Portfolio Performance & Presidents

October 6, 2019

by Steve Stofka

The employment report released Friday was a Goldilocks gain of 136,000 jobs for the month of September. Why Goldilocks? Not as weak as some feared following news this week that manufacturing was getting hit hard in the trade war with China (Note #1). Not so strong that it ruled out the possibility of another rate cut from the Fed this year. Just weak enough to speculate on another rate cut by year’s end. After several days of big losses, the market rallied on Friday.

Although manufacturing has been contracting, a report on the rest of the economy was more encouraging, although a bit lackluster (Note #2). Service businesses are continuing to hire but the pace has slowed. New export orders have accelerated but new orders in total slowed significantly from August. Something to like, something not to like.

Billions of dollars are around the world are traded as soon as the employment report is released each month. During Mr. Obama’s tenure private citizen Donald Trump accused Obama of fudging the employment numbers. Larry Kudlow, now Mr. Trump’s economic advisor, took him to task for that. Mr. Kudlow worked in the Reagan administration and knew well how sacrosanct the employment numbers were. The BLS is an independent agency working in the Department of Labor and its 2400 employees try to collect and publish the most accurate data it can accomplish. The agency’s Commissioner is the only political appointee in the BLS and once confirmed by the Senate, serves four years, the same as the head of the Federal Reserve (Note #3). According to Mr. Kudlow, the White House gets the number the night before only to prepare a press release when the report is released.

Mr. Trump’s reckless behavior helped him take out 16 other Republican presidential candidates in the 2016 election. He acts quickly and aggressively. That lack of caution has led to several bankruptcies, and because of that, no bank in the world will loan him money (Note #4). What if, on an impulse, Mr. Trump tweeted out the employment number shortly before its official release time? Some traders pay a lot of money so that the news will hit their trading desk a split second faster than a conventional news release. It’s that important. An early leak of the employment numbers would cost a lot of influential people big money around the world and would prompt a national if not a global crisis. Forget about the phone calls to foreign leaders to discredit Joe Biden. That would be an act of treason for sure – against the global financial community. Can’t happen? Won’t happen?

Mr. Trump knows no rules. His father protected him when his rash behavior got him into trouble as a child. The elder Trump sheltered Donald from his own mistakes in the real estate industry and his foolish foray into the Atlantic City gambling business. Now that Mr. Trump’s father is no longer there, he depends on others to protect him. He has enlisted a long line of people in that effort. They have come in the revolving door to the White House and left. The list is longer than I imagined (Note #5). John Bolton, the third National Security Advisor under Mr. Trump’s tenure, was the last high-profile team member to leave.

Mr. Trump has said that Americans would get tired of winning so much while he was President. To use a baseball analogy, when he takes the mound, the team doesn’t win very often. People who lose a lot either give up or blame everyone and everything else for their losses. They need to have an ideal environment or get lucky to win. Mr. Trump berates the independent Fed because he wants them to protect him. He needs every crutch he can get. He couldn’t succeed in a war or in the financial crisis because he is not disciplined or organized.

What does this mean for the average investor? Take a cautious approach and keep a balanced portfolio. Betting that Mr. Trump will pitch a good game is a poor bet.

Or is it? At an event on Friday, he claimed that the stock market has gone up 50% since he was elected. Not quite but it is up 42% since the day after he was elected (Note #6). It’s been about 35 months. That’s pretty good. A 60-40 stock-bond portfolio has gone up 30% in that time. Under Obama’s tenure the market only went up 27%. A balanced portfolio went up almost 40% and he had to deal with the worst recession since the Great Depression. The budget battles with Republicans put a big dampener on investor enthusiasm during Obama’s first term.

35 months after the Supreme Court awarded the presidency to George Bush, the market was down 25% but a balanced portfolio was up 21%. Even Mr. Clinton could not best Mr. Trump, although he comes close. 35 months after the 1992 election the market was up 38%. A balanced portfolio was up 40%. The winner? A balanced portfolio.

What might an investor expect? At today’s low interest rates and inflation, a break-even return might be 5% a year, for a total gain of 22% in four years. Will Mr. Trump’s first four years be one of his few wins? Check back in a year. It’s bound to be a tumultuous year.

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Notes:

  1. Institute for Supply Management (ISM). (2019, October 3). September 2019 Manufacturing ISM Report on Business. [Web page]. Retrieved from https://www.instituteforsupplymanagement.org/ISMReport/MfgROB.cfm
  2. Institute for Supply Management (ISM). (2019, October 3). September 2019 Non-Manufacturing ISM Report on Business. [Web page]. Retrieved from https://www.instituteforsupplymanagement.org/ISMReport/NonMfgROB.cfm?navItemNumber=28857&SSO=1
  3. Bureau of Labor Statistics. (n.d.). About the U.S. Bureau of Labor Statistics. [Web page]. Retrieved from https://www.bls.gov/bls/infohome.htm
  4. Business Insider. (2019, August 28). The world is talking about Trump’s relationship with Deutsche Bank. [Web page]. Retrieved from https://markets.businessinsider.com/news/stocks/trump-tax-returns-deutsche-bank-relationship-drawing-intense-scrutiny-2019-8-1028482268#why-it-matters2
  5. Wikipedia. (n.d.). List of Trump administration dismissals and resignations. [Web page]. Retrieved from https://en.wikipedia.org/wiki/List_of_Trump_administration_dismissals_and_resignations
  6. Prices are SPY, the leading ETF that tracks the SP500. Clinton: 42 to 58 (approximately) – up 38%. Bush: 138 to 103 – down 25%. Obama: 91 to 116 – up 27%. Trump: 208 to 295 – up 42%. Balanced portfolio returns from Portfolio Visualizer calculated using a mix of 60% U.S. stock market, and 40% of an evenly balanced mix of intermediate term government and corporate bonds. Dividends were reinvested and the portfolio re-balanced annually.

