The Coming Boom or Not

November 27, 2016

For most of Obama’s time in the White House, the Republican led House has fought more borrowing to repair the nation’s decaying infrastructure.  The incoming Trump administration has promised to fulfill a campaign pledge to spend $500 billion or more on these repairs. Funding this spending while reducing taxes may prove to be improbable.  A lack of available labor in parts of the country may stress the economies of some states.

In 2010, economists Robert Frank and Paul Krugman recommended additional infrastructure spending to take care of much needed repairs at low interest rates and an idle construction workforce.  In February 2010, the unemployment rate among construction workers was 27% (FRED).

Since early 2010 construction spending has increased by 42% (FRED).  As older workers in the field retire, the severe downturn in the housing industry dissuaded many young workers from entering the profession in the past decade.  Following the housing bust and the 2008 crisis, many workers native to Mexico left the U.S. to find lower paying work in their home country. Continuing high unemployment did not attact new migrant workers who would contribute to the productivity of the U.S. economy. A mood of hostility towards foreigners has furthered dampened the appeal of work in the U.S.  Only the desperate now risk the dangers of crossing the border.

While roofing companies struggle to find workers at $20 an hour, farmers are simply leaving crops to rot for lack of available workers to pick the vegetables and fruits.  Automated picking machines still can not tell ripe from unripe produce. As job openings go unfilled, employers cut back on plans for expansion.  After six years of paralysis and debate, fiscal stimulus may be achievable under a Trump regime.  Irony may have the final curtain if the extra spending is too much too late. Readers with a WSJ subscription can read more here.

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Existing Home Sales

Sales of existing homes in October notched a recovery high at 5.6 million.  Home prices are rising fastest in the western states at a 7.8% clip.  Prices are now 50% higher than the country’s median. (NAR)  Volume increases of 10% are far outpacing the national yearly increase of 5.9%. Expect continuing price increases in the western states.

Mortgage interest rates have risen 1/2% but are still low by comparison with past decades.  The increase has prompted an uptick in refinances.  Higher rates will put homes in some neighborhoods out of reach for first time buyers as well as current owners who were hoping to trade up.

In the early part of 2008, the delinquency rate on single family mortgages rose above 5%.  During the 90s and 00s, the rate averaged a little over 2%.  Despite seven years of recovery, escalating home prices and extremely low mortgage rates, the delinquency rate just fell below 5% earlier this year.  In short, there is still a lot of pain out there.

On the other hand, credit card delinquency is at an all time low.  So are consumer loan delinquency. Consumer credit continues to grow but at a slower pace since the financial crisis.

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Commercial Loans

Tightening lending standards for large and mid-size companies has proven to be a reliable recession indicator.   When the percentage of cautious banks grows above 25%, recession has followed within the year.

We can also see periods of doubt in this chart.  In late 2011 to early 2012 a short rising spike indicates a growing caution following the budget standoff in the summer of 2011.  In response to an economic dip in the beginning of this year, banks again grew more cautious.

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Stocks make new highs

Stocks continue to rise modestly on hopes of greater economic growth, future profits, lower taxes and tax policy changes.  After more than a year of declining profits, price levels are a bit rich but may be justified if…  After spiking up on election night, volatility has fallen near year to date lows.   Traders have priced in the likelihood that the Fed will raise rates in mid-December.

Procession, Not Recession

May 24, 2015

Existing home sales of just over 5 million (annualized) in April were a bit disappointing.   Since the recession, there have been only about six months that sales have been above a healthy benchmark of 5.2 million set in the late 1990s to early 2000s.

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Procession, not Recession Indicator

When reporting first quarter results, many of the big multi-national companies in the Dow Jones noted that sales had declined in Europe.  The broader stock market, the SP500, has not had a 5% decline for three years and is due for a correction.  Greece is likely to default on their Euro loans in June.  Combine all of these together and some pundits predict a 30 – 40% market correction this summer and/or a recession this year.  Corrections can be overdue for a long time.  Some treat the stock market as though its patterns were almost as predictable as a pregnancy.  Here’s an early 2014 warning that finds a chilling similarity between the bull market of today and, yes, the one before the 1929 crash.

Bull and bear markets tend to confound the best chart watchers.  The bear market of 2000 – 2003 was not like that of 2007 -2009.  Some argue that market valuations are like a rubber band.  The longer prices become stretched, the harder the snapback.  However, the data doesn’t show any consistent conclusion.

The 2003 – 2007 bull market ran for 4-1/2 years without a 5% correction.  That one didn’t end well, as we all know.   The mid-1990s had a three year stampede from the summer of 1994 to the summer of 1997 before falling more than 5%.  After a brief stumble, the market continued upwards for a few more years.  Turn the dial on the wayback machine to the early 1960s for the previous stampede, from the summer of 1962 to the spring of 1965.  That one ended much like the 1990s, dropping back before pushing higher for a few more years. These long runs occur infrequently so there is not much data to go on but the lack of data has never stopped human beings from predicting the end of the world.

April’s Leading Economic Indicator was up .7%, above expectations, but this increase was helped along by an upsurge in building permits.  This series has been unreliable in predicting recessions and its methodology has been revised a number of  times to better its accuracy.  Doug Short does a good job of tracking the history of this composite and here is his update of April’s reading.

A much more consistent indicator of coming recessions is the difference in the interest rates of two Treasury bonds.  The time to start thinking about recessions is when the 10 year interest rate minus the two year rate drops below zero.  The current reading simply doesn’t support concerns about recession in the mid-term.

The Federal Reserve has made it easy for us to track this flattening of the yield curve.  They even do the subtraction for us.  The series is called T10Y2Y, as in “Treasury 10 year 2 year.”

New Home Sales Sink

April 26, 2015

Housing

A few months ago sales of new homes per 1000 people climbed above the low water mark set during the back to back recessions of the early 1980s.  In a more normal environment, new home sales would be closer to 800,000, not 500,000.

This past week came the news that new home sales fell more than 11% in March.  The good news is that they were up more than 10% over this month last year.  The supply of new homes is still fairly thin, less than half a year of sales, so builders are unlikely to slow the pace of construction.  As new home sales were climbing this winter, sales of existing homes – 90% of all home sales – languished.  The process flipped in March as existing home sales surged, up 10% year over year.

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Long Term or Short Term

Somewhere I read that all investment or savings is a loan.  Loans are short or long term, principle assured or not.  When we deposit money in a checking or savings account, we are loaning the bank money, principle assured.  When we buy shares in an SP500 index mutual fund, we are loaning our hard earned money to “Mr. Market,” as it is sometimes called.  Principle not assured. We hope we get paid back with a decent rate of interest when we need to cash in our loan.  Most of us probably think that this type of investing is long term but, in this model, most stock and bond investments by individual investors are liquid, which is by definition short term.  Every month that a person leaves their money in a stock or bond fund, it is a decision to roll over the loan.  The value of our asset loan depends on the willingness of others to roll over their loans to that same asset market.  Occasionally many lenders to the stock and bond markets shift their concern from return on principal to return of principal and call in their loans.  When phrased this way, we come to understand the inherent fragility of our portfolios.

