It’s Only Money

September 24, 2017

Republicans in Congress hope that they can enact comprehensive tax reform that will lower taxes for individuals and corporations. The Congressional Budget Office estimates  that, under current law and before any tax reform, the current $20 trillion deficit will grow to $30 trillion by 2026. They recommend a combination of decreased spending and increased revenue that would amount to $620 billion (in current dollars) annually, about 15% of current Federal spending of $4.2 trillion. CBO’s goal is to achieve a level of public debt to GDP that is about 40%, the 50-year average.

Lawmakers struggle to cut even 5% of spending but let’s assume that they could accomplish that and reduce spending by $210 billion. That might be the easier task. The Federal government is currently collecting 18.5% of GDP in taxes, a few tenths more than the 18.2% collected during the Reagan years. The CBO says that the dollars collected is not adequate to meet the Federal government’s current level of spending and obligations and they project that annual deficits will increase over the next decade. The 70-year average of federal revenues is 17.5% of GDP.


Raising an additional $410 billion, or 10% extra in revenue, will require raising taxes or increasing GDP. Republican lawmakers and some economists hold fast to a theory that reducing tax rates will increase economic growth. To raise an additional $410 billion for a total of $4 trillion dollars, and collect the 50-year average of 17.9% of GDP in tax revenue, GDP next year would need to be almost $23 trillion, a whopping 20% increase from the 2016 level of $19 trillion. No amount of tax decrease will spur that much growth. A Republican Congress will not pass a tax increase.

In a recent Senate budget committee hearing, I was surprised to learn that half of the cost of corporate taxes is borne by the workers, as estimated by the Tax Foundation. The OECD finds that corporate income taxes are most injurious to people’s incomes and is why most developed countries have lower corporate tax rates than the U.S. These countries augment their revenues with a consumption tax, most often a VAT, or value added tax. Another surprise: consumption taxes are less of a burden to a worker than higher corporate taxes.

The founding of this country was instigated by a protest over a tea tax. In the Framer’s Coup, Michael Klarman relates the bitter debates over slavery and taxes at the 1787 Constitutional Convention. 230 years later, the debate over slavery may have ended but the debates over taxes are just as ferocious.

Since last November, the stock market has priced in the probable passage of tax reform by the end of this year or early next year. Republican lawmakers have been unable to repeal Obamacare and I think they will have an equal amount of difficulty passing tax reform.

CBO budget projections restrain the freedom of lawmakers to enact their favorite theories. Lawmakers are highly motivated to answer the whoops and hollers of their voters, many of whom may not be interested in the achingly dull but necessary procedures of budget craft. The parliaments of European governments can enact sweeping legislative changes that are difficult under our federalist system. The U.S. chose a different path of checks and balances embedded in a Constitution hammered out by compromise and a suspicion of human beings given legislative power. Time and time again we are reminded that those suspicions were well founded. Voters and lawmakers may become frustrated with the procedural obstacles of crafting legislation but the U.S. Constitution is the longest living Constitution because of those obstacles.

History lesson done. Stock investing lesson: don’t count your tax reform before it hatches.

Bull Runs

September 17, 2017

Lloyd Blankfein, the CEO of Goldman Sachs, commented recently (CNBC) that the length of this bull market has worried the traders at Goldman. Being a curious sort, I wondered how this bull market compared to previous ones. Wanting a big picture, I looked at the quarterly data for the SP500 index for the past sixty years. A lengthening sequence of quarterly closes above the three-year average is a reliable indicator of a bull market.

In the 1980s, the SP500 had a run of 19 consecutive quarters above its three-year average. That streak ended in the 3rd quarter of 1990, at the start of a mild recession that lasted until March 1991. The animal spirits of the stock market could not be contained for that long. After one quarter down, the market began another streak in the 4th quarter of 1990, a monster bull run of 40 consecutive quarters above the average until the first quarter of 2001.


The end of the dot-com boom, the start of a mild recession, then 9-11, the Enron and accounting scandals – all of it led to a 50% drop in the index. Almost three years later, the market finally closed above its three-year average. That began a 17-quarter bull run that ended March 2008.


