Category: stock market

Winter Wonderland

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December 8th, 2013

The Bureau of Labor Statistics rode down like Santy Claus on the arctic front that descended on a large part of the U.S. The monthly labor report showed a net gain of 203,000 jobs in November, below the 215,000 private job gains estimated by ADP earlier in the week, but 10% higher than consensus forecasts.  Thirty eight months of consecutive monthly job growth shows that either:

1) President Obama is an American hero who has steered this country out of the worst recession – wait, let me capitalize that – the worst Recession since the Great Depression, or

2) American businesses and Republican leadership in the House have overcome the policies of the worst President in the history of the United States. 

Hey, we got some Hyperbole served fresh and hot courtesy of our radio and TV!

The unemployment rate dropped to 7.0% for the right reasons, i.e. more people working, rather than the wrong reasons, i.e. job seekers simply giving up.  The combination of continued strong job gains and a big jump in consumer confidence caused the market to go “Wheeee!”

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A broader measure of unemployment which includes those who want work but haven’t looked for a job in the past four weeks declined to 7.5%.  This is still above the high marks of the recessions of the early 90s and 2000s.

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Construction employment suffered severe declines after the collapse of the housing bubble.  We are concerned not only with the level of employment but the momentum of job growth as the sector heals.  A slowing of momentum in 2012 probably factored into the Fed’s decision to start another round of QE in the fall of last year.

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Job gains were broad, including many sectors except federal employment, which declined 7,000. Average hours worked per week rose by a tenth to 34.5 hours and average hourly pay rose a few cents to $24.15.

Discouraged job seekers are declining as well.  The number of involuntary part time workers fell by 331,000 to 7.7 million in November.  As shown in graph below, the decline is sure but slow.

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There are still some persistent trends  of slow growth.  Job gains in the core work force aged 25 -54 are practically non-existent.

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The percentage of the labor force that is working edged up after severe declines this year but the trend is down, down and more down.

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The number of people working as a percent of the total population has flatlined.

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Let’s turn to two sectors, construction and manufacturing, which primarily employ men.  The ratio of working men to the male population continues to decline.  Look at the pattern over 60 years: a decline followed by a leveling before the next decline, and so on.  Contributing to this decline is the fact that men are living longer due to more advanced medical care and a fall in cigarette smoking.

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The taxes of working people have to pay for a lot of social programs and benefits that they didn’t have to pay for thirty years ago.  Where will the money come from?  A talk show host has an easy solution: tax the the Koch Brothers, cut farm subsidies to big corporations and defense.  Taking all the income from the Kochs and cutting farm subsidies and defense by half will produce approximately $560 billion, not enough to make up for this year’s budget deficit, the lowest in 4 years.  What else?

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In a healing job market, those aged 16 and up who are not in the labor force as a percent of the total population  continues to climb.

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A familiar refrain is the steady decline in manufacturing employment.  Recently the decline has been arrested and there is even slight growth in this sector.  Although construction is regarded as a separate sector, construction is a type of manufacturing.  Both employment sectors appeal to a similar type of person.  Both manufacturing and construction have become more sophisticated, requiring a greater degree of specialized knowledge.  Let’s look at employment trends in these two sectors and how they complement each other.

During the 90s, a rise in construction jobs helped offset moribund growth in manufacturing employment.

In 2001, China became a member of the World Trade Organization (WTO) , enabling many manufacturers to ship many lower skilled jobs to China.  At the same time, a recession and the horrific events of 9/11 halted growth in the construction sector so that there was not any offset to the decline in manufacturing jobs.

As the economy began recovering in late 2003, the rise in construction jobs more than offset the steadily declining employment in the manufacturing sector.  People losing their jobs in manufacturing could transition into the construction trades.

As the housing sector slowed, construction jobs declined and the double whammy of losses in both sectors had a devastating effect on male employment.

In the past three years, both sectors have improved.

Although the Labor Dept separates two sectors, we can get a more accurate picture of a trend by combining sectors.

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In the debate over the effectiveness of government stimulus, there is a type of straw man example proposed:  what if the government were to pay people to dig holes, then pay other people to fill in the holes?  Proponents of Keynesian economics and government stimulus argue that such a policy would help the economy.  Employed workers would spend that money and boost the economy. Those of the Austrian school argue that it would not.  Digging and filling holes has no productive value.  Ultimately it is tax revenues that must pay for that unproductive work.  Therefore, digging and filling holes would hurt the economy.

So, let’s take a look at unemployment insurance through a different set of glasses.  Politicians and the voters like to attach the words “insurance” and “program” to all sorts of government spending.  Regardless of what we call it, unemployment insurance is essentially paying people to dig and fill holes – except that the holes are imaginary.  IRS regulations state that unemployment benefits are income, that they should be included in gross income just as one would include wages, salaries and many other income.

If unemployment is income, how many workers do the various unemployment programs “hire” each year?  Unemployment benefits  vary by state, ranging from 1/2 to 2/3 of one’s weekly wage. (Example in New Jersey)  As anyone who has been on unemployment insurance can verify, it is tough to live on unemployment benefits. I used the average weekly earnings for people in private industry and multiplied that by 32 weeks to get an average pay, as though governments were hiring part time workers.  I then divided unemployment benefits paid each year by this average.  Note that the divisor, average pay, is higher than the median pay, so this conservatively understates the number of workers that are “hired” each year by state and federal governments.

What is the effect of “hiring” these workers?  I showed the adjusted total (blue) and the unadjusted total of unemployed and involuntary part time workers.  The green circle in the graph below illustrates the effect that extensions of unemployment insurance had on a really large number of unemployed people.

At its worst in the second quarter of 2009, the unemployed plus those involuntary part timers totaled 24 million, almost 16% of those in the labor force.  8 million were effectively “hired” to dig imaginary holes.  In the long run, what will be the net effect of paying people to dig holes and fill them?  First of all, a politician can’t indulge in long run thinking.  In a crisis, most politicians will sacrifice long run growth so that they can appease the voters and keep their own jobs.

In the long run, ten years for example, paying people to do nothing productive will hurt the economy.  The argument is how much?   Keynes himself wrote that his theory of stimulus and demand only worked when there was a short run fall in demand.  At the time Keynes wrote his “General Theory,” the world economy was floundering around in a severe depression.  The severe crisis of the Depression birthed a theory that divided the economists into two groups: the tinkerers and the non-tinkerers.  Keynesian economists believe in tinkering, that adjusting the carburetor of the economic engine will get that baby purring.  Austrian or classical economists keep asking the Keynesians to stop messing with the carburetor; that all these adjustments only make the economy worse in the long run.