Because pension and sovereign wealth funds may carry a sizeable position in a market, the entirety of their position is not liquid.  Substantial changes in position will probably affect the price of the asset.  Even in a large position, however, there is a certain amount of liquidity because the fund can sell so many thousand shares of an asset without a material change in the price.  A family’s decision to leave their 401K money in a stock fund in any month, to roll over the loan, joins them at the hip with a sovereign wealth fund in Dubai or CALPERS, the California state employee pension fund.  They are all participants in the short term asset loan market.

In March 2000, at the height of the dot-com boom fifteen years ago, many investors were still loaning money to the NASDAQ market (QQQ).  This past month investors who had bought and held QQQ finally broke even on the nominal value of their loans.   The relatively small dividend payments over the years hardly compensated for the 27% loss of purchasing power during those fifteen years.  

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Taxes

Every facet of our culture seems to get a calendar month, so I guess April is tax month.  In that spirit, let’s look at some historical trends in income taxes.  In 2001, the Congressional Budget Office did an assessment of changes in Federal tax rates by income quintile for the years 1979 – 1997.   These are effective, not marginal, rates.  If someone makes $100K gross and pays $15K in Federal income tax, then their effective rate is 15%.

Effective corporate income tax rates went down for all quintiles while Social Security and Medicare taxes went up for those at all income levels.  The top 20% of incomes saw little change in their effective rates during this 19 year period, while everyone else enjoyed lower rates.  The reason why the top 20% saw little reduction was that their income grew faster than the incomes of those in the other quintiles.

The negative income tax rate for the lowest quintile was due to the adoption of the Earned Income Tax Credit and the increasing generosity of the credit given to low income families. (In 1979, a worker with three children received $1400 in 2012 dollars.  In 2012, they received $5,891, a 400% increase)

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International Currencies

This graphic from the global financial nexus Swift com shows just how much the US dollar and the Euro dominate international trade.  For those of you interested in international currency wars, you might like this Bloomberg article.

Bank analyst Dick Bove thinks that it is unlikely that the Fed will raise interest rates this year.  The U.S. dollar has gained so much strength that a raise in interest rates has too many dangerous implications for other economies and would destabilize global trade.

A well written, informative and entertaining read is James Rickards’ Currency Wars (Amazon).  The author, a former CIA agent, weaves a coherent and interesting narrative that connects a lot of information and events of the past one hundred years.

Income, Housing and Durable Goods

In this week’s downturn, prices of the SP500 almost touched the 26 week, or half year, average of $203.90.  Since August 2012, when the 50 day average crossed above the 200 day average, these price dips have been good buying opportunities as the market has resumed its upwards climb after each downturn.

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Manufacturing and Durable Goods

Preliminary readings of March’s Purchasing Managers’ Index (PMI) showed an uptick back into strong growth.  Survey respondents were concerned about weak export sales as the dollar’s strength makes American products more expensive overseas.  The full report will be released this coming Wednesday.

This past Wednesday’s report that Durable Goods had dropped 1.4% in February caused an already negative market to fall another 1.5% for the day and this marked the close of the week’s activity as well.  New orders for non-transportation durable goods have steadily declined since the fall.  Although the year-over-year comparisons are consistent with GDP growth, about 2.3%, the downward trend is concerning.

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Housing

Existing home sales in February rose almost 5% in a year over year comparison, the best in a year and a half but still below the 5 million annual mark. The positive y-o-y gains during the past six months has prompted some optimism that sales may climb back above the 5 million mark in the spring and summer season.

New home sales in February surged back above a half million.  In a more healthy market, sales of new homes are 6% – 7% of existing homes.  In 2006, that ratio started climbing above the normal range, getting increasingly sicker until it reached almost 18% in May 2010.  February’s ratio was 9%. If the ratio were in the normal range, existing home sales would be over 8 million, far above the current 4.9 million units actually sold.

In a 2014 report the National Assn of Realtors noted that boomers tend to buy new or newer homes to avoid maintenance headaches while younger buyers buy older homes because they are less expensive (page 3).  38% of all home buyers are first timers but the percentage is double for those younger than 33 (Exhibit 1-9 in the report).  As the supply of existing homes is inadequate to meet the demand, prices climb and suppress the demand, forcing first timers to either buy a smaller new home or continue renting.

Sales of new homes and the fortunes of home builders are based on the churn of existing homes.  Since October, the stocks of home builders (XHB) have climbed 20% in anticipation of growing sales, but weak existing home sales may prove to be a choke point for growth.

The larger publicly traded homebuilders also build multi-family units.  Real investment in this sector has tripled from the lows of early 2010 but are still below pre-crisis levels.

The housing market in this country is still wounded.  63% of the population are white Europeans (Census Bureau) but are 86% of home buyers (Exhibit 1-6).  While few will admit to racial prejudice in the current housing market, the numbers are the footprints of this nation’s long history of racial discrimination and socio-economic disparity.  Mortgage companies that made – let’s call them imprudent – credit decisions that helped precipitate the housing crisis are especially cautious, making it more difficult for younger buyers to purchase their first home, despite the historically low mortgage rates.  This market will not heal until mortgage companies relax their lending criteria just a bit and that won’t happen while rates are so low.

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Income

The Bee Gees might have sung “Words are all I have to take your heart away” because they were singing about love, not economics and finance.  Graphs often tell the story much better than words.  A milestone was passed a few years back.  For the first time since World War 2, the growth in income crossed below the growth in output.

This past week, the Bureau of Labor Statistics released a revision to their initial estimate of multi-factorial productivity in 2013.  There is a lot of data to gather for this series.  An often quoted productivity growth rate calculates the GDP of the nation divided by an estimate of the number of hours worked, a statistic that is accessible through payroll reports submitted monthly and quarterly.  The contribution of capital to GDP is much more difficult to assess and is largely disregarded by those like Robert Reich, former Secretary of Labor under President Clinton, who have a political axe to grind.  Truth is on a path too meandering for politics.

Total output in the years 2007 – 2013 was just plain bad, growing at an annual rate of only 1%, a third of the 2.9% growth rate from the longer period 1987 – 2013.  In the BLS assessment, the growth rates of both labor and capital inputs were poor by historical norms but capital input accounted for all of the meager gains in non-farm business productivity.  People’s work is simply not contributing as much to growth as before.  That reality means that income growth will be meager, which will prompt louder political rhetoric to make some kind of change, any kind of change, because voters like to believe that politicians have magic wands.

A Week In The Life

September 28, 2014

This past Monday George was out in the backyard when his wife Mabel came out on the back deck to announce that lunch was ready.  From the deciduous vines that grew on the backyard fence George was pulling leaves that had turned an autumn shade of red.

