Interest Rate Ceiling

June 23, 2019

by Steve Stofka

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

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

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

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

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

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

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

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

Economic Cracks

February 17, 2019

by Steve Stofka

As the recovery enters its tenth year, there are signs of strain. As debtors struggle to pay their loans in a weakening economy, the percentage of non-performing loans increases.  The current rate of one percent indicates a healthy economy (Note #1). When the annual change in the rate of delinquency increases, that has been a reliable indicator that the economy is growing stagnant. Here’s a chart of the percent change in non-performing loans. A change above zero has preceded the last three recessions.

Non-PerfLoansChange

Let’s add one more series to the graph to help us understand the cycle of consumer credit. In the graph below, the red series is the percentage of banks tightening lending standards. Notice how the banks respond to a rise in delinquencies by being more selective in their credit criteria. Eventually, this tightening of credit leads to a recession. The cycle is as natural as the ocean currents that distribute heat around the planet.

NonPerfBankTighten

The financial news agency Bloomberg reports that delinquent auto loans are the highest since 2012 (Note #2). Bankrate reports that credit card debt has risen since last year. Less than half of people surveyed have emergency funds (Note #3).

December’s retail sales report, released only this week because of the government shutdown, showed a surprising decline of 1% from November. Have some consumers reached their limit? Retail sales, adjusted for inflation and population growth, does not show the strain so far. Look at the period from late 2015 through late 2016 when sales growth consistently slowed below 1%. That was a key factor that cost Hillary Clinton the election. Trump turned voter dissatisfaction into an electoral victory in the Midwest.

RetailRealAdjPop

Politicians ride to power on the anger of voters. In 1994, Republicans overcame forty years of Democratic rule in the House by promising less regulation and lower taxes in a “Contract with America.” When the Supreme Court decided the 2000 election in favor of a Republican president, they enacted tax cuts to reverse the tax increases passed by Democrats in 1993. In 2006, voters were angry with the incompetent Bush administration and reinstalled Democrats in the House.

In the depths of the Financial Crisis in 2008, Democrats rode a wave of anger, despair and hope to take the White House and command a filibuster proof majority in the Senate for the first time since the post-Watergate Congress thirty years earlier. Such a rare majority indicated that voters strongly wanted a solution to the crisis (Note #3). The Obama administration and Democratic Congress protected the financial and insurance industries while ordinary people lost their homes and their savings. The one piece of legislation that emerged from that majority was Obamacare, the bastard child of back alley compromises between mainstream Democrats and the health care industry. Few who voted for it knew what was in the bill.

In 2010, Republicans rode the anger wave of the Tea Party caucus to retake the House. With an equal number of Senate seats up for re-election, Republicans took six seats from Democrats and ended their filibuster proof majority (Note #4). In 2014, voters handed the Senate back to Republicans, then gave the reins entirely to the Republicans with the election of Donald Trump to the presidency in 2016.

In 2018, Democrats rode a wave of anger to take back control of the House. Social media campaigns whip up indignation to fan the flames of voter anger in the hopes that Democrats can at least take back the presidency in 2020. Voters may not be in enough economic distress to give Democrats control of the Senate in 2020, but it is the Republicans who have the most seats up for re-election this coming Senate cycle (Note #4).

Credit expands and contracts in a seasonal multi-year cycle. Banks are tightening in response to higher delinquencies. Will the timing of the credit cycle coincide with the 2020 election?

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Notes:
1. In 2016, China, Japan and Germany had rates below 2%; the U.K. and Canada had less than 1%. On the high side, Greece had 36%; Italy had 17%, and Spain had 7%.
2. Why are so many people delinquent on auto loans? Bloomberg
3. In 1964, the Supreme Court forced the states to redistrict their state legislatures based on population changes. For fifty years, Democrats were sometimes able to forge filibuster proof Senate majorities because racist Southern states were effectively one party Democratic states. Reynolds v. Sims . Since the ratification of the 17th Amendment in 1914, Republicans have never had a filibuster proof majority
4. A third of Senators are up for election every two years so party advantage shifts with every election cycle.

Long-Term Trends

January 7th, 2018

by Steve Stofka

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

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

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

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

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

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

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

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

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

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Employment

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

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

ConVsPayemsGrowth

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

NotInLabForceVsPayems

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

WeeklyEarnVsInflation

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

WeeklyEarnStressPoints

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

River Rafting

July 15, 2017

After a good year of snowfall in the Rockies, the rivers run strong. A popular spot for rafting is the Colorado River as it runs through the dramatic scenery of the Glenwood Canyon in western Colorado. Investing is a lot like rafting. We can’t control the amount of snowfall, the change in elevation, where the rocks are or the streams that feed into the river.

Our individual and group behavior on the river can help or hinder our progress. In a good year, rafting companies charge more for a rafting adventure. As more people come onto the river, we must pause in quiet water at the river’s side to give a safe distance between rafts. This crowding effect is made worse by stretches of river that require more caution to navigate. We can steer right or left to avoid some rocks but we are largely at the mercy of the river and each other.

Since the budget crisis in the late summer of 2011, the stock market has enjoyed a fairly strong run, more than doubling since that time. The financial crisis nine years ago was like a winter of extraordinarily deep snowfall. The Fed has kept interest rates abnormally low to thaw that snow, and equity investors have had a wonderful ride.

