Category: oil prices

Price Paths Rejoin

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February 12, 2023

by Stephen Stofka

Divergent paths rejoin. This week’s letter revisits a correlation between movements in oil prices and the general price level. On July 10th of last year, I noted a divergence between the change in oil inflation and price inflation. The chart graphed the change – or momentum – in oil and price inflation, not the inflation itself. Transportation is a fundamental component and cost of our economy and companies must factor in shifts in price momentum in their pricing decisions. Here’s that chart.

At the time I had thought it likely that the change in broad price inflation – the red line in the chart – would moderate toward the momentum change in oil prices, the blue line. It did. Here is a chart with the most recent data through the end of 2022.

As I was writing last July, the momentum in general price inflation had already peaked and would start declining throughout the rest of the year. Think of momentum as a strong dog on a leash. Where it pulls, general price inflation will follow. Here’s a monthly comparison of inflation and its momentum.

At just a hint that inflation was moderating, the broad market began a rally in late October but it fizzled out in early December for a few reasons. The labor market was strong despite the Fed’s interest rate hikes and market participants correctly anticipated another 0.75% rate hike. In addition, Christmas retail sales were slow, increasing the likelihood that earnings gains would decrease. The broad market has rallied 7% since the beginning of the year.

A last note for those of you who are working on taxes and reviewing your portfolio, the investment advisor Edward Jones (2023) has a nice chart titled Investment Performance Benchmarks at the bottom of the page showing the 1, 3, and 5-year returns on various asset classes within the cash, bonds, and stocks categories. Despite the 18% drop in large cap stocks last year, the five-year performance is 9%, close to the decades long averages. The tech sector lost almost 30% in value last year but its 5-year return is almost 16%. During volatile years, relatively passive investors should keep their sights on the long-term averages.

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Photo by Jens Lelie on Unsplash

Edward Jones. (2023, January 24). Quarterly Market Outlook. Quarterly Market Outlook | Edward Jones. Retrieved February 9, 2023, from https://www.edwardjones.com/us-en/market-news-insights/stock-market-news/quarterly-market-outlook

Oil and Inflation Diverge

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July 10, 2022

by Stephen Stofka

The jobs report this past Friday surprised to the upside, showing a monthly gain of 372,000 jobs, far above the 250,000 expected gain. This is one of three indicators I wrote about last week. The positive job gains lowers the chances of a coming recession but the Atlanta Fed is now projecting a 2nd quarter decline of 2% in real GDP. As some economists have noted, it is unusual to have strong positive employment growth and negative GDP growth. In the graph below is the percent change in employment (blue line) and real GDP (red line). Since labor accounts for the majority of production costs, the two series move closely together.

Historically, employment growth (blue line) is declining before recessions. Here is a look at the period before the 2008-9 recession.

Let’s turn to another prominent concern – inflation. When the price of oil declined below $100 this past week, some economists interpreted that as a sign of decreased demand and a greater likelihood of recession. The price of oil factors into the production of most goods, even the electricity that comes into our homes. In the graph below I’ve charted the acceleration in the price of oil and prices in general. The magnitude is less important than the direction. Most of the time, the direction of each is the same.

Now I want to focus on recent years. As the economy recovered from pandemic restrictions in 2021, the changes in both series shot higher as expected. In the past year, the acceleration in oil prices (blue line) has declined while the acceleration in general prices has gone up.

The divergence is unusual and indicates that inflation is grounded more in supply disruptions and pent up demand than in the price of oil. I’m guessing that the Fed has noticed a similar trend. To appreciate how unusual this divergence is, let’s go back to the 1970s when the price of a barrel of oil went from $3 to $34. Even though the price movement was extreme, the acceleration in oil prices and the general price level moved in the same direction.

There is no shortage of opinions about Fed monetary policy and the Biden administration’s fiscal policy. The second stimulus payments went out in the first two weeks of 2021 under the Trump administration. Retail sales rose 5% that month, but fell 2% in February. Inflation in February was 1.7%, below the Fed’s target of 2%. On March 11, 2021, six weeks after taking the oath of office, Joe Biden signed the American Rescue Plan and in late March a third round of stimulus payments went out. Retail sales rose 11% in March but most of that increase happened before people received their payment. The odd thing is that there was little change in retail sales in the following months. This is one of many oddities surrounding this pandemic.

The general adult population received vaccines in April, May and June. Inflation rose above 5% by June 2021, then leveled off through September. In the graph above, the acceleration in oil prices and the general price level began to show a divergence. In the last three months of 2021, inflation started climbing while the acceleration in oil started falling. Why? It had never happened before.

Russia’s invasion of Ukraine has aggravated the situation and no one is happy. Xcel Energy, the public utility in my area, has raised electricity prices by 42% over last year; natural gas prices by 14%. The Fed’s next FOMC meeting is July 26-27 and the market is pricing in a 97% chance that the Fed will raise interest rates by another .75%, moving the federal funds effective rate near 2%. From 1954-2008, the average rate was 5.65%. From 1988-2008, the rate averaged 4.71%. Since 2008, the rate has averaged .62%. Near zero interest rates are abnormal.

Can the Fed retrain investors and consumers expectations toward a 3-4% federal funds rate in line with historical averages? The Fed conducts a lot of research but the current circumstances are unusual and the data shows conflicting trends. In a few years with the benefit of hindsight and firm, revised data, an economist can devote a few chapters if not an entire book to the past two years.

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Photo by Tim Johnson on Unsplash

Groundhog Day

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April 24, 2022

by Stephen Stofka

As the press announces the latest inflation numbers, we hear that this is the highest inflation number in four decades. These two periods share few similarities. In 1982, the economy was in a deep recession, the worst since the Great Depression. A clerical position or warehouse job would draw forty in-person applicants. Inflation had been sporadic and persistent for a decade. Two oil supply shocks and a surge of young Boomers into the workforce led to high unemployment and high inflation, a phenomenon termed “stagflation.” Since that time, economists have struggled to understand the peculiarities of that era.

Human behavior produces what economists call simultaneous causality, a recursive loop where event A causes event B which feeds back into event A. Just the anticipation of a policy causes people to act differently before the policy is implemented. This week Fed Chairman Powell strongly hinted that the Fed would raise interest rates by ½% at their May 3-4 meeting (FOMC, 2022). Anticipating that the rate increase could be as high as ¾% and more rate hikes than the market had already priced in, the market sold off on Friday. When in doubt, run, the survival strategy of squirrels and their large cousins, groundhogs.

Uncertainty joins all decades. Policymakers and investors must make forecasts and decisions with less than complete information. The more unusual the circumstances the more likely the flaws. In 1977, Congress enshrined the Fed’s independence in law and gave it a twin mandate of full employment and stable prices (Fed, 2011). A year later, Congress passed the Full Employment and Balanced Growth Act. The text of this act demonstrates how several years of stagflation had confused the direction of causality. The Act reads:

 High unemployment may contribute to inflation by diminishing labor training and skills, underutilizing capital resources, reducing the rate of productivity advance, increasing unit labor costs, and reducing the general supply of goods and services.

(U.S. Congress, 1978)

High unemployment accompanies or is coincident with diminished labor skills, resource utilization and productivity. Unemployed people lowers demand and that contributes to lower prices, not inflation. In 1979, a year after this act was passed, the Iranian Revolution overthrew the Shah and strikes in the oil fields cut global oil production by 6-7% (Gross, 2022). U.S. refineries were slow to switch production to alternative sources. Typical of that time, the Congress and U.S. agencies overmanaged prices, supply and demand in key industries. This regulation contributed to long lines at gas stations and a 250% increase in gas prices.

