Author: sgstofka

Readin’, Writin’ and Arithmetic

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April 21, 2013

In any lively discussion of public education – its effectiveness, the spending and taxes required – some people bring out their swords, others their shields, and some are armed with both.  Armed only with a crayon, I will examine some of these trends.

Let’s look first at higher education spending.  The National Center for Education Statistics (NCES) at the U.S. Dept of Education reported that real – that is, inflation adjusted – spending per pupil had increased 233% in the past 31 years, an annual growth rate in real dollars of 2.8%.

NCES reports a slower spending growth in K-12 education – 185% in 28 years, or an annual growth rate of 2.2%.

But the annual growth rate during the past decade, 1999 – 2009,  has slowed to just under 2%.

 

When we zoom in on the spending growth during the 1960s and 1970s, we see a real growth rate of 3.6%

What we see in the per pupil data is a gradual slowing down of the real growth rate of spending.  Those who claim that there have been spending cuts in education have not looked at the data.  There have been no cuts in real spending, only reductions in the rate of growth. 

Some decry “austerity” policies recently undertaken in some European countries – the U.K. is an example – claiming that a country pursuing these policies has cut spending.  When we look at the spending data, we find that there have been no decreases in real spending, only in the growth of spending.  This misconception is common and results from a comparison of what we expect and what happens. 

If we have usually received a wage or salary increase of 3% each year, we come to expect a 3% increase.  If we get a 2% increase this year, it is 33% less than our expections and feels like a cut.  A retiree who has become accustomed to an annual 8% return on her investments, may feel that she has lost money if her investments only gain 5% this year.  It does no good to mention that she has really not lost anything.

Let’s get up in our hot air balloons and travel to California, where the size of its economy puts the state above many  countries.  California has often been the leading edge of trends that spread to the other states.  Ed-Data reports that per pupil spending has flattened since the recession started in 2008.  In real dollars, there has been NO GROWTH in per pupil spending in the past ten years.

Another complaint from teachers is that money is increasingly being spent on administrative costs, not teaching.  In California, teachers still command the lion’s share of spending  – more than 60%.

The proportion of teacher spending has remained relatively constant – above 60% – in the past ten years.

What has been growing?  On a per pupil basis, “Services and Other Operating Expenses” have grown 4% per year, or 1.8% real annual growth,  above the 2.2% annual growth in inflation.  Administration expenses have grown at the same rate of inflation so that real growth has been flat.  However, spending on teacher salaries has declined in real money at an annual rate of .7%.  However, their benefits expenses have grown 1.4% annually in real dollars.  Again, most people do not “feel” the cost of a benefit increase.  The bottom line to most of us is what we bring home.  It does not pay to tell a K-12 teacher that they are actually receiving a slight increase in real total compensation.

In California, as in many states, property taxes are a major component of revenues for K-12 education.  Over the past nine years, revenues from property taxes for education have declined 3% annually in real money.  For each student, there is $500 less money available from property taxes than it would have been if property tax revenues had kept up with inflation.  As a percent of total revenue for K-12 education, property taxes make up a little over 60%.

In 2011-2012, property tax revenues essentially paid teacher salaries.  Ten years ago, the percentage of revenues from property taxes was about 6% higher.

Other State revenues have had to make up for the shortfall in property taxes; the gap is about $1000 per student.  The problem would be even worse if it were not for the slight decline in students for the past 8 years.

While California faces challenges from declining property tax revenues, what about the rest of the country?  Let’s climb back in our data balloon and look at student enrollment throughout the country.  The NCES reports the same slight decline in K-12 enrollment.  However, they estimate a total 6% growth in K-12 enrollment in this decade.

As K-12 enrollment grew by a little more than 1 million in the 2000s, post secondary education enrollment grew by 6 million, or 37%, to over 21 million. (Source http://nces.ed.gov/fastfacts/display.asp?id=98).  The growth rate in older students, those aged 25+ is even faster, rising 42%. In this decade, “NCES projects a rise of 11 percent in enrollments of students under 25, and a rise of 20 percent in enrollments of students 25 and over.”

 The ratio of K-12 students to post-12 students was 28% in 2000; a decade later, it was 38%.  While K-12 enrollment is projected to increase for the rest of the decade, post-12 enrollment is estimated to be much faster.  How do these students pay for college?  The most recent data from NCES is at the start of the recession; I would guess that the need for aid has grown mightily since then. 

Put all of this in the blender: a declining work force (see my blog two weeks ago), a generational swelling of older people retiring, recovering but not robust state and local revenues, and more demand for K-12 AND post secondary education services.  How will politicians react in the midst of so many competing demands for money?

The increasing pressures for money from different segments of the population puts us in the precarious position that we can not afford to go into a recession, an impossible situation since the normal business cycle includes a recession every 7 – 10 years.  Europe is already in recession; China’s growth is still robust but slowing; on Friday, India announced a growth rate below 5%, the weakest in four years; in a hopeful sign, Brazil, the economic powerhouse of South America, is projecting GDP growth over 3%, rising up from an anemic 2.7% growth of the past 5 years.  (World Bank source)

Slackening demand around the world presents challenges for the U.S. economy, problems that a spastic Congress will only worsen. Y’all be careful out there…

Things That Spring

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April 14th, 2013

Across the land, springtime wakens the trees and flowers, birds chirp and squirrels chatter.  From the buildings where the humans live comes the wailing and gnashing of teeth as many procrastinators spend this last weekend before the tax deadline in a spring ritual of angst.  The lost W-2 form is finally found beneath the Netflix DVD that has lain casually on the bookcase, waiting to be watched.  The 1099DIV form is found beneath a birthday card that was never sent.

Lay aside your problems; let’s climb inside the hot air balloon and look at the big picture.  A few weeks ago, economic growth for the fourth quarter of 2012 was revised marginally higher into positive territory, but dropping from the annualized growth rate of 3.1% in the 3rd quarter of 2012.  Let’s look at GDP from a per person basis since WW2.  Until the recession hit in late 2007, economic growth had consistently outpaced population growth.  Then POOF! went the economy and blew away a big gap in GDP.

