Monday, June 09, 2014 - Record Highs and a Few Crumbs

Record Highs and a Few Crumbs

by Sinclair Noe

DOW + 18 = 16,943
SPX + 1 = 1951
NAS + 14 = 4336
10 YR YLD + .02 = 2.61%
OIL + 1.73 = 104.39
GOLD - .30 = 1253.00
SILV + .05 = 19.16

The major indices are now up for 4 consecutive sessions. The Dow Industrials hit a record high close for the 10^th time this year. The S&P is now up 14 of the last 17 trading sessions. The last time the Dow experienced a 10% correction was back in October 2011; since then, the Dow has gained almost 60% over 32 months without a 10% correction. Typically, you can expect a correction about every 12 months on average. The longest period without at least a 10% pullback was an 82 month run from 1990-1997. The S&P 500 hit a record high close for the 19th time this year. The S&P bull market is now at 62 months and counting, the best run since 1994 to 2000.

The CBOE Volatility Index moved a little higher today to 11.34. On Friday, the VIX hit a low of 10.73, the lowest level since January 2007. The VIX can go low and stay low for an extended period of time. In 2007, after hitting a low, the VIX steadily rose for the remainder of the year but stock prices didn’t peak until the end of 2007. The VIX measures options trades, but does it really mean investors are dangerously complacent? The Murdoch Street Journal reports: “Last week, 39% of respondents to a long-running weekly survey from the American Association of Individual Investors said they were bullish about stocks. That is well above readings of just over 27% in both February and April, when violence in Ukraine weighed on sentiment. But it is far from giddy. In fact, it is in line with the average since the poll's inception in 1987.”

Today had all the signs of a bull market, in addition to record highs, we had a good old fashioned Merger Monday. Tyson foods agreed to buy Hillshire for $8.5 billion, or $63 a share cash. That follows a bidding war between Tyson and Pilgrim’s Pride that pushed Hillshire from $37 a share on May 23 to the current bid.

Drugmaker Merck paid $3.9 billion, or $24.50 a share in cash for Idenix Pharmaceuticals, a 240% premium to Friday’s close of $7.23. Idenix has three drugs to treat Hepatitis C in clinical trials, but none on the market. Chipmaker Analog Devices agreed to buy Hittite Microwave Corp for $2.5 billion, or $78 a share, a mere 29% premium to Friday’s close.

Depending on the source, deal volume is up about 65% to 70% this year. Worldwide, companies are sitting on about $7.5 trillion of cash. With organic top line growth hard to come by in sluggish economies, many are turning to acquisitions.

You can buy a share of Apple for about $93; that following a 7 for 1 split; the first split for Apple in 9 years. A split is generally a non-event. If you owned 100 shares of Apple on Friday, you now own 700 shares, but the price was divided by 7. The financial structure and value of the company doesn’t change.

The yield on a 10-year US Treasury note was up a couple of basis points today to 2.61%. Meanwhile, the yield on the 10-year Spanish government bonds dropped 5 basis points to yield 2.59%. Normally, you would expect a government bond yield to correspond to demand and overall safety of the bond and the country backing the bond. Things are a little upside down. The good news is that investors aren’t expecting the Eurozone to disintegrate; the bad news is that investors aren’t expecting any growth in the Eurozone.

James Bullard, president of the St. Louis Federal Reserve Bank, speaking at a conference in Florida today, said the US macroeconomy is much closer to a normal state than it has been in 5 years and only weak labor markets and low inflation is keeping the Fed’s accommodative monetary policy in place. Last month, Bullard said that while the housing and labor markets remain weak, he expects recovery through the rest of the year, and said inflation would likely move towards the Fed's desired 2% rate.

Bullard told reporters after his speech: “If you get 3% growth for the rest of this year, if you get unemployment coming down below 6%, if you continue to have jobs growth at 200,000, if you continue to see inflation moving back up toward target, I think if we get to the fall of the year and all of those things are transpiring as I’m suggesting they will, that will change the conversation about monetary policy, and there will be more sentiment toward an earlier rate hike.”

The housing market may not be as strong as some Fed policymakers believe. On Friday, the jobs report showed the economy had regained all the jobs lost in the recession, but that isn’t the case for the home building sector. The number of construction jobs has been climbing, rising about 7% in May from a year earlier, to 2.6 million, including electricians and other specialty trade contractors; but that's way down from the high of 3.45 million in April 2006. While jobs overall are back to their pre-recession peak, residential construction jobs are 34% below their peak.

