote for in the Presidential race?  The survey is voluntary.  Each state has its own rules for participation in the survey.  Federal election law specifies a set of common rules that each state has to follow in conducting their survey.

Each state gets a certain number of Electoral College votes based on population.  The survey in each state simply tells the state what the wishes of the people are for President. There is no requirement in the Constitution that a state must follow the survey results, but each state has, over time, passed state laws that promise to abide by the will of the people in that state.

In 2000 and again in 2016, the Democratic candidate won the popular vote of all the states but lost the state by state vote in the Electoral College.  Some people in dense urban areas who vote Democratic would like to abolish the Electoral College.  If there were no college, Presidential  candidates could concentrate their campaign resources and promises to win the vote in the urban areas and largely leave the less populous areas of the country alone.

In the current system, a candidate must mount a campaign that involves and employs people in each state, a difficult if not impossible task.  The appeal and focus of the campaign must be broader than just urban or rural areas.  Resources and time are limited so a candidate must make critical choices regarding the deployment of those limited tools.

A candidate must surround him or herself with smart people who can:

1) organize and  deploy human and media resources within each state,
2)  organize the outreach for financial support,
3)  search for and identify undercurrents of sentiment and concern in each state,
4)  compact a message that will resonate with those sentiments and concerns,
5)  sample and analyze the ongoing responses to a candidate’s message.

There is an algorithmic strategy used in many fields called “win-stay, lose-shift.” The problem is commonly called the multi-handled bandit.  In a casino with many one-armed bandits what is the best strategy to maximize profits and minimize losses?  Mathematically, the problem may be insoluble but a reliable quasi-solution exists that is better than chance.  Stay with a particular bandit as long as it wins, then shift when it loses and start again.

Donald is a casino owner so he may be familiar with the strategy and used it quite successfully to conduct an unusual campaign.  A campaign has a number of characteristics – a saying or slogan (“Si se puede” or “Build the wall”), a policy (foreign trade or national security), an issue (abortion or honesty), or an attitude (impassioned, combative, or calm and reassuring).  A candidate feeds people’s sentiments into each of these characteristics like one would feed coins into a slot machine.  Now pull the handle.  If that theme pays off the majority of the time, then stick with it.  If it doesn’t, then shift.

Now here’s the brilliant part that Donald played whether he was conscious of it or not.  Every political bandit that was a loser for Donald Trump was not only abandoned but moved over to Hillary’s casino.  In many cases, she couldn’t win at them either.

Honesty?  Donald had a problem.  Load up the honesty bandit and move it over to Hillary’s casino. Let her feed people’s sentiments into that bandit and see if it pays off.  The woman issue?  Another non-paying bandit for Donald.  Again, move it over to Hillary’s side and let her see if she can win with the machine.  In both cases, she pulled the handles over and over again with only modest success.

Each Presidential campaign seems to bring some new innovation.  Successes are often incorporated into later campaigns.  Obama’s campaign was noted for its ability to raise money online with many small donations.  The campaign carefully tested the appearance of different web pages, measuring even the appearance of one click button over another.  Obama outraised his opponents in the 2008 and 2012 campaigns.   In the 2016 race, Hillary Clinton and her superPACS outraised Donald Trump almost 2:1, yet he won. (Bloomberg)

We should all wish that a President has a successful term.  Unsuccessful terms are usually accompanied by economic and military events that are not good for ourselves, our families, and our communities.  Whether Donald Trump has a successful term or not, he has certainly made a long lasting impact on future campaigns for President.  Who can be out with the first book?  Already CNN is advertising a comprehensive look at the election. As we put a bit more distance in the hindsight mirror, expect a number of books on the election.  Masters’ theses and doctoral dissertations will explore the many aspects of the campaign.


