Author: sgstofka

The Active and the Inactive

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October 4, 2015

A disappointing September jobs report capped off a third week of losses a rescue from a third week of losses in the stock market.  The initial reaction on Friday morning was a 1.5% drop in the SP500. Over the past several weeks, the stock (SPY) and long term Treasury market (TLT) have become little more than speculative gambles on when the Fed will raise interest rates.  Until Friday’s jobs report, the choices were mainly restricted to October or December 2015. Janet Yellen voiced a commitment to raising interest rates this year in comments (see last week’s blog) at the U. of Massachusetts.  However, the lackluster jobs report ushered in another choice – March of 2016.  By the closing bell on Friday, the SP500 had gained 1.5%, a reversal of 3% on the day and a gain of 1% in the index for the week.

Emerging markets bounced up almost 5% this week, showing that there are enough buyers who are willing to invest at these low price levels.  The Vanguard ETF VWO formed a “W” pattern on a weekly chart and strong volume.

Despite the tepid job growth of 142,000, the unemployment rate remained steady because more than 300,000 left the work force.  Probably the biggest surprise was that July and August’s job gains were revised downward as well.  I had been expecting an upward revision in August’s numbers.

The Labor Force Participation Rate (CLF) declined .2% to 62.4%.  The CLF rate measures the (number of people working or looking for a job) / (number of people who can legally work).  There is another measurement that I have used before on this blog: the ratio of (people not working or looking for a job) / (the number of people working).  Let’s call it the Inactive Active ratio, or IARATIO.

Visually, the blue CLF rate doesn’t show us much; it is a relatively monotonic data series.  In contrast, the decades long fluctuations in the red IARATIO present some useful information.  We can see a simple answer for the federal budget surplus at the end of the 1990s, when the ratio of inactive to active workers was very low. Although politicians like to claim and blame for every data point, the simple truth is that there were almost as many adults working as not working in the late ’90s. Working people tend to put in more than they take out of the kitty.  For two decades there was a striking correlation between the Federal Surplus/Deficit and the IARATIO.

At about .75, the ratio of this past recovery was similar to that of the first half of the 1980s.  In the past two years, the IARATIO has dropped to .72, a good sign,  similar to the readings of 1986, a time of economic growth.

The ever greater number of Boomers retiring over the next decade will put upward pressure on this IARATIO.  The fix?  More jobs. Jobs solve a lot of problems, both for families and government budgets.

The Phillips Curve

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September 27, 2015

Worries about economic growth in China, in the EuroZone and in emerging markets have prompted fears of a recession in the U.S.  It could happen – it will happen – at some point in the future but not in the near future.  The Fed likes to use a Personal Consumption chain weighted inflation index called the PCE Price Index which more reliably captures underlying inflation trends.  Preceding each recession we see the rate of economic growth fall below the annual growth rate of the PCE index, multiplied by a 1.5 factor.  While GDP growth is not robust, it is far above the growth of the PCE price level.

Speaking of growth, inflation-adjusted GDP growth for the second quarter was revised upwards to a 3.9% annual rate.  Consumer spending was revised higher and inventory growth – a bit worrisome, as I noted earlier – was revised lower.

The SP500 index began the year at a price level ($2068) that was just a bit above the inflation adjusted price level ($2018) of 2000 (Graph here).  Oops! we’re back below that year 2000 level. A sense of pessimism since mid-August has led to an 8% decline in the broad stock index, or 6% below the price level at the beginning of 2015.  A broad composite of bonds, Vanguard’s BND ETF, is also down -about 1.5% – since early 2015.

Some sectors of the market can not find a bottom.  XME, a blend of mining stocks, is down 45% for the year.  Brazil’s index, EWZ, is down a similar amount – about 40%.  Emerging Market stocks (VWO) in general have lost about 17% this year, and are at June 2009 prices.  After losing 5% of their value in the first week of September, they appeared to have found a bottom, regaining that lost 5% in the next two weeks.  This past week they gave up those gains, touching the bottom again.  The second time is a charm.  If this market draws in buyers a second time, this might be a good time to put some long term money to work.

