Place Your Bets

January 6, 2019

by Steve Stofka

This will be my tenth year writing on the financial markets. As I’ve written in earlier posts, we’ve been sailing in choppy waters this past quarter. In 2018, a portfolio composed of 60% stocks, 30% bonds and 10% cash lost 3%. In 2008, that asset allocation had a negative return of 20% (Note #1). We can expect continued rough weather.

If China’s economy continues to slow, the trade war between the U.S. and China will stall because a slowing global economy will give neither nation enough leverage. Will the Fed stop raising interest rates in response? If there is further confirmation of an economic slowdown, could the Fed start lowering interest rates by mid-2019? Ladies and gentlemen, place your bets.

Thanks to good weather and a strong shopping season, December’s employment reports from both ADP and the BLS were far above expectations (Note #2). Wages grew by more than 3%. Will stronger wage gains cut into corporate profits? Will the Fed continue to raise rates in response to the strong employment numbers and wage gains? Ladies and gentlemen, place your bets.

The global economy has been slowing for some time. After a 37% gain in 2017, a basket of emerging market stocks lost 15% last year. Although China’s service sector is still growing, it’s manufacturing production edged into the contraction zone this past month (Note #3). Home and auto sales have slowed in the U.S. What is the prospect that the U.S. could enter a recession in the next year? Ladies and gentlemen, place your bets.

The partial government showdown continues. The IRS is not processing refunds or answering phones. If it lasts one more week, it will break the record set during the Clinton administration. Trump has said it could go on for a year and he does like to be the best in everything, the best of all time. Could the House Democrats vote for impeachment, then persuade 21 Republican Senators (Note #4) to vote for a conviction and a Mike Pence Presidency? Ladies and gentlemen, place your bets.

When the winds alternate directions, the weather vane gets erratic. This week, the stock market whipsawed down 3% one day and up 3% the next as traders digested the day’s news and changed their bets. Interest rates (the yield) on a 10-year Treasury bond have fallen by a half percent since November 9th. When yields fell by a similar amount in January 2015 and January 2016, stock prices corrected 8% or so before moving higher. Since early December, the stock market has corrected by a similar percentage. Will this time be different? Ladies and gentlemen, place your bets.

Staying 100% in cash as a long-term investment (more than five years) is not betting at all. From a stock market peak in 2007 till now, an all cash “strategy” earned less than 1% annually. A balanced portfolio like the one at the beginning of this article earned a bit less than 6% annually. Older investors may remember the 1990s, when a person could safely earn 6% on a CD. Wave goodbye to those days for now and place your bets.



  1. Portfolio Visualizer results of a portfolio of 60% VTSMX, 30% VBMFX and 10% Cash
  2. Automatic Data Processing (ADP) showed 271,000 private job gains. The Bureau of Labor Standards (BLS) tallied over 300,000 job gains.
  3. China’s manufacturing output in slight contraction
  4. The Constitution requires two-thirds majority in Senate to convict an impeached President. Currently, there are 46 Democratic Senators and Independents who caucus with Democrats. They would need to convince 21 Republican Senators to vote for conviction to get a 67 Senator super-majority. 22 Republican Senators are up for re-election in 2020 and might be sensitive to public sentiment in their states.

The Donald and the Washington Post

March 22, 2016

The editorial board and several other employees at the Washington Post recently sat down with Donald Trump.  Here is a transcript of the conversation .

Here are some highlights.   Donald rambles a lot but I think I got the kernel of his responses.  I think my edited version does Donald more justice than the sometimes incoherent responses he actually gave. He really is not ready for prime time. At this point in the campaign his responses to questions about foreign policy, international trade, and other issues mentioned on the campaign trail should be more practiced, not the rambling sentiments that any of us might have in a conversation with a co-worker at a lunch break.

WP = Editorial staff at Washington Post, DT = Donald Trump.  I’ve included some context where I thought it might be needed.

WP: “is there a secretary of state and a secretary of defense in the modern era who you think have done a good job?”