Election Autopsy 

After each Presidential election, those in the campaign business do an autopsy of both the losing and winning campaigns.  What worked?  What didn’t?  Dems need to ask themselves if they neglected the needs of everyday working Americans. In 2008, Obama promised that the needs, values and perspective of his grandparents, who raised him, would guide his decisions. Then he and his party started bailing out the banks, car companies and solar industry as many ordinary people struggled and suffered with job loss, home loss and bankruptcy. With majorities in both Houses, he fiddled with decades old Democratic dreams like healthcare and climate change while working class Americans felt discarded.

Some attribute the heavy Demcratic losses in 2010 to Obamacare but that was only a symbol for the larger betrayal that many Obama voters felt. Having control of both the Presidency and Congress is a mandate that a party can abuse.  It is given to that party to get something done fairly quickly.  When a political party uses it for pet projects, people turn away or vote the other way.  Many turned away in the 2010 election.  Six years later, Republicans control the majority of state legistatures, the governerships, the House and Senate.

As Majority House Leader, Nancy Pelosi certainly had a hand in the growing disaffection with the Party yet she insists that she should continue in her role as Minority Leader.  Her strength as a formidable fund-raiser may prove to be the winning card that trumps her past errors.



A familiar meme on social media is that there is a vaccine conspiracy between pharmaceutical companies and the government who force parents to vaccinate their children and pad the pockets of Big Pharma.  The U.S. has a policy of giving infants and children more vaccines than any other developed country.  Do pharmaceutical companies make millions off vaccines? You be the judge.

The PVC13 vaccine given to older people costs the provider $16 per dose (CDC Price List). In March 2016, the discounted price from Kaiser was $313 for the vaccine alone. The labor to give the vaccine was a separate line item. That is a 2000% markup on the vaccine itself by Kaiser, not the manufacturer.

It is the providers who administer the vaccines who make the money.  Investors who own the stocks of a pharmaceutical company often pressure the company to get out of the vaccine business because most vaccines are low margin products and yet carry partial liability.

If the pharma companies don’t want to bother making many vaccines, should the government simply build their own vaccine manufacturing labs?  Patents and other intellectual property could be a hurdle but Congress could arrange to purchase them or use eminent domain to set a price and seize the intellectual property.


Retail Sales

Average = Strong.  When growth is rather anemic, a return to average seems strong.  In October, retail sales rose 4.3% above October sales in 2015, a welcome bump up from the lackluster growth of the past two years.  Last month I showed that recent sales growth less population and inflation growth has been negative or close to 0.

The stock and bond markets have been shifting money around in anticipation of fiscal stimulus and more relaxed regulation from a Republican Party in control of the levers of government.  Small business stocks (VBR) are up more than 10% and financial companies (XLF, VFH) have shot up about 12%.  Consumer discretionary stocks (XLY, VCR) are up about 4% while the more defensive consumer staples stocks (XLP, VDC) are down 2%. Oil stocks (XLE, VDE) are up about 3%.

Will consumers put aside their cautions and spend more?  Active stock managers are certainly hoping so.


Ideas for IRA contributions

Emerging market stocks are still up 8% YTD after falling more than 6% in November.  Much of that decline has come on the heels of Trump’s election win.

A broad bond index has fallen almost 4% in the past few months.

Election Volatility

November 13, 2016

Sometimes the hardest thing an investor can do is nothing.  That’s pretty much what a casual investor with a balanced portfolio should do in response to the election results.  With a portfolio of 57% stocks and 43% bonds and cash, my total portfolio has risen 1/2% this week, or much ado about nothing.  Let’s dig into this week’s election results and the market’s reaction.

Donald Trump, the President-elect, has long maintained that his campaign was a movement and was proved right this past Tuesday.  White voters from rural districts around the country rallied in strong numbers to Trump’s promise to straighten up Washington.

Voters generally want a change of direction after one party has occupied the White House for two terms and this election proved to be no different. In the modern era of politics, only H.W. Bush was able to gain a 3rd Presidential term for the Republican party in 1988 after two terms of Ronald Reagan.  Countering the emotion and momentum of the Trump movement on the right were the voters on the left who passionately turned out for Bernie Sanders in the Democratic primaries.  Voters and superdelegates chose the establisment candidate, Hillary Clinton.  Some say that the process and the rules favored Clinton over Sanders.  His supporters are convinced that Sanders could have beat Trump.  Movement against movement.

