Young Beasts of Burden

October 8th, 2017

The Federal Reserve recently released their triennial survey of household income, debt and wealth. Rising asset values have lifted the fortunes of many, but younger families are struggling.  I’ll show a reliable indicator of recessions as well as some trends peeking out behind the numbers. The incomes below are denoted in inflation adjusted 2016 dollars.

The good news is that lower income workers have recently seen some income gains, which the Federal Reserve attributes to the enactment of minimum wage laws in 19 states at the start of 2017. However, single parent families have struggled with income gains, as they have for three decades. The decade from the late 1990s to the financial crisis in 2008 lifted the incomes of single parents but they have struggled during the recovery. Median incomes for this group remain below the 2007 level.


That this group needed back-to-back historic asset bubbles in order to see some income gains shows just how vulnerable they are.

Much has been written about income inequality among households. During booms, there is a growing inequality even among those in the top 10% of incomes. The median in any data set is the halfway point in the numbers, and is usually less than the average of the numbers. If the numbers are evenly distributed the median is closer to the average and the percentage of median to average is high.  When there are a lot of outliers that raise the average far above the median, as in home prices, the percentage is lower.  During boom times there is growing inequality, even among the top 10%  of incomes. (Data from survey)


The growth of inequality of income obeys a power law distribution. Think of a 1’x1’ square. The area is 1. Now double the sides to 2’x2’. The area quadruples to 4. Triple the sides to 3’x3’ and the area increases by a factor of 9. Let’s imagine that the area inside of a square is money. How fair is it that the 2’ square has four times the money that the 1’ square has? Politicians may pass tax and social insurance laws to take some of that money from the 2’ square and give it to the 1’ square.  The redistribution of income and wealth can’t change the fundamental characteristics of a power law distribution. Despite the political rhetoric, solutions are bound to be temporary.

The income figures most cited are for households but this data has only been collected since the mid- 1980s. A fall in real median income usually precedes a recession except for the latest fall in 2014 when oil prices began to slide.


Let’s turn to the data for family household income that has been collected since the mid-1950s. What is the difference between a household and a family? By the Census Bureau definition, a family household consists of at least one person who is related to the householder by blood, marriage or adoption. A fall in family income has preceded every recession except a mild one in the 1960s. Family incomes rose very slightly just before that recession, due in part to a new optimism about the presidency of JFK and the promise of tax cuts.


Because this family income data is released annually at mid-year, this indicator is usually coincident with the start of a recession. However, it has proven quite reliable in marking the start of recessions.

Non-family households are not related. This includes roommates or a childless couple living together but not married. Non-family households are generally younger and their income is less than the income of family households. Over the past three decades, the ratio of the incomes of all households to family households has declined.


Although younger people are experiencing slower growth in incomes, they will face increasing pressure to meet the demands of older generations expecting social insurance benefits like Social Security and Medicare. As the oldest Americans begin living in nursing homes in increasing numbers, they are expected to put an ever-growing burden on the Medicaid system (CMS report).  It is the Medicaid system, not Medicare, which covers nursing home costs for seniors after they have depleted their resources. Although the number of nursing homes and certified nursing home beds have declined slightly in the past decade (CMS Report page 21), Medicaid spending still increased a whopping 10% in 2015 as enrollment expanded under Obamacare.

Colorado Governor John Hickenlooper has said that many states are expecting an increase in Medicaid spending on nursing home care as the first of the large Boomer generation turns 75 at the beginning of the next decade. CMS expects total health spending to increase 5.6% per year for the next decade. The last time we had nominal GDP growth that high was in 2006, at the peak of the housing boom.

The demands of both low income families and seniors on the Medicaid system will strain both federal and state budgets.  The federal government can borrow money at will; states are constitutionally prevented from doing so.

What will drive the high growth needed to sustain the promises of the future?  New business starts are at an all-time low (CNN money). How did we get here? The financial crisis caused the failure of many small businesses, many of which are funded with a home equity loan by an entrepreneur.  Home equity loans are down 33% from their peak in early 2009. At the end of last year, the Case-Shiller home price index finally regained the value it had in 2006. In the past decade there has been no home equity growth to tap into.