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The November report from the Institute for Supply Management (ISM) showed strong to robust growth in the both the manufacturing and services sectors.  As I noted this past week, I was expecting the composite CWI index of these reports that I have been tracking to follow the pattern it has shown for the past three years.  Within this expansion, there is a wave like formation of surging growth followed by an easing period that has become shorter and shorter, indicating a growing consistency in growth.  The peak to peak time span has decreased from 13 months, to 11 months to 7 months.  The index showed a peak in September and October so the slight decline is following the pattern.   IF – a big if – the pattern continues, we might expect another peak in April to May of 2014.

To get some context, here’s a ten year graph of the CWI vs the SP500 index.

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As the stock market makes new highs each week, some financial pundits get out of bed each morning, saddle up their horses, load up their latest book in the saddle bags and ride through TV land yelling “The crash is coming, the crash is coming.”  Few people would listen to them if they shouted “Buy my book, buy my book.”  They sell a lot more books yelling about the crash.

How frothy is the market?  I took the log of the SP500 index since January 1980 and adjusted it for inflation using the CPI index.  I then plotted out what the index would be if it grew at a steady annualized rate of 5.2%.   Take 5.2%, add in 3% average inflation and 2% dividends and we get the average 10% growth of the stock market over the past 100 years.  The market doesn’t look too frothy from this perspective.  In fact, the financial crisis brought the market back to reality and since then, we have followed this 100 year growth rate.

Now, let’s crank up the wayback machine.  It’s November 1973.  Despite the signing of the Paris Peace accord and an act of Congress to end the Vietnam war, thousands of young American men are still dying in Vietnam.  The Watergate hearings continue to reveal evidence that President Nixon was involved in the break in of the Democratic National Committee and the subsequent attempts to cover it up.  Rip Van Winkle is disgusted.  “This country is going to the dogs,” he mutters to himself.  He lies down to take a nap in an alleyway of the theater district of New York City.  The SP500 index is just below 100.  Well, Rip doesn’t wake up for 20 years.  In November 1993, he wakes up, walks out on Broadway and grabs a paper out of nearby newspaper machine.  The SP500 index is 462.  Rip doesn’t have a calculator but can see that the index has doubled a bit more than twice in that time.  Using the rule of 72 (look it up), Rip estimates that the stock market has grown about 8% per year.  Which is just about normal.  But normal is what Rip left behind in 1973.  “Normal” is SNAFU.  So he goes back into the alleyway and goes back to sleep for another twenty years, waking up just this past month.  He walks out on Broadway and reads that the index has passed 1800.  “Harumph” Rip snorts.  That’s two doublings in twenty years, a growth rate of a little over 7%.  Rip reasons that eventually he’ll wake up, the country will have mended its ways and Rip will notice a growth rate of 9 – 10% in the market index.  He goes back to sleep.

In the 40 years that Rip has been asleep, we have had three bad recessions in the 70s, 80s and 2000s, a savings and loan crisis in the 80s, an internet bubble, a housing bubble, and the mother of all financial crises.  Yet the market plods along, slowing a bit, speeding up a bit.  Long term investors needs to take a Rip Van Winkle perspective.

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And now, let’s hop in the wayback machine – well, a little ways back.  Shocks happen.  During periods when the market is relatively well behaved as it has been this year, investors get lulled into a sense of well being.  From July 2006 through February 2007, the stock market rose 20%.  Steadily and surely it climbed.  Housing prices had already reached a peak and the growth of corporate profits was slowing. Some market watchers cautioned that fundamentals did not support market valuations. At the end of February 2007, the Chinese government announced steps to curb excessive speculation in the Shanghai stock market (CNN article).  The stocks of Chinese companies tumbled almost 10%, sending shocks through markets around the world.  The U.S. stock market dropped more than 5% in a week.

“Here comes the crash” was the cry from some. The crash didn’t come.  Over the next six months, the market climbed 16%.  Finally, continuing declines in home sales and prices, growing mortgage defaults and poor company earnings began to eat away at the market in October 2007.  Remember, there is still almost a year to the big crash in September and October of 2008.

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Next week I’ll put on a different shade of glasses to look at inflation.  Cold air, go back to the North Pole.

Trends and Bubbles

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November 17, 2013

This week the department store Macy’s reported sales growth that was above forecast.  Same store sales rose 3.5%, about 50% better growth than expected.  Macy’s attracts a higher income customer than Target, J.C. Penney or Wal-Mart.  On Thursday, Wal-Mart announced that their sales had declined for a third quarter in a row.  The holiday season depends on lower and middle working class folks, the kind who shop at Wal-Mart, to open their pockets.  Investment firm Morgan Stanley expects this retail season to be the worst since 2008 when the country was deep in recession. (Source)
What can we learn from a bird’s eye view of the growth in consumer credit?  At 5.6% year over year, it is stable.

Note the response time lag in this series.  The growth in consumer credit did not decline below 5% till months after the recession started.  Despite the loss of hundreds of thousands of jobs in the beginning of 2008, this net job loss represented less than 1% of the work force in mid-2008.  The job loss would mount into the millions but jobs are “sticky,” meaning that a downturn in the economy has a minor effect on most people most of the time.  After the fact, it is easy for us to point at some chart, arch our eyebrows in a knowing glance, and say “We can see the breakdown of the economy beginning here.”

On a long term chart, we can see a reduction in growth swings over the past thirty years.  Relatively flat income growth for a majority of workers has dampened the swings.  While good for household balance sheets, it means that we can expect less economic volatility but also muted growth for the next decade.

Expectations for the holiday season are not reflected in the price of retail stocks.  A basket of retail companies has grown about 40% this year and is up about 70% over two years.  It may be time to take a bit off the table in this sector.

The Consumer Financial Protection Bureau (CFPB) was created a few years ago to act as a watchdog over the credit practices of the largest banks.  On Tuesday, Richard Cordray, Director of the agency appeared before a Senate committee.  He confirmed that the agency collects a lot of anonymized data on 900 million credit card accounts each month as part of its supervisory role.  Questions should be raised whenever any government agency collects data on us.  How is the data protected?  Who has access to the data?  What about my privacy?