Let’s zoom in on the past ten years to see the effect.  On a per person basis, the gap is $5,000 of spending that simply didn’t get spent.

Call it the GDP dust bowl of the 2000s, similar to the dust bowl of the 1930s when the wind blew the top soil from the prairie of the Oklahoma panhandle and forced many families from their farms.  In this case, the wind blew away a lot of jobs and chunks of home equity.

Policy makers in Washington want to close that $5000 per person gap.  If they could write a law forcing everyone to spend that $5000, they would.  Instead, they keep giving away money in unemployment benefits, food stamps, disability benefits, crop subsidies – all to keep people from not spending even less and making the problem worse.

Retail sales account for about 1/3rd of the total economy.  Including automobile sales and parts, consumers are still below twenty year averages.

This past Friday, the monthly report on retail sales showed little change from the past month.  When we look at per person real retail and food sales and take out automotive sales we get a feel for core sales, those that we make on a frequent basis.  Once again, we see the same gap that we saw in GDP.  Since mid-2009, this core consumer spending has grown 2.3% annually, above the 1.8% annual growth trend from 1992 through 2006, but it still down $2000 a year from what we would have spent if we had stayed on the same trend line before this past recession hit.

To make it a bit clearer, let’s look again at that chart and compare the 15 year annual growth rate from 1992 to the longer 21 year growth rate.  It has fallen from 1.8% to 1.1% annual growth.

GDP measures spending; let’s look at Gross Domestic Income, or GDI.  A fundamental principles of economics is that it takes money to spend money.  A six year old asks a parent “Why can’t we just go out and get more money?” to which the parent replies “Whaddya think money grows on trees?!”  End of Chapter One in the Parent’s Guide to Economics.

When we compare the country’s income to spending, we find that a dip in income below production precedes recessions.

After the 2008 – 2009 crash and recovery in national income and spending, both are limping along.

A few weeks ago came the monthly New Orders, an indication of business confidence.  As regular readers know, I have been watching this declining trend since September of last year, when the percent change in New Orders was negative.  The recent rise has been a welcome sign of growing confidence but new orders fell 2.7% in February and now hover around the zero growth line. 

On a quarterly basis, the year over year (y-o-y) percent change is still firmly in negative territory, meaning that businesses are not putting up more money to invest in new equipment.  Why?  Because they are still not sure about consumer spending. The six month run up in the SP500 stock index might lead a casual observer to think that the economy and companies are gearing up.  New Orders indicates that there is much more caution out there than the stock index would indicate.

This past Friday, business’ caution to commit to new investment was only reinforced when the latest Consumer Sentiment index was released.  After climbing the past few months, confidence is sinking again.  Maybe it’s the extra 2% coming out of paychecks since January 1st.  Whatever it is, it doesn’t inspire many business owners to put a lot of money into expanding their production.

When the stock market is trading on hope, it looks six months ahead.  The recent run up is hoping for double digit profit growth in the second half of this year.  When the market trades on fear, it looks ahead about 2 seconds, faster than the normal investor can or should react.  Let me get out my broken record for another spin, cue the needle and play that same old song “Diversify.”

P.S. For those of you who are more active investors, check the latest post from Economic Pic in my blog link list on the right.  It shows the past 40 year returns for a strategy of selling the SP500 index in May and buying the long term government / credit index.  The iShares ETF that tracks this index is ITLB.  A comparable ETF from Vanguard is BLV.

Labor Participation Rate

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April 6th, 2013

First I will look at a rather disappointing March Labor Report, released this past Friday.  Then I will zoom up and look at the big picture and some disturbing trends.  The net job gains this past month were 88,000, about half of the 169,000 average gains of the past year.  Remember that it takes about 150,000 job gains each month just to keep up with population growth.  Although the headline unemployment rate dropped .1% to 7.6%, it was because almost half a million people dropped out of the work force, meaning that they had stopped looking for a job in the past month.

Mitigating the meager job gains were revisions to previous months gains as more survey data was returned by employers. January’s job gains were revised from +119,000 to +148,000, and February’s gains were bumped upward from +236,000 to +268,000.  The two revisions added up to an additional 61,000 jobs; adding that to March’s gain of 88,000 gets close to the minimum gains needed of 150,000. The initial reaction of the market was a swift loss at Friday’s market opening of almost 200 points on the Dow.  By the end of the day, the market had regained much of the ground it lost, ending down about 40 points.

The average hours worked increased again to 34.6, a hopeful sign, but earnings saw no change.

Construction continued to show gains; the media’s attention to this area of employment probably gives the casual reader the impression that contruction jobs are a larger part of the work force than they actually are.

Compare that to Professional and Business Services, which has showed consistently strong gains and low unemployment.

Employment in the health care field continues to grow.  As a percent of total employment, health care continues to reach new heights, although its growth has moderated.  Taking care of the sick may be a sign of a compassionate society, but it consumes resources, prompting the question: what is the upper limit?  One in nine workers now work in health care.  Twenty years ago, the ratio was one in twelve. 

Over the past twenty years, the employment market has shifted markedly away from producing goods.  As a share of total employment, about 1 in 7 workers produces goods.  Just ten years ago, the ratio was 1 in 6.

What jobs did those workers find?  Serving food and drink to the ever growing share of people in Professional and Business Services.

The core work force, those aged 25 – 54, shows no growth over the past year.  I use the words “work force” to include only the employed.  “Labor force” includes both the employed and unemployed.  More on that in a bit.

I have written before about the year over year (y-o-y) percent change in the headline unemployment rate, or U-3 rate, and that past recessions usually follow when this change goes above 0.  The unemployment rate has benefitted remarkably from the number of people who continue to drop out and are no longer counted as unemployed.  Because of the drop outs the percent change in the unemployment rate is still in good territory.