Today, much of the supply line has been affected by the pandemic and the effects linger. China has again shut down some tech manufacturing regions. The prices of building materials have been erratic. The ratio of home prices to median household income has now exceeded the heights during the housing crisis (Frank, 2022). Millennials have endured the dot-com crash, 9/11, the housing crisis, and the pandemic. Now a housing affordability crisis. The Fed’s survey of household finance reports that the median amount of household savings is $5300 (Wolfson, 2022).

War in Ukraine, crazies in Congress and little accountability. Since the end of 2019, inflation-adjusted wages have not improved (FRED Wages). Low unemployment should have driven wages far higher. Profit margins shrank or turned negative during the pandemic. Supply constraints have presented businesses with an opportunity to raise prices and make up for profits lost during the pandemic. As prices climb, policymakers and economists engage in a round of finger pointing.

Now comes the bit about a recession. Casual readers may have heard of a yield inversion. Time has value. Risk has value. A debt that is due five years from now should return or yield more than a debt due one year from now. There is more that can go wrong in five years. When shorter term debt has a greater yield than longer term debt, that is called a yield inversion. The yield curve is a composite of interest rates over different periods. A common measure is the difference between the 10 year Treasury note and the 2 year Treasury. When that spread turns negative over a period of 3 months, investors show their lack of confidence in the near future. A recession has occurred within 18 months.

Why should this be? As I noted at the beginning, we are a feedback machine. Our anticipation of events contributes to the likelihood that they will occur. The weekly version of the graph above did turn negative a few months before the pandemic struck in the spring of 2020. However, the weekly chart may give false forecasts. The quarterly chart captures sustained investor sentiment.

At the right side of the chart, we see how negative the sentiment has turned. The Fed knows that rising interest rates will drive that sentiment further down. By law – that 1977 law I mentioned earlier – they can’t ignore the force of rising prices. Employment, their other mandate, is strong enough to withstand some rate hikes. What worries the Fed now is a different type of unemployment – idle capital. Worried investors and business owners are less likely to begin new projects. That lack of confidence becomes self-fulfilling, creating an economic environment of pessimism. To Millennials, it feels like Groundhog Day all over again.

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Photo by Pascal Mauerhofer on Unsplash

Fed. (2011). The Federal Reserve’s “Dual Mandate”: The Evolution of an Idea. Federal Reserve Bank of Richmond. Retrieved April 23, 2022, from https://www.richmondfed.org/publications/research/economic_brief/2011/eb_11-12

FOMC. (2022). Meetings Calendars, Statements and Minutes (2017-2022). Board of governors of the Federal Reserve System. Retrieved April 23, 2022, from https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

Frank, S. (2022). Home price to income ratio (US & UK). Longtermtrends. Retrieved April 23, 2022, from https://www.longtermtrends.net/home-price-median-annual-income-ratio/

FRED Real Wages, Series LES1252881600Q. Index level 362 in 2019:Q4. Index level 362 in 2021:Q4.

Gross, S. (2022, March 9). What Iran’s 1979 revolution meant for US and Global Oil Markets. Brookings. Retrieved April 23, 2022, from https://www.brookings.edu/blog/order-from-chaos/2019/03/05/what-irans-1979-revolution-meant-for-us-and-global-oil-markets/

U.S. Congress. (1978). Public law 95-254 95th Congress an act. Congress.gov. Retrieved April 23, 2022, from https://www.congress.gov/95/statute/STATUTE-92/STATUTE-92-Pg187.pdf

Wolfson, A. (2022, March 2). Here’s exactly how much money is in the average savings account in America. MarketWatch. Retrieved April 23, 2022, from https://www.marketwatch.com/picks/heres-exactly-how-much-money-is-in-the-average-savings-account-in-america-and-psst-you-might-feel-inadequate-in-comparison-01646168736

The Price of Oil

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November 28, 2021

by Stephen Stofka

On Friday, fears of another wave of Covid lockdowns caused a sharp decline in equity and commodity prices worldwide. The decline was fueled by short-term traders who did not want to hold their positions over the holiday weekend and sold into a thin market. Crude oil prices fell 12% and closed the day below $70, and below the price of oil in the summer and early fall of 2018. Did we forget how high prices were just a few years ago? Rising oil prices helped fuel voter discontent that Democrats rode to take back control of the House that year.

Below is a graph of West Texas Intermediate, one of two oil benchmarks used domestically and shipped around the world. The price is adjusted to 2020 constant dollars.

As the price of oil broke out of its price channel in the early 2000s, companies began to develop more effective horizontal drilling techniques (Mead & Stiger, 2015, 4). In 2013, U.S. production reached a 24-year high and both political parties claimed credit. Oversupply led to a 50% price decline in 2014. Drivers liked the prices at the pump but states which had enjoyed the boom were hurt by the bust. Republican candidates promised better times in these red states if they were elected.  

In a democracy, politicians must play a game of voter persuasion. They spend millions in opinion polls  to test the temperature of voter passions, to discover the emotional buttons that will win votes. They rig Congressional districts to maximize the voter sentiment in one party’s favor. Like heralds marching into battle, candidates wave their principles and values for all to see. We have chosen this system, this political game, as the best alternative to armed conflict in the streets. Many of us were alarmed when the January 6th rioters championed a return to the violence that shook the foundations of civil society in France during the 19th century. Seventy years of successive revolts in that country left many bodies in the streets. We have far more sophisticated weapons and lots of them. Do we want that bloodbath?

As bread was a rallying cry in the French Revolution, the price of oil sparks political passions in the U.S. Higher prices impact rural folk more than urban residents, blue collar businesses more than white collar firms. When workers have to pay $100 – $200 to fill up a 40 gallon tank on a service truck, they complain. If their party is in power, it’s the fault of speculators and they will soon forget the pain when prices decline.  Voters protest loudest at high oil prices when their party is not in power. Politicians promise that their policies will bring down oil prices. They know their promises are as real as unicorns but voters like unicorns and fairy tales.

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Photo by David Thielen on Unsplash

Mead, D., & Stiger, P. (2015). The 2014 Plunge in Import Petroleum Prices: What Happened. BSL: Beyond The Numbers, 4(9), 1-8. Retrieved November 27, 2021, from https://www.bls.gov/opub/btn/volume-4/pdf/the-2014-plunge-in-import-petroleum-prices-what-happened.pdf

The Association – A Split

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August 25, 2019

by Steve Stofka

A few things before I continue the saga of our mountain community. Bond yields have sunk to remarkable lows as the prices of those bonds climb higher in response to global demand for safe assets. Governments have borrowed trillions since the financial crisis, yet there is not enough debt to meet demand.

The private market created a huge supply of “safe” assets called Collateralized Debt Obligations, or CDOs, based on house mortgages. When the housing market imploded, it left a big hole in the market for safe assets. As countries around the world have adopted capitalistic market structures, the living standards of millions of people have improved and that has led to more savings in search of safe investments.

The U.S. still pays a positive interest rate on its debt and that is attracting a lot of foreign capital to our country – capital that is driving down the interest rates on our savings and pension assets. Unlike some other countries, capital moves freely across U.S. borders. It doesn’t wait in crowded spaces behind chain link fences.

Donald Trump’s family business relies heavily on borrowing, and most of that has come from a single source, the German firm Deutsche Bank. No other bank is willing to risk capital on a family business with a history of failure. The family’s business depends on the free movement of capital across national borders, yet Trump himself is adamantly opposed to the free movement of labor across borders.