Mr. Cordray noted that several other agencies as well as private industry collect this data.  Because the data is anonymized, we are little more than a number to  the agency, but there are several concerns.  Federal agencies have a great deal of legal power, enabling them to get a warrant to access  the data on anyone.  Cordray repeatedly assured the committee that no one at the agency is interested in our personal data but left off one adverb – “now.”  In the aftermath of 9-11, anti-war protestors found themselves turned away at airports or flagged for additional screening.  How did federal agencies know the travel plans of many protestors?  It does not take a team of FBI agents to trace the activities of any citizen when several federal agencies have our monthly financial activity at their fingertips.  Secondly, there is the matter of security.  How many parties does our data go through on its way to the agency?  Where and at what stage in the process of data aggregation is the anonymizing done?  Is our personal credit card info transmitted first to a separate third party anonymizer before being transmitted to the various agencies?  Is the raw data being transmitted to an agency which then anonymizes the data using a third party program or process?  In any case, it was clear that our monthly card transactions are making the rounds in both private industry and various government agencies.

The stock market continues to rise, prompting talk of a bubble.  If you have access, try to read “Is This A Bubble” by Joe Light in this weekend’s edition of the Wall St. Journal.   It is both informative and measured in its assessment.

 In February 2012, I mentioned the Golden Cross which had occurred in late January.  This long term indicator of market sentiment is a crossing of the 50 day moving average of stock market prices above the 200 day average.

Since then the market has risen about 40%.  Man, if I had only taken my own advice and moved all my investments and money into the stock market!  As the market continues to rise, more and more investors catch the “if only” disease and start moving money from safer investments into stocks.  This is why many of us tend to buy high and sell low.  Instead we should stay with the fundamentals of diversify, diversify, and lastly – diversify.  A long term indicator like the Golden Cross is not a signal to dump all of our savings into stocks – unless we are in our 30s and have lots of time before we need the money.  A more sensible approach is to adjust allocation upwards towards stocks and this depends on a person’s age, needs, and fears.  If a person has a 50% stock allocation, with the remaining 50% in bonds and cash (I’ll leave alternate investments out for right now), that indicates a moderate tolerance for risk.  They might shift the allocation to 55% stocks or 60% when they see a Golden Cross.   A person who has a 70% allocation to stocks, indicating a high tolerance for risk, might start adjusting to an 85% to 90% allocation.  Using this more moderate approach, a person would have lightened up their stock allocation in December 2007 when a reverse Golden Cross happened.

So what if someone has been very scared of the stock market and has only 10% of their savings in stocks?  Should they move some money into the market now?  That depends.  If the thought of making even a slight change leads a person to lose sleep, then no.  Should someone change their allocation of stocks from 10% to 50% now?  That is a major allocation change and should be done using dollar cost averaging.  This is a process where one takes money from one investment basket every month and puts it in another investment basket. There is also a psychological advantage to this approach.  As a person’s allocation percentage becomes a bit riskier, they can adjust to the additional risk in a measured way.

Tolerance for risk is a composite of several components:  psychological or emotional, future liquidity needs, age, and assets as well as income sources.  Too often, people think of tolerance for risk as an emotional response only.  While it is true that our emotions can cloud our measured response to risk, it is important to keep in mind that it is only one of the components.

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In answer to calls from his own party members, President Obama announced an administrative change to the Affordable Care Act (ACA) that allows those with policies in the individual health care market to retain their policies even if the policies don’t meet the minimum standards of the ACA.  Politicians, pronouncements and podiums – stir them together and voila!  The President’s pronouncement was little more than political cover at this late stage in the transition to Obamacare.  Only if the states allow it and companies decide to offer the plans will an individual policy holder be able to “keep their plan,”  as the President promised on numerous occasions in the past few years.

On Friday, the Energy and Commerce Committee released emails subpoenaed from CMS, the agency that administers Medicare and the ACA.   The emails contradict previous testimony by both CMS head administrator Marilyn Tavenner and HHS Secretary Kathleen Sibelius that only routine problems with the healthcare.gov web site were anticipated before the launch of the web site.  Ms. Tavenner testified that there were enough problems that they decided to delay the implementation of the small business plans on the web site but it appears that the problems went much further and top officials were alerted.

Henry Chao, the deputy CIO at CMS, was made aware of many major security, transactional and design problems with the web site during the summer but decided – or was pressured to decide – that the site would go live on October 1st regardless.  President Obama’s repeated selling point has been what he calls “smart” government. The rollout of the federal health care website has  revealed – once again – that the government in Washington has become too big and too top down to be smart, or effective.  To keep their campaign coffers filled, too many in Washington must placate those companies which fund those coffers, including special favors and bailouts for the elite on Wall Street.  To get the votes, they must placate the poor with programs and promises.

A conflict of interests and a clash of incentives makes most of the Washington crowd ineffective.  Turn on C-Span and watch the faces of the House and Senate Budget Conference (House and Senate).  These are intelligent, committed people who feel the pull of these different puppet masters, those political interests that keep them in their respective seats.   Each one of them earnestly wants to fix the problem – and that is the problem.  Much of the time, they are fixing the previous fixes they implemented.  This approach makes Congress feel important. I would suggest that they do little more than enact incentives and let their constituents craft the solutions.  Sure, the solutions will not be crafted with the superior technical expertise that Washington promises. Instead, they will emerge in a stumbling, hodge-podge way that will disenchant those who believe in the romantic notion of omniscient experts who engineer elegant solutions to social and economic problems.  I hope that one day the Washington elite will let Main St. try to figure out the solutions to some of these problems. We can do better.

Shoot Out At the OK Corral

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October 20th, 2013

This coming Saturday is the 132nd anniversary of the gunfight at the OK corral.  We got our own OK corral in Washington and there was a whuppin’ this week – a Washington style whuppin’, which means that no one got whupped but everyone agreed on an appointment date for a  future whuppin’.

Congress passes a continuing budget resolution with the same frequency that many of us get our teeth and gums cleaned.  Many government reports were not released this past week but the National Assoc of Homebuilders (NAHB) released a very positive monthly report of the national housing market, showing a slight decline over the past few months last month but still a strong index reading of 55.  Two years ago this October, that index stood at 15.  In fact since the latter part of 2007, the index oscillated in the range of 15 – 20, so this has been a strong and sustained growth surge.