Even five years after the housing meltdown, a sizeable chunk of homeowners remain underwater. About 6.3 million homes, or 12.7% of all properties with a mortgage, were underwater as of the first quarter.  About 1 in 10 homeowners are almost underwater, with less than 10% equity in their homes, meaning it would probably cost them to sell, when including selling related expenses.

A survey released last week by the MacArthur Foundation found that 43% of those polled said it is no longer the case that owning a home is an excellent long-term investment and one of the best ways for people to build wealth. More than half said that buying a home has become less appealing than it once was. And 70% believe the nation is still in the middle of a crisis and that the worst is yet to come.

One major demographic group that isn’t buying homes is the Millennials; they are just trying to pay off student loans. President Obama announced Monday that he will expand a federal program designed to reduce student loan payments. The program, called “Pay As You Earn”, will give as many as five million more Americans with federal student loan debt the ability to cap their monthly student loan payments at 10% of their income and to have their remaining debt forgiven after either 10 years (for government and some non-profit workers) or 20 years (for other workers).

The current program is only available to Americans who began borrowing after October 2007 and kept borrowing after October 2011; the new order will allow students who borrowed money before October 2007 and those who have not borrowed since October 2011 to participate. The new program will begin in December 2015.

Of course, like so much consumer debt, if you pay the smallest monthly minimum, you just string out the loan and end up paying more over time; so, the new plan might not work for everybody. The best idea is to work some numbers, comparing monthly payments and lifetime costs; there are calculators for this at the Department of Education website.

The housing market is just one factor in an economy that doesn’t seem quite as strong as Fed President Bullard suggests. This was supposed to be a breakout year for economic growth but it started with negative GDP in the first quarter. And even though we have regained the jobs lost in the recession we still have nearly 10 million unemployed, and that’s more than 2 million more than in January 2008; and the quality of the jobs, and the pay has gone downhill for most workers. Income growth is at its lowest point since 2007. When people are shopping, they’re using borrowed money.

Corporations and Wall Street raked in profits unseen in their history. At the end of 2013, corporate profits hit an all-time high of $1.9 trillion. Those profits were largely achieved not by growing, but by cutting jobs and investments; and relying instead on mergers, buybacks, stock splits, QE, and other financial legerdemain.

The economy hasn’t really turned positive. It could change. Maybe the Fed will quit QE and try something that actually helps the economy. Until then, enjoy your milk and cookies, or whatever crumbs might come your way.

Monday, June 02, 2014 - Clean Power Plan

Clean Power Plan

by Sinclair Noe

DOW + 26 = 16,743
SPX + 1 = 1924
NAS – 5 = 4237
10 YR YLD + .07 = 2.53%
OIL - .31 = 102.40
GOLD – 7.80 = 1244.50
SILV - .05 = 18.86

The ISM got it wrong this morning. The Institute for Supply Management reported its May manufacturing index came in at a weaker than expected 53.2, but there was a software problem that didn’t properly reflect season adjustments; the ISM issued a revision; the May index was 56.0; but for some reason, that wasn’t correct, so they issued another revision. The May manufacturing index was 55.4; that’s the number and they’re sticking with it. Embarrassing? Yes.

Meanwhile, stocks and bonds were all over the board. Stocks fell into negative territory early on, but bounced back as revisions were issued. Bonds are hyper sensitive to economic growth, and the yield on the 10 year note moved higher and stayed higher, despite the initial numbers and the revisions. And if you look past the revisions, and you should, because it appears to be nothing more than an honest mistake, caught quick and corrected; the bottom line is a pretty strong number for manufacturing, more or less in line with the idea of a second quarter bounce in the economy.  

The bigger story this week will be the jobs report on Friday. It is widely expected the economy added about 200,000 to 215,000 jobs in May, which would be down from a very strong report of 288,000 net new jobs in April. The unemployment rate is expected to tick up from 6.3% to 6.4% as more people enter the labor force.

