Category: jobless claims

A Pause On the Road

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August 30, 2015

For the past few weeks, the volatility in the stock market has been front and center.  I finished last week’s blog with a note that the market would be conducting a vote of confidence in the coming weeks.  In the opening minutes last Monday morning, the Dow Jones index dropped a 1000 points, almost 6%.  No doubt many investors had spent the weekend worrying and put their sell orders in the night before.  By Friday’s close, however, the SP500 had gained almost 1% for the week.

A few weeks ago the Dow Jones index, composed of just 30 large company stocks, marked a death cross. The death cross is the crossing of the 50 day price average below the 200 day average.  See last week’s blog if you are unfamiliar with this.  This week the broader SP500 index, composed of the largest 500 U.S. companies, marked it’s own death cross.

Two weeks ago, I noted the attitude of one Wall St. Journal reporter to the dreaded death cross. In one word: blarney.  In two words: hocus-pocus.  So why do some investors and the press give this any attention?  Used as a trading system in the broader SP500 the death cross (sell) and it’s companion golden cross (buy) signal have produced a winning trade 4 out of 5 times.  Where do I sign up?, you might be thinking.  In an almost sixty year period of the SP500, however, the extra annual return is slight – about  8/100ths of a percent, or 8 basis points  – over no timing strategy, i.e. buy and hold.  To the average small investor, taxes and other fees more than offset this negligible advantage.

In contrast to any technical stock market price indicators, the fundamentals of the U.S. economy are mostly strong or expanding. Consumer Confidence rose above 100 this past month, surpassing the optimism of the benchmark set in 1985.  The second estimate of GDP growth released this past week was above some of the high estimates.  After inflation, real GDP growth continues at 2.65%.

Corporate profits are growing at 7.3%, home prices are up 5%.  Real, or inflation-adjusted, consumption spending and income is  growing at more than 3%, equaling the heights of pre-recession spending and income growth in early 2007.

Housing prices are increasing for a good reason.  Inventory of homes for sales is relatively low.  In the middle of the 2000s, prices rose even though inventory of homes for sale were going up, a sign of a speculative bubble.  Ah, things look so clear in the rear view mirror.

New jobless claims remain at historically low levels and job growth has been consistently solid.  There are more involuntary part-timers than we would like to see and the participation rate is low.  Gloom and doomers will tend to focus on the relatively few negative points in an otherwise optimistic economic panorama.  Gloom and doomers think that those who disregard  negative signs are Pollyannas.  Eventually, years later, the gloom and doomers are right.  “My timing was off but, see, I was right!” they exclaim. The lesson of the death cross and the golden cross are this: a person can be right most of the time.  The secret to successful investing is knowing when we are wrong and acting on it.

For the individual investor, signals like the death cross can be calls to check our assets and needs.  Older investors may depend on some stability in their portfolio’s equity value for income, selling some equities every quarter to generate some cash.   Financial advisors will often recommend that these investors keep two to five years of income in liquid, low volatility investments.  These include cash, savings accounts, and short to medium term corporate bonds and Treasuries.  Younger investors may see this price correction as an opportunity to put some cash to work.

A Busy Week

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October 5, 2014

On Monday George and Mabel flew to Portland, Oregon so Mabel could attend a teacher conference in Eugene on the development of strategies and practices for online learning.  “How’d you get invited?  You’re retired,” George had asked a few months earlier.  Mabel had spent many years both as a teacher and high school principal.

“The conference is focused on post-secondary education, but Lorraine thought I would be interested and wangled me a spot.” Her friend Lorraine was a department chair at a local community college. “I might be able to give her some perspective from the high school level as these kids make the transition to college courses.”

They had to get up early to make the morning flight.  Retired people should only get up this early when they are having a colonoscopy, George thought.  After the conference, they planned to spend a few days on the Oregon coast, which they were both looking forward to.  They sat in the Denver airline terminal awaiting the boarding call.  George couldn’t understand most of what they said.  Millions of dollars to build an airport and the contractors seemed to have bought the cheapest speakers through somebody’s Uncle Harry who knows a guy who’s got a connection with some exporter in Malaysia. Airline service had become little more than a subway in the sky.  In fact, the speakers sounded just as bad as the ones used in New York subway cars.  “Gate 23, now pre-boarding …” came out of the speakers as “Ateleeteehoweeornayhinienegetcrispbeergoremekeens.” Passengers, please get in the metal tube, sit down and be quiet.  The metal tube will go up in the air and deposit you at your destination.  Transportation for the masses.  The future has turned out slightly different than the one imagined at the New York World’s Fair in 1964.