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Phillips – the curve, not the screwdriver

In a speech/lecture at U. of Massachusetts this week, Federal Reserve Chair Janet Yellen voiced her desire to raise interest rates sometime this year.  She included in her remarks some comments on the Phillips curve, a mainstay of economics textbooks during the past 50 years.  In the 1950s Bill Phillips presented one hundred years of unemployment and inflation data in the United Kingdom and showed that there was a trade-off between unemployment and inflation.  Higher inflation = lower unemployment.  Lower inflation = higher unemployment.  When the number of unemployed workers are low, workers can press employers for higher wages.  Higher wages lead to a higher inflation rate.

As you can see in the graph above (included in the Wikipedia article on the Phillips curve), the regression estimate, the red line, shows a tenuous inverse relationship between unemployment and inflation.  The standard error S of the regression estimate is a guide to the reliability of the estimate to predict future relationships in the data. The S in this regression is not shown but looks to be rather large; a lot of the data points are pretty far away from the red estimate line and so the regression model is unreliable.

Within fifteen years after the Phillips curve became an accepted tenet of economics, the stagflation of the 1970s disproved the central thesis of the Phillips curve.  During that decade, there was both high inflation and high unemployment.  This led economists to revise their thinking; the relationship described by the Phillips curve may have some validity in the short run but not in the long run.

For those of you who might like to go down the rabbit hole on this issue, there are several fascinating but challenging perspectives on the relationship between unemployment, the labor market, and inflation, the price level of goods in an economy.  One is Jason Smith’s Information Transfer model version of the Phillips curve.  Jason is a physicist by education and training who uses the tools of information theory to bring fresh insights to economic data, trends and models.

Roger Farmer (whose blog I link to in my blog links on the right hand side) has developed another perspective based on a sometimes overlooked insight in Keynes’ General Theory published in 1936. Roger is the Department Chair at UCLA’s Dept of Economics.  For the general reader, I heartily recommend his book “How the Economy Works”, a small book which presents his ideas in clear, simple terms. His history of the development of central economic theories weaves a concise narrative of ideas and people that may be the best I have read.

For those of you with the background and math chops, his paper “Expectations, Employment and Prices” (also a book) contains a well-developed mathematical model of longer term economical and business cycles that find an equilibrium at various levels of unemployment. Roger undermines an idea predominant in economics and monetary policy: the so called natural rate of unemployment, or NAIRU, that guides policy decisions at the Fed and is often mentioned by Yellen and others at the Fed.

Holding Pattern

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September 20, 2015

The big news this week was the decision by the Fed to not raise interest rates this month.  Big mistake.  The Fed’s decision signaled a lack of confidence in the global economy.  Are we to believe that the continuing strength of the American economy is so weak that it can not weather even a 1/4% interest rate increase?

Message received.  When the news was announced on Thursday, the initial reaction was good.  Yaay!  no rate increase.  Then, the reality sunk in.  Does the Fed know something that the rest of us don’t? The buyers went to the back of the bus.  The sellers started driving the bus.  Pessimism wiped out the gains in the early part of the week and ended the week down 7/10%.  When in doubt, traders get out.

There are many aspects of the labor market.  The Fed crafts a composite of over 20 factors, called the Labor Market Conditions Index (LMCI).  The latest reading was released on September 9th, a week before this month’s Fed meeting.  This may have contributed to the caution in the Fed’s decision making.  The overall labor market has still not fully recovered from the downturn this past spring.

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Automation

Will your job become automated?  In this fast morphing economy, the demand for a particular skill set can change quickly.  Younger people, whether working or still in school, need to focus on developing transferable skills.   Here’s a list of the nine criteria that some researchers determined were important to keeping a job from being automated: “social perceptiveness, negotiation, persuasion, assisting and caring for others, originality, fine arts, finger dexterity, manual dexterity and the need to work in a cramped work space.”

When the first Boomers were born at the end of World War II, 16% of the workforce was employed in agriculture.  Millions of agricultural jobs have been lost in the past 70 years. Now it is less than 2%. (USDA source)

Computerization has led to the loss of millions of clerical and accounting jobs in the back offices of businesses throughout this country. Despite those job losses of the past 25 years, there are almost twice as many professional and business employees now as there were in 1990 (Source )

In contrast, construction employment is about the same as it was 20 years ago – an example of an industry that boomed and busted in the past two decades.  Despite that lack of growth, construction employment is still almost twice what it was in the go-go years of the 1960s. (Source)

Despite all these job losses due to automation and more efficient production methods, there are 350% more people working now (140 million) than there were at the end of WW2 (40 million). (Source)

Those who get left behind are those who have a narrow set of skills.