Job Threats

September 8, 2019

by Steve Stofka

The greater threat to your job – automation or other workers? For thousands of years people have stored their human capital in writing. In some cultures, only a privileged few were allowed access to these “secrets.” The invention of the printing press in the 15th century caused massive unemployment among monks and scribes who copied treasured books by hand.

No, that didn’t happen. Demand for books, particularly the Bible, added many jobs. A symbiosis of knowledge exploded through Europe and parts of Asia. In the network of knowledge, the sciences flourished. The mathematics of chance and the development of calculus spawned the birth of modern physics in Newton’s Principia Mathematica. In the following centuries came the understanding of air and other gases, the physics of fire, electromagnetism and the very structure of stuff. All this human capital was written down in words and equations written in a single language called mathematics.

Books could hold and display the knowledge but couldn’t make the calculations. All that changed when the computer was invented in the mid-20th century. Dancing on pathways etched on silicon circuit boards, electrons simulated the calculations that the human brain had learned.

After defeat by IBM’s Deep Blue chess computer in 1996 (he won the first game), Garry Kasparov realized that computers could become human partners. Crude mechanical computers had automated some tasks during the the 19th and 20th centuries. Now they were ready for some of the tasks of knowledge workers like lawyers (Note #1). Some clerical tasks in the practice of law have been automated but there is still much that relies on judgment gained through experience and “je ne sais quoi” – the subtle weighing of multiple factors that are difficult to write algorithms for.

Thirty years ago, a grocery clerk had to be good at arithmetic – able to multiply four apples times 89 cents per apple and punch in the total on older cash registers. Clerks who could do those calculations quickly and accurately were paid good money.

An accounting clerk in a finance office had to know what calculations to do to get a loan payoff, or to calculate how much credit to extend to a customer. Today a clerk with much less knowledge and training can tab from box to box on a screen and enters the data that the program asks for. Natural language processing is rapidly making even that obsolete. A clerk will simply be able to ask a program a question and it will compute the answer or ask for more information if needed. We used to have to give Google the formula to compute the volume of a sphere. No longer. Ask “what is the volume of a sphere with a radius of 2?” Each year more human capital is being transformed into technology capital.

Some are concerned about the number of jobs that will be lost to automation. The development of the Cotton Gin in the early years of the nineteenth century reduced the number of workers needed to harvest an acre of cotton. Did plantation owners tell their slaves “I don’t need your services any longer?” No. They devoted more acres to the growing of cotton and the demand for slave labor increased.

A few years earlier before the cotton gin, the invention of the Loom greatly improved the efficiency of garment workers. Manufacturers reduced prices of some finished goods, the demand for silk and cotton soared, and employment in the industry grew.

The invention of primitive computers in the middle of the 20th century should have put arithmeticians out of business. Instead the demand increased for people who could do the more difficult or time-consuming computations. Careful but relatively unskilled people could punch in data on a punch card and the computer would tabulate the results. In the 1960s, the demand for business data dramatically increased.

Those in technical professions like lawyers and doctors lobby to protect their jobs not from automation but from other people who could do portions of their job.  In some states, a dental technician cannot fill a cavity. In some states, routine tasks can be performed by a paralegal with less training. They also command lower salaries. In other states, those tasks have to be carried out by a lawyer or with the active supervision of a lawyer.

Some areas of the country are based on a monoculture, an industry that dominates the local economy. The leaders in those industries exert a lot of political influence. A fundamental shift happens when one monoculture competes with another. Many coal workers may be convinced that former President Obama killed the coal industry with burdensome regulations. In 1979, the rock group The Buggles sang “Video Killed the Radio Star;” a similar shift has happened to the coal industry. The surge in lower cost natural gas supplies killed the coal industry. North Dakota against West Virginia and Wyoming. The coal industry’s leaders had less political influence and could not push back against the regulators.

In the 1990s, checkers at Albertson’s went on strike to protest the adoption of scanning technology and UPC codes that were first developed in the 1970s. They were concerned that the store chain would begin hiring lower-paid workers who simply had to pass a grocery item over a scanning screen.

Technological change displaces one type of worker with another type. Millions of workers are doing jobs today that didn’t exist 50 years ago because of technological change. I was at a get-together a few months ago and spoke with a woman who was a social media manager. That’s a job. As the growth of social media has exploded around the world, thousands of new jobs have been created. In the past two decades, programmers have automated some coding. Programmers who could not adapt did lose their jobs but many more jobs were created for those with different or more complicated skills.

What can’t be automated -so far – is people taking care of people. The fact that these are some of the lowest paid professions speaks to the values of our society. Companies pay paltry wages to the people who take care of our parents and grandparents. Those jobs cannot be automated to any great degree. It’s possible that some company will develop a robot that can help an older person into a bathtub or shower, but the process requires many delicate decisions, patience and empathy.

In monoculture economies around the country, some worry that unauthorized immigrants will take lower paying jobs from Americans. Immigrants are more willing to move for a job than Americans. In a county dominated by oil, gas, coal, mining, agricultural or car manufacturing industries, there isn’t much variety in employment and native residents of those towns and cities have something to worry about.