A secondary indicator may be the y-o-y percent gain in the employed.  The long term average is 1.5%.  When the percent gain falls below that, recession soon follows.  The percent gain just fell below the long term 1.5% average.

Let’s zoom out to the past forty years to see how this percent gain in employment has preceded past recessions.  The exception was in 1973-74 when the Arab oil embargo created a sudden and deep recession in the country.

There was a decline in the number of people who dropped out but had been searching for work (but not in the past month) and were available to work.

The long term trend of those not in the labor force continues to reach new heights.  As a percent of the population, it  keeps climbing at an alarming rate.

Older workers are retiring, either voluntarily or involuntarily, at the rate of 800,000 a year.

Which brings us to several sometimes confusing concepts, the Civilian Labor Force (CLF), the Participation Rate, and other metrics.  The Civilian Labor Force is those people aged 16 and over who are either employed or unemployed.  To be counted as unemployed, a person is not working but has searched for work in the past month.  The unemployment rate is simply the percentage of unemployed in the Civilian Labor Force, which now totals about 155 million.  An unemployment rate of 7.6% means that about 12 million people are counted as unemployed. 

Then there is the Civilian Labor Force Participation Rate, or simply the Participation Rate, which is the percentage of the Labor Force to what the BLS calls the Civilian Non-Institutional Population (CNP).  Don’t go to sleep on me.  The CNP is those people who are aged 16 or more and who are not in prison or the military. 

So, the Participation Rate (PR) is the number of people who ARE working as a percent of people who CAN legally work; i.e. who are over 16 and not in some institutional setting that prevents them from working or finding work.


Let me give you some numbers and a pie chart.

The total population of the U.S. is estimated at 313 million; the CNP is estimated at 245 million.  The difference between those two figures are mostly children under 16 and people in prison and the military.  Here’s how the Labor Force compares with those not in the labor force and children under 16.

Why does the the Participation Rate (PR) matter?  As it declines, workers have to support more of those who are not working.  Many seniors feel that they “paid into the system” but the “system” – yes, your elected representatives in Congress – spent the additional money paid into the system over the past thirty years.  Social Security is a “Pay as you Go” system meaning that existing workers must somehow pay back into the system to pay benefits for those who retire.  Pay back = higher taxes. As the percentage of the population who works declines, taxes must rise or benefits decrease regardless of who paid into the system. 

This past month the BLS estimated a further decline of .2% to a level of 63.3%.  For comparison, Canada has a PR of 66.6%. 

Part of the decline is a natural demographic change as the population ages.   So how much has the aging of the population contributed to the decline in the PR?  What is the PR for those of working age 16 – 64?  Oddly enough, the time series figures are not easy to come by.  But before we get to that, let’s get to the surprises.

Since 2010, the older labor force, those aged 65+, has grown by 1.2 million. 

In 20 years, the participation rate among seniors has risen 50%, from 11.8% in 1990 to 17.4% in 2010.  The BLS projects that it will rise to 22.6% by 2020, a doubling in thirty years.  Seniors will continue to compete for jobs with the working age population.

Meanwhile, the participation rate of the core work force, those aged 25 – 54, is on a steady decline.

Now comes the biggest surprise, the decline in the working age Participation Rate.  To get the time series, I had to add a number of series together and take some population estimates by the Census Bureau.  Changing demographic shifts and 2010 census revisions make the series not entirely accurate but does give a good representation of the approximate 6% decline.

Let’s look at the last five years for the overall Participation Rate, which has declined about 5%. 

The aging of the population is contributing maybe 20% to the overall decline.  The bulk of the decline is a deterioration of the working age labor force.  Some are going back to school, some have given up looking for a job recently.  Many younger workers are finding it difficult to find a job. The Consumer Credit report released Friday shows another surge in student loans.  The FinAid student debt clock shows that student loans now exceed a trillion dollars. I have the sinking feeling that this will end badly. The participation rate for those aged 20 – 24 has declined about 7% and is now slightly less than the rate for all working ages. 

Payments under the Social Security Disability program, or SSDI, took about 10% of Social Security taxes in 1984.  They now consume 20% of SS taxes and are becoming an increasing burden on the Social Security program even as the boomers begin to retire.  The ranks of the disabled have grown more than 10% in the past three years.

A declining percentage of the population working to pay for an increasing number of benefits – this economic tension is sure to produce social and political conflict.  Many of us probably hold the vague hope that it will all work out somehow.  Some think that politicians in Washington will figure it out despite the fact that the solutions that Congress comes up with to most problems only exacerbate the problem or shift the problem to another area.

On the other hand, the baseball season is still young and anything is possible, right? 

Home Sweet Home

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March 31st, 2013

From its catatonic state the housing market continues to make headlines.  On Tuesday came a somewhat disappointing report on new home sales for February; at 411,000 it was a bit below expectations of 425,000.   A real estate saleswoman told me this week that it’s now a seller’s market in Denver.  I presume that means that buyers are now having to offer the asking price or above when submitting a sales contract to a seller.

For a long term perspective, let’s zoom out fifty years.  Home sales are at past recession bottoms BUT they are better than last year and the year before and the housing and labor markets are hoping.

Will the patient stir, starting to rise, only to fall back on the bed?  PUH-LEEZ DON’T!

Housing Starts, which include multi-family dwellings, are on an upswing but are also coming from a deep trough.

What is more telling for the labor market is the ratio of home sales to housing starts, which continues to decline as more and more multi-unit apartment buildings and condos are being built.

Construction of multi-unit dwellings takes less labor per family unit and the type of construction is often skewed to a different kind of labor force than the construction of single family homes.  There is more steel, concrete and masonry work in multi-unit construction, employing trade skills unfamiliar to some in single family residential construction.  This shifting emphasis of skills in the work force may damper growth in the construction labor market.

Let’s go up in our hot air balloons and take a gander at home valuation for the past 130 years.  The Case-Shiller Home Price index surveys home prices throughout the nation and adjusts for inflation.  The homes of today offer more than the homes of 100 years ago, both in convenience, comfort and safety.  However, the index is approaching an upper range that may be less attractive to potential buyers.