Capital requires a legal framework of property rights protection, a robust banking system capable of servicing that capital, and a political system that protects the profits generated by investment from graft and corruption. Labor requires a social framework in addition to a legal system that enforces basic personal rights. Capital comes to this country because we spend a lot of money to nurture and protect it more than some other countries. Labor comes to this country for the same reasons – a higher return on their effort, an educational system that nurtures their families, a social and legal system that offers some protections.

“They’re taking our jobs!” some people complain of immigrant labor, yet few Americans are affected by an immigrant labor force that takes mostly lower paying jobs. The flow of capital into our country creates a competition that affects many more Americans – anyone who has a savings account, a pension fund, a 401K, an IRA. Where is the outcry against foreign capital?

Let us return to those dear souls who inhabited an abandoned mining town. In last week’s story, they had formed a homeowner’s association which created Money, Debt, and traded with another community called the Forners.

The board of the homeowners’ association complained often about the expense of handling the Money that it had created. The association decided that it would be more efficient to reduce the use of paper Money. It gave each homeowner a bank account and a Money shredder which scanned and tabulated the Money that each homeowner shredded. Homeowners didn’t have to go to the community center when they needed to pay another homeowner or the association. When they did receive Money, they deposited it in the shredder, which added the amount to their balance. When they wanted to pay someone, they tapped some buttons on their shredder and the amount went from their account to the other homeowner’s account. Paying their monthly homeowner fees was so much more convenient.

A homeowner called Mary decided to re-open the old restaurant, but she would need more Money than she had. What to do? The association could print the Money and loan it to her. Mary would put up 10% of what she needs, and the association would print the other 90%.  She would pay the money back over time with interest. One of the homeowners asked, “How will we be paid if we do work for Mary’s restaurant?” Someone answered, “With the same Money that you get paid when you work for the association.”

That was acceptable to everyone. With the extra Money earned by fixing up Mary’s restaurant, several other homeowners put down deposits and opened businesses with loans from the association (Note #1). The association held a mortgage on each business, but the business owner decided how to run the business and received the profits from the business.

When Stan’s business failed, the homeowners discussed what to do. Stan had spent the printed Money that the association had loaned him, so the Money had not disappeared. Like all the printed money, it was spread around the community. The effect of Stan’s business failure was the same as if the association had started the business, hired people to do work, paid them and then closed the business after a time. The printed Money went out into the community but never made it back to the association in the form of loan payments. Someone said, “There is extra Money in our community because Stan’s business loan won’t be paid back.”

They agreed that this was so but what to do about it? They all had some extra Money because of Stan’s business loan. “What if more businesses fail?” someone asked. “What will we do with all the extra money the association has printed?”

“Prices will go up,” someone else said. “That’s what happened last time.”

“If more businesses failed, I would be more careful and buy less stuff,” another offered. Several heads nodded. “I’d deposit some extra Money in the shredder.”

“Well, that doesn’t make the Money go away,” someone argued. “The money is still in your bank account with the association.”

“But prices won’t go up because people are spending less Money, isn’t that right?” someone asked. That was the confusing part. The last time there was extra Money, prices went up. But in this case, prices were likely to go down if more businesses failed and there was extra Money.

Someone stood up and said, “I’ve got the answer. When we all worked fixing up Stan’s business, the Money was exchanged for our labor and supplies. Since the Money was exchanged for goods and services, there is no extra Money.”

Someone else countered, “What if we all started businesses, borrowed Money from the association and we all failed? There would be a lot of extra Money.”

The other person answered, “Yes, the amount of circulating Money would be suitable for a thriving community. Too many people with a lot of Money and nowhere to spend it would drive up prices. But just one or two business failures has such a small effect that it is negligible.”

They decided to continue printing and loaning money but formed a loan committee whose job was to review an applicant’s business plan before loaning the money.

Bob, the community’s propane dealer, bought his supplies from the Forners. One month, the Forners got very angry at the whole community and would not sell propane to Bob. He contracted with another community for propane but there wasn’t enough for everyone’s needs. Bob raised the price of propane then began rationing propane by selling only to those who were in line at his station at 6 A.M. After two hours, he shut off supplies until the next day. Some homeowners threatened Bob and so he had to hire a few people for extra security (Note #2).

Mary used a lot of propane for cooking, so she had to spend several hours each day buying propane. Naturally, she raised prices to account for the additional time and higher price of propane. Homeowners ate fewer meals at Mary’s and she had to let go of several employees.

As prices rose, some homeowners who had bought association debt at low interest rates began to complain. “We loaned the association money at 5% interest and prices are going up at 10% a year. We’re losing money!”

Everyone agreed that this wasn’t fair, but no one knew what to do about it. Should they cancel the old debt and reissue debt at higher interest rates? That would lead to higher homeowner fees for everyone. “You want us to pay extra so that your interest income will keep up with inflation? Why should I take money out of my pocket and put it in yours?”

Tempers flared. “I’m not loaning this association money ever again,” complained one homeowner and several stormed out of the clubhouse. True to their word, these homeowners would not renew their loans to the association unless it paid much higher interest rates. After several months, the Forners resumed propane deliveries but a vicious cycle of higher prices had started. Homeowners had to pay higher association fees and wanted more money for their labor to pay those higher fees. No one knew how to fix the situation.

“We need to charge high interest rates on the Money we print and loan to homeowners for their businesses and homes,” a board member said.

“Are you crazy?!” Several complained. “Rates are already too high. People can’t afford to start businesses or buy a home!”

“We need to raise them so high that it will hobble the economy for a while,” the board member said. “That’s the only way to bring prices down. It won’t take long.”

It took much longer than anyone anticipated, and the economy declined for almost two years. This period of higher prices followed by high interest rates caused a divide among the homeowners – between those who relied on the association for services and help during hard times, and those who formed a deep distrust of the association (Note #3). No one fully understood how deep the divide would grow.

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Notes:

  1. The process where loans generate income for others which generates more loans is called the Money Multiplier in economics.
  2. In the 1970s, two gas embargoes led to similar circumstances.

This is a retelling of the high inflation of the late 1970s, followed by nose-bleed interest rates that caused back-to-back recessions in the early 1980s. The recession of 1981-82 was the most severe since the 1930s Depression.  

New Directions

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December 28th, 2014

Emergency Plan

Let’s say you have $60 invested in the stock market.  You have $30 invested in bonds and $10 sitting in your savings account, for a total of $100.  This is essentially a 60/40 stock/bond mix. You do not rely on your investments for current income.

Some crisis unfolds, sending shock waves through global markets.  Within a month, the stock market loses 30%.  Bonds have gone up 10% as investors flee to safety.  Financial soothsayers are predicting further stock losses, perhaps as much as 50%.  Others are saying that the market has bottomed.

Your stock portfolio has lost $18 (30% of the $60).  Your bond portfolio has gained 10% or $3.  Your portfolio is now valued at $42 stocks, $33 bonds, $10 savings, a 50/50 mix of stocks/bonds.

Now, let’s add some historical context. From 1968 to 1982, a period of fourteen years, there was no change in the SP500.  From 1982 to 2000, the SP500 rose 1400%.  Then from 2000 to early 2013, almost thirteen years, there was no change in the SP500.  Yes, it’s only been a year and a half since the market regained those levels of 2000.

