The Practical Economist

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  • EDITOR'S LETTER - October 27, 2014

    Editor's Letter

    We like our Scorecards.  We think they capture the picture pretty well...both the current state of things and where things are headed.  The timeframe on our forecasts, at least the Leading Indicators, is one intentionally tweaked to be one that readers can easily relate to....roughly three to four months out.

    But we need to take a look at the bigger picture sometimes.

    We have long emphasized the role of the largest economic zones in forging the direction of the global economy.  These are notably the Euro Zone, the United States, and Japan.  We exclude China because (1) we cannot completely trust data published by China and (2) there is too much of China's economy that is strongly managed centrally, taking an important element of things out of our hands: the natural tendency of factors to work together in certain predictable ways.

    The plain fact, as we have said for some time, to echo former Fed Chair Bernanke, is that fiscal policy is moving in the opposite direction of monetary policy.  This is true in the U.S., Europe, and Japan.  In other words, we, The Practical Economist, are strongly wedded to the perspective that until--and unless--there are significant changes to fiscal policy, we may see degrees of moderate growth in these zones, but there will be nothing approaching economic expansion.

    We are firmly wedded to that perspective.

    Your next question is logical and one that we can foresee:  is this is the case all over the globe?

    And the answer is "No."

    There is one--and only one--economic zone that we think is going to continue to see not just economic growth, but something approaching the lower end of expansion, at the very least.  We think it will extend pretty deeply into 2015.  And it is....Brazil.

    In a nutshell, all of the major monetary variables for strong growth are in place...and, yes, fiscal policy is different, in fact it is the only one of the world's major economic players to have it positioned so as to engender an increasing level of capital formation.

    Brazil--

    We are predicting now that you will be reading more about economic developments--industrial production growth, mergers, capital inflows, and the like--in the general business press in the coming months.

    And it's likely that when that happens, many will ask what Brazil is doing that no one else is doing.

    Well...you read it here first: they have gotten their fiscal policy act together.

    It's a priority for them and they understand how monetary and fiscal policies work together.

    Would that it were the same in the major developed countries.

  • ECONOMIC & MARKET ANALYSIS - October 27, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims fell 1.1%.

    S&P 500 Index - The Index finished at 1964.58, up 4.1% from last week.

    US Dollar Index - The Index finished at 85.73, up 0.7% from last week.

    Gold - Gold finished at 1232.75, down 0.1% from last week.

    Commodities - Spot Prices finished at 369.81, down 0.7% from last week. 

    Ten Year Government Bond Index - The Index finished at 2076.40, down 0.4% from last week.

    Industrial Production - The 12-month rolling average rose 4.0% in September.

    Consumer Prices - Consumer Prices rose at an annualized rate of 1.8% in September.

    Sales of Single-Family Homes - In September, the value of sales rose 1.7%.

    Big, important data this week.  And, it's good news...not great, but it is good. 

    First, let's talk about Inflation.  On both an all-in basis and core basis, Inflation came in very tamely.  In both cases, prices rose at an annualized rate in September of 1.8%.  The key takeaway is not that it's below the Fed's target of 2.0%, but that this rate is the smallest in the past four months.  It's not smaller by much month-over-month, but every dollar that inflation doesn't take up leaves a bit more to be saved or spent.

    And that's where we want to look at Industrial Production.  Declining Inflation is good, but isn't worth much to us if the economy doesn't at least stay where it is...or, better, rise.  The good news is that while Industrial Production didn't expand at a faster rate over last month, it did continue to expand at an annualized rate of 4.0%.  And that's a very good rate.  Same rate of growth in Industrial Production, but lower Inflation?  That's a good combination.  The cautionary word here?  Industrial Production was flat over last month and has been, for all intents and purposes, flat for four months.

    This is, as you've probably already observed, completely consistent with what we said would happen...: that moderate growth would continue, but that acceleration in the pace of growth would slow down.