Let’s look at housing evaluations from an affordability perspective.  The National Association of Realtors offers an affordability index based on a composite of mortgages.  I prefer a different measure, one that is based on disposable income – income after taxes.  For many of us, buying a house is the biggest purchase of our lives.  Before we make such a big commitment, we need to have some savings (except during the housing boom) to make a down payment, and we need to feel some certainty about our future income.  Mortgage payments will probably take the largest bite out of our income.  

When we look at a long term history of the growth of the home price index (purchases only) and the growth of inflation adjusted disposable income, they track each other closely – until the housing boom really took off in 2000.  Below is a graph of the past 20+ years, showing the relationship between the two.

 

The upturn in home prices is still above the trend line growth of disposable income and until personal income can resume or surpass a 3% growth rate, any rise in home prices will be constrained.

Blossoms and Blight

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March 24th, 2013

The Blossoms

There have been a number of encouraging reports these past several months, helping to fuel new highs in the popular SP500 stock index.  After falling off dramatically five years ago, real (inflation adjusted) retail sales finally surpassed 2007 levels.

Housing prices around the country are on the mend.  Although the purchase only home price index is still below the vaulted levels of the bubble years, it is exactly where it would have been if there had been no bubble and housing prices had grown at their customary 3 – 4% per year.

In recent months, the manufacturing sector of the economy has surged upward, rebounding from weakness in the latter part of 2012.  For the past year, the Eurozone has been in or near recession, yet some are hopeful that increased demand in this country and some emerging markets are helping to balance the contractionary influence of decreased demand in the Eurozone.  Let’s hope that this surge in the first part of the year does not fade as it did in 2012.

New claims for unemployment continue to decline. 

The Blight

But a 7.7% unemployment rate and a record 14 million disabled (SSA Source) show that the labor market is still sick.  The percent of working age people who are working, or the participation rate, continues to drift downward.

While the steadily improving retail sales indicate growing consumer confidence, per capita purchases are about where they were in the late 1990s, 15 years ago.

While consumers have been shedding debt, state and local governments continue to hold large levels of debt which does not include promised pension and health care benefits to retirees.

Federal Spending continues to outpace receipts, adding to the debt at a rate of more than 4% per year. At that rate the debt will double in about 18 years, reaching $30 trillion in 2030.  As a percent of the entire economy of the country, the deficit or annual shortfall between spending and revenues is still about 7%.
 

As housing prices recover and households either pay down or shed debt in foreclosure or bankruptcy, household balance sheets are looking better. What has happened in the past five years is a massive shift of household debt to the balance sheets of local, state and federal governments.

The blossoms catch our eye, inspiring hope, causing some to not notice the blight.  But the stock market, the barometer of millions of watching eyes, tells a more complete story.  While the stock market has shown renewed optimism in the past several months, its inflation adjusted value indicates a more tempered enthusiasm for the long term future of the economy and corporate profits.

Widgets and Labor

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March 9th, 2012

Labor costs are the major share of the expense of producing goods and services.  While the percentages vary by industry, a rule of thumb is that labor is about 70% of the final cost of a product.  The cost of labor to produce one widget should keep rising with inflation.  With the passage of time, widgets sell for more and employees demand more pay to produce those widgets.  Not surprisingly, the Bureau of Labor Statistics keeps track of the labor cost to produce widgets; they call it Unit Labor Cost.  In laymen’s terms we can think of it as the Widget Labor Cost.  The cost is indexed to a particular year year; in this case it is 2005.  If the labor cost of a widget was $2.43 in 2005, we’ll set that to 100.  Indexing makes what might seem like arbitrary numbers more uniform.  If the labor cost of a widget in 2012 is $2.67, then the index would read 110, or 10% more than 2005.

Widget labor costs typically fall or flatten out in a recession.  A graph of the past ten years shows that we still have not reached 2007 levels.

Keynesian economists say that labor costs are “sticky”, i.e. they do not decline in proportion to the downturn in the economy and the reduced demand during a recession.  Wages are the price of labor. Union contracts and employment laws do not allow these prices to fall to what is called the market clearing level.  Labor prices thus become too expensive and employers want less labor, resulting in higher unemployment.

Several decades of data allows us to see some changing growth trends in the labor costs to make widgets.

As I noted earlier, labor costs rise with inflation.  The graph below shows the relationship between the two.

After WW2, the rise in labor costs was just slightly ahead of the rise in inflation, allowing workers a greater standard of living and to put away some money for the future.  During the “stagflation” of the 1970s, this gap widened as workers demanded more pay in response to rising inflation while economic growth stagnated.  When the economy recovered in the mid-1980s, we began to see a narrowing between unit labor costs and the rate of inflation.  Had this narrowing stopped around the year 2000 and labor costs continued rising with inflation we would have a healthier work force and a healthier  economy.  But the gap narrowed further until labor costs were no longer keeping up with inflation.  Dwindling increases in labor costs have resulted in more profits for companies.  Although the labor market has a strong influence on the stock market, it is an indirect influence.  Stock prices are directly influenced by rising corporate profits and the perception that future profits will increase at a faster or slower rate.

Because wages do not rise and fall in proportion to the swings in the business cycle, companies took the only course of action left.  They reduced the labor component cost of their goods and services where they could.  Union contracts offer a company less flexibility in responding to downturns in the economy.  Companies reduced their exposure to union labor by outsourcing production to other countries, or by subbing out production to smaller companies with non-union workforces.  

Many people have been waiting several years for employment to recover.  As the chart above shows, there has been a systemic decrease in labor needed to produce each widget.  There is little indication that this trend will end as the economy continues to recover.  Since this economy is consumer driven, it is dependent on a healthy labor market.  A stumbling labor force will not produce robust gains in the economy. 

That is the background, the context for a look at February’s monthly labor report from the BLS, a better than expected report.  The headline job gain was 236,000, far above the 170,000 anticipated employment gain.  The unemployment rate dropped to 7.7% and the year over year decrease in the unemployment rate indicates little chance of recession.