The Federal Reserve has committed to a series of gradual rate increases. Despite the low rates, people continue to pour their extra money into savings accounts and CDs. Wells Fargo is paying almost 1% below the Fed discount rate on their savings accounts. Why? As long as their customers are willing to accept savings rates of .3%, Wells Fargo has no incentive to raise rates. Discover, Goldman Sachs, American Express, Ally and Synchrony are paying about 1.15%, the Fed rate. (Bankrate) Savings account balances are near $9 trillion, more than double the balances in late 2007 before the recession began. The fear lingers.  Many people stand on the shore, too cautious to ride the river’s tumble and flow.

Until 2015, retail sector stocks (XRT) have been on a fast raft, quintupling from the market lows of March 2009. Over the past two years they have drifted into a side pool, losing about 20%. This year the stocks have been quite volatile as investors gamble on the future of the retail industry. Will Amazon continue to take sales from traditional brick and mortar stores?

June’s retail sales (RSXFS) were disappointing. Year over year growth was 3%, less than the 5 year average of 3.3%, and far below the near 5% growth of the 1st quarter. Excluding auto sales and auto parts (RSFSXMV), annual growth was only 2.4%, a 1/2% below the five year average and half of the 1st quarter rate.

The Trump administration and the Republican Congress have aimed for 3% real – inflation adjusted, that is – GDP growth. In an economy that depends so heavily on consumer sentiment, slowing retail sales will make that growth goal difficult to achieve.

For now, the sun is shining, the river is running strong and I am enjoying myself.  As long as I don’t look around the next bend in the river, everything looks fine!

 

Sales Tax Collections

January 8, 2017

The New Year begins, the 9th year of this blog that began during the financial crisis.  For two decades I had studied financial markets but the financial crisis surprised most people.  This was my attempt to organize and share my thoughts.

Sales Tax Collections

Let’s look at a data point that has been a consistent indicator of economic health – sales tax collections. This is not survey data or economic estimates but actual tax collections based on consumer purchases. For the first 3 quarters of 2016, sales tax collections are up 1.6% above the same period in 2015. (Census Bureau)    As we will see, this tepid growth rate does not compare well with the historical data of the past 25 years.  Below is a quarterly graph of sales tax collected in the 50 states.

As we can see in the graph above, the 2nd quarter (orange bar) is the highest each year, and is a good indicator of consumer activity and confidence. Since population growth is about 1%, the annual growth of sales tax collected should be above that mark to be effectively positive.

In the graph below, we can see negligible or negative growth in 2001, 2008 and 2016. In 2001 and 2008, we were already in recession, although it took the recession marking committee at the NBER almost a year to declare the beginning of those recessions.  By selecting the 2nd quarter growth rate in the historical data, we can more easily see the weakness at the start of an economic downturn.

In retrospect, 25 years of data is rather sparse.  We can only hope that this year’s lack of sales tax growth may turn out to be a warning sign only, a fluke.  Third quarter tax collections were effectively positive, but only 2% growth, and that annual growth has consistently declined in the past three years in a pattern exactly like the weakening of 2006 – 2008.

Of particular note in the graph above is the steep 10% drop in sales tax collections in the second quarter of 2009. Fom a vantage point eight years in the future, we may have forgotten the degree of fear during the winter of 2008-2009.  The American people were holding onto their money.  State budgets were crippled by the lack of sales tax collections, an important and ongoing source of revenue for state and local governments.

See end for a side note.

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Population Growth

Business Insider published a chart of 2015-2016 population data from the Census Bureau.  We can see a clear shift from the northern states to the mountain and southern states.  Retiring boomers, who want to maximize their fixed incomes, will shift from states with high state income and property taxes like New Jersey and New York, and move to states with lower taxes.

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Tax Reform

In a few weeks Republicans will control the legislative machinery, and have promised  tax reform that, after thirty years, is overdue.  One of the proposals on the bargaining table is the end of the home interest deduction, which prompted this blog post at Slate.  The author contends that the elimination of this deduction will hurt middle class homeowners, who will see the value of their homes decline by 7%.

I’ll add in some contextual data from the IRS.  In 2011, 22% of the 145 million (M) returns claimed mortgage interest totalling $321 billion. ( IRS tax stats Table 3) People making a middle class income of less than $100K claimed half of that interest – 14% of all returns.  The average interest deduction for these middle class households was $8100.

Two million returns with incomes of $500K and above claimed $46B in mortgage interest, about 15% of the total interest claimed.  For these high earners, the average deduction was $20,000.

The tax reform of 1986 eliminated the interest deduction on credit cards and cars, but lawmakers could not go the final distance and squelch the home mortgage interest deduction.  At the time, auto dealerships complained that, without the interest deduction on new car loans, their business would suffer.  Tax subsidies affect both consumers and the businesses who are indirect recipients of the subsidy. Should 78% of taxpayers subsidize the housing costs for 22% of taxpayers?   Certainly, the 22% appreciate the subsidy! The real estate industry continues to resist any tax changes that might have a negative impact on their business.  Each industry deserves a subsidy of some kind because that industry is important to the overall economy – or so the argument goes.