“George, what are you doing?”
“I thought I would pull these leaves off before they fall.  This way I won’t have to stoop so much a few weeks from now to pick them out of the rock garden.  The leaves are getting in the pond and clogging up the filter.”
“Well, come on, dear.  Lunch is ready.  I heard on the radio a little while ago that the market is down.  You know how I worry about that.”
“Oh, really?” George replied.  “It was down last Friday.  Did they give any reason?”
“Something about housing.  I’m sure you’ll find out all about it while you are eating.”

Mabel had set a nice lunch plate of panini bread, cheese and vegetables.  George was a tall man, a big boned man, prone to weight gain in retirement. Although George was fairly fit for his age, she worried about his health, particularly his heart, the male curse.  Mabel made sure that they both ate sensible, healthy meals.

Mabel took her lunch into the living room, leaving George alone in the kitchen.  He liked to check in on the stock market a few hours before the close to get a sense of the direction of the day’s action.  She would have chosen to keep all their savings in CDs and savings accounts but the interest rates were so low that living expenses would slowly erode their principle.

“We’ll put just 25% of our money in the market,” George had told her.  “I’ll watch it carefully and if anything like 2008 happens again, we can pull it out right away.  I’ll know what the signs are.”

George had studied a book on technical indicators which were supposed to help a person understand the direction of the market.  Despite her confidence in George’s ability and sensibility, Mabel still worried.  The stock market had always seemed to her like gambling.

At the kitchen table, George turned on the computer while he chewed his carrots and celery.  He had never been fond of vegetables but found that his likes and dislikes had mellowed with age.  He liked that Mabel cared.  The market helped distract him from the vegetables.  He paged through the daily calendar at Bloomberg, then checked out the headlines at Yahoo Finance. Existing home sales in August had fallen more than 5% from the previous August but that was a tough comparison because 2013 had been a pretty strong year.  Existing home sales were still above 5 million.

Before George had invested some of their savings in the stock market, he had bought several books on how to read financial statements but soon gave up when he realized that knowing the fundamentals of a company would not protect their savings in the case of another meltdown like the recent financial crisis.  Patient though she might be, Mabel would be extremely upset with him if he lost half of his investment in the market.

He then turned to the study of technical indicators which analyzed the behavior of other buyers and sellers in the stock market.  As an insurance adjuster, he had learned C programming back in the 1990s and found a charting program whose language was familiar to him.  As a former adjuster for the insurance of commercial buildings, he was used to making judgments based on a complex interplay of many factors.  He played with several indicators, found a few that seemed to be reliable, but got burned when the market melted down in the summer of 2011.  He got out quickly but not quickly enough for he had lost more than 10% of his investment in the market.  The market healed but at the time it seemed as though there might be a repeat of the 2008 crisis.  Had George and Mabel been younger, George could have just ridden out the storm.  Retirement had made him cautious and the 2011 downturn made George almost as leery of the market as Mabel.

Tuesday was a fine day in late September.  Mabel put her crochet down and made the two of them some soup, with fruit, crackers and cheese.  She took pride in the variety of food that she prepared.  When she walked out on the deck to call George in for lunch, a startled crow took to flight.  George was sitting on the edge of the deck where the crow had been.

“What are you doing, George?”
“I was teaching that little crow how to break open a peanut,” George replied. “I think they learn how to do stuff like that from their parents but I haven’t seen the flock in a few days and this guy was just wandering around the backyard looking for something to eat.  When I gave him a peanut, he didn’t seem to know what to do with it.  He’d pick it up in his beak, then drop it and stare at it.  He pecked at it a few times but that only made the peanut skitter away. “
George held up a branch.  “I carved a claw into the end of this branch and held down the peanut for him.”  George held up half a peanut shell.  “See, he got it figured out.  He flew off when the door opened but I’ll betcha he’ll be back.”
“Well, come on in then.  Lunch is ready.  The market is down again.  Something about housing again.”
“Hmmm,” George grunted and followed Mabel into the kitchen.  “Hmmm, that soup smells good.”
“A little beef vegetable that I doctored up a bit,” Mabel said with a smile.
George gave her a little hug. “I sure like your doctoring.”

He sat down to eat, wondering what all the fuss in the market was.  Checking the Bloomberg Calendar, he saw that it was the House Price index from the Federal Housing Administration that had dampened spirits.  The monthly change was drifting down to zero, a sign of weakness.  Although housing prices were still rising, the rise was slowing down.

A disappointment, George thought, but not a catastrophe.  However, the market had been down for three days in a row.  He finished his lunch and went into the living room.  Mabel was reading a book.
“You know, Mabel, I think it’s just a short term thing.  The bankers from the developed countries met last week and they kinda put out a wake up call to the market.  I think there’s a bit more caution and common sense after that.”
“Well, as long as you’re watching it, dear.”
“You know, we did good this last year,” he reassured her.
“I just worry that it was too good.  We should have taken some of that out of the market and put it somewhere safe.”
 “Well, I’m keeping an eye on it,” he said.  “I checked CD rates last week and they are paying like 1% for a one year CD.  It just ain’t like it used to be. We just have to take some risk.”

They had a 3-year CD coming due in a month. He didn’t want to tell her that he was thinking about not rolling over the CD.  Maybe buy a bond fund.  She wouldn’t like that. For a time he had dabbled in some short to medium term trading but barely broke even.  He had lost sight of his original goal – to keep their savings safe while taking some risk with the money.  Fortunately, this insight had come to him toward the end of 2012.  The market had been mostly up since then, rewarding those who sat out the small downturns.

Late Wednesday morning, Mabel could hear George on the side of the house clearing brush or some such thing.  He said he was going to cut down an elm tree sapling that was growing near the house but when she went out to call him into lunch, he had cut everything but the elm sapling.

“I thought you were going to cut that down, dear.”
“Well, I was but the squirrels are using it to climb up to the old swamp cooler we have perched up there.  You remember the litter from early this spring?  Well, I think there’s another litter in there.  I haven’t seen any young ones but there’s a squirrel carrying twigs up that sapling to the cooler.  She’s even got a piece of one of my rags.  Must’ve fallen out of my pocket.”

Mabel looked up at the platform George had mounted to the side of the house years ago.  On top of the platform sat the old abandoned cooler.  George had meant to take it down and disassemble the platform but then the squirrels had used it as a nursery this winter and neither of them had been able to dismantle it while the little ones were scampering around in and out of the cooler.  Of course, George was supposed to take the cooler down during the summer but never got around to it.  Now she saw that he had tied a cord from the platform to the sapling to bend the sapling close to the platform, making it easier for the squirrel to get from the tree to the platform.

She shook her head and said “George Liscomb, I hope you don’t let that sapling get out of hand.  You know how elm trees are.  They grow faster than a puppy.”
“Well, the tree won’t grow much during the winter and I’ll cut it down in the spring.”
“Ok, well, come on it.  Lunch is ready.  I heard on the radio that the market is up a lot today.  Housing again.  Maybe you were right about it being short term.”
“Well, of course, I’m right,” he made a grand gesture.  “The squirrels will confirm that.”