Imagine a couple in their late 30s or early 40s who bought a home 10 to 15 years ago. They may have only recently recovered the value of their home when they bought it. One or both may long to start a new venture but how likely are they to take a chance? In some of the bigger metro areas where home prices grew much stronger during the boom, prices are still below their peak ten years ago.


The market has priced in a tax cut package that will lower corporate taxes. Investors are expecting a third or more of those extra profits in dividends. Investors are expecting a compromise that will enable companies like Apple to “repatriate” their foreign profits to the U.S. and for that money to be used to buy back stock or pay down debt, both of which are positive for stocks. The IMF projects 3.6% global GDP growth in 2018. There’s good cause for optimism.

Investors have not priced in the long term effects of this year’s hurricanes, the volatility of commodities, the future risk of conflict with North Korea, the risk that the debt bubble in China, particularly in real estate, could escape the careful management by the Chinese government. Add in the several fault lines in household finances that the Federal Reserve survey reveals and there is good cause to season our optimism with caution.

Individual investors surveyed by AAII are cautiously optimistic, a healthy sign, but the sentiment of actual trading by both individuals and professionals shows extreme optimism, a negative sign.  The VIX – a measure of volatility – just hit a 24-year low this past week, lower than the low readings of early 2007.  Sure, there was some froth in the housing market, investors reasoned at that time, but nothing that was really a problem.

Then, oopsy-boopsy, and stocks began a two year slide. So, don’t run with joy, Roy. Don’t go for bust, Gus. Pocket your glee, Lee. Stick with your plan, Stan. There are at least “50 Ways To Leave Your Money,”  and one of them is investing as though the future is predictable.


October Surprise

October 11, 2015

A good week for stocks (SPY), up over 3%.  Emerging markets (VWO) were up over 5%, but are still down 18% from spring highs and are on sale, so to speak, at February 2014 prices.

On news that domestic crude oil production had fallen 120,000 barrels per day, about 15%, in September, an oil commodity ETF (USO) rose up 8% this week.  On fears, and confirmations of fears, of an economic slowdown in much of the world, commodities have taken a beating in the past year, falling 50% or more.  A broad basket of commodities (DBC) was up 4% this week but are still at ten year lows.  An August 2010 Market Watch commentary recounted the evils of commodity ETFs as a place where the pros take the suckers’ money.  Not for the casual investor.

The Telegraph carried a brief summary of the latest IMF assessment of credit conditions around the world.  There is an informative graphic of the four stages of the macro credit cycle and which countries are at what stage in the cycle.


Social welfare

Some people say they dislike redistribution schemes on moral grounds.  The government takes money from some people based on their ability and gives it to other people based on their need, a central tenet of Communism.

In a 2014 paper IMF researchers have found that redistribution is a hallmark of developed economies.  Why?  Because advanced economies have the most income inequality.  Why?  Developed economies have greater income opportunity and opportunity breeds inequality.  A sense of human decency prompts the voters in these developed countries to even the playing field a bit.

In countries with greater equality, living standards and median income are lower.  There is less income to redistribute.  In the real world where the choices are higher income and redistribution vs an equality of poverty, I’ll take the more advanced economies.



Since the beginning of this year the manufacturing component of the Purchasing Managers’ Index has continued to expand.  The strong dollar has made U.S. products more expensive around the world and this has hurt domestic manufacturers.  Growth has slowed from the strong expansion of the last half of 2013 and all of 2014.  September’s survey of manufacturers is right at the edge between expansion and contraction.  The CWPI weights the new orders and employment portions of each index more heavily.  Using this methodology, the manufacturing side of the equation looks stronger than the headline index indicates.

The services sector, most of the economy, is still enjoying robust growth and this strength elevates the combined CWPI.