In the past decade, voters have expressed a preference for rallying cries, for mantras of momentum like “Si se puede!” (Obama), “Build the wall!” (Trump) and “Medicare for all!” (Sanders).  Candidates must learn to condense their message into a short slogan that can be easily waved.  McCain, Romney and Clinton never found a verbal cadence that would act as a catalyst for voters to enthusiastically join the parade.  Sarah Palin, McCain’s Vice-Presidential candidate in 2008, understood the need for slogans.

 Note to future Presidential candidates who would like to actually win:  criticize the candidate, not that candidate’s supporters.  Hillary Clinton made the same mistake that Romney made in the 2012 election – disparaging their opponent’s voters.

Election night.  As a Trump victory became increasingly probable, global markets began to sell risk (stocks) and buy safety (bonds).  In the early morning hours after the polls closed, the networks called the state of Wisconsin for Donald Trump and put him over the threshold of 270 votes in the Electoral College.  Several  minutes later, about 2:45 AM on Nov. 9th, we learned that Hillary Clinton  had called Donald Trump to concede and wish him luck.  Dow Futures were down about 4% at that point.  Japan’s stock market was down 5.5%.  The yield on the 10 year Treasury note was down 7.22%, meaning that the price was up about 8% as investors in world markets were seeking the safety of U.S. debt.  Emerging markets fell in anticipation of protectionist trade policies under a Trump administration.

About 3 A.M.  President-elect Trump began to give a sedate and rational acceptance speech that began with a gracious nod to Hillary Clinton’s fight.  He spoke of unity, healing and more importantly, infrastructure spending and tax cuts.  With control of the Congress and Presidency in Republican hands, there was real hope that Washington could end the years of stalemate and finally implement fiscal policy to rescue a economy that had been kept afloat by an exhausted monetary policy for six years.

The overseas markets began to turn around.  By the time U.S. markets opened more than six hours later, stocks and Treasuries had reversed.  Stocks were now off less than 1/2% and Treasury prices were down severely.  TLT, a popular ETF for long term Treasuries, opened about 2% lower, a price swing of 10%.  EEM, a composite of Emerging Market stocks, opened up almost 3% down and lost ground during the trading session.  By week’s end the SP500 had risen 3.8% for the week, and EEM had fallen by that same percentage.

This week’s action in the bond market was a good example of the mechanics of bond pricing so let’s look at the price action and what it says about the future guesses of the direction and extent of interest rates.  First, bond prices move inversely to interest rates.   The extent that these prices move is measured by a bond’s duration.  Here is a link to the iShares page for the TLT ETF on long term Treasuries.  I have captured a section of the page with the duration highlighted.

If you have a bond fund, the mutual fund company will state the bond duration as well.  What does this tell you?  Leverage.  Duration tells you the approximate change in price for a 1% change in interest rates.  In this case, a 1% increase in interest rates will generate about a 17% decrease in price.  Because TLT is a composite of long term Treasuries, its price is more sensitive to changes in interest rates, or the consensus on interest rates six months to a year in the future.  The price of TLT fell 7.4% this week as traders repriced future interest rates.  With some grade school math, we can calculate what traders are guessing interest rates will be a half year to a year from now.

The Fed last raised rates at the end of 2015, putting them at approximately 1/4% – 1/2%.  In July, the price of this ETF was about $142.  It closed this week at $122, a decline of 14% from the summer high. Now we divide the 14% by the bond’s duration of 17.41% to get a ratio of .80.  This is the new guess of how much interest rates are likely to rise – approximately 3/4% – 1%.  By the fall of 2017, traders are betting that the benchmark Fed interest rate will be about 1.25% to 1.5%.