    As we've often said in the past, it may not be immediately obvious, but the sales of new single-family homes is richer as an economic indicator than you might think it is.  Here's the good news: the sales (volume x price) of such homes, on a 12-month rolling average basis, rose 1.7% in September.  That's a respectable figure and is probably a good representation of how the summer felt.  The bad news?  It's the highest that indicator has been since December 2013.  And here's the more important takeaway from the data: the ratio of inventories to sales has stopped declining, at least for now.  We're seeing a pattern of stability the past several months, with only minor variation.  This indicator is probably our best important indicator the direction of housing in the United States.  Declining inventory given a constant rate of sales spells higher demand and higher prices.  When inventory ceases to decline?  That tells us that the nice price acceleration we saw starting in the third quarter of 2012 is appearing to stall. 

    Led by a decline in the price of the 10-year U.S. government bond, you cannot but conclude that the Market viewed the week as one in which it felt somewhat reassured...especially with the Equity Markets and Dollar both showing increases.  Is such a feeling justified for the medium- to long-term?  We think the jury is out on that, but...working with just the week's data, it's not an unjustified position.

    The Global Scorecard was updated this week.

  • ECONOMIC & MARKET ANALYSIS - October 20, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims fell 1.5%.

    S&P 500 Index - The Index finished at 1886.76, down 1.0% from last week.

    US Dollar Index - The Index finished at 85.11, down 0.9% from last week.

    Gold - Gold finished at 1234.25, up 1.30% from last week.

    Commodities - Spot Prices finished at 372.56, down 0.5% from last week. 

    Ten Year Government Bond Index - The Index finished at 2083.72, up 0.5% from last week.

    Retail Sales - The annualized rate of growth in the 12-month rolling average in September was 4.5%.

    Business Sales and Inventories - The 12-month rolling average of growth in August was 4.7%.

    Let's take a quick look at the market data.  Government bonds up, stocks down, Dollar down, commodities down...and Gold up.  What you're looking at is a classic example of what the Market believes is a broad slowdown in progress, with a corollary belief that it will result in further monetary easing and Dollar devaluation.  Study it, remember it.  This is what it looks like. 

    It's hard to reinforce just how highly priced 10-year government bonds now are.  On the one hand, a rising bond market and a declining stock market help level out the disequilibrium in valuation that has existed between the bond and stock markets.  (That ratio has been out of whack and a danger signal for several months.)  On the other hand, bond prices are screamingly high.  You need to consider: professional investors are willing to tie up money for ten years to obtain a yield of roughly 2.5%.  Think about that long and hard.

    You'll notice that, after roughly a month of steady increases in the Dollar and steady declines in Commodities, these investment classes appear to be leveling out.  We hope you're not one of the people who jumped into what they thought was going to be a continuing trend.  If you're a regular reader, you have probably read our admonitions in this regard.  You want to bet into declining commodities?  Wwhen they're already fallen a good amount in a short amount of time with no rational basis for believing that further declines are in the offing...except for baseless speculation?

    And the Dollar...as we have said, if you want to bet that the Dollar is going to continue its upward run after it has already risen several percentage points in value, you're implicitly making a strong bet that the economic relationship between US on the one hand and Europe and Japan on the other, will continue and grow, i.e. the disparity will continue.  That's not a bet you want to make.

    As for the hard economic data this week, Retail Sales is one of those marquee kind of data points that say a lot about the current picture, but that's the point:  it tells you a ton about the current picture and where we just were, so to speak.  It doesn't tell you much about where things are headed.  But, we shouldn't discount how good it is at telling us the current situation. 

    In a nutshell, this month's figure is pretty strong.  The absolute rate of growth, at least, is pretty strong.  However, what's notable is the rate of slowing.  In September, the rate of change actually declined. 

    If we exclude auto-related sales from the total, the picture is much the same.  Instead of a 4.5% rate of growth, we get 3.4%, respectable, but not quite as strong.  And, the rate of change month-over-month?  It's flat.  If you've been reading all along, you'll know that this is not far from the general forecast we made about how the story would change in early fall.