His lunch plate held some broccoli spears and six, no more and no less, tater tots.  “I know you don’t particularly like broccoli so I thought a few tater tots might ease the pain,” Mabel said with a slightly sardonic smile.

He laughed.  “I’m married to a kind prison guard.”  He sat down at the table, wondering what could have buoyed the market so much.  Housing yet again.  “Holy moly!” he called out to Mabel. He went into the living room to tell her the good news. “Finally, after more than six years, new homes are selling at a rate of more than half a million a year.  That’s what’s got the market dancing.”

On Thursday, she found George working on the stream that he had built in the rock garden.  A few feet from George a squirrel cautiously sipped water from the stream.  The squirrel saw her and scampered up the nearby fence.  “It’s remarkable how comfortable they are with you,” she told him.  “I try to move slowly when I’m working,” George replied. “They seem to be less anxious.”
“What are you doing today?” she asked.
“Got a leak somewhere.  I’ve lost about 15 gallons since last night.  Still haven’t found it.”
“Well, you’re not going to like what going on in the market.  It’s way down today and it’s not about housing.”

He followed her into the house and broke into a big grin when he saw what was for lunch. “Tuna fish!”  Mabel had dressed up her famous tuna fish salad with lettuce, tomatoes, some green onions and put it open faced on some toasted bread.  It was scrumptious.  Not so the market.  The SP500 was down about 1-1/2% on several news releases.  The whopper was that Durable Goods Orders were down 18% in August from the previous month.  But most of that drop was a decline in aircraft orders after a surge in those same orders in July.  Aircraft orders were notoriously volatile. Year-over-year gains in non-defense capital goods, the core reading, were up almost 8%.

The weekly report of new unemployment claims had risen slightly but was still below 300,000.  September’s advance reading of the services sector, the PMI Services Flash, was slightly less than the robust reading of August but still very strong.  So what was causing these overreactions to news releases?  The short term traders execute buy or sell orders within seconds of a news release.  Computer algorithms trade within nanoseconds of the release.  If new unemployment claims are up even by 1, the word “up” or “rise” or some variation will occur within the release.  Sell.  New home sales up?  Up is good for this report.  Buy.  Why would the short-termers be so active this week?  Because they are trading against each other.  The mid and long termers, the portfolio managers, will take the stage at the beginning of next week to adjust their positions at quarter end when funds report their allocations.

Late Friday morning, Mabel stood out on the back deck, her mouth open at the sight of George hunched down as he came out of the shed in the backyard.  Hundreds of wasps swarmed above him.  He knelt down and closed the doors to the shed and hurried to her on the deck.

“My God, George!  Are you all right?”
“Oh, yeah, no worries.  Anything on me?” he asked.
“No.”  There were just a few wasps visible outside the closed doors.  “What on earth?!”
“Well, they’ve really built themselves a city since I was in there last,” George explained.  He sat down on the deck.  The shed was where they kept old tax records and camping gear that they hadn’t used in quite a long time but hadn’t given away or sold – just in case they went camping again.  “I should have sprayed them earlier in the summer but it was such a small hive.  Those doors get sun most of the day so they like it in there.  They’re right above the doorway so they’re not bothering any of our stuff and I was able to stand up in the shed and they just left me alone.”
“I don’t care. What if I had gone out there to get something?!” she said angrily.
“Yeh, you’re right.  I’ll take care of them this weekend.  I was kinda waiting for the cold weather to do its job.”  He held up his hands a couple of feet apart from each other.  “That hive is like this, strung out along the studs that frame the doorway.”
“Why were you out there?” she asked.
“Well, I wanted to see if we still had the box that the TV came in a few years ago.”
“Didn’t you throw it out?” she asked.
“Well, I thought that in case we had trouble with the TV but then the box was behind a bunch of stuff and it was hard to get to and I guess I forgot,” he admitted.
“Well, come on it and eat your lunch.  The market is up again today, I heard them say.”

George settled down at the kitchen table.  A few salami slices, some macaroni salad, carrots, olives and crackers sat on the plate.  “Working man’s antipasto, hey?”
“There are some sardines in there, too” she said.
“I have the best wife and cook in the world.  Anthony Bourdain, move ovah!  Mah honey’s takin’ ovah!”
Mabel laughed.  “Now let me get back to my book.  Second to last chapter and I think the niece did it.  I haven’t trusted her since the first chapter.”

The 3rd estimate of 2nd quarter GDP had been revised up from 4.2% to 4.6%, helping to compensate for the weak first quarter.  Good stuff, thought George.  The U. of Michigan Consumer Sentiment Survey had risen in September to 84.6 from August’s 82.5.  Confident consumers buy stuff, a good sign.  Anything above 80 was welcome and more was better.  To round out the daily trifecta of news releases, corporate profits for the second quarter were revised upward.  The year over year gain without inventory and depreciation adjustments was 12.5%.  Not spectacular but solid.

Even with Friday’s triply good news, the market closed below what it opened at the previous day.  This was usually an indication that the short term downward trend in the market might have a little way to run.  Then he promised Mabel that he would get rid of the wasps this weekend, and yes, he would be careful.  Did she remember seeing the wasp spray that he bought earlier that summer?

Housing and Bond Trends

August 24, 2014

Housing

The week began with a bang as July’s Housing Market index notched its second consecutive reading of +50, growing a few points more than the 53 index of last month.  Readings above 50 indicate expansion in the market.  The index, compiled by the National Assn of Homebuilders, is a composite of sales, buyer traffic and prospective sales of both new and existing homes.  The index first sank below 50 in January and stayed in that contractionary zone for a few months before rising again in June and July.

Housing Starts rose back above the 1 million mark but the big gains were in multi-family dwellings.  Secondly, this number needs to be put in a long term perspective. We simply are not forming new households at the same pace as we did for the past half century.

After monthly declines in May and June, new home sales popped up almost 16% in July.  Existing home sales rose in July but have now shown 9 consecutive months of year-over-year decreases.

The number of existing home sales is at the same level as 1999-2000.  On a per capita basis, we are about 11-12% below the rather stable level of those years, before the housing bubble really erupted in the 2000s.

During the 1960s and 1970s, households grew annually by 2.1% (Census Bureau data).  That growth slowed to 1.4% in the 1980s and 1990s and has declined in the past decade to 1% per year.  During the 1960s and 1970s, the number of households with children headed by women exploded by over 3% per year, leading to a growing economic disparity among households.  During the 1980s, growth slowed but still hit 2.5%.  In the past two decades, this growth has stabilized at 1.2 to 1.3% per year, just a bit above the total rate of growth of all households.

The trend of slower growth in household formation shows no signs of changing in the near term.  We can expect that this will curtail any historically strong growth in the housing industry.  The price of an ETF of homebuilders, XHB, has plateaued since the spring of 2013.  The price has tripled from the dark days of 2009 but is unlikely to reach the formerly lofty heights of the mid-$40s anytime soon.

