Pickup and Letdown

May 8, 2016

Based on ISM’s monthly survey of Purchasing Managers, the CWPI blends both service and manufacturing indexes and gives additional weight to a few components, new orders and employment.  Last month we were looking for an upward bend in the CWPI, to confirm a periodic U-shaped pattern that has marked this recovery. This month’s reading did swing up from the winter’s trough and we would expect to see further improvement in the coming few months to confirm the pattern. A break in this pattern would indicate some concern about a recession in the following six months. What is a break in the pattern? An extended trough or a continued decline toward the contraction zone below 50.

Since the services sectors constitutes most of the economy in the U.S., new orders and employment in services are key indicators of this survey.  A sluggish winter pulled down a composite of the two but a turn around in April has brought this back to the five year average.

Rising oil prices have certainly been a major contributor to the surge in the prices component of the manufacturing sector survey. The BLS monthly labor report (below) indicates some labor cost increases as well.  Each month the ISM publishes selected comments from their respondents.  An employer in the construction industry noted a severe shortage of non-skilled labor, a phenomenon we haven’t seen since 2006, at the height of the housing bubble.

Last week the BEA released a first estimate of almost zero growth in first quarter GDP, confirming expectations.  Oddly enough, the harsh winter of 2015 provided an even lower comparison point so that this year’s year over year growth, while still anemic, is almost 2%.



April’s employment data from the BLS was a bit disheartening.  Earlier this week, the private payroll processor ADP reported job growth of 150,000 in April and lowered expectations for the BLS report released on Friday.  While the BLS estimate of private job growth was slightly better, the loss of about 10,000 government jobs, not included in the ADP estimate, left the total estimate of jobs gained at 160,000. The loss of government jobs is slight compared to the total of 22 million employed at all levels of government but this is the fourth time in the past eight months that government employment has declined.

A three month average of job growth is still above 200,000, a benchmark of labor market health that shows job growth that is more than the average 1% population growth  With a base of 145 million employees in the U.S, a similar 1% growth rate in employment would equal 1.5 million jobs gained each year, or about 125,000 per month.  To account for statistical sampling errors, the churn of businesses opening and closing, labor analysts add another 25,000 to get a total of 150,000 minimum monthly job gains just to keep up with population growth.  The 200,000 mark then shows real economic growth.  In March 2016, the growth of the work force minus the growth in population was 1.2%, indicating continued real labor market gains.

Job growth in the core work force aged 25 -54 remains above 1%, another good sign.  It last dipped briefly below 1% in October.  This core group of workers buys homes, cars, and other durable goods at a faster pace than other age groups; when this powerhouse of the economy weakens, the economy suffers. In the chart below, there is an almost seven year period, from June 2007 through January 2014 where growth in this core work force group was less than 1%.  From January 2008 through January 2012, growth was actually negative.  The official length of the recession was 17 months, from December 2007 through June 2009.  For the core work force, the heart of the economic engine, the recession lasted much longer.

In 2005, a BLS economist estimated that the core work force would number over 105 million in 2014.  In December 2014, the actual number was 96 million, a shortage of 9 million workers, or almost 10% of the workforce.  In April 2016, the number was almost 98 million, still far less than expectations.

Some economists and pundits mistakenly compare this recovery from a financial crisis with recoveries  from economic downturns in the late 20th century.  For an accurate comparison, we must look to a previous financial, not economic, crisis – the Great Depression of the 1930s.

The unemployment rate in April remained the same, but more than a half million people dropped out of the labor force, reversing a six month trend of declines.  It is puzzling that more people came back into the labor force during the winter even as GDP growth slowed.

Average hourly earnings increased for the second month in a row, upping the year over year increase above 2.5%.  For the past ten years, inflation-adjusted weekly earnings of production and non-supervisory workers have grown an anemic .75% per year.  In the sluggish winter of January and February 2015, earnings growth notched  a recovery high of 3%, leading some economists and market watchers to opine that lowered oil costs, on the decline since the summer of 2014, would finally spur worker’s pay growth in this long, subdued recovery.  A year later, earnings growth is about 1.2%, a historically kind of OK level, but one which causes much head scratching among economists at the Federal Reserve.  When will worker’s earnings begin to recover?



A reader sent me a link to a CNBC article  on food insecurity in the U.S. The problem is widespread and not always confined to those who fall below the poverty benchmark. Contrary to some perceptions, food insecurity is especially prevalent in rural areas, where food costs can be 50% higher than urban centers.  How does the government determine who is food insecure? The USDA publishes a guide with a history of the project, the guidelines and questions.  To point out the highlights, I’ll include the page links within the document. The guidelines have not been revised since this 1998 revision.

In surveys conducted by the Census Bureau, respondents are asked a series of questions.  The answers help determine the degree of household food insecurity.  The USDA repeatedly emphasizes that it is household, not individual, insecurity that they are measuring.  The ranking scale ranges from 0, no insecurity, to 10, severe insecurity and hunger. An informative graph of the scale, the categories and characteristics is helpful.

In 1995, a low .8 percent were ranked with severe food insecurity (page 14) . To be considered food insecure, a household must rank above 2.3 (household without children), or above 2 .8 (with children) on the scale.  Above that are varying degrees of insecurity and whether it is accompanied by hunger. (Table)

The USDA admits that measuring a complex issue like this one can provoke accusations that the measure either exaggerates or understates the number of households.  What are they measuring?  Page 6 contains a formal definition, while page 8 includes a list of conditions that the survey questions are trying to assess, and that a condition arose because of financial limitations like “toward the end of the month we don’t have enough money to eat well.”

Page 9 describes the rather ugly pattern of progressively worse food insecurity and hunger.  At first a household will buy cheaper foods that fill the belly.  Then the parents may cut back a little but spare the kids the sensation of hunger.  In its most severe stage, all the family members go hungry in a particular day.

Those of you wanting additional information or resources can click here.



Almost a month ago the giant aluminum manufacturer Alcoa kicked off the first quarter earnings season.  87% of companies in the SP500 have reported so far and FactSet calculates a 7% decline in earnings.  They note “the first quarter marks the first time the index has seen four consecutive quarters of year-over-year declines in earnings since Q4 2008 through Q3 2009.”  Automobile manufacturers have been particularly strong while the Energy, Materials and  Financial sectors declined.  Although the energy sector gets the headlines, there has also been a dramatic decrease in the mining sector.  The BLS reports almost 200,000 mining jobs lost since September 2014.

The bottom line for long term investors: the economic data supports an allocation that favors equities.  The continued decline in corporate earnings should caution an investor not to go too heavily toward the equity side of the stock/bond mix.


(Edited May 11th in response to a reader’s request to clarify a few points.)

Home Sweet Asset

April 3, 2016

Normally we do not include the value of our home in our portfolio.  A few weeks ago I suggested an alternative: including a home value based on it’s imputed cash flows.  Let’s look again at the implied income and expense flows from owning a home as a way of building a budget.  The Bureau of Labor Statistics and the Census Bureau take that flow approach, called Owner Equivalent Rent (OER), when constructing the CPI, and homeowners are well advised to adopt this perspective.  Why?

