Will ECRI's Call for Recession Prove Accurate?

Sunday, May 13th, 2012

ECRI's Lak­sh­man Achuthan was mak­ing the rounds yes­ter­day, with yet another defense of his firm's reces­sion call – the first claim which came early last fall.  I do think (from mem­ory) he has pushed out the time frame a bit from when the ini­tial call came, but since early this year has claimed we will see it by mid year.  Per­haps the very warm win­ter hurt the call as well – who knows with these black boxes.  Below we have a video with CNBC and there is one nugget in there I did not know.  Con­ven­tional wis­dom is a reces­sion is back to back quar­ters of neg­a­tive GDP… but accord­ing to the NBER (and Achuthan) that is but one of a group of poten­tial signals.

The Com­mit­tee does not have a fixed def­i­n­i­tion of eco­nomic activ­ity. It exam­ines and com­pares the behav­ior of var­i­ous mea­sures of broad activ­ity: real GDP mea­sured on the prod­uct and income sides, economy-wide employ­ment, and real income. The Com­mit­tee also may con­sider indi­ca­tors that do not cover the entire econ­omy, such as real sales and the Fed­eral Reserve's index of indus­trial pro­duc­tion (IP).

10 minute video – email read­ers will need to come to site to view

Tags: Black Boxes, Cnbc, Conventional Wisdom, Economic Activity, Economy, Federal Reserve, GDP, Lakshman, Lakshman Achuthan, Measures, Memory, Nber, Nugget, Quarters, Real Gdp, Recession, Signals, Time Frame, Video Email, Warm Winter
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Michael Pettis Revisits 12 Predictions On China

Friday, May 4th, 2012

Via Michael Pet­tis of China Finan­cial Mar­kets,

In 2006 I started mak­ing a num­ber of pre­dic­tions based on what I thought was the nec­es­sary and log­i­cal devel­op­ment of China’s growth model. Some of these pre­dic­tions seemed fairly out­landish, espe­cially to China ana­lysts – Chi­nese and for­eign – who had very lit­tle knowl­edge of eco­nomic his­tory or other devel­op­ing coun­tries, but many of them so far have turned out quite well.

As more and more ana­lysts are begin­ning to under­stand the con­straints of the Chi­nese growth model I think it might be use­ful to list some of these pre­dic­tions to get a sense of what might be still to come.? Per­haps my bet with The Econ­o­mist has caused me to throw cau­tion to the winds, since a smart econ­o­mist never makes his pre­dic­tions explicit, but here they are:

1. China will be the last major econ­omy to emerge from the global cri­sis. My basic argu­ment was that the global cri­sis was caused by the nec­es­sary rever­sal of the great trade and cap­i­tal imbal­ances of the past decade, and a coun­try can only be said to have emerged from the cri­sis when those under­ly­ing imbal­ances had been resolved.

Since China’s con­tri­bu­tion to the global imbal­ances has been its exces­sively high sav­ings rate, China could not emerge from the cri­sis until the high sav­ings rate had been reduced to a more rea­son­able level. Since 2007-08, of course, the oppo­site has hap­pened, as Bei­jing has exac­er­bated its domes­tic imbal­ances in order to keep growth rates high. But with­out infi­nite debt capac­ity this can­not go on. I think it is pretty clear that over the next few years China will be forced to address and reverse the high sav­ings rate, and it will only be after this hap­pens that China can be said to have emerged from the cri­sis. This may take a decade or more.

2. Chi­nese con­sump­tion will con­tinue to stag­nate or decline as a share of GDP until the growth model is aban­doned. By “aban­don­ing” the model I mean that trans­fers from the house­hold sec­tor to sub­si­dize rapid growth must be elim­i­nated and reversed.

This is really a con­tin­u­a­tion of the first pre­dic­tion. It is too early to say, but 2012 may be the first year in which con­sump­tion growth will out­pace GDP growth, but only if GDP growth turns out to be much lower than expected – say below 7%. As long as GDP growth rates exceed 7%, there can be no real rebal­anc­ing of consumption.

3. Although there were many fac­tors that explained both rapidly ris­ing GDP and the con­tract­ing con­sump­tion share, finan­cial repres­sion would even­tu­ally be rec­og­nized to be the key fac­tor. It took many years to make this point, but it has become pretty clear to every­one that finan­cial repres­sion is at the heart of China’s prob­lem. This may explain Pre­mier Wen’s recent and rather shock­ing attack on the banks, although in my opin­ion it will still be at least another year or two, if ever, before we see any real lib­er­al­iza­tion of inter­est rates.

Remem­ber that the more debt there is, the harder it is to raise inter­est rates, and the longer we take to raise inter­est rates, the more debt we run up. In the end I sus­pect that finan­cial repres­sion will be elim­i­nated not by an increase in nom­i­nal rates but rather by a decline in GDP growth (remem­ber that the size of the finan­cial repres­sion tax is a func­tion of the dif­fer­ence between nom­i­nal GDP growth and the nom­i­nal lend­ing rate).

4. Invest­ment is being mis­al­lo­cated on a mas­sive scale and this was not due to any spe­cial Chi­nese char­ac­ter­is­tic but was rather a fun­da­men­tal require­ment of the way the sys­tem oper­ated. Although there are still some econ­o­mists who dis­agree that invest­ment is being mas­sively wasted, I think this is so well under­stood by now that there is no need to bela­bor the point. Peo­ple respond to incen­tives, and for the last decade or longer there has been a strong incen­tive to keep invest­ment lev­els high regard­less of their returns. It would be sur­pris­ing if this did not result in a lot of wasted spending.

5. Debt is ris­ing at an unsus­tain­able pace and debt lev­els will become unsus­tain­able well before the end of the decade. This fol­lows from the above point – if invest­ment is debt funded and if it is being wasted, then by def­i­n­i­tion debt must be increas­ing at an unsus­tain­able pace – i.e. faster than debt-servicing abilities.

In the past three years this warn­ing about ris­ing debt has become much more widely accepted, espe­cially since Vic­tor Shih started count­ing local gov­ern­ment debt in late 2009. There is still some dis­agree­ment on the sus­tain­abil­ity of debt, with some ana­lysts, like Arthur Kroe­ber of Drag­o­nom­ics and the guys at The Econ­o­mist, say­ing that China doesn’t have a seri­ous debt or over-investment prob­lem. I sus­pect nonethe­less that in another year or two no one will doubt that the Chi­nese growth model tends towards unsus­tain­able debt and that we are rapidly reach­ing the limit.

6. When spe­cific debt prob­lems are inden­ti­fied, res­olute attempts by Bei­jing to resolve them would be warmly wel­comed by ana­lysts but wholly irrel­e­vant – because the prob­lem of debt was sys­temic, not spe­cific. This fol­lows from the above. The issue is not that spe­cific bor­row­ers may run into debt prob­lems. It is that the run-up in debt is sys­temic and can­not be pre­vented as long as China main­tains the exist­ing growth model.? If there is rapid GDP growth, say any­thing above 6% or 7%, debt within the sys­tem must be ris­ing at an unsus­tain­able pace.

7. Pri­va­ti­za­tion, a topic all but for­bid­den in polite com­pany, would become a very hot topic of con­ver­sa­tion by 2013–14. I have dis­cussed why in sev­eral of the more recent blog entries.

8. As some pol­i­cy­mak­ers grad­u­ally became aware of the prob­lem with the growth model and the risk of cri­sis, a fun­da­men­tal polit­i­cal split would emerge between those that demanded rapid reform and those that wanted to main­tain con­trol of resources. The prob­lem is that con­tin­u­ing the growth model will lead to a debt cri­sis, but aban­don­ing the model will lead to much slower growth, and espe­cially to much slower growth in the accu­mu­la­tion of state sec­tor assets. This is polit­i­cally very dif­fi­cult for many to accept and will lead to more polit­i­cal con­flicts over the next few years.

9. Chi­nese gov­ern­ment debt will con­tinue to bal­loon through the rest of this decade. Pri­va­ti­za­tion is the best way to effect the trans­fer of wealth from the state sec­tor to the pri­vate sec­tor, and would be espe­cially effi­cient if pri­va­ti­za­tion pro­ceeds were used to extin­guish debt, but for the rea­sons dis­cussed above it will be extremely dif­fi­cult to do it. This means that debt build-up and the state absorp­tion of pri­vate sec­tor debt will con­tinue for many years.

10. If the tran­si­tion is not mis­man­aged, aver­age Chi­nese GDP growth rates will drop to 3% for the 2010–20 decade. As my bet with The Econ­o­mist sug­gests, this is one pre­dic­tion that is still an out­lier. The Economist(and many oth­ers) still believe that Chi­nese growth will make it the largest econ­omy in the world before the end of the decade, but much slower growth is what rebal­anc­ing requires and it is hard to make the num­bers work at growth lev­els much above 3%. By the way if I am wrong and Chi­nese growth this decade is mate­ri­ally higher than 3%, my pre­dic­tion is that the “lost decade” of much lower growth stretch out over two decades.

11. If China rebal­ances cor­rectly, then much slower GDP growth rates will be accom­pa­nied by only slightly slower growth rates in house­hold income. In that case there need be no social insta­bil­ity. The polit­i­cal risk comes from insta­bil­ity at the top, not at the bot­tom. Fac­tional dis­putes, in other words, haven’t ended with the Chongqing affair. They will persist.

12. Non-food com­mod­ity prices are set to col­lapse over the next three to four years. “Col­lapse” is not too strong a word. China’s share of global demand for such com­modi­ties as iron, cement, cop­per, etc. is com­pletely dis­pro­por­tion­ate to its size and almost wholly a func­tion of its very high growth in invest­ment. As invest­ment growth drops sharply, as it must, global demand for non-food com­modi­ties will plummet.

This is an abbre­vi­ated ver­sion of the newslet­ter that went out two weeks ago. Aca­d­e­mics, jour­nal­ists, and gov­ern­ment and NGO offi­cials who want to sub­scribe to the newslet­ter should write to me at chinfinpettis@yahoo.com, stat­ing your affil­i­a­tion, please. Investors who want to buy a sub­scrip­tion should write to me, also at that address.

Copy­right © China Finan­cial Markets

Tags: Beijing, Bet, Caution, Chinese Growth, Constraints, Consumption, Debt Capacity, Decade, Developing Countries, Economic History, Economist, Economy, Financial Markets, GDP, Global Crisis, Growth Model, Household, Little Knowledge, Logical Development, Michael Pettis
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The Income Hunt: Opportunities Abroad

Wednesday, May 2nd, 2012

by Russ Koes­terich, Chief Invest­ment Strate­gist, iShares

Investors often have a home coun­try bias when it comes to their fixed income port­fo­lios, which means they are gen­er­ally too reliant on domes­tic issues. Today, how­ever, there are a num­ber of rea­sons why investors should con­sider main­tain­ing a strate­gic bench­mark allo­ca­tion to emerg­ing mar­ket debt.

In recent posts, I’ve high­lighted some of these argu­ments, includ­ing the increased sta­bil­ity and improv­ing fun­da­men­tals of emerg­ing mar­ket coun­tries. But since so many investors are ask­ing me lately about emerg­ing mar­ket debt, I fig­ured I’d expand on the case for this asset class in this post. Here’s a bit more on four argu­ments favor­ing expo­sure to emerg­ing mar­ket fixed income.

Bet­ter fis­cal posi­tions: Emerg­ing mar­kets exited the finan­cial cri­sis in a far bet­ter posi­tion than their devel­oped mar­ket coun­ter­parts. The aver­age debt bur­den of emerg­ing mar­kets is less than 40% of gross domes­tic prod­uct, while devel­oped mar­ket debt has soared to more than 100% of GDP on aver­age. This greater fis­cal sta­bil­ity is partly why emerg­ing mar­ket bonds should now be less volatile rel­a­tive to their devel­oped coun­ter­parts than in the past.

Fad­ing infla­tion risk: While investors in emerg­ing mar­kets were rea­son­ably con­cerned about infla­tion in 2011, infla­tion appears to be a fad­ing risk in most of the large emerg­ing mar­ket coun­tries, the excep­tion being India. Chi­nese infla­tion is cur­rently run­ning at 3.6%, roughly half the level of last July. In Rus­sia, infla­tion has fallen to 3.7% in March from nearly 10% last May. Even in Brazil, a coun­try with a his­tory of stub­bornly high infla­tion, con­sumer price infla­tion has dropped to 5.2% in March, down from 7.3% in Sep­tem­ber. Inter­na­tional Mon­e­tary Fund esti­mates sug­gest that this trend should con­tinue, with emerg­ing mar­ket infla­tion expected to fall through­out 2012.

High pre­mium: Despite emerg­ing mar­kets’ improv­ing fun­da­men­tals, emerg­ing mar­ket bonds are offer­ing a sig­nif­i­cant, and his­tor­i­cally high, pre­mium over most devel­oped mar­ket debt. Cur­rently, emerg­ing mar­ket bonds are yield­ing roughly 350 basis points over the 10-year Trea­sury, close to a record high.

Diver­si­fy­ing hedge: Emerg­ing mar­ket bonds add diver­si­fi­ca­tion and a hedge on the dol­lar, although they are more volatile than domes­tic bonds. And for those wish­ing to avoid the for­eign cur­rency expo­sure asso­ci­ated with inter­na­tional bonds, there are dol­lar denom­i­nated emerg­ing mar­ket bonds and funds that offer the incre­men­tal yields with­out the for­eign cur­rency risk.

In short, most investors are arguably under­weight emerg­ing mar­ket bonds in their fixed income port­fo­lios though there’s a strong case for con­sid­er­ing increas­ing expo­sure to this asset class through vehi­cles such as the iShares J.P. Mor­gan USD Emerg­ing Mar­kets Bond Fund (NYSEARCA: EMB) and the iShares Emerg­ing Mar­kets Local Cur­rency Bond Fund (NYSEARCA: LEMB).