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Labor Market Analysis

Each August the Federal Reserve hosts an economic summit for central bankers, economists and academics.  In 2014, Fed chair woman Janet Yellen commented on several aspects of the labor market:

“Labor force participation peaked in early 2000, so its decline began well before the Great Recession. A portion of that decline clearly relates to the aging of the baby boom generation. But the pace of decline accelerated with the recession. As an accounting matter, the drop in the participation rate since 2008 can be attributed to increases in four factors: retirement, disability, school enrollment, and other reasons, including worker discouragement.“

As Yellen noted, some changes were structural, some cyclical:
“Over the past several years, wage inflation, as measured by several different indexes, has averaged about 2 percent, and there has been little evidence of any broad-based acceleration in either wages or compensation. Indeed, in real terms, wages have been about flat, growing less than labor productivity.“

Ms. Yellen agrees that the headline unemployment rate, the U-3 rate, does not reflect current labor market conditions:  “the recent behavior of both nominal and real wages point to weaker labor market conditions than would be indicated by the current unemployment rate.“

Since unemployment peaked at 25% during the Great Depression in the 1930s there has been an ongoing debate about unemployment during recessions.  Why don’t employees simply offer to work for less when the economy starts slowing down? Yellen offered some insights [my comments in brackets below]:

” the sluggish pace of nominal [current dollars] and real [inflation-adjusted] wage growth in recent years may reflect the phenomenon of ‘pent-up wage deflation.’ The evidence suggests that many firms faced significant constraints in lowering compensation during the recession and the earlier part of the recovery because of ‘downward nominal wage rigidity’–namely, an inability or unwillingness on the part of firms to cut nominal wages. To the extent that firms faced limits in reducing real and nominal wages when the labor market was exceptionally weak, they may find that now they do not need to raise wages to attract qualified workers. As a result, wages might rise relatively slowly as the labor market strengthens. If pent-up wage deflation is holding down wage growth, the current very moderate wage growth could be a misleading signal of the degree of remaining slack. Further, wages could begin to rise at a noticeably more rapid pace once pent-up wage deflation has been absorbed.”

Crossroad

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September 13, 2015

The SP500 index is very close to crossing below its 25 month average this month, four years after a similar downward crossing in September 2011.  Worries over the economy and political battles over the budget had created a mood of caution during that summer of 2011.  The market immediately rebounded with a 10% gain in October 2011 and has remained above the 25 month average in the four years since.   Previous crossings, however – in November 2000 and January 2008 – have marked the beginnings of multi-year downturns.

These long term crossings are coincident with extended periods of re-assessment of both value and risk.  Sometimes the price recovery after a crossing below the 25 month average is just a few months as in August 1990, and October 1987, or the quick rebound in 2011.  More often the price of the index takes a year or more to recover, as in 1977, 1981, 2000 and 2008.

The downward crossings of 2000 and 2008 preceded extended periods of price weakness.  Recovery after the popping of the dot-com bubble lasted till the fall of 2006.  In January 2008, just over a year after the end of the last recovery, another downward crossing below the 25 month average occurred.  Later on that year, it got really ugly.

As the saying goes, we can’t time the market.  However, we can listen to the market.  For the fourth year in a row the bond market continues to set records.  The issuance of investment grade and higher risk “junk” corporate bonds has totaled $1.2 trillion so far this year.  Ahead of a possible rate hike by the Federal Reserve this month, Wednesday’s single day bond issuance set an all time record. The reason for the high bond issuance is understandable – companies want to take advantage of historically low interest rates.  The demand for this low interest debt is a gauge of the long term expectations of low inflation.

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CWPI

The Purchasing Manager’s Index presents a somewhat contradictory note to the recent volatility in the stock market.  The CWPI, a composite of the manufacturing and services surveys, shows strong growth.  The manufacturing sector has weakened somewhat.  The strong dollar has made U.S. exports more expensive.

On the other hand…the ratio of inventory to sales remains elevated at 1.37, meaning that merchants have 37% more product on hand than sales.  The particularly harsh winter was unexpected and hurt sales, helping to boost inventories.  Five months after the winter ended, there should have been a notable decline in this ratio.

Has some of the strong economic growth gone to inventory build-up?