1) By regarding the house as an asset generating flows, it may provide some emotional detachment from the house, a sometimes difficult chore when a couple has lived in the home a long time, perhaps raised a family, etc.

2) It focuses a homeowner on the monthly income and rent expense connected with their home ownership.  It asks a homeowner to visualize themselves separately as asset owner and home renter. It is easy for homeowners to think of a mortgage free home as an almost free place to live. It’s not.

3) Provides realistic budgeting for older people on fixed incomes.  Some financial planners recommend spending no more than 25% of income on housing in order to leave room for rising medical expenses.  Some use a 33% figure if most of the income is net and not taxed.  For this article, I’ll compromise and use 30% as a recommended housing share of the budget.

A fully paid for home that would rent for $2000 is an investment that generates an implied $1400 in income per month, using a 70% net multiplier as I did in my previous post. Our net expense of $600 a month includes home insurance, property taxes, maintenance and minor repairs, as well as an allowance for periodic repairs like a new roof, and capital improvements.

Using the 30% rule, some people might think that their housing expense was within prudent budget guidelines as long as their income was more than $2000 a month.  $600 / $2000 is 30%.

However, let’s separate the roles involved in home ownership.  The renter pays $2000 a month, implying that this renter needs $6700 a month in income to stay within the recommended 30% share of the budget for housing expense.  The owner receives $1400 in net income a month, leaving a balance of $5300 in income needed to stay within the 30% budget recommendation. $6700 – $1400 = $5300.  Some readers may be scratching their heads.  Using the first method – actual expenses – a homeowner would need only $2000 per month income to stay within recommended guidelines.  Using the second method of separating the owner and renter roles, a homeowner would need $5300 a month income. A huge difference!

Let’s say that a couple is getting $5000 a month from Social Security, pension and other investment income.  Using the second method, this couple is $300 below the prudent budget recommendation of 30% for housing expense.  That couple may make no changes but now they understand that they have chosen to spend a bit more on their housing needs each month.  If – or when – rising medical expenses prompt them to revisit their budget choices, they can do so in the full understanding that their housing expenses have been over the recommended budget share.

This second method may prompt us to look anew at our choices.  Depending on our needs and changing circumstances, do we want to spend $2000 a month for a house to live in?  Perhaps we no longer need as much space.  Perhaps we could get a suitable apartment or townhome for $1400?  Should we move?  Perhaps yes, perhaps no.  Separating the dual roles of owner and renter involved in owning a home, we can make ourselves more aware of the implied cost of our decision to stay in the house.  A house may be a treasure house of memories but it is also an asset.  Assets must generate cash flows which cover living expenses that grow with the passage of time.


The Thrivers and Strugglers

“Bravo to MacKenzie. When she was born, she chose married, white, well-educated parents who live in an affluent, mostly white neighborhood with great public schools.”

In a recent report published by the Federal Reserve Bank at St. Louis, the authors found that four demographic characteristics were the chief factors for financial wealth and security:  1) age; 2) birth year; 3) education; 4) race/ethnicity.

While it is no surpise that our wealth grows as we age, readers might be puzzled to learn that the year of our birth has an important influence on our accumulation of wealth.  Those who came of age during the depression had a harder time building wealth than those who reached adulthood in the 1980s.

Ingenuity, dedication, persistence and effort are determinants of wealth but we should not forget that the leading causes of wealth accumulation in a large population are mostly accidental.  It is a humbling realization that should make all of us hate statistics!  We want to believe that success is all due to our hard work, genius and determination.



March’s job gains of 215K met expectations, while the unemployment rate ticked up a notch, an encouraging sign.  Those on the margins are feeling more confident about finding a job and have started actively searching for work.  The number of discouraged workers has declined 20% in the past 12 months.

Employers continue to add construction jobs, but as a percent of the workforce there is more healing still to be done.

The y-o-y growth in the core workforce, aged 25-54, continues to edge up toward 1.5%, a healthly level it last cleared in  the spring of last year.

The Labor Market Conditions Index (LMCI) maintained by the Federal Reserve is a composite of about 20 employment indicators that the Fed uses to gauge the overall strength and direction of the labor market.  The March reading won’t be available for a couple of weeks, but the February reading was -2.4%.

Inflation is below the Fed’s 2% target, wage gains have been minimal, and although employment gains remain relatively strong, there is little evidence to compel Chairwoman Yellen and the rate setting committee (FOMC) to maintain a hard line on raising interest rates in the coming months.  I’m sure Ms. Yellen would like to get Fed Funds rate to at least a .5% (.62% actual) level so that the Fed has some ability to lower them again if the economy shows signs of weakening.  Earlier this year the goal was to have at least a 1% rate by the end of 2016 but the data has lessened the urgency in reaching that goal.

ISM will release the rest of their Purchasing Manager’s Index next week and I will update the CWPI in my next blog.  I will be looking for an uptick in new orders and employment.  Manufacturing lost almost 30,000 jobs this past month – most of that loss in durable goods.  Let’s see if the services sector can offset that weakness.


Company Earnings

Quarterly earnings season is soon upon us and Fact Set reports that earnings for the first quarter are estimated to be down almost 10% from this quarter a year ago.  The ten year chart of forward earnings estimates and the price of the SP500 indicates that prices overestimated earnings growth and has traded in a range for the past year.  March’s closing price was still below the close of February 2015.  Falling oil prices have taken a shark bite out of earnings for the big oil giants like Exxon and Chevron and this has dragged down earnings growth for the entire SP500 index.

Still Worried

November 1, 2015

Today is the day that U.S. readers fall back.  Let’s hope it’s the only thing that falls back!

Eight years ago, in October 2007, the SP500 index reached a pre-recession high of 1550. After this month’s 8% recovery the index stands at 2079, more than a third above that long ago high.  A decade long chart of the SP500 shows the inflection points of sentiment.  We can compare two averages to understand the shifts in investor confidence.  A three month average, one quarter of a year, captures short term concerns and hesitations.  A one year average reflects doubts or optimisms that have strengthened over time.  The crossing of one average above or below the other gives us a signal that a change may be coming.  Concerns may be temporary – or not.

After falling below the 12 month average, the 3 month average strained and groaned to pull its chin above that long average, notching five consecutive weekly gains.  Both China and the EU central banks have announced plans for lower interest rates or QE to spur their economies.  Oil prices continued to bounce around under the $50 mark.  OPEC suppliers announced they could not agree on production cuts.  Fearing a continuing oversupply of crude, oil prices fell 4 – 5%.  Then came the news that the number of oil rigs in the U.S. had fallen.  Prices went back up.

Commodities and mining stocks remain under pressure.  After falling over 18% in September, mining stocks gained back most of those losses in the first two weeks of October, then fell back in the last half of this month, closing the month with a 3% gain.  15 to 20% gains and losses in a sector during a month looks like so much scurrying and confusion.