People were getting woke to the reality that housing prices can go down. The neighbor living in the house behind my folks in NYC said to me, “I don’t know what’s going on. Housing prices are not supposed to go down.” As though housing prices obeyed a fundamental physical law like gravity. The bailout of Bear Stearns that first quarter of 2008 was just the beginning of a developing financial crisis that would cripple the global economy. In 2010 and 2011, market prices clawed their way above the 3-year average only to fall back.

Finally, in the last quarter of 2011, after the fitful resolution of the budget crisis, the SP500 broke again above its 3-year average. Since then the market has notched 24 consecutive quarters above that average. This latest bull run has beat every previous SP500 streak except for the 1990s run up.


This is what is worrying Blankfein and the traders at Goldman. Long bull runs in the past have ended horribly.  Like the bull run in the 1990s, there have been few negative, or corrective, quarters during this run.  Those are the quarters in red in the chart above. Some negative sentiment acts as a constraint on ever climbing asset prices.  For now, investors are convinced that inflation and interest rates will remain low, a prime environment for stocks.

Employment Trends

September 10, 2017

I’ll review a few notes from last week’s employment report and highlight some long-term trends. There’s good news and bad news.  Figuring out the future is tough because it hasn’t happened yet.  Heck, scholars still haven’t figured out what went on in the past.

The unemployment rates are computed from a Household Survey and is a self-reporting statistic. The answers of survey respondents are not verified. The monthly job gains come from a separate survey of businesses and the data is more reliable. One of the recession indicators I use is the change in employment from the business survey. I regard a 1% year-over-year gain as a minimum threshold for a stable or growing economy. 1% is about the rate of population growth. If our economy cannot keep up with population growth, that is a pretty sure indicator of a coming recession. Here is a chart of the past five years. Growth is still above 1% but there is a definite downward trend.


Here’s a graph of the past two recessions showing that crucial decline below the 1% threshold.


Due to higher manufacturing employment and higher population growth during the 1960s – 1980s, the recession threshold was closer to 2%. Here’s a graph of the 1970s to 1990s. The exception that broke the rule was the economic shock of the 1973 Arab-Israeli war. The oil embargo that followed straightjacketed the U.S. economy.


The NAFTA agreement signed in the early 1990s began an erosion of the manufacturing base and employment in this country. Still, the decline was rather mild until China was admitted into the WTO in 2001. The streamlining of ocean shipping and land transport of goods by cargo container reduced costs and catalyzed a mass migration of manufacturers and supply chains to China and southeast Asia.

Gains in construction employment are waning. A sustained plateau followed by a decline precedes every recession.  Notice that the growth is not in the actual number of construction employees but in the percentage of construction employment to total employment.


A plateau in construction employment began in April 2000 and persisted through one recession till the spring of 2003. In late 2002, there was talk of another recession. Fed chair Alan Greenspan continued to push rates down to 1% to ward off the boogie man of recession.


With unemployment as low as it is, wage growth should be stronger.  In the latter part of 2016 and earlier this year the hourly earnings of private employees sometimes pushed toward 3% annual growth. Since April, growth has stayed rock steady at a mild 2.5%.  It’s like some joker is laughing at the dominant economic models.

Speaking of predictive models, the Fed has discontinued the Labor Market Conditions Index (LMCI), a broad composite of 19 employment indicators. As a general picture of the employment market, it was satisfactory. As a predictive tool of developing trends, the Fed thought it was too sensitive. For those readers who would like a deeper dive, Doug Short of Advisor Perspectives examines the Feds remarks on this index.


Lloyd Blankfein, the CEO of Goldman Sachs, commented recently (CNBC) that the length of this bull market has worried the traders at Goldman.   Next week, I’ll compare this bull run with those of the past.