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Annuity

In  the blog links to the right was an article written by Wade Pfau on the mechanics of income annuities.  Even if you are not considering annuities, this is a good chance to expose yourself to some basic concepts about these financial products.

Crossings

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September 6, 2015

I am not going to say a lot about the August employment numbers, reported at 173,000,   since August’s numbers are routinely revised.  The BLS survey was 20,000 less than the ADP survey of private payrolls.  The revised figure will probably be closer to 210,000 jobs gained in August.  We can see the more important trends when we look at the annual job gains averaged over 12 months.

The slowdown in China and other markets and the selloff in markets around the world inevitably prompts talk of recession.  Since WW2 there has been only one recession – the one that followed the 1973 oil embargo –  that occurred when monthly job gains were above 200,000.   There have been 12 recessions since WW2. The work force was very much smaller fifty years ago.  There has been only one exception to this “rule” and when we look at this exception in closer detail we see that it was very much like the prelude to other recessions. Averaged monthly job gains were declining sharply as they do before every recession.  Job gains are NOT declining sharply today.

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Resource Countries On Sale

Monday came the news that the Canadian economy was officially in recession.  California, the most populous of fifty U.S. states, has two million more people than all of Canada, whose economic vitality relies on its vast stores of timber, oil, gas and minerals.  Australia, Russia, Norway and New Zealand also ride the roller coaster of commodity prices. (WSJ article )  An ETF that captures a composite of Canadian stocks, EWC, is down almost 30% from its high of August 2014.  The 50 week (not day, but week) average is about to cross below the 200 week average.

These long term downward crossings are often bullish, indicating that prices are near a low point in the multi-year cycle.  An ETF composite of Australian stocks, EWA, is down a bit more than 30% and its 50 week average just crossed below the 200 week average.

A Vanguard ETF composite of energy stocks is near the lows of 2011.

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Subprime Mortgages

Conventional wisdom: subprime mortgages started the recent financial crisis in 2008.  A recent National Bureau of Economic Research (NBER) analysis (A short summary ) of home foreclosures overturns that misconception.  The authors found that twice as many prime borrowers lost their homes to foreclosure as subprime borrowers.

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Inflation

In 2007, the Social Security Administration estimated that prices would be 20% higher in 2015. Then came the severe recession of 2008-09 and persistently low inflation.  Prices this year are only 15% higher than those in 2007.  Social Security payments will total almost $900 billion this fiscal year (FRED series), more than 20% of Federal spending, and are indexed to inflation.  Low inflation “saves” the Federal government about $40 billion each year when compared with earlier projections.  Sounds good?  Life is a trade-off.  The 60 million (SSA) people who receive social security spend most of it.  That savings of $40 billion is money not spent.  In addition, low interest rates have reduced income for many retirees, who depend on safer investments for an income stream.  These safer accounts, which include savings, CDs, short and mid-term bond funds, have paid historically low interest rates since the Federal Reserve lowered its target interest rate to near-zero (ZIRP) in 2008.

A Pause On the Road

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August 30, 2015

For the past few weeks, the volatility in the stock market has been front and center.  I finished last week’s blog with a note that the market would be conducting a vote of confidence in the coming weeks.  In the opening minutes last Monday morning, the Dow Jones index dropped a 1000 points, almost 6%.  No doubt many investors had spent the weekend worrying and put their sell orders in the night before.  By Friday’s close, however, the SP500 had gained almost 1% for the week.

A few weeks ago the Dow Jones index, composed of just 30 large company stocks, marked a death cross. The death cross is the crossing of the 50 day price average below the 200 day average.  See last week’s blog if you are unfamiliar with this.  This week the broader SP500 index, composed of the largest 500 U.S. companies, marked it’s own death cross.

Two weeks ago, I noted the attitude of one Wall St. Journal reporter to the dreaded death cross. In one word: blarney.  In two words: hocus-pocus.  So why do some investors and the press give this any attention?  Used as a trading system in the broader SP500 the death cross (sell) and it’s companion golden cross (buy) signal have produced a winning trade 4 out of 5 times.  Where do I sign up?, you might be thinking.  In an almost sixty year period of the SP500, however, the extra annual return is slight – about  8/100ths of a percent, or 8 basis points  – over no timing strategy, i.e. buy and hold.  To the average small investor, taxes and other fees more than offset this negligible advantage.