So, what would you do?  Do you:

A)  Invest the $10 in savings to bring you back closer to your original allocation mix of 60/40 stocks/bonds.

B) Stick to allocation goals.  Keep the $10 tucked away in savings for emergencies, sell some bonds and buy stocks to get closer to your allocation goals.

C) Change your allocation mix.  Cut your losses by selling the stocks you own and buying the better performing bonds.

D) Shrug and make no changes.  Turn on the game and order a pizza. The stock market will rebound in due time and automatically rebalance your portfolio on its own.

E)  Freeze, not knowing what to do.  Yes, not knowing what you would do is a game plan, a choice.  Perhaps its not the best plan but it is often one chosen as the default.

Now, run that same scenario, changing only one thing. You rely on your investments and savings for half of your current income.  Now what do you do?

Was the past year and a half the beginning of an eighteen year run up in prices similar to the 1982 – 2000 period?  Could the SP500 index, currently trading near 2100, be valued at 21000 (1500 * 1400%) in 2032?  Maybe.  Could 2014 be the last year in the previous flat cycle so that the market drops 25% to the 1500 level of 2000 and 2007?  Maybe.

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GDP
The third estimate of 3rd quarter GDP growth was a strong 5% on an annualized basis, more than offsetting the weak 1st quarter of this year. On a more sobering note, it is only in the past six months that per person GDP has firmly surpassed 2007 levels.
GDP is a measure of tradeable goods and services in an economy.  There is much important human activity that is not measured in GDP so it is far from perfect.  If you want perfect, go to the universe next door. Per person GDP growth below 1% causes concern among traders, money managers, economists and policy makers.  This year per capita growth is a healthy 2% – not robust but respectable.  
Contributing to GDP growth in the third quarter was a 4% yearly increase in federal government spending, more than double the rate of inflation.
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Oil 
Monday’s meeting of the OPEC members left little doubt that Saudi Arabia is content to let the price of oil fall as low as natural supply and demand might take it.  They said they would not consider production cuts until oil went as low as $20 a barrel, about a third of what oil is currently trading at, and a fifth of its price in 2013.  This rhetoric was aimed directly at two non-OPEC members, the U.S. and Russia, warning both countries that the Saudis intend to keep their leadership position in the international oil market.
Missouri was the first state to report an average price per gallon of gas that was lower than $3.  Others are sure to follow.  A few weeks ago an EIA administrator testified before Congress, revealing a number of dramatic shifts in U.S. oil production, consumption and import.  Once the largest importer of petroleum products, the U.S. is now the world’s largest exporter.  Despite falling oil prices, the EIA expects production to increase 10% in 2015.  

An Unwelcome Guest

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Nov. 30, 2014

The short week of Thanksgiving should have been rather uneventful.  The week before, officials in Ferguson, Missouri had announced an imminent decision in the grand jury hearing of the fatal shooting of Michael Brown, an African American, by Darren Wilson, a Ferguson police officer who was European American.

Slavery, the denial of civil rights to African Americans, and persistent housing and job discrimination against African Americans are an integral part of American history.  Bankruptcy is a formal discharge of debt.  There is no formal procedure for discharging past wrongs.  Some Southerners are still distrustful of the Federal bureaucracy in Washington that committed so many wrongs in the period after the Civil War.  The wounds inflicted by white skinned Americans on dark skinned Americans is fresher than those suffered by Southerners during the Reconstruction period almost 150 years ago.  Fresh wounds bleed easily when scratched.

The grand jury took several days longer than “imminent” to reach its decision, announced Monday night.  Several weeks of protests during the course of the hearing erupted into violent rioting at the grand jury’s decision that Officer Wilson should not be indicted for any charges, ranging from first degree murder to manslaughter.  The decision, right or wrong on the facts, picked at the scab of the soul of some African Americans, provoking senseless violence.  Americans of every skin color riot when their team wins the World Series (San Francisco 2014) or Super Bowl (Denver 1998).  Dark skinned Americans riot when they perceive that some injustice has been committed against them.

The costliest riots, over $1 billion in damages, had occurred in Los Angeles in 1992 after the Rodney King beating.  Whether in response to victory or injustice, rioting provoked confusion and condemnation in any society.  It was both uncomfortable and strangely seductive to watch the emergence of a super two-year old, having a temper tantrum, from a group of civilized human beings.

Property damage from civil unrest was covered by many business insurance plans, George knew, but he wondered how many businesses damaged in the Ferguson riots were covered for interruption of business operations, replacing some or all of the owner’s lost income.  Sometimes these were sold as riders to a commercial policy.

People with jobs were less likely to get angry.  Unemployment among African Americans was at the same level as the early seventies, when the economy was in a severe recession, and the oil embargo and inflation had prompted Nixon to enact wage price controls.  Those had not been good times for many Americans. Five years after the official end of this last recession, the unemployment rate among African Americans was twice the rate of the general labor force.

The participation rate among African Americans was about 1% less than that for the entire labor force but the rate difference for men was about 4 to 5%.

George was a bit concerned that Monday night’s riots in Ferguson might have a secondary effect on Tuesday’s trading if the 2nd estimate of GDP growth for the 3rd quarter was below 3%.  Yes, he should have been more focused on making turkeys out of construction paper for the Thanksgiving dinner.  He and Mabel – well, mostly Mabel – had started the tradition when the kids, Robbie and Emily, were younger.  Somehow they had continued the tradition after the kids had gone.  George told Mabel that he would do it while they watched the season finale of Dancing With the Stars on Tuesday night.  Somehow he felt like a kid saying he would do his homework later.  Long marriages result from both partners doing stuff they don’t particularly like doing, George thought.