Let’s look at a more balanced composite bond ETF that financial advisors might recommend for casual investors.  Vanguard has a more conservative composite ETF whose ticker symbol is BND, with a duration of 5.8, about a third of the TLT ETF. (Spec Sheet here)  This week BND lost almost 2% and is down almost 4% from its summer high.  When we divide 4% by 5.8% (the duration in percentage terms) we get a guess of about a .7% raise in interest rates.  Because BND contains shorter term bonds, this guess is slightly below that of TLT.

Why are traders betting on more aggressive interest rate increases after Donald Trump was elected?  He has spoken about infrastructure spending and tax cuts, two fiscal stimulus programs that will likely spur inflation upward.  With a Republican party that has control of the Presidency and both houses of Congress, these measures are likely to be passed in some form.  Some sectors of the economy will likely benefit from more infrastructure spending so they rose this week.  Shares in technology giants like Apple and Google fell as traders switched money among sectors but are still up by healthy margins since February lows.

Let’s say that next March comes and the Trump White House and the House Budget Committee can not come to terms on either of these programs.  Investors would likely reprice interest rate expectations and lower them, causing the price of bond ETFs or mutual funds to rise.


Miscellaneous Election Notes

I’ll share a distinction that NPR’s David Folkenflik made this week.  Those on the left took Donald Trump literally, but not seriously.  Those who voted for him took him seriously, but not literally.

During Thursday’s trading the Mexican peso fell to 15.83 per dollar, the lowest since 1993 when Mexico reset their currency. Why the big drop?  Trump has repeatedly said that he would cancel the NAFTA agreement that binds Mexico, Canada and the U.S.  The NAFTA agreeement requires only a 6 month notification before termination.  There is some disagreement whether the White House would need Congressional approval to cancel NAFTA which might delay the action.  Some in the Republican party like free trade agreements and are likely to put up a fight.  Some analysts think that the devaluation of the peso could lead to a recession in Mexico, which was already under economic pressure due to falling oil prices.

131 out of 231 million registered voters cast their vote in this election, slightly below the voter total in the 2008 election. (538)  Trump and Clinton each took 26% of registered voters.

The Trump White House can reverse Obama’s executive action on the Keystone pipeline and re-initiate construction.  It will likely amend or repeal tentative proposals to mitigate climate change.

Why did pre-election polls get it so wrong?  According to Pew Research, more than a third of households would respond to a survey a few decades ago.  Now it is only 9%.  Statisticians must tweak this rather small sample to make it more representative of the population as a whole.  A particular demographic constituent in the sample – say white working class men – might be underrepresented in the survey.  Survey methodology then gives the opinion of relatively few sample respondents more weight than it actually has in the general voter population.

Some statisticians recommend using economic and demographic algorithms to gauge future election results based on actual past voting records.

Of the 700 counties that voted for Obama in 2012, a third of those voted for Trump in 2016.  Polls indicated that Hillary Clinton would capture the majority of the white college-educated vote for the first time in decades but she failed to do so.  More white voters voted for Obama than Hillary.

A third of Democrats in the House come from just three states:  California, New York and Massachusetts.  This concentration may answer to the concerns of those states but indicates that the party has become out of touch with the voters in many states.

Each time a Democratic candidate is elected President, unfounded rumors circulate that the new President will take away people’s guns.  People rush out to buy guns.  Trump’s surprise win caused the stock of gun maker Smith and Wesson to decline 22% in a couple of days.

On the other hand, many women feared that Trump and a Republican Congress would restrict birth control and stocked up in the days after the election. Here is a map of abortion regulations in the states before the 1972 Supreme Court’s decision in Roe v. Wade.  Abortion was more permitted in the southern states than the northeast states.

Here‘s a state-by-state breakdown of the vote from NPR.

Small Business Uncertainty

November 6, 2016

Small Business Survey

The uncertainty index in the recent NFIB (National Federation of Independent Businesses) surveys has been at its highest in the past forty years.  Except for one high point in 2012, every high in this reading has been followed by a recession.

This index is compiled from responses of “I don’t know” to six questions about future sales, employment, economic conditions, and business expansion. Small businesses typically pause in the face of uncertainty, holding off on hiring and capital outlays. They must be alert to the underlying climate of their particular market or go out of business.