In contrast to any technical stock market price indicators, the fundamentals of the U.S. economy are mostly strong or expanding. Consumer Confidence rose above 100 this past month, surpassing the optimism of the benchmark set in 1985.  The second estimate of GDP growth released this past week was above some of the high estimates.  After inflation, real GDP growth continues at 2.65%.

Corporate profits are growing at 7.3%, home prices are up 5%.  Real, or inflation-adjusted, consumption spending and income is  growing at more than 3%, equaling the heights of pre-recession spending and income growth in early 2007.

Housing prices are increasing for a good reason.  Inventory of homes for sales is relatively low.  In the middle of the 2000s, prices rose even though inventory of homes for sale were going up, a sign of a speculative bubble.  Ah, things look so clear in the rear view mirror.

New jobless claims remain at historically low levels and job growth has been consistently solid.  There are more involuntary part-timers than we would like to see and the participation rate is low.  Gloom and doomers will tend to focus on the relatively few negative points in an otherwise optimistic economic panorama.  Gloom and doomers think that those who disregard  negative signs are Pollyannas.  Eventually, years later, the gloom and doomers are right.  “My timing was off but, see, I was right!” they exclaim. The lesson of the death cross and the golden cross are this: a person can be right most of the time.  The secret to successful investing is knowing when we are wrong and acting on it.

For the individual investor, signals like the death cross can be calls to check our assets and needs.  Older investors may depend on some stability in their portfolio’s equity value for income, selling some equities every quarter to generate some cash.   Financial advisors will often recommend that these investors keep two to five years of income in liquid, low volatility investments.  These include cash, savings accounts, and short to medium term corporate bonds and Treasuries.  Younger investors may see this price correction as an opportunity to put some cash to work.

The China Syndrome

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August 23, 2015

Some of you may have spent the summer vacation on a small island in the Pacific where there was no access to the news.  So a quickie catch up.  The new Mission Impossible movie Rogue Nation is edge of the seat great fun and its still on the big screen.  And, yeh, almost two weeks ago the central bank of China devalued the Yuan a bit over 3%. Yes, that was a bit unusual.  An unexpected 8% drop in July’s exports spooked economists in the Chinese government.

That brought some additional pressure on oil stocks but the larger market eked out a .7% gain at the close of the week on August 14th.  But – cue up the going down the dark stairs into the basement music – the 50 day average of the Dow Jones crossed below the 200 day average during that week.

Yep, the death cross of doom.  Of course, the Dow Jones is only 30 stocks, weighed down by the plunging fortunes of oil giants like Chevron and Exxon.  The 50 day average of the broader SP500 index was still above the 200 day average so there was cause for concern, but not panic.

For the first two days of this past week, the market was essentially flat.  USO, a commodity ETF that tracks West Texas Intermediate crude oil (WTI) rose more than 1% on Tuesday.  Then came the news that crude oil inventories were continuing their relentless advance upwards. On the good side, lower oil prices are leading to higher demand but sometimes investors focus on the bad news.  WTI oil dropped 4.4% on Wednesday.  Whispers of disappointing manufacturing production out of China added fuel to the fire. On Thursday, the broader market fell 2%, joining the continuing downturn in energy stocks and emerging markets.  A PMI (Purchasing Managers Index) survey of Chinese manufacturers confirmed a slight contraction in the Chinese economic machine. That spooked investors, leading to a 3% drop in the broader market on Friday.

By the time the smoke cleared at the end of the week’s battle, the broader index had lost 5.6% for the week.  Energy and emerging market indexes were down 8%.  Weekly volume in the popular SP500 ETF SPY was the highest this year, an indication that this concern may be more than a temporary blip.

The 50 day average of the SP500 is still above the 200 day average.  No feared death cross yet.

After four years without a 10% correction, the SP500 crossed below that mark this week, falling 10% from the recent high in late May.  Time to sell? Did you get out of the market last October when the broader market fell more than 6% in a month?  Remember that one? The market was going to fall by 50%, according to some market gurus.  Friday’s close is 5% above that October low.

Some long term traders use a 50 week average as a guideline.  As long as it is rising, why worry?  Until this week, the 50 week average had been substantially rising since September 2009.  Why do I use the word “substantially?”  There were a few weeks in late 2011 and early 2012 when the average dipped a few cents.  This week’s decline was like those little dips – a mere 5  cents in SPY, the popular ETF that tracks the SP500.