Source: Bloomberg

Dis­clo­sure: Author is long EMB

Diver­si­fi­ca­tion may not pro­tect against mar­ket risk. Bonds and bond funds will decrease in value as inter­est rates rise. Inter­na­tional invest­ments may involve risk of cap­i­tal loss from unfa­vor­able fluc­tu­a­tion in cur­rency val­ues, from dif­fer­ences in gen­er­ally accepted account­ing prin­ci­ples or from eco­nomic or polit­i­cal insta­bil­ity in other nations. Emerg­ing mar­kets involve height­ened risks related to the same fac­tors as well as increased volatil­ity and lower trad­ing vol­ume. Nar­rowly focused invest­ments typ­i­cally exhibit higher volatil­ity and are sub­ject to greater geo­graphic or asset class risk. The Fund may be sub­ject to credit risk, which refers to the pos­si­bil­ity that the debt issuers will not be able to make prin­ci­pal and inter­est payments.

Tags: asset class, Bias, Chief Investment Strategist, Consumer Price Inflation, Counterparts, Debt Burden, Emerging Market Bonds, Emerging Market Countries, Emerging Markets, Estimates, Financial Crisis, Fiscal Positions, Fiscal Stability, Fixed Income, GDP, Gross Domestic Product, Inflation Risk, International Monetary Fund, Portfolios, Russ
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"Release the Kraken" (Hussman)

Monday, April 30th, 2012

by John P. Huss­man, Ph.D., Huss­man Funds

Over the past 13 years, and includ­ing the recent mar­ket advance, the S&P 500 has under­per­formed even the minus­cule return on risk-free Trea­sury bills, while expe­ri­enc­ing two mar­ket plunges in excess of 50%. I am con­cerned that we are about to con­tinue this jour­ney. At present, we esti­mate that the S&P 500 will likely under­per­form Trea­sury bills (essen­tially achiev­ing zero total returns) over the com­ing 5 year period, with a prob­a­ble inter­ven­ing loss in the range of 30–40% peak-to-trough.

Why? First, with respect to 5-year prospec­tive returns, it's impor­tant to rec­og­nize that returns at that hori­zon are pri­mar­ily dri­ven by val­u­a­tions — not the "Fed Model" kind, but the nor­mal­ized earn­ings and dis­counted cash flow kind. Stocks remain stren­u­ously over­val­ued here, and only appear "fairly priced" rel­a­tive to recent and near-term earn­ings esti­mates because cor­po­rate profit mar­gins are more than 50% above their long-term norm. Mean­while, cor­po­rate prof­its as a share of GDP are about 70% above the long-term aver­age. As I detailed in Too Lit­tle To Lock In, these abnor­mally high mar­gins are tightly related (via account­ing iden­tity) to mas­sive fis­cal deficits and depressed house­hold sav­ings rates, nei­ther which are sustainable.

Our pro­jec­tion for 10-year S&P 500 total returns — nom­i­nal — is about 4.4% annu­ally, which is far bet­ter than the 2000 peak, far infe­rior to the 2009 trough, and save for the period before the 1929 crash, worse than any prospec­tive return observed prior to the late-1990's bub­ble — even in peri­ods hav­ing sim­i­larly depressed inter­est rates.

Of course, rich val­u­a­tions can per­sist for some time — pre­dictably result­ing in poor long-term returns, but often doing lit­tle to pre­vent short-run spec­u­la­tion and tem­po­rary gains. The issue is then to iden­tify the point at which over­val­ued con­di­tions are joined by suf­fi­ciently overex­tended con­di­tions, and a suf­fi­cient loss of spec­u­la­tive dri­vers, to make rich val­u­a­tions "bite" even in the shorter-term. This is where addi­tional cri­te­ria come in, such as over­bought tech­ni­cal con­di­tions and extreme opti­mism in the form of low bear­ish sen­ti­ment, depressed mutual fund cash lev­els, and heavy insider sell­ing. Presently, it doesn't help that T-bill yields and long-term bond yields remain higher than 6 months ago, and we have signs of oncom­ing reces­sion. This is par­tic­u­larly evi­denced by col­laps­ing eco­nomic mea­sures in Europe, soft­en­ing eco­nomic per­for­mance in devel­op­ing economies includ­ing China and India, and jointly weak year-over-year growth in key U.S. eco­nomic mea­sures such as real per­sonal income, real per­sonal con­sump­tion, real final sales, and reli­able lead­ing indi­ca­tors from the OECD and ECRI, as well as our own measures.

The com­bi­na­tion of rich val­u­a­tions, over­bought con­di­tions, over­bull­ish sen­ti­ment, and dete­ri­o­rat­ing lead­ing eco­nomic evi­dence can still unfor­tu­nately per­sist for months before being resolved. But once the hos­tile syn­dromes we've seen recently have emerged in the data, attempts at con­tin­ued spec­u­la­tion have amounted to play­ing with fire. Sim­i­lar con­di­tions have repeat­edly resulted in dis­as­trous out­comes for investors. It would be nice to be able to "time" these out­comes bet­ter. We haven't found a reli­able way to do so, and would still be con­cerned about robust­ness — sen­si­tiv­ity to small errors — even if we did. Yet even when unfor­tu­nate out­comes are not imme­di­ate, the fact that the S&P 500 has under­per­formed T-bills for 13 years is not very sym­pa­thetic to argu­ments that stock mar­ket risk has been worth tak­ing over­all, except in con­fined doses.

Tags: 13 Years, Corporate Profit, Corporate Profits, Discounted Cash Flow, Earnings Estimates, Fed Model, Fiscal Deficits, GDP, Household Savings, Hussman Funds, Kraken, Market Advance, Market Plunges, Model Kind, Profit Margins, Speculation, Term Earnings, Treasury Bills, Trough, Valuations
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Sell in May and Go Away? Not this Year

Sunday, April 29th, 2012

Sell in May and Go Away? Not this Year

By Frank Holmes, CEO and Chief Invest­ment Offi­cer, U.S. Global Investors

One catchy invest­ing maxim that’s pop­u­lar this time of year is “sell in May and go away,” the notion that investors should cash in their invest­ments and take the sum­mer off. His­tor­i­cally, this hasn’t been a bad strat­egy. You can see from this chart that June, July, August and Sep­tem­ber have been the worst four months of the year for the S&P 500 Index since 1988.

Since 2000, the June-September period for the S&P 500 is split. Half of the years saw pos­i­tive returns, while the other half were neg­a­tive. His­tor­i­cally, you have only about a fifty-fifty chance for a pos­i­tive gain dur­ing those months while your odds are roughly 10 per­cent bet­ter dur­ing the rest of the year.

The trend is less con­sis­tent for emerg­ing mar­ket stocks. You can see that the median monthly return for the MSCI Emerg­ing Mar­kets Index since 1988 is neg­a­tive for June and August, but pos­i­tive for July and Sep­tem­ber. The fre­quency of pos­i­tive returns dur­ing the June-September period is roughly 6 per­cent lower than the rest of the year.

Last year, investors who employed the “sell in May” strat­egy averted an almost 17 per­cent drop in the S&P 500 and a nearly 25 per­cent drop in the MSCI Emerg­ing Mar­kets Index from June-September. Sum­mer of 2010 was a sim­i­lar experience.

With last year fresh on the minds of investors, should they take the sum­mer off? We don’t think so.

We believe it’s a much bet­ter mar­ket this year. After fol­low­ing a sim­i­lar tra­jec­tory as the pre­vi­ous year from Octo­ber to the begin­ning of March, improv­ing eco­nomic data pushed the S&P 500 over 3 per­cent higher in March 2012 after trend­ing side­ways dur­ing the same time period last year.

Nom­i­nal GDP in the U.S. grew 3.8 per­cent dur­ing the first quar­ter of 2012 ver­sus 0.4 per­cent in 2011, and sev­eral areas of the econ­omy are much stronger than they were a year ago. Non­farm pay­rolls (up 29 per­cent), ISM Man­u­fac­tur­ing (up 2 per­cent) and auto sales (up 8 per­cent) have all improved from a year ago, accord­ing to J.P. Mor­gan. In fact, auto sales are cur­rently at a four-year high.

More impor­tantly, the U.S. hous­ing sec­tor con­tin­ues to improve. The ISI Group’s home­builders sur­vey is cur­rently at 50.4, nearly 40 per­cent higher than a year ago.

Build­ing per­mits are 35 per­cent higher and the num­ber of hous­ing starts is 3 per­cent higher than a year ago, accord­ing to Credit Suisse. Sales of exist­ing homes are up 5 per­cent on a year-over-year basis. Credit Suisse says, “The sup­ply of exist­ing one-family homes has fallen from a peak of 11.5 months in July 2010 to 6.3 months in March (in line with the 20-year average).”

ISI Group says an improve­ment in hous­ing is impor­tant because it lifts con­sumer net worth and employ­ment, which leads to ris­ing con­sumer con­fi­dence. Hous­ing accounts for just over 2 per­cent of U.S. GDP, but roughly 27 per­cent of house­hold wealth, accord­ing to Credit Suisse.

Earn­ings Sea­son Off to a Record Start

The improv­ing global econ­omy is reflected in the thirteenth-straight quar­ter of better-than-expected cor­po­rate earn­ings. As of Thurs­day, 80 per­cent of S&P 500 com­pa­nies have reported earn­ings above ana­lyst esti­mates. Earn­ings for the 260 com­pa­nies report­ing so far were up 11.4 per­cent year-over-year and beat the con­sen­sus esti­mate by 6.3 percent.

This is good news for share­hold­ers. Accord­ing to a Bloomberg story this week, “com­pa­nies are increas­ing share­holder returns in the form of div­i­dends and buy­backs after the 2008 finan­cial cri­sis led them to hoard cash to a record $1 tril­lion by the end of 2011.” The num­ber of S&P 500 com­pa­nies pay­ing out div­i­dends now sits at 401, the largest num­ber since Jan­u­ary 2000. Cor­po­ra­tions bought back roughly $543 bil­lion worth of shares in 2011 and J.P. Mor­gan esti­mates com­pa­nies will pur­chase another $679 bil­lion worth in 2012.

U.S. com­pa­nies aren’t the only ones report­ing stronger results. This chart from Credit Suisse shows earn­ings momen­tum is strength­en­ing around the world based on 12-month for­ward earn­ings per share esti­mates for the MSCI ACWI (All Com­pany World Index). This is the oppo­site of what we expe­ri­enced in 2011.

Buy in May?

May has his­tor­i­cally been a strong one for mar­kets. Since 1988, the median return for the S&P 500 and MSCI Emerg­ing Mar­kets dur­ing May has been 1.22 per­cent and 1.28 per­cent, respec­tively. In fact, May returns rank in the top half for both indices.

This is also a pres­i­den­tial elec­tion year in the U.S., which has his­tor­i­cally pro­duced pos­i­tive returns. Since 1972, the stock mar­ket has ral­lied in 5 of the 8 elec­tion years, accord­ing to J.P. Mor­gan, with mar­ket gains of 12–26 per­cent. Only dur­ing reces­sion years (2000 and 2008) did the S&P 500 pro­vide neg­a­tive returns.

Last week, Bank of America-Merrill Lynch sug­gested “investors posi­tion for an eco­nomic upturn” by increas­ing their expo­sure to equi­ties. The firm’s Global Wave indi­ca­tor, a com­pi­la­tion of seven global met­rics designed to pro­vide a com­pre­hen­sive assess­ment of trends in global eco­nomic activ­ity, was sig­nal­ing a trough in the global cycle. Accord­ing to BofA-ML’s research, the MSCI ACWI (All Coun­try World Index) aver­ages a 14.2 per­cent increase for the 12 months fol­low­ing a trough in the Global Wave. His­tor­i­cally, the index has expe­ri­enced a pos­i­tive return 86 per­cent of the time.

Instead of “sell­ing in May and going away” for the sum­mer in 2012, we think investors should look to global stock mar­kets and ride the global wave.

Tags: Amp, August And September, Chief Investment Officer, Economic Data, Emerging Market Stocks, First Quarter, Four Months, Frank Holmes, GDP, Maxim, Months Of The Year, Msci Emerging Markets, Msci Emerging Markets Index, Nominal Gdp, Nonfarm Payrolls, Previous Year, Same Time Period, Time Of Year, Trajectory, U S Global Investors
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Big GDP Miss: 2.2% Vs Expectations Of 2.5%, Composition Even Uglier

Friday, April 27th, 2012

So much for the +3.0% GDP whis­per num­ber. Instead of print­ing at the expected num­ber of +2.5%, the first pre­lim­i­nary GDP data point (two more revi­sions pend­ing) came out at 2.2%, a big dis­ap­point­ment for a quar­ter which had a sub­stan­tial boost from the weather. And while of the 2.2%, Per­sonal Con­sump­tion came in strong — as expected, as it was pre­cisely the fac­tor most impacted by pulling in demand for­ward cour­tesy of "April in Feb­ru­ary", 0.59% of the 2.2% was an increase in inven­to­ries, some­thing which was not sup­posed to hap­pen as it means that the qual­ity of the eco­nomic growth in Q1 was far worse than expected. Cement­ing the ugly com­po­si­tion of Q1 GDP was fixed invest­ment which added just a pal­try 0.18% — this is the num­ber which is crit­i­cal for ongo­ing cash­flow gen­er­a­tion and unfor­tu­nately, the very low print means that growth out­look for Q2 is now even worse than before and we expect econ­o­mists will promptly trim their already bear­ish pre­dic­tions for Q2 GDP. Finally, gov­ern­ment "con­sump­tion" sub­tracted just 0.6% from the total num­ber, a decrease from the 0.84% in Q4, which means that once again the gov­ern­ment is start­ing to become less of a detrac­tor to growth — a dag­ger in the heart to any­one who claims there is "qual­ity" in GDP growth. And the num­ber you have all been wait­ing for: At March 31, US Debt/GDP was 100.8%.