September 3, 2017

Hurricane Harvey invaded the lives, homes and businesses of so many people in Houston and the surrounding area of southeast Texas. People around the world watched the plight of so many who were caught in the rising waters. I was cheered by the dedication of first responders, by those who came from near and far to help with their boats, with food and clothing. I have never been in a flood. Some of those interviewed had been in several. Why do they stay there, I wondered? The answer is some or all of these: their family, their church, their job, their school, their culture.

Watching so many vulnerable people reminded me of my own. If given a few minutes to leave my house, what would I put in a garbage bag? In the urgency and stress of the moment so many people in Houston forgot their medications.  My list: Pets, papers, clothes, medications. Food? Will the shelter have food? Pet food, as well? Where are we going? Oops, what about a phone charger? And the laptop. What about the list with all the passwords? That too. What about the photos in the closet? I was going to get those scanned in and uploaded. No time now. Take a few of the smaller framed photos on the shelf in the living room. Out of time. Gotta go. All the questions that must have been bouncing around inside the heads of those forced to evacuate as the brown water took possession of their house.

If I don’t call it Climate Change, I could call it Flood Frequency, or Flood Freak for short. Here is a chart showing the increased frequency of flooding during the past century. This was from an article in the WSJ (paywall).

This week’s theme – vulnerability. The signs of it and what we can do to lessen it. Debt is a vulnerability. For the past three years, households have been increasing their debt load in mortgages, auto and student loans. Here’s a breakdown of household debt from the NY Fed. (As a side note, this report gives a breakdown of the different types of debt by credit score. For example, the median credit score for an auto loan is about 700).

Mortgage debt is more than 2/3rds of total debt. Despite the rise in home prices, more than 5 million homes, or 7%, are still badly “under water.” (Consumer Affairs)

Credit card debt has stayed stable for the past thirteen years. Households are only using 10% of their after-tax income to service their debt.


Despite low interest rates, households are continuing to deleverage, to decrease their vulnerability. The ratio of household debt – the total of that debt, not the payments – to income climbed above 2.5 in late 2007. It has fallen below 2.2 but is still high. We are still up to our eyeballs in debt.


Debt reduction will curb economic growth for the near future. According to several cabinet members, Trump is focused on GDP growth in discussions about trade policy, defense policy, infrastructure spending, and the regulatory environment. How does this or that policy get us to 3% growth? he asks.

2/3rds of the nation’s economy is based on the public willingness to spend money. Jobs helps. Higher wage growth helps. Low interest rates help. But without the willingness to take on more debt relative to income, policymakers may feel like they are trying to goad a stubborn mule to go faster. Tough to do.



Continuing the theme of vulnerability.  As a percentage of the unemployed, the number of long-term unemployed remains stubbornly high at close to 25%.  I call them the 27ers because 27 weeks of unemployment is the cutoff that the BLS uses to determine whether someone is categorized as long term unemployed. 27 weeks or six months is a long time to be actively looking for work and not finding a job.  Eight years after the end of the recession, today’s percentage of 27ers is at the same level as the worst of most past recessions.


During any recession the number of long term unemployed climbs higher. When these past few recessions have ended, the number of 27ers doesn’t start to decline.  Instead, they continue to increase and reach a peak several months after the recession is officially over. In the last three recessions, the peaks came later than previous recessions.

This more vulnerable cohort in the labor force struggles to recover after a recession.  Manufacturing is the more volatile element in the business cycle.  As manufacturing has declined, recessions are less frequent. However, manufacturing used to put a lot of people back to work at the end of recessions.  In a recovery, the service sectors are not as quick to add jobs.

The structural shift in the labor force will continue to leave more workers and families vulnerable and needing help just as many older workers are claiming retirement benefits. More than half of voters, both Republican and Democrat, have received benefits from at least one of the six entitlement programs (Pew Research). Elected officials offer promises of future benefits in exchange for taxes, and votes, today. When circumstances force a clash of priorities and promises, Congress seems incapable of resolving the conflict. President Trump’s approval ratings are in the low thirties, but his popularity far exceeds the public’s dismal ratings of Congress.

In a crisis, Americans come together to help each other but why do we wait till there is a crisis? Have we always been a nation of drama queens?  Maybe that’s the American charm.