Emerging market indexes lost ground this past week, slipping more than 4%.  Worries of a global recession continue to haunt various markets.  For large and medium U.S. companies, a slowdown in European and Asian markets is sure to have a negative effect on the bottom line.

The first estimate of 3rd quarter GDP growth was a paltry 1.5%, far below the 3.9% annual rate of the 2nd quarter.  Two-thirds of the SP500 companies have reported earnings for the 3rd quarter and FactSet estimates a decline of 2.2% for the quarter, the second consecutive quarter of earnings declines.


The Causes of Depression

The economic kind, not the emotional and psychological variety.  Economics history buffs will enjoy David Stockman’s critique of the extraordinary amount of monetary easing under former Fed chairman Ben Bernanke.  As President Reagan’s budget director, Stockman was at the forefront of supply side economics, a theory which promised an answer to the stagflation of the 1970s that drove many to question the assumptions and conclusions of Keynesian economics.

At first a champion of this new approach to economic policy making, Stockman grew disillusioned and later coined the term “voodoo economics” to describe the contradictory thinking of his boss and others in the Republican Party who stuck by their beliefs in supply side economics in spite of the evidence that these policies generated large budget deficits and erratic economic cycles.

In 2010, Stockman penned an editorial  that held some in the Republican Party, his party, culpable for the 2008 fiscal crisis.  He understands that politicians and policy makers become welded to their ideological platforms, disregarding any input that might upset their model of the world.

For those who have a bit of time, an Atlantic magazine December 1981 an article acquainted readers with David Stockman in his first year as budget director.  The budget process seems as broken today as it was 35 years ago when Stockman assumed the task of constructing a Federal budget.

 These “internal mysteries” of the budget process were not dwelt upon by either side, for there was no point in confusing the clear lines of political debate with a much deeper and unanswerable question: Does anyone truly understand, much less control, the dynamics of the federal budget intertwined with the mysteries of the national economy?

Stockman understands the political gamesmanship that permeates Washington.  He criticizes Bernanke’s analysis of the 2008 Great Recession as well as the 1930s Great Depression. Faulty analysis produces faulty remedies. Stockman goes still further, finding fault with Milton Friedman’s monetary analysis of the causes of the Great Depression.  In a 1963 study titled A Monetary History of the United States Friedman and co-author Anna Schwartz found that monetary actions by the Federal Reserve deepened and lengthened the 1930s Depression.  Friedman became the leading spokesman of monetarism in the late 20th century, the thinking that governments can more effectively guide a national economy by adjusting the money supply rather than employing an ever changing regime of fiscal policies.

Students of the great debate of the past 100 years – bottom up or top down? – will enjoy Stockman’s take on the matter.

Steady As She Goes

March 22, 2015

Monetary Policy

The FOMC is a committee of Federal Reserve members who meet every six weeks to determine the course of monetary policy.  A statement issued at the end of each two day meeting is carefully parsed by traders in an orgy of exegesis.  And thus it was so this past week.  Recent statements by the Fed included the word “patient” as in low inflation and some lingering weaknesses in the labor market allow us to take a patient approach with monetary policy.  If the Fed removed the word patient, then it was a good bet that they would start raising rates at their mid June meeting.  By the end of the year, the thinking was, the benchmark Fed funds rate could be 1%-1.25%.

So here’s what happened while you were at work, or at lunch or picking up the kids on Wednesday afternoon when the Fed meeting concluded. The initial reaction was negative, or at least that’s how the HFT (high frequency) algorithms parsed the Fed’s statement.  “Patient” was gone.  Sell, sell, sell. Then some human traders noticed that the Fed was also saying that they did not have to be impatient either – the perfect neutral stance.  Buy, buy, buy.  The SP500 jumped 1.5% in a few minutes.  The neutral stance of  the Fed caused many to revise their estimates of the Fed rate at the end of the year to .75% or less.  The broad market index ended the week at the same level as it was when the month began.  Volatility as measured by the VIX is rather low but there has been a lot of  positioning since Christmas and a net gain of only 1% in those three months.


Earnings Recession

The analytics firm FactSet projects a year-over-year decline in the earnings of the SP500 companies for this first quarter of 2015.  Here is a good review of the historical response of the stock market to earnings recessions, defined as two quarters of year-over-year declines in the composite earnings of the SP500.



Oil is an international commodity that trades on world markets in U.S. dollars.  A prudent strategy for countries which are net importers of oil is to stock up on dollars to pay for its short term oil needs.   As the demand for dollars climbs so does its price in other currencies, a self-reinforcing mechanism.  Half of the drop in the price of oil is due merely to the appreciation of the dollar, which has spiked some 25% since the beginning of the year.

For decades, many in academia and government have advocated the adoption of an international currency called the SDR, already in use by the International Money Fund.   Here is an article from last May, before the price of oil started its slide.  The dollar is the latest in a series of reserve currencies over the past 500 years and has been the dominant currency for almost 100 years (History here). The reliance on one country’s currency works – until it begins to cause more problems than it solves.  The  largest producer and consumer of oil, Saudi Arabia and the U.S., have formed a decades long agreement to price oil in U.S. dollars, binding the rest of the world to the movements in the U.S. dollar.The recent volatility in the dollar in threatening the economic stability of many nations, who are increasing their calls for a change in international monetary policy.


Sticky CPI

In a survey of newspaper articles, inflation was mentioned more than unemployment or productivity.  In the U.S., inflation is often measured by the Consumer Price Index (CPI).  A subset of that measure is called the core CPI and excludes more volatile food and energy items to arrive at a fundamental trend in inflation.  (IMF primer on inflation ) Critics of the core CPI point out that food and energy items are the most frequent purchases that consumers make and have a fundamental effect on the economic well being of U.S. households.  Responding to some of the inherent weaknesses in the methodology of the CPI, the Atlanta branch of the Federal Reserve began development of an alternative measure of inflation – a “sticky” CPI. (History)  This metric gives a statistical weight to the components of the CPI by how much prices change for each component.  The Atlanta Fed has an interactive graph that charts both the sticky measure and a more volatile, or flexible CPI that is similar to the conventional CPI.  The sticky CPI tends to measure expectations of future changes in inflation and moves rather slowly.

Over a half century, the clearest trend is the closing of the gap between the regular CPI and the sticky CPI.

When we compare all three measures, core, sticky and regular CPI, we see that the sticky CPI is usually above the core CPI.  January’s readings are 2.06% for the sticky index, 1.64% for the core index and -.19% for the headline CPI index.

A private project called Price Stats goes through the internet comparing prices on billions of items.(WSJ blog article here)  This data is more timely and shows an uptick in core inflation that is approaching 2%, the Federal Reserve’s target rate.  When asked why the Fed uses 2%, chair Janet Yellen answered that inflation indexes do not capture improvements in products, only prices, so they tend to overstate inflation as a matter of design and practical data gathering.  Secondly, the 2% mark gives the Fed a statistical cushion so that they are able to take appropriate monetary steps to avoid deflation.