    And how about business sales and business spending on inventories?  That 4.7% figure is pretty strong, no doubt about it.  However, as with retail sales, it is just a bit off where sales and spending has been the past few months.

    Remember the general tone of our forecast for the fall: growth would continue, but at a slower pace than during the summer.  What happened during the summer is akin to what an expansion looks like.  Not only does growth proceed at a relatively strong rate, but the rate of growth in the growth rate is strong.  What we're experiencing now.  Upward change in the growth rate is either declining or flat.  Bad news?  Just uninspiring and a halt to a true expansion.

    It would be easy if all things moved in a smooth and consistent trend for extended periods.  But that's not the way it usually works.  And right now?  We are in a time of transition. 

  • EDITOR'S LETTER - October 13, 2014

    Editor's Letter

    If ever there were a transition afoot, with regard to economic activity and major variables that affect major investment classes, it is NOW.  Transitions often--in fact, usually--make for opportunities.  The funny thing about opportunities is that, by definition, they're plunges that not everyone is taking.  Taking these plunges can feel scary.  You can surround yourself with the comfort of a crowd, but by definition, the opportunity will be less of an opportunity.  More demand = less yield.  This is definitional.  You think you're going to uncover and dive into a great opportunity with everyone at the same time?  You'll have to explain to us how that works. 

    First, it's not that we're going to pat ourselves on the back, but we are going to say, "We told you so."  The point is not that we have a crystal ball.  We certainly couldn't possibly tell you with any high degree of certainty how the Equity Market will move in any particular month -- never mind a particular week or day -- but you were warned, for months, and we hope you took appropriate action.

    The point, as we hope you all understood, was not that the Market was grossly overvalued relative to any other major measure of output or activity...or that the outlook for earnings was dismal.  The outlook for earnings was not rosy, but it was not bad, either. 

    The point is that, especially given a ho-hum outlook for earnings, the expected return for risk was just too low.  It's not scandalously low, so to speak, but it is low.  Over the very long term, few investment classes are as highly performing as the Equity Market, but there are points along the spectrum in which the Market is priced to deliver excess reward for risk...and there are times, such as now, when the Market is priced to deliver insufficient reward for risk.  You can reach for an extra 1% or 2% in total yield if you want, but adjusted for risk?  Well, you'll do it without us.

    The second point we want to make is about what's going on in Commodities and the U.S. Dollar. 

    Has everyone gone crazy?

    Yes, the Dollar has appreciated several percentage points over the past month and yes, the prices of major commodities have plummeted.  And yes, the prices of major commodities correlate very strongly in an inverse way with the direction of Inflation.  But here are the two points:

    1.  It's only a month's worth of data, and therefore no conclusion about the medium-term trend can be extrapolated.

    2.  You're hard-pressed to come up with a convincing case for why the Dollar and Commodities would continue to move down further.

    If you want to bet that you can identify when an absolute bottom in Commodities has been reached, good luck to you.  But when you see a drop on the magnitude of what we've had, you can be sure that we're at a relative low--and very likely, extremely close to the absolute low, if we haven't already hit it.

    If you're betting that these trends will continue, you are implicitly betting that (1) Saudi Arabia will continue its current policy of higher oil production for a sustained period and (2) that the economic relationship of the U.S. to Europe and Japan will continue, i.e. the U.S. will continue to expand or that Europe and Japan will continue to deteriorate relative to the U.S.

    Are these bets that you want to make?

    Let's be very clear: you are not obligated to make any bet at all.  But if you don't, you have no business pretending to make considered decisions about investment classes...and, if you take that route, you are ultimately abdicating your responsibility to put your investments and your future at risk.

    Your investment strategy is your investment strategy.  It may be that there is no place in it for investment classes that are suited more to trading strategies than investing strategies, AND, no one should ever counsel you to dive into an investment class you're not familiar with, but...we are going on notice as saying that we believe that there is an opportunity being presented in these classes that don't often arise.  If you wait for the Business Press to say it, by definition, the return will have eroded, and it will no longer be what we call an opportunity.

    A word to the wise, as we are wont to say, is sufficient.