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The End of Capitalism – Almost

Let’s get in the wayback machine and dial in 1997.  The dot-com boom is not yet a bubble but is growing.  Cell phones are growing in acceptance but the majority of people do not have one.  A one year CD is paying more than 5%.  The unemployment rate is about the same level as today (2016).  What is very different between then and now is the number of publicly traded companies.  In 1997, there were over 9000 listed companies.  Today, there are about 6000 companies.  The 2002 Sarbanes-Oxley (SB) law has such stringent and plentiful financial reporting regulations that many companies decide not to go public, or to sell themselves to a larger company that already has the internal infrastructure in place to comply with SB regulations.  Both parties want to repeal or amend the law but cannot agree on the details.  Readers can click for more info.

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Next week I will compare the 10 year performance and risks of various portfolios.  There are some surprises there.

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Side note on Sales Tax.  The Federal Reserve charts retail sales but these are based on data samples and will not be as accurate as the actual tax collected.  When retail sales are adjusted for inflation, the year over year growth can give a number of false positives.  In the graph below, I have marked up periods that went negative without the economy going into recession.  I think that the actual tax collected may be a much more accurate predictor of economic weakness.

Electoral College

November 20, 2016

Did you know that the U.S. has the highest Presidential voting record in the world?  100%.  No other country comes close.  How do we achieve this extraordinary participation rate?  The Electoral College (EC).

What the heck is the Electoral College and why doesn’t any other democracy use this system?  Firstly, the U.S. is not strictly a Democracy, in which people vote directly for their leader.  It is a democratic (small ‘d’) republic.  Within this republic, the states are semi-autonomous regions in a Federal alliance.  It is the states, not the people, who elect the President.

Each Prez election is a survey conducted by the state asking its citizens: who do you want the state to vote for in the Presidential race?  The survey is voluntary.  Each state has its own rules for participation in the survey.  Federal election law specifies a set of common rules that each state has to follow in conducting their survey.

Each state gets a certain number of Electoral College votes based on population.  The survey in each state simply tells the state what the wishes of the people are for President. There is no requirement in the Constitution that a state must follow the survey results, but each state has, over time, passed state laws that promise to abide by the will of the people in that state.

In 2000 and again in 2016, the Democratic candidate won the popular vote of all the states but lost the state by state vote in the Electoral College.  Some people in dense urban areas who vote Democratic would like to abolish the Electoral College.  If there were no college, Presidential  candidates could concentrate their campaign resources and promises to win the vote in the urban areas and largely leave the less populous areas of the country alone.

In the current system, a candidate must mount a campaign that involves and employs people in each state, a difficult if not impossible task.  The appeal and focus of the campaign must be broader than just urban or rural areas.  Resources and time are limited so a candidate must make critical choices regarding the deployment of those limited tools.

A candidate must surround him or herself with smart people who can:

1) organize and  deploy human and media resources within each state,
2)  organize the outreach for financial support,
3)  search for and identify undercurrents of sentiment and concern in each state,
4)  compact a message that will resonate with those sentiments and concerns,
5)  sample and analyze the ongoing responses to a candidate’s message.

There is an algorithmic strategy used in many fields called “win-stay, lose-shift.” The problem is commonly called the multi-handled bandit.  In a casino with many one-armed bandits what is the best strategy to maximize profits and minimize losses?  Mathematically, the problem may be insoluble but a reliable quasi-solution exists that is better than chance.  Stay with a particular bandit as long as it wins, then shift when it loses and start again.

Donald is a casino owner so he may be familiar with the strategy and used it quite successfully to conduct an unusual campaign.  A campaign has a number of characteristics – a saying or slogan (“Si se puede” or “Build the wall”), a policy (foreign trade or national security), an issue (abortion or honesty), or an attitude (impassioned, combative, or calm and reassuring).  A candidate feeds people’s sentiments into each of these characteristics like one would feed coins into a slot machine.  Now pull the handle.  If that theme pays off the majority of the time, then stick with it.  If it doesn’t, then shift.

Now here’s the brilliant part that Donald played whether he was conscious of it or not.  Every political bandit that was a loser for Donald Trump was not only abandoned but moved over to Hillary’s casino.  In many cases, she couldn’t win at them either.

Honesty?  Donald had a problem.  Load up the honesty bandit and move it over to Hillary’s casino. Let her feed people’s sentiments into that bandit and see if it pays off.  The woman issue?  Another non-paying bandit for Donald.  Again, move it over to Hillary’s side and let her see if she can win with the machine.  In both cases, she pulled the handles over and over again with only modest success.

Each Presidential campaign seems to bring some new innovation.  Successes are often incorporated into later campaigns.  Obama’s campaign was noted for its ability to raise money online with many small donations.  The campaign carefully tested the appearance of different web pages, measuring even the appearance of one click button over another.  Obama outraised his opponents in the 2008 and 2012 campaigns.   In the 2016 race, Hillary Clinton and her superPACS outraised Donald Trump almost 2:1, yet he won. (Bloomberg)

We should all wish that a President has a successful term.  Unsuccessful terms are usually accompanied by economic and military events that are not good for ourselves, our families, and our communities.  Whether Donald Trump has a successful term or not, he has certainly made a long lasting impact on future campaigns for President.  Who can be out with the first book?  Already CNN is advertising a comprehensive look at the election. As we put a bit more distance in the hindsight mirror, expect a number of books on the election.  Masters’ theses and doctoral dissertations will explore the many aspects of the campaign.