Over the past hundred years, house prices have risen at about the same rate as inflation, so that the real price of homes stays about the same.  Most homeowners finance their home purchase and it is this interest cost that determines the total capital cost of the home.  That capital cost and the interest cost is divided over the life of the mortgage into monthly payments.  PITI is a familiar acronym to many home owners and buyers; the initials represent the components of a monthly house payment. The ‘P’ stands for Principal – the monthly capital cost of the home.  The ‘I’ is interest on the amount of the loan.  The ‘T’ represents the local real estate taxes which are included in the monthly house payment sent to the mortgage servicer who forwards them on to the local taxing agency. The ‘I’ represents Insurance.  This can be both house insurance and, for those with an FHA loan, the amount of the loan insurance.  The interest rate on the home loan is a key component and although there has been an increase in mortgage rates since the spring, they are near all time lows.  A 30 year mortgage is a common benchmark.

Let’s index the CPI and the house price index to 1991 and look at the divergence.

Declining interest rates have enabled many more people to qualify for a home purchase, thus driving up home prices. In 1995, Congress made some major revisons to the 1977 Community Reinvestment Act, making home loans more available in distressed urban and rural districts.  This further exacerbated the rise in home prices, creating a large divergence between the CPI and the housing price index.

As every homeowner knows, the cost of a home includes maintenance, repairs, utilities, and improvements.  As I discussed last week , real median household incomes plateaued during the 2000s.  The rise in home values and changes in banking laws enabled homeowners to tap the equity in their homes to meet these additional obligations and to augment stagnant incomes.

In the past dozen years, many people discovered that housing is not a reliable source of income.  At the turn of the century, stock traders who quit their jobs to trade stocks during the tech bubble, discovered the same truth about the stock market, whose price returns are a few percent above inflation.  A nifty calculator at  DQYDJ illustrates the average returns of the SP500 over the past 100 years.

 

At the heart of the financial follies of past centuries is that a surge in price for some asset, be it tulip bulbs, Florida real estate or tech stocks leads people to conclude that they can hop on the gravy train.  What is the gravy train?  As an asset increases in value, more people invest in the asset bubble, the valuation continues to rise and – for a time – it is possible to convert a stock, a store of value, into a flow of income by either buying and selling the asset or borrowing money against the asset.  There is always some constraint – the rise of inflation, or the rise of personal incomes, or the growth rate of profits – that eventually brings an asset valuation down to earth.  Einstein famously quipped that the most powerful force in the universe was compound interest.  He might have mentioned  what may be the most powerful force – reversion to the mean.

Corporate Profits and New Orders

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Wednesday’s release of durable goods orders showed a rather large downward revision to July’s data and an increase in August’s orders.  The transportation component makes the overall reading of this report quite volatile.  A more consistent read is gained by excluding transportation and defense goods, which showed a less dramatic 3.3% decline in July, followed by a slight increase of 1.5% in August.  The year on year increase is 7.6%.

In nominal dollars, not adjusted for inflation, we have reached the level of new orders before the recession began in late 2007 – early 2008.  Had the economy stayed “on trend” new orders would be over $84 billion this year.

When adjusted for inflation, we are at about 2006 levels – seven years of no net growth.

Second quarter corporate profits are up almost 6% and have tripled in the past ten years.

Despite all the daily and weekly responses to political as well as economic news, the SP500 stock market index essentially rides the horse of of corporate profits.  The market’s fluctuations reflect changing current expectations of future profits.  Except for the “irrational exuberance” of the late 90s, there is a remarkable correlation between the SP500 and corporate profits.

Focusing on the past ten years, we can see these two forces as they dance around each other.   As sales and profit emerge over each quarter, companies guide analysts estimates of profits up and down.  The market renegotiates its value based on these revisions of emerging profit estimates.  As a rule of thumb, an investor with a mid term horizon of 1 – 3 years might grow wary when these trends diverge as they did in the late 90s and 2006 – 7.

 

As a percent of the total economy, profits have doubled over the past ten years.  At the trough in 2008, when some financial pundits were forecasting the end of capitalism, profits as a percent of GDP were at the 25 year average.  Investors had become used to this lop-sided economy where corporations grab more of the economic pie.

A growing share of profits is earned overseas; that growing globalization and two decades of effective lobbying have enabled corporations to lower the tax bite on those profits.

The taxation of corporations is a two-edged sword.  One effect of more taxes for corporations means less dividends to investors, who probably pay taxes at a higher rate than the effective rate of corporations.  During the 1980s and 90s, dividends averaged around 40 – 50% of earnings after taxes.  In the past decade and especially after the cash crunch of 2008, corporations have retained more of their earnings as an emergency cash cushion, paying investors about 30 cents on each dollar of earnings.  That rush to safety will probably reverse itself in the coming years, prompting corporations to pay out more in dividends as a percent of profits.

There may be volatility in the market in the coming days and weeks as Congress wrestles over the funding and implementation of the health care act, threatening to shut down most non-essential functions of the entire government.  A similar budget battle in late July and August of 2011 was accompanied by an almost 20% drop in the market.  The longer term trend is told by the rise in corporate profits, by the rise in industrial production and by the rise in new orders.  A move downward in the market may be a good time to put some cash to work, or to make that IRA contribution for 2013.

Labor and Money Flows

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September 1st, 2013

On this Labor Day weekend, I’ll review some things that caught my attention this past week.

The employment picture has shown steady but slow improvement.  The weekly survey of new unemployment claims continues to show downward movement.  In a survey that is about 13 years old, called the JOLTS, the BLS gathers data on Job Openings, Layoffs and Turnovers.  A component of this survey includes the number of employees who have quit their jobs, referred to as the “JOLTS quit rate.” In the aggregate, it indicates a hive intelligence, the estimation of millions of people about the prospects of getting another job.  Decades ago, researchers asked a number of people to estimate the number of jelly beans in a jar.  Each estimate has very small chances of getting close to the actual number, but the average of all estimates was found to be almost exactly the number of jelly beans in the jar.  I don’t know whether this experiment has been replicated but it is interesting.

After recent months of surging new orders for durable goods, July’s report, released Monday, showed signs of caution and a “return to the mean” of a positive upswing this year.