Full break­down by category:

Tags: Composition, Dagger, Detractor, Disappointment, Economic Growth, Economists, GDP, Gdp Data, GDP Growth, Government Consumption, Growth Outlook, Heart, Inventories, Personal Consumption, Q2 Gdp, Q4, Revisions, Ugly, Weather, Whisper Number
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Jeff Gundlach Explains Biflation

Thursday, April 26th, 2012

Appro­pos Bernanke's razor's-edge tight-rope-walk fence-sitting as the not-too-cold-not-too-hot econ­omy reduces the Fed's abil­ity to do any­thing, Jeff Gund­lach of Dou­ble Line pro­vided a suc­cinct expla­na­tion of the the 'uncom­fort­able posi­tion' the place-of-confusion Fed finds itself in. Sim­pli­fy­ing the dilemma to: the Fed can­not raise rates as the dra­matic impli­ca­tions for the huge debt load (and implictly the inter­est expense sav­ing the bud­get deficit) of the US Gov­ern­ment are unten­able while at the same time infla­tion (in the things we need — not just want) is ris­ing notably. How­ever the new bond-king notes rather sar­cas­ti­cally, that the Fed can show that there is only mod­est infla­tion thanks to hous­ing and wage growth (and here­lies 'the bifla­tion'). The old-school-Fed's efforts at pre-emptive strikes against infla­tion is sim­ply not going to hap­pen, he states, cit­ing an "inten­tional attempt to sup­press national income — an attempt to stop nom­i­nal GDP grow­ing too much — sim­ply won't be tol­er­ated until infla­tion moves into the 4–5% cat­e­gory".

Tags: Budget Deficit, Confusion, Debt Load, Dilemma, Dramatic Implications, Emptive Strikes, Fence, GDP, Gundlach, inflation, Interest Expense, New Bond, Nominal Gdp, Old School, Razor, Rope Walk, Succinct Explanation, Tight Rope, Uncomfortable Position, Us Government
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The Day Austerity Died (Tchir)

Tuesday, April 24th, 2012

by Peter Tchir, TF Mar­ket Advisors

Aus­ter­ity is dead! Long live Spending!

Futures are up, Ital­ian and Span­ish bonds are up, CDS spreads on them are at least 10 bps tighter, and MAIN is 3 bps tighter on the day (though I have this feel­ing I bet­ter type fast as we are start­ing to fade off the best levels).

Lots of lit­tle things seem to be con­tribut­ing to the strength, TXU earn­ings, no eco­nomic data, auc­tions that raised the required money, etc., but there does also seem to be a belief that Ger­many finally “gets it”. That Ger­many is finally going to relent on their demands for austerity.

The first ques­tion is “what is defined as aus­ter­ity?” Pro­grams that are pro­vid­ing money today, that is quickly re-circulated into the econ­omy because it is pay­ing for peo­ple to live should not be cut – that is bad aus­ter­ity. Rais­ing taxes in gen­eral is prob­a­bly bad aus­ter­ity, but what about actu­ally col­lect­ing taxes on all those who have avoided pay­ing what they owe? Plans to reduce long term ben­e­fits must go for­ward, min­i­mal cur­rent cost to the econ­omy, but nec­es­sary for any long term solu­tion. So while “aus­ter­ity” hasn’t worked, it is not all bad, and some forms need to be main­tained to have any hope that the sit­u­a­tion can be turned around in the future.

The sec­ond, and more impor­tant ques­tion, is “why does any sane per­son think spend­ing for growth will work?” Just pause for 1 moment. How were these mas­sive deficits built up? Was all the spend­ing friv­o­lous? I don’t think so. A lot of spend­ing was meant to tar­get growth in cer­tain areas. It is just very dif­fi­cult to achieve. If spend­ing to get growth was so easy in a global econ­omy, the U.S., the cur­rent king of spend­ing, would have Chi­nese like GDP growth. It is not that easy to spend your way to growth. I’m sure at some level, Solyn­dra received money because there was a real belief some­where that it was a good invest­ment for growth. GM might be used as an exam­ple, but I’m not con­vinced that the gov­ern­ment spend­ing did any­thing more than pri­vate cap­i­tal would have done in the wake of a real bank­ruptcy. The excite­ment over “spend­ing for growth” is almost mind-boggling, because it basi­cally goes against a decade of his­tory show­ing the inabil­ity of gov­ern­ments to spend and achieve real growth. But, there is one part that does make sense, at least from a Wall Street perspective.

So the final ques­tion is, “who will finance all that spend­ing?” Ahhh, the real rea­son Wall Street is enthu­si­as­tic about spend­ing for growth. The only way a spend­ing for growth cam­paign can begin, is with another mas­sive round of bal­ance sheet expan­sion by cen­tral banks. That has been great for banks and wall street, while less clear what it has done for the econ­omy, or any­one with­out a sig­nif­i­cant por­tion of their wealth in stocks. If Spain announced a big new spend­ing cam­paign, would any­one really believe it would work? What would they do? Build more homes to get con­struc­tion going? How would that help when an unpopped real estate bub­ble is part of the prob­lem (actu­ally the bub­ble has burst, it just hasn’t been rec­og­nized on banks’ and cajas’ bal­ance sheets). Would investors who aren’t excited about lend­ing 5 year money at 4.75% sud­denly line up to buy all this debt think­ing the new spend­ing ini­tia­tives (which increase debt in the short term) will really work? I don’t think so. Buy­ing new debt in an envi­ron­ment where coun­tries feel free to spend and run deficits because aus­ter­ity doesn’t work, will only frighten pri­vate cap­i­tal. So the cen­tral banks of the world will have to step up again and pro­vide the fund­ing. I don’t think that is a good thing, but can see why some do, and can really see why some of those push­ing the most for a return to debt issuance and spend­ing and cen­tral bank inter­ven­tion would want it – because they ben­e­fit, not because it will work.

The real­ity is that spend­ing won’t solve any­thing. It will grow debt faster than the spend­ing can improve the econ­omy. Stop­ping longer term aus­ter­ity pro­grams will make the future debt to GDP ratios look even more hor­rific. There will ulti­mately need to restruc­tur­ing on a mas­sive scale.

It is no co-incidence that more and more sov­er­eign debt is being funded by insti­tu­tions in that coun­try. It is specif­i­cally to make leav­ing the Euro eas­ier. An Ital­ian pen­sion plan for exam­ple has both its assets and its lia­bil­i­ties in Italy. A con­ver­sion back to Lire is man­age­able in a sit­u­a­tion like that. Yes, the pen­sion plan’s rede­nom­i­nated Ital­ian Lire bonds may trade down because of the deval­u­a­tion, but their pen­sion oblig­a­tions would also be rede­nom­i­nated at the same time, off­set­ting a lot, if not all of the pain. The same is true in the bank­ing sec­tor. Cor­po­ra­tions won’t have that lux­ury as many are global, but it may explain why Ital­ian and Span­ish com­pa­nies have been busy issu­ing debt. So return­ing to tra­di­tional cur­ren­cies has the least impact on the coun­try and the Euro­zone if the debt is largely held inter­nally. That is the direc­tion the coun­tries and the ECB have been mov­ing, so don’t ignore this as a more likely real solution.

Debt restruc­tur­ing in terms of coupon reduc­tion, notional reduc­tion, and matu­rity exten­sion are all real pos­si­bil­i­ties too. If coun­tries learned any­thing from Greece, it is that by wait­ing too long, and accept­ing more Troika money than the pri­vate sec­tor wrote-off, the prob­lem doesn’t go away. Restruc­tur­ing early and harshly is far bet­ter than wait­ing and doing it in bits and pieces, and it has to affect ALL cred­i­tors. One rea­son that the ECB hasn’t resumed its SMP just yet is that coun­tries aren’t sure how much they want to owe the ECB. The ECB has proven itself to be an unhelp­ful part­ner in restruc­tur­ing. Watch what the ECB does (or doesn’t do) and ask your­self why.

So “Aus­ter­ity Now” may be over, but killing some­thing that didn’t work, isn’t the same as solv­ing the prob­lem. Going back to the norm that caused the prob­lem in the first place, hardly seems like a solu­tion either. Cur­rency rever­sion and/or debt restruc­tur­ing will be the ulti­mate end-game.

We get a del­uge of hous­ing data out this morn­ing. I expect it to dis­ap­point, but at this stage I’m not sure another hous­ing dis­ap­point­ment does any­thing for the mar­ket. It would merely con­firm what is becom­ing a con­sen­sus view – that the actual weather actu­ally played a role in mak­ing the win­ter num­bers look bet­ter than they might oth­er­wise have been.

Good luck with the rest of the day, though I sus­pect that once Europe goes home we will do noth­ing but watch every move in AAPL like we did yes­ter­day after­noon. In the mean­time I hope I can get the Don Maclean Amer­i­can Pie song out of my head on “the day aus­ter­ity died”….

Copy­right © TF Mar­ket Advisors

Tags: Auctions, Austerity Programs, Belief That, Bonds, Bps, Current, Earnings, Economic Data, Futures, GDP, GDP Growth, Global Economy, Gm, Long Term Solution, Money, Nbsp, Sane Person, Taxes, Tf, Txu
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Run, Don't Walk (Hussman)

Monday, April 23rd, 2012

by John Huss­man, Huss­man Funds

We cur­rently esti­mate the prospec­tive 10-year total return on the S&P 500 at about 4.5% annu­ally, in nom­i­nal terms, based on our stan­dard val­u­a­tion method­ol­ogy. This may not seem bad, rel­a­tive to 2% yields on the 10-year Trea­sury bond, pro­vided that investors actu­ally con­sider either fig­ure to be an ade­quate 10-year invest­ment return, and pro­vided that they view 4.5% annual returns as ade­quate com­pen­sa­tion for secu­ri­ties that have sev­eral times the volatil­ity of a 10-year Trea­sury bond (espe­cially when yields are low), and pro­vided that investors ignore the fact that prospec­tive mar­ket returns tend to enjoy a sig­nif­i­cant range over the course of the mar­ket cycle, so that "lock­ing in" present prospec­tive returns must nec­es­sar­ily forego any higher prospec­tive return that might be observed in the com­ing decade. Even given robust growth in GDP and cor­po­rate rev­enues, a move to prospec­tive returns of just 6% at some point in the next two years would likely leave investors with no return (includ­ing div­i­dends) in the interim (see Too Lit­tle to Lock In).

Wall Street con­tin­ues to focus on the idea that stocks are "cheap" on the basis of for­ward price/earnings mul­ti­ples. I can't empha­size enough how badly stan­dard P/E met­rics are being dis­torted by record (but reli­ably cycli­cal) profit mar­gins, which remain about 50–70% above his­tor­i­cal norms. Our atten­tion to profit mar­gins and the use of nor­mal­ized val­u­a­tion mea­sures is noth­ing new, nor is our view that record profit mar­gins have cor­rupted many widely-followed val­u­a­tion mea­sures. As I noted in our Sep­tem­ber 8, 2008 com­ment Deja Vu (Again), which hap­pened to be a week before Lehman failed and the mar­ket col­lapsed, "Cur­rently, the S&P 500 is trad­ing at about 15 times prior peak earn­ings, but that mul­ti­ple is some­what mis­lead­ing because those prior peak earn­ings reflected extremely ele­vated profit mar­gins on a his­tor­i­cal basis. On nor­mal­ized profit mar­gins, the market's cur­rent val­u­a­tion remains well above the level estab­lished at any prior bear mar­ket low, includ­ing 2002 (in fact, it is closer to lev­els estab­lished at most his­tor­i­cal bull mar­ket peaks). Based on our stan­dard method­ol­ogy, the S&P 500 Index is priced to achieve expected total returns over the com­ing decade in the range of 4–6% annu­ally." Present val­u­a­tions are of course more ele­vated today than they were before that plunge.

Suf­fice it to say that every P/E mul­ti­ple is sim­ply a short­hand for proper dis­counted cash-flow meth­ods, because there are count­less assump­tions about growth, mar­gins, return on invested cap­i­tal and other fac­tors qui­etly baked inside. Like price-to-forward oper­at­ing earn­ings mul­ti­ples, even our old price-to-peak earn­ings met­ric has been ren­dered mis­lead­ing due to his­tor­i­cally high profit mar­gins. Of course, we knew that was hap­pen­ing even before the credit cri­sis began, and believe that numer­ous widely-followed val­u­a­tion mea­sures remain dis­torted by record profit mar­gins here.

On the eco­nomic front, the recent uptick in new unem­ploy­ment claims is con­sis­tent with the lead­ing eco­nomic mea­sures and "unob­served com­po­nents" esti­mates that we obtain from the broad eco­nomic data here (see the note on extract­ing eco­nomic sig­nals in Do I Feel Lucky?). Indeed, it will be dif­fi­cult to get the expected flat or neg­a­tive April employ­ment print if weekly new claims don't rise toward about 400,000 in the next few weeks. We've seen "sur­pris­ing" weak­ness in some of the more recent regional sur­veys such as Empire Man­u­fac­tur­ing and Philly Fed. A con­tin­u­a­tion of that trend would also be informative.

As I noted a few months ago, "exam­in­ing the past 10 U.S. reces­sions, it turns out that pay­roll employ­ment growth was pos­i­tive in 8 of those 10 reces­sions in the very month that the reces­sion began. These were not small num­bers. The aver­age pay­roll growth (scaled to the present labor force) trans­lates to 200,000 new jobs in the month of the reces­sion turn, and about 500,000 jobs dur­ing the pre­ced­ing 3-month period. Indeed, of the 80% of these points that were pos­i­tive, the aver­age rate of pay­roll growth in the month of the turn was 0.20%, which presently trans­lates to a pay­roll gain of 264,000 jobs. Notably how­ever, the month fol­low­ing entry into a reces­sion typ­i­cally fea­tured a sharp dropoff in job growth, with only 30% of those months fea­tur­ing job gains, and employ­ment losses that work out to about 150,000 jobs based on the present size of the job force. So while robust job cre­ation is no evi­dence at all that a reces­sion is not directly ahead, a sig­nif­i­cant neg­a­tive print on jobs is a fairly use­ful con­fir­ma­tion of the turn­ing point, pro­vided that lead­ing reces­sion indi­ca­tors are already in place." (see Lead­ing Indi­ca­tors and the Risk of a Blind­side Reces­sion).

The upshot is that while I expect a weak April jobs report, we should hes­i­tate to take lead­ing infor­ma­tion from what remains largely a short-lagging indi­ca­tor. We're already see­ing dete­ri­o­ra­tion in eco­nomic data, but it remains largely dis­missed as noise. An accel­er­a­tion of eco­nomic dete­ri­o­ra­tion as we move toward midyear would be more dif­fi­cult to ignore. My impres­sion is that investors and ana­lysts don't rec­og­nize that we've never seen the ensem­ble of broad eco­nomic dri­vers and aggre­gate out­put (real per­sonal income, real per­sonal con­sump­tion, real final sales, global out­put, real GDP, and even employ­ment growth) jointly as weak as they are now on a year-over-year basis, except in asso­ci­a­tion with reces­sion. All of these mea­sures have neg­a­tive stan­dard­ized val­ues here. My guess is that we'll even­tu­ally mark a new reces­sion as begin­ning in April or May 2012.