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Election Autopsy 

After each Presidential election, those in the campaign business do an autopsy of both the losing and winning campaigns.  What worked?  What didn’t?  Dems need to ask themselves if they neglected the needs of everyday working Americans. In 2008, Obama promised that the needs, values and perspective of his grandparents, who raised him, would guide his decisions. Then he and his party started bailing out the banks, car companies and solar industry as many ordinary people struggled and suffered with job loss, home loss and bankruptcy. With majorities in both Houses, he fiddled with decades old Democratic dreams like healthcare and climate change while working class Americans felt discarded.

Some attribute the heavy Demcratic losses in 2010 to Obamacare but that was only a symbol for the larger betrayal that many Obama voters felt. Having control of both the Presidency and Congress is a mandate that a party can abuse.  It is given to that party to get something done fairly quickly.  When a political party uses it for pet projects, people turn away or vote the other way.  Many turned away in the 2010 election.  Six years later, Republicans control the majority of state legistatures, the governerships, the House and Senate.

As Majority House Leader, Nancy Pelosi certainly had a hand in the growing disaffection with the Party yet she insists that she should continue in her role as Minority Leader.  Her strength as a formidable fund-raiser may prove to be the winning card that trumps her past errors.

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Vaccines

A familiar meme on social media is that there is a vaccine conspiracy between pharmaceutical companies and the government who force parents to vaccinate their children and pad the pockets of Big Pharma.  The U.S. has a policy of giving infants and children more vaccines than any other developed country.  Do pharmaceutical companies make millions off vaccines? You be the judge.

The PVC13 vaccine given to older people costs the provider $16 per dose (CDC Price List). In March 2016, the discounted price from Kaiser was $313 for the vaccine alone. The labor to give the vaccine was a separate line item. That is a 2000% markup on the vaccine itself by Kaiser, not the manufacturer.

It is the providers who administer the vaccines who make the money.  Investors who own the stocks of a pharmaceutical company often pressure the company to get out of the vaccine business because most vaccines are low margin products and yet carry partial liability.

If the pharma companies don’t want to bother making many vaccines, should the government simply build their own vaccine manufacturing labs?  Patents and other intellectual property could be a hurdle but Congress could arrange to purchase them or use eminent domain to set a price and seize the intellectual property.

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Retail Sales

Average = Strong.  When growth is rather anemic, a return to average seems strong.  In October, retail sales rose 4.3% above October sales in 2015, a welcome bump up from the lackluster growth of the past two years.  Last month I showed that recent sales growth less population and inflation growth has been negative or close to 0.

The stock and bond markets have been shifting money around in anticipation of fiscal stimulus and more relaxed regulation from a Republican Party in control of the levers of government.  Small business stocks (VBR) are up more than 10% and financial companies (XLF, VFH) have shot up about 12%.  Consumer discretionary stocks (XLY, VCR) are up about 4% while the more defensive consumer staples stocks (XLP, VDC) are down 2%. Oil stocks (XLE, VDE) are up about 3%.

Will consumers put aside their cautions and spend more?  Active stock managers are certainly hoping so.

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Ideas for IRA contributions

Emerging market stocks are still up 8% YTD after falling more than 6% in November.  Much of that decline has come on the heels of Trump’s election win.

A broad bond index has fallen almost 4% in the past few months.

All Aboard!

July 17, 2016

I have changed the blogger template to make it easier to read on a mobile phone. On my Android phone, the dynamic template defaulted to classic view without all the widgets on the side and was easier to read. The graphs are easier to see in landscape mode, when the long part of the phone is horizontal to the ground. Perhaps some readers can give me some feedback if there are problems viewing on an Apple phone.  Now on to this week’s business!

As I noted last week, things can get a bit ugly when both stocks and Treasuries surge upward at the same time, as they have in the past few weeks following the sharp downward response to the Brexit vote in the U.K.  The buying of stocks signals that investors have more of an appetite for risk.  The buying of Treasuries and gold signal a desire for safety.  At the beginning of the week the world woke up to the news that the Japanese central bank was going to provide a lot of stimulus to goose economic growth.  This gave a boost to Asian stocks and the rally in equities was on.  By the end of the week, the Japanese stock market had risen 8% during the week and it’s currency, the yen, had fallen the most since 1999.

Economist Paul Krugman has called on Japanese policy makers to set higher inflation targets and provide even more stimulus to spur an economy now lethargic for two decades.  According to Krugman’s own textbook, the roles of an economist are 1) to describe the economic and market mechanisms; and 2) form predictions of how the economy and market would react if certain policy actions were adopted.

However, Krugman has a lot of visibility as an op-ed writer in the NY Times.  In this role, he often offers prescriptive solutions, and this week’s call is yet another prescription from Dr. Krugman.  Japan has been basing their policies on Krugman’s predictions for a decade with mixed or muted results. More stimulus seems to be the eternal cry from Krugman, a smart man who seems to have but one or two solutions for the majority of social and economic problems.