For the whole country, there will not be enough people to fill many lower paying jobs. The Bureau of Labor Statistics estimates that jobs for home health and personal care aides will grow by 36% – rising to almost five million workers. Difficult to keep up with a growth rate far above the 7% average growth of all occupations. Employment for in-facility nursing assistants and orderlies are expected to grow by 9%. Even taking care of our pets will be more difficult – job opportunities for vet assistants are expected to grow by 19%.

If only Congress could set up an immigration program to help our hospitals, clinics, long-term care facilities and home aide programs fill these positions. If only. The H-2B visa program is for temporary jobs only and there are far too few permits issued each year (Note #3). Most of the demand for health care services comes from urban and suburban areas, whose votes have less influence in a rural state where the legislature heeds the wishes of the extractive and “ag” industries. We are not fighting the machines. We are fighting each other.

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 Notes:

  1. Kasparov recounts that match with Deep Blue in the TED talk (transcript)
  2. BLS estimates of employment growth for health care aides
  3. 1H-2B visa program

Interest Rate Ceiling

June 23, 2019

by Steve Stofka

After the Federal Reserve meeting this week, traders are betting on a cut in interest rates in July and the market hit all-time highs. Is a cut in interest rates warranted at this time? Such an action is usually taken in response to weak employment numbers, a decline in retail sales or sluggish GDP growth. Let’s review just how good the economy is.

Unemployment is at 50-year lows. The percent of people unemployed more than fifteen weeks is near the lows of the late 1990s. At almost 18 million vehicles, auto sales are near all-time highs. Real retail sales continue to grow more than 1% annually. In the first quarter of this year, real GDP growth was over 3%. Ongoing tariffs may cause real GDP to decline one percent but a growth rate above 2% is above average for this recovery after the financial crisis.

Corporate profits have been strong. In fact, that may account for the volatility of the past two decades. The chart below is after tax corporate profits (CP) as a percent of GDP. The multi-decade norm is in the range of 5-8% but the past twenty years have been above that trend except for the plunge in profits and GDP during the GFC.

Companies have paid part of those extra profits as dividends to shareholders who tend to be cautious pension funds or older, wealthier and more cautious individuals.  Some profits have been used to buy back shares and boost the return to existing shareholders.

Despite the above average profits, investors still have a strong thirst for lower yielding government debt. Why? The Federal Reserve has kept interest rates below a market equilibrium, which is currently about 3.8%, far above the current 2.4% federal funds rate (Note #1). As with any price ceiling, the below-market price creates a shortage. In this case, the shortage is in the capital investors want to supply to governments to meet the demand for capital. Consequently, investors have been searching for alternative substitutes or near-substitutes. That distortion is being reflected in stock market prices.

Despite a strong economy and corporate profits, the SP500 has gained less than 5% from its peak high in February 2018 after the passage of the 2017 tax cuts. Including dividends, the SP500 has gained just 5.7% in 16 months. If we turn the clock back a few weeks to the end of May, the total return of the SP500 during the past fifteen months was a big, flat zero. Those gains of the past sixteen months have come in the past three weeks on the hope and the hint of rate cuts.

An intermediate bond ETF like Vanguard’s BIV has returned 5.2% in the same period. On a scale of increasing risk 1-5, with 1 being a safe investment, BIV is rated a 2. The SP500 is rated a 4. Investors buying the broad stock market have not been rewarded for the additional risk they are taking.  How long will this situation persist? For as long as the Fed keeps a price ceiling on interest rates.

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Notes: A popular model of equilibrium interest rates is the Taylor rule proposed in 1993 by John B. Taylor, a member of the Council of Economic Advisors under three presidents. The Atlanta Fed has a utility that calculates the current rate and allows the reader to change the parameters. Click on the graph icon, accept the default parameters and the utility graphs the equilibrium rate and the historical Fed funds rate.

Marching Forward

April 28, 2019

by Steve Stofka

When former President Obama took the oath of office, the economy was in the worst shape since the Great Depression 75 years earlier. Tax receipts plunged and benefit claims soared. Millions of homes and thousands of businesses fell into the black hole created by the Financial Crisis. In sixteen years of the Bush and Obama presidencies, the country added $16 trillion to the public federal debt, more than tripling the sum at the time Clinton left office in early 2001.

Although growth has remained slow since the financial crisis (see my blog last week), the economy has not gone into recession. Despite the fears of some, a recession in the next year does not look likely. The chart below charts the annual percent change in real GDP (green) against a ratio called the M1 money multiplier, the red line (Note #1). Notice that when the change in GDP dips below the money multiplier for two quarters we have been in recession.

The money multiplier seems to act like a growth boundary. While some economy watchers have warned of an impending recession, GDP growth has been above 2.5% for more than a year and is rising. In 2018, real disposable personal income grew nearly 3%. This is not the weak economic growth of 2011 or the winter of 2015/16 when concerns of recession were well founded.

The number of people voluntarily quitting their job is near the 1999 and 2006 highs. Employees are either transferring to other jobs or they feel confident that they can quickly get another job. An even more important sign is that this metric has shown no decline since the low point in August 2009.

In 2013, the Social Security disability fund was in crisis and predicted to run out of money within a decade. As the economy has improved, disability claims have plunged to all-time lows and the Social Security administration recently extended the life of the fund until 2052 (Note #2).

Approximately 1 in 6 (62 million) Americans receive Social Security benefits and that number is expected to grow to 78 million in a decade. However, the ratio of workers to the entire population is near all time highs. The number of Millennials (1982-1996) has surpassed the number of Boomers. This year the population of iGen, those born after 1996, will surpass the Millennial generation (Note #3). Just as a lot of seniors are leaving the work force, a lot of younger workers are entering. The ratio of worker to non-worker may reach 1 to 1. 45 years ago, one worker supported two non-workers.