Why is deflation a bad thing?  In answering this question, we discover the true benefit of the core CPI.  Food and energy are regularly consumed.  Demand for these goods is relatively “sticky”.  A family may change what types of foods it buys in response to price changes but it is going to buy food. Deflation in these core purchases can be a good thing as it takes less of a bite out of the average household’s wallet.

On the other hand, deflation in less frequently purchased goods, which the core CPI tracks, is not good because it leads to a self-perpetuating cycle in which consumers delay making purchases in the expectation that tomorrow’s price will be lower than today’s price.  If I expect that the price of an iPhone will be lower next week, how likely am I to buy one this week?  As consumers delay purchases, suppliers lower prices even more to move their goods.  Seeing the price competition among vendors, consumers are even more likely to delay purchases, waiting for prices to come down even further.  As sales drop, vendors and manufacturers begin to layoff employees.  Lower prices no longer entice consumers who become concerned about keeping their jobs and purchase only what they need.


The Conference Board, a business association, released their monthly index of Leading Indicators this week but it has a spotty history of forecasting trends. Doug Short puts together a nice snapshot of the Big Four indicators, Employment, Real (inflation-adjusted) Sales, Industrial Production, and Real Income.

Adjusting the Carburetor

November 9, 2014

About two thirds of companies in the SP500 had reported earnings for the third quarter. George guessed that positive earnings surprises were somewhat above the normal 70% but as former Presidential contender Herman Cain said, “I don’t have facts to back that up.”  Checking his guess, George went to Fact Set which provides a weekly update summary of earnings reports.  Positive earnings surprises were the highest percentage in over four years. On the other hand, Fact Set was reporting that the forward price earnings ratio of the SP500 was above the 5 and 10 year average.  Einstein famously quipped that the most powerful force in the universe was compound interest.  He might have mentioned an equally powerful force – reversion to the mean.

George updated his spreadsheet with data from Robert Shiller, the Yale economist who had devised the CAPE ratio, an inflation adjusted Price Earnings ratio for the SP500.  When the CAPE was higher than average, as it had been the past two years, price gains over the following five years were likely to be low or negative.  George had added a spreadsheet column to measure the annual percent gain in stock prices five years in the future, then plotted these five year gains against the CAPE ratio.  In the long run of several years, the above average gains in stock prices of the past few years were likely to drift lower or turn negative, bringing their 5 year return to the post-WW2 historical mean of 7%.

But in the post-WW2 period, the stock market had almost always gained in the year after a mid-term election.   It’s like a junction on a hiking trail with many signs and no mileage, George thought.

Monday’s report on auto and truck sales was almost exactly in the middle of the range of expectations.  Promotional sales in August before the introduction of 2015 models had propelled sales upwards in August. Sales in September and October had stayed on trend, a sales curve that was flattening.

Manufacturing data from ISM was strong and continuing to rise, but the market seemed to be in pause mode a day before the elections.  “One more day!” Mabel exclaimed. “We’re being bombarded with political ads.” George reflected on that for a second. “I don’t think I’ve actually seen one ad,” he said.  “We buzz through them when we’re watching a program.”  “Well, sometimes I like to watch the local news live or the weather channel,” Mabel responded.  “It’s become impossible to watch anything live on TV.”  George wondered how many millions would be spent on this election.  How many voters were like he and Mabel, paying little if any attention?  Mabel was a straight ticket voter.  It took her less than ten minutes to vote.  Amendments to the Colorado Constitution – no. “Don’t you even read them?” George had once asked her.  “Nope, they’re all sponsored by special interests,” she had replied.  “What about the marijuana amendment two years ago?” George had asked. “Well, I did vote yes on that one,” Mabel had conceded.  George spent hours researching candidate bios and their positions on the issues.  He would sometimes bring up a name of an independent candidate or a Libertarian candidate to Mabel.  “Why waste your time?” Mabel had asked.  “Whether we like it or not, we’ve got a two party system in this country.  Pick one and vote.  No Independent or Libertarian candidate is going to win.” “Yeh, what about Ross Perot in ’92?” George had asked.  “Cost Bush the election,” Mabel had responded. “No, it didn’t.  Perot took about as many votes from Clinton as he did from Bush,” George had argued.  Where had he read that?  Probably Wikipedia.  “Fine,” Mabel had countered with that tone of voice meaning end of argument.

As they watched election results on Tuesday, George commented that he had been wrong.  “No!” Mabel exclaimed, her hands raised in supplication to the fates.  “Let me write this down,” she said. “Hecklers, always the hecklers,” George shook his head in a mock display of discouragement. “No, really.  I thought the Republicans would gain the Senate but just barely.  Gardner is cleaning Udall’s clock.  Look at Mia Love in Utah.  Methinks there’s a change in the wind, oh forsooth.”

Colorado was a toss-up.  As they turned in for the night, one channel had declared the Republican gubernatorial candidate, Bob Beauprez, as the winner in the race.  In the state senate and house, the Democrats held a slim majority that could be overturned but the races were too close to call.  George expected a bump up in the market the next day unless ADP, the private payroll processor, had a disappointing report of private job gains.

Wednesday morning they woke to the news that incumbent Colorado governor John Hickenlooper had squeaked out a win but his rival had still not conceded.  State senate and house races were still undecided and there might be recounts through November. “If this were a baseball or football game, this would be exciting.” George’s banter had little effect with Mabel who was in a rather sour mood. “Look,” he added, the Dems will have a chance to take back the Senate in 2016.  The Republicans will have six or seven Senate seats up for grabs by the Democrats.  It’s the math of Senate elections.”

In addition to gaining the Senate, Republicans had extended their control of the House.  George turned to the ADP report of private job gains – 230,000.  The market had popped up about 1/2% at the open, showing a curious restraint after the previous night’s Republican sweep.  One of their CDs would be due in a few weeks but George knew this was not a good time to bring up the subject of moving some of that really safe money into something else.  Their son Robbie, his wife Gail and their grandson Charlie would be coming over this weekend and that would help brighten up the mood in the house.

The price of West Texas Intermediate crude oil crossed below the $80 mark.  The game was on to control the world market for oil.  Fracking in the U.S. had increased supply, reducing net imports of oil by the U.S.  However, the cost per barrel using fracking methods is more expensive than conventional drilling.  The only way that the Saudis could strengthen their dominance of the market was to drive the price down to a point where fracking was no longer profitable, putting pressure on these suppliers.  At a price below $80, plans to start new wells might be put on hold.  At a sustained price below $80, some suppliers with higher drilling costs might shut down or reduce their output.  Russia, Venezuela and Mexico depended on a higher oil price to fund their governments and social programs.  The lower revenues from oil were exerting a lot of political pressure within these countries.

ISM released their monthly report on the service sectors.  George added the new data to his spreadsheet. He had expected a decline from September’s peak, but the composite of manufacturing and non-manufacturing was as strong as September.