Tuesday morning’s report of GDP growth allayed George’s concerns.  October’s initial estimate of growth had been 3.5%.  This second estimate was higher, at 3.9%.  The Case Shiller 20 city home price index showed a slight month-to-month increase, but the yearly increase in price was just about 5%, more in line with historical averages.  
 Corporate Profits for the 3rd quarter gained 3.8% year-over-year, slowing down from the 4.6% year-over-year growth in the 2nd quarter.  Profit growth was ultimately driven by growth in productivity.  Capital investments in technology had reaped the greater share of overall growth in the past decade or more.  Labor’s share of growth had been particularly weak the past few years, far below the average of the past forty years. 
A closer look at labor productivity gains in the past decade showed just how meager they were.  
A work force unable to capture productivity growth could not command strong pay growth.  Economists at the BLS anticipated increasing overall output growth in this next decade but those projections were sullied by the lack of clarity regarding the causes for the slow growth in labor productivity of the past decade. Did the shift further away from manufacturing make gains harder to come by?  Was there a limit to growth that could be achieved by better management, process design and innovation? Some blamed the exponential growth of the regulatory state, forcing businesses to devote an increasing number of hours on compliance and reporting.  Others blamed the increase in social benefit programs for softening the competitive edge of American workers.  Got a reason?  Throw it in the hat, George thought. The market traded in a flat range for the day.
On Wednesday, George went to the bank to cash in the joint CD that he and Mabel had discussed the previous week.  He was surprised to learn that the bank did not require the both of them to cash in a joint CD.  Mabel was busy with Thanksgiving fixings so it was convenient that George could go alone to handle the matter.  He picked up a certified bank check from one bank and drove over to the bank where they kept their checking account to deposit the money.  He was also surprised to find that the bank did not credit the money to their account for a few days. “The other bank is just like 10 to 15 blocks away,” George told the teller.  “Well, we have to guard against fraud,” the teller responded.  “So it would have been better to have gotten cash?” George asked. “Well, yeh, but then I think you would have to fill out a form because it’s a large cash transaction,” the teller informed him.  “You know, to say you got the money by legal means, that you’re not a drug dealer,” he went on, “but I’d have to ask my supervisor about that.”
George was going to transfer the money that day to their brokerage but thought he should wait till Monday.  George was tempted to buy maybe a 1000 shares of USO, the commodity ETF that tracked West Texas Intermediate Oil.  OPEC was scheduled to meet Thanksgiving day to discuss the near term future of oil prices.  They had dropped by about a third in the past year as increasing barrels of U.S. shale oil were added to the supply for a weakening global demand.  U.S. oil production was now at 9 million barrels a day, the same level  as the mid-1980s, and rising toward the record production of 10 million barrels in the early 1970s.
Poorer countries in OPEC who funded their government with the sale of oil, wanted to set production cuts to halt any further declines in oil prices.  With their huge supply of oil and relatively inexpensive production costs, the Saudis were content to let the slide continue.  On Tuesday, oil prices had dropped a few percent.  But if the other members of OPEC prevailed and production cuts were announced, George reasoned, he could make a bundle of money in a short time by buying oil the day before.  That was the speculative angel, or devil, on his shoulder whispering in his ear.  His other angel simply asked, “Are we investing or gambling?”  George gave in to his cautious angel.  He could also lose a bunch of money really quickly if the Saudis prevailed.  
Thanksgiving dinner was a relatively muted affair, unlike those of past years.  Bob, George’s older brother, and his wife, Flo, had flown down to Cabo to work on an archaeological dig.  The digging part of that “vacation” didn’t sound appealing to George but this archaeological club, or group, would put them up for 10 days in exchange for their labor and they would still have time for sun and surf.  Bob had become fascinated with archaeology when he was about 60 years old and had pursued it with a passion since then.
Mabel, the oldest of five siblings, had taken on the Thanksgiving festivities.  Two of her sisters lived in Colorado but only Susan, the youngest, came to dinner this week.  Most unusual, George thought, that Charlie was the only child at the dinner this year.  The talk at the dinner table turned to Ferguson.  Robbie had read quite a lot of the testimony at the grand jury hearing and was full of facts.  Charlie got bored as the adults chattered on during the meal. He saw a squirrel coming down the trunk of the tree in the front yard and asked George if he could have some peanuts to feed them.  George had showed Charlie how to sit still on the back deck after putting peanuts out for the squirrels in the middle of the backyard.  He was quite surprised that a child of that age could be motionless and silent for that long as they waited for the squirrels to scurry out from the bushes to snatch up a peanut in their wiry paws.
As the talk and opinions swirled around the table, Mabel was quiet, chewing methodically while listening attentively to the others.  George had already had a few testy words with her earlier in the week so he knew how strong her opinions were.  Robbie’s wife Gail all but accused her husband of being a racist because he did not understand that the facts of the case had been carefully cultivated in favor of the police officer.  Robbie asked his mom for some affirmation.  Mabel finished a bite of sweet potato. 
“About fifteen years ago, I stayed a bit late after school, finishing up some paperwork,” she said to Robbie, then turned to the others around the table.  “It was late October,  maybe early November.  The sun had already set.  There were only a few cars left in the parking lot.  There was one of those parking lot lights, the high ones like street lights, near my car but it would go on for a few seconds, then go off for about a minute.  As I walked to my car in the semi-darkness, I noticed a figure walking to me from my right as though to intersect me as I got to my car.  A second glance up and I saw he was wearing one of those,” she paused, “hoodies, I think they’re called.  As he got closer, maybe twenty feet away, I realized that I couldn’t see his face, that it was a black man in a hoodie. My heart instantly started flippity flopping as I realized that I was going to be attacked.”  
Mabel had everyone’s attention, a difficult thing to do in an family that was not reluctant to share their opinions. “There was no one else in the parking lot that I could call out to for help,” she continued in a purposeful voice. “I hurried my step, reached into my bag, fumbling for the car keys as I approached the car.  I didn’t want to look panicked, fearing I don’t know what.  Maybe that my panic would provoke the attacker.  As I reached out my arm to unlock the car, the man’s voice broke the darkness.  All I heard was ‘Hey’ and I turned and I yelled back ‘Aaaaahhhhh,’ grunting it out like some Kung-Fu movie.  “Mabel?  Is that you? I didn’t mean to startle you,” the voice from the hoodie said.  He brushed back the hood of his parka and I could see that it was James, the biology teacher. 
He was so apologetic and I pretended that I had not noticed him until just that minute. ‘My battery’s dead and I was wondering if you have some cables, could give me a jump,’ he explained to me.  ‘I was going to call AAA and then I saw someone come out of the school entrance and I thought it might be you but I wasn’t sure,’ he went on.  I had cables in the trunk, but I was so upset that I lied and told him no, I didn’t have any.  He thanked me and went back across the parking lot to his car.”  Mabel took a quick sip of water from her glass.  George had never heard this story.  After 35 years of marriage, that rarely occurred.
“I started up the car, then sat there crying,” she continued, her lips tense.  “It’s as though my ideals, my view of myself, was a cloak that I had worn and then, that night, I looked in the mirror without my cloak on.  I wasn’t racist in spirit,” she paused, searching for the words to complete the thought, “or intention, but I realized that I was a racist in perception. Racism is embedded in our culture, in me, whether I like it or not.”  
She stopped and there was silence around the dinner table, a rare event at a Liscomb family gathering.  Robbie, sitting close by his mother, reached across the table to grasp his mother’s hand. From the far end of the table, George was struck by her – what would he call it? Her forthrightness. She had an ability he lacked, and perhaps that’s why the seeing of it in her gave him a sense of admiration.  The moment snapped like a crisp carrot as the front door swung open and Charlie burst through the doorway.  “The squirrel was eating a peanut this far from me!” he yelled excitedly and spread wide his arms.

On Friday, George learned that the Saudis had prevailed at the OPEC meeting.  By the end of the day, USO had dropped more than 8%.  We bear the fruits of what we do and don’t do, George reminded himself, then wondered if that was a line from Shakespeare or maybe Leonard Cohen?

While the stock market stayed relatively quiet during the week, ten year bond prices continued to gather strength.  Stocks and bonds tended to move opposite each other in a dance of risk and return. When they both gained in strength, something had to give.  The last time they met at this strong level was at the end of August, when bonds faltered first, falling  about 5% over two weeks while the SP500 remained fairly stable.  In mid-September they flipped.  Bonds rallied up 8-9% as stocks fell the same amount.  Then stocks rallied to all time highs in the past four or five weeks but bond prices had not fallen more than a few percent.  George resolved to watch this dance during the following week.  It was the first week of the month, filled with a number of reports including the employment report that could renew or drain confidence in the stock market. 

A Long Term Plan

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November 16, 2014

“Yaaaaay!” Charlie erupted as he kicked the pile of leaves in the backyard. Rusted orange, dried blood crimson and mustard yellow flew up into the air.  Rake in hand, George smiled at his grandson’s exuberance. “Hey, champ, let’s get these leaves in the bag.”  The little arms gathered up the colored leaves and swung to the trash can which was about the same height as the four year old boy.  Charlie threw the leaves up over the lip of the trash can.  Very few leaves made it into the can. Charlie tilted the black plastic can toward him so that he could look in the can. “Look, Ganpa!” he exclaimed, proudly showing the inside and the few leaves that had made it into the can.  “The kid’s a politician,” George remarked to his son Robbie sitting on the back deck. “Get’s very little accomplished with a lot of fanfare.”