As the presidential cycle gets into gear, we will hear claims that there are not enough workers to pay promised benefits. Those claims are based on the Civilian Employment Participation Rate, which is the ratio of workers to adults. While the number of seniors is growing, the number of children has been declining. To grasp the total public burden on each worker, we want to look at the ratio of workers to the total population. As I noted before, that is at an all time high and that is a positive.

Raising a child is expensive. The average cost of public education per child is almost $12K (Note #4).  Public costs for housing, food and medical care can push average per child public cost to over $20K annually.

Let’s compare to public costs for seniors. The average person on Social Security receives $15,600 in benefits (Note #5). In 2018, the Medicare program cost an average of $10,000 per retiree (Note #6). The public cost for seniors is not a great deal more than those for children.

As a society, we can do this.

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Notes:

  1. The M1 money multiplier is the ratio of cash and checking accounts to the amount of reserves held at the Federal Reserve.
  2. SSDI solvency now extended to 2052. Here’s a highlight presentation of the trustee’s report.
  3. Generation Z will surpass the numbers of Millennials in 2019. Report
  4. Public education costs per pupil
  5. Social Security costs
  6. Medicare program cost $583 billion. There are approximately 60 million on the program. CMS

The Line of the Idle

July 8, 2018

by Steve Stofka

It used to be easy for a horse to get a job. This week I’ll look at the workers who have been idled by a century of automation. As a counterpoint to the daily rhythms of being busy, a casual idleness helps us recharge our batteries. In an America whose moral foundations are the Protestant work ethic, a constant idleness taints a person’s character. Those who have retired after a lifetime of work are expected to stay active. Leisure time is a resource not be squandered.

The phrase “pull your weight” meant to act like a horse and contribute to the team effort. From the Revolutionary War for Independence to World War 1, horses fought bravely and earned a place of respect in American history. Many a statue portrays a general atop his brave steed. Horses helped turn America into the bread basket of the world. Then the gas engines came after their jobs. Motors took over the jobs of pulling horse drawn carriages, plows and work wagons. Thousands of horses joined the line of the idle.

Then the engines came for the jobs of the agricultural workers. In the first half of the 20th century, farm employment fell from 40% of the labor force to 20% in 1950, and is 2% today.

Then the robots came for the jobs of manufacturing workers. A 1987 BLS report found that “relatively few employees have been laid off because of technological change.” Thirty years later, the National Council on Compensation (NCCI) summarized data from several sources. “In 2016 the United States produced almost 72% more goods than in 1990, but with only about 70% of the workers.” This two-part report is a bit lengthy but a quick glance at the graphs on the first page tell the story of the decline in agricultural and manufacturing jobs. (Part 1 and Part 2) . As a percent of the labor force, agricultural jobs peaked in the late 1800s. Manufacturing employment peaked just after World War 2.

Robots help assemble the horseless carriages in the car factories. In businesses across the land, the robots now weld and lift, pick and sort, box and ship – jobs that humans had a monopoly on. The robots are now learning how to drive and to think. Almost 40% of adults, and 20% of adults in the prime of their lives now sit idle, joining the horses in pasture.

Electric motors, long chained by a cord to a wall, have broken free and are now taking the jobs of gas engines. Robots built by workers in other countries compete for the jobs of American-built robots. Now the machines are making other machines obsolete.

Forged by the Protestant work ethic, the retired generation of Boomers pursue their leisure in earnest. RV sales are at record levels and last year’s visits to national parks almost matched the record numbers of 2016. Each year there are more visits than there are people in the country (Nat’l Park Service link). This growth in recreation occurs at a time when continuing drought in the western states has put extraordinary pressure on plants and wildlife. Summer in the west is now the season of fire.

In 1900, people welcomed their idleness as a byproduct and hallmark of progress and prosperity. The idleness of prosperity looks very different from the idleness of poverty visible in many troubled countries around the world, including parts of America. Which line is longer and which line are we on?

Building A Peak

June 3, 2018

by Steve Stofka

First I will look at May’s employment report before expanding the scope to include some decades long trends that are great and potentially destructive at the same time. In the plains states of Texas, Oklahoma, Kansas, and Nebraska, summer rain clouds are a welcome sign of needed moisture for crops. That’s the good. As those clouds get heavy and dark and temperatures peak, that’s bad. Destruction is near.

May’s employment survey was better than expected. The average of the BLS and ADP employment surveys was 203K job gains. The headline unemployment rate fell to an 18 year low. African-American unemployment is the lowest recorded since the BLS started including that metric in their surveys more than thirty years ago. As a percent of employment, new unemployment claims were near a 50-year low when Obama left office and are now setting records each month.

During Obama’s tenure, Mr. Trump routinely called the headline unemployment rate “fake.” It’s one of many rates, each with its own methodology. Now that Mr. Trump is President, he takes credit for the very statistic that he formerly called fake. The contradiction, so typical of a veteran politician, shows that Mr. Trump has innate political instincts. A President has little influence on the economy but the public likes to keep things simple, and pins the praise or blame on the President’s head.

The wider U-6 unemployment rate includes discouraged and other marginally attached workers who are not included in the headline unemployment rate. Included also are involuntary part-time workers who would like a full-time job but can’t find one. Mr. Trump can be proud that this rate is now better than at the height of the housing boom. Only the 2000 peak of the dot com boom had a better rate.