Emphat­i­cally, how­ever, our con­cerns about the stock mar­ket con­tinue to be inde­pen­dent of these eco­nomic expec­ta­tions, as the hos­tile invest­ment syn­dromes we've seen in recent months have his­tor­i­cally been suf­fi­cient to pro­duce very neg­a­tive mar­ket out­comes, on aver­age, even in the absence of eco­nomic strains (see Goat Rodeo and An Angry Army of Aunt Min­nies). As always, I strongly encour­age investors to adhere to their dis­ci­plines — includ­ing those fol­low­ing a buy-and-hold approach — pro­vided that they have care­fully con­tem­plated the full-cycle risk and their abil­ity to stick to their strat­egy through the worst parts of the invest­ment cycle. What I am adamantly against is the idea that spec­u­la­tors can suc­cess­fully "game" over­val­ued, over­bought, over­bull­ish mar­kets — par­tic­u­larly in the face of numer­ous hos­tile syn­dromes, near-panic insider sell­ing, spec­u­la­tion in new issues, and broad diver­gences in mar­ket inter­nals, all of which we are now observing.

In the absence of hos­tile syn­dromes like we observe today, we gen­er­ally have more equa­nim­ity about mar­ket prospects — rec­og­niz­ing the aver­age out­come, but also empha­siz­ing the wide range of indi­vid­ual out­comes asso­ci­ated with a given set of mar­ket con­di­tions. The major­ity of our past mar­ket com­ments are filled with reminders that our expec­ta­tions are based on aver­age return and risk char­ac­ter­is­tics, and should not be taken as fore­casts about any spe­cific instance. At present, the out­comes that have his­tor­i­cally emerged from sim­i­lar con­di­tions are so uni­formly neg­a­tive that too much equa­nim­ity would be misleading.

One way to gauge your spec­u­la­tive expo­sure is to ask the sim­ple ques­tion — what por­tion of your port­fo­lio do you expect (or even hope) to sell before the next major mar­ket down­turn ensues? Almost by def­i­n­i­tion, that por­tion of your port­fo­lio is spec­u­la­tive in the sense that you do not intend to carry it through the full mar­ket cycle, and instead expect to sell it to some­one else at a bet­ter price before the cycle com­pletes. With respect to those spec­u­la­tive hold­ings, and when to part with them, my own view is straight­for­ward. Run, don't walk.

Notes on bank­ing and mon­e­tary policy

Banks con­tinue to report seem­ingly pleas­ant earn­ings, as long as one doesn't look under the hood at the dri­vers of those reports. Two dri­vers have been par­tic­u­larly impor­tant this quar­ter. One is the fur­ther reduc­tion of reserves against future loan losses, which shows up as a pos­i­tive con­tri­bu­tion to bank earn­ings. For exam­ple, a decline in loan loss reserves was the source of about one-third of the earn­ings reported by Cit­i­group. The other dri­ver is some­thing called a "debt val­u­a­tion adjust­ment" or DVA. You might recall that as a result of Euro­pean credit strains last year, investors sold off the bonds of major banks. In the world of bank account­ing, the debt was there­fore cheaper to retire, so — I am not mak­ing this up — the decline in the value of the bonds was booked as earn­ings. Of course, the value of bank debt has recov­ered some­what since then, as investors have set aside con­cerns about Europe (which we doubt is a good idea). One might expect that since banks booked DVA as a con­tri­bu­tion to earn­ings last year, we would see the oppo­site effect this quar­ter. But one would be wrong. As Peter Tchir noted last week, "Mor­gan Stan­ley no longer includes DVA in its 'con­tin­u­ing oper­a­tions' head­line num­ber. It was a loss of $2 bil­lion this quar­ter. With 2 bil­lion shares out­stand­ing, that would have wiped out the gain. What both­ers me, is that in Q3, when it was a gain of $3 bil­lion, it was part of con­tin­u­ing ops." It was the same story at Bank of Amer­ica, prompt­ing one ana­lyst to observe "one-time items are to be ignored when neg­a­tive, and praised when pro­vid­ing a 'one-time benefit.'"

Tyler Dur­den of Zero­Hedge has started refer­ring to the Fed­eral Reserve as sim­ply "CTRL+P" — which is bril­liant, because it really cap­tures the full intel­lec­tual con­tent of Fed pol­icy in recent years. Keep in mind that when the Fed engages in quan­ti­ta­tive eas­ing, it pur­chases Trea­sury secu­ri­ties and pays for them by cre­at­ing new base money. From an equi­lib­rium per­spec­tive, the U.S. gov­ern­ment has financed its deficit in recent years partly by issu­ing new Trea­sury debt that was bought by the pub­lic, and partly by print­ing money that is now held by the pub­lic (cor­re­spond­ing to the Trea­suries bought by the Fed). Of course, the Fed can "unprint" the money, so to speak, by revers­ing its trans­ac­tions, and sell­ing those Trea­sury secu­ri­ties back to the pub­lic. But the Fed's abil­ity to do such mas­sive sell­ing with­out dis­rup­tion is unproved, to say the least.

Some have asked why the Fed will ever need to reverse its trans­ac­tions. Couldn't the Fed just leave the mon­e­tary base out there and per­pet­u­ally roll the Trea­sury port­fo­lio for­ward? The answer depends on what sort of infla­tion we would like to observe, par­tic­u­larly in the back-half of this decade.

To put some struc­ture on this ques­tion, I've updated our Liq­uid­ity Pref­er­ence chart (1947-present), which illus­trates the close rela­tion­ship between nom­i­nal inter­est rates and mon­e­tary base per dol­lar of nom­i­nal GDP. Cur­rently, the U.S. mon­e­tary base amounts to 17 cents per dol­lar of GDP — a level that is con­sis­tent with con­tained infla­tion only if short-term (3-month Trea­sury) yields are held below about 10 basis points. For more on the rela­tion­ship between the mon­e­tary base, inter­est rates, nom­i­nal GDP and infla­tion, see Six­teen Cents — Push­ing the Unsta­ble Lim­its of Mon­e­tary Pol­icy, and Charles Plosser and the 50% Con­trac­tion in the Fed's Bal­ance Sheet.

Think of it this way. The will­ing­ness of peo­ple to hold a given amount of base money, per dol­lar of nom­i­nal GDP, is inti­mately tied to the rate of return that they could get on an interest-bearing secu­rity. Higher inter­est rates reduce the demand for zero-interest cash. So if there is upward pres­sure on inter­est rates, and the Fed leaves the money sup­ply alone, how do you reach equi­lib­rium? Sim­ple — nom­i­nal GDP becomes the adjust­ment vari­able. If there's not enough real GDP growth to absorb the excess base money, prices rise to do the job.

Like­wise, expand­ing the amount of base money per dol­lar of nom­i­nal GDP puts down­ward pres­sure on Trea­sury bill yields and short-term inter­est rates, but really only if there are no infla­tion­ary pres­sures in the sys­tem. Clearly, if infla­tion­ary pres­sures are present (sug­gest­ing that the mon­e­tary base is already too large), an expan­sion in the mon­e­tary base won't pro­duce lower inter­est rates. Rather, it will accel­er­ate those infla­tion­ary pres­sures as nom­i­nal GDP is forced to keep up with the mon­e­tary base — even if real GDP isn't grow­ing at all. All hyper­in­fla­tions are built on this dynamic. That said, it's worth empha­siz­ing that unteth­ered money growth is invari­ably a reflec­tion of unteth­ered fis­cal deficits (the cen­tral bank just buys the gov­ern­ment debt and replaces it with money). So sig­nif­i­cant infla­tion is ulti­mately not a mon­e­tary phe­nom­e­non as much as it is a fis­cal one.

In any event, the sim­ple fact is that the Fed can sus­tain the cur­rent size of its bal­ance sheet, with­out infla­tion­ary pres­sures, only to the extent that peo­ple (and banks) are will­ing to sit on idle, low or zero-interest money bal­ances. In an envi­ron­ment of credit con­cerns and an increas­ingly likely implo­sion of the Euro­pean bank­ing sys­tem (where the fresh lever­age taken to pur­sue the "Sarkozy trade" is now turn­ing into lever­aged losses), the short-term will­ing­ness to hold idle but "safe" cash bal­ances is quite high. So in the event of addi­tional credit strains, the abil­ity of the Fed to go fur­ther out to the right on the Liq­uid­ity Pref­er­ence curve is nearly unconstrained.

The prob­lem is that this pol­icy is incon­sis­tent with any eco­nomic envi­ron­ment except one where credit is implod­ing and the Fed is run­ning the whole show in set­ting short-term inter­est rates. As the Fed increases the mon­e­tary base, it becomes a greater and greater chal­lenge to reverse those actions in the future. Get­ting into the posi­tion may be as easy as hit­ting CTRL+P, but get­ting out of the posi­tion promises to be a dis­rup­tive night­mare — not to men­tion the effect that these poli­cies have in dis­tort­ing finan­cial mar­kets, reward­ing reck­less lenders, pun­ish­ing savers, and mis­al­lo­cat­ing capital.

Notably, any exoge­nous pres­sure on short term inter­est rates to even 0.25% (on the 3-month Trea­sury yield), would effec­tively require the Fed to move back to the pre-QE2 mon­e­tary base in order to fore­stall incip­i­ent infla­tion pres­sures. Of course, the Fed could delay that out­come by boost­ing the inter­est it pays to the bank­ing sys­tem for hold­ing idle reserves. Then again, the Fed already has a bal­ance sheet lever­aged more than 50-to-1 against its own cap­i­tal. So upward inter­est rate pres­sure would begin to induce cap­i­tal losses on the Trea­sury secu­ri­ties the Fed has accu­mu­lated at low yields. Rais­ing inter­est pay­ments to banks would fur­ther strain the Fed's bal­ance sheet, pro­duc­ing an insol­vent Fed while pro­vid­ing a fis­cal sub­sidy to the bank­ing sys­tem at tax­payer expense.

Need­less to say, I don't expect that all of this will end very well, but given that the full his­tor­i­cal record cap­tures infla­tion, defla­tion, reces­sion, expan­sion, Depres­sion, credit expan­sion, and credit cri­sis, we are pre­pared to respond to a wide range of pos­si­ble events, with­out rely­ing on the hope for per­pet­u­ally high profit mar­gins, end­less mon­e­tary inter­ven­tions, absence of major sov­er­eign defaults, sta­bil­ity of the euro-zone, or avoid­ance of what we view as an oncom­ing reces­sion. For now, both mar­ket and eco­nomic evi­dence remain neg­a­tive, and we remain accord­ingly defen­sive. That will change, but we emphat­i­cally view present con­di­tions as being among the most neg­a­tive sub­set we've observed in the his­tor­i­cal record.

Mar­ket Climate

As of last week, the Mar­ket Cli­mate con­tin­ued to be char­ac­ter­ized by rich val­u­a­tions and a vari­ety of hos­tile syn­dromes (gen­er­ally related to over­val­ued, over­bought, over­bull­ish con­di­tions, and other vari­ants that cap­ture a gen­eral syn­drome of "overex­tended mar­ket cou­pled with a loss of sup­port­ing fac­tors"). This places mar­ket con­di­tions among the most neg­a­tive 1% of obser­va­tions on record, par­tic­u­larly on a 6–18 month hori­zon, though shorter hori­zons are clearly neg­a­tive as well here. Strate­gic Growth and Strate­gic Inter­na­tional Equity remain tightly hedged. Strate­gic Div­i­dend Value con­tin­ues to be about 50% hedged, which is its most defen­sive posi­tion. In Strate­gic Total Return, we raised our expo­sure in pre­cious met­als shares to about 12% of net assets in response to recent price weak­ness in that sec­tor. The ratio of gold prices to the XAU is now nearly 10-to-1, which is close to a record high. His­tor­i­cally, gold stocks have been treated as hav­ing "insur­ance" fea­tures, and their neg­a­tive cor­re­la­tion with other stocks was accom­pa­nied by pre­mium val­u­a­tion mul­ti­ples. At present, many pre­cious met­als shares have higher yields than most S&P 500 stocks, and are also sig­nif­i­cantly depressed rel­a­tive to gold prices, which sug­gests a rel­a­tive mar­gin of defense even if gold prices were to decline sub­stan­tially. This sec­tor still has sub­stan­tial volatil­ity, which is why our expo­sure in terms of net assets is not aggres­sive (though we would likely increase that expo­sure on sig­nif­i­cant eco­nomic weak­ness). Over­all, we're com­fort­able shift­ing to a mod­er­ately higher expo­sure in this sec­tor, rec­og­niz­ing that we may observe addi­tional volatil­ity as mar­ket con­di­tions change. Strate­gic Total Return con­tin­ues to hold a dura­tion of just under 3 years in Trea­sury secu­ri­ties, and a few per­cent of assets in util­i­ties and for­eign currencies.

Copy­right © Huss­man Funds

Tags: Adequate Compensation, Corporate Revenues, Deja Vu, Dividends, Forward Price, GDP, Hussman Funds, Investment Return, John Hussman, Lehman, Methodology, Metrics, Norms, Price Earnings, Profit Margins, Record Profit, Robust Growth, Several Times, Volatility, Year Treasury Bond
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The Economy and Bond Market Radar (April 23, 2012)

Sunday, April 22nd, 2012

The Econ­omy and Bond Mar­ket Radar (April 23, 2012)

Trea­suries were more or less unchanged this week. U.S. eco­nomic data was broadly in line with esti­mates and Trea­suries didn’t move around much this week. One inter­est­ing data point that was released this week was hous­ing per­mits, which rose faster than expected to 747,000 (sea­son­ally adjusted annu­al­ized rate). This can be eas­ily seen in the chart below and has finally bro­ken out of the range that it occu­pied for the past three years. This appears to be a very favor­able devel­op­ment, as new hous­ing activ­ity looks as if it is finally pick­ing up.