Employment and New Orders were two key factors in the services sector.  For the fourth month in a row, the readings pushed the 60 level, the boundary between strong growth and robust growth.  There had only been two times in 2005 when readings had been this strong.

 On Friday, the BLS released their monthly report of employment gains.  Although net job gains were slightly below expectations, there were gains in most industries, a healthy sign.  As usual, George averaged the BLS estimate and ADP’s estimate.  Subtract the 5000 new jobs in government from the 214,000 reported by the BLS to get private job gains of 209,000.  Average that with the 230,000 jobs estimated by ADP to get 220,000, then add back in the 5000 government jobs. A strong report in a string of strong reports.

George had heard a number of explanations for the swing toward the Republicans. The economy was growing.  Why had voters handed such a decisive hand to the Republicans?  It was a repudiation of Obama’s failed policies.  George noticed that Mabel had not eaten all her nacho chips from the night before. There are rules so he asked politely if he could finish them.  Chipotle’s chips were the best. No, they were Democrats focused on tactics rather than ideas.  No, it was a resounding affirmation of conservative principles by the Amuhrican people. No, it was a throw the bums out election.  No, it was a frustrated electorate that is sick of Washington gridlock and a do-nothing Congress.  No, it was shifting sentiments among age groups and demographic groups. Voters over 60 were a greater percentage of voters in this election while voters under 30 were a smaller percentage.  Asian and Hispanic voters had voted Democratic but with less commanding majorities.  Men swung Republican more than women swung Democratic. Post-election analysis sometimes reminded George of post-Super Bowl analysis.  There was one chart that encapsulated a big problem that Democrats had.  Part-timers couldn’t find full-time jobs.

Each of those 3 million extra involuntary part-timers were counted as one job, regardless of the hours.  A little more than 1 million jobs had been created since the peak of employment in 2007.  Job growth, in short, had been paltry.  A good indicator of job growth was Social Security tax revenue collected each year. In 2006, near the height of the housing boom, the Federal Government had collected $809 billion in Social Security taxes (Treasury data), a 27% increase over the amount collected in 2000, at the height of the dot com boom, just before George Bush took office.  In 2008, the year before Obama took office, the government collect $674 billion.  Six years into Obama’s tenure as President, the government would collect about $755 billion in 2014, a modest increase of 12%.  It was true, Obama had been handed an extremely dysfunctional financial system and a global economy in a death dive.  

Strong wage growth had preceded the past three recessions.  Since this past recession, wage growth had fallen and stayed persistently low, causing discontent among frustrated voters.  Many workers were barely keeping up with inflation.

Voters were like the shade tree mechanics of George’s youth.  To adjust a carburetor, turn the screw this way or that way, trying to find the position where the engine idle sounded the smoothest.  It was a negotiation of sorts between air and gas.  Every two years, voters turned the political adjustment screw and waited to see if it made a difference.

A Surprise Guest

October 26, 2014

Shortly after Monday morning’s sunrise, George sat on the back deck, coffee in hand.  Some brilliant, utterly mad painter rushed around the neighborhood, dabbing the trees with what seemed like the entire palette of warm colors. Armies of invisible elves set up accent lights in the branches, highlighting the hues of rust-orange-yellow-gold.  As George absorbed the movie magic moment, a van from the local cable company pulled up on the grass alleyway behind the backyard fence. “Starting early,” George thought as he glanced at this watch.  7:30.

He opened the backyard gate to the alley, meaning to ask the service guy if repairs on the pole would interrupt his and Mabel’s service this morning.  A guy who looked too trim, too neat, and too fit to be a repairman opened the passenger door of the van and called out to him, “Sir, stay inside the yard.”  George took a step backward and looked up above.  Was there a loose wire or something dangerous?  Cable wire carried low voltage so what could be the problem?  He glanced back at the man and the van.

From the rear of the van, two men hopped out.  Like the guy in front, they were both dressed in black windbreakers over blue polo shirts, black slacks.  It was like a SWAT team of rugged fashion models.  One of the men came to the rear gate.  George stepped back another step.  The man scanned the yard to the left and right of George, looked past George at the rear of the house.  George noticed that the other two men scanned the alley, the nearby houses.  The man at the gate glanced at a phone in the palm of his hand, then looked at George.  “George Liscomb?” he asked in the commanding tone of one who routinely asks questions and expects answers.  George nodded.  “Is there a Mabel Liscomb living here?”  George nodded again.  “Is she here?” Another nod.  “Your wife?”  One more nod. “Any other residents inside the house?”  George shook his head.  The man turned his head sideways, keeping one eye on George.  “Bravo,” he called to the two other men.

From the side door another man emerged, dressed much like the others. George felt a numbness inside like he was on a movie set.  “Move back a few feet, please.”  Finally a slim figure emerged from the side of the van. The ears were the dead giveaway.  George forgot that he was still holding his coffee cup as he instinctively jerked his hand to his face.  The coffee cup clipped his lower jaw.  “Ouhhhhh,” George barked. The sudden grunt drew everyone’s gaze.  “You OK?” President Obama called out to him. The lukewarm coffee had spilled on George’s shirt but he was hardly mindful.  “Uh, yeh,” George replied.

Like four points of a compass, the four men surrounded the President as the group seemed to flow through the backyard gate.  The front man stood aside and the President held out his hand to George. “Great morning here in Denver, isn’t it,” the President said, an upbeat easygoing smile on his face. George paused briefly to figure out the coffee cup thing.  He put the coffee cup in his left hand then held out his right hand to shake the President’s hand.  What does one say to the President, George wondered.  “Good morning, President.”  Ok, that worked.  “George, is it?” the President asked? “Yeh,” George replied in a monotone.  “I was wondering if Mabel – that’s your wife? – is she here?  Is she available?”  “Uh, yeh,” George replied, “she’s in the living room.”  “May we go in?” the President asked politely. “Uh, sure.”  George had barely drunk his first coffee before spilling it.  Maybe that’s why his brain seemed to be stuck in monosyllabic mode.

The front man strode to the house.  “Maybe George should go with you and we’ll wait a moment on the deck,” the President called out.  George joined the man, who opened the rear door and glanced inside before allowing George to go through the doorway.  “Hey, Mabel,” George called out.   “Are you decent?  We’ve got company.”  He could hear her get up from her easy chair.  “Be right there,” she called back.  She appeared at the far end of the kitchen, saw the man next to George and asked, “What’s the matter, dear?”  “You’re not going to believe this,” George replied.  Already the man was moving toward Mabel.  George forewarned her.  “This guy needs to ask you a few questions.”