Let’s look at a key ratio whose current value is both terrific and portentous, like a summer’s rain clouds. First, some terms. The Civilian Labor Force includes those who are working and those who are actively seeking work. The adult Civilian Population are those that can legally work. This would include an 89-year old retiree and a 17-year old high school student. Both could work if they wanted and could find a job, so they are part of the Civilian Population, but are not counted in the Labor Force because they are not actively seeking a job. The Civilian Labor Force Participation Rate is the ratio of the Civilian Labor Force to the Civilian Population. Out of every 100 people in this country, almost 63 are in the Labor Force.

While that is often regarded as a key ratio, I’m looking at a ratio of two rates mentioned above: the Labor Force Participation Rate divided by the U-3, or headline, Unemployment Rate. That ratio is the 3rd highest since the Korean War more, ranking with the peak years of 1969 and 2000. That is terrific. Let’s look at the chart of this ratio to understand the portentous part.

CLFUIRatio
Whenever this ratio gets this high, the labor economy is very imbalanced. Let’s look at some previous peaks. After the 1969 peak, the stock market endured what is called a secular bear market for 13 years. The price finally crossed above its 1969 beginning peak in 1982. In inflation-adjusted prices, the bear market lasted till 1992 (SP500 prices). Imagine retiring at 65 in 1969 and the purchasing power of your stock funds never recovers for the rest of your life. Let’s think more pleasant thoughts!

For those in the accumulation phase of their lives, who are saving for retirement, a secular bear market of steadily lower  asset prices is a boon. Unfortunately, bear markets are accompanied by higher unemployment rates. The loss of a job may force some savers to cash in part of their retirement funds to support themselves and their families. Boy, I’m just full of cheery thoughts this week!

After the 2000 peak, stock market prices recovered in 2007, thanks to low interest rates, mortgage and securities fraud. Just as soon as the price rose to the 2000 peak, it fell precipitously during the 2008 Financial Crisis. Finally, in the first months of 2013, stock market prices broke out of the 13-year bear market.

We have seen two peaks, followed by two secular bear markets that lasted thirteen years. The economy is still in the process of building a third peak. Will history repeat itself? Let’s hope not.

May’s annual growth of wages was 2.7%, strengthening but still below the desirable rate of 3%. The work force, and the economy, is only as strong as the core work force aged 25-54. This age group raises families, starts companies, and buys homes. For most of 2017, annual employment growth of the core fell below 1%. It crossed above that level in November 2017 and continues to stay above that benchmark.

Overall, this was a strong report with job gains spread broadly across most sectors of the economy. Mr. Trump, go ahead and take your bow, but put your MAGA hat on first so you don’t mess up your hair.

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Executive Clemency

This week President Trump pardoned the filmmaker Dinesh D’Souza, serving a five-year probation after a 2014 conviction for breaking election finance laws. He helped fund a friend’s 2012 Senate campaign by using “straw” contributions. D’Souza complains that he was targeted by then President Obama and General Attorney Holder for being critical of the administration. A judge found no evidence for the claim but if he didn’t see the conspiracy against D’Souza, then he was part of the conspiracy, no doubt. I reviewed the 2016 movie in which D’Souza unveiled the perfidious history of the Democratic Party and its high priestess, Hillary Clinton.

Prejudice and Jobs

April 22, 2018

by Steve Stofka

America is built on prejudice and the passionate denial that we are a country built on prejudice.

Investors who understand the role of prejudice in the economics of this society can recognize a few early signs of a coming recession. A strong economy, like a bull stock market, raises all boats, including those at the margins who are easily stranded.  During the financial crisis, they were the first to be discarded.  As the current strength of the economy is finally able to lift the fortunes of the more vulnerable, countervailing forces will undermine that strength.

From the country’s founding, broken and forced land treaties, enforced by superior military power, have sidelined those with red skin.  Like the thoroughbred horses in the upcoming Kentucky Derby, Americans with black or brown skin must carry an extra weight during the race of life. I’ll show one data sign of this weight. White people must bear their own burden: privilege. Centuries of discrimination blocked those with black skin from many housing and job choices to give those with white skin a better chance at success. The prejudice against those with brown skin is less strong but has intensified when Candidate Trump used the issue of illegal immigration to taint those with brown skin or Hispanic surnames, regardless of their citizenship.

America has a shorter history of isolating and persecuting immigrants of white skin. First it was the Irish who immigrated to America after the potato blight devastated Ireland’s staple crop in the mid-19th century. Newspapers and periodicals portrayed the Irish as ignorant, shiftless criminals. In a country dominated by Republicans, many Irish were Catholic and suspected of being more loyal to the pope in Rome than democratically elected leaders in America.

As the century turned, Italians and southern Europeans became the target of American prejudice (History). Like the Irish, many Italians were Catholic and not to be trusted. To this day, no Italian has been elected President. JFK was the first successful Irish Catholic candidate for the Presidency, and he had to overcome objections that he would turn to the Pope for advice on national policy.

As discriminatory as Protestants have been to Catholics, they have been especially unkind to those of other Protestant sects. As more Catholics migrated to America, many Protestants in America deflected their prejudices from other Protestants to the Catholics as easy targets of discrimination.

In America, Jews encountered less discrimination than in Europe but housing, job and social discrimination were prevalent in the first half of the 20th Century. In the 19th Century, those of the Mormon faith were driven out of Ohio, then Missouri, and Illinois by Protestant sects who regarded Mormons as non-Christians. The abandoned farms and businesses were auctioned off to the Christian righteous who remained. Mormons escaped across the Great Plains and the Rocky Mountains to settle in a valley in Utah. Following the Holocaust during World War 2, there was a proposal to settle many European Jews in Utah, but Mormons nixed the idea. Even those who suffer persecution for their religious beliefs are not immune to bias.