In Portland they rented a car and drove down to Eugene.  Settling down in their hotel room, George was pleasantly surprised to find they had good wi-fi reception.  The market had been up but had closed below Friday’s close, indicating that there was still more negative sentiment to come.  Personal income in August had gained 4.3% above the level of August 2013.

That bit of good news was offset somewhat by a report from the National Assn. of Realtors that year-over-year pending home sales were down a little bit more than 2% in August.  This confirmed last week’s housing reports and made it unlikely that tomorrow’s Case-Shiller report on home sales would have any positive surprises.

Tuesday morning, George slept in while Mabel got up early to go to the nearby conference at the University of Oregon.    He missed the free breakfast at the hotel but the woman at the reception desk pointed him to a nearby coffee shop that served egg croissants and a good cup of coffee. The sun broke out on the short walk to the coffee shop, brightening George’s mood.  Despite the mid-morning hour, a number of people sat in the coffee shop working on their laptops.  West coast time was three hours behind New York so half of the day’s trading had occurred before many Oregonians had started work.

The Case-Shiller home index showed that home prices in 20 metropolitan areas had declined for the third month in a row.  Year over year gains were still positive at 6.7% but the pace of growth was slowing. Last Friday’s Consumer Confidence survey from the U. of Michigan had been positive and rising.  A separate Confidence survey by the Conference Board was positive but showed a declining sentiment on worries about employment and income.

In the afternoon, he drove near the campus to meet Mabel.  The campus was an artist’s rendition of what a college was supposed to look like.  Shade trees dotted the grounds between the grand buildings of gray stone.  Lawns and bushes were clipped but didn’t look overly manicured.  The concrete walkways that led from one building to another were well maintained but showed the typical wear of traffic and a wet climate.  The ghosts of mankind’s great minds and talents would feel comfortable on these grounds and in these halls.

Mabel introduced George to several colleagues attending the conference.  Most attendees were teachers and administrators in their forties and fifties.  For 300 years, teachers and students had gathered in  a classroom in what was called face-to-face education.  Students prepared for class at home at various times outside of the classroom but the daily routine of classes centered the educational activity of the students.  Online learning was a new phase in distance learning, attempting to blend the broader educational training of traditional colleges and universities with the asynchronous methods of the correspondence schools of the past century.

On Wednesday came further confirmation that the growth in housing sales and construction was slowing.  Year-over-year construction spending had increased 5% but the growth had declined for 9 months.  George thought this was a fairly normal cycle but the market reacted negatively, dropping more than 1% by the end of the day.

European Central Bank head Mario Draghi announced that they would continue to keep interest rates low to help spur the non-existent growth or decline in many European countries.  The private payroll processor ADP reported job gains of 215,000, slightly above expectations.  The Institute for Supply Management (ISM) showed a slight decline from the robust growth of the previous month but overall a very positive report.

Wednesday evening after the conference had concluded, George and Mabel had dinner at a restaurant with two women who had attended the conference.  The conversation was lively, the food a bit pricey for the quality but George enjoyed the evening.  For the past two days he had encountered many young people, reminding him of his college days decades before.

“I’ve decided I want to be 20 years old again, only not as dumb and inexperienced,” George quipped. He remembered sagely pronouncing that Fitzgerald’s novel, The Great Gatsby, was about social classes that no longer existed in America and was irrelevant. Somehow he had survived his own poor judgment.  He did want to jump high in the air once again, twisting toward the basket and snapping a 3-point shot at the basketball net.  The losses in physical vitality were offset by the gains in sagacity, George hoped.

On Thursday, George and Mabel woke up early (again! two times in one week!) to drive out from Eugene to the Oregon Coast.  At the Oregon Dunes they walked through coastal rain forest, then dunes, then a less dense strip of rain forest, then beach and ocean. “I get smaller the more I walk,” he told Mabel.  “What do you mean?” she asked.  “We walk through places like this, they’re like landscapes, I guess you could call it, shaped by this wind around us, the ocean out there,  and underneath our feet the earth is shifting about.  It’s like we’re teeny tiny bacteria walking on the ridges of paint left by some artist’s brush.”

Mabel smiled, “Well put.”  She paused.  “With the physical classroom, students and teachers can have field trips out to the Oregon dunes.  How do we take that and put it in an online environment?” she wondered.  George glanced at her.  “Someone has brought the conference to the beach, I think.” Later, they stopped off for a coffee in the old town of Florence before ending the day in Yachats where they stayed at the Overleaf Inn.