Strengths

• As men­tioned above, hous­ing is show­ing some signs of life and appears to be pick­ing up.
• India’s cen­tral bank cut inter­est rates this week and China has indi­cated a will­ing­ness to ease mon­e­tary pol­icy in the near future. The global eas­ing cycle continues.
• Retail sales rose a very strong 0.8 per­cent in March, well ahead of expec­ta­tions and with broad-based strength.

Weak­nesses

• Span­ish 10-year bond yields rose above 6 per­cent this week as the mar­ket rotates through south­ern Europe, with the cur­rent focus on Spain.

• Weekly ini­tial job­less claims rose to 386,000 this week, con­tin­u­ing the recent trend of higher readings.

• The Bank of Canada has become more hawk­ish and indi­cated that rates may be headed higher on better-than-expected eco­nomic growth and higher inflation.

Oppor­tu­nity

• After a dis­ap­point­ing first-quarter GDP result, the Chi­nese are likely to ease mon­e­tary pol­icy as early as this quarter.

Threat

• Ris­ing oil and gaso­line prices com­bined with liq­uid­ity impli­ca­tions of global eas­ing, led by Europe, may raise the prospect of a reap­pear­ance of higher infla­tion going forward.

Tags: Bank Of Canada, Bond Market, Bond Yields, Economic Data, Economic Growth, First Quarter, Gasoline Prices, GDP, inflation, Initial Jobless Claims, liquidity, Market Radar, Monetary Policy, Quarter Gdp, Retail Sales, S Central, Signs Of Life, Southern Europe, Treasuries, Willingness
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Jeremy Grantham: How to "Survive Betting Against Bull Market Irrationality"

Thursday, April 19th, 2012

Ridicu­lous as our mar­ket volatil­ity might seem to an intel­li­gent Mar­t­ian, it is our real­ity and every­one loves to trot out the “quote” attrib­uted to Keynes (but never doc­u­mented): “The mar­ket can stay irra­tional longer than the investor can stay sol­vent.” For us agents, he might bet­ter have said “The mar­ket can stay irra­tional longer than the client can stay patient.”

— Jeremy Grantham

Here with­out fur­ther com­ment is an open­ing excerpt from Grantham's lat­est let­ter. You can read/download the whole let­ter in the slid­edeck below.

Jeremy Grantham — Let­ter to Investors Q1 2012

My Sister’s Pen­sion Assets and Agency Prob­lems
(The Ten­sion between Pro­tect­ing Your Job or Your Clients’ Money)

The cen­tral truth of the invest­ment busi­ness is that invest­ment behav­ior is dri­ven by career risk. In the pro­fes­sional invest­ment busi­ness we are all agents, man­ag­ing other peo­ples’ money. The prime direc­tive, as Keynes¹ knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To pre­vent this calamity, pro­fes­sional investors pay ruth­less atten­tion to what other investors in gen­eral are doing. The great major­ity “go with the flow,” either com­pletely or par­tially. This cre­ates herd­ing, or momen­tum, which dri­ves prices far above or far below fair price. There are many other inef­fi­cien­cies in mar­ket pric­ing, but this is by far the largest. It explains the dis­crep­ancy between a remark­ably volatile stock mar­ket and a remark­ably sta­ble GDP growth, together with an equally sta­ble growth in “fair value” for the stock mar­ket. This dif­fer­ence is mas­sive – two-thirds of the time annual GDP growth and annual change in the fair value of the mar­ket is within plus or minus a tiny 1% of its long-term trend as shown in Exhibit 1. The market’s actual price – brought to us by the work­ings of wild and wooly indi­vid­u­als – is within plus or minus 19% two-thirds of the time. Thus, the mar­ket moves 19 times more than is jus­ti­fied by the under­ly­ing engines!

This incred­i­ble demon­stra­tion of the behav­ioral dom­i­nat­ing the ratio­nal and the “effi­cient” was first noticed by Robert Shiller over 20 years ago and was coun­tered by some of the most tor­tured logic that the ratio­nal expec­ta­tions crowd could offer, which is a very high hur­dle indeed. Shiller’s “fair value” for this pur­pose used clair­voy­ance. He “knew” the future flight path of all future div­i­dends, from each start­ing posi­tion of 1917, 1961, and all the way for­ward. The result­ing the­o­ret­i­cal value was always sta­ble (it barely twitched even in the Great Depres­sion), but this data was widely ignored as irrel­e­vant. And ignor­ing it may be the cor­rect response on the part of most mar­ket play­ers, for ignor­ing the volatile up-and-down mar­ket moves and attempt­ing to focus on the slower burn­ing long-term real­ity is sim­ply too dan­ger­ous in career terms. Miss­ing a big move, how­ever unjus­ti­fied it may be by fun­da­men­tals, is to take a very high risk of being fired. Career risk and the result­ing herd­ing it cre­ates are likely to always dom­i­nate invest­ing. The short term will always be exag­ger­ated, and the fact that a corporation’s future value stretches far into the future will be ignored. As GMO’s Ben Inker has written,2 two-thirds of all cor­po­rate value lies out beyond 20 years. Yet the mar­ket often trades as if all value lies within the next 5 years, and some­times 5 months.

Ridicu­lous as our mar­ket volatil­ity might seem to an intel­li­gent Mar­t­ian, it is our real­ity and every­one loves to trot out the “quote” attrib­uted to Keynes (but never doc­u­mented): “The mar­ket can stay irra­tional longer than the investor can stay sol­vent.” For us agents, he might bet­ter have said “The mar­ket can stay irra­tional longer than the client can stay patient.” Over the years, our esti­mate of “stan­dard client patience time,” to coin a phrase, has been 3.0 years in nor­mal con­di­tions. Patience can be up to a year shorter than that in extreme cases where rela­tion­ships and the tim­ing of their start-ups have proven to be unfor­tu­nate. For exam­ple, 2.5 years of bad per­for­mance after 5 good ones is usu­ally tol­er­a­ble, but 2.5 bad years from start-up, even though your pre­vi­ous 5 good years are well-known but helped some­one else, is absolutely not the same thing! With good luck on start­ing time, good per­sonal rela­tion­ships, and decent rel­a­tive per­for­mance, a client’s patience can be a year longer than 3.0 years, or even 2 years longer in excep­tional cases. I like to say that good client man­age­ment is about earn­ing your firm an incre­men­tal year of patience. The extra year is very impor­tant with any invest­ment prod­uct, but in asset allo­ca­tion, where mis­takes are obvi­ous, it is absolutely huge and usu­ally enough.

What Keynes def­i­nitely did say in the famous chap­ter 12 of his Gen­eral The­ory is that “the long-term investor, he who most pro­motes the pub­lic inter­est … will in prac­tice come in for the most crit­i­cism when­ever invest­ment funds are man­aged by com­mit­tees or boards.” He, the long-term investor, will be per­ceived as “eccen­tric, uncon­ven­tional and rash in the eyes of aver­age opin­ion … and if in the short run he is unsuc­cess­ful, which is very likely, he will not receive much mercy.” (Empha­sis added.) Review­ing our expe­ri­ences of being early in sev­eral extreme out­ly­ing events makes Keynes’s actual quote look painfully accu­rate in that “mercy” some­times was as lim­ited as it was at a bad day at the Col­i­seum, with a sea of thumbs down. But his attri­bu­tion, in con­trast, has proven too severe: we appear to have survived.

Jglet­ter All 4–12

Tags: Calamity, Central Truth, Clairvoyance, Discrepancy, Flight Path, GDP, GDP Growth, Inefficiencies, Investment Behavior, Investment Business, Investment Outlook, Irrationality, Jeremy Grantham, Keynes, Market Volatility, Martian, Pension Assets, Prime Directive, Professional Investment, Professional Investors, Rational Expectations, Robert Shiller, Stable Growth, Term Trend, Volatile Stock Market
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The Economy and Bond Market Radar (April 16, 2012)

Sunday, April 15th, 2012

The Econ­omy and Bond Mar­ket Radar (April 16, 2012)

Trea­suries ral­lied this week, send­ing yields sharply lower. The non­farm pay­rolls report that was released on Good Fri­day dis­ap­pointed and with neg­a­tive rum­blings out of Europe, it was a “risk off” week. China reported first quar­ter GDP growth below expec­ta­tions, which increases the like­li­hood of addi­tional pol­icy accom­mo­da­tion from the Chi­nese author­i­ties in the near future.

Strengths

• Nat­ural gas fell below $2 this week, pro­vid­ing con­sumers with some relief to higher gaso­line prices.
• Sev­eral infla­tion data points were released this week and were over­all in line with expec­ta­tions. This is gen­er­ally sup­port­ive of the exist­ing Fed­eral Reserve policies.
• Whole­sale inven­to­ries rose 0.9 per­cent in Feb­ru­ary, indi­cat­ing con­tin­ued restock­ing that should boost first quar­ter GDP in the U.S.

Weak­nesses

• March non­farm pay­rolls grew a mod­est 120,000, well below mar­ket expectations.

• Weekly ini­tial job­less claims jumped to 380,000 this week, the high­est read­ing since January.

• Spain remains in the spot­light as yields spike higher and investors remain ner­vous about long-term solu­tions for the country’s finan­cial woes.

Oppor­tu­nity

• The weak Chi­nese GDP num­ber implies that the cur­rent global eas­ing poli­cies are likely to remain in place for the fore­see­able future.

Threat

• Ris­ing oil and gaso­line prices, com­bined with liq­uid­ity impli­ca­tions of global eas­ing led by Europe, may raise the prospect of higher infla­tion going forward.

Tags: Bond Market, Chinese Authorities, Federal Reserve, Financial Woes, Gasoline Prices, GDP, GDP Growth, Good Friday, Inflation Data, Initial Jobless Claims, liquidity, Long Term Solutions, Market Expectations, Market Radar, Nonfarm Payrolls, Quarter Gdp, Reserve Policies, Rumblings, Treasuries, Wholesale Inventories
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Voldemort, Volcker, and Magic (Tchir)

Friday, April 13th, 2012

by Peter Tchir, TF Mar­ket Advisors

Yesterday’s move seemed almost mag­i­cal. Yellen spoke and the mar­kets lev­i­tated overnight. Job­less claims were a big dis­ap­point­ment. Revi­sions hit the prior week’s num­ber and yesterday’s num­ber was much closer to 400k than to the almost myth­i­cal 350k the mar­ket had become used to expect­ing. The magic of BLS revi­sions have ensured that although num­bers close to 350k were reported for at least 3 weeks, they have all been re-written as 360k or higher.

The mar­kets briefly fell, but then sto­ries of “gnomes” leak­ing China GDP started the mar­kets higher again. That 9% GDP print turned out to be illu­sion­ary, as the real num­ber came in at 8.1%, and since I see no rea­son for China to lie about it to make the data worse than it is, the real growth is prob­a­bly even slower than that.

The weak­ness in sov­er­eign debt over the past week finally made investors look behind the cur­tain of Draghi’s LTRO show, and they are under­whelmed. The fact that LTRO does what it is sup­posed to – ensure banks have access to money – is now a dis­ap­point­ment as too many peo­ple had believed that LTRO could do more than it actu­ally could.

Which leads us to Volde­mort and Vol­cker. How much of JPM’s earn­ings were a direct or indi­rect result of the activ­i­ties of the CIO’s office. We may never know, espe­cially the indi­rect part. I believe the pri­mary trade they have on is long credit via tranches on IG9 vs short HY17 and HY18. The trade makes sense, both as a trade, but for JPM and their busi­ness in par­tic­u­lar. It explains both the price moves in IG9 and the decom­pres­sion of HY CDS in an envi­ron­ment that would nor­mally see com­pres­sion. He is big, but the “prop” trad­ing peo­ple are wor­ried about the wrong things. The Vol­cker rule was meant to limit prop bets on mar­ket mak­ing desks. Banks do need to take risk. Every­one, the Fed included, wants the banks to lend more, but each and every loan is a prop bet, and there is no prof­itable way to run a fully hedged lend­ing book. Let the CIO and trea­sury run the bank.

Cor­re­la­tion desks, includ­ing the one at JPM should be looked at closely. If a desk buys a tranche and sells a cor­re­spond­ing amount of “delta” is that not a “prop” bet? As a mar­ket maker, they haven’t bought and sold some­thing, they bought one thing, and sold another. Vol­cker should be look­ing at those posi­tions and deter­min­ing how much model risk should be allowed. A cor­re­la­tion bet is a bet like any other (just more com­pli­cated). The noise about IG9 is rea­son­able, just misplaced.

As yesterday’s magic dis­si­pates, it is hard to see any­thing in the data that jus­ti­fies the bull­ish­ness. I remain wary of the mar­ket, and cer­tainly feel bet­ter today as being caught too short yes­ter­day was painful. CDS indices are weak across the board. Spi­tal­ian 10 year bonds are both trad­ing down today, and 5 year Spain now yields 16 bps more than 5 year Italy. A clear sign that the manip­u­la­tion has run its course (the size of the Span­ish bond mar­ket makes it far eas­ier for the ECB and banks to con­trol prices – at least for brief peri­ods of time).

I will be look­ing to add HY17 or HY18 risk today. Not as a gen­eral risk on trade, but because if I am cor­rect and they are part of the “whale” trade, they will be left alone by the big buyer and we can see some of that com­pres­sion that should have occurred ear­lier this year. HYG and JNK are both back to “pre­mi­ums” to NAV that seem unsus­tain­able, par­tic­u­larly given the over­all tone of trad­ing so far today.

Tags: Banks, Bet, China Gdp, Curtain, Decompression, Desks, Disappointment, Draghi, Earnings, GDP, Gnomes, Indirect Result, Jobless Claims, Prop Bets, Revisions, Sovereign Debt, Tf, Tranches, Volcker, Voldemort
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Gary Shilling Still Looking for a Recession in 2012 Part I

Wednesday, April 11th, 2012

Gary Shilling has been more dour than most on the under­ly­ing econ­omy the past 3–4 years, and that could be argued was a rel­a­tively good call.  Despite never before seen lev­els of fed­eral gov­ern­ment and cen­tral bank inter­ven­tion, the econ­omy con­tin­ues to limp along at what I call a "meh" pace.  Nor­mal recov­er­ies sans mas­sive inter­ven­tion should have had some sus­tained peri­ods of 4–5%+ type GDP growth; we're happy with 2–3% nowa­days.  Gary's long U.S. Trea­suries call has been against the grain, and mostly right the past few years, and he's had quite a few other pre­scient calls as well.  Shilling posted 2 arti­cles on Bloomberg, stat­ing the case for a reces­sion in 2012 – which is now again an out­lier view.  We'll look at part 1 today, and look at part 2 which focuses on the labor mar­ket tomorrow.