There were other positive signs in this latest report.  Average hourly earnings of private-sector production and nonsupervisory employees broke above $20, increasing to $20.04.  After rising and stuttering last year, earnings have increased steadily since August 2012.  Despite these gains, hourly earnings of production employees are little changed from 1965 levels.

A slowly improving economy gave some hope that we might see the number of discouraged unemployed workers decline below 800,000 this month.  Instead the number rose from 804,000 to 885,000.

The Labor Force participation rate dropped another .1%.  Fewer and fewer workers are being asked to shoulder the benefits of the retired and unemployed.  The core work force aged 25-54 is still showing no substantial improvement.

While employment gains in the 25 – 54 age group have stagnated, the larger group aged 25+ continues to show improvement.  The unemployment rate for this larger group declined another .2% and now stands at a respectable 6.3%.  The employment picture for new entrants into the labor force, those aged 16 – 19, remains bleak.  This past month, the rate of the unemployed in this group increased and now stands at 25%.  Hispanics have seen a 10% decrease in unemployment during the past year but there are still almost 10% unemployed.  The minority group that has suffered the most through this recession has been African-Americans, whose unemployment rate has stayed subbornly high.  There have some small declines in unemployment over the past year, but almost 14% of this group is unemployed.

However, a group that has had persistently high unemployment, those without a high school diploma, saw a significant decline from 12% to 11.2%.

A significant contributor to that decrease is the steady rise in construction employment.

Perhaps not so widely followed is the “Craigslist indicator of construction activity.”  No, you won’t find this one charted anywhere but it does give a clue to what it going on in your area.  Search for “work van”, “work truck”, “step van” or “cube van” in your local Craigslist.  If there are a lot of listings, it means things are not good.  A few years ago, the Denver area used to have pages of work vehicles for sale by both owners and dealers.  This month there are few listings.

Other positives were the increase in the weekly hours worked to 34.5, in the pre-recession range.  Health care enjoyed strong gains as usual.  Professional and business services enjoyed strong gains, offsetting the unusually flat gains of January.  A rise in retail hiring was a nice surprise.

A bit of a head scratcher was the revision of January’s job gains, erasing 25% of the 160,000 job gains that month.  Revisions of that size leads to doubts about the winter seasonal adjustments that the BLS makes to the raw data. 

There are still 3 million fewer people working than in January 2008, when the BLS reported employment of 138 million.

In the past week the Dow Jones Industrial average crossed above the high mark of 2007.  On an inflation adjusted basis, the Dow is still well below the level it attained in 2000 and has still not passed 2007 price levels.  Some argue that the average 2.2% in stock dividends paid out each year partially compensates for the 3% loss in purchasing power.  Others argue that the dividend is compensation for the risks the investor assumes in the stock market and should not be taken into account.  If we disregard dividends, the inflation adjusted SP500 index is – well, it’s better than it was in 1990.

If a buy and hold investor has been in the market since 1990, she has gained 4% per year after inflation.  Adding in a dividend yield of about 2.5% over that time results in a total gain of 6.5%.  Had she bought a 30 year Treasury note in 1990, she would have been making about 8% per year for the past 23 years.  There are three lessons to be learned from this:  Diversify, diversify, diversify.

Capital Goods and New Claims

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March 3rd, 2013

This past week came a number of positive economic reports.  The first one I will look at is the Durable Goods Orders, which indicate a willingness by consumers and businesses to commit money now to buy stuff that will last for several years.  A critical component of this index is capital goods, durable goods like machinery which produce more goods and services.  As a key indicator of business confidence in the future, it is one of the trends I watch. (See Predictions and Indicators)

Until the past few months, this component has been particularly weak, warning of recession.  Resolution of the “fiscal cliff” issue at the beginning of the year has sparked more optimism and it shows in the new orders for capital goods.  This deep a decline in the year over year percentage change has been followed with an uptick in the past, only to fall into recession.

When we smooth out the monthly data with quarterly averages, the trend is still in negative territory.

Every week the Bureau of Labor Statistics issues a report on the number of New Unemployment Claims.  This past week, the BLS reported a lower than expected number of 341,000, a drop of 22,000 from the week before. Numbers of more than 400,000 are a major concern.  The weekly series can be volatile; most analysts look at the 4 week moving average to get a better gauge of the trend. 

As with many data series, I am interested in the year over year (y-o-y) percentage change in the data.  Because the SP500 index is a volatile series, I’ve smoothed out the data to a 6 month average to show the negative correlation between stock prices and  new unemployment claims. 

In other words, when unemployment claims go up, the stock market goes down.  This particular data series is good when it is low, bad when it is high so I reverse the percentage change to show its correlation with the SP500. 

On a quarterly basis, this negative correlation has proved to be a reliable trading signal for the longer term investor.  When the y-o-y percentage change in new unemployment claims crosses above the SP500 change, sell.  When the claims change crosses below the SP500 change, it’s safe to buy.

Again, this strategy is for the long term investor who is more concerned with major structural changes in the economy that can cause a significant dent in her savings.  Using this strategy she will not maximize her gains but she will avoid major losses and it does not require that she check her stock portfolio more than four times a year.  An investor using this strategy for the past twenty something years would have bought in the first week of Oct. 1990 and been in the market during the 1990s as the index climbed, then stalled in the mid 1990s, then climbed again.  She would have sold in the first week of Jan. 2001, missing most of the market drop for the next several years.  She would have re-entered the market in the first week of October 2003 and sold again in the first week of April 2008, just before the financial meltdown in September of that year.  She would have bought again in the first week of January 2010 and would still be in the market.

For the long term investor who does not want to devote a part of their lives to reading financial news or watching CNBC, it is often difficult to separate the “noise” – the weekly headlines and economic reports – from the real motion or trend.  This indicator is a low maintenance signal for that investor.