The previous highs in uncertainty were set in late 2006 and early 2007 as the housing bubble was cooling off.  A recession followed in late 2007 that lasted till June 2009. In the late part of 2000, near the end of the dot com bubble, a high in this uncertainty index preceded a recession in the early part of 2001, and a two year downturn in the market.

A high uncertainty reading in late 2012 was a combination of concerns about slow growth. Starting in September 2012, the Federal Reserve responded with QE3, a monthly program of bond buying to spur growth and avoid recession.

When the canary sings, pay attention.


Retail Sales

Weak sales growth underlies current business concerns.  September’s year over year (y-o-y) growth was 2.2%.  After adjusting for inflation and population growth, sales growth was negative and has been less than 1% for two years.  As I noted last week we are at the edge of a plateau.  We either fly or fall from here.

The chart below shows retail sales less food services like bars and restaurants, and is adjusted for inflation and population growth.  In 2015, analysts attributed the y-o-y growth to the decline in gasoline prices, which began in the middle of 2014. Economists were asking why people were not spending the money they were saving on gas. This year’s y-o-y growth rate has little influence from gas prices, which have been higher for part of this year.  People are not confident enough to increase their spending.


Individual Stocks

Casual investors are encouraged to invest in broad categories of stocks rather than individual stocks, in order to minimize the effect, good or bad, of any one stock.  We are in the middle of earnings season for the 3rd quarter and I thought I would point to an example of the price volatility that an earnings announcement can generate.

We expect volatility from smaller companies so I will look at a “hyuge” (as Donald would say) company like Microsoft, the third largest company in the world.  During the past year or so, owners of Microsoft shares have seen some gut wrenching price moves on the day when Microsoft announces its quarterly results.  On April 24, 2015 the stock jumped 10% in reaction to first quarter results.  Disappointing second quarter results led to a price drop of almost 4% on July 22, 2015. Another 10% jump in response to third quarter results on October 23, 2015.  April 22, 2016 saw a 7% drop, July 20th a 5% gain, and a 4% gain on October 21st.

The tech sector can be more volatile than the Consumer Staples (Proctor and Gamble) sector, for example. An investor who owns shares in a company should be prepared for occasional volatility.  A good rule of thumb is that the value of one company’s stock should be no more than 5% of an investor’s portfolio. A safer rule might be 5% of one’s stock allotment.  If stocks were 50% of an investor’s portfolio, then 5% of that would be 2.5% of the total portfolio.

A broader view

Here’s an interesting viewpoint by someone who argues that the stock market has plenty of room to run.  However, the SP500 index has gained an average of 11% annually for the past seven years. This is far above the 6.5% annual price gains of the past twenty years, and the 7.4% yearly gains of the past thirty years.  Reaching back even further, a forty year time span shows 7.85% yearly gains. However, we should take into account the much higher inflation rates of those earlier decades.  Adjusted for inflation those annual gains would be much lower, making the comparison with the past seven years even more dramatic.

We like to think that “this time is different,” that the rules have changed.  After a sobering decline in equities, we resolve not to be fooled again and then…we forget once again.  We tell ourselves yet again that it really is different this time.  Shakespeare made his living reminding us of our follies.  We read his tragedies, his comedies and we think yes, but that was so long ago and so much has changed since then.  What hasn’t changed, what remains persistent is the nature of human beings and the eternal constant, the Law of Averages.

Constant Weighted Purchasing Average (CWPI)

October’s surveys of Purchasing Managers across the country, the PMI, edged down slightly from last September’s upward surge.  The CWPI composite of the manufacturing and non-manufacturing PMI surveys remains at the bottom end of healthy expansion and barely below the index’s five year average. This index has had a cyclic peak and trough pattern for most of the recovery, peaking at a strong growth level, then falling to a trough that was still above the neutral line between expansion and contraction.  Since February, the index had drifted in a plateau of healthy growth.  We wait and see.