Although this past month’s data was negative, industrial production shows a clear uptrend.

In an analysis released a few months ago, the Federal Reserve examined data from the 2010 triennial (every 3 years) survey of households and estimated that inflation adjusted net worth per household (green line in the graph) has just climbed back to the level it was almost ten years ago.

 

On the positive side, average net worth is not less than it was ten years ago.  On the negative side for those nearing retirement, it is not more that it was ten years ago.

On Friday, the Personal Consumption and Expenditures (PCE) report showed a 1.4% year over year percent gain, indicating the tepid growth in household spending.  Below I’ve charted the percent gain in PCE vs the percent gain in GDP for the past thirty years.

We are still below the low points of the 1980s, 1990s and early 2000s.  The Federal Reserve is projecting GDP growth of 3 – 3.5% in 2014 but this may be another in a string of rosy forecasts by the Fed, who have repeatedly revised earlier rosy forecasts.  If the Fed were a contractor, it would be out of business due to poor estimating.  A $16 trillion economy is not a kitchen remodel by any means, but it does illustrate how difficult it is for the best minds to make even short term predictions of the economy from the vast amounts of sometimes conflicting data.  Consider then the folly of the Government Accountability Office (GAO), the economic watchdog created by Congress and mandated by Congress to come up with ten year estimates of economic growth and the consequences of existing and proposed legislation.  Those in Congress continue to trot out these fantasy numbers to support or criticize policy and legislation.

Washington continues to vacuum in money and talent from the rest of the country.  Of the richest counties in per capita income in the U.S., the Washington metro area has two of the top three.  The other county in the top three is a stone’s throw from the metro area.  As Washington politicians convince the rest of us that they have the solutions, lobbyists and graduates flock to the concentration of power, jobs, money and influence.
 
Bond yields have increased more than 1% since the spring, meaning that the prices of the bonds themselves have fallen dramatically.  Most of this change has been a reaction to forecasts for stronger growth and a tapering of the Fed’s stimulus program called Quantitative Easing.  Washington is sure to get in the way of stronger growth for the economy as a whole.  Policy out of Washington is designed to promote strong economic growth for Washington.

The market research firm Trim Tabs regularly monitors money flows into and out of the stock and bond markets.  They  reported today that outflows from the stock market in August were half of the record inflows in July.

The blood spilled this year has been in the bond market.  Trim Tabs reports that outflows from bond funds and ETFs have totalled more than $123 billion in the past three months.  Flows into bond funds and ETFs were about $750 billion in 2012, almost a doubling from the $400 billion invested in 2011. (Fed Flow of Funds tables F.120, F.121)

While the prospect of higher rates may have been the trigger that caused a reversal of bond inflows, the underlying current is also an overdue correction of the surge of investment in bonds in 2012.

Households continue to shed debt in one form or another so that total liabilities continue to decline. However, every man, woman and child in this country is carrying, on an inflation adjusted basis, 2-1/2 times the amount of debt they carried thirty years ago.  This level of household liability will continue to put downward pressure on growth.

This next week will kick off with the ISM manufacturing report on Tuesday and finish the week with the monthly employment report.  Year over year percent gains in employment have been steady and guesstimates are for maybe 200,000 net job gains.  150,000 net jobs are needed to keep up with population growth.

The Fed meeting is coming up in mid-September so this employment report will be watched closely to guess the next steps the Fed will take. 

Credit Patterns

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July 28, 2013

Economic growth is hampered when credit growth declines.  In 2008, we experienced a sharp decline in confidence and lending that has only now reached the levels before the decline.

When we look at the big picture, we can see that we are now at more sustainable growth trends.

The amount of outstanding commercial and industrial loans is almost at the level last seen in 2008.

A smiliar slow recovery in business loans occurred during the 2001 recession.

Although housing evaluations have been rising, the amount of revolving equity lines of credit (HELOC) continues to decline.  The total outstanding is still high but approaching a more reasonable trendline of growth.

Recently rising bond yields have contributed to banks’  operating profit margins but the corresponding value of banks’ bond portfolios has fallen quite dramatically.

This decline in asset value affects bank capital ratios, which makes them less likely to increase their lending. which will be an impediment to economic growth.

This Wednesday the first estimate of 2nd quarter GDP will be released.  Real GDP growth is expected to be about 1.1%, less than the meager 1.8% growth of the 1st quarter.  Slowing growth may revive interest in bonds.  The recent sell off in bonds has probably been an over reaction incited by fears that the Federal Reserve will reduce its bond buying program dubbed “Quantitative Easing.”  While there are positive signs in the economy, they do not indicate any impending robust growth.

In addition to Wednesday’s release of GDP figures, the payroll firm ADP will show their monthly report of private employment growth, guesstimated to be slightly below the 188,000 gain predicted for June.  The BLS monthly labor report follows on Friday and will be watched closely.  Unemployment has been stuck in the mid-7% range since March and reductions in unemployment have been largely due to people either leaving the work force or taking part time jobs because they could not find full time work.

The Federal Reserve has said that its target for withdrawing its quantitative easing program is an unemployment target of 6.5%, with a caveat that inflation remains tame. A slow economy will naturally reduce inflationary pressures and improvements in the labor market are slowing as well.  In short, the Fed is likely to continue its monetary support for another year at least.

For a month now, the stock market has risen steadily in small increments, making up the losses that began in the third week of May.  Volume typically declines during summer months but this year’s volume of trading in SPY, the ETF that tracks the SP500 index, is 20% lower than this same time last year.  This week, we may see a market hesitation before the release of both the GDP and labor reports.

Business Cycles

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June 16th, 2013

The manufacturing sector accounts for less than 20% of the economy but is probably the major cause of business cycles in the economy.  In the 1990s, the growing development of technology and business services in the U.S., together with what was called “just in time” inventory management, led some economists to declare an end to the business cycle. Cue the loud guffaws.

May’s monthly report on industrial production released Friday showed no monthly gain, after a decline of .4% in April.  The year over year change in the index was just under 2%.  In a separate report from the Institute for Supply Management (ISM) released a week ago, the Manufacturing Purchasing Managers Index (PMI) index for May fell into contraction, its lowest reading since June 2009, when the recession was ending.


New Orders and Production components of this index saw sizeable decreases.  Computer and electronic businesses reported a slowdown that they attributed to the sequester spending cuts enacted a few months ago.