P.S.  You can get this report yourself without much trouble. 
Enter “Fred New Claims” into your browser’s search bar. 
The first link should be “Unemployment Insurance Weekly Claims Report – FRED” at the Federal Reserve.

Click the link, then select the first series “4-Week Moving Average of Initial Claims”. 
When the graph displays, click Edit Graph in the lower left below the graph.
Select the 10 Years range radio button. 
In the Frequency field below the graph, select “Quarterly” and leave the Aggregation method at the default setting of “Average”. 
In the Units field below that, select “Percent Change From Year Ago”. 

(Adding the SP500 stock market index)
Below the “Redraw Graph” button, select the blue bar Add Data Series. 
Leave the New Line button selected.
In the Search field, type SP500 and select the default SP500 index.  The graph will redraw automatically but it will make little sense at this point until we edit the settings for the SP500 index. 
Select the 10 Year range button for the SP500.  Make sure you are editing the SP500 data graph and not the New Claims indicator. 
Change the Frequency field to “Quarterly” just as you did for the New Claims. 
Change the Units field to  “Percent Change From Year Ago” just as you did with New Claims. 
Click the Redraw Graph button and voila!

Fill ‘er up!

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February 23, 2013

Most of us with cars have noticed the rather dramatic increase in gas prices since the beginning of the year.  I’ll use the all formulations series, which is about 8 – 10 cents cheaper than what a family might pay at the pump.

A reason given for the upsurge in prices is that this is a normal seasonal change as refineries shut down to make the change over from a winter gas formulation to a summer gas formulation.  Heavier volatile organic compounds are removed from gas during the summer months to reduce smog.  The resultant decrease in supply therefore leads to an increase in price.  It’s Econ 101.  If that were true, then the year-over-year percent change would be relatively minor at this time of year.  In one of those contradictory anomalies, this year is the only year that the refinery change-over explanation actually fits.  Price changes over the same months in 2012 have been minor.  Notice that in other years, price increases in the early months contradicted the theory.

The change has been particularly noticeable because gas prices decreased to near $3 a gallon toward the end of 2012.  In the Denver area, prices dropped below $3 a gallon, prompting comments in idle conversation.  The average driver uses about 10 gallons a week but out west, where driving distances are greater, that average gas consumption is probably closer to 15 – 17 gallons.  The difference between $3 gas and $4 gas can mean a weekly gas “tax” of $15 or more.  For those of us who use a vehicle for work, the difference can be $30 or more.

Since the recession began in 2007, our use of gasoline has decreased, ending a multi-decade rise in overall gasoline consumption (EIA Source)

However, since the late nineties average gas prices are rising and have become quite volatile.  So why?  Our gasoline use was increasing during the nineties but prices were flat at a little over a $1 a gallon. Why the big increase in the past 10 – 15 years?  If one were buying gasoline with gold, the price has fallen over the past two decades.

If our consumption has levelled off in the past few years and we are producing more oil in this country, why has the price of gasoline stayed pretty consistently above $3 a gallon?

The three main variations of crude oil are heavy (Venezuela, for example), medium (North Sea and MidEast) and light (Texas). The benchmark for medium grade is Brent Crude; for light grade it is West Texas Intermediate (WTI). The two benchmarks have traditionally moved in tandem with Brent Crude trading about $2 above WTI.  Over the past few years, the difference in price between the two benchmarks has widened considerably.  “Fracking” has led to an upsurge in domestic production; production in the North Sea has been steadily declining; tensions in the MidEast and North Africa have contributed a risk premium to medium crude produced in the region.

Refineries are set up to process a particular type. Most east coast refineries process Brent Crude; higher transportation costs of domestically produced crude oil over land made it more cost efficient for eastern refineries to import oil from overseas.  Since the majority of the U.S. population lives in the eastern U.S., the majority of the American people use imported gas.  Gas prices move in tandem with the spot price of Brent crude.

While U.S. oil consumption has declined, world consumption has been rising.

The U.S. Energy Information Administration projects  a slow, steady rise in oil consumption over the next two decades as the standard of living improves.

No magic wand will cause gas prices to decline.  Crude oil and its derivative products are a world commodity and can be shipped inexpensively in large tankers all around the world.

Last week I wrote about the long term trend in federal debt; that it was not a “New Normal” but a continuation of the same old normal of the past several decades.  The continued rise in oil prices is another trend that has become a fixture of our daily lives and will continue to eat at the dollars in our pocketbooks for the foreseeable future.

The Law of Averages

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February 17th, 2013

The spending sequester, or sequestration, set to take effect March 1st is a series of automatic and indiscriminate spending cuts that was part of the “Grand Bargain” compromise between President Obama, together with a Democratically led Senate, and the House Republicans in the Budget Control Act of August 2011.  The agreeement was rather like a Sword of Damocles, a chopping of spending programs cherished by one party or the other.  The term “sequester” means that there will be some actual spending cuts, not the usual budget and appropriations gimmicks that Congress is fond of. The unpalatable cuts to both defense spending and social programs were supposed to be an incentive for both parties in Congress to come to an agreement on deficit reduction as a condition of raising the debt limit.  It was hoped that the 2012 election would decide which party’s priorities would take precedence and the dominant party could then pass legislation to avoid or modify the sequester.  Instead, the election left the balance of power unchanged.  Republicans had dismissed the probability of the Democrats winning a majority in the House.  There were just too many seats that the Democrats need to gain to accomplish that.  Hoping to take the Presidency and having a good chance of taking control of the Senate in the 2012 elections, Republican lawmakers agreed to the sequester. The 2010 post-census election had put Republicans in charge of crafting voting districts, which enabled them to retain a majority in the House despite losing the total popular vote for House seats in the 2012 election. Several key Senatorial races imploded when Republican candidates made ill-advised (to be charitable) remarks.  Instead of gaining control of the Senate, Republicans lost two Senate seats.  Despite the high unemployment rate and the poor to middling economy, President Obama won re-election.