I could get used to this, George thought, checking the market news from his balcony while the last streaks of sunset and orange turned to purple and gray out over the ocean.  The BLS reported that the 4-week average of new unemployment claims had fallen below 295,000.

Levels lower than this had occurred rarely – in early 2006, 2000 and the winter of 1987-88. Yet there was no dancing in the streets.

Instead, investors focused on the 10% drop in factory orders for August.  Most of the decline was due to volatile aircraft orders, which had surged in July followed by an equal drop in August. The market remained flat.

On Friday, George and Mabel walked several miles on the 804 trail, a sometimes dirt, sometimes asphalt path that ran for many miles along the Oregon cliffs.  They ate at the Drift Inn that evening.  Good food.  “You think there’s much work for younger folks around here other than the tourist industry?” he asked Mabel.  “I doubt it,” she replied. “We’ve seen a lot of twenty-somethings working at hotel reception desks, waiters, waitresses, the coffee shop in Florence.  They can’t be making a lot of money.  Still it is lovely here”, she mused.  “Could be more sun, ya know?”  George nodded.  “We’re kinda spoiled in Colorado,” he said.

When they returned to their hotel room later that night, a stiff wind blew off the ocean, bringing with it a bit more chill than either of them had packed for on this trip.  George checked the monthly employment data released that morning by the BLS.  Job gains had surprised to the upside at almost 250K but the market had still closed below Wednesday’s opening price and was still below the 10-day average. He pulled up some FRED data to get a snapshot of the relative health of the labor force seven years after the start of the recession.   The results were rather chilling – or maybe it was the dampness of the Oregon coast that he was unaccustomed to.  In seven years the number of employed people had grown just 1% – not 1% annually but 1% total for the entire time.

2.6 million more people were working part time because they could not find full time work. The number of underemployed had grown almost twice the 1.4 million new jobs created in seven years.

The unemployment rate had dropped below 6% in September but even that bit of positive news did not look so good when George pulled up the historical snapshot of unemployment since the recession began.

The rate had risen more than 1% in those seven years.  Despite all the talk of recovery, the surge of stock prices from the lows of 2009 and the rise in home values, the labor market was still wounded.

“Why don’t you help me figure out where we’re going to stay tomorrow in Newport?”, Mabel asked.  “One of my friends suggested the Elizabeth St. Inn.”
“Fine with me.  I want to see the Aquarium if it’s open,” George replied.  “Hey, check out the moon.”  Then he put on his windbreaker, pulled a blanket off the bed and went to sit out on the balcony.  Through the shifting clouds, moonlight shone softly on the water below.  Mabel, taking a cue from her husband, tugged a blanket from the second bed, wrapped it around her and sat with him.

Homes

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July 27, 2014

This week I’ll take a look at the latest home sales reports, a few trends in Social Security, and the latest reading in the Consumer Price Index.  Lastly, I’ll ask whether a home should be included in an investor’s bond allocation.

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Home Sales

Existing home sales rose in June, topping 5 million but are still down 2.3% on  a year over year basis.  The Federal Housing Finance Agency reported that home price increases have slowed slightly, notching a 5.5% year over year gain.

The bad news this week was the 12% year-over-year drop in single family new homes sold in June, falling from 459,000 in June 2013 to 406,000 in June of this year.

The comparison was a tough one because June 2013 was the best month for new home sales in the post recession period.  However, the year-over-year comparison of the three month moving average of new home sales shows a falling trend as well, down 6% from last year.  The decline began in January and shows little signs of improvement.

I will remind readers of a 2007 paper presented by economist Ed Leamer in which he demonstrated that falling new home sales tends to precede a recession by three to four quarters.  I wrote about it in February this year.

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Jobless Claims

In contrast to the disappointing report on new home sales, jobless claims fell unexpectedly to 284,000, dropping the 4 week moving average to a post-recession low of 302,000.  No doubt this will raise expectations for a strong employment report next Friday.

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Social Security Trust Funds

When the U.S. Treasury collects more in Social Security taxes than the Social Security Administration (SSA) pays out in benefits, the Treasury “borrows” the money from the Social Security Trust Fund by selling it non-marketable Treasury bonds that the SSA holds.  The interest rate for each new bond is an average of the yields on intermediate and long term Treasuries. The Treasury credits this interest to the trust funds every month.  SSA has a web page where a reader can select a year and month and see the average interest rate that the trust funds were earning on that date.  In December 2013, the average annual yield was about 3.6%, down significantly from the 5.25% being credited at the end of 2005, when interest rates were higher.  At the end of 2012, the trust funds had a balance of about $2.7 trillion, earning about $100 billion annually, enough to make up the $75 billion shortfall each year projected by the Trustees of the fund.