DT: “I think George Shultz [Reagan’s Sec’y State] was very good, I thought he was excellent.”  “I think your last secretary of state [Hillary Clinton] and your current secretary of state [John Kerry] have not done much.”  Trump uses the word “your” to indicate that media institutions are partisan and biased, and including the WP in the liberal media. It indicates that Trump’s essential sense of the world is polarized, a game of warball.  That may be the case in Washington but it mutes Trump’s appeal among independent voters who have less polarized outlooks. Trump offered an example of Kerry’s bad negotiating tactics with Iran: “We should have had our prisoners before the negotiations started.”

In response to a question about promoting values like democracy and freedom around the world,
DT: “I don’t think we should be nation building anymore,” indicating that he is not a neo-con. “We’re sitting probably on a bubble and, you know, it’s a bubble that if it breaks is going to be very nasty. And I just think we have to rebuild our country.”   Trump is not the only person who thinks that extremely low interest rates for seven years have over inflated stock, bond and housing values.  Trump immediately changes the subject and endorses infrastructure spending, aligning himself with economists Paul Krugman, Robert Frank, and others who recommend large Federal stimulus programs to repair infrastructure and employ those with low to modest educational backgrounds.  Trump recalls that we built schools in Iraq, and rebuilt them several times when they got bombed “and yet we can’t build a school in Brooklyn. We have no money for education, because we can’t build in our own country. And at what point do you say hey, we have to take care of ourselves. “

WP: “So what would you do for Baltimore [as an example of a city with troubled inner neighborhoods]”

DT: “I’d create economic zones. I’d create incentives for companies to move in. I’d work on spirit because the spirit is so low… unemployment for black youth in this country, African American youth, is 58-59 percent.”  These are called enterprise zones and have been used with mixed success in the U.S. but particularly in Britain.  See this article

WP: “in general, do you believe there are disparities in law enforcement?”

DT: “I’ve read where there are and I’ve read where there aren’t…I have no opinion on that.  We have to create incentives for people to go back and to reinvigorate the areas and to put people to work…we have lost million and millions of jobs to China and other countries.”   When Trump doesn’t like the topic, law enforcement, he switches subjects to an old refrain, jobs lost to China, and now Mexico. “Mexico is really becoming the new China.”

WP, returning to the topic:  “There is disproportionate incarceration of African Americans vs. whites. Is that something that concerns you?”

DT: “It would concern me. But at the same time it can be solved to a large extent with jobs.”  Some economists and social scientists have championed this idea that people in poor neighborhoods will choose  legal employment if presented with better job prospects.  Over time, residents in the area will become more committed to the neighborhood, to the protection of their property, to law and order.

WP: “Baltimore received a lot of federal aid over the years. What’s different specifically about your approach to these issues from what’s been tried in the past, because a lot of effort has been put in just the direction you just described.”

DT: “I think what’s different is we have a very divided country.”  He goes on about how divided the country is, as if we didn’t already know that.  How does that answer the question about Baltimore? “I thought that President Obama would be a great cheerleader for the country. And it just hasn’t happened. You have to start by giving them hope and giving them spirit and that has not taken place. I actually think I’d be a great cheerleader for the country.”

WP: “What presidential powers and executive actions would you take to open up the libel laws?”

DT: “I’ve had stories written about me … that are so false, that are written with such hatred.  I think libel laws almost don’t exist in this country.  I think that [the media] can do a retraction if they’re wrong. They should at least try to get it right. And if they don’t do a retraction, they should, they should you know have a form of a trial. I don’t want to impede free press, by the way.”

WP: “So in a better world would you be able to sue [the Post]?”

DT: “In a better world I would be able to get a retraction or a correction. Not even a retraction, a correction.”

WP: “Would you require less than [actual] malice for news organizations?”  “Actual malice” is a legal standard, a criteria for liability for libel set up the Supreme Court in 1964.  See below.

DT: “I would make it so that when someone writes incorrectly, yeah, I think I would get a little bit away from malice without having to get too totally away.”  What does that mean?

WP: “How are you defining ‘incorrect?’ It seems like you’re defining it as fairness or your view of fairness rather than accuracy.”