Most economists are rather circumspect, arguing among themselves the mechanisms and validation of varied predictions.  But there are a few stand outs who reach out to the general public, ready and willing to engage in the political debate.  The subfield of economics called macroeconomics forms a beautiful mud pit for the struggle of political policies, for politicians often cite macroeconomic rationale when championing a set of policies.  For thirty years, Nobel winner Milton Friedman espoused a more conservative and monetary model of the economy, emphasizing montetary, not fiscal, policy by the central bank as the chief intervention in the market economy.  Search YouTube and you will find many of his talks and lectures and they are both informative and entertaining.

Krugman is one of the more vocal macroeconomists who diagnose economic maladies, build a predictive model based on policy or monetary fixes, then diagnose their model when their predictions are in error.  The patient didn’t take enough of the medicine or there is some response lag or the full extent of the problem was not known or was disguised by something or other.  The descriptive aspect of macroeconomics doesn’t seem to help develop a predictive model.  Perhaps the study of economic phenomenon on a national and international scale is just too difficult to have much predictive ability. Let’s hope not.  For the past decade, so many really smart people have been wrong.

Once again this week, central bankers signalled that they were ready to adopt what are called accommodative policies to reassure markets.  If stock markets were an athlete with a knee injury, central bankers would be the good doctor who drains the knee then injects a bit of pain medication and cortisone into the joint before sending the athlete back onto the field.

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Retail Sales

Wildlife scientists may study herds of grazing animals to gain insight into both the seasonal behaviors of the herd and its response to conditions that alter the animals’ environment.  These include drought, war, or the burning of forests for farmland.  Economists follow a different kind of herd – people.

Macroeconomists focus on the behavior of the entire herd; microeconomists analyze the behavior of individuals acting within the herd.   Two telltale signs of human behavior are paycheck stubs and sales receipts, which act in tandem like entangled particles in a quantum dance.  In this consumerist economy, retail sales are fueled by the earnings of 140 million workers; the monthly reports on each activity guide the analysis of economists.

Each month a sample of paycheck stubs is gathered and reported by the Bureau of Labor Statistics.  The Census Bureau produces an estimate of retail sales based on a survey of almost 5000 companies.  (For those interested in the methodology.) Year-over-year growth in real, or inflation adjusted, sales fell below 1% in March this year and spurred some concern that consumption power was being eroded by slow income growth. Following the extraordinary labor report a week ago, the monthly retail sales report, released this past Friday, was stronger than the consensus.  Inflation adjusted sales rose 1.67% over last year, rising up a 1/2% from May’s year-over-year reading.  2% real growth would be ideal but anything over 1.5% is a sign of a growing economy. Why the 1.52% threshold?  1% of each year’s growth can be discounted as simply population growth.
 
On a sobering note, the year-over-year growth in retail sales is gradually declining as we can see in the graph below.

What negative signs should an ordinary investor watch for?  Where is the herd going?  Investors should get cautious when year-over-year growth in real retail sales consistently falls below 1.5%.  After December 2006, growth remained below this threshold and did not cross back above it till March 2010 – a period of 3-1/4 years that darkened the lives and hopes of many Americans.  During that period January 2007 through March 2010, the SP500 index fell from about 1440 to 1170, a decline of 19%.  We are part of the herd but with some observant caution we may be able to move some of our savings to the fringes of the herd movement and avoid getting trampled.

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MyRA

Earlier this year the U.S. Treasury introduced a Roth IRA tool called myRA for employees who work at a company that does not offer a retirement savings account.  This is a fully guaranteed account similar to a savings account that grows tax free.  The maximum one can save in this kind of account is $15,000 and part of the contribution amount is entitled to a tax credit.  This can be a good way to get started with retirement savings.  The Federal Reserve has an article on the subject here.

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Amtrak Train Trance

On vacation in California recently, I rode Amtrak’s Pacific Surfliner several times on day trips from Los Angeles.  Unlike the east-west Amtrak routes, these north south routes along the coast are more frequent, running several times a day sometimes only two hours apart. Part of the route is along the beach, part along a highway, and part travels the urban backcountry – the backyards of businesses, farms and homes that most of us do not see from a car.  The experience was a sightseeing delight, a meditative trance of motion.

Most of Amtrak’s lines do not make money and rely on government subsidies.  Like so much of our transportation infrastructure in this country, railroad infrastructure needs upgrade and repair.  Opponents of government subsidies often don’t realize how much of what they personally use is subsidized.  Here is a link to a Business Insider article on Amtrak’s operations and the political debate over federal subsidies for Amtrak.  The debate crosses party lines because rural politicians of both parties tend to support subsidies for Amtrak when the rail service crosses through their geographic region.

Air travel, the most frequent mode of long distance transporation, is heavily subsidized by the federal government.  Here is a USA Today article on that subject and the $2 billion in subsidy for one airport alone, LaGuardia airport in New York City.  Likewise are the massive amount of indirect subsidies for automobile transporation, which rely on roads maintained by federal, state and local tax dollars.  These repairs are only partially paid for with dedicated gasoline tax dollars; state and local taxes must make up the difference.  Let us also include the multi-billion dollar bailouts of the industry that arise every few decades because of poor planning by industry executives in response to market demand or foreign competition.