We also expect some big economic news out of Europe this week, and we’re likely to see a small announcement instead. You will recall that European Central Bank President Mario Draghi announced back in the summer of 2012 that he would do “whatever it takes” to save the euro. And then he spent the following two years doing nothing. This week he’s expected to actually do something, specifically he’s expected to unveil a package of measures to fight deflation. Analysts expect the ECB to cut both its main interest rate and reduce its deposit rate to below zero, meaning the central bank would charge lenders to hold money with it overnight. Although any reduction will be modest, a negative deposit rate has never been introduced by a major central bank; and the thinking goes, this will force the banks to start lending.

It doesn’t take much to see the flawed logic. Many countries in the Euro periphery are still struggling with Great Depression level unemployment. As long as unemployment remains as high as this, it’s nearly impossible for countries to generate the internal demand necessary for durable growth. The biggest obstacle to a bold move would seem to be Germany, which is enjoying a pretty strong economy, but even there, the inflation rate has dipped down to 0.6%. The ECB seems to think a little fine tuning will right the ship and then a rising tide will lift all boats. Doubtful. 

As expected, the EPA today issued the "Clean Power Plan" proposal, calling it "a commonsense plan to cut carbon pollution… Climate and weather disasters in 2012 cost the American economy more than $100 billion," the agency says in a document accompanying the proposal.

EPA Administrator Gina McCarthy said: "We don't have to choose between a healthy economy and a healthy environment. Our action will sharpen America's competitive edge, spur innovation and create jobs."

The regulations would force power plants to cut carbon dioxide emissions by 30% by 2030. The rules would set guidelines that states could choose how to follow. Under the plan, each state would have its own goal within the overall national pollution reduction effort. That’s an attempt to be politically and practically flexible in implementation. The EPA would set targets for each state for carbon emissions reductions. Then state governments would come up with their own plans for hitting these targets. The proposed regulation in essence gives them four different approaches they could try. They could renovate existing coal-fired plants with newer, more clean-burning technology; they could switch coal plants to natural gas, which produces much less carbon; they could try to persuade residents to be more efficient in their use of electricity; or they could band together with other states in a cap-and-trade network for emission reductions.

In a cap-and-trade network, companies would buy and sell permits allowing them to produce a certain amount of carbon emissions. Clean producers would be the sellers, while dirtier producers would be the buyers.

Almost a third of America's carbon emissions comes from electricity generation. EPA officials concede some of the dirtiest power plants now operating, such as older coal-fired plants, will end up shuttered as the nation shifts its reliance from traditional fossil fuel sources to cleaner alternatives. Coal supplied 37% of US electricity in 2012, compared to 30% from natural gas, 19% from nuclear power plants, 7% from hydropower sources such as dams and 5% from renewable sources such as wind and solar. By 2030, just over 30% of US electricity will come from coal and about the same amount from natural gas, with wind, solar and other alternative sources providing about 9%.

According to the EPA, the proposed new rules would reduce carbon pollution by the same amount as removing two-thirds of all cars and trucks form American roads. It put the cost as high as $8.8 billion a year, but noted health gains such as fewer premature deaths and respiratory diseases along with other benefits would be worth tens of billions of dollars to the US economy. Recent analysis quantifies the benefits in health, air quality and clean water at $63 billion a year. Since 1970, every dollar invested in compliance with Clean Air Act standards has yielded $4 to $8 in economic benefits.

Will this move actually clean up global pollution? Not really. No matter what the US does, global emissions will keep skyrocketing in the near future. This is because most of the rise in emissions is being driven by China. China’s carbon pollution has soared in the last 15 years, and is now about double the US level. The rest of the increase has come from oil-producing countries and from other, more slowly developing Asian nations; but China overshadows all of the other sources.

American per capita emissions, of course, are still more than twice as large as China’s. And the simple fact is that we won’t get far trying to tell China they have to cut emissions if we aren’t willing to cut our own emissions. Of course, if we unilaterally cut our emissions, that doesn’t mean China will be willing to follow our lead. Self-restraint might do nothing more than push down the price of high carbon energy sources, allowing China to burn more for less. What this move really does is position the US as a leader in cleaner energy technology, and even if we can’t export natural gas to China or many other parts of the globe, we could export cleaner energy technology and expertise.

One way to do this is to tax carbon intensive imports; something not included in today’s proposal. The US is still China’s most important export market, so a US carbon-import tax will provide a huge incentive for Chinese companies to reduce emissions.