DT: “Fairness is… part of the word. I’ve had stories that are written that are absolutely incorrect. I’ll tell you now and the word ‘intent’, as you know, is an important word, as you know, in libel.”  Trump then gives an example of a news account of a protester at a Trump rally.  The video tape is edited to make Trump supporters look guilty of unprovoked violence.  Trump says these are professional protesters with trained voices that can be heard throughout a large hall in order to disrupt Trump’s speech or a question from the crowd.  Trump says that news media accounts do not potray these incidents accurately.

Through several questions various people from the Post try to get Trump to acknowledge that Trump condones violence.  Trump insists that he supports law and order, not violence.  Trump’s campaign manager notes that there are repeated public service messages before every rally that the audience should not confront protestors and to let security personnel do that.  Trump repeats that some protesters, when interviewed, say they don’t know why they are there, implying that the protesters are paid agitators by those who want to make Trump rallies look violent.  Some protesters simply interrupt his speeches with shouted obscenities.  Out of 20,000 attending a rally, Trump claims that there are just a few protesters and that they are strategically placed at the rally venue.

WP:  “given the Supreme Court rulings on libel — Sullivan v. New York Times — how would you change the law?”  New York Times v. Sullivan is a 1964 decision by the Supreme Court that there must be a malice standard applied before reporting about a public official can be considered libel.  “Actual malice” is a legal concept that the media outlet knew the information was incorrect or should have known, i.e. that they exercised little or no effort to find the correct information.  After this decision, a person claiming libel in the U.S. must prove the untruth of something published.  This departed from centuries of common law precedent.  In Britain, for example, the defendant of a libel claim must prove the truth of the information they published.

DT: “I’d have to get my lawyers in to tell you, but I would loosen them up.”  Although Trump is not specific on this, I’m guessing that he would like some balance between the strict U.S. system and the Briitish system.  U.S. precedent was based on a problem that existed in the southern states during the early 20th century.

WP: “Would that be the standard then? If there is an article that you feel has hatred, or is bad, would that be the basis for libel?”

DT: “The Washington Post never calls me. I never had a call, ‘Why – why did you do this?’ or ‘Why did you do that?’ It’s just, you know, like I’m this horrible human being. And I’m not.”  If a news organization makes no effort to validate information, is that cause for libel?  “I want to make it more fair from the side where I am, because things are said that are libelous, things are said about me that are so egregious and so wrong, and right now according to the libel laws I can do almost nothing about it because I’m a well-known person.”

WP: “can you talk a little bit about what you see as the future of NATO? Should it expand in any way?”

DT: “Ukraine is a country that affects us far less than it affects other countries in NATO, and yet we are doing all of the lifting, [European members of NATO are] not doing anything.”

WP: “Could I ask you about ISIS, speaking of making commitments, because you talked recently about possibly sending 20 or 30,000 troops”

DT: “I said the generals, the military is saying you would need 20- to 30,000 troops, but I didn’t say that I would send them. I would put tremendous pressure on other countries that are over there to use their troops and I’d give them tremendous air … support because we have to get rid of ISIS. I would get other countries to become very much involved.”

WP: “What about China and the South China Sea?”

DT: “We have trade power over China. I don’t think we are going to start World War III over what they did, it affects other countries certainly a lot more than it affects us. I always say we have to be unpredictable. We’re totally predictable.  And predictable is bad. Sitting at a meeting like this and explaining my views and if I do become president, I have these views that are down for the other side to look at, you know. I hate being so open.”

WP:  Asks about Iraq and ISIS

DT: “We then got out [of Iraq] badly, then after we got out, I said, “Keep the oil. If we don’t keep it Iran’s going to get it.” And it turns out Iran and ISIS basically—”  Trump is interrupted but I wonder if he was going to say that Iran and ISIS were conspiring to get Iraq’s oil?  Iran and ISIS are blood enemies.  Iran embodies the Shia sect of Islam, ISIS is Sunni.

WP: “How do you keep it without troops, how do you defend the oil?”

DT: “I would defend the areas with the oil [with U.S. troops].”  Asserting that Iran is out for Iraq’s oil, Trump says, “Iran is taking over Iraq as sure as you’re sitting there. And I’ve been very good on this stuff. My prognostications, my predictions have become, have been very accurate, if you look.”