The man went through the same procedure with Mabel.  She answered curtly as though she were about to throw this impudent intruder out of her house.  “You have a holstered weapon.  Are you with the police?”  she asked after answering the first two questions.  From a few incidents at the high school, she recognized the bulge at the man’s side.   “Secret Service, ma’am,” the man answered. “Secret what?” Mabel asked and the man opened his windbreaker enough to see the ID badge hanging from his neck.  She looked past the man and spoke to George, “What the hell is going on, George?”  He could tell she was upset.  “It’s OK, just answer the questions,” George called back to her.  No, there was no one in the house.  Yes, she was Mabel Liscomb.  She leveled her gaze directly at the man when he asked her birthdate.  She responded quickly but in a slightly menacing tone.  “You have the audacity to ask me to identify myself in my own home!”  Then the man’s voice softened as though he were an actual human being.  “Sorry, ma’am.  Have to do my job.”  He stepped back to where George stood at the rear door.   The man opened the screen door and nodded, “It’s allright.”

George joined Mabel in the kitchen as the group on the deck flowed through the rear doorway, keeping the President protected.  “Mrs. Liscomb,” the President greeted her with a warm smile, “good to meet you.  You wrote me a letter a few months back, didn’t you.”  Mabel stuttered.  Had he ever hear Mabel stutter, George wondered.  “I-I-I-I-did I?  I can’t muh-member,” Mabel answered.  “You had some good ideas that I’d like to talk to you about, if you have time?”  Mabel nodded.  George could see that she was recovering quickly from her shock.  She was good at that.  The habits of a high school principal asserted themselves and Mabel told the President, “I’m flattered that you are interested, of course.  Why couldn’t your staff make an appointment?”  Geez, George thought, she’s using the command voice with the damn President of the U.S.  He noticed that each member of the security detail had moved to a window.  George glanced to his right and saw that one had gone into the living room.  The fourth guy – had he gone up the stairs to check the bedrooms?

“I was supposed to be golfing with your Senator Udall but he had to cancel,” the President explained.  “I offered to appear at a fundraiser with Diana DeGette but her staff said she’d have to get back to us.  I don’t seem to be too popular for this election.”  Mabel made a brushing gesture.  “Don’t worry about it.  Same thing happened to Eisenhower ,Reagan and Bush at the midterm of their second terms,” Mabel told him.  “With a recession still going on, Mamie Eisenhower was a lot more popular on the political circuit leading up to the ’58 mid-terms.”  “Oh, Michelle is on everyone’s dance ticket,” the President replied.  “Me, not so much.  The quarterback takes the blame when things go wrong.  When things go right, it’s the offensive line that gets the credit.  Just part of the game, I suppose.”

“Well, come on in and sit down,” Mabel turned toward the living room.  In a brief exchange, Mabel and the President had become buddies of a sort.  George still wasn’t sure how it happened but each of them had recognized something in the other that they both had in common.  Mabel sat down in her favorite chair, then motioned the President to sit on the couch nearby.  She turned to George and said, “Do you want to make some coffee? I think I took the last of the first pot.”  George nodded. “Yeh, I haven’t even had my first cup.”

The President was different in person.  When interviewed on 60 Minutes, he had showed a casual aloofness that George didn’t like. The folded legs, the studied composure didn’t ring true for George.  Now, here in this living room, he sat, legs unfolded, leaning slightly forward in an attentive pose, earnestly having a conversation with Mabel.

For the next hour Mabel discussed education policies with the President. She didn’t like the implementation of educational standards. Yes, she understood the desire for uniformity.  No federal department can understand local educational needs. Too much politics in education already.  Washington makes it worse.   “How did you come to read my letter?” she asked.  “Kind of a mistake,” the President replied. “It should have gone to Arne’s people but it got in my pile by mistake. I left it on the table and Michelle saw it.  She told me, ‘you need to hear this.  This woman’s been there her whole life.  She understands.  You’re not hearing this in Washington.’  And, to tell you the truth, it’s just been sitting in the policy pile for months.  The first thing I found out as President – probably every President faces this quickly – is that there is never enough time to get to everything on his plate.”

George stayed out of the living room for much of the time, preferring to give Mabel the opportunity to discuss her ideas with the President.  He actually served coffee to the President. The kids wouldn’t believe it when they told them. There was a woman out on the deck, talking into the air.  “Do you want some coffee,” George asked. Had she been there all along?  “No, thanks.  You’re Mr. Liscomb?” she asked.  “George,” George nodded.  “Sherry, personal assistant,” she shook his hand.  George started to invite her in but she held up her hand and started talking to the air again.

After too short a time, the assistant came in, excused herself, leaned over and whispered something in the President’s ear.  The President stood up. “I’ll have to go.  It was wonderful meeting you and talking with you, Mrs. Liscomb,” he said and bowed slightly.  Mabel rose up from her chair, “A great pleasure, Mr. President, and thank you for your insights,” Mabel responded and – you gotta be kidding me, George thought – did a slight curtsy.  The President laughed.  George shook hands with the President, then they were gone.  “Holy mackeral,” George said as he sat down on the couch. “I’m sitting in the same seat as the President of the United States.  It’s still warm.”  Mabel gave him a look.  “Oh, damn!” George remembered.  “We forgot to take a picture!”  They both laughed.  George ran out on the back deck, hoping that they had not driven away yet but the van was gone.  The story of a lifetime and no picture to prove it.

Then George remembered that he had hit the buy button the past Friday.  He sat down at the computer. The market had opened up that morning slightly lower but several earnings reports were positive.  Apple and IBM were scheduled to announce earnings after the close.  Later that day, Apple’s earnings and sales were above consensus estimates. To offset Apple’s upbeat numbers, IBM announced a chilling quarterly report. For the 10th consecutive quarter, revenue at the technology giant had declined.  The death blow: earnings for 2014 were projected to be less than 2013’s earnings, something that hadn’t happened since 2002.  This stalwart of so many institutional portfolios was continuing to stumble.  If September’s Existing Home Sales, due to be released the following morning, declined any further, Tuesday could be a seriously down day.

George woke up again before sunrise on Tuesday.  Mabel was already awake as usual.  Thankfully, sales of existing homes  showed a bounce back in September to an annual pace of close to 5.2 million homes, the benchmark for a healthy churn.

George checked earnings stats at Zacks.  Before the opening bell, the staffing giant Manpower, announced better than expected earnings.  Although sales declined in some areas, McDonald’s earnings were 10% more than expectations.  Aircraft giant Northrup Grumman reported better than expected earnings as well. Yahoo reported earnings that were more than double the consensus.  Most of the extra profits came from the sale of shares that it owned in Alibaba’s IPO.  The market opened up sharply, closing the day with a 2% gain.  Their son, Robbie, called that evening and they told him all about the visit from the President. “How many pics did you get?  You should put them up on Facebook,” he told them. “We forgot,” George informed Robbie. “Daaaad,” came the exasperated reply.  “Well, we’re old people. We’re not used to recording every event in our lives, I guess.”

On Wednesday, the Bureau of Labor Statistics announced that inflation had grown 1.7% in the past year, in line with expectations.  The Federal government closes its fiscal year at the end of each September.  Each October, the Social Security Administration sets the inflation adjustment to Social Security checks for the coming calendar year.  A 1.7% increase meant an average $20 increase in monthly benefits.  For too many seniors depending on Social Security as their primary source of income, the low annual increases in payments did not keep up with increases in drug and food costs.  Retired folks on the lower rungs of the economic ladder then had to apply for food stamps to make up for the low yearly increases in benefits.