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Interest Rates

As the long days of summer wane and children return to school, central bankers gather in the majestic mountains of  Jackson Hole, Wyoming. Let’s crank up the wayback machine and return to those yester-years when fear and despondency continued to grip the hearts of many around the world.  In August 2010, the Chairman of the Federal Reserve, Ben Bernanke, announced that the Fed would continue to buy Treasuries and other bond instruments to maintain a balance sheet of about $2 trillion dollars, which was already far above normal levels. Bernanke hinted that the Fed would be ready to further expand the program should the economic recovery show signs of faltering. This speech would later be viewed as a pre-announcement of what would be dubbed QE2, or Quantitative Easing Part II, which the Fed announced in November 2010.  The promise of Fed support helped fuel a 30% rise in the market from August 2010 to the spring of 2011.

Like the announcement of a new pope, investors look toward the mountain and try to read the smoke signals rising up from this annual confab.  Financial gurus practiced at linear regressions and Bayesian probabilities struggle to  parse the words of Fed Chairwoman Janet Yellen. Did she use the word “likely” or “probably” in her speech? What coefficient of probability should we assign to the two words?  Did she use the present perfect progressive or the past perfect progressive verb tense?

Here’s the gist of Ms. Yellen’s speech – essentially the same gist that she has given in several testimonies before Congress:

monetary policy ultimately must be conducted in a pragmatic manner that relies not on any particular indicator or model, but instead reflects an ongoing assessment of a wide range of information in the context of our ever-evolving understanding of the economy.

Investors like simple forecasting tools – thresholds like the unemployment rate or the rate of inflation.  In 2012 and 2013, former chairman Ben Bernanke reminded investors that thresholds are benchmarks that may guide but do not rule the Fed’s decision making.  Ms. Yellen reiterated several points:

Estimates of slack necessitate difficult judgments about the magnitudes of the cyclical and structural influences affecting labor market variables, including labor force participation, the extent of part-time employment for economic reasons, and labor market flows, such as the pace of hires and quits….the aging of the workforce and other demographic trends, possible changes in the underlying degree of dynamism in the labor market, and the phenomenon of “polarization”–that is, the reduction in the relative number of middle-skill jobs.

 Each month I have encouraged readers to go beyond the employment report headlines, to look at these various  components of the labor market.  The Fed uses a complex model of 19 components:

This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.

Long term bond prices are at all time highs, leading some to question the reward to risk ratio at these price levels.  Prices took a 10% – 12% hit in mid-2013 in anticipation of a rate hike in 2014, indicating that investors are that jumpy. Since the beginning of this year, prices have risen from those lows of late last year.  Will 2015 be the year when the Fed finally begins to raise interest rates? Investors have been asking that question for four years.

Since the spring of 2009, 5-1/2 years ago, an index of long term corporate and government bonds (VBLTX as a proxy) has risen 65%.  From the spring of 2000 to the spring of 2009, a period of nine years, this index gained the same percentage.  Perhaps too much too fast?  Only time will tell.

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Takeaways

Housing growth will be constrained by the slower growth in household formation.  Further valuation increases in long term bonds seem unlikely.

GDP and Education

June 29, 2014

This week I’ll review some of this week’s headlines in GDP, personal income, spending and debt, housing and unemployment.  Then I’ll take a look at some trends in education, including state and local spending.

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Gross Domestic Product First Quarter 2014

The headline this week was the third and final estimate of GDP growth in the first quarter, revised downward from -1% to -2.9%.  This headline number is the quarterly growth rate, or the growth rate over the preceding quarter.  A year over year comparison, matching 2014 first quarter GDP with 2013 first quarter GDP, shows an annual real growth rate of 1.5%, below the 2.5 to 3.0% growth of the past fifty years.  The largest contributor to the sluggish GDP growth was an almost 5% drop in defense spending.  Simon Kuznets, the economist who developed the GDP concept, did not include defense spending in the GDP calculation.

Contributing to the quarterly drop was the 1.7% decline in inventories.  Businesses had built up inventories a bit much in the latter half of 2013 in anticipation of sales growth only to see those expectations dashed by the severe winter weather.  Final Sales of Domestic Product is a way of calculating current GDP growth and does not include changes in inventory.  Let’s look at a graph of the annual growth in Real (Inflation-Adjusted) GDP and Real Final Sales of Domestic Product to see the differences in the two series.

Note that Real GDP growth (dark red line) leads Final Sales (blue line) as businesses build and reduce their inventory levels in anticipation of future demand and in reaction to current and past demand.
  
The Big Pic: if we look at these two series since WW2, we see that ALL recessions, except one, are marked by a year over year percent decline in real GDP.  The 2001 recession was the exception.

Secondly, note that in half of the recessions, y-o-y growth in Final Sales, the blue line in the graph, does not dip below zero.  We can identify two trends to recession: 1) businesses are too optimistic and overbuild inventories in anticipation of demand, then correct to the downside, causing a reduction in employment and a lagging reduction in consumer spending; 2) consumers are too optimistic and take on too much debt – selling an inventory of future earnings to creditors, so to speak – then correct to the downside and reduce their consumption, causing businesses to cut back their growth plans.  In case #1, a decrease in consumer spending follows the cutbacks by businesses.  In case #2, businesses cut back following a downturn in consumer spending.

In this past quarter, employment was rising as businesses cut back inventory growth, indicating more of a rebalancing of resources by businesses rather than a correction.  Consumer spending may have weakened during the first quarter but, importantly, did not decline.  We have two hunting dogs and neither is pointing at a downturn.

For a succinct description of the various components of GDP, check out this article written for about.com by Kimberly Amadeo.  Probably written in the first quarter of 2014, her concerns about the inventory buildup in 2013 were proved accurate.

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Income and Spending

Personal Income rose almost 5% on an annualized basis in May but consumer spending rose at only half that pace,  2.4%.  The spending growth is only slightly more than the 1.8% inflation rate calculated by the Bureau of Economic Analysis, revealing that consumers are still cautious.

I heard recently a good example of how data can be presented out of context, leading a listener or reader to come to a wrong conclusion.  Data point: the dollar value of consumer loans outstanding has risen 45% since the start of the recession in late 2007. Consumer loans do not include mortgages or most student loan debt. If I were selling a book, physical gold, or a variable annuity with a minimum return guarantee, I could say:

My friends, this shows that many consumers have not learned any lessons from the recession.  They are living beyond their means, running up debts that they will not be able to pay. Soon, very soon, people will start defaulting on their debts and the economy will collapse.  This country will suffer a depression that will make the 1930s depression look tame.  Now is the time to protect yourself and your loved ones before the coming crash.

Data is little more than an opportunity to spread one’s political message.  Data should never lead us to reconsider our message, our point of view.  If I were penning a politically liberal message, I could write:

The families in our country are desperate.  Without enough income to satisfy their basic needs, they are forced to borrow, falling ever deeper into debt while the 1% get richer.  We need policies that will help families, not the financial fat cats on Wall Street.  We need a tax structure that will ensure that the 1% pay their fair share and not have the burden fall on the shoulders of most of the working Americans in this country.