The world’s economy has come to depend on the growth of two stalwarts – the U.S. and China. For the past eight years, the Eurozone has fumbled and floundered through a cobweb of of political and economic problems. When the U.S. economy cratered in 2008 – 2009, the economic burden shifted to China, whose expansionist growth truly saved the world from a Great Depression.  Although the U.S. economy is showing strong growth, can it offset the economic weakness in China?  The stock market is holding an election, a vote of confidence on that very question.

A Bull In A China Shop

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August 16, 2015

The big news this week was China’s decision to devalue its currency, the yuan, by 3.5% in two days.  At week’s end, the yuan was about 3% less than what it was at the start of the week.

The decline in value came abruptly in  a market that moves in hundredths of a percent, called basis points, each day.  Since the beginning of the year, the euro has lost more than 8% against the dollar but it has done so in little teeny tiny moves.

What prompted China’s central bank to make this devaluation?  China expected a small drop in exports in July, but 8% was far more than expected. (Bloomberg )  The timing of the devaluation couldn’t be worse.  Emerging markets in southeast Asia have had sluggish growth in the past year and depend on exports.  The devaluation of the Yuan makes Chinese exports more competitive.  Vietnam and Malaysia devalued their currencies this week to maintain a competitive edge with China.

Emerging markets have had a rough ride this year.  A popular Vanguard Emerging Markets ETF is down 18% from its high in April.  However, today’s price level is barely below the price in mid-December.

While the SP500 has gone nowhere for the past nine months, emerging markets went on a tear in the beginning of the year, rising about 20% before falling back.  Talking about the SP500…

Dow Jones Death Cross alert!!! This past week the 50 day moving average of the Dow Jones Index crossed below the 200 day average.  The sky is falling.  Run for the hills.  The rhetoric does get a bit dramatic.  Should an investor disregard this signal as so much hocus-pocus?  Brett Arends at MarketWatch suggests that this “indicator” is hogwash. Yes and no.  The Dow Jones is a narrow index composed of just 30 stocks (CNN Money on component performance YTD).  Although it is meant to capture the essentials of the U.S. market, its narrowness makes it an unreliable indicator in some environments.  The oil giants Chevron and Exxon have dropped 23% and 15% respectively, dragging the index down.  There has still not been a death cross in the broader SP500 index.

To investors now over 60, the equity markets of the past 15 years have told a sobering message.  Investors need to either pay some attention or pay someone to pay some attention.  The SP500 stock market index has only recently recovered the inflation adjusted value that it had in 2000.

In nominal, or current, dollars, recoveries from major price declines can often take seven years.  Past recovery periods were 1968 – 1972, 1973 – 1980, 2000 – 2007, and 2007 to early 2013.

Long term trending indicators may be able to help an investor avoid some – emphasize some – of the pain.  For the casual investor, a death cross is a signal to pay a bit more attention to the market on a weekly basis.  All death crosses are not created equal.  Some death crosses are wonderful buying opportunities.  In July 2010, after a two month drop of almost 20%, the 50 day average of the SP500 dropped below the 200 day average, a death cross.  Good time to buy.  Why?  Because it is a death cross coming after a sharp recent drop in price.  The same type of death cross occurred in August 2011 after a steep drop in stock price in late July after the “budget battle” between Obama and Boehner went unresolved.  Good buying opportunity.

In December 2007, a death cross was not a good buying opportunity?  Why?  Because it came after six months of the market seesawing with indecision and no net change in price.  That indicates that there is a shifting sentiment, a lack of confidence among investors.

Some mid-term to long-term strategists use a weekly chart which measures the price at the end of each week, that price that short term traders feel comfortable with as they head into the weekend.  In a bullish or positive market the 12 week, or 3 month, price average stays above the 50 week, or one year, average.  As indecision creeps in the two averages will get close.  Finally, the 50 week average will top out, either gaining nothing or losing just a tiny bit as the 12 week average crosses below.  We’re not there.  We may get there.  Who knows?

Once that weekly cross happens, a long term investor might look at a daily chart.  What is a good rule(s) of thumb to determine whether a death cross is a good buying opportunity, a negative signal, or a palms up, who knows what the heck is going on, signal?