Robbie held up his phone. “Let me get a shot of the two of you.”  George picked up Charlie and held him over the trash barrel.  Charlie clasped him around the neck and Robbie snapped the picture.  George set the child down and the boy once again gathered up a clump of leaves and threw them up into the air.  Robbie took another picture of his son.  George walked over to the deck.  “Let me see.”  Robbie showed him the two pictures then looked at the picture of his son tossing up the leaves.  He handed the phone to his dad.  “Looks like a scatterplot, doesn’t it?” Robbie asked. George looked.  “Wow, what have you been working on?  Most people don’t see a scatterplot in a cloud of leaves.” A scatterplot is a number of data observations plotted on a graph.

“Still working on pattern recognition for drones,” Robbie said, a bit of tiredness in his voice.  “A lot of tough problems to crack.”  George nodded toward Charlie. “I can remember when you were this age,” George said, a fondness in his voice. Robbie went on, “Charlie – any four year old – has better visual processing that the most sophisticated algorithms we write. The brain scientists plot the paths in our brains but we still sit around the lab wondering what is it that our brains are doing when we interpret the world.  Well, we just keep kicking at this mule…” His voice drifted as Charlie came over to them, leaves clenched in his little fists.  He slumped on Robbie’s knees.  “You need to rake more leaves, Ganpa,” he whined.  George looked up and saw that Charlie had leveled the pile of leaves.  “Ok, champ, let’s rake more leaves.”

Mabel opened the rear screen door.  “I need a potato peeling person!” she called out.  Robbie stood up.  “I’ll get it,” Robbie said, “you rake.”

As he raked, George thought back to that time when Robbie was the same age Charlie was.  At that time, thirty years had seemed like a lifetime because it was.  He and Mabel had been in their thirties.  George remembered some  meetings with their accountant at the time. She had given them the talk, one that she probably gave to other young families. “You need to keep some things in mind for your kids, and for your retirement.  I know it seems like a long time away now but your little boy will be in college before you know it.”  The accountant was only a few years older than they were but talked like a Solon.  George had supposed that the profession encouraged that kind of long term thinking.  Heck, his time horizon was about five years and this woman was stretching their imagination out twenty, thirty and forty years. “The choices you make now will limit or expand your choices in the future.”

Almost thirty years later, George and Mabel had done well by following her advice over the years.  George wanted to thank her but she had moved her business to Oregon or Washington and they had lost touch.  They had not bought the really big house although they had sometimes wished they had more room, especially when the kids were teenagers.  They had treated the two houses they had owned as a place to live, not as an investment vehicle or a store of wealth to borrow from.  The mild downturn in the residential market in the early 1990s had not worried them.  When the prices of homes crashed in 2007 and 2008, they lost little sleep because the mortgage was paid off.  George did take a hit on his 401K though.  He was close to retirement as the market tanked and both of them worried a lot through that 2008 – 2009 winter.

In the late 1980s, George had opted in for what was then a fairly new idea, a 401K plan, at work.  These were termed “defined contribution” plans.  The employee, not the employer, took the risk and the responsibilities for the investment allocations in the plan.  The employer made its contribution to the plan and had no long term liabilities for the results that the investments did or didn’t make.

When Mabel returned to teaching in the mid 1990s, she had taken a conventional defined benefit pension plan, the only one that the school offered.  In early 1999, as the Nasdaq climbed to nosebleed valuations, George had eased up on the stock allocation in his 401K.  He didn’t know a whole lot about investing, only that stocks were riskier than bonds.  As the market continued to climb, he sometimes regretted his decision but stuck with it as a matter of common sense. By the end of 2000, as stock prices continued to fall, he was glad he had been more conservative.  In late October 2014, the Nasdaq 100 had finally climbed above the level it reached in 1999, 15 years earlier.

They enjoyed a wonderful Sunday dinner with Robbie, his wife Gail, and their grandson Charlie.  Robbie asked about Emily, his sister, but no they hadn’t heard from her in almost a year.  Two kids grow up in the same house.  One of them is stable, has a good career, and a wonderful family.  The other leads a troubled life, and is consumed by some inner demon.  Emily was not a fit conversation for a dinner table so the talk moved onto other topics.  Robbie, Gail and Charlie drove back to Colorado Springs that evening.  There was a front moving down from Canada or Alaska so they declined the offer to stay in the guest room for the night.

There wasn’t a lot of economic news scheduled for the week so George was not expecting any strong moves in the market.  Much of the earnings season had come and gone.  According to FactSet  almost 80% of companies had reported above consensus estimate of earnings.  A more disturbing sign: three times as many companies had issued negative guidance for fourth quarter earnings as those that had indicated a more positive outlook.

The big news for the week was the Rosetta spacecraft.  Launched ten years earlier, it had rendezvoused with a comet 300 million away on its journey from the far reaches of the solar system to the sun.  As if that wasn’t spectacular enough, the spacecraft then launched a washing machine sized landing vehicle to sit down on the comet as it sped through space.  Talk about long term planning.

On Thursday, the spot price of a barrel of crude oil dropped below $75.  The Energy Information Agency (EIA) announced that the average price of a gallon of gasoline had fallen further to $2.94, the second week below $3.   Several analysts pegged the price range of $65 – $70 as a “make or break” benchmark for many fracking operations.  If oil were to stay down at that level for any length of time, many new drilling plans would be put on hold.  Operations at existing wells might be cut back.  The strong dollar meant that countries who were net exporters of oil would be paid in dollars, which could be traded for more of their own currency.  For these countries, the strong dollar was helping offset the impact of lowered prices.

On Thursday, the BLS released the September report of job openings and turnover, or JOLTS.  The number of employees quitting their jobs had risen to a recovery high of 2%.  Workers who were not confident of finding another job did not quit their current job.  Job quitters acted as a canary in a coal mine, where a relatively small part of an ecosystem or economy indicated the health of the entire system.  A rate of 2% or higher indicated a healthy confidence in the employment grapevine.

On Friday, George had lunch with a few former colleagues.  Four old guys sitting at a booth, drinking too much coffee. As usual, the discussion was lively.  Each of them had a take on the elections just past but the conversation got a bit heated when Stan said that there were just too many people who didn’t want to work.  Who was going to pay for all these people?  Who was going to pay for all the government programs?  He had just read a report from Pew Research that summarized the changing trends in the labor force participation rate and the sometimes contentious debates about those changes.  The participation rate was the number of people working or looking for work as a percentage of the adult population, the civilian non-institutional population, as it was called.  A 90 year old person could still work and was counted as part of that population of potential workers.

The core work force, those aged 25-54, showed a slightly declining participation.  The first boomers had grown out of this age group at the turn of the century.

George’s opinion, one echoed by the Congressional Budget Office, was that much of the reduction in the participation rate was due to changing demographics.  Since the mid-1990s, women, particularly white women, had had a historically high participation rate.

Some workers of earlier generations who had not needed a college education to earn a middle class wage found themselves less desirable in this more technological work environment.  During the recession, employers shed many workers with long term health problems.  As the economy improved employers were reluctant to hire these job seekers who may have had a good work ethic but possessed no above average skills or education.   Some applied for disability, or retired early if they could, or simply gave up trying.

Those with college level education and higher were more likely to be working.  The downtrend in the participation rate for both groups had started during the Clinton years, long before the Bush presidency, the 2008 recession or Obama’s presidency.