The latest data for non-defense capital goods excluding aircraft from the U.S. Dept of Commerce showed an uptick after a period of decline in the latter half of 2012; however, there is a month lag in this data set.



The sentiment among small businesses improved somewhat, as shown by the monthly National Federation of Independent Businesses (NFIB) survey.  The overall index of 94 indicates rather tepid expectations of growth by small business owners.  Plans for capital spending to expand business are still at recession levels.

A business builds inventory in anticipation of sales growth.  Since the beginning of this year the net number of small businesses expanding inventory has finally turned positive.

  In a 2003 paper, economist Rolando Pelaez tested an alternative model of the Purchasing Managers Index that would better predict business cycles, specifically the swings in GDP growth.  Assigning varying constant weights to several key components of the overall PMI index, his Constant Weighted Index (CWI) model is more responsive to changes in business conditions and expectations.  In early 2008, the PMI showed mild contraction but Pelaez’ CWI model began a nose dive. It would be many months before the National Bureau of Economic Research (NBER) would mark the start of a recession in December 2007 but the CWI had already given the indication.  In May of 2009, the CWI reversed course, crossing above the PMI to indicate the end of the contractionary phase of the recession.  It would be much later that the BEA would mark the recession’s end as June 2009.


The CWI index is rather erratic.  We lose a bit of its ability to lead the PMI when we smooth it with a three month moving average but the trend and turning points are more apparent in a graph.

Before the 2001 recession the CWI index led the PMI index down.

OK, great, you say but what does this have to do with my portfolio?  Smoothing introduces a small lag in the CWI but it is a leading, or sometimes co-incident indicator of where the stock market is headed over the next few months.

Let’s look at the last six years.  In December 2007, the smoothed CWI crossed below the PMI, which was at a neutral reading of about 50.  The stock market had faltered for a few months but as 2008 began, the CWI indicated just how weak the underlying economy was.  The NBER would eventually call the start of the recession in December 2007.  In June 2009, the CWI crossed back above the PMI.  Coincidentally, the NBER would later call this the end of the recession.

The period 2000 – 2004 was a seesaw of broken expectations, making it a difficult one to predict because it was, well, unpredictable.  I did not show this example first because this period is a difficult one for many indicators.  Before 9-11, we were already in a weak recession.  Although the official end was declared in November 2001, the effects were long lasting, a preview of what this last recession would be. In 2002, we seemed to be pulling out of the doldrums but the prospect of an Iraq invasion and a general climate of caution, if not fear, prompted concerns of a double dip recession.

An investor who bought and sold when the smoothed CWI crossed above or below 50 would have had some whipsaws but would have come out about even instead of losing 15% over the five year period.

The present day reading of both the CWI and PMI are at the neutral reading of 50.  Given the rather lackluster growth of the manufacturing sector, the robust rise of the stock market since last November indicates just how much the market is riding on expectations and predications of the future decisions of the Federal Reserve regarding future bond purchases and interest rates. Over the past thirteen years, when the year over year percent change in the stock market hits about 22%, the percentage of growth in the index declines.

So what is a normal run of the mill investor to do?  The CWI, a predictor of business cycles, is not published anywhere that I could find. This and many other indicators are used by the whiz kids at investment firms, pension funds, by financial advisors and traders, to anticipate business conditions as well as the movements of the markets.  But look again at the SP500 chart above and remember that it is the composite of millions of geniuses and not so geniuses trying to anticipate the market.  As I have mentioned in previous blogs, when that percentage change drops below zero, it is time for the prudent investor to consider some portfolio adjustments.  Since 1980, the average year over year percent change in the SP500 is 9.7%, using a monthly average of the SP500 index. Despite the recent 20% gains, the average year over year percent gain during the past ten years is only 4.9%.  If we look back to the beginning of the year 2000, the average is only 3.1%.  Those rather meager gains look robust when compared to the NASDAQ index, which is still 25% below its January 2000 high.  Think of that – thirteen years and still 25% down. The Japanese market index, the Nikkei 225, is at the same level as it was in early 1985, almost thirty years ago.  Both of these examples remind us that we need to pay some  attention or pay someone to do it for us.

Job Trends

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This past Wednesday the payroll firm ADP released their monthly report of private employment with a rather tepid 119,000, prompting an equally tepid sell off in the market, which lost about .7% by the end of Wednesday.  Although the price move was under 1%, the volume of trading was high.  Was this the end of the 6+ month run up in stock prices?  Was the economy slowing down? 

Came Thursday and a very cheery weekly report of new claims for unemployment and moods brightened.  The market regained the ground lost Wednesday and then some, but on rather low volume.  Standing on the sidewalks of Wall Street, traders repeatedly opened up their umbrellas, then closed their umbrellas, put on their sunglasses, then took off their sunglasses. 

[And now a pause from our sponsor.  A trader tells his doctor he’s anxious and asks for a prescription.  The doctor gives him some advice: “stop looking at the market so much.”]

Back to our story. Friday morning dawned, the heavens opened and the sun shone.  The Bureau of Labor Statistics issued its monthly weather – er, labor – report and traders threw down their umbrellas and put on their shades.  Huzzahs rang throughout the canyons of lower Manhattan.  Some slacker dudes cooly tossed their stocking caps in the air, while men dressed in crisp suits wished that they too had hats.

The labor report is released an hour before the market opens at 9:30 AM.  The market opened up 1%, drifted higher but ended the day at about the same price as it opened.  So, huh? We’ll get to the huh part later.

The reported job gains of 165,000 for April were just slightly above the 150,000 jobs consensus estimate and the replacement rate needed to keep up with population growth.  Spurring the initial enthusiasm was relief that job gains were not as weak as some had feared (100,000 or so) and the revisions to previous months job gains, adding 114,000 to February and March’s job gains. But February’s revision from strong to very strong job growth provokes some head scratching.

What good things happened in February to inspire such strong job growth?  Hmmmm….here’s a table of the past 12 months data from the establishment survey. 

There was a lot to like in this month’s report.  The unemployment rate dropped a tenth of a percent to 7.5%.  We just passed employment levels of February 2006 – yep, it’s been a slow recovery.

To get the big picture, let’s look at the last forty years.

From this perspective, we can see just how deep the job losses have been since 2008.  From this rather sobering point of view, let’s look at some of the positives from this month’s report.