1) Has there been a decline of 15 – 20% (high price to low price) in the past 2 – 3 months? Is today’s price several percent below the 50 day average? Then it is probably a good buying opportunity as I noted above.  It is not always clear cut.  In September 2000, the SP500 began a 12% slide in price that would mark the beginning of a downturn lasting several years.  In mid-October 2000 a death cross occurred.  Was that a large enough slide in price to present a good buying opportunity?  Not really.  The price that day was almost the same as the 50 day average.  The recent drop in price had contributed to the death cross but a longer term re-evaluation of value was also taking place that would cut the SP500 index by 45% toward the end of 2002.

2) If there has been no substantial decline in the past few months, look at the closing price on the day of the death cross.  How many months can you go back to find the same price level and how many times has that price level been tested?  If just a few months, then this is an indeterminate period of indecision that may resolve itself.  Prices may move either higher or lower depending on the resolution.  But, if you can go back six to nine months of price flipping and flopping, then it is a bit more serious.  There may be a spreading questioning of value, a re-positioning of asset balances.  Does it mean sell tomorrow?  No.  It means pay attention.

After several years of declining prices in the years from 2000 – early 2003, the market had a Golden Cross (50 day average rises above 200 day) in May of 2003.  A death cross occurred more than a year later, in August 2004, at the 1095 price level.  That day’s price was close to the 50 day and 200 day average and so was not a standout buying opportunity. The market had first crossed above that price level in December 2003, then retested that level three times on market declines only to rise again.  Might it have been worth waiting a few weeks to check the market’s short term sentiment and see if that price level would hold again?  Probably. As it turned out, the market continued to rise for three more years.

These are not ironclad rules but act as guidelines to help an investor gauge the underlying mood of the market to make more informed investing decisions.

Which Way Sideways?

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August 9, 2015

As we all sat around the Thanksgiving table last November, the SP500 was about the same level as it closed this week.  Investors have pulled off the road and are checking their maps to the future.  After forming a base of good growth in the past few months, July’s CWPI reading surged upwards.

Despite years of purchasing managers (PMI) surveys showing expanding economic activity, GDP growth remains lackluster.  Every summer, in response to more complete information or changes to statistical methodologies, the Bureau of Economic Analysis (BEA) revises GDP figures for the most recent years.  A week ago the BEA revised real annual GDP growth rates for the years 2011 – 2014 from 2.3% to 2.0%.  “From 2011 to 2014, real GDP increased at an average annual rate of 2.0 percent; in the  previously published estimates, real GDP had increased at an average annual rate of 2.3 percent.”

A composite of new orders and rising employment in the service sectors showed its strongest reading since the series began in 1997.  The ISM reading bested the strong survey sentiments of last summer. We can assume that the PMI survey is not capturing some of the weakness in the economy.

This level of robust growth should put upward pressure on prices but inflation is below the Federal Reserve’s benchmark of 2%.  Energy and food prices can be volatile so the Fed uses what is called the “core” rate to get a feel for the underlying inflationary pressures in the economy.

The stronger U.S. dollar helps keep inflation in check.  There is less demand from other countries for our goods and the goods that we import from other countries are less expensive to Americans. .  Because the U.S. imports so much more than it exports, the lower cost of imported goods dampens inflation.  In effect, we “export” our inflation to the rest of the world.

When the economy is really, really good or very, very bad we set certain thresholds and compare the current period to those benchmarks.  When the financial crisis exploded in late 2008, the world fled to the perceived safety of the dollar in the absence of a exchange commodity of value like gold.  Because oil is traded in U.S. dollars and the U.S. is a stable and productive economy and trading partner, the U.S. dollar has become the world’s reserve currency.  The conventional way of measuring the strength of a currency like the dollar has been to compile an index of exchange rates with the currencies of our major trading partners.  This index, known as a trade weighted index, does not show a historically strong U.S. dollar.  In fact, since 2005, the dollar has been extremely weak using this methodology and only recently has the dollar risen up from these particularly weak levels.

As I mentioned earlier, a strong dollar helps mitigate inflation pressures; i.e. they are negatively correlated. When the dollar moves up, inflation moves down.  To show the loose relationship between the dollar index and a common measure of inflation, the CPI, I have plotted the yearly percent change in the dollar (divided by 4) and the CPI, then reversed the value of the dollar index.  As we can see in the graph below, the strengthening dollar is countering inflation.

What does this mean for investors?  The relatively strong economy allows the Fed to abandon the zero interest rate policy (ZIRP) of the past seven years and move rates upward.  A zero interest rate takes away a powerful tool that the Fed can employ during economic weakness: to stimulate the economy by lowering interest rates.