The Disability Insurance (DI) portion of the trust fund is projected to run out of money by 2016.  This Do-Nothing Congress will not resolve the problem in this mid-term election year,  promising to make the issue a contentious one for the 2016 election cycle.  If the problem is not resolved by then, current law requires that benefits be reduced accordingly.  The Trustees estimate that Disability beneficiaries will get about 80% of their scheduled benefit.  Democrats will likely use the issue to paint Republicans as Meanies who care only about the rich and big corporations while Republicans portray Democrats as tax-and-spenders who buy votes with government charity.  It’s all coming to a TV screen in our homes.  Can’t wait.

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Consumer Price Index

June’s inflation numbers from the BLS notched a 2.1% year-over-year gain, slightly above the Fed’s 2% target.  The core CPI, which excludes more volatile energy and food prices, is up 1.9% y-o-y.  Gasoline jumped 3.3% in June but year over year gains are at target levels of 2%.

Over the next few years, we will hear increasing calls for a switch to what is called a chained consumer price index, or C-CPI.  The chained index attempts to more closely replicate a cost of living index by taking into account the substitutions that consumers make in response to changes in price.  The CPI may calculate that the Jones Family bought the same amount of hamburger meat even when it rises 20% in price.  The Chained CPI calculates that the Jones Family may buy a little bit less hamburger meat and a bit more chicken if chicken remains relatively stable in price.  The two indexes closely track each other but the CPI tends to be slightly higher than the Chained CPI.

At various times in budget negotiations with the Republican controlled House over the past two years, President Obama has said that he was open to a discussion on transitioning from the CPI as it is currently calculated to the chained CPI.  Social Security payments are one of the many benefits indexed to the CPI.  The current political climate and the upcoming mid-term elections undermine the chances of any adult conversation on the topic.   Republicans are likely to retain the House and want to take the Senate.  A discussion of the CPI invites accusations from Democrats that Republicans – yes, The Cold Heartless Ones – are going to throw seniors under the bus if Social Security payments are decreased by even $5 a month because of a change in the calculation of the CPI.

The reason younger people don’t vote much may be that they hear the rhetoric of most political campaigns and realize that the discussions are much like those they heard in middle school.

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House = Bond?

Let’s crank up the wayback machine and travel to those heady days of 1999 when the stock market was booming.  Current profits did not matter.  New metrics were invented. Customers were revenue streams whose future value could be used to justify the present value of customer acquisition costs. Investments were made to position a company as the dominant player in the sector space of the internet frontier.  These metrics have some validity but the stumbling block was the simple fact that current profits do matter.

About that time some finance professors made the case in a Wall St. Journal editorial (sorry, no link.  WSJ doesn’t go back that far) that most households were overweighted in bonds. How so? A house is like a bond, they argued, relatively stable in price and pays the owner the equivalent of 6% – 7% annually.  House prices do average about 15 – 16 times annual rents according to the real estate analytics firm Jacob Reis.  At the height of the housing boom in the mid-2000s, houses were selling for 25x annual rents.

Secondly, it did not matter whether the house was paid for or not.  To illustrate this rather dubious viewpoint, let’s consider a renter who pays $12,000 annually in rent for an apartment.  She has a $500,000 portfolio, $300,000 of it in stocks, $200,000 in bonds, a 60/40 allocation split.  The bonds generate a 6% annual return of $12,000 which she uses to pay her rent.  A responsible financial advisor would not say “Oh, those bonds don’t count to your allocation mix because the income they earn is used for rent.”

Now, let’s look at a homeowner with the same $500,000 portfolio and the same allocation, 60% stocks, 40% bonds.  She owns a home valued at $200,000 which, if she rented it out, would net her $12,000 annually.  Her PITI  (mortgage payment and taxes) and maintenance repairs is also $12,000 annually.  Like the renter, the homeowner uses the $12,000 in income from her bonds to pay the house costs.  Unlike the renter, she is building some equity in the house by paying down principal.  On average, the value of her house is gaining about 3 – 4% per year based on historical patterns.  In short, the house is generating an unrealized gain that is ignored in conventional allocation models.