Amtrak subsidies look miniscule in comparison. The railroad suffers from a chicken and egg problem of investment and revenue.  Which comes first?  Without more investment the railroad can only offer once a day service on east-west routes, which does not attract strong ridership.  Without a show of rider demand, there is little incentive to provide investment. The California Zephyr leaves a major city like Denver enroute to the west coast at 8 A.M. only once a day.

Boarding times in a particular region may be inconvenient.  Barstow, CA is a city of 23,000 north of Los Angeles that is serviced by the southern east-west Amtrak route called the Southwest Chief.  Like the Zephyr, this train starts in Chicago but heads southwest through Kansas, Colorado and New Mexico before heading west through northern Arizona to the west coast.  The Barstow railroad station, if it can be called that, consists of a bench and a slight overhang typical of urban bus stops.  There is no bathroom or other facilities.  The 4-1/2 hour trip to Union Station in Los Angeles arrives and departs once a day in Barstow at 3:40 AM, a unwelcoming time for a train jaunt into the big city.  The large city of San Bernadino, CA has a slightly more hospitable departure time of 5:30 AM.

In the early 19th century, before the refinement of petroleum deposits into gasoline, railroads were developed and built in Britain, then spread to Europe.  Early investment in rail transportation both for goods and people embedded the concept and the technology in European politics, its economies and cultures.

Many decades ago, this country chose to subsidize the movement of people by car, reserving the rails for the transportation of goods.  The land was big, and population centers west of the Mississippi were distant.  Steam locomotives run on wood,  a precious commodity west of the 100th meridian (central Nebraska), where there was not enough rainfall for trees to grow on the vast plains.  Oil deposits were plentiful in several regions within the country and gasoline is portable and a rich source of energy, packing a lot of BTUs per volume.

We love our cars, the hum of tires on blacktop as we run down the highway. But a train has another quality that is difficult to get in a car – a reduced sense of movement, a trance like floating through space while staring out the picture window of a rail car at a movie in motion.  If you have a few days and you are not in a rush, take a seat and let the landscape unroll before you.

Avoidable Taxes

April 19, 2015

Taxes

Some call them loopholes, tax breaks, or giveaways but the official name for them are tax expenditures.  In August of last year, the Joint (House and Senate) Committee on Taxation detailed  the many gimmes in the tax code.  The Pew Research Center graphed out the largest expenditures including the big banana, tax free employer paid health insurance premiums. (They forgot to include the $38 billion in Sec. 125 cafeteria plans.) That program started during World War 2 when wage increases were frozen by law.  That war ended 70 years ago but the “temporary” tax break goes on and on.

The list of giveaways runs for 12 pages. Those with incomes above $100,000 get 80% of the mortgage interest deduction (page 37), 90% of real estate tax write-offs (page 38),  60% of the child care credits (page 39), and claim 86% of the charitable contributions (page 38).  Reduced rates on dividends and capital gains cost almost $100 billion in 2014.

28 million low income families qualify for the earned income tax credit but the $68 billion cost for that is less than half the cost of tax free health insurance premiums.  Almost 37 million families claim a child tax credit for $57 billion dollars (page 41).

Seniors get $60 billion of gimmes in tax free Medicare benefits (page 32).  In 2015, tax breaks for all types of medical spending will total almost 1/4 trillion dollars in foregone tax revenue.   As spring arrives, let’s lobby for tax deductions for gardening expenses.  Gardening is therapeutic, a genuine medical expense.

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CWPI

As expected, the composite Purchasing Managers Index (PMI) in the manufacturing and service sectors declined further but remains strong. We may see a slight decline for one more month before the cycle upwards starts again.

New orders and employment in the service sectors is strong and growing, offsetting some weakness in the manufacturing sector.

March’s retail sales gain of almost 1% was a bit heartening after the winter slump.  Excluding auto sales, year over year gains have dropped sharply since November and the trend continued in March as the yearly gain was only 1/4%.

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Labor Market Conditions Index

The Federal Reserve takes about a week after the release of the monthly labor report to compile their Labor Market Conditions Index (LMCI), a comprehensive snapshot of the many facets of the labor market.  For the first time in three years, the index turned negative in March.  It barely crossed below 0 but is sure to give some pause, a watch and wait when the FOMC meets at the end of this month.  While some of the FOMC members have been making a more aggressive case for raising interest rates, chair Janet Yellen is sure to point out that the economy is below target in both employment and inflation.

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Mortgage Banking

In an April 8th article, the Wall St. Journal reported that loans backed by bank deposits fell from 44% in 1980 to 20% in 2008.  Since 2012, the big banks have fled the mortgage business and now account for only a third of new federally guaranteed mortgages.  Small finance companies, which avoid much of the oversight and regulation in Dodd-Frank, now account for more than half of new mortgages.

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Glootch or Glut?

March 15, 2015

Retail

Indicators of business activity and confidence have all been strong.  The Purchasing Managers Index, the monthly employment report, and the NFIB small business index have shown exceptional strength in the past several months.  A week after a strong employment report came the worrisome news that retail sales declined for the third month.

A 2% drop in auto sales was the primary driver of February’s decline but the lack of demand is evident in the broader economy.  Excluding auto sales this is the second three month period of declining sales since the recovery began.  Following the slump in 2012, the SP500 sagged about 7%.  The market’s response to this slump has been muted so far.