Another specific not included in today’s proposal would be to implement a carbon tax or equivalent here in the US. This won't cut worldwide emissions enough to make a dent in global warming, but the funds could be used to spur research and development into things like gas, solar, wind and energy efficiency. We should think of carbon taxes mainly as incentives for the private sector to discover all the carbon-cutting technologies, and fund the research that will make green energy cheaper than coal.

Fortunately, renewable energy is up to the challenge of replacing those dirty fuels. In just the last three years, solar panels have gotten 60% cheaper and the price of wind energy has fallen more than 40%. Far from being expensive, clean energy is already beating both coal and natural gas on price in many parts of the country.

Coal and oil are low tech fuels whose time has passed, just as surely as the days of using whale oil to light our lamps, but the transition won’t be easy. The apprehension in coal country to leave this current path is understandable. We would all feel it if we were in their shoes. Outsiders can't ignore the plight of the families and the affected communities. And there will be massive political opposition, especially from the politicians backed by coal and big oil, which is most of the politicians. And most of these new regulations won’t go into effect until 2015, and there will be legal challenges, but the future is changing.

ISM, manufacturing index, jobs report, ECB, Mario Draghi, Gina McCarthy, EPA, Clean power Plan, record high close, Sinclair Noe, 

Monday, February 24, 2014 - Wine and Neurosis

Wine and Neurosis

by Sinclair Noe

DOW + 103 = 16,207
SPX + 11 = 1847
NAS + 29 = 4292
10 YR YLD + .01 = 2.75%
OIL + .64 = 102.84
GOLD + 10.50 = 1337.60
SILV + .11 = 22.07

The S&P 500 hit a new high today; topping out at 1858; surpassing the intraday high of 1850 set back January 15^th, and finishing at 1847.61, just below the record high close of 1848.38, again from January 15. So, we couldn’t hold on to a record close, but it was tempting. The S&P was banging up against resistance, briefly floating above the ceiling and into new, rarified air. And we would all love to be on that rocket, if it really is going to soar. Patience, patience.

Now, we know that fundamentals, the news of the day, only offers justification for movement, and we know that the fundamentals can also prove to be contrary indicators. Still, the best explanation I’ve heard today for the enthusiasm is the recent M&A activity has created something of a halo effect. There has been quite a bit of merger action. Consider: RF Micro Devices will merge with Triquint Semiconductor in an all stock deal announced this morning, last week was news of Men’s Warehouse upping its offer for Joseph A. Bank conditioned on Bank dropping its bid for Eddie Bauer, Actavis is buying Forest Laboratories, Comcast buying Time Warner Cable in a deal to create the world’s biggest consumer complaint, and Facebook buying WhatsApp.

And suddenly everybody wants to catch the M&A fever. Maybe that explains new market highs, maybe not. What we haven’t seen is an improvement in the economy; blame it on the weather if you wish, but it’s hard to find demand. Households, businesses, governments are all holding onto their money; meaning supply outweighs demand. Another way to look at this is when demand increases, buyers bid prices higher, or you have too much money chasing too few goods, and the result is inflation, and this is usually a sign of an expanding economy. But prices are not inflating.  We saw the CPI and PPI reports last week and what we have is disinflation or perhaps just stagnation; and the economy is just muddling along.

Of course, there are multiple causes of inflation; you might see supply decrease and cost of production increase, and that could push prices higher; this is known as cost-push inflation; you might see demand increase while supply remains constant or drops, and that pulls prices higher; this is known as demand-pull inflation. The Fed has hoped that by throwing money into the banking system, they could increase demand. That hasn’t happened, and so the Fed is backing away from their monetary stimulus scheme and they are cutting back QE.

Last Friday we saw the transcripts of the Fed’s deliberations from 2008, and it revealed policymakers were largely in the dark about the impending meltdown; they were in the dark about how the markets would respond to stimulus; they were in the dark about where and why and to whom they should apply stimulus – they really missed the mark on that count; they were in the dark about how economic models could miss changes in conditions; they were in the dark about the consequences of a meltdown; they are still in the dark to this very day.

So, we’re back to the basics of supply and demand. Throwing money at Wall Street does not increase demand; it does increase mergers and acquisitions and stock buybacks and executive bonuses. And that creates a feverish frenzy among Wall Street traders looking for the next big buyout. Anyway, we hit a high but we couldn’t hold onto it. You can celebrate that record with wine and neurosis.