Full time workers as a percent of the total population were about the same level as the mid-1980s, when the economy was in a growth phase.  The 1990s and 2000s had been marked by unsustainable bubbles – the dot com boom and the housing debacle.

Older workers contributed to the high participation rates of the 1990s and 2000s.  A lot of people came to regard these abnormally high participation rates as normal.  They weren’t, George argued.

Sure, people are living longer, George argued, but the number of older workers can’t keep rising indefinitely.  Since the early 1990s, older workers had risen by 20 million, from 12% of the work force to 24% of the work force.  They were competing with younger workers for jobs.

27% of the entire population was older than 55.  Most of that population was past working age yet older workers made up 24% of the work force.

Workers who might have retired in decades past were continuing to work, clogging up the labor pipeline.

Stan thought the economy had still not recovered and was worried about the next recession.  Who’s gonna pay for all these people, he wondered again.  George reminded him that average weekly hours of all private workers – most of the work force – was now at the same level as before the recession.

The Civilian Labor Force was higher now than before the recession started.  The growth rate was lower but still growing.

But George agreed that there were persistent problems.  A third of those unemployed had been out of work for more than a half year.

Real weekly earnings were stagnant, neither growing or declining.

There were still a lot of people who were not counted in the labor force because they were not actively looking for work.  They wanted jobs but had given up.  As bad as it is now, George reminded Stan, discouraged job seekers are at the same level as they were in the mid-1990s.  Did you even notice back then?  George asked.  Stan admitted he hadn’t.

“A lot of us weren’t paying attention,” George told the group seated at the booth.  “Sure, it got bad sometimes, but we figured we would get through it.  This last recession was bad, bad, bad and there is a lot more information available now.  We can see how bad it was five years ago and there’s plenty more information to worry over as we look to the future.”

“So, you’re optimistic?” Stan challenged.  “Yeh, I am,” George replied. “Thirty years ago my accountant told me that by the time we retired, politicians would have to do one of three things:  increase taxes, cut benefits, or increase the retirement age.  She told Mabel and I that politicians would probably do a little of all three to spread the pain out and avoid getting thrown out of office.  I was doubtful.  How could she know what was going to happen so far in the future?  ‘It’s just math,’ she told us. ‘The largest generation of people is going to start turning 65 in twenty-five years and the system is not designed for it.  They’re gonna get sick and who’s gonna pay for it?  You think the little that you pay into Medicare is going to cover that?’  I look back now at her predictions.  They’ve raised the retirement age.  Check. The low inflation rate is helping to reduce the growth in Social Security benefits.  A half-check.  Medicare costs are growing at two to three times the rate of inflation.  They haven’t raised taxes yet but it’s coming.”

Stan said sardonically, “And you call yourself an optimist.”  George laughed.  “I guess I’m an optimist because she got Mabel and I planning for all of this a long time ago.  When they raised the retirement age, we weren’t surprised.  When they cut Social Security benefits in the future, we won’t be surprised.  When they raise taxes, we won’t be surprised.”

“Is this lady still your accountant?  She sounds pretty smart.” Stan asked.  “No,” George replied. “I think she and her husband moved to Oregon or Washington.  They wrote business and investment software but they gave up trying to defend their software from copying.  This was in the late 1980s and early 1990s.  Even their own clients were copying their software and giving it to their friends. ‘Smaller companies like ours just don’t have the time or resources to protect against theft,’ she told us.  ‘Eventually we’ll go to work as consultants for the larger companies.’  And several years later, that’s what they did.”

The waitress brought the check.  Normally they would split it four ways but Stan picked it up and handed it to George.  “Shouldn’t the optimist pay?”  George laughed.  “This one time,” he said, “but on one condition.  You all have to agree with me.  Isn’t that how they do it in politics?”  They all laughed, grunting as they straightened up after sitting so long.

The Flame of Fame

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On Monday, George finished a re-read of Nassim Taleb’s Fooled By Randomness, an examination of probability without the mathematics. Taleb wrote from the point of view of a market trader but the book contained apt lessons for many kinds of decision making.  Mabel went out with a few friends to see the movie Birdman.  She asked George if he wanted to go but he was happy to sit around and read.

Taleb told the story of a emerging market bond trader in the 1990s who made a quarter billion dollars for his firm by “buying on the dips.”  When the price of the bonds declined, the trader took a highly leveraged long position, betting that the price of the bonds would rally.  Each time they did.  The man became convinced that he knew this market well.  He believed in his own astute judgment.  Then came a dip with no subsequent rally.  Instead, prices continued to fall.  The trader had no stop loss set, a floor price where a trader closes his position to prevent further losses.  Instead the trader convinced his bosses at the firm that prices would soon rally.  He increased his position as prices fell further.  Eventually, prices fell so low that the firm, near bankruptcy, fired the trader and closed the position, losing almost 600 million.  George thought about that.  There had been one correction in April and May of 2012, a near correction in October and November of that same year.  Smaller dips had occurred in June and August of 2013, then in January, April and August of this year.  Finally, this month a 7% or so dip.  Like the bond trader in the 1990s, the winning strategy of the past few years had been to buy on these dips.  The subsequent rise in prices helped convince buyers that their particular view of the market, whether fundamental or technical, was a sound one.  Note to self, George thought, don’t confuse good luck with genius.

Earnings and sales reports would drive the market for a few days until Wednesday when the Fed was expected to end its bond buying program.  On Thursday, the first estimate of 3rd quarter GDP would be released.  After the close Monday, Amgen reported earnings that were 12% better than expected.  That would help set a positive mood for Tuesday’s open.

Tuesday’s gauge of consumer confidence from the Conference Board was almost 95, the highest since 2007.  Lower gasoline prices have put extra money in consumer pockets.  A 25% decrease in the price of gas ($4 – $3) puts about $800 in a consumer’s pocket, a “raise” of almost $20 a week.  The declining price of oil caused Chevron to revise its earnings guidance downward by 15-20% for 2014 and 2015 but that was not as bad as anticipated and the shares rose.

The Case Shiller index of home prices in 20 metropolitan areas showed a 5.6% year over year gain, the lowest yearly gain in two years.  After almost a decade, the housing market seemed to be returning to more normal patterns of price appreciation.

On the whole, this earnings season seemed positive but the cautionary tone of Taleb’s book reminded George to stay watchful.  On Sunday, the European Banking Authority had released the results of their 2014 stress tests on more than 120 European banks. Approximately 20% had failed the test, most of them in Italy, Greece, Cyprus and Spain. When a football game ends, fans leave their seats and move toward the exits in a loosely organized fashion.  When a larger bank or sovereign country seems to be in danger of failing or defaulting, investors rush toward the exits as though someone called “Fire!”  Still, George was feeling – well, vindicated – that he had seemed to catch this latest dip near the bottom.
 
The mild weather of late October continued.  In shorts and tee shirt, George raked leaves in the backyard on Wednesday morning.  Taking a break, he poured himself another cup of coffee, then glanced out the window overlooking the front yard.  “Oh, wow,” he muttered.  He went to the front door, commenting to Mabel as he opened it, “Must be a bad accident down the street.  There’s a Channel 3 van parked across the street.  I’m gonna check it out.”  If Mabel had a stopwatch, she would have clocked 14 seconds before George was rushing back inside, hurriedly closing the front door. “Geez,” he exclaimed.  “What’s wrong?” Mabel asked.  “Some woman from the TV station, she starts running across the street toward the house when she saw me!  She called my name, for Chrissake!”