Selling a political persuasion and selling a car brand often employ similar techniques.  Data should never lead us to question our loyalty to the brand.  If I were crafting a conservative message, I could write:


The misuse of credit indicates an immaturity fostered by cradle to grave social programs, which are eroding the very character of the American people, who come to rely less on their own resources and more on some agency in Washington to help them out.  People steadily lose their sense of personal responsibility, becoming more like children than self-reliant adults.

However, the facts behind the data point lead us to a different story. In the spring of 2010, consumer loans spiked, rising $382 billion in just two months.

That surge represents more than a $1000 in additional debt per person. Consumers did not suddenly go crazy.  Banks did not open their bank vaults in a spirit of generosity. Instead, banks implemented accounting rules FAS 166 and 167 that required them to show certain assets and liabilities on their books. $322 billion of the $382 billion increase in consumer loans during those two months in 2010 was the accounting change. If we subtract that accounting change from the current total, we find that real consumer loan debt increased only 5.5% in 6-1/2 years.  And that is the real story.  Never in the history of this series since WW2 have consumers restrained their borrowing habits as much as we have since December 2007.  We had to.  In the eight years before the financial crisis in 2008, real consumer debt rose 33%, an unsustainable pace.

About two years ago, loan balances stopped declining and since then consumers have added $80 billion, much of it to finance car purchases. $25 billion of that $80 billion increase has come only since the beginning of this year.  On a per capita, inflation adjusted basis, consumer loan balances are still rather flat.

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Housing

New home sales in May were up almost 20% over April’s total, and over 6% on an annual basis.  Existing homes rose 5% above April’s pace but are down 5% on an annual basis.  Each year we hope that housing will finally contribute something to economic growth.  Like Cubs fans, we can hope that maybe this year….

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Unemployment Claims

New unemployment claims continue to drift downward and the 4 week moving average is just below 315,000.  Our attention spans are rather short so it is important to keep in mind that the current level of claims is the same as what is was last September.

It has taken this economy six months to recover from the upward spike in claims last October.  The patient is recovering but still not healthy.

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Minimum Wage

The number of workers directly affected by changes in the minimum wage are small.  We sympathize with those minimum wage workers who try to support a family.  The Good Samaritan impulse in many of us prompts us to say hey, come on, give these people a break and raise the minimum wage.  What we may forget are the implications of any minimum wage increase.  Older readers, stretch your imagination and remember those years gone by when you were younger. Workers in their early working years often see the minimum as a benchmark for comparison.  The much larger pool of younger workers who make above minimum wage may push for higher wages in response to increases in the minimum wage.

Fifty years ago, Congress could have made the minimum wage rise with inflation, ensuring that workers in low paid jobs would get at least a subsistence wage and that increases would be incremental.  Of course, there are some good arguments against any nationally set minimum wage.  $10 in Los Angeles buys far less than $10 in Grand Junction, Colorado.  Ikea recently announced that they will begin paying a minimum wage that is based on the livable wage in each area using the MIT living wage calculator .  Several cities have enacted minimum wage increases that will be phased in over several years but none that I know of are indexed to inflation as the MIT model does.

Congress could enact legislation that respects the differences in living costs across the nation.  For too long, Congress has chosen to use the minimum wage as a political football.  Social Security payments are indexed to inflation because older people put pressure on politicians to stop the nonsense.  There are not enough minimum wage workers to exert a similar amount of coordinated pressure on the folks in Washington so workers must rely on the fairness instinct of the larger pool of voters if any national legislation will be passed.

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Education

Demos, a liberal think tank, recently published a report recounting the impact of rising tuition costs on students and families.  Student debt has almost quadrupled from 2004 – 2012.  Wow, I thought.  State spending per student has declined 27%.  More wows.  How much has enrollment increased, I wondered?  Hmmm, not mentioned in the report.  Why not?

The National Center for Education Statistics, a division of the Dept. of Education, reports that full time college enrollment increased a whopping 38% in the decade from 2001-2011.  Part-time enrollment increased 23% during that time.  Together, they average a 32% increase in enrollment. Again, wow!  Ok, I thought, the states have been overwhelmed with the increase in enrollment, declining revenues because of the recession, etc.  Well, that’s part of the story.  Spending on education, including K-12, is at the same levels as it was a decade ago.

From 2002-2012, states have increased their spending on higher ed by 42%.  Some argue that the Federal government should step up and contribute more.  In 2010, total Federal spending on education at all levels was less than 1% ($8.5B out of $879B).  Others argue that the heavily subsidized educational system is bloated and inefficient.  As much cultural as they are educational institutions, colleges and universities have never been examples of efficiency.  Old buildings on college campuses that are expensive to heat and cool are largely empty at 4 P.M.  Legacy pension agreements, generously agreed to in earlier decades, further strain state budgets.  We may need to rethink how we can deliver a quality education but these are particularly thorny issues which ignite passions in state and local budget negotations.

Although state and local governments have increased spending on higher ed by 42% in the decade from 2002-2012, the base year used to calculate that percentage increase was particularly low, coming after 9-11 and the implosion of the dot-com boom.  Nor does it reflect the economic realities that students must get more education to compete for many jobs at the median level and above.

Let’s then go back to what was presumably a good year, 2000, the height of the dot-com boom.  State coffers were full.  In 2000, state and local governments spent 5.14% of GDP (Source).  By 2010, that share had grown to 5.82% of GDP (Source). That represents a 13% gain in resources devoted to education.  But that is barely above population growth, without accounting for the rush of enrollment in higher education during the decade.

Let’s take a broader view of educational spending, comparing the total of all spending on education, including K-12, to all the revenue that Federal, state and local governments bring in.  This includes social security taxes, property taxes, sales taxes, etc.  As a percent of all receipts, spending on education has declined from 30% to under 18%.

Many on the political left paint conservatives as being either against education or not supportive of education.  Census data shows that Republican dominated state legislatures, in general, devote more of their budget to education than Democratic legislatures.  W. Virginia, Mississippi, Michigan, S. Carolina, Alabama and Arkansas devote more than 7% of GDP to education, according to U.S. Census data compiled by U.S.GovernmentSpending.com.  Only two states with predominantly Democrat legislatures, Vermont and New Mexico, join the plus-7% club (Wikipedia Party Strength for party control of state legislatures).

In the early part of the twentieth century, a high school education was higher education.  In the early part of this century, college may be the new high school, a minimum requirement for a job applicant seeking a mid level career.  What are our priorities?  In any discussion of priorities, the subject of taxes arises like Godzilla out of the watery depths.  People scramble in terror as Taxzilla devours the city. Older people on fixed incomes and wealthy house owners resist property tax increases.  Just about everyone resists sales tax increases.  Proposals to raise income taxes are difficult to incorporate in a campaign strategy for state and local politicians running for election.