How much will the substandard growth in the rest of the world affect the U.S. economy?  Industrial production in Germany declined last month.  China’s growth is slowing.  GDP growth in the Eurozone is barely positive.  Emerging markets are struggling with capital outflows.  Developed economies that are dependent on natural resources – Canada and Australia – are struggling.  The GDP growth rate of both countries is very slightly negative. The U.S. is probably the one economic ray of hope.  September’s lackluster labor report and the Fed’s decision to delay a rate increase has attracted capital back into the stock market. This past Monday, volatility in the market (VIX – 17) dropped down below its long term historical average of 20 but is a tiny bit above its 200 day average.  I’d like to see another calm week before I was convinced that the underlying nervousness in the market has abated.  Third quarter earnings season is here and estimates by Fact Set  are for a 5% decline in earnings, the second consecutive quarter of declines since 2009.

Zorro Moon

October 12, 2014

Last Sunday, George and Mabel flew back to Denver from Portland.  They took a bus shuttle from the terminal to long-term parking and discovered that neither of them could find the parking stub which indicated which section they had parked in.  Mabel dutifully looked through her purse.  “I know you kept the stub, George, but I’ll look anyway.”  Mabel remembered details like this so George knew she was probably right. “I should have put it in my wallet and it’s not there,” George replied.  They asked to be let out at the main exit booth.  The attendant told them to go inside the office where they met a nice man with a patient look.  His English was barely accented with the round vowels of Spanish.  “My name is George.  How can I help you?” the attendant announced.  “Hey, that’s my name too,” George replied, as though each of them belonged to a brotherhood.  “Well, we seem to have lost our ticket stub and we can’t remember where we parked our car,” George told him.  “What day did you come in?” the other George asked.  “Last Monday, about 7:30 in the morning.”  The attendant’s face adopted an odd stillness, his eyes looking far away. “That was a busy morning.  We were parking in GG and HH at the far end of the lot.”  Both George and Mabel were amazed at the man’s memory and said so.  The attendant smiled graciously.  He pulled a set of keys from a hook on a key board, picked up two of their bags and led them to an idle shuttle parked near the office.  At the far end of the lot, the attendant drove slowly down one row until they reached the edge of the lot, then drove down the next row.  Mabel was the first to see their car. “There it is!” she exclaimed.  George gave the attendant a $10 bill, thanking him for his help.  The attendant nodded graciously, then drove back toward the office.  “There’s someone with  a remarkable talent working at a parking lot,” Mabel remarked.  “I think our schools do a terrible job of helping students discover their own talents.   The structure of our society, our economy – it could uncover and use these talents better.”

Sitting at his desk Sunday night, George mulled over the same thought that had distracted him on the flight from Portland.  Should he sell some or all of their stock holdings?  Two indicators said yes, another said maybe, one said this was temporary.  While on vacation, he had not compiled his makeshift index based on the monthly Purchasing Managers Index.  ISM, the publishers of the index, had released the services sector figures that past Friday.  He pulled up the latest report, then input the figures into his spreadsheet.  The index seemed to have peaked in September at a very robust reading near 70, rising up a few points from an already robust reading in August.

This composite of economic activity was a “stay out of trouble” indicator, giving buy and sell signals when the index rose above and below 50.  The last signal had been a buy signal in August 2009 when the SP500 was about half its current value.  Before that, the previous cue had been a sell signal in January 2008, a month after the official start of the recession.  Because employment and new orders were the largest components of the index, a chart of just these two components of the services sector reflected the larger composite.

So, the American economy was strong and Friday’s employment report had been a positive surprise. What seemed to be worrying investors was weakness over in Europe.  But Europe had been nearing recession for a few quarters now and that had not worried investors during the past year and a half.  Yes, no, yes, no decisions swirled around in George’s head.  Should he wait till the market opened Monday morning and see what the mood was?  Well, what if it was rather flat?  What would that tell him?  As Yogi Berra said, when you come to a fork in the road, take it.  So George did.  He put in an order to sell half of their stock holdings, essentially taking both forks of the road.

On Monday the market opened up above Friday’s close, indicating that a number of investors had put their buy orders in over the weekend after the positive employment report.  Active traders took the market back down below the level of Friday’s close.  In 1970s lingo, it was “negative vibes,” or negative sentiment in normal speak.

The Federal Reserve announced that they would begin publishing a labor market index that compiled 19 different labor market indicators to give an overall report card on employment.  The index was first proposed in a working paper published in May and the Fed was cautioning that the index was not “official.”

A chart of the various components of the index showed the correlations of each component with overall economic activity in the country.