If you are trying to trade these markets, don’t get caught up in the M&A fever. Follow the trend, not the fad. This means that you will not hit the tops and bottoms in the market. In other words, you will not be exactly right on any given trade; you will be a little late on any given entry and exit, but you will let the technical data, the price action tell you when to buy or sell. You won’t predict where the market is going but rather follow the market. If it sounds a bit stressful, it is. But you have to ask yourself if you want to be right or if you want to be profitable. Or maybe that’s not the question at all. Maybe you should be questioning why you are in the market at all.

If you can make it through a weekend without checking the stock quotes, you might consider not checking the quotes for a week. So says Warren Buffet.

Mere mortals should not try to outsmart the stock market. That’s what Warren Buffet is saying, or writing in his upcoming annual letter to investors. Buffet writes:  "The goal of the nonprofessional should not be to pick winners -- neither he nor his 'helpers' can do that -- but should rather be to own a cross section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal."

Buffett thinks the best course of action is to take almost no action. Stick to what you know, which is probably nothing. Buy a basket of 500 stocks, a smattering of bonds, and forget about it for the next 100 years or so. Treat investing this way and you'll actually beat the experts in the long run.

Buffett takes a few shots at the hedge fund managers and the newsletter writers and the talking heads on CNBC and similar outlets. Buffett writes: “Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits -- and, worse yet, important to consider acting upon their comments," Buffett writes, adding: "In the 54 years [partner Charlie Munger and I] have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people."

So sayeth the Oracle of Omaha, and he’s right, of course; unless you didn’t get out at the top and prices are collapsing and you’re wondering whether to eat your losses or buy more, and remembering that you don’t have quite the balance sheet of Warren Buffett.

Meanwhile, Defense Secretary Chuck Hagel today outlined a modest proposal to deal with spending caps ahead of the formal budget presentation next week. Hagel has laid out how he will cut spending. The Department of Defense plans to reduce the size of the Army to between 440,000 and 450,000 soldiers, he said. The Army is currently about 520,000 soldiers and had been planning to draw down to about 490,000 in the coming year.

A reduction to 450,000 would be the Army's smallest size since 1940 - before the United States entered World War Two - when it had a troop strength of 267,767, according to Army figures. The Army's previous post-World War Two low was 479,426 in 1999.

The Defense Department is in the process of reducing projected spending by nearly a trillion dollars over a 10-year period. A two-year budget deal in Congress in December gave the Pentagon some relief from the budget cuts, but still forced it to reduce spending in the 2014 fiscal year by $30 billion. The Pentagon's budget for the 2015 fiscal year is $496 billion, roughly the same as in 2014 but still lower than had been projected last year. There would also be cuts to some spending on equipment, but Hagel argues the cuts would be more draconian and less strategic if executed under sequestration.

Hagel also announced a series of steps to try to reduce the Defense Department's military and civilian personnel costs, which now make up about half of its spending. While Congress voted to undo cuts to military retiree benefits on February 12, some cuts will still be made to compensation, however the new recommendations do not cut pay. Hagel said the department would slow the growth of tax-free housing allowances, reduce the annual subsidy for military commissaries and reform the TRICARE health insurance program for military family members and retirees.

Hagel cautioned that reducing Army troop levels would increase the risk involved in protracted or simultaneous ground operations, as the US saw during the wars in Iraq and Afghanistan. Hagel said: “As a consequence of large budget cuts, our future force will assume additional risks in certain areas.”

Hagel also raised the specter of disaster if Congress does not reverse sequestration cuts to the military that would set in at deeper levels two years from now.

“Sequestration requires cuts so deep, so abrupt, so quickly, that we cannot shrink the size of our military fast enough. In the short-term, the only way to implement sequestration is to sharply reduce spending on readiness and modernization, which would almost certainly result in a hollow force - one that isn’t ready or capable of fulfilling assigned missions.”

“In the longer term,” Hagel went on, “after trimming the military enough to restore readiness and modernization, the resulting force would be too small to fully execute the president’s defense strategy.”

This is a major change in defense spending and a bit of a gamble in a midterm election year. Defense advocates in both parties will debate the merits of closing bases and idling factories and what benefits must be honored for the troops and their families. And there will be people arguing for cutting the deficit yet arguing for more defense spending.