Let’s disregard for a moment the ideological argument over Federal funding or control of education.  Let’s ask ourselves one question:  does this declining level of total revenues reflect our priorities or acknowledge the geopolitical realities of today’s economy?

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Takeaways

Reductions in defense spending, inventory reductions and a severe winter that curtailed consumer spending accounts for much of the sluggishness in first quarter GDP growth.

A surge in new home sales is a sign of both rising incomes and greater confidence in the future.

Consumer spending growth is about half of healthy income gains.

Spending on education has grown a bit more than population growth and is not keeping up with surging enrollment in higher education.

Spring Fever

April 27th, 2014

Existing Home Sales

Sales of existing homes in March were disappointing, dropping 7.5% year over year.  Some analysts use the 5 million mark as an indication of a healthy housing market.

As a percent of the population, the change in existing home sales is rather small, yet the change of ownership prompts remodeling projects and home furnishing purchases after the sale, spiff ups before the sale, and commissions and fees for real estate professionals at the time of the sale.

As a percent of the total stock of homes, sales are likewise small yet determine the valuation of everyone’s home.  There are concrete consequences: a lowered evaluation of a home’s value might mean that a person cannot get a home equity loan to help start a new business.  As we discovered in this last recession, lowered valuations of a  home can mean that homeowners are upside down on their mortgages.  Low valuations “box in” a homeowner’s choices so that they may feel that they can not move to a nearby town to be closer to a new job.  These cumulative effects can promote a defeatist attitude among homeowners.  In the past several years, many of us recently found that we were worth less – $50K, $100K, $200K – because the value of our homes had dropped.  Even though many of us had no intention of moving, we felt poorer.

The methodology underlying the calculation of the Consumer Price Index (CPI) involves the concept of Owner Equivalent Rent (OER).  The CPI treats home ownership as though the family who owns the home is renting the home to themselves.  In this sense, owning a home is like a owning a U.S. Treasury bond that pays regular interest payments, or coupons.  Until the recent recession, many regarded home ownership as though it were a Treasury bond, unlikely to ever lose value.  Even better than a Treasury bond, a house was likely to gain in value.

Most of us, however, do not think in  terms of OER.  We feel poorer when the value of our home drops by 20%. Likewise, a stock market drop of 20% has a significant effect on the value of our retirement funds.  Even if we do not need that money for 10 years or more, we are poorer on paper and this affects many other buying decisions.

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Spring Fever

Other economic reports this week offset the negative news on home sales.  The flash, or preliminary, index of manufacturing activity indicates a positive report next week on the sector.  Durable goods orders were strong, reinforcing the signs that manufacturing is on a spring upswing.  New claims for unemployment were a bit above expectations but nothing significant and the 4 week moving average of claims indicates a much improved labor market.

Although UPS and 3M had disappointing earnings or forecasts, industrial giants GM and Caterpillar surprised to the upside, as did tech giants Microsoft and Apple.  Expectations for this earnings season were rather lukewarm but the aggregate earnings growth of the SP500 may come in below 1%.  Some attribute Friday’s drop in the market to accelerating tensions in Ukraine but the market was essentially flat this past week, reflecting a general lack of enthusiasm or worry.

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Buffet Investing Advice

In mid March Warren Buffet got the attention of many when he made a surprising recommendation:

Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. I suggest Vanguard’s. (VFINX) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions, or individuals – who employ high-fee managers.

Doughroller presented some good observations on Buffet’s recommendation.  Also at the same site Rob Berger offers a fresh perspective on the stock – bond allocation mix.

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Consumer Price Index and College Tuition

In a recent analysis of trends in the various components of the Consumer Price Index, Doug Short presented several graphs of the annualized growth rates of the different components.  It comes as no surprise that medical care costs have risen 70% in the past 13 years.  The real surprise to me was that college tuition costs have shot up almost twice that – 130% in the same period.  Average tuition and fees for an in state student at a public four year college are currently almost $9K per year.

The growth in costs should worry parents with a son or daughter six years away from entering college.  Perhaps they may have planned on $10K – $12K a year.  However, if these growth trends remain as constant in the coming years as they have in the past, tuition and fees will be more like $15K per year when their child begins college.  By the time they graduate – if they graduate within four years – the cost could be $20K per year.  Remember, this doesn’t include any housing costs.  Higher education receives heavy subsidies from each state and the Federal government. So why the skyrocketing tuition costs?  Heavy lobbying, influence in the state capitols in the nation, inefficient and bloated administrative structures, protectionism – these are just a few of the reasons for the escalation in costs.  A spokesman for higher education won’t give those reasons, of course.  She will cite the need to attract quality teachers, investments in new technologies, aging infrastructure that is costly to maintain, and those certainly do contribute to increasing costs.  Higher education is still largely built on a framework that was suited for the sons of the landed gentry in the 18th and early 19th centuries.  As Obama and voters discovered after the 2008 elections, change comes slowly.  Like the tax system, higher education will continue to receive incremental changes, a hodgepodge of patches to fix this and that, to pad the pockets of this interest group or ameliorate a select slice of voters.

Productivity & GDP

March 23rd, 2014

Industrial Production

The week opened with a positive report on industrial production.  The .8% rise offset Janary’s decline and was the 4th month in which this index has been above the level of late 2007, the onset of the last recession.  To give the reader a sense of historical perspective, this index of industrial production has been produced for almost hundred years.  The average recovery period of civilian production is 2-1/2 years.  This recovery period of this past recession, 6 years, is second only to the  7-1/2 year recovery of the 1930s Depression.  I have excluded the 6-1/2 year post WW2 recovery period from war time production, which doubled production to produce goods and armaments for the war.  If that period is included, the average is 3 years.

Here is a comparison of the recovery periods since 1919.  The back to back dips of 1979 and 1980-83 were, in effect, one long dip lasting 4 years, making it the third worst recovery period of the past one hundred years.

When industrial production takes several years to regain the ground lost during a recession, it is vulnerable to even minor economic weaknesses.  As production recovered from a 7-1/2 year dip during the 1930s Depression, the Federal Reserve tightened money and production slid once again before reviving to produce arms to ship to British and European forces in the early years of World War 2.  Outgoing Federal Reserve chairman Ben Bernanke, a noted scholar of the 1930s Depression, understands the inherent weakness of an economy when production takes several years to recover.  For this reason, he was reluctant to ease up on monetary support until production was clearly and securely recovered.

The new Federal Reserve chairwoman, Janet Yellen, has decades of experience and is well aware of the fragility that is inherent in an economy that experiences a long period of industrial recovery.  This will be one of several factors that the Federal Reserve watches closely for any signs of faltering.  Those who think that the Fed will make any abrupt changes in monetary policy have not been reading the footprints left by the past.