The Fed provided a permanent link to a spreadsheet that they would update each month.  It was  a zero-based index.  Readings above zero meant overall conditions were improving; below zero, conditions were deteriorating.

The market opened up Tuesday with the news that Germany’s industrial output had dropped 4% in August.  A key leader and consistent performer, Germany was the Derek Jeter of the Eurozone.  As every baseball fan knows, if Derek was not producing, the whole team was in trouble.  The whole team in this analogy was the world.  The IMF revised their global growth rate for 2014 from 3.4% to 3.3%.  Quelle horreur!  Never mind that Tuesday’s JOLTS report showed the most job openings since 2001 when China was admitted to the World Trade Organization and started sucking jobs from the U.S.

Tuesday evening, George and Mabel watched the full moon, the Hunter’s moon, when it was about 30 degrees above the eastern horizon.  Clouds had obscured the moon when it was first rising and really big.  Wisps of clouds still drifted across the pale disk.  “It’s a Zorro moon,” George remarked.  “Zorro would go out on a night like this and undo the oppressive plans of the evil comandante.”  Mabel laughed.  “We’ll rename it the Zorro moon, then.  All those calendars we get each year will have to be changed.”  “Yeh, what’s with that?” George asked.  “No one ever sends a pamphlet of favorite quotes or prominent dates in history.  Just calendars.”

Mabel set her alarm to get up at 4:15 AM so she could watch the lunar eclipse.  She woke up about 7:30 that morning, disappointed that her sleeping self had turned off the alarm without even bothering to notify her lunar eclipse watching self.

On Wednesday afternoon, the Federal Reserve released the minutes of the September meeting of the Open Market Committee, the group within the Fed that that determined interest rate policy.  The sentiment of the Committee was rather dovish, and the stock market rallied up sharply in the last two hours of trading.  Still, the close was not as high as the opening price on Monday, two days earlier.  Volume was the highest it had been since August 1st and should have been confirmation that sentiment had reversed to the positive.  George was still cautious.

The market is essentially an argument over value.  The difference between each day’s high and low price indicates how much investors are arguing. The 5-day average of that difference was now double the 200 day average and rising.  George had learned that bigger arguments usually led to lower prices.  He had enjoyed a nice run up in 20-year Treasuries during the summer but then got out in mid-September.  Now two thirds of his investing stash was sitting on the sidelines in cash.  Treasuries had rallied, proving that it was difficult, if not impossible, to time the market.  Something George didn’t like was the relatively small movement in the price of Treasuries as the stock market rallied.

On Thursday, the market dropped quickly on news that German exports had dropped almost 6% in August. By the end of the day, the SP500 index had lost about 2%.  Bears saw an opportunity to hawk their books warning of the coming collapse of the global economy.  “Is the end near?  Next we go to Doug Munchie of Funchee Crunchie Capital.  Doug, tell our audience some companies that you think will do well as the coming global meltdown approaches.” Doug is looking sharp in a $300 white shirt and a $200 blue and red tie. “Good morning, Megan.  For our cautious clients, we recommend gold Lego blocks.  Our clients can construct many creative projects with their gold while they sit out the collapse.” “Thanks, Doug.  When we come back, we’ll talk to a priest who claims that holy water can cure Ebola.”

By the time he died, George thought, he will have heard at least 1 million hustles.  “Doctor, do you know the cause of Mr. Liscomb’s death?”  “Yes, he suffered from Bullshitis, the accumulation of a lifetime of blather.  A person’s brain becomes clogged and shuts down.”

The decline continued on Friday, bringing the SP500 back to the price levels of late May.  The closing price touched the 200-day average.  For long term investors, the next week might be a good  opportunity to move some idle cash into stocks. If the downturn became a serious decline, the 50 day average would cross below the 200-day average in a few weeks or so.  That crossing was called the Death Cross, a serious shift in sentiment.

Watching the news later that evening, Mabel asked, “We’re fine?”  “We’re fine,” George replied. Then he changed the subject to their recent visit to Oregon.  “I wish could be close to the ocean and yet not have all the dampness.”  “It’s called southern California,” Mabel quipped.