American businesses had hoped that their customers would spend the dollars saved at the gas pump but consumers may be tucking away some of that cash. The slowdown in retail sales may be partly due to the harsh winter in the east, or a lack of income growth.  The strong dollar has made American products more expensive to export so businesses are especially dependent on domestic demand. Since last summer, prices at the wholesale level have declined steadily.  Commodities other than oil are also showing slack demand.

The inventory to sales ratio has climbed abruptly in the last half of the year.  Businesses make their best guess in anticipating future demand.  A capitalist economy is based on the decision making of millions, not a central committee of a few.  If inventories continue to mount, we can expect that businesses will adjust to the new environment and rein in production and expansion plans.

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Retirement

Twenty years ago I read articles on portfolio diversification like this one and was glad that I wasn’t old enough to be concerned about that kind of stuff.  Then one morning I was shaving and noticed that I was developing a slight turkey wattle in my neck, the same thing I had noticed in my Dad. OMG! I was getting old!
A Bankrate.com blog post features a chart of savings goals that a person at each stage of life should have accumulated to ensure that they can maintain their living standard in retirement.  The benchmarks are based on one’s current income.  Many Americans do not even meet these modest goals.  According to the chart, a person making $60K  who retires at 67 should have $500K in savings and investments.  
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Apple
Telephone and radio were the high tech firms of the early 20th century.  In 1916, ATT was added to the Dow Jones Industrial Average (DJIA), acknowledging that the company had become a pillar of the American economy. 
At the close of trading on March 18th, almost a hundred years later, ATT will be dropped from the DJIA and replaced by Apple, a high tech firm of the 21st century.  Apple’s projected earnings growth for this year may cancel out the anticipated negative earnings growth of the DJIA but Apple is a more volatile stock than stodgy ATT so daily price changes in the index are likely to be a bit more dramatic.
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Budgeting
Last week, economist Greg Mankiw wrote a piece in the New York Times explaining the recent change from static to dynamic budget scoring in the new Congress.  These are two different methods for estimating the effects of proposed tax changes on the budget over the following ten years.  Static scoring, the previous system, has been in place for decades and assumes no changes to the economy resulting from the proposed tax changes.  Dynamic scoring estimates changes in GDP and revenues resulting from the tax changes. Several examples illustrate differences between the two types of scoring.  The article is well written and easy to understand without the use of complicated economic models.

Sales, Savings and Volatility

August 17, 2014

This week I’ll take a look at the latest retail sales figures, a less publicized volatility indicator, a comparison of BLS projections of the Labor Force Participation Rate, and the adding up of personal savings.

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Retail Sales

Two economic reports which have a major influence on the market’s mood are the monthly employment and retail sales reports.  After a disappointing but healthy employment report this month, July’s retail sales numbers were disappointing, showing no growth for the second month in a row.  The year-over-year growth is 3.7%, which, after inflation, is about 1.5% real growth.  Excluding auto sales (blue line in the graph below), sales growth is 3.1, or about 1% real growth, the same as population growth.

As we can see in the graph below, the growth in auto sales has kicked in an additional 1/2% in growth during this recovery period. Total growth has been weakening for the past two years despite strong growth in auto sales, a sign of an underlying lack of consumer power.

Real disposable income rebounded in the first six months of this year after negative growth in the last half of 2013 but there does not seem to be a corresponding surge in sales.

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Labor Force Projections

While we are on the subject of telling the future…

All we need are 8 million more workers in the next two years to meet Labor Force projections made in 2007 by the Bureau of Labor Statistics (BLS).   8 million / 24 months = 300,000 a month net jobs gained. Hmmm…probably not.  In 2007, the BLS forecast slowing growth in the labor force in the decade 2006 – 2016.  Turned out it was a lot slower. Estimates then for 2016 projected a total of 164 million employed and unemployed.  In July 2014, the BLS put the current figure at 156 million employed.  The Great, or at least Big, Recession caused the BLS to revise their forecast a number of times.  The current estimate has a target date of 2022 to hit the magic 164 million.  In other words, we are 6 years behind schedule.

The Participation Rate is the ratio of the Civilian Labor Force to the Civilian Non-Institutional Population aged 16 and above.  The equation might be written:  (E + UI) / A = PR, where E = Employed, UI = Unemployed and Actively Looking for Work, and A = people older than 16 who are not in the military or in prison or in some institution that would prevent them from making a choice whether to work or not.  As people – the A divisor in the equation – live longer, the participation rate gets lower.  It ain’t rocket science, it’s math, as baseball legend Yogi Berra might have said.

The Participation Rate started rising in the 1970s as more women entered the work force, then peaked in the years 1997 – 2000.  Prior to the recession of 2001, the pattern of the participation rate was predictable, declining during an economic downturn, then rising again as the economy recovered.  The recovery after the recession of 2001 was different.  The rate continued to decline even as the economy strengthened.

In 2007, the BLS expected further declines in the rate from a historically high 67% in 2000 to 65.5% in 2016.  In 2012, the rate stood at 63.7%.  Current projections from the BLS estimate that the rate will drop to 61.6% by 2022.