Professional and Business services added a whopping 73,000 jobs this month, far above the 49,000 average of the past 12 months.  Restaurant and bar jobs were up 50% above their 12 month average, showing gains of 38,000. Temp help posted strong gains of 31,000, its highest of the past year.

Construction jobs showed little change, a surprise at this time of year.  Construction has been averaging gains of 27,000 a month for the past six months. This past week, I spoke to a woman at a Denver branch of a national temp agency.  This branch focuses on manual labor, mostly for the construction industry.  She confirmed that business has been brisk but most of the calls are for road repair and rebuilding and some commercial construction.  When I asked her about calls for helpers and job site clean up for residential construction, she said it had been sporadic.

Job gains in health care were somewhat below their 12 month average of 24,000 but any slack in health care was made up by strong growth in retail.  Government jobs continue to contract slightly each month.

Underlying the positive aspects of the job market are some anemic indicators.  The average of weekly hours dropped .2 hour to 34.4; the average has lost .1 hr in the past year.  The ranks of the long term unemployed dropped by 258,000 workers but the number of people working part time who would like a full time job jumped 278,000.  The ranks of the “involuntary” part timers – those who would like a full time job but can’t find one – is about 5 million.  Here’s a surprise. Today’s levels of involuntary part timers as a percent of total employment is only the third highest in the past fifty years; the late 1950s and the early 1980s were worse.  But this only means that the ranks of part timers have fallen mercifully from nose bleed levels.

The diffusion index is showing some weakness; this is the share of employers who are reporting job gains vs. job losses, with a value of 50 being neutral.  Manufacturing employers are already reporting more job losses than gains.  Overall, employers are slowly drifting toward neutral in their hiring for the past several months.

The core work force aged 25 – 54 is still limping along.

Even more disturbing is the participation rate of this core work force.

Shortly after the market opened on Friday came the report on factory orders and it muted some of the enthusiasm generated by the labor report.  New orders for durable goods, a barometer of business confidence, fell 5.8%, confirming the slowdown in manufacturing.  Employment in this sector has been flat the past two months.

While the monthly labor report makes headlines, it is not a leading indicator. Professional investors watch the squiggles of daily and weekly economic and news reports, trying to anticipate developing trends.  Many of us have neither the time or inclination.  For the long term “retail” investor, continuing job gains are positive, particularly if they are at or above the replacement level of 150,000. The long term investor is more concerned about significant losses in their retirement portfolio.

What if an investor lightened up on their stock holdings shortly after the BLS reported the first job losses?   I looked back at historical employment releases ; I wanted to use the original releases, not the revised figures of later months, to capture the sentiment at the time.  We must make decisions in the present.  We don’t have the luxury of going into the future, looking at data revisions, then coming back to the present and making our investing decisions.  That would be a good time machine, wouldn’t it?  Here’s an example of how employment data can be reported initially and later revised.  The graph shows the later revisions.

In early August 2000, the BLS reported job losses of 108,000 in July.  But this was due to the layoff of 290,000 temporary Census workers.  Do census workers really count in our strategy?  Let’s say not.  We wait till next month’s report, which shows a loss of 105,000. Should we use our strategy?  Again, those darn census workers.  Without them, there would have been a small gain in jobs.  So we don’t sell in September.  Then, in the beginning of October comes the news of strong job gains in September, followed by more job gains in October, November and December.  Good thing we didn’t sell at that first downturn, we tell ourselves.  Meanwhile the stock market has been slipping and sliding since that first negative job report.  Eventually, it will fall about 40%.

Wow, we should have taken that first signal and avoided all those losses!  But if our strategy is to then buy back in when there are positive job gains reported, then we could be in and out of the market like a yo-yo in years when the economy is struggling to find direction or strength. We were looking for a more even tempered strategy.

To emphasize how the revisions in employment can mean the difference between job gains and job losses,  take a look at the chart below.  These are the revised figures.  I have noted months where the initial monthly labor report showed positive job gains but were later revised to job losses.  Some of these revisions can happen months later.

From the first reported job losses in mid 2000, more than three years passed before job gains would exceed the “replacement” level of 150,000.  That is the number of jobs needed for the growth in the labor force. While many, myself included, have blamed the knucklehead politicans who enacted the Bush tax cuts in 2003, it is understandable that they were beginning to wonder if the labor market would ever turn around.  Three years of job losses is a long time.

Let’s move on to the last decline.  The market had already begun its decline before the first job losses were announced in early February 2008.

In this past recession, the job losses were severe but the first job increases were announced about two years after the first decrease, in early April 2010.  When reviewing the historical BLS releases, this really surprised me that the 2000 – 2003 labor downturn lasted longer than this last one, though it was much less severe.  By the time the first job increases had been announced in 2010, the market had already been on an upswing for a year. 

In short, the headline monthly job gains don’t appear to offer a long term casual investor any particular insight or advantage.  In a work force of 143 million, a hundred thousand jobs can be a slip of the pencil.  But reported job gains of 150,000 or more do offer an investing hint – quit worrying about your retirement portfolio for at least another month.  Go fishin’, play with the kids, hang out with friends.

A labor indicator that seems to be more reliable is the year over year percent change in the unemployment rate, which I have discussed in earlier blogs.

Although the unemployment rate – or percentage – is derived from the count of total employment, the revisions are much smaller.  Secondly, we are using a percentage gain in that percentage, further reducing swings.

The stock market continues to post new highs in anticipation of good corporate profits in the latter part of the year.  What is a bit troublesome is the number of revenue shortfalls reported by companies in the first quarter.  Reducing expenses and boosting productivity can only get a company so far.  Profit growth becomes harder and harder to come by without revenue growth.

Blossoms and Blight

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March 24th, 2013

The Blossoms

There have been a number of encouraging reports these past several months, helping to fuel new highs in the popular SP500 stock index.  After falling off dramatically five years ago, real (inflation adjusted) retail sales finally surpassed 2007 levels.

Housing prices around the country are on the mend.  Although the purchase only home price index is still below the vaulted levels of the bubble years, it is exactly where it would have been if there had been no bubble and housing prices had grown at their customary 3 – 4% per year.