WP:  Asks Trump about his claim that he could use trade as a diplomatic cudgel against China’s territorial ambitions in the South China sea.  These disputes involve Vietnam, the Phillipines, and Malaysia.

DT: “You start making it tougher [for Chinese exporters]. They’re selling their products to us for… you know, with no tax, no nothing. If you’re a manufacturer, you want to go into China? It’s very hard to get your product in, and if you get it in you have to pay a very big tax.” “I don’t like to tell you what I’d do, because I don’t want to…”

WP: “This theory of unpredictability …there are many people who think that North Korea invaded South Korea precisely because [Secretary of State Dean] Acheson wasn’t clear that we would defend South Korea. So I’m curious, does ambiguity sometimes have dangers?”  Acheson served under Truman from 1949 to 1953.  In 1950, the N. Korean People’s Army crossed the 38th parallel to invade South Korea.

DT: “President Obama, when he left Iraq, gave a specific date – we’re going to be out. I thought that was a terrible thing to do. [The enemy] pulled back, and after we left, all hell broke out, right?”

WP: “What you’re saying [about European NATO members] is very similar to what President Obama said to Jeffrey Goldberg (Atlantic article) in that we have allies that become free riders. Do you have a percent of GDP that they should be spending on defense? Because it’s not that you want to pull the U.S. out [of NATO].”

DT:  “No, I don’t want to pull it out. NATO is costing us a fortune and yes, we’re protecting Europe but we’re spending a lot of money.”  Again, nothing specific in answer to the question.

WP:  “does the United States gain anything by having bases [in Japan and S. Korea]?”  The Post cites an unnamed public source that the U.S. pays 50% of non-personnel costs to maintain the bases.

DT: “I think we were a very powerful, very wealthy country. And we’re a poor country now. We’re a debtor nation.  We’re spending that [money] to protect other countries. We’re not spending it on ourselves. We have armor-plated vehicles that are obsolete. The best ones are given to the enemy.”  Donald relates that the son of one of his friends has served three tours in Iraq and Afghanistan.  “He said the enemy has our equipment – the new version — and we have all the old version, and the enemy has our equipment.  “We send 2,300 Humvees over, all armor-plated. we have wounded warriors, with no legs, with no arms, because they were driving in stuff without the armor. And the enemy has most of the new ones we sent over that they captured. And he said, it’s so discouraging when they see that the enemy has better equipment than we have – and it’s our equipment.”

There was more, including someone at the Post asking about the size of Donald’s hands.

The China Syndrome

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

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.

China, Oil, Treasuries and Stuff

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.

Central Banks

September 14, 2014

This week I’ll take a look at the latest JOLTS report from the BLS and an annual assessment of  global financial risks by the Bank of International Settlements.



The BLS releases their Job Openings and Labor Turnover Survey (JOLTS) with a one month lag.  This past week’s release covered survey data for July.  The number of employees quitting their jobs is regarded as a sign of confidence in finding another job.  When it is rising, confidence is increasing.  The latest survey is optimistic.

The number of job openings have accelerated since the January lows.  In June, they passed the peak reached in 2007.

However, since May, the growth of job openings in the private sector has stalled.

The number of new hires continues to increase but we should put this in perspective.  The hire rate, of percentage of new hires to the total number of employees, has only just surpassed the lows of the early 2000s after the dot com bust and the 2001 recession.  This “churn” rate is still low, even below the level at the start of the 2008 Recession.


Consumer Credit

Auto sales and the loans to finance them have been strong but consumers have been slow to crank up the balances on their credit cards.  Although the latest consumer credit report indicates that consumers have loosened their wallets in the past few months, the overall picture is rather flat.



China reported growth in factory output that was below all estimates at 6.9% and below target growth of 7.5%.  The Purchasing Managers Index, a barometer of industrial production,  shows that both China and Brazil are hovering at the neutral mark while the global index shows moderate growth.  Home prices in China have fallen for 4 months in a row.  As growth momentum slows, the clamor quickens for more easing by the central bank.