This is not going to be easy, but to maintain a little perspective, in 2013 the US spent about $680 billion on our military, which works out to 4.4% of GDP. We spend more than any other country. We have about 5% of the world population but we account for 39% of the world military spending. The cutbacks would still leave us spending more than any other country by a long shot. The plan calls for downsizing so we can fight one land war, not two, at the same time. Maybe we could avoid war for a while and really save some money. 

Friday, November 22, 2013 - Big Round Numbers

Big Round Numbers

by Sinclair Noe

DOW + 54 = 16,064
SPX + 8 = 1804
NAS + 22 = 3991
10 YR YLD - .04 = 7.74%
OIL - .60 = 94.84
GOLD + 1.30 = 1244.70
SILV - .16 = 19.93

Record highs for the Dow Industrials and the S&P 500; we also have Dow Transports confirming the movement of the industrials, and small caps, as represented by the Russell 2000 are looking strong, pricey but strong. This was the 41^st record high close for the Dow Industrials this year.

The S&P 500 is above 1800 and that round number now becomes support. The 1800 level is 17% above the record highs from the Spring of 2000. So, if you just followed the buy and hold, you made 17% over 13 ½ years; which is lousy; and even worse if you dig into the numbers. Adjusted for inflation, the 1800 level is 14% lower than the highs of 2000. Then you should also consider the S&P 500 is a capitalization weighted index, meaning the bigger companies have a bigger impact on the index. Back in 2000 there were 25 companies that accounted for 45% of the value of the 500 stock index; so, really back then it was more like a 25 stock index, and a 475 stock index.

And really, the S&P is a dynamic index; meaning, the companies change. Back in the day, the high flyers were Lucent, MCI Worldcom, AIG, Sun Micro, Dell. This year, we're seeing about 450 of the 500 stocks in the S&P are up; that is a broad based rally.

The Dow closes the week up; the seventh straight week of gains; the longest weekly winning streak since the 8 week rally of December 2010 to January 2011. The S&P finishes a seven-week winning run. Investors are pouring more money into US stock mutual funds than they have in 13 years. Morningstar reports stock funds took in $172 billion in the year’s first 10 months, the largest amount since they got $272 billion in all of 2000. Even with most of the cash going to international funds, domestic equity deposits are the highest since 2004. The move marks a reversal from the four years through 2012, when investors put $1 trillion into fixed income as the financial crisis drove many to redeem from stocks. Losses this year in bond portfolios, combined with 25% gains in the S&P, and suddenly everybody is pouring back into stocks. This is called performance chasing, and it is risky business.

Market investors now have about 57% of assets allocated to equities. We've seen high equity valuations before, in 1999, and in 2006-2007. Sentiment among individual investors grew increasingly positive as the S&P 500 set new highs. Bullishness in the American Association of Individual Investors’ weekly survey has averaged 43 percent this quarter, up from 29 percent in August and a long-term average of 39 percent.

Now normally, that kind of bullish optimism would be a contrarian indicator. But that doesn't always mean we're headed for a drop.  In ICI data going back to 1984, annual mutual-fund flows turned positive twice before: in 1989, preceding market gains in eight of the next 10 years, and in 2003, when the S&P kept rallying until October 2007.

And don't forget that December is a historically good month for stocks. With average returns around 1.4%, compared to 0.5% for all other months. June and July have even better average returns than December does. When ranked according to average returns, December is in third place.

Furthermore, there is not much consistency to December's return from year to year. In fact, December on average was one of the worst performing months during several of the decades in the early part of the last century.

Bottom line: stay alert and let the market tell you what it is doing.

The stock market reached several very important big round numbers this week and experts suggested that reaching these round numbers could mean that the stock market will reach other, larger round numbers in the near future. Maybe. Maybe not.

These same experts suggest you ignore the fact that these round numbers have almost no meaning for your own particular individual life and keep your focus on the round numbers themselves, because they are round, and also larger than previous round numbers the market has reached.

Why is this happening, you might be asking, if you are one of the 62% of Americans who think the economy is getting worse. It is partly due to the Federal Reserve pumping cash directly into markets to keep the economy from teetering back into a recession. It is also partly due to the fact that President Obama has been the least effective socialist dictator in history, overseeing record highs in corporate profits while wages stagnate, widening income inequality, in what has been an extremely uneven recovery. 