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Productivity

Last August I wrote about the rather slow growth of multi-factorial productivity (MFP) since 2000.  The Bureau of Labor Statistics (BLS) calculates a meager 1% annual rate of growth in that time.  Far down in their historical tables is a revealing trend: Labor’s contribution to production has declined dramatically in the past ten years while capital’s share of inputs has increased.  Capital inputs include equipment, inventories, land and buildings.  In 2011, the most recent year available, labor’s share of input had decreased to 63.9%, far below the 60 year average of 68.1%.

Capital’s share of input had increased to 36.1%, far above the average 31.9%

As I mentioned last August, the headline productivity figures are misleading because they simply divide output by number of hours worked and ignore the contributions of capital to the final output.  As capital’s share of input increases, the contributors of that capital want more return, i.e. profit, on their increased contribution.

In the twelve years from 2000 – 2011, capital’s share of input has increased 20%, from 30% to 36%.  In that same period, after tax profits have grown by 130%, a whopping return on the additional 20% capital invested.  While overall MFP growth has slowed, the mix has changed.

Given such a rich return, we can expect this trend to continue until the growth of profits on ever larger capital investments reaches a plateau and slows.  Until then, labor’s share of productivity gains will be slight, acting as a continuing restraint on family incomes.

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Existing Home Sales

The 5 million sales of existing homes in 2013 was 9% above 2012 levels but the percentage of cash buyers has increased as well, now making up almost 1/3 of existing homes sales. (National Assn of Realtors).  The percentage of first time buyers declined from 30% in December 2012 to 27% in December 2013. For the past half year sales of existing homes have declined and the latest figures for February show a 7% decline from 2013 levels.

In May 2013, the price of Home Depot’s stock hit $80, a 400% rise from the doldrums of the spring of 2009.  Since then, it has traded in a close range around that price.  In May 2013, the price of the stock was 200% of the 4 year average, an indication that all of the optimism had been baked into the stock price.  It now trades at 160% of the 4 year average, rich but more reasonable if expectations for a continued housing recovery materialize.

In January 2000, the stock broke above $50 and was also trading at almost 250% of it’s 4 year average.  After trading in a range in the high $40s for several months, the stock began to fall.  By mid-June of 2000, the stock traded for 150% of its 4 year average.

The range bound price of Home Depot’s stock price for 8 months now is a good indication that investors have become watchful of the real estate sector, particularly the existing home market.  The percentage of cash buyers has risen 10%, replacing the similar decline in the number of first time home buyers.  Remember that this stalling is taking place at a time when interest rates are near historic lows.

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Reader questions

A reader posed a few questions about last weeks blog.

When annualized sales rates are down, but annualized inventory rates are up, is that usually because of prior contracts that businesses must accept?  Or is it usually hope for their future?  In other words, is a higher inventory rate a positive sign or a negative one?

When sales are going down and inventories are going up, it means that businesses were not prepared for the change in sales. This ratio measures the amount of surprise.  Businesses will then reduce their orders to factories, wholesalers, etc.  They may decide to reduce any hiring plans.  On the other hand, they might increase their marketing expense.  Look closely at the Inventory to Sales Ratio (ISRATIO) graph from the Fed.  In the early part of the recession in the first quarter of 2008, the ISRATIO moved up a bit, then down in the 2nd quarter but it was still in the subdued normal range of 1.25 to 1.30 established since 2006.  During the summer of 2008, the ISRATIO rose again but it was not until September 2008 that this ratio began it’s several month upward spike as sales crashed.

Re:  Decline in real personal consumption below 2.5% has ALWAYS led to a recession within a year.  Are there any substantive changes in how the economy is run now than in the past?  For example, has the Fed always been involved with quantitative easing like it is now?  Could that easing create a better economic climate despite personal consumption decline?  When we look at the past, are we generally comparing apples to apples?

The fact that a recession has always happened when inflation adjusted personal consumption falls below 2.5% does NOT mean that it will happen this time.  These are indicators, not predictors and we must remember that indicators of past trends are with revised data.  Investors and policy makers must make decisions with the currently available data, before it is fully complete. Personal consumption for 2013 could be revised higher in the coming quarters.  Some revisions happen as much as three years later.  What it does mean is that the Fed will be watching this sign of weakness in the consumer economy and is unlikely to make any dramatic policy changes.

So how do you think our leaders should lead in regards to SS?  Do you think the age should be raised to say 70?  Do you think we will not be able to depend on SS being there throughout our lifetimes?  It must be of great concern to your kids that it may not be there for them, esp. after having contributed over the years.

I think politicians will have to spread the pain on Social Security.  These suggestions are not new.

1) Raise the salary level that is subject to the tax so that more tax is captured from higher salaries.  This years maximum is $117K. (SSA) This is a tough sell.  The ratio of the maximum taxed earnings to the median household income (Census Bureau Table H.6) has gone up from 150% in 1980 to almost 220% in 2012.

Well to do people feel like they are already paying their “fair share.”  Senator Bernie Sanders and other Democrats use the ratio of the maximum taxed earnings to the top 10% of incomes to make the case that the maximum should be as high as $175K.  Computers and the availability of so much data enable policy makers and think tanks to produce whatever data set they want in order to support their conviction.

2)  Raise the employee and employer share of the tax .1% each year for the next five years.  Democrats will not like this one because it raises the burden on lower income families.

3)  Initially raise the social security age by two months each year over the next five years and index it to the growth in the life expectancy of a 65 year old so that the official retirement age is 15 years less than the life expectancy.  In 2025, if the life expectancy is 85 years, then the official retirement age would be 70.  Early retirement should be set at 3 years less than full retirement age.  In this case, early retirement would be 67.

All of these are tough choices and most politicians don’t want to touch them.   Voters are not noted for their prudence and are unlikely to pressure pressure policy makers for more taxes and less benefits. In order to sell these difficult proposals, I would add one more proposal.

4) Guarantee the payout of benefits for ten years, regardless of death.  Each retiree would name beneficiaries for their social security and payments would go to those beneficiaries until the 10 year anniversary that retirement benefits began.  This would incentivize retirees who could afford it to delay the start of their retirement benefits until 70, knowing that their heirs would get at least ten years of benefits. This delay would ease some of the fiscal shock as the boomer generation is now retiring.

Currently, the highest social security benefit is paid to a surviving spouse.  If a man dies with a higher monthly benefit than his wife, then the wife gets the husband’s higher benefit amount each month but loses her benefit.  Under this proposal, the wife would get her benefit and the husband’s benefit plus her benefit if her husband dies within ten years of retirement.  Often, a couple’s income is cut in half or by a third when a spouse dies.  Older women are particularly impacted, finding that they can no longer afford the mortgage or rent in their current housing situation. This feature would enhance the popular understanding that Social Security is like an insurance annuity.  It would help particularly vulnerable older surviving female spouses, an emotionally appealing feature that politicians could sell to voters, thus making it more likely that voters would accept the higher taxes and raised retirement age.  Whether the idea is fiscally sound is something that the Board of Trustees at the SSA could calculate.

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%.

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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.

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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.