Dow Chemical surprised to the upside as did industrial manufacturers Graco and General Dynamics.  The positive mood on Wall Street was interrupted by the news of an attack on the Canadian Parliament.  George was cleaning leaves out of the front gutter when Mabel opened the door to tell him the news.  The market reacted negatively to the news but did not give up all of Tuesday’s gains, a positive sign.

On Thursday, the BLS reported that new claims for unemployment had risen slightly the previous week but that the four week average had fallen to the lowest level in 14 years.  Positive earnings reports from 3M and Caterpillar, both of whom had a large international customer base, propelled the market higher, trading above the range of Tuesday’s rally.

On Friday, September’s new home sales of 467,000 were the best of the recovery.  August’s robust sales figures were reduced by almost 50,000 to a revised 466,000, giving George a WTF frown.  A 10% revision?  The drug manufacturer Bristol Meyers and consumer giant Colgate reported higher than expected earnings.  Ford surprised with significantly higher than expected earnings but the details in the report were not encouraging.  Revenues in both North and South America had declined and Ford expected flat earnings growth for the full year.  The market gained almost 1%.  In the past seven trading days, it had gained back all the ground lost the six days prior, closing near the level of October 8th.

For 2-1/2 years, each decline had been followed by a sharp upturn.  “Buying on the dip” had become a often used phrase.  Anticipating a bounce with each dip, investors had been coming back into the market after a short decline.  Since mid-September, investors who had bought in on the bounce had been disappointed when the market continued to decline.

Despite all the positive earnings reports, George was still concerned that stock valuations were just a bit on the high side.  Earnings gains, as well as the growth in profit margins, were becoming slower.  There had been two brief fallbacks in 2013, and already three fallbacks and a correction of more than 5% in 2014.  Frequent small fallbacks were healthy for the market, shaking out excess optimism.  The last real correction – a 10% decline in price – had last occurred in May 2012.  The market of the mid-2000s had gone for several years without a 10% correction and that did not end well.  George worried that the Feds low interest policy, kept in place for almost six years, gave investors too few choices and herded them into the riskier stock market. Gotta stay watchful, he thought.

Retail Sales, Autos, Sell in May

May 18, 2014

This week I’ll look at sentiment among small business owners, retail and auto sales, and revisit the “Sell in May” idea.

Small Business

Cue the trumpets, clouds part, sun rays stream down upon the green fields.  After almost seven years, sentiment among small business owners broke through the 95 level according to the monthly survey conducted by the National Federation of Independent Businesses (NFIB).  Despite the many positives in this latest survey, hiring plans remain muted.  This unfortunately confirms several other reports – the monthly employment report, JOLTS, disposable income, to mention a few – that indicate a befuddling lack of robust employment gains during this recovery.


Retail Sales

The monthly reports on employment and retail sales probably have the most impact on short term investor sentiment.  Retail sales were flat in April but have rebounded well after the particularly harsh winter.  With a longer term perspective, year over year retail gains are not robust but are still in the healthy zone of 2-1/2%.

Per capita inflation adjusted retail and food service sales are strong.  Rising home prices in the early 2000s drove an upsurge in retail sales, followed by an offsetting plunge as home prices dropped and the financial crisis of 2008 hit consumers hard.  The landslide of employment losses undercut retail sales.

Motor Vehicles sales are particularly strong and are now back to the pre-recession trend line.

However, that recession dip represents millions of vehicles not sold and contributes mightily to the record average age of more than 11 years for vehicles in the U.S. (AutoNews)  As the article noted, better engineering has lengthened the serviceable life of many autos.  There are 247 million registered passenger vehicles and light trucks, more than one for each of the 240 million people in this country over the age of 18 (Census Bureau) According to the industry research firm Motor Intelligence (spreadsheet), April’s year to date passenger car sales have declined 1.8% while sales of light pickups have surged 8.3%.  The particularly harsh winter months probably reduced traffic at car dealerships around the country, but the year-over-year comparison in April was only a 3.6% gain.  The lack of a spring bounce indicates that household income gains are meager.  The rise in sales of light pickups is largely due to a 10% increase in construction spending in the past year.

On an annualized basis, auto sales are approaching 16 million, a level last seen in November 2007 and far above the 10 million vehicle sales in 2009.

The numbers look rather strong but annual sales per capita are at the recession levels of the early 1990s.   Clearly, something has changed.

Better engineering has increased serviceable vehicle life.  Demographic changes may be having an effect. The population is aging and older people who drive less may decide to hang on to their vehicles longer.  A population shift toward urban centers reduces demand for autos.  There is a greater availability of public transportation.  In some areas of the country, an electric scooter or bicycle meets many transportation needs.
Long term shifts in an industry prompt employers to look for opportunities to adjust some part of their strategy or cost structure to meet those changes.  Three weeks ago, Toyota announced that they will move their headquarters from Torrance, CA, in the South Bay area of metro L.A., to Plano, TX.  As the largest employer in Torrance, the city’s economy will surely take a hit. (Daily Breeze)  Toyota joins a list of large employers leaving or reducing their presence in California (article)


Sell in May

The market has flatlined since early March.  Most of the companies in the S&P500 have reported earnings for the first quarter.  68% beat expectations but this has become a highly sophisticated game of managing expectations.  What is notable is that sales growth has slowed.  As I noted a few weeks earlier, labor productivity is poor.  Companies have done a remarkable job of cutting costs to boost profits but it is unclear how much more they can cut.  Last year’s 30% rise in the market has spurred the rise of mergers, or growing profits through economies of scale.

If the market were to decline 10 – 20% from here, some would point to the chart of the S&P500 and say they saw it all along.  “Classic case of a market top,” they would intone.  “Several failed attempts to break through resistance at the 1900 level indicated a major market correction.”  Oh, and they have a newsletter that you can subscribe to.

If the market goes up 10%, a different set of people will proclaim that they saw it all along.  “The market was forming a baseline of support,” they will sagely pronounce.  Each of these people also have a newsletter.

“Sell in May and go away” is an old quip of short term trading.  In 2011, I explored (here and here) the truths and myths behind this old saw. On a long term basis, one earns better returns by disciplined monthly, or quarterly, investing. Still, in a slight majority of the almost 20 years I reviewed, the Sell in May approach had some validity. Let’s look back at the last five years.  Typically an investor would sell the S&P500 and go into long Term Treasuries (TLT).  A more cautious investor might pick a less volatile intermediate bond fund.

In 2013, the SP500 went nowhere from May 1st to September 1st.  Great call by our intrepid investor who took some of her money out of the market and invested in Long Term Treasuries (TLT) in early May.  By early September, however, her investment would have depreciated 13%. Ooops!  Better to have stayed in stocks.