Here are some of his views as he looks at the main pil­lars of the economy:

• For sev­eral months, I’ve been fore­cast­ing a reces­sion in the U.S. this year, argu­ing that weak­ened con­sumer spend­ing – the key to the eco­nomic out­look — would tip the econ­omy back into a down­turn.  But what about recent pos­i­tive data and markets? Do they affect my forecast?
• Con­sumers Are the Linch­pin: The U.S. econ­omy is being fueled these days by strong con­sumer spend­ing, which increased in Feb­ru­ary by 0.8 per­cent, its best show­ing in seven months, after ris­ing 0.4 per­cent in Jan­u­ary. Retail sales rose 1.1 per­cent in Feb­ru­ary — the fastest pace in five months — while same-store sales advanced 4.7 per­cent. These num­bers cor­re­late with recent gains in con­sumer con­fi­dence and sentiment.
• I don’t see this pace con­tin­u­ing. Personal-income growth con­tin­ues to be weak — up just 0.2 per­cent in Feb­ru­ary — mean­ing this recent exu­ber­ant con­sumer spend­ing is being fueled largely by increased debt and tap­ping of savings.
• At the same time, pay per employee is ris­ing slowly and con­tin­ues to fall in real terms. So increased job growth remains the key to any increases in real house­hold after-tax income, which declined in Feb­ru­ary for a sec­ond straight month and gained a mere 0.3 per­cent, com­pared with Feb­ru­ary 2011.
• Spend­ing, Sav­ing and Debt: The sup­port that con­sumer spend­ing has received from less sav­ing and more debt appears tem­po­rary. House­hold debt – includ­ing mortgages,student loans, and auto and credit-card loans — has fallen rel­a­tive to dis­pos­able per­sonal income, though. In my analy­sis, this is largely because of write-offs of trou­bled mort­gages. Nev­er­the­less, revolv­ing con­sumer credit, mostly on credit cards, is no longer being liquidated.
• Non-revolving con­sumer credit con­tin­ues to rise in response to grow­ing sales of vehi­cles — most of which are financed — and in stu­dent loans, as the poor job mar­ket keeps stu­dents in school or sends them back. Tuition increases encour­age more bor­row­ing, while inter­est costs on past-due loans mount.  [Mar 8, 2012: What Drove Yesterday's Surge in Con­sumer Credit? Mas­sive Upswing in Fed­eral Stu­dent Loans]
• It would seem, then, that con­trary to my stead­fast belief that con­sumers are being forced to save more and reduce debt to rebuild net worth, they have been doing the oppo­site lately.
• Con­sumer Retrench­ment: The data so far aren’t con­clu­sive, but evi­dence of U.S. con­sumer retrench­ment is emerg­ing. Con­sumer con­fi­dence has moved up recently but remains far below the lev­els of early 2007 before the col­lapse in sub­prime mort­gages set off the Great Recession. Real per­sonal con­sump­tion expen­di­tures growth has been volatile in recent months and falling on a year-on-year basis. Voluntary depar­tures from jobs, another mea­sure of con­fi­dence, may be decreasing. And con­sumer spend­ing will no doubt have a big slide if my fore­cast of another 20 per­cent drop in house prices pans out. (Mark's note: that seems aggressive!)
• Hous­ing activ­ity remains depressed, with the only signs of life com­ing from the mul­ti­fam­ily com­po­nent, which is being dri­ven by the appetite for rental apart­ments as home­own­er­ship declines.
• What Oil Threat?: Recently, there has been great con­cern about $4 per gal­lon gaso­line and whether, as in 2008, those high prices will act as a tax on con­sumer incomes and force dras­tic cut­backs in other pur­chases.  These con­cerns are overblown. Amer­i­can con­sumers have reacted to ris­ing gaso­line prices as you would expect in tough times: by con­sum­ing less. Demand (DOEDMGAS) in the mid-February to mid– March four-week period was down 7.8 per­cent from a year ear­lier, mainly due to more effi­cient vehicles.
• As a result, the recent surge in gaso­line prices has had a rel­a­tively small impact on con­sumer pur­chas­ing power. The $14.8 bil­lion increase from Octo­ber 2011 to March 2012, com­pared with the year-earlier period, amounts to about 0.3 per­cent of con­sumer spending.

Con­clu­sion:

• Con­sumer spend­ing is the only major source of strength in the U.S. econ­omy this year. State and local-government spend­ing remains depressed because of deficit woes and under­funded pen­sion plans. Housing suf­fers from excess inven­to­ries and may face a fur­ther 20 per­cent drop in prices. Excess capac­ity restrains cap­i­tal spending. Recent inven­tory build­ing appears involuntary. So con­sumer retrench­ment will tip the bal­ance toward a mod­er­ate and over­due recession.

Tags: Bloomberg, Central Bank Intervention, Consumer Confidence, Downturn, Economic Outlook, Federal Government, Five Months, Gary Shilling, GDP, GDP Growth, Market Tomorrow, Massive Intervention, Personal Income Growth, Pillars, Recession, Retail Sales, Sentiment, Seven Months, Tapping, Treasuries
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Too Little to "Lock In" (Hussman)

Monday, April 2nd, 2012

Too Lit­tle to "Lock In"

by John P. Huss­man, Ph.D., Huss­man Funds

We've reg­u­larly observed that cor­po­rate profit mar­gins (and economy-wide, prof­its as a share of GDP) have a strong ten­dency to "mean revert" over time — specif­i­cally, ele­vated profit mar­gins are asso­ci­ated with unusu­ally weak earn­ings growth over the fol­low­ing 5-year period, and depressed profit mar­gins are asso­ci­ated with unusu­ally strong earn­ings growth over that hori­zon (see last week's com­ment, A False Sense of Secu­rity ). Notably, the ratio of cor­po­rate prof­its to GDP is presently nearly 70% above its his­tor­i­cal norm. Of course, the most com­mon val­u­a­tion meth­ods used by Wall Street ana­lysts (whether they use the "Fed model" or "for­ward oper­at­ing earn­ings times arbi­trary P/E mul­ti­ple") rely almost exclu­sively on esti­mates of year ahead earn­ings. Embed­ded in these toy mod­els is the quiet assump­tion that cur­rent profit mar­gins will be sus­tained indefinitely.

By con­trast, a wide range of mea­sures that use "nor­mal­ized" fun­da­men­tals of one form or another are extra­or­di­nar­ily stretched. Andrew Smithers recently took note of the ele­vated lev­els of cycli­cally adjusted P/E ratios and price to replace­ment cost ("q") and observed "As of 8th March, 2012, with the S&P 500 at 1365.9 , the over­val­u­a­tion by the rel­e­vant mea­sures was 48% for non-financials and 66% for quoted shares. Although the over­val­u­a­tion of the stock mar­ket is well short of the extremes reached at the year ends of 1929 and 1999, it has reached the other pre­vi­ous peaks of 1906, 1936 and 1968."

At 1400 on the S&P 500, the market's over­val­u­a­tion has now reached 70% on these mea­sures, which have a far stronger cor­re­la­tion with sub­se­quent mar­ket returns than the Fed Model or other unad­justed meth­ods using for­ward oper­at­ing earn­ings. This is par­tic­u­larly true over hori­zons of 4 years or longer. As a side note, since the reliance on for­ward oper­at­ing earn­ings is now an estab­lished Wall Street prac­tice, Valu­ing the S&P 500 Using For­ward Oper­at­ing Earn­ings details how to improve the reli­a­bil­ity of mar­ket val­u­a­tions based on these figures.

We presently esti­mate a nom­i­nal total return on the S&P 500 aver­ag­ing 4.1% annu­ally over the com­ing decade. This mod­estly exceeds the yield avail­able on a 10-year Trea­sury, but by a small mar­gin that — out­side the late 1990's bub­ble period — has pre­vi­ously been seen only dur­ing the two-year period approach­ing the 1929 peak, between 1968–1972 (which was finally cleared by the 73–74 mar­ket plunge), and briefly in 1987, before the crash of that year.

While it's true that inter­est rates are depressed, appar­ently set­ting a low "bar" for equi­ties, an addi­tional ques­tion one should ask is whether inter­est rates them­selves are "fair" in the sense of being ade­quate com­pen­sa­tion for long-horizon risks. For exam­ple, back in 1982, stocks had a rea­son­able 10-year prospec­tive risk-premium ver­sus bonds, but both were priced to achieve extra­or­di­nar­ily strong returns. Presently, stocks have a weak 10-year prospec­tive risk-premium ver­sus bonds, but both are priced to achieve unsat­is­fac­tory returns. In 1982, investors had an incen­tive to lock in either, and were served well regard­less of their choice. At present, investors have no rea­son­able incen­tive at all to "lock in" the prospec­tive returns implied by cur­rent prices of stocks or long-term bonds (though we sus­pect that 10-year Trea­suries may ben­e­fit over a short hori­zon due to con­tin­ued eco­nomic risks and still-unresolved debt con­cerns in Europe, which has already entered an eco­nomic downturn).

It's also inad­vis­able to view the present 4.1% pro­jected (nom­i­nal) 10-year return on the S&P 500 as if it is some sort of "yield," because even that expected return involves the risk of sig­nif­i­cant volatil­ity and severe short-horizon loss.

But don't low inter­est rates at least limit the poten­tial down­side in stocks, allow­ing stocks to remain at ele­vated val­u­a­tions that are con­sis­tent with sim­i­larly low prospec­tive returns? On that ques­tion, the his­tor­i­cal record is instruc­tive. Since 1930, the 10-year Trea­sury yield has been below 3% nearly 30% of the time. In 78% of those peri­ods, the prospec­tive 10-year total return on the S&P 500 exceeded 10% (based on our stan­dard esti­ma­tion method). In fact, the 10-year Trea­sury yield has his­tor­i­cally been below 2.5% about 15% of the time (pri­mar­ily in the period prior to 1952) and in fully 94% of those peri­ods, the prospec­tive 10-year total return on the S&P 500 exceeded 10%. The belief that prospec­tive equity returns are tightly linked to bond yields is largely an arti­fact of the 1980–1998 period (when both enjoyed a per­sis­tent decline dur­ing a long period of dis­in­fla­tion), and is far less evi­dent in broad mar­ket history.

Ignore the fact that long-term "sec­u­lar" bull mar­ket advances have invari­ably started from val­u­a­tions imply­ing prospec­tive 10-year total returns of nearly 20% annu­ally (which is pre­cisely why the sec­u­lar advances that fol­low are so durable). The mar­ket decline required to build in prospec­tive returns of that mag­ni­tude seems too extreme to even con­tem­plate. Indeed, we esti­mate that the S&P 500 would presently have to decline by nearly 40% sim­ply to reach val­u­a­tions con­sis­tent with prospec­tive 10-year total returns of 10% annu­ally. It's an open ques­tion whether we'll see that level of prospec­tive return in the next mar­ket cycle, but even if we touch that level of prospec­tive returns 5 or 6 years from now, stocks will have gone nowhere in the interim (includ­ing div­i­dends). Investors would need to have a ter­ri­bly short mem­ory in order to rule out that sort of risk. Last week's val­u­a­tion chart may be a use­ful reminder of where we stand rel­a­tive to history.

On the sub­ject of profit mar­gins, James Mon­tier at GMO pub­lished a nice piece last week, using a little-known national income iden­tity (the Kalecki prof­its equa­tion) to demon­strate that:

Prof­its = Invest­ment — House­hold Sav­ing — Gov­ern­ment Sav­ings — For­eign Sav­ings + Dividends

Some might object that this is sim­ply an iden­tity (true by def­i­n­i­tion) and doesn't imply causal­ity. That's a rea­son­able point, but as with all analy­sis, it's not enough just to toss out an objec­tion and walk away — you've got to go to the data and find out the truth. So let's do that.

We can actu­ally sim­plify things a bit to make the point more intu­itive. As we've shown before, gross pri­vate invest­ment has a very strong rela­tion­ship with the cur­rent account deficit ("for­eign sav­ings"). Specif­i­cally, large increases in gross pri­vate invest­ment are almost invari­ably financed by run­ning a trade deficit in goods and ser­vices, and import­ing for­eign sav­ings to make up the dif­fer­ence. Mean­while, div­i­dends tend to be very smooth, so they don't intro­duce a lot of vari­abil­ity to the equation.

What remains then is a fairly sim­ple asser­tion: the pri­mary way to boost cor­po­rate prof­its to abnor­mally high — but unsus­tain­able — lev­els is for the gov­ern­ment and the house­hold sec­tor to both spend beyond their means at the same time.

If we go to the data, we see the link between profit mar­gins and deficits in the quar­terly fig­ures, but the tight­est rela­tion­ship is actu­ally a causal one — large gov­ern­ment deficits (as a per­cent­age of GDP) cou­pled with weak house­hold sav­ings rates result in tem­porar­ily high cor­po­rate profit mar­gins, with a lead of about 4–6 quarters.

The con­clu­sion is straight­for­ward. The hope for con­tin­ued high profit mar­gins really comes down to the hope that gov­ern­ment and the house­hold sec­tor will both con­tinue along unsus­tain­able spend­ing tra­jec­to­ries indef­i­nitely. Con­versely, any delever­ag­ing of presently debt-heavy gov­ern­ment and house­hold bal­ance sheets will pre­dictably cre­ate a sus­tained retreat in cor­po­rate profit mar­gins. With the ratio of cor­po­rate prof­its to GDP now about 70% above the his­tor­i­cal norm, dri­ven by a fed­eral deficit in excess of 8% of GDP and a deeply depressed house­hold sav­ing rate, we view Wall Street's embed­ded assump­tion of a per­ma­nently high plateau in profit mar­gins as myopic.