From Europe, Protestant settlers brought their prejudices with them. Those Protestants who immigrated to America because of religious persecution were often fleeing long standing animosities with other Protestant sects. Eight of the thirteen colonies established churches of a particular denomination and only those citizens belonging to that denomination were allowed to hold office. Each Protestant sect was convinced that the other sects had strayed from the message and meaning of the Bible. To counter such discrimination, Virginia adopted an amendment to protect religious freedom even before the founding of the United States. Mindful of these bedrock prejudices, the Founding Fathers based the language of the First Amendment on the laws of several states protecting religious freedom.

Jobs and their compensation reflect the value that a society places on an individual’s labor. The graph below is a sign of prejudice in America. The unemployment rate for blacks is always higher than the rate for whites. If this were a chart from the year 1890, the persistently higher unemployment rate could be labeled Irish or Italian.  A disadvantaged class of worker is more willing to do unpleasant jobs for less money.

UnemployBlackWhite

Under Obama, the unemployment rate for black men dropped from 18% in the spring of 2010 to 7.7% in November 2016. Since Trump’s election to the Presidency in November 2016, that rate has fallen another 20%. At 6.1% this rate is the lowest since the early 1970s. There are black grandfathers who thought they might die before seeing a younger generation enjoying an unemployment rate this low.

Still, the current rate for black men is 2.8% higher than the 3.3% rate for white men. Over the past forty years, the average difference between the two unemployment rates is close to 6%. This is the burden of being black in America. In the past half century, there have been few times when the difference in rates is this low: 1) during the Vietnam War when many black and white men were removed from the labor force; 2) 1999, near the height of the dot-com boom; and 3) several months this past year.

UnemplRatesDiff

It’s not just skin color, religion and nationality that drives prejudice in America. Five years after the end of the Civil War in 1865, the 15th Amendment gave black males the right to vote. Women suffragettes lobbied hard to be included in the Amendment and win their right to vote. Susan B. Anthony and Elizabeth Cady Stanton were prominent leaders of this movement. The idea was just too crazy, they were told. Women were too guided by their emotions, and too irrational, particularly during their menses, to be trusted with the vote.

In 1920, exactly fifty years later, the ratification of the 19th Amendment gave women the right to vote. The Suffragette movement had allied with the Prohibition movement to press each of their causes in a joint effort. The Volstead Act, the implementation of the 18th Amendment prohibiting the sale of intoxicating liquor, was passed a few months before the ratification of the 19th Amendment. They were a package. Had women been granted the right to vote in 1870, the Prohibition movement would have lacked a critical partner to win passage of the Amendment. Without Prohibition, the rise of organized crime might not have occurred.

Whenever there is a war, or any act of aggression with another country, Americans single out those nationalities or races for discrimination. In the 19th Century, those of Mexican descent were vilified after the Mexican-American War.

Many Germans were denied jobs and housing following the start of WW1. Historical prejudices were resurrected. German soldiers, known as Hessians, had fought with the British against American colonists in the War for Independence. Americans began to see that there was something wrong with the German character. Political cartoons pictured Germans as Huns, a mongrel and violent race of uncivilized people always lusting for battle.

Following Japan’s 1941 attack on Pearl Harbor, U.S. citizens of Japanese descent were forced to sell their homes and businesses at below market value, then were moved to internment camps away from the west coast.

The most recent assault on U.S. territory was the 9-11 attack by multiple suicide squads. Most hijackers were from Saudi Arabia, but we did not single out Saudi nationals in the U.S. Unlike the targets of previous war discrimination, Saudis have no unique language. Instead we singled out all Muslims, and all Arab speakers as potential threats.

Prejudice based on sex, on religion, on skin color, and on nationality have formed our country. America is built on prejudice and the passionate denial that we are a country built on prejudice. We can’t do the work of healing until we admit the reality.

Low unemployment rates among minority groups means that the economy is especially strong. Low levels of unemployment for black, brown and white men usually precede a recession. For white men, the benchmark is 4%. For black men, it’s 7%. For Hispanic men, 5%. Below those benchmarks, the Fed has coincidentally seen what they consider to be inflationary pressures.

In a strong economy with low unemployment, confidence and spending increase. This puts some upward pressure on prices. Central bankers jump at the slightest hint of rising prices. Inflation and employment models like the Phillips curve are imperfect. Despite mountains of surveys, equations and data, inflation is difficult to measure, and many factors influence its rise and fall.  Building a model is made more difficult because each high inflation period has had its own unique features. Among economists, fears of an awakening of the inflation beast has persisted since the recovery in 2009.  Economists had begun to worry why the beast has not awoken.  The models said the beast should be awake! Finally, the Fed is seeing some consistent signs that inflation is growing toward their 2% mark. It has begun to lift interest rates to curb inflationary pressures.

I’ve added the Federal Funds rate to a chart of the unemployment rate for white men to show the pattern. I’ve left off the series for black males that I showed earlier so that the chart was not too cluttered.

UnemplVsFedFundsRate

Economists joke that it’s the Fed’s job to remove the punch bowl just when the party is getting going. Want to know what’s ailing the stock market lately? One of them is the greater likelihood of four rate hikes by the Fed this year. At the start of the year, investors put the chances of four rate hikes at 15%. This week it stands at 45%.