Likewise, in 2012, stocks went nowhere from early May to early September.  Unlike 2013, an investor buying long term Treasuries during that period had a 7% gain BUT if she had waited a week to sell in September, there was no gain.  The gains were a matter of luck.

2011 was the bing-bang year for the Sell in May crowd.  The stock market lost about 12% during the summer while long Treasuries gained 20%.

In 2010, stocks fell 7% during the summer while long Treasuries gained 10%.  During the summer of stocks gained almost 12% while Treasuries changed little.  In short, the strategy worked three summers out of the past five.

Now for a more fundamental approach – investing in companies that are more stable.  Horan Capital Advisors referred to a report from S&P Capital IQ that found that companies in the S&P500 with a low beta offset or reduced any summer market volatility.  Beta is a measure of a stock’s price volatility.  A value of 1 is the volatility of the entire index.  Betas less than 1 mean that a company’s stock price is less volatile than the index.  As volatility of the total market increases, investors tend to seek companies with a more reliable outlook and performance.  The screening criteria produced a mix of companies dominated by those in the consumer discretionary and health care sectors.  Worth a look for investors who buy individual stocks.

Spring Fever

April 27th, 2014

Existing Home Sales

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

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

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

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

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


Spring Fever

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

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


Buffet Investing Advice

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

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

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


Consumer Price Index and College Tuition

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

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

Market Bumps

January 26th, 2014

In a holiday shortened week, the market opened higher than the previous Friday but fell a bit more than 3% by week’s end.  On this same week in 2012, the market lost 2.5% in 3 trading days.  As I mentioned last week, there were few economic reports this past week to detract from the focus on corporate earnings.

IBM opened up the week by beating profit estimates but missed revenue estimates by $1 billion, or about 3%, and were about $1.5 billion less than the final quarter of 2012.  The 4th quarter is usually IBM’s strongest quarter each year; lower revenues from this giant indicate a cautious business investment outlook.  IBM is selling for the same price now that it did in mid 2011, a price earnings ratio of 12.

The following day, China announced that the country’s industrial production has fallen just below the neutral mark.   The reaction to the news was exaggerated by sharp declines in some emerging market currencies, which started a cascade of selling. See SoberLook blog for some charts. Similar weakness out of China last summer prompted a much more subdued reaction.

On Thursday, McDonald’s reported weak sales growth, which added to concerns.  After a run up of 30% last year, many traders were on high alert for any negative news.  The U.S. stock market has enjoyed a tail wind from Federal Reserve stimulus policy, but a global economy is largely outside of the Fed’s influence.

A 14 month support trend line that has been in place since November 2012 sets a mark at about 1760.  Dropping below that would signal a short to mid term shift in market sentiment.  The SP500 index closed at 1790 on Friday, 1.7% above that support trend line.  The 10 month average of the index is 1700.  A drop below that mark would signify a change in mid to long term sentiment. A few weeks ago, I noted that the market was close to 10% over its 10 month average.  This week’s decline puts that percentage at a bit over 5%.


Existing home sales notched up a bit in December but the yearly percent gains were relatively flat.  The 4 week average of new claims for unemployment declined to 331,000.  Several weeks ago it was close to the psychological 350,000 mark.  Mitigating the decline in new claims, continuing claims have been rising lately and are approaching the 3 million mark.

To put that 3 million people in historical perspective, take a look at the chart below.

The number of long term unemployed is ever a concern.


In early October I noted the relative sluggish performance of retail stocks vs the larger market index of the SP500 ahead of the Christmas buying season.  Below is an updated chart of a retail index ETF vs the larger market.

Shortly after that post, renewed hopes for a strong Christmas season led to higher prices for the group.  Disappointing sales gains announced as the season ended deflated that balloon.  Since the new year began, a composite of retail stocks has lost 8%.

Typically retailers report their earnings in mid to late February.  Traders have already priced in a rather disappointing earnings season for the retailers.  In the context of a longer time frame, retail stocks are still up 25% year over year.  If an investor had bought this composite on this date seven years ago when the economy was strong and retail stocks were at a high, she would still have doubled her money, easily outpacing the 38% gains in the larger market since then.  The resilience of consumer demand, despite an extremely severe downturn when unemployment and falling house prices put a brake on consumer spending, has helped make this sector a sure footed long term winner.  

Housing, Unemployment and CPI

January 19th, 2014

A strong retail report for December and an improvement in sentiment among small business owners buoyed the market at the start of the week.  Both reports continue a trend that indicates a healthy economy:  results are at at the upper bound or above expectations.

The latest report of  jobless claims at 325,000 pulled the 4 week average further down away from the psychological mark of 350,000.  This is sure to reassure short to mid term traders.  The weak BLS employment report released a week ago may have just been an anomaly.  Other employment indicators, as well as retail sales and business production simply do not confirm the headline numbers from the BLS.

The Consumer Price Index for December showed a mild 1.5% year over year increase and will reassure the Fed that its stimulus program poses little danger of igniting inflation.

The National Assn of Homebuilders reported continued strong growth in their Housing Market Index.

Featured on one of the blogs that I link to is a chart of the annual returns of the SP500.  Double digit gains in the index, like the one we had last year, are rather common, occurring about 40% of the time.  A reassuring takeaway for the longer term investor is that the market goes up in 75% of the years for the past eighty years.

The number of unfilled job openings in November was the highest since March of 2008, indicating continuing strengthening in the labor market.  Job openings have been above the ten year average for over a year now.

The number of people who voluntarily quit their jobs continues to climb over the past year.  Employees quit when they feel more confident about job prospects. While this metric has been improving, it is only at the lowest levels of the past decade.

Housing starts declined slightly in December to a million but is still growing from the lows of the bust.

Let’s get a bit of perspective. There is a decided shift downward from the post war building boom.  Below is a graph of  housing starts adjusted for population growth.

Adjusted for population growth, the multi-family component of housing starts has reached the normal levels of the past two decades.  This is the more stable component of housing starts.

Starts of single family homes have not yet reached the lows of past recessions.  The words “improvement” and “recovery” should be viewed in the context of these abysmal lows.

The Consumer Price Index (CPI) for December showed a year over year increase of 1.5%.  I believe this understates current inflationary pressures on consumers but it is the official rate, one that the Federal Reserve will use to guide policy.  The low rate will help allay fears that continuing stimulus will spur inflation in the near term.

Stock prices will be driven largely by earnings reports at this time.  About 10% of SP500 companies have reported this past week, too few to get a solid feel yet for the past quarter.  62% of companies have beat expectations, a bit less than the more normal 70%.  The market is largely trading sideways as it digests both the past quarter’s results and the forward guidance that companies give when they report.  IBM, Johnson and Johnson, and Verizon kick off this holiday shortened week when they report earnings on Tuesday. McDonald’s, Microsoft, Proctor and Gamble, and Netflix are due to report this week as well.  There don’t appear to be any significant market moving economic reports coming up this week.  Existing Home Sales on Thursday might have some minor impact and traders will be watching the continuing trend in new unemployment claims.