And most of the gain in stocks seems to go right back to Federal Reserve policy. This week we had Bernanke saying the U.S. economy is getting better and, as per incoming data, the Fed will at some point slowly start to pull back support. But for right now, they aren't pulling back support because the economy is still too weak to stand on its own two feet. And you've got the OECD doing what all forecasters do these days: marking down their estimates for future growth and warning of various headwinds.

Meanwhile, mixed in with all this near-term analysis, many in my world are mulling over Larry Summers' warning that whatever the cycle is doing, the underlying problem is one of structural slog.

Barring new fiscal break-downs, like the failure to come to some kind of an agreement on the budget that expires mid-January, there will be less fiscal drag in 2014 than this year, and that should add to growth.* But don't mistake less fiscal headwinds for tailwinds. The optimistic view is that lousy, austere fiscal policy is sucking about 1.5 points off of real growth this year and will take 0.5 of a point off of next year's growth.

The fact that less growth is reaching the broad middle class and lower wage workers is a constraint on consumption, which remains 70% of the US economy. During the housing bubble years, (dangerously) cheap credit and the wealth effect from inflated home prices offset this drag, but that's behind us. Looking at inflation and average compensation, we see that there is no pressure from wages or prices on inflation and real compensation growth is flat, flat-lining in fact.

Meanwhile, we know that the economy's been growing and that company profits have been high. There's nothing wrong with profits, but there's definitely something wrong when they fail to lead to employment and earnings gains for the broad majority. 

Uneven consumer spending along with fiscal drag/austerity and political dysfunction have contributed to a weaker investment climate, not just in the US but in most economies. You keep hearing about "trillions on the sidelines." Again -- that's also a symptom of high profitability amidst weak demand, along with low inflation. Investors just don't see enough domestic projects with high enough prospective returns to get them back in the biz of investing in structures, equipment, software, at least not at rates that would give us the growth pop we need.

Of course, this begs for a strategy of investment in public goods, but that runs into the austerity buzzsaw. And besides, who needs infrastructure when you can just chase performance up to the next big round numbers in the stock market. We just might get there, or not.

Thursday, November 21, 2012 - Size and Composition

Size and Composition

by Sinclair Noe

DOW + 109 = 16,009
SPX + 14 = 1795
NAS + 47 = 3969
10 YR YLD - .01 = 2.78%
OIL + 1.59 = 95.44
GOLD - .40 = 1243.40
SILV + .14 = 20.09

Intraday, the Dow industrials were higher last Friday and last Monday, but this was a record high close, and that is what we look at – the close. The reason we look at the close is largely arbitrary, and the reason we celebrate the Dow record high close as opposed to the S&P 500 record high close, is again arbitrary. The significance of a close above 16,000 is not a big deal; it's just a number. Earlier in the week the market looked at the round number and could not close above; there was a pause; then today, a move above. Test, retracement, breakout; that's bullish.

We have discussed that there is a disconnect between the markets and the broader economy. We have discussed that the trickle down effect or the wealth effect has been less than satisfying for. Still, some of that money will filter into the broader economy; and the bottom line is that it's better than a poke in the eye with a sharp stick.

At some point the Fed will taper; the easy money party will end; until then, well, enjoy the milk and cookies.

Initial claims for state unemployment benefits fell 21,000 to a seasonally adjusted 323,000. Meanwhile, prices at the wholesale level dropped 0.2%. The PPI core rate, excluding gas and food rose 0.2%; so the lesson is that we can all get lower prices if we just stop driving and eating; and, we are seeing disinflation at the wholesale and retail levels. Also this morning, the Philadelphia Federal Reserve Bank reported its business activity index fell to its lowest level since May. Wall Street's pretzel logic saw this bad economic news as a positive, indicating the Fed will continue to be accommodative. Just how long the Fed can keep pumping easy money into the stock market is the big question. Japan may serve as a playbook. Today the Bank of Japan left its massive stimulus policy, known as Abenomics, in place. So, with Japan as a guide, the Fed could do much, much more. The dollar rose to its highest against the yen in more than four months.

Today, European Central Bank President Mario Draghi said the ECB would not cut the deposit rate into negative territory. Draghi tried to dispel talk the ECB was considering charging banks to deposit cash overnight in a bid to boost economic activity. The Federal Reserve pays banks to deposit funds, and there has also been talk that they might consider not paying to get that money out of the vaults and into circulation. Draghi said the central bank did not see deflation materializing, but clearly deflation is a greater concern than inflation, and deflation may force the ECB to reach deeper into their tool belt.