Bank of International Settlements Annual Report

The Bank of International Settlements (BIS) is the clearing house for central banks around the world, including the Federal Reserve and the European Central Bank. It is the central banker’s central bank that facilitates and monitors money and debt flows among the nations.  The BIS has cast a particularly watchful eye on Asian economies, who are about 15 years into their financial cycle.

Their annual June 2014 report sounds a word of caution, emphasizing that central bankers should focus more on the financial cycle than the business cycle as they construct and administer monetary policy:

To return to sustainable and balanced growth, policies need to go beyond their traditional focus on the business cycle and take a longer-term perspective – one in which the financial cycle takes centre stage. They need to address head-on the structural deficiencies and resource misallocations masked by strong financial booms and revealed only in the subsequent busts. The only source of lasting prosperity is a stronger supply side. It is essential to move away from debt as the main engine of growth.

In Chapter 4 the BIS notes the high levels of private sector debt relative to output, particularly in emerging economies. In a low interest environment, households and companies “feast” on debt, leaving them particularly vulnerable when interest rates rise to more normal levels.  International companies in emerging markets can tap the global securities market for funding and much of this private debt remains off the radar of the central bank in a country’s economy.

Financial booms in which surging asset prices and rapid credit growth reinforce each other tend to be driven by prolonged accommodative monetary and financial conditions, often in combination with financial innovation. Loose financing conditions, in turn, feed into the real economy, leading to excessive leverage in some sectors and overinvestment in the industries particularly in vogue, such as real estate. If a shock hits the economy, overextended households or firms often find themselves unable to service their debt. Sectoral misallocations built up during the boom further aggravate this vicious cycle.

While there is no consensus on the definition of a financial cycle, the peak of each cycle is marked by some degree of stress that encompasses a region of the world and can have a global effect.  Emphasizing the global component of financial cycles, the BIS is indirectly encouraging central bankers to communicate with each other.  Money flows largely ignore national borders.  It is not enough for a central banker to sit back, confident in the sage and prudent policies of their nation. Each banker should ask themselves: what are the neighbors doing that could impact my nation’s economy and financial soundness?

Financial cycles tend to last 15 – 20 years, two to three times the length of the business cycle.  It takes time to build up high levels of debt, to lower credit standards and become complacent about downside risks. There may be no clearly identifiable cause that precipitates a financial crisis.

Different regions have different cycles.  More advanced western economies have been on a downward recovery phase after the crisis of 2008 while emerging economies in the east are near the apex of their cycle.  Asian economies experienced their last peak at the start of the millenium.  They have had 15 years to inflate asset and property prices, to lower credit standards and accumulate debt, all hallmarks of a developing environment for a financial crisis.

The report notes that borrowers in China are especially vulnerable to rising interest rates but that many economies in the region would be pushed into crisis should interest rates rise just 2.5%, as they did a decade ago.



Employee confidence and hiring are strong but private sector hiring may be stalling.  The next crisis?  Look east, young man.

Market Bumps

January 26th, 2014

In a holiday shortened week, the market opened higher than the previous Friday but fell a bit more than 3% by week’s end.  On this same week in 2012, the market lost 2.5% in 3 trading days.  As I mentioned last week, there were few economic reports this past week to detract from the focus on corporate earnings.

IBM opened up the week by beating profit estimates but missed revenue estimates by $1 billion, or about 3%, and were about $1.5 billion less than the final quarter of 2012.  The 4th quarter is usually IBM’s strongest quarter each year; lower revenues from this giant indicate a cautious business investment outlook.  IBM is selling for the same price now that it did in mid 2011, a price earnings ratio of 12.

The following day, China announced that the country’s industrial production has fallen just below the neutral mark.   The reaction to the news was exaggerated by sharp declines in some emerging market currencies, which started a cascade of selling. See SoberLook blog for some charts. Similar weakness out of China last summer prompted a much more subdued reaction.

On Thursday, McDonald’s reported weak sales growth, which added to concerns.  After a run up of 30% last year, many traders were on high alert for any negative news.  The U.S. stock market has enjoyed a tail wind from Federal Reserve stimulus policy, but a global economy is largely outside of the Fed’s influence.