The strong dollar, however, makes Fed policy makers cautious. Higher interest rates will make the dollar more appealing to foreign investors which will further strengthen the dollar and continue to put deflationary pressures on the economy.  The Fed is more likely to take a slow and measured approach.  Earlier this year, estimates of the Effective Federal Funds Rate at the end of 2015 were about 1%.  Now they are 1/2% – 3/4%.  In anticipation of higher interest rates, the price of long term Treasury bonds (TLT) had fallen about 12% in the spring.  They have regained about 7% since mid-July.

DBC is a large commodity ETF that tracks a variety of commodities but has about half of its holdings in petroleum products.  It has lost about 15% since May and 40% in a year.  It is currently trading way below its low price point during the financial crisis in early 2009.  A few commodity hedge funds have recently closed and given what money they have left back to investors.  Perhaps this is the final capitulation?  As I wrote last week, there is a change in the air.

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Labor Report

Strong job gains again this month but labor participation remains low.  A key indicator of the health of the work force are the job gains in the core work force, those aged 25 – 54.

While showing some decline, there are too many people who are working part time because they can’t find a full time job.  Six years after the official end of the recession in the summer of 2009, this segment of the work force is at about the same level.

In some parts of the country job gains in Construction have been strong.  Overall, not so much.  As a percent of the work force, construction jobs are relatively low.  In the chart below I have shown three distinct phases in this sector since the end of World War 2.  Extremes are most disruptive to an economy whether they be up or down.    Note the relatively narrow bands in the post war building boom and the two decades from 1975 through 1994.  Compare that to the wider “data box” of the past two decades.

For several months the headline job gains have averaged about 225,000 each month.  The employment component in the ISM Purchasing Managers’ Index (on which the CWPI above is based) is particularly robust.  New unemployment claims are low and the number of people confident enough to quit their jobs is healthy.  The Federal Reserve compiles an index of many factors that affect the labor market called the Labor Market Conditions Index (LMCI).  They have not updated the data for July yet but it is curiously low and gives more evidence that the Fed will be cautious in raising rates.

China, Oil, Treasuries and Stuff

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August 2, 2015

An exciting and unnerving ride this past week as the Chinese market fell 8% on Monday and finished out the week about 10% down (Guardian here  and analysis here).  If trading had not been halted in a number of companies, the damage could have been much worse.  In the past year the Shanghai Composite has shot up 150% as individual investors piled into the market with both their own savings and borrowed money. Despite the loss of 14% for the entire month of July, investors in the Shanghai index are still up 13% for the year.

Let’s turn to the U.S. where the SP500 index has gained 6% since the downturn in October 2014.  Below is a chart of SPY, an ETF that tracks the SP500 index.  MACD is a common technical indicator that follows market trends.  The most common setting is to compare 12-day and 26-day price averages (the MA in MACD) and measure the convergence and divergence (the C and D in MACD)  Comparisons of longer time periods can clarify overall trends in sideways markets like we have experienced this year.  The chart below compares the 30-day and 72-day averages (blue line). The red line is a signal line, a 15-day average of the blue line.  The market seems to be at the end of a mildly positive cycle  that has been in place for nine months.

We may see a renewed move upwards but the near zero reading of the past few weeks indicates the uncertainty in the market.  Earlier this year, the price of long term bonds went down (yields went up) in anticipation of rate increases from the Federal Reserve. Counteracting that trend in the past month, long-term bond yields have gone down (U.S. Treasury) as investors bid up treasuries in the hopes that the Fed will delay raising rates till after September.

On July 22, the price of of a barrel of West Texas Intermediate (WTI) oil broke below $50 (NYMEX). Two previous times this year the price has come close to the psychologically important $50 mark only to rise back up.  Now traders are concerned that the U.S. Energy Information Administration’s (EIA) short term estimates of oil reserves and rig counts may not be accurate.  “When in doubt, get out” has been a recent refrain.

Let’s  go up in our time balloon to see why the breaking of this price point has some traders worried.  The last time WTI broke $50 was in the 2008 meltdown.

China’s growth is slowing.  Europe is idling in neutral.  Forecasts for global economic growth are subdued = low demand and this is why commodity prices are at ten year lows. Positive economic growth in the U.S.  may be the only bright spot in this global forecast.