After navigating a mind numbing maze of previous law and baseline budget projections to arrive at actual spending reduction goals, the sequester will reduce defense spending by $55 billion and non-defense spending by $38 billion in 2013.  While this sounds like a lot of money, this is just 2.4% of the estimated $3.8 trillion in total federal spending in 2013 or a mere .6% of the estimated $16 trillion of this country’s GDP.  This past week the Democratically controlled Senate revealed a plan that would avoid the sequester for 2013.  The plan achieves deficit reduction goals with spending cuts and revenue increases but the revenue increases will probably be unwelcome to the Republican majority in the House.  Despite the rhetoric of calamity coming from either side of the aisle, both parties are anticipating that the sequester will probably take effect in two weeks.

Since mid November the SP500 has risen 12%; except for a sharp decline in the last week of the year in response to fears of the fiscal cliff, the market has climbed steadily.  The market has been largely ignoring the upcoming sequestration. 

More concerning to some is the slowdown in Europe, where the Eurozone economy has contracted for 4 quarters in a row.  Even Germany, the manufacturing and export stalwart of the Eurozone, saw a .6% contraction in the final quarter of 2012.

For many decades, the two prominent parties have been fighting an ideological battle over the role of the Federal government.  The Democratic Party regards the Federal government as largely beneficial and wants a greater role for the Federal government.  They have ushered in many social programs including Social Security, Medicare and Medicaid, programs that are largely on autopilot, beyond the reach of the Appropriations Committee in the House, where a select few can make the law by deciding which programs and federal agencies receive funding.  The philosophy of the Republican Party is that the Federal government is intrinsically a burden and therefore deserves a smaller role.  The Republican Party was out of power in the House for forty years until 1994; as a result, their role consisted largely of blocking or modifying Democratic Party ambitions.  Except for four years from 2007 – 2011, they have controlled the House since 1994 yet often conduct themselves as the opposition party that they were for much of the latter part of the 20th century.

In the tug of war between these two ideologies, the budget has suffered.  A recent report by the non-partisan Congressional Budget Office (CBO) contains a graph of Federal revenue and outlays and their long term averages which clearly pictures the “scrimmage” of ideologies between two yardlines, marked 18% and the 21%.  Republican politicians, together with conservative talk show hosts and commentators, speak of the “traditional” role of the Federal government at 18% of GDP.  This is simply the average of Federal revenues, not its role, for the past fifty years. Revenues have been, on average, 3% below that of Federal spending, which has averaged 21% of GDP.  The “traditional” role of the federal government, then, is to have an average annual deficit of about 3% of GDP.  In a $16 trillion economy, that average deficit is $500 billion.

Republicans simply can not say “no” to the Defense Dept; at times, they have forced spending programs on the Defense Dept that it doesn’t want.  The Democratic Party has become the champion of a hodge podge of Federal social welfare programs.  Neither party proposes taxes that will actually pay for the spending.  For all the Democratic rhetoric about taxing the rich, there simply aren’t enough rich people to pay for that average $500 billion deficit.  Large corporations continue to dominate both parties.  Campaign laws in most states as well as the federal government permit no fundraising in government buildings.  Almost every day, the members of the House and Senate must leave the government building where they work in order to do the daily drudgery of promising favorable legislation to corporations and associations in return for campaign contributions. 

We are still way above the 3% deficit average of the past fifty years.  The CBO projects that this year’s deficit will be 5.2% of GDP, almost half of the 10% deficit in 2009.

Over the next two decades, that 3% budget deficit average is about to grow larger.  For the past fifty years, the demographic bulge known as the Boomers have been paying into Social Security.  Those taxes have exceeded payments in most years, reducing overall Federal government deficits by .6% of GDP each year (Table 1.2 OMB historical tables, 2013 Budget).  Those surpluses have masked the reality that average annual Federal deficits, excluding Social Security, have been about 3.6% of GDP.  In a $16 trillion economy, that is close to $600 billion.  As the Boomers retire over the next twenty years and are collecting Social Security payments, add in another $100 billion a year as the Boomers draw down the $2.7 trillion dollar Social Security surplus they have built up.

We’re now up to a $700 billion annual deficit based on revenue and spending patterns over the past fifty years.  As the total Federal debt grows, so will the interest costs on that debt.  Over the past seventy years, interest costs have averaged 1.8% of GDP, almost 30% higher than the 1.4% of the past few years (Table 3.1 OMB 2013 Budget)  Ballooning debt levels and rising interest rates could easily add another $100 billion to annual deficits.  We’re now up to $800 billion and growing, based on historical averages.

Republicans will continue to call for spending cuts – it’s their brand.  Democrats will call for more programs and more taxes – but not on the poor and middle class – that’s their brand.  The political and economic tug of war will continue, meaning that uncertainty will be the new normal.  Uncertainty usually leads to lower economic growth which exacerbates social and political tensions which leads to more uncertainty until eventually there will be another crisis. 

In preparation for a cycle of uncertainty and crisis, the prudent investor might ask “What’s my backup plan?”  If you are lucky enough to have a defined benefit pension plan with the company you work for, what is your backup plan if that “defined” benefit is “redefined.”  Well, you might be thinking, my company is so large and dominant in its market that such a possibility is unlikely.  Tell that to the employees of United Airlines, a dominant player in its industry, who lost part, or in some cases, more than half of their benefits when United Airlines shed part of its pension obligations in bankruptcy court.

In the mid nineties, IBM converted its defined benefit plan to a “cash balance” plan, effectively lowering the pension amounts due older workers.  After seven years, a contested lower court decision and a victorious appeal, IBM won their right to do this.  IBM and other large companies have lots of lawyers and accountants trying to figure out legal ways to reduce their liabilities.  How many lawyers and accountants do you have? 

A March 6, 2012 article in the Wall St. Journal reported that “Business groups are urging Congress to let employers put less money into their pension funds, saying that exceptionally low interest rates are forcing them to set aside too much cash.”  I’ll bet your company has more lobbyists in Washington than you do.