A 14 month support trend line that has been in place since November 2012 sets a mark at about 1760.  Dropping below that would signal a short to mid term shift in market sentiment.  The SP500 index closed at 1790 on Friday, 1.7% above that support trend line.  The 10 month average of the index is 1700.  A drop below that mark would signify a change in mid to long term sentiment. A few weeks ago, I noted that the market was close to 10% over its 10 month average.  This week’s decline puts that percentage at a bit over 5%.


Existing home sales notched up a bit in December but the yearly percent gains were relatively flat.  The 4 week average of new claims for unemployment declined to 331,000.  Several weeks ago it was close to the psychological 350,000 mark.  Mitigating the decline in new claims, continuing claims have been rising lately and are approaching the 3 million mark.

To put that 3 million people in historical perspective, take a look at the chart below.

The number of long term unemployed is ever a concern.


In early October I noted the relative sluggish performance of retail stocks vs the larger market index of the SP500 ahead of the Christmas buying season.  Below is an updated chart of a retail index ETF vs the larger market.

Shortly after that post, renewed hopes for a strong Christmas season led to higher prices for the group.  Disappointing sales gains announced as the season ended deflated that balloon.  Since the new year began, a composite of retail stocks has lost 8%.

Typically retailers report their earnings in mid to late February.  Traders have already priced in a rather disappointing earnings season for the retailers.  In the context of a longer time frame, retail stocks are still up 25% year over year.  If an investor had bought this composite on this date seven years ago when the economy was strong and retail stocks were at a high, she would still have doubled her money, easily outpacing the 38% gains in the larger market since then.  The resilience of consumer demand, despite an extremely severe downturn when unemployment and falling house prices put a brake on consumer spending, has helped make this sector a sure footed long term winner.  

Summer Sale

June 23rd, 2013

It would be a mistake for the casual investor to think that the decline in the market this week was due entirely to Fed chairman Ben Bernanke’s comments regarding future Fed policy.  There was little that was not anticipated.  The Fed will continue to follow a rules based approach to its quantitative easing program, scaling back its purchases of government securities if employment improves or inflation increases above the Fed’s target of 2%.  Bernanke also reiterated that the Fed would increase its purchases if employment does not improve and inflation remains subdued.  So why the drop?

Shortly after the conclusion of each Fed meeting, Bernanke holds a press conference, where he issues a ten minute or so summary of the meeting and issues discussed.  He then takes about twenty questions.  At the start of this past Wednesday’s press conference at 2:30 PM EDT, the market was neutral as it had been all morning.  The Fed chairman was more specific about the anticipated timeline of the wind down of quantitative easing if the economy continued to improve.   Although he was essentially repeating himself, the voicing of a specific and concrete timeline evidently jolted some sleeping bulls who surmised that the party was over; in the final hour of trading the SP500 fell a bit more than 1% in the final hour.  For many traders, it was time to take profits from the eight month run up in prices.  “Quadruple witching”, a quarterly phenomenon that occurs when stock and commodity options and futures expire, was approaching.  The few days before this event usually see a spike in volume as traders resolve their options and futures bets.

With much of the Eurozone in a mild recession and slow growth in emerging markets, the rest of the world perked up their ears as the central banker of the largest economy envisioned an easing of monetary stimulus sometime in 2014.

Overnight (Wednesday/Thursday) came the news that the Shanghai interbank rate had shot up from about 4% to 13%, a rate so high that it threatened to seize up the flow of money between Chinese banks.  This bit of bad news from the second largest economy added additional downward pressure on world markets.  For some time, analysts covering China have been warning about the amount of poorly performing loans at China’s biggest banks.  The spike in interbank rates, prompted by the Chinese government, was an official warning to Chinese banks to be more cautious in their lending practices.

On Thursday morning came the news that jobless claims had increased, adding more downward pressure.  The SP500 opened up another 1% lower that morning and dropped a further 1.5% during the trading day. This classic “one-two” punch knocked the market down about 4%.  European markets fell about 5%, while emerging markets endured a 7.5% drop in two days.