To those on the edges of our society and labor force, and to those just entering the job market, the easier job market that others have enjoyed for several years is just opening to them. If there has been a party, they have been left out. As their prospects brighten, the Fed’s raising of interest rates is a cruel joke.

As interest rates go higher, fewer people can afford to buy homes, cars and furniture. Many companies run on borrowed money to meet short term funding needs and long-term investment. As money becomes more expensive, companies tighten their belts and hiring slows. The most vulnerable are the recently hired and they are often the first to be let go. Like marine life that lives in the tidepools at the ocean’s edge, some are left high and dry when the tide of easy money ebbs.

 

Trade Wind Turbulence

April 8, 2018

Remember the clip of Jack Nicholson In the 1980 movie The Shining? Jack hacks his way through a door with an axe, then presses his face to the jagged hole and announces, “It’s Johnny!” Substitute “Trade Wars” and we get a dramatic portrayal of the stock market this past week. On several days, the Dow swung 700+ points, or more than 2%, in response to fears of a tariff feud between the U.S. and China.

The share of global commodities that China consumes far exceeds its share of the world’s population (1/5) or the global economy (1/6). Here’s a chart from Visual Capitalist.

On Thursday, the market opened almost 2% down in response to comments from the chief Tweety Bird in the White House. Later that morning, Larry Kudlow, Trump’s new NEC Director, did a quite effective job of easing market jitters. Kudlow has been a host of CNBC and his own radio program for many years and is savvy to shifting sentiments. No, he said, Trump is a free trader in disguise. This is just a bargaining tactic. The market started the day 500 points down and finished up 240 points.

This is a trader’s market. Much of the price action is taking place in the last hour of the trading day. Each price recovery since mid-March has failed, so the overall sentiment is negative and Friday’s trading was near the 200-day average. For an investor who has not yet made their 2017 IRA contribution, buying now is somewhat equivalent to dollar cost averaging over the past nine months. For those with shorter time horizons, cash looks good till the market finds its head.

The Labor Report for March showed job gains of just 103,000. This was below the 175,000 anticipated gains and far below ADP’s 240,000 estimate of job gains. Mid-March weather on the east coast may have had a negative effect on this month’s survey. The average of the BLS and ADP surveys is 172K, and I find that average to be a more accurate long-term estimate.

The BLS recently released a report on unemployment rates and weekly earnings classified by degree. This chart is a dramatic picture of the advantages of higher education.

UnemplEarnByDegreeBLS
VividMaps released a map showing the income needed to buy an average home in each state. Because the data uses average house prices, the map overstates the affordability problem for many families but does reveal the underlying trend. Why do I say overstates? The average home price is far above the median price because extremely expensive homes raise the average.

First quarter earnings to be released in the next two weeks are expected to show strong annual growth. Will the confirmation of rosy expectations overcome the darker fears of a global trade war? Stay tuned.

The Puff

February 25, 2018

by Steve Stofka

Each week I’m hunting scat, the data droppings that a society of human beings leaves behind. This week I’m looking for a ghost ship called the Phillips Curve, a relationship between employment an inflation that has had some influence on the Federal Reserve’s monetary policy. The ideas and policies of others, some long dead, have a daily impact on our lives. I’ll finish up with a disturbing chart that may be the result of that policy.

A word on the word “cause” before I continue. As school kids we learned a simplistic version of cause and effect. Gravity caused my ball to fall to the ground. As kids, we like simple. As adults, we long for simple. As we grow up, we learn that cause-effect is a very complex machine indeed. The complexity of cause-effect relationships in our lives are the chief source of our disagreements.

So, “cause” is nothing more than shorthand for “has an important influence on.” The dose-response mechanism is a key component of a causal model in biology. If A causes B, I should be able to give more of A, the dose, and get more of B, the response, or a more frequent response.

Let’s turn to the Phillips Curve, an idea that has influenced the Federal Reserve’s monetary policy since it was proposed sixty years ago by economist A.W. Phillips. Simply stated, the lower the unemployment rate, the higher the inflation rate. There is an inverse relationship between unemployment and inflation.

Inverse relationships are everywhere in our lives. Here’s one. The lower the air temperature, the more clothes I wear. I don’t say that air temperature is the only cause for how many clothes I wear. There is wind, humidity, sex, age and fitness, my activity level, social protocols, etc. While there is a complex mechanism at work, I can say that air temperature has an important effect on how many clothes I wear. If I measure the varying air temperatures throughout the year and weigh the amount of clothes that people have on, I will get a strong correlation. High temps, low clothes.

Now what if the temperature got colder and people still wore the same amount of clothes? I would need to come up with an explanation for this discrepancy. Perhaps there never was much of a relationship between air temperature and clothes? That seems unlikely. Perhaps clothes fabrics have been improved? I would need to look at all the other factors that I mentioned above. If I could find no difference, then I would have to conclude that air temperature had little to do with clothes wearing. Headlines would herald this new discovery. Important areas of our economy would be upended. Retail stores would stop stocking coats or bathing suits a few months in advance of the season. Businesses around the country who depend on warm weather clothing would go out of business.

Unlike air temperature and clothes, the relationship between inflation and employment is two-way. The change in one presumably has some influence on the other. During the 1970s, inflation and unemployment both rose. The hypothesis behind the Phillips curve posits that one should go up when the other goes down. Some economists threw the Phillips curve in the trashcan of ideas. Milton Friedman, an economist popular for his lectures and his work on monetary policy, proposed a concept we now call NAIRU. This is a “natural” level of unemployment. If unemployment goes below this level, then inflation rises.