These past few years have been a wake up call for those who worked, diligently saved and invested, planning on a certain retirement income based on historical returns of various investments in the stock, bond and CD markets.  Too many people discovered that their backup plan was either to keep working or go back to work, a fact supported by the monthly household survey from the Bureau of Labor Statistics. 

Many retirees built CD “ladders” in federally insured certificates of deposit that paid 4 – 5% interest or more, offering them the safety of their principal and a steady income.  With interest rates for CDs at 1% or less, many retirees have either had to find more risky investments or simply spend less or – there’s that backup plan again – go back to work to make up the difference.

Then there are the folks who planned on selling their home, downsizing and using the difference as an income stream in their retirement years.  Now they wait, hoping that housing values will return to the lofty levels of the mid-2000s or – backup plan again – keep working.

Some people think that the past few years have been an aberration and are waiting for things to get back to normal, or average.  What I’ve tried to show is what those averages have been for the past fifty years and that those averages are better than what we can plan on for the next twenty years.  We certainly can not plan on a vague hope that the folks in Washington will find either a solution or a compromise to a problem that has remained unresolved for the past half century and will continue to worsen in the next two decades.

GDP, Profits and Labor

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Feb. 2nd, 2013

A lot to cover this week – the monthly labor report and the Dow Industrial Average breaks the psychological mark of 14,000.  Let’s cover the stock market rise because that will give us some context for the labor report.

The stock market rises and falls on the prospect for the rise and fall in corporate profits.  For the past year, profits have been healthy, increasing year over year by 15-20%.

The stock market is a compilation of attempts to anticipate these profit changes by six months or so. Sometimes it guesses wrong, sometimes it guesses right but the market loosely follows the trend in profits.

As a percent of GDP, corporate profits have reached a record high and this growing share of the economy is largely responsible for the doubling of the SP500 in the past three years.

There can be too much of  a good thing and this may be it.  An economy becomes unstable as one segment of the economy accumulates a greater share of the pie.

Facts are the nemesis of partisan hacks who simply disregard any information that does not fit with their model of how the universe works.  Data on government spending and investment contradict those who complain that government has too much of a share of the economy; it is now at historic lows.

This includes government at all levels: federal, state and local.  Reductions in government spending continue to act as a drag on both GDP and employment growth. What gives some people the sense that government spending is a larger percentage of the economy are transfer payments, like Social Security.  Neither the calculation of GDP or government spending includes these transfer payments, so the percent of government spending in relation to GDP as shown in the chart above is a truer picture of government’s role in the economy. 

Speaking of GDP – this past week came the first estimate of GDP growth for the fourth quarter of 2012.  The headline number was negative growth of 1/10th of a percent on an annualized basis.

Two quarters of negative growth usually mark the beginning of a recession.  Concern over this negative growth led to small losses in the stock market at mid-week as investors grew concerned about the January labor report, which was released Friday.  The negative growth was largely due to a severe reduction in defense spending and exports.  As a whole, the private economy grew at an annualized rate of 3.6%, a strength that helped moderate any market declines in mid week.

When the Bureau of Labor Statistics released their monthly labor report this past Friday, the headline job increase of 157,000+ and an unemployment rate stuck at 7.9% did not calm investors’ fears.  The year over year percent change in unemployment is still in positive territory.

The numbers of long term unemployed as a percent of total unemployment ticked down but remains stubbornly high at about 38% (seasonally adjusted)

What prompted Friday’s relief rally in the market were the revisions in the previous months’ employment gains.  As more data comes in, the BLS revises previous months’ estimates.  This month also included end of the year population control adjustments.

November’s gains were revised from +161,000 to +247,000; December’s gains were raised from +155,000 to +196,000.  For all of 2012, the revisions added up to additional job gains of 336,000, raising average monthly job gains for 2012 to 181,000 – near the benchmark of 200,000 needed to make a dent in the unemployment rate.  Previous decreases in the unemployment rate have been largely the result of too many people giving up looking for work and simply not being counted as unemployed.

Overall, the labor report put the kibosh on any fears of recession and the stock market responded with a rally of just over 1%.  Construction jobs continued their recent gains but employment levels are one million jobs fewer than the post-recession lows of 2003 and two million jobs less than the 2006 peak of the housing bubble.

The core work force aged 25-54 continues to struggle along.

The older work force has garnered much of the gains in the past year but this month was flat.

The larger group of workers counted as unemployed or underemployed, what is called the U-6 Rate, remained unchanged as did the year over year percent change. 

As the stock market continues to rise, retail investors have reversed course and have started to put more money into the stock market.  Sluggish but steady GDP and employment growth has prompted the Federal Reserve to continue its program of buying bonds every month, which tends to push up stock market values.  The Fed can continue this program as long as the sluggish pace keeps inflation in check and below the Fed’s target rate of 2.5%. 

In the short run, it is a good idea to follow the maxim of “Don’t Fight the Fed.”  What is of some concern is the long term picture.  Below is a 30 year chart of the SP500 index, marked in 10 year periods with two trend lines based on the first decade, one trend line (with the arrow) a bit more positive than the other. 

The market has changed in the past two decades.  The bottoms in 2002, 2003, 2010, 2011 were simply a return to trend, a return to sanity.  The downturn of late 2008 – early 2009 was the only downturn that broke below trend; truly, an overcorrection. Among the changes of the past two decades is a Federal Reserve that, some say, has helped drive these erratic asset bubbles by making aggessive interest rate moves, then keeping interest rates at low levels for a prolonged period of time.  Whether and how much the Fed’s interest rate policies contribute to stock market valuations is a matter of much vigorous discussion.  Whatever the causes are, it is important to recognize that over two decades the market has shifted into a jagged, cyclic investment.  The long term investor who has a ten year time frame before they might need some of the money invested in the stock market can be reasonably certain that they will be able to get most of their money back if not make a healthy profit.  For those with a shorter time horizon like five years, they will need to monitor the financial and economic markets a bit more closely or hire someone to do it for them.  This is especially true when one is buying at current market levels which are above trend.