So, how would one compute the asset value of the house?  By imputing it from the income and unrealized gains that the house generated.  So, if a homeowner paid $3000 annually toward principal reduction and the house appreciated 3%, or $6000, the house generates a value to the homeowner of $9,000.  Using the historical 6% average return on a house, this would make the asset value of the house $150,000.  Adding that to the stock and bond portfolio gives a new total of $650,000, $350,000 of which is in bonds and the house, a bond-like asset.  Using this method, the allocation mix is 46% stocks, 54% bonds, perhaps more conservative than the homeowner desired.

After reappraising their portfolio in this manner, the professors suggested that homeowners might sell some bonds and buy more stocks to get the desired allocation mix.  To achieve a true 40% bond mix in this example, the target total would be $260,000 in the house and bonds.  Subtracting the $150,000 house value, the homeowner would want to have $110,000 in bonds.  To achieve this, the homeowner would sell $90,000 in bonds and invest in the stock market.  The investor would then have $390,000 stocks and $110,000, slightly above a 75/25 stock/bond allocation mix.  Older readers may shudder at this mix, thinking that it is quite risky.

So, let’s come back to the present day, after the housing bubble.  The calculations are not based on the actual price of the house but 1) on the income that it would generate if it were rented out and, 2) the principal pay down.  The finance professors did not factor in homeowners who were “under water,” i.e. owing more on the house than its current market value, because the debt on a house or any asset did not count in this model.

Let’s say that a homeowner bought at the height of the market in 2005, paying an inflated $300,000 for a house that would later be valued for $200,000.  The principal paydown is so small in the early years of a mortgage that it has only a small effect on the calculation.  Secondly, rent prices were under pressure during the housing boom, making the calculation of the asset value of the house lower.  In fact, a person using this method and contemplating the purchase of a house at that time might have asked themselves “Why am I paying $300,000 for an asset whose income and unrealized gain generates an asset value of $200,000 at most?”

As to the timing, whoa, boy!  What a bad call, selling $90,000 in bonds and putting it into the stock market right before the dot-com bubble popped.  By June 2001, long term bonds (VBLTX as a proxy) had gained almost 10% in value and were paying about 6%.  Our homeowner was not a happy camper.  Over two years, she had lost about $9K in value and another $10K in dividends on that $90,000 in bonds that she sold.  At mid-2001, she had lost an additional  $4,000 in value on the $90K that she invested in stocks near the height of the dot-com boom.

By the end of 2013, twelve years later, she still had not made up for those initial losses.

By including a housing value in the allocation calculations, our investor had an approximately 75/25 mix of stocks and bonds.  During those 14 years, a 75/25 stock/bond mix had about the same total return as a 60/40 stock/bond mix.  There is one clear advantage to the 60/40 mix, however: the risk adjusted return is much better.  The average annual return as a percentage of the maximum drawdown, or the CAR/MDD ratio,  was much higher and the higher the better.

This ratio could be called the sleep ratio.  Let’s say an active investor makes $50K profit in a year on a $500,000 portfolio, but during the year, the investor’s portfolio lost half its value before recovering.  Then the sleep ratio is $50K/$250K, or .2.  Not much sleep for all that activity.  As a benchmark, a buy and hold strategy in the stock market had a CAR/MDD ratio of .2 from 2001 – 2013.

The conventional 60/40 mix had a sleep ratio of .6 during this period.  The 75/25 mix had a sleep ratio of .35, making it the poorer risk adjusted model.  Interestingly, a buy and hold strategy in long term bonds had a sleep ratio of .48, showing that some balance between bonds and stocks produces a better risk adjusted return.

While the rationale for including a house in one’s bond portfolio mix might seem to be a good one, there was a timing disadvantage over this 14 year period.  Long term investors should remember that the past 15 years have been a rather unique combination of two severe downturns in the stock market and a housing bubble.  Such a combination is sure to test even the soundest theory.

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Takeaways

New home sales are down while existing home sales continue their moderate growth trend.  Jobless Claims are at a post-recession low.  Fixes to the Disability trust fund and any transition to a chained CPI are off the discussion table till 2015, at least.  An allocation model that includes a home’s value in an investor’s bond portfolio may have merit over a long time horizon.

Next week come four reports that are sure to fire up the market if any of them surprises to either the upside or downside:  GDP growth for the 2nd quarter, Employment gains, Motor Vehicle Sales, and the Purchasing Manager’s Index for the manufacturing sector.  

Summer Sale

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June 23rd, 2013

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

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

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

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

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

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

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

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