In the past four weeks, there has been a decided shift in market sentiment.  When the market is bullish, it tends to shrug off minor bad news.  As it turns toward a bearish stance, the market reacts negatively to news that just a few months ago it largely ignored.

Over the past two months, long term bonds have declined 10% and more.  Here is a popular Vanguard long term bond ETF that has declined 12% since early May.

For the long term investor, periods of negative sentiment can be an opportunity to put some cash to work.

Regulation Riddle

I’ll continue my look at favorite myths of both the left and right. This week it’s the right’s turn.

A familiar myth of conservatives is that over-regulation led to the decline of manufacturing in the U.S. Is this true? While labor and environmental regulations in a well developed country like the U.S. may play some part in the total cost of a manufactured good, they are not the only costs. Below is a chart from the Bureau of Labor Statistics showing a comparison of labor costs in the U.S., China, Mexico and a few other areas.(Click to see larger image in separate tab)

As we can see, Chinese manufacturing companies have a huge advantage in this area. There are few labor regulations and those regulations which are in place are loosely enforced. The U.S. would have to abolish almost all of its labor regulations regarding minimum wage, overtime, Social Security, Unemployment insurance and Workmen’s Compensation and they still would not be competitive with China. Chinese manufacturing plants enjoy a host of other competitive advantages, according to Manufacturing News: many do not have to pay for the land their factories are built on; many companies do not pay income taxes, property taxes or value-added taxes. In rural areas, manufacturing plants pay only enough to compete with the small, if any, compensation that an overworked person can make in subsistence farming. Parts of Mexico enjoy the same advantages. If minimum wage laws were abolished in the U.S., would you take an assembly job for $2.60? If so, then we could stay competitive with Mexico and China.

How much manufacturing have we lost over the past two decades?  According to the Small Business Administration (SBA), there were almost 28 million private businesses in the U.S. in 2007. 22 million were what are called non-employer firms, i.e. businesses that report no employees.  These would include people who work for themselves as sole proprietors or Subchapter S corporations. In 1988, 6.5% of private employer businesses were classified as manufacturing and they accounted for  22% of private employment.  In 2007, only 4.7% of businesses were classified as manufacturing, accounting for 11% of private employment.  If we had the same percentage of employment in manufacturing that we did in 1988, we would have approximately 13 million more people employed.  The Bureau of Labor Statistics (BLS) reports  that the number of unemployed was 14.8 million in September.

There is no magic formula that will enable us to compete in manufacturing and assembly industries which can produce with low cost, marginally educated labor.  The edge we have and must maximize over newly industrializing nations must be a more educated workforce, one which can command the higher precision and more complicated manufacturing industries.  Improving educational standards is a multi-decade commitment of dollars and community.

So why do conservatives consistently trumpet regulations as the chief cause of the decline of manufacturing jobs in this country? Because it gives them a justification for policies to reduce the existing labor and environmental regulations. Conservatives know that, if they advocated abolishment of many or all of these regulations in order to be competitive, most of the voters would turn away from them in disgust. So they promise that some reasonable reduction in regulations will make a big difference, hoping that the voters will buy the argument on its plausibility without checking the facts.

The Dump

Recycling has become popular in China.

In 1999, Chinese state owned banks dumped $200B (U.S.) of bad loans made during the 1990s into Asset Mgmt Companies (AMC) or “bad banks”, banks set up to hold “toxic assets” and non-performing loans. Six years later, they dumped another $170B into these AMCs. Many of these loans are carried on the books at face value, far above their true market value. When the loans came due this year, most were rolled over for another ten years. Here is a brief summary from the Gerson Lehman Group.

Large private companies have been accused of managing, or massaging, earnings in order to sustain a higher stock price for the company’s stock. Tempting as this practice is for private executives, public officials are under even greater pressure to put their best foot forward by manipulating asset values. China’s strong, rapid move to urbanize is bound to incur casualties along the way. The commercial real estate market is beset with vacancies, while newly constructed factories stand ready to supply a world whose demands have slowed. When state owned banks defer the recognition of bad real estate loans, it becomes difficult to honestly evaluate their financial status.

FXI is an ETF that tracks China’s top banks. A word of caution.