Much of the decline in the participation rate was attributed to demographic causes in the 2007 BLS projections:

“Age, sex, race, and ethnicity are among the main factors responsible for the changes in the labor force participation rate.” (Pg. 38)

Comparing estimates by some smart and well trained people over a number of years should remind us that it is extremely difficult to predict the future.  We may mislead ourselves into thinking that we are better than average predictors.  Our jobs may seem fairly secure until they are not; a 5 year CD will get about 5 – 6% until it doesn’t; the stock market will sell for about 15x earnings until it doesn’t; bonds are safe until they’re not.

The richest people got rich and stay rich because they know how unpredictable the world really is.  They hire managers to shield them – hopefully – from that unpredictability.  They fund political campaigns to provide additional insurance against the willy-nilly of public policy.  They fight for government subsidies to provide a safety cushion, to offset portfolio losses and mitigate risk.  What do many of us who are not so rich do to insure ourselves against volatility?  Put our money in a safe place like a savings account or CD.  In real purchasing power, that costs us 1 – 2%, the difference between inflation and the paltry interest rate paid on those insured accounts.  In addition, we can pay a hidden “insurance” fee of 4% in foregone returns by being out of the stock and bond markets.  We stay safe – and not-rich.  Rich people manage to stay safe – and rich – by not doing what the not-rich people do to stay safe.  Yogi Berra couldn’t have said it better.

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China

For you China watchers out there, Bloomberg economists have compiled a monetary index from several key factors of monetary policy.  After hovering near decade lows, China’s central bank has considerably loosened lending in the past two months.  The chart shows the huge influx of monetary stimulus that China provided in 2009 and 2010 as the developed world tried to climb up out of the pit of the world wide financial crisis.

The tug of war in China is the same as in many countries.  Politicians want growth.  Central banks worry about inflation.  The rise in this index indicates that the central bank is either 1) bowing to political pressure, or 2) feels that inflationary pressures are low enough that they can afford to loosen the monetary reins.  As is often the case with monetary policy, it is probably some combination of the two.

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Personal Savings Rate

Over the past two decades, economists have noted the low level of savings by American workers.  While economists debate methodologies and implications, politicians crank up their spin machines. More conservative politicians cite the low savings rate as an indication of a lack of personal responsibilty.  As workers become ever more dependent on government programs, they do not feel the need to save.  Over on the left side of the political aisle, liberals cite the low savings rate as a sign of the growing divide between the middle class and the rich.  Many families can not afford to save for a house, or their retirement, or put aside money for their children’s education.  We need more programs to correct the economic inequalities, they say.

While there might be some truth in both viewpoints, the plain fact is that the Personal Savings Rate doesn’t measure savings as most of us understand the term.  A more accurate title for what the government calls a savings rate would be “Delayed Consumption Rate.”  The methodology used by the Dept. of Commerce counts whatever is not spent by consumers as savings.  “To consume now or consume later, that is the question.”

If a worker puts money into a 401K each month, the employer’s matching contribution is not counted.  If a consumer saves up for a down payment for a house, that is included in savings.  When she takes money out of savings to buy the house, that is a negative savings.  The house has no value in the “savings” calculation.  Many investors have a large part of their savings in mutual funds through personal accounts and 401K plans at work.  Capital gains in those funds are not counted as savings.  (Federal Reserve paper) In short, it is a poor metric of the aggregate behavior of consumers.  Some economists will point out that the savings rate indicates a level of demand that consumers have in reserve but because a significant portion of saved income is not counted, it fails to properly account for that either.

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Volatility – A section for mid-term traders

No one can accurately predict the future but we can examine the guesses that people make about the future.  In his 2004 book The Wisdom of Crowds (excerpt here) James Surowiecki relates a number of studies in which people are asked to guess answers to intractable problems, like how many jelly beans are in a jar.  As would be expected, respondents rarely get it right.  The surprising find was that the average of guesses was remarkably close to the correct answer.

Through the use of option contracts, millions of traders try to guess the market’s direction or insure themselves against a change in price trend.  A popular and often quoted gauge of the fear in the market is the VIX, a statistical measure of the implied volatility of option contracts that expire in the next thirty days.  When this fear index is below 20, it indicates that traders do not anticipate abrupt changes in stock prices.

Less mentioned is the 3 month fear index, VXV (comparison from CBOE). Because of its longer time horizon, it might more properly be called a worry index.  Many casual investors have neither the time, inclination or resources to digest and analyze the many economic and financial conditions that impact the market.  So what could be easier than taking a cue from traders preoccupied with the market?  Below is a historical chart of the 3 month volatility index.

Historically, when this gauge has crossed above the 20 mark for a couple of weeks, it indicates an elevated state of worry among traders.  The 48 month or 4 year average of the index is 19.76.  Currently, we are at a particularly tranquil level of 14.42.

When traders get really spooked, the 10 day average of this anxiety index will climb to nosebleed heights as it did during the financial crisis.  As the market calms down, the average will drift back into the 20s range, an opportunity for a mid-term trader to get cautiously back into the water, alert for any reversal of sentiment.

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Takeaways

Retail sales have flat-lined this summer but y-o-y gains are respectable.  So-so income growth constrains many consumers.  The 3 month volatility index is a quick and dirty summary of the mid-term anxiety level of traders.  A comparison of BLS labor force projections shows the difficulty of making accurate predictions.  The personal savings rate under-counts savings.