[Geek's Note: If you think in terms of equi­lib­rium in the asso­ci­ated real out­put (actual goods and ser­vices of one sort or another), the Kalecki equa­tion also means that the deficit-financed goods and ser­vices are essen­tially already spo­ken for, so the result­ing cor­po­rate prof­its are not matched by sim­i­lar increases in real invest­ment. Instead, cor­po­ra­tions accu­mu­late claims on the gov­ern­ment and house­holds (i.e. they acquire a pile of gov­ern­ment and con­sumer debt oblig­a­tions). These oblig­a­tions can only be "spent" in aggre­gate by the cor­po­rate sec­tor on invest­ment goods once house­holds and the gov­ern­ment begin to release a "sur­plus" of out­put by sav­ing instead of spend­ing beyond their means. Either that, or the trade deficit would explode as cor­po­ra­tions accu­mu­lated invest­ment goods by trans­fer­ring their claims on the U.S. gov­ern­ment and house­holds to foreigners.]

A few quick eco­nomic notes. Real income declined month-over-month in the lat­est report, which is very much at odds with the job cre­ation fig­ures unless that job cre­ation reflects extra­or­di­nar­ily low-paying jobs. Real dis­pos­able income growth has now dropped to just 0.3% year-over-year, which is lower than the rate that is typ­i­cally observed even in reces­sions. Real per­sonal con­sump­tion growth ticked up slightly from 1.6% to 1.8% year-over-year, remain­ing in a range that is rarely observed except in asso­ci­a­tion with reces­sion. Given the con­trac­tion in real income, we also saw a sharp down­turn in the sav­ings rate in the lat­est report, to the low­est level since just before the last reces­sion. While the slight bump in con­sump­tion could help near-term cor­po­rate prof­its, the income dynam­ics aren't sup­port­ive of a con­tin­u­a­tion at all.

Finally, we've been watch­ing the new unem­ploy­ment claims data for some time. Almost with­out fail, when a new num­ber is released, the new claims fig­ure for the pre­vi­ous week is revised upward by about 3000 or so. Last week, we saw an unusual revi­sion in new claims data, not just for the pre­vi­ous week, but in months of prior releases, with upward revi­sions aver­ag­ing about 10,000 in the most recent reports (e.g. the Feb 25 fig­ure was revised from 354,000 to 373,000). This reflects an annual update in the sea­sonal fac­tors used by the Labor Depart­ment (which is why the revi­sions weren't matched by sim­i­lar changes in the non-seasonally adjusted data). It's not clear what this implies for revi­sions in the monthly employ­ment fig­ures, if any­thing, but our "unob­served com­po­nents" mod­els con­tinue to sug­gest a gen­eral trend toward dis­ap­point­ments in eco­nomic data, par­tic­u­larly over the next 6–8 weeks. Given that so much investor enthu­si­asm has focused on the new claims fig­ures, it's inter­est­ing that the large and gen­er­ally upward revi­sions in months of prior data seemed to go vir­tu­ally unnoticed.

Mar­ket Climate

As of last week, the Mar­ket Cli­mate remained char­ac­ter­ized by a hos­tile syn­drome of over­val­ued, over­bought, over­bull­ish, rising-yield con­di­tions. We've reviewed a vari­ety of oper­a­tional def­i­n­i­tions of this syn­drome in numer­ous prior weekly com­ments. For­get about the major declines that typ­i­cally fol­lowed the hand­ful of other instances we've observed this syn­drome in the past, includ­ing the major peaks in 1972, 1987, 2000, and 2007. Even if we look over the past two years — and despite some early sig­nals where mar­ket weak­ness was post­poned by extra­or­di­nary mon­e­tary inter­ven­tions — we still have not observed these con­di­tions with­out result­ing mar­ket declines of more than 15% (one in 2010 and another in 2011) that wiped out all of the gains since the ear­li­est sig­nal occurred, and then some.

Mon­e­tary inter­ven­tions can peri­od­i­cally fuel spec­u­la­tive runs, which defer and spread out the adjust­ments that result from per­sis­tent over­val­u­a­tion and mis­al­lo­ca­tion of cap­i­tal. But they can't get around the inevitabil­ity of those adjust­ments. The only real choice pol­icy mak­ers have is how large a bub­ble they choose to see col­lapse. On that front, we're clearly in bet­ter shape than we were at the peaks of 2007, 2000 and 1929, but con­di­tions are gen­er­ally more hos­tile than they have been in the vast remain­der of mar­ket his­tory. This will change. By our analy­sis, now remains one of the worst times on record to assume that mar­ket risk is acceptable.

Strate­gic Growth and Strate­gic Inter­na­tional remain fully hedged. Strate­gic Div­i­dend Value remains 50% hedged, its most defen­sive posi­tion, and Strate­gic Total Return con­tin­ues to carry a dura­tion of just under 3 years in Trea­suries, with about 5% of assets allo­cated across pre­cious met­als shares, util­i­ties, and for­eign cur­ren­cies. We don't view the prospec­tive returns in any asset class as being desir­able enough to "lock in" on an invest­ment basis, which means that most finan­cial risks here are essen­tially spec­u­la­tive, and rely on the emer­gence of investors will­ing to accept even lower prospec­tive returns. Again, the one con­stant in the finan­cial mar­kets is that these con­di­tions will change. Patient oppor­tunism remains essen­tial here.

—

Tags: 8th March, Andrew Smithers, Assumption, Corporate Profit, Corporate Profits, Correlation, Earnings Growth, Extremes, False Sense Of Security, Fed Model, GDP, Horizons, Hussman Funds, Profit Margins, Ratios, Sense Of Security, Stock Market, Toy Models, Valuation Methods, Wall Street Analysts
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Real GDP unchanged in Q4 2011, Corporate Profits Advanced

Friday, March 30th, 2012

Real GDP unchanged in 2011:Q4, Cor­po­rate Prof­its Advanced

by Asha Ban­ga­lore, North­ern Trust

Real GDP of the US econ­omy grew 3.0% in the fourth quar­ter of 2011, unchanged from the prior esti­mate. How­ever, some com­po­nents of GDP were mod­i­fied. Equip­ment and soft­ware spend­ing (+7.5% vs. +4.8%), gov­ern­ment out­lays (-4.2% vs. –4.4%), and struc­tures (-0.9% vs. –2.6%) show upward revi­sions, while exports show a down­ward revi­sion in the final report of fourth quar­ter GDP.

Cor­po­rate prof­its before tax with inven­tory val­u­a­tion and cap­i­tal con­sump­tion adjust­ments rose 0.9% in the fourth quar­ter vs. a 1.7% increase in the third quar­ter. In the fourth quar­ter, the entire increase in cor­po­rate prof­its was from domes­tic indus­tries (+3.8%), with prof­its from oper­a­tions in the rest of the world post­ing a decline (-9.2%).

There is a con­tro­versy about whether one should use real gross domes­tic prod­uct (GDP) or real gross domes­tic income (GDI) to eval­u­ate the per­for­mance of the U.S. econ­omy. Real GDP is obtained by adding up spend­ing across the econ­omy and real GDI is com­puted by adding up income earned. Con­cep­tu­ally, GDP and GDI are iden­ti­cal but the source data for each is dif­fer­ent and they yield dif­fer­ent num­bers. As Chart 3 shows, the two mea­sures drift apart some­times. The GDI mea­sure is gain­ing atten­tion; Jeremy Nale­waik of the Fed­eral Reserve has pointed out the National Bureau of Eco­nomic Research uses monthly indi­ca­tors, GDI and GDP to deter­mine offi­cial dates of busi­ness cycle peaks and troughs. Going for­ward, an aver­age of the two mea­sures may become the pre­ferred measure.

Tags: Business Cycle, Capital Consumption, Corporate Profits, Different Numbers, Downward Revision, Federal Reserve, Fourth Quarter, GDP, Government Outlays, Gross Domestic Product, Inventory Valuation, Investment Decisions, National Bureau Of Economic Research, Northern Trust Company, Preferred Measure, Quarter Gdp, Real Gdp, Source Data, Troughs, Upward Revisions
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The Dating Game: Michael Pettis Challenges The Economist to a Bet on China

Friday, March 30th, 2012

The Econ­o­mist says "China’s GDP, mea­sured in nom­i­nal dol­lars, will be the world’s largest by 2018". Michael Pet­tis at China Finan­cial Mar­kets dis­agrees and says I would like to make a bet with The Econ­o­mist.

I recently read in The Guardian an arti­cle by enthu­si­as­tic ori­en­tal­ist Mar­tin Jacques in which he says that The Econ­o­mist has just pre­dicted that China’s GDP, mea­sured in nom­i­nal dol­lars, will be the world’s largest by 2018. Ear­lier esti­mates, he says had China becom­ing the largest econ­omy in the world by 2027.

I have always been a lit­tle skep­ti­cal about the 2027 claim ... given how much we would have to assume about the sus­tain­abil­ity of Chi­nese growth, about the like­li­hood of cur­rent GDP num­bers not hav­ing been vastly inflated by an over-investment boom, and about the unsta­ble range of polit­i­cal out­comes. It seemed to me to be a pre­dic­tion about as valu­able as the world-beating pre­dic­tions about the USSR in the 1960s or Japan in the 1980s.

Still, this 2018 pre­dic­tion deserves I think more than a lit­tle ques­tion­ing — it requires that nom­i­nal Chi­nese GDP growth in dol­lars out­pace nom­i­nal US GDP growth by 12% a year.

So I am won­der­ing whether we could set up a friendly bet — not for too large stakes. I would like to bet that by the end of 2018 China will not be the largest econ­omy in the world.

If I win, per­haps The Econ­o­mist could invite a very cool under­ground Chi­nese band of my choice to per­form at their next big con­fer­ence, whereas if I lose I could buy four-year sub­scrip­tions (stu­dent rates, please) to a group of Peking Uni­ver­sity fresh­men. Every­body would end up feel­ing pretty pleased with them­selves no mat­ter who wins, right? So?

The Dat­ing Game

Inquir­ing minds are look­ing at an inter­ac­tive chart on The Econ­o­mist in an arti­cle called The Dat­ing Game.

AMERICA'S GDP is still roughly twice as big as China’s (using mar­ket exchange rates). To pre­dict when the gap might be closed, The Econ­o­mist has updated its inter­ac­tive chart below with the lat­est GDP num­bers. This allows you to plug in your own assump­tions about real GDP growth in China and Amer­ica, infla­tion rates and the yuan’s exchange rate against the dol­lar. Over the past ten years, real GDP growth aver­aged 10.5% a year in China and 1.6% in Amer­ica; infla­tion (as mea­sured by the GDP defla­tor) aver­aged 4.3% and 2.2% respec­tively. Since Bei­jing scrapped its dol­lar peg in 2005, the yuan has risen by an annual aver­age of just over 4%. Our best guess for the next decade is that annual GDP growth aver­ages 7.75% in China and 2.5% in Amer­ica, infla­tion rates aver­age 4% and 1.5%, and the yuan appre­ci­ates by 3% a year. Plug in these num­bers and China will over­take Amer­ica in 2018. Alter­na­tively, if China’s real growth rate slows to an aver­age of only 5%, then (leav­ing the other assump­tions unchanged) it would not become num­ber one until 2021. What do you think?

Snap­shot of The Econ­o­mist Base­line Assumptions

The inter­ac­tive graph is too large for my blog, but the above screen snap­shot shows The Econ­o­mist base­line assump­tions. To play around with the num­bers, click on the above link.

I share a view­point with Pet­tis that The Econ­o­mist is way too gen­er­ous in their esti­mate of real GDP growth for China.

Pet­tis thinks China will aver­age 3% growth and I already posted I found that num­ber rea­son­able. As far as Yuan appre­ci­a­tion is con­cerned, I am not at all con­vinced the Yuan is under­val­ued at all, yet I plugged in a nom­i­nal 2% annual appreciation.

Assum­ing a "Real GDP growth" of 3% and Infla­tion at 4% yields a chart that looks like this.

Snap­shot of Mish Base­line Assumptions

Even still, I won­der if the year 2030 is still far too opti­mistic from the stand­point of China.

I strongly believe peak oil and energy con­sump­tion is going to put a seri­ous damper on Chi­nese growth, and that is on top a nec­es­sary and very painful shift away from an entirely unsus­tain­able growth model based on exports, hous­ing, and fixed investment.

I share Pet­tis' view regard­ing "inflated GDP num­bers, an over-investment boom, and the unsta­ble range of polit­i­cal out­comes" adding my own energy con­cerns and yuan val­u­a­tion con­cerns on top of it all.

Thoughts on Chi­nese Growth

• March 23, 2012: Excel­lent Doc­u­ment on Decou­pling and Global Sup­ply Chains by ECRI; Why BRIC, and U.S. Decou­pling Won't Happen
• Feb­ru­ary 29, 2012: World Bank Warns of Eco­nomic Cri­sis in China; Only 3% Growth for Decade Says Michael Pettis
• Sep­tem­ber 21, 2011: Mis­lead­ing Indi­ca­tors — China's Growth Won't Last; Chanos on Chi­nese Prop­erty Bub­ble and Growth
• August 22, 2011: Michael Pet­tis on Long-Term Out­look for China, Europe, and the World; 12 Global Predictions

I find the argu­ments by Pet­tis, the ECRI, and Chanos com­pelling. Add to that the restraint of peak oil cou­pled with poten­tial polit­i­cal insta­bil­ity and the proper con­clu­sion is that long-term Chi­nese growth of 7.5% is Fan­ta­sy­land material.

Mike "Mish" Shed­lock
http://globaleconomicanalysis.blogspot.com

Tags: Bet, China Economy, China Gdp, Chinese Growth, Dating Game, Economist, Financial Markets, Game America, Gap, GDP, GDP Growth, Inquiring Minds, Interactive Chart, Investment Boom, Market Exchange Rates, Michael Pettis, Orientalist, Peking University, Political Outcomes, University Freshmen
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The HARPEX Index is superior to the Baltic Dry Index!

Friday, March 23rd, 2012

Like many ana­lysts and econ­o­mists I have been an avid fol­lower of the Baltic Dry Index (BDI) as a so-called lead­ing indi­ca­tor of global eco­nomic activ­ity. How­ever, I have come to the con­clu­sion that the BDI as such is of no fur­ther use to me. The mas­sive growth in demand for com­modi­ties from espe­cially China from 2005 to 2008 led to a sig­nif­i­cant increase in capac­ity as the num­ber of ships built surged through until the 2010 cri­sis that resulted in a major change in sup­ply from rel­a­tively inelas­tic to highly elas­tic. Fur­ther­more, it means that changes in the Baltic Dry Index occur in what is essen­tially a down­trend or, put dif­fer­ently, in a bear market.