It's generally accepted that central banks monetary policies implemented in response to the global financial crisis prevented a deeper recession and higher unemployment than there otherwise would have been. These measures, along with a lack of demand for credit as a result of the recession, contributed to a decline in real and nominal interest rates to ultra-low levels that have been sustained over the past five years.

A new report from the McKinsey Global Institute examines the distributional effects of these ultra-low rates. Over the past 5 years, governments in the eurozone, the United Kingdom, and the United States collectively benefited by $1.6 trillion both through reduced debt-service costs and increased profits remitted from central banks.

Nonfinancial corporations benefited by $710 billion as the interest rates on debt fell, however this did not result in higher levels of investment. The impact that ultra-low interest rates have had on banks has been mixed. They have eroded the profitability of eurozone banks, resulting in a cumulative loss of net interest income of $230 billion between 2007 and 2012. But banks in the United States experienced an increase in effective net interest margins and a cumulative increase in net interest income of $150 billion. The experience of UK banks falls between these two extremes.

Meanwhile, households in these countries have lost a combined $630 billion in net interest income; that's not total losses from the economic downturn, that's just net interest income.

There are limits to central bank monetary stimulus schemes. The Federal Reserve has been buying mortgage backed securities at a rate of $40 billion per month and they now hold an estimated 26% of the total of mortgage backed securities outstanding. Each month the Fed continues buying, they increase their stake by 0.8%. Even if the Fed were to taper in March and stop all MBS purchases by the end of 2014, Fed holdings of MBS would rise to about 34% of the total MBS market.

The Fed has already distorted the housing market, and if QE continues much longer, they could corner the market. What would that look like? I'm not sure, I'm just asking. Another question is whether the asset purchases have really done the job. The Fed might want to look at buying something else. Quantitative easing can be targeted at all kinds of assets and with the Fed swallowing up the entire MBS market, maybe it's time to look elsewhere. There is probably nothing to prevent the Fed from jumping into the corporate bond market, or maybe they could start buying up municipal bonds; they could start with Detroit, Riverside, and Stockton.

Regardless of whether you agree with the idea or not, or whether you appreciate the irony or not, the point is that the Fed can not only make adjustments to the size but also the composition of its asset purchases.

Today marked a big change in the Senate. I'm still trying to figure how it will affect business and the economy but a friend asked me to speak on it today, so I'll say a few words.

Senate Majority Leader Harry Reid pulled the trigger today, deploying a parliamentary procedure dubbed the "nuclear option" to change Senate rules to pass most executive and judicial nominees by a simple majority vote. The Senate voted 52 to 48 for the move, with just three Democrats declining to go along with the rarely used maneuver.

From now until the Senate passes a new rule, executive branch nominees and judges nominated for all courts except the Supreme Court will be able to pass off the floor and take their seats on the bench with the approval of a simple majority of senators. They will no longer have to jump the hurdle of 60 votes, which has increasingly proven a barrier to confirmation during the Obama administration.

Reid opened debate in the morning by saying that it has become "so, so very obvious" that the Senate is broken and in need of rules reform. He rolled through a series of statistics intended to demonstrate that the level of obstruction under President Barack Obama outpaced any historical precedent.

Half the nominees filibustered in the history of the United States were blocked by Republicans during the Obama administration; of 23 district court nominees filibustered in U.S. history, 20 were Obama's nominees; and even judges that have broad bipartisan support have had to wait nearly 100 days longer, on average, than President George W. Bush's nominees. There has been gridlock; that's true. Changing the rules can come back to bite you at a later date; that's true, too.

I have no problem with the filibuster, at least the old fashioned filibuster. I hate the modern filibuster, where a senator just says: “I filibuster” and everything grinds to a halt. If you want a filibuster, then stand up on the Senate floor, (like when Mr. Smith Goes to Washington) talk until your voice or your bladder gives out. Read from Dr. Seuss of actually try to display intelligence. We know this is possible because every time a Senate committee calls an expert witness to testify at a hearing, we never hear the witness, just the various Senators, bloviating on without end.

And if they ever did bring back the old fashioned filibuster, the could set up a wind farm on the steps of the Capitol to capture the never-ending torrent of hot air.