Some economists complained that NAIRU was a statistical figment designed to fit the Phillips curve to existing data. Economic predictions based on the Phillips curve have been consistently wrong. Still, the Congress has mandated that the Federal Reserve maintain “maximum employment, stable prices, and moderate long-term interest rates” (Federal Reserve FAQs). Economists at the Fed must consider both employment and inflation when setting interest rates. The models may not accurately describe the relationship, but many will instinctively feel that the relationship, in some form or another, is valid.

For the past several years, the economy has been at or near maximum employment. In January 2018, the unemployment reading was 4.1%. Whenever that rate has been this low, the country has either been at war or within a year of being in recession. The puzzlement: only lately have there been signs of an awakening inflation.

Because inflation was below the Fed’s 2% benchmark while unemployment declined, the Fed kept its key interest rate near zero for seven years. For its 105 year history, the Fed has never kept interest rates this low for as long as it did. Low interest rates fuel asset bubbles. Such low rates cause people and institutions who depend on income to take inappropriate risks to earn more income. The financial industry develops and markets new products that hide risk and provide that extra measure of income. We can guess that these products are out in the marketplace, waiting to blow up the financial system if a set of circumstances occurs. What set of circumstances? We will only know that in the rear view mirror.

Here’s a chart that tracks price movement of the SP500 ETF SPY for the past twenty years. I’ve shown the tripling in price that has occurred during the past five years.  Notice the long stalk of rising prices. That growth has been nurtured by the Fed’s policy.  Well, maybe this time is different.  Maybe not.

SPYPF20180223

Long-Term Trends

January 7th, 2018

by Steve Stofka

This week I’ll look at a few long-term trends in the marketplace for goods and labor.  Millennials born between approximately 1982 – 2002 are now the largest generation alive. Their tastes will dominate the marketplace for the next twenty years at least.  In the first eighteen years of the new century, change has been a dominant theme.

Some businesses drowned in the rush of change. A former member of the Dow Jones Industrial Average, the film giant Eastman Kodak is a shadow of its former self after it emerged from bankruptcy in 2013.

Some in the music business complain that the younger generations don’t want to pay for music. Much of YouTube music is pirated material and yes, Google, the site’s owner, does remove content in response to complaints. There’s just so much of it. Album sales revenue in the U.S., both digital and physical, fell 40% in the five years from 2011 to 2016. Globally, the entire music business has lost 40% in revenues since the millennium and is just now starting to grow again (More).

Some in the porn industry make the same complaint as those in the music business. As online demand for porn grew, the industry helped pioneer digital payment security. Now there is too much free porn on the internet. Producers and distributors pirate each other’s content. Who wants to invest in good production values only to see their work ripped off? (Atlantic article/interview on the porn industry) Will the lack of quality reduce demand? ROFL!

An ever-diminishing number of city newspapers struggle to survive. Some complain that people don’t want to pay for local news. Local reporters have long been the bloodhounds who sniff out the corruption in city halls and state capitols around the country. There are fewer of them now.  Think that corruption has been reduced?  ROFL!

Surviving bookstores glance over their shoulders at Amazon’s growing physical presence in the marketplace. This year Amazon became the 4th largest chain of physical bookstores. The large book publishing houses try to preserve their hegemony as readers turn to a greater variety of alternatively published books.

As online sales grow, brick and mortar stores struggle to produce enough revenue growth to sustain the costs of a physical store.  During the past three years, an ETF basket of retail sector stocks (XRT) is down almost 10%.

Hip-hop music was a fad of the ‘80s and ’90 until It wasn’t. Rock ‘n Roll was a fad that has lasted sixty years. In the early 60s, the Beatles were told to make it rich while they could, and they worked hard to capitalize on their success before it fizzled. Never happened.

How are we going to predict the future if it is so unpredictable? Some standards fade while some fads become standards. We face the past, not the future, as the future sneaks up on us from behind.

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Employment

A few notes on what was the weakest employment report of the past year. Job gains were only 150K as reported to government surveyors but the percentage of businesses responding to the survey was particularly low. Expect the BLS to revise those job gains higher next month when more of the survey forms come in. I have long used an average of the BLS numbers and ADP’s estimate of private job gains. That average was 200K – a healthy number indicative of a growing economy.

The long-term trend remains positive. The annual growth of total employment should be at 1.5% or above. We are currently holding that threshold despite the loss of jobs to automation and the growing number of Boomers retiring.  Growth in construction jobs  remains at or above the growth in total employment – another healthy sign.

ConVsPayemsGrowth

The employment market faces a long-term challenge as the largest generation of workers in history is retiring. In January 2000, 69 million adults were out of the labor force. That figure now stands at 95 million. As a ratio, there were 53 adults not in the labor force for every 100 adults with a job. Now there are 65 adults for each 100 workers.

NotInLabForceVsPayems

Although growth in hourly wages is at 2.5%, weekly paychecks have grown 3% as part-time workers get more hours or find full-time jobs. Look for inflation to approach that growth in paychecks.

WeeklyEarnVsInflation

When inflation rises above paycheck growth, workers struggle more than usual to balance their income with spending.  I’ll use that same chart to highlight some stress points during the past decade.

WeeklyEarnStressPoints

As the economy continues to improve, the Fed is expected to continue increasing interest rates either two or three times in the coming year.  After a decade of zero interest rates (ZIRP), those with savings accounts may have noticed that their bank is paying 1% or more in interest.  It is still a far cry from the 4% to 5% rates paid on CDs in the ’90s and 2000s.  This past decade has been particularly worrisome for older folks trying to live off their savings.