In recent months, the manufacturing sector of the economy has surged upward, rebounding from weakness in the latter part of 2012.  For the past year, the Eurozone has been in or near recession, yet some are hopeful that increased demand in this country and some emerging markets are helping to balance the contractionary influence of decreased demand in the Eurozone.  Let’s hope that this surge in the first part of the year does not fade as it did in 2012.

New claims for unemployment continue to decline. 

The Blight

But a 7.7% unemployment rate and a record 14 million disabled (SSA Source) show that the labor market is still sick.  The percent of working age people who are working, or the participation rate, continues to drift downward.

While the steadily improving retail sales indicate growing consumer confidence, per capita purchases are about where they were in the late 1990s, 15 years ago.

While consumers have been shedding debt, state and local governments continue to hold large levels of debt which does not include promised pension and health care benefits to retirees.

Federal Spending continues to outpace receipts, adding to the debt at a rate of more than 4% per year. At that rate the debt will double in about 18 years, reaching $30 trillion in 2030.  As a percent of the entire economy of the country, the deficit or annual shortfall between spending and revenues is still about 7%.
 

As housing prices recover and households either pay down or shed debt in foreclosure or bankruptcy, household balance sheets are looking better. What has happened in the past five years is a massive shift of household debt to the balance sheets of local, state and federal governments.

The blossoms catch our eye, inspiring hope, causing some to not notice the blight.  But the stock market, the barometer of millions of watching eyes, tells a more complete story.  While the stock market has shown renewed optimism in the past several months, its inflation adjusted value indicates a more tempered enthusiasm for the long term future of the economy and corporate profits.

GDP, Profits and Labor

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Feb. 2nd, 2013

A lot to cover this week – the monthly labor report and the Dow Industrial Average breaks the psychological mark of 14,000.  Let’s cover the stock market rise because that will give us some context for the labor report.

The stock market rises and falls on the prospect for the rise and fall in corporate profits.  For the past year, profits have been healthy, increasing year over year by 15-20%.

The stock market is a compilation of attempts to anticipate these profit changes by six months or so. Sometimes it guesses wrong, sometimes it guesses right but the market loosely follows the trend in profits.

As a percent of GDP, corporate profits have reached a record high and this growing share of the economy is largely responsible for the doubling of the SP500 in the past three years.

There can be too much of  a good thing and this may be it.  An economy becomes unstable as one segment of the economy accumulates a greater share of the pie.

Facts are the nemesis of partisan hacks who simply disregard any information that does not fit with their model of how the universe works.  Data on government spending and investment contradict those who complain that government has too much of a share of the economy; it is now at historic lows.

This includes government at all levels: federal, state and local.  Reductions in government spending continue to act as a drag on both GDP and employment growth. What gives some people the sense that government spending is a larger percentage of the economy are transfer payments, like Social Security.  Neither the calculation of GDP or government spending includes these transfer payments, so the percent of government spending in relation to GDP as shown in the chart above is a truer picture of government’s role in the economy. 

Speaking of GDP – this past week came the first estimate of GDP growth for the fourth quarter of 2012.  The headline number was negative growth of 1/10th of a percent on an annualized basis.

Two quarters of negative growth usually mark the beginning of a recession.  Concern over this negative growth led to small losses in the stock market at mid-week as investors grew concerned about the January labor report, which was released Friday.  The negative growth was largely due to a severe reduction in defense spending and exports.  As a whole, the private economy grew at an annualized rate of 3.6%, a strength that helped moderate any market declines in mid week.

When the Bureau of Labor Statistics released their monthly labor report this past Friday, the headline job increase of 157,000+ and an unemployment rate stuck at 7.9% did not calm investors’ fears.  The year over year percent change in unemployment is still in positive territory.

The numbers of long term unemployed as a percent of total unemployment ticked down but remains stubbornly high at about 38% (seasonally adjusted)

What prompted Friday’s relief rally in the market were the revisions in the previous months’ employment gains.  As more data comes in, the BLS revises previous months’ estimates.  This month also included end of the year population control adjustments.

November’s gains were revised from +161,000 to +247,000; December’s gains were raised from +155,000 to +196,000.  For all of 2012, the revisions added up to additional job gains of 336,000, raising average monthly job gains for 2012 to 181,000 – near the benchmark of 200,000 needed to make a dent in the unemployment rate.  Previous decreases in the unemployment rate have been largely the result of too many people giving up looking for work and simply not being counted as unemployed.

Overall, the labor report put the kibosh on any fears of recession and the stock market responded with a rally of just over 1%.  Construction jobs continued their recent gains but employment levels are one million jobs fewer than the post-recession lows of 2003 and two million jobs less than the 2006 peak of the housing bubble.

The core work force aged 25-54 continues to struggle along.

The older work force has garnered much of the gains in the past year but this month was flat.

The larger group of workers counted as unemployed or underemployed, what is called the U-6 Rate, remained unchanged as did the year over year percent change. 

As the stock market continues to rise, retail investors have reversed course and have started to put more money into the stock market.  Sluggish but steady GDP and employment growth has prompted the Federal Reserve to continue its program of buying bonds every month, which tends to push up stock market values.  The Fed can continue this program as long as the sluggish pace keeps inflation in check and below the Fed’s target rate of 2.5%. 

In the short run, it is a good idea to follow the maxim of “Don’t Fight the Fed.”  What is of some concern is the long term picture.  Below is a 30 year chart of the SP500 index, marked in 10 year periods with two trend lines based on the first decade, one trend line (with the arrow) a bit more positive than the other. 

The market has changed in the past two decades.  The bottoms in 2002, 2003, 2010, 2011 were simply a return to trend, a return to sanity.  The downturn of late 2008 – early 2009 was the only downturn that broke below trend; truly, an overcorrection. Among the changes of the past two decades is a Federal Reserve that, some say, has helped drive these erratic asset bubbles by making aggessive interest rate moves, then keeping interest rates at low levels for a prolonged period of time.  Whether and how much the Fed’s interest rate policies contribute to stock market valuations is a matter of much vigorous discussion.  Whatever the causes are, it is important to recognize that over two decades the market has shifted into a jagged, cyclic investment.  The long term investor who has a ten year time frame before they might need some of the money invested in the stock market can be reasonably certain that they will be able to get most of their money back if not make a healthy profit.  For those with a shorter time horizon like five years, they will need to monitor the financial and economic markets a bit more closely or hire someone to do it for them.  This is especially true when one is buying at current market levels which are above trend.