George walked into the kitchen, then took up a position on the side of the fridge where he could look out the window onto the street without being seen.  “There’s some guy with a video camera with her!” He said, managing to fit anger, annoyance and exasperation into the tone of his voice.  Mabel got up from her chair, stood by the living room window, partly concealed by the drapes as she looked out at the street.  “What do you think they want, George?  Should we go out and talk to them?”  “No, that’s the problem.  I think that’s exactly what they want – to talk to us.  Weird!”  Mabel noticed that the rooftop mounted dish on the TV van had been raised up.  “I think they’re broadcasting, honey,” she told George in a loud whisper.  The woman outside stood on the sidewalk, her back to the house, gesturing, turning to the house, then turning back to the camera man who wielded a shoulder mounted video camera pointed at the woman and George and Mabel’s house.  “They wouldn’t come into our front yard, would they?” George wondered aloud. “Isn’t there some kinda law against that?”

Mabel switched channels from the weather to Channel 3. “Oh, no!  This is a live feed.” She turned up the volume.  The woman reporter standing out on their sidewalk was looking at Mabel from the TV screen. There seemed to be several seconds of delay so that George and Mabel could see the woman reporter gesturing on the front sidewalk, then seeing that same gesture shortly on the TV as though time had fractured.

Reliable source, the reporter said.   In advance of the mid-terms, President visited Liscombs, who have not demonstrated active role in politics for either party.  Speculation about election strategy in the hotly contested Senate and Governor’s races.  A man presumed to be Mr. Liscomb ran back into the house to avoid answering questions.  Supposedly independent political organizations spending a lot of money in Colorado.  Are the Liscombs bundlers for one of these organizations?  Just how independent are these organizations?  Why did the President visit this house, this couple?  Were campaign rules broken?

George had joined Mabel, standing beside her, staring dumbstruck at the TV.  “Are they saying we’re like some kind of political action group like the ones the Koch Brothers fund?” George asked Mabel.  “Oh, they’re not saying anything,” Mabel said with a touch of anger.  “They’re suggesting, provoking…” she stopped as the report concluded.  “Now here comes the tease before the commercial,” she said.  “More on the upcoming elections here in Colorado when we come back,” announced the lunchtime news host.  “You watch too much TV,” George kidded her.  “You’ve gotten hip to their tricks.”

Both of them turned to look outside the living room window.  The reporter now stood with the video tech near the rear of the van.  “I think they’re leaving,” George said.  “No, wait,” Mabel told him.  “The dish on the van is still elevated for upload.  Wait till they lower it.  Then we’ll know they’re leaving.”  “Where did you learn all this stuff?” George asked her.  “Remember when we had that knife fight at the school five years ago?” Mabel asked.  George nodded.  “Two kids went to the hospital.  The local stations covered it, of course.  Got to see the vans.  It’s amazing how much equipment they cram in a regular van.  There’s probably a third person in the van working all the computers and equipment.”

Eventually, the van pulled away from the curb.  George realized that he’d missed the announcement from the Fed on their bond buying program, switched channels to confirm that they had ended the program. Although the Fed had stopped adding to its balance sheet, it continued to hold a whopping $4.5 trillion in assets, the total of the past several years of printing money to support the economy as the country struggled to recover from the Great Recession.

The market closed at the about the same level as Tuesday.  Dreamworks, the studio that produced the How to Train Your Dragon movies,  reported better than expected earnings after the close, sending the stock up 5% in after hours trading.  Kraft also reported earnings slightly higher but the overall sales picture was tepid.  Samsung reported a huge 60% decline in profit, squeezed on the high end by Apple and under pressure from mid and low end competitors.  The giant insurer MetLife had a blow out quarter.  Visa reported better than expected earnings, sending the stock over 4% higher in after market trading.

If Thursday’s first estimate of 3rd quarter GDP growth had come in at 2.5%, below the consensus of 3%, the market could have dropped 2% or more, George thought.  Instead, the estimate was 3.5%.  The market opened up lower then climbed about 1% during the day.

In each earnings season, there are several stories.  One was Gilead Sciences, a small cap biotech firm, whose “killer app”  was a new hepatitis drug called Sovaldi. Gilead reported earnings of $1.79 for the past quarter.  This was about 10% above earlier guidance but in the crazy world of Wall St., investors had been expecting $1.92, a “whisper” earnings number based on anticipated higher sales of Sovaldi.  Instead, sales of the drug were 20% less than the previous quarter.  The stock dropped about 5% on Wednesday, before climbing to new highs on Thursday.  The stock had more than quadrupled since the beginning of 2012.

On Friday the market jumped 1% at the open.  Overnight, the Bank of Japan had announced a massive stimulus program to combat risks of deflation, the bugaboo of all modern economies.  If prices might be slightly lower next year, why buy this year?  As consumers postpone some purchases, the decline in sales leads to further price declines as companies compete more fiercely to get those fewer sales.  Japan’s core CPI, excluding food and energy prices, had risen above 1% in response to earlier stimulus programs but had now fallen in the past several months back toward 1%.

On the domestic front, personal income gains in September were positive, averaging about 2.4% annually and above inflation. Wages and salaries jumped .4%, double the overall income growth. Consumer spending remained tepid, declining to a 1.4% annual pace of growth.  Amazon had warned earlier that they expected the Christmas season to be subdued this year.  Some speculated that the low rate of inflation and consumer spending would further check any rise in interest rates before the middle of 2015 at the earliest.

The market closed just slightly above the level it had reached six weeks earlier.  George had to remind himself that it was just luck.  But he sure felt smart.  Then he noticed a disturbing sign, the dragonfly doji after a gap up, on the chart of SPY, the ETF that tracks the SP500 index. The doji are one of many candelestick patterns, a type of technical analysis that tries to understand the psychology of buyers and sellers in the market from price movements over one to three days. After a number of up days, such a pattern might signal that buying pressure has become exhausted. After reading Taleb’s book, George reminded himself once again to be skeptical of signals. The last dragonfly doji after a 1% gap up that George could find in the past few years occurred on April 28, 2012.  The market had turned down after that one, losing more than 10% over the following five weeks.  Of course, George could have missed some doji simply because the market had not turned after the occurrence of one.  As Taleb noted, our view of historical data suffers from hindsight bias, from knowing what happened after a particular event.  We can not see the future very well but it’s worse than that. We don’t see the past very well either.  George had laughed when he read that.

Next week was the first week of the month when several economic reports would capture the attention of investors.   The monthly labor report at the end of the week would get the most attention.  The ISM indexes of the manufacturing and service sectors would be closely watched for any signs of a slowdown.  The sluggish growth in Europe and the strong dollar would have a negative impact on exports, which would show up in the manufacturing index.  The CWPI, a composite of both of the ISM indexes, had probably peaked the previous month, and should be lower this month as a natural part of the cyclic pattern of the past several years.  Investors could react negatively though to this cyclic decline.  The VIX, the volatility indicator, had dropped into a more calm zone and below its 10 day average.

But investors had not abandoned the safety of long-term Treasuries.

If Republicans took control of the Senate in Tuesday’s election, the market would probably get a boost, George figured.  The results might not be known for days or weeks if there were recounts in some key senatorial races and that might drag the market down a bit in advance of the upcoming labor report.  Would the market go up or down?  George could definitely say yes!  He looked out the window Saturday afternoon and could tell the direction of one thing for sure – leaves.  They were calling to him, or was it his wife with a helpful reminder?