How­ever, I have dis­cov­ered an indi­ca­tor that is far supe­rior to the BDI. The HARPEX Index was devel­oped by Harper Petersen, a global lead­ing char­ter­ing agent. The Index is cal­cu­lated by using the actual time char­ter rates for seven classes of ships. This index there­fore mea­sures the rates of mov­ing mostly fin­ished goods glob­ally and is an excel­lent indi­ca­tor of global con­sumer activ­ity. Unfor­tu­nately the his­tor­i­cal data on the web­site only date back to 2009. (http://www.harperpetersen.com/harpex/harpexVP.do)

In the graph below I depicted the HARPEX Index against my GDP-weighted Major Economies Man­u­fac­tur­ing PMI as well as the Markit Euro­zone PMI, with both the PMIs lead­ing by two months. In the graph it is evi­dent that the HARPEX Index should be rated highly as a coin­cid­ing indi­ca­tor in any eco­nomic fore­cast­ing model. The value of man­u­fac­tur­ing PMIs as lead­ing indi­ca­tor comes to the fore as it is evi­dent that the GDP-weighted man­u­fac­tur­ing PMI of the major economies leads the HARPEX Index by two months. The bot­tom­ing and sub­se­quent rise of the PMIs in Jan­u­ary this year indi­cated that the HARPEX Index would rise through end March.  It has indeed risen from $376 at the end of Feb­ru­ary to $393 cur­rently. The slight weak­en­ing of the major economies’ PMI in Feb­ru­ary indi­cates that freight rates in April are likely to go nowhere and even decline.

Sources: Harper Petersen; CFLP; Li & Fung; Markit; ISM; Plexus Asset Management.

The value of the HARPEX Index can be seen in the fol­low­ing graph. Dur­ing the great finan­cial cri­sis in 2008/2009 the HARPEX Index fell to $300 and remained rel­a­tively unchanged until Feb­ru­ary 2010. The global man­u­fac­tur­ing sec­tor started to expand in August 2009 when the GDP-weighted Major Economies Man­u­fac­tur­ing PMI rose above the 50 level in August 2009. It there­fore took six months of global expan­sion to take up the slack in the con­tainer ship­ping indus­try. There­after the PMI and the HARPEX Index moved in the same direc­tion, with the PMI lead­ing by approx­i­mately two months.

Sources: Harper Petersen; CFLP; Li & Fung; Markit; ISM; Plexus Asset Management.

The cur­rent level of the HARPEX Index is indica­tive of how weak the global man­u­fac­tur­ing sec­tor really is. This sec­tor is still in a much bet­ter shape than in 2009 as the HARPEX Index is still 30% higher than the pre­sum­ably $300 absolute min­i­mum level at which ships can oper­ate. In my opin­ion any fur­ther strength in the global man­u­fac­tur­ing sec­tor is likely to have an imme­di­ate impact on global con­tainer­ized freight rates as the sec­tor is not recov­er­ing from a deep reces­sion as it did in 2009.

In a recent arti­cle I pre­sented you with a graph of my cal­cu­lated PMI sea­sonal fac­tors of the CFLP Man­u­fac­tur­ing for China against the Baltic Dry Index, which  not only explained the weak­ness in the BDI but also the shorter-term move­ments in the BDI. I argued that January/February would also mean a sea­sonal low for the Baltic Dry Index and a major rever­sal would be evi­dent in March and April.

Sources: CFLP; Li & Fung; I-Net Bridge; Plexus Asset Management.

The BDI sub­se­quently made a low of 647 on 3 Feb­ru­ary and is cur­rently at 897. Although the BDI is up 38.6% it is still a far cry from what it should nor­mally have been in light of the usu­ally strong sea­sonal period. It is there­fore an indi­ca­tion of the under­ly­ing weak­ness of China’s man­u­fac­tur­ing sector.

Although I argue that changes in the Baltic Dry Index occur in a bear mar­ket due to the under­ly­ing fun­da­men­tal fac­tors, the BDI should not be dis­carded in total as it does give an indi­ca­tion of the under­ly­ing strength of China’s man­u­fac­tur­ing sec­tor. I regard the HARPEX Index as a bet­ter coin­ci­dent indi­ca­tor of global eco­nomic activity.

Tags: Actual Time, Baltic Dry Index, Baltic Dry Index Bdi, Bear Market, Charter Rates, Commodities, Commodity, Conclusion, Economic Forecasting, Economists, Follower, GDP, Global Consumer, Global Economic Activity, Graph, Leading Indicator, Massive Growth, Pmi, Pmis, Ships, Time Charter
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The Emerging Market Growth Story Continues (ING)

Tuesday, March 20th, 2012

by Dou­glas Coté, ING

We have dis­cussed the pos­si­bil­ity, and risk, of a hard land­ing in China (growth slow­ing to less than 7%), but what has been going on in some of the other BRIC’s like India and Brazil? Right now India is in the midst of bud­get nego­ti­a­tions which would reign in its gross fis­cal deficit to 5.9% of GDP (total debt is around 50% of GDP). India’s GDP growth is expected to sub­side to 6.9% after two solid years of greater than 8% growth. A global slow­down as well as high oil prices have con­tributed to the decrease. How­ever, Indian finan­cial offi­cials expect a return to 9% plus growth in the future. Mean­while Brazil has just over­taken the U.K. to become the sixth largest econ­omy in the world. Brazil grew 2.7% in 2011 com­pared to U.K.’s mea­ger .8%. And with sub­stan­tial oil and gas reserves fuel­ing their exports, Brazil has their eye on num­ber 5. You can find some key sta­tis­tics about India and Brazil as well as other emerg­ing mar­kets on page 33 of the Global Per­spec­tives book.

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Tags: Brazil, BRIC, Budget Negotiations, Economy, Emerging Market, Emerging Markets, Financial Officials, Fiscal Deficit, Gas Reserves, GDP, GDP Growth, Global Perspectives, Global Slowdown, India, Ing, Ing Investment Management, Key Statistics, Midst, Nbsp, Oil and Gas, Oil Prices, risk
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Is Risk in Emerging Economies Less Than Developed Economies?

Monday, March 12th, 2012

To get an over­all view of the health of emerging-market economies I devel­oped a GDP-weighted man­u­fac­tur­ing PMI as well as a GDP-weighted non-manufacturing/services PMI index using 2010’s GDP con­verted to U.S. dollars.

Fol­low­ing a double-dip in Sep­tem­ber and Novem­ber last year, growth in man­u­fac­tur­ing is steadily increas­ing, with the man­u­fac­tur­ing PMI in Feb­ru­ary ris­ing to 52.0. The PMI is still sig­nif­i­cantly below the recent peak of 54.3 in Jan­u­ary last year.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management.

In the first half of last year growth in the man­u­fac­tur­ing sec­tor of emerg­ing economies was sig­nif­i­cantly slower than that of the major devel­oped economies. The sov­er­eign debt cri­sis in the Euro­zone lev­eled the score in the sec­ond half, though.

Sources: Markit; HSBC; CFLP; Kag­iso; ISM; Plexus Asset Management.

With a weight of 51.9% China’s man­u­fac­tur­ing sec­tor has a major bear­ing on the emerg­ing economies’ man­u­fac­tur­ing PMI. Nowa­days it is pop­u­lar to say that when China sneezes the other the emerging-market economies catch a cold – yes, the same adage used for the U.S. in the past. My analy­sis indi­cates it is devoid of any truth. It is evi­dent that the trend of my cycli­cally adjusted China CFLP Man­u­fac­tur­ing PMI is out of sync with the GDP-weighted Man­u­fac­tur­ing PMI of the emerg­ing economies exclud­ing China. The grad­ual weak­en­ing of China’s PMI from Octo­ber 2010 to Feb­ru­ary 2011 had no effect on the rest of the emerg­ing economies as the latter’s PMI con­tin­ued to rise until Japan’s ter­ri­ble twin dis­as­ters in March. The Man­u­fac­tur­ing PMI (exclud­ing China) bot­tomed in Sep­tem­ber last year while China’s PMI only bot­tomed in Novem­ber, but the two series are now ris­ing in unison.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management.

The GDP-weighted PMI (exclud­ing China) is highly cor­re­lated with the GDP-weighted Man­u­fac­tur­ing PMI that I cal­cu­late for the major devel­oped economies.

Sources: Markit; HSBC; CFLP; Kag­iso; ISM; Plexus Asset Management.

Due to lim­ited data, I was forced to focus on the BRIC coun­tries when cal­cu­lat­ing the non-manufacturing/services PMI for emerg­ing economies. Con­trary to the man­u­fac­tur­ing PMI the non-manufacturing/services PMI of the BRICs remained well above 50 at the height of the Euro­zone cri­sis and in Feb­ru­ary regained pre-crisis levels.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management.

It is note­wor­thy that while the ser­vices sec­tor in the devel­oped economies col­lec­tively was severely affected by Japan’s twin dis­as­ters the ser­vices sec­tor in the BRIC zone was largely unaf­fected. It was only when the Euro­zone cri­sis deep­ened that sig­nif­i­cant weak­ness appeared in the BRIC ser­vices sec­tor. This sec­tor also led the recov­ery as the cri­sis started to dissipate.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management.

China’s non-manufacturing sec­tor that com­prises 44.7% of the BRIC zone’s non-manufacturing/services PMI ini­tially held up extremely well rel­a­tive to the other BRIC economies when the Euro­zone cri­sis hit the head­lines, but in the end suc­cumbed when the cri­sis deep­ened. The drop in China’s PMI in Feb­ru­ary last year can be ascribed to the later than nor­mal Chi­nese Lunar New Year.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management.

It is also inter­est­ing to note that growth in the ser­vices sec­tor of the BRIC zone is very steady com­pared to that of the devel­oped economies – even with the stal­wart China excluded.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management

Although the country’s weight is only 3.4%, I included South Africa in the cal­cu­la­tion of a GDP-weighted com­pos­ite PMI (man­u­fac­tur­ing and ser­vices com­bined) for emerg­ing economies as rep­re­sented by the BRICS zone (BRIC plus South Africa).

The BRICS Com­pos­ite PMI recov­ered sharply to 55.5 in Feb­ru­ary after nearly stalling in Novem­ber last year.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management.

The com­pos­ite PMI of BRICS remained rel­a­tively steady in the after­math of Japan’s twin dis­as­ters but even­tu­ally gave way as the Euro­zone cri­sis deepened.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management.

Again China’s dom­i­nance in the com­pos­ite PMI had a major impact as it is note­wor­thy that the BRICS Com­pos­ite PMI exclud­ing China bot­tomed in Sep­tem­ber while China’s PMI only bot­tomed two months later.

Sources: Markit; HSBC; CFLP; Kag­iso; Plexus Asset Management.

I asked myself whether rel­a­tive strength in the BRICS com­pos­ite PMI rel­a­tive to devel­oped economies mat­ters in the rel­a­tive per­for­mance of the emerging-market equity indices against mature-market equity indices.

There is clear evi­dence that China’s stock market’s per­for­mance rel­a­tive to the MSCI World Index in terms of U.S. dol­lar is in fact heav­ily influ­enced by the per­for­mance of the under­ly­ing econ­omy rel­a­tive to the global econ­omy as mea­sured by rel­a­tive com­pos­ite PMIs. The der­at­ing of China’s stock mar­ket rel­a­tive to global stock mar­kets in the sec­ond quar­ter of last year stands out. Over the past three months the Chi­nese mar­ket has made up some lost ground but sig­nif­i­cant rel­a­tive upside poten­tial remains.

Sources: Markit; HSBC; CFLP; Kag­iso; I-Net Bridge; Plexus Asset Management.

My research indi­cates that the under­ly­ing econ­omy of India as mea­sured by the com­pos­ite PMI has no bear­ing on the rel­a­tive per­for­mance of the Indian stock mar­ket. The rel­a­tive per­for­mance of China’s econ­omy has a huge impact, though.

Sources: Markit; HSBC; CFLP; Kag­iso; I-Net Bridge; Plexus Asset Management.

As in the case of India the under­ly­ing econ­omy of Brazil as mea­sured by the com­pos­ite PMI has no bear­ing on the rel­a­tive per­for­mance of the Indian stock mar­ket. What I found is that the Brazil­ian stock market’s per­for­mance rel­a­tive to global stock mar­kets is highly cor­re­lated to the GDP-weighted Emerg­ing Economies’ man­u­fac­tur­ing PMI.

Sources: Markit; HSBC; CFLP; Kag­iso; I-Net Bridge; Plexus Asset Management.

In Russia’s case the rel­a­tive per­for­mance of the stock mar­ket is pri­mar­ily influ­enced by oil prices and not the state of the under­ly­ing econ­omy as mea­sured by the com­pos­ite PMI rel­a­tive to the global economy.

Sources: I-Net Bridge; Plexus Asset Management.

The rel­a­tive per­for­mance of the South Africa’s econ­omy also has no bear­ing on the stock market’s per­for­mance. Metal prices are the main determinants.

Sources: I-Net Bridge; Plexus Asset Management.

In con­clu­sion, the emerg­ing economies are not as depen­dent on China as many would like to believe. In light of the steadi­ness of espe­cially the non-manufacturing/services com­pos­ite PMI of BRICs rel­a­tive to that of the JP Mor­gan Global Ser­vices PMI I am of the opin­ion the eco­nomic risk in emerg­ing economies is less than that of devel­oped economies. Do emerg­ing mar­kets then not deserve bet­ter rat­ings and more expo­sure in global diver­si­fied port­fo­lios? It is clear to me that dif­fer­ent fac­tors influ­ence the rel­a­tive per­for­mance of the indi­vid­ual emerg­ing mar­kets and they are there­fore not a homoge­nous group.

Tags: Adage, Asset Management, Bearing, China, Debt Crisis, Disasters, Double Dip, Emerging Economies, Emerging Market Economies, Eurozone, GDP, Ism, Manufacturing Sector, Manufacturing Services, Pmi, Russia, Score, Second Half, Sovereign Debt, Sync, Unison
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