  • ECONOMIC & MARKET ANALYSIS - October 13, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims fell 2.5%.

    S&P 500 Index - The Index finished at 1906.13, down 3.1% from last week.

    US Dollar Index - The Index finished at 85.91, down 0.9% from last week.

    Gold - Gold finished at 1219.00, up 2.0% from last week.

    Commodities - Spot Prices finished at 374.44, up 0.4% from last week. 

    Ten Year Government Bond Index - The Index finished at 2073.82, up 0.8% from last week.

    We get a little break from hard economic data this week, which is just as well, since we're appreciating having a little extra time to synthesize everything that's going on.

    In a nutshell, we are living in a time of transition.  There's nothing particularly notable about that except that there is a large disjoint between where the average consumer feels to have been recently and where we're going.

    Your key to the tea leaves is right there in the market data this week.  Equities, Commodities, and the Dollar...all down.  Gold and the U.S. 10-Year Government Bond were up. 

    It's hard to get a clearer picture of what the Market thinks is happening.  This is a picture of fear of a broad economic slowdown that is expected to result in some form of monetary easing.  How do we jump from the first conclusion to the second?  Your clue is in Gold's performance.  It's perfectly normal for Gold to move in a direction opposite that of the Dollar.  The key is the amount of the change.  When Gold moves by 2.0% and the Dollar by less than 1.0%, Gold's performance is not just about the Dollar's drop.  Remember: regardless of what sophisticated Nobel-Prize winning economists will tell you, Gold is still the ultimate store of value.  If it isn't, kindly explain to all of us why Gold, pretty much since the deepest depths of the Financial Crisis, has been trading at roughly 70 times over Silver when the historical ratio is more like 20:1.

    Of all the data points you have to look at this week, probably the most significant is the movement of the Ten-Year Bond.  The facile interpretation would be that bond investors are telling you to expect lower inflation.  Is that really the case?  What bond investors are telling you is that interest rates will remain subdued.  The question is what the reason is.  Is it, in fact, because the medium- to-long term outlook for Inflation is subdued?  Or is it because the economic outlook is more subdued than the view for Inflation? 

    This "little" topic is actually enormous if you think about it...and it's one we address, indirectly, in this week's Editor's Letter.  It's a topic we're going to come back to with relative frequency over the next three months.

    For the moment, your key takeaway to last week is that the Market is sending you clear signals that it is nervous about a broad global slowdown.

  • SCORECARDS - October 6, 2014

    Current Scorecard - Domestic

    October 2014

    Quick View:

    Weighted Average:    9
    Current Month:        21
                                                
          

    Full Scorecard:

                                                                                                 Current                     Four                          12
                                                                                                  Month                  Mos. Ago                Mos. Ago

     OVERALL               1              0                  4
     LEADING & CONFIRMING SCORE              21            18                29
     Leading Indicators               0            -5                 4 
     Confirming Indicators             40            29                43 
     Foundation            -49            -57               -71



    A reminder of the relatively new feature at the top.  The Quick View tells you quickly where we are.  The Weighted Average tells you the directionality over the past year, rather than how strong the economy actually is.  The best way to think of that figure is as a sense of how things likely feel right now, which will be a reflection, not just of what's happening now, but an accumulation of the past year's experience. The second figure tells you our forecast for how the economy is trending.  We think it's a good way for you to get a quick sense of what's going on.

    If you only had 60 seconds this month to peak at anything on this website, your time would be well invested in just looking at the Current Month/Leading & Confirming Score.  The Current Month Score is a blended measure of two things: current economic activity and our leading indicators of where the economy is headed.  Timing?  As a general rule of thumb, the Score is looking forward roughly four months.  Especially, if you contrast where that figure is at present with where it's been most recently and where it was a year ago you will get the key to the economic state. 

    What's this month's Score telling us?  Well, at 21, it's moderate.  It's hardly an expansionary figure and it's hardly a contractionary figure.  It's simply indicative of very moderate growth.  Context?  It is actually the highest it's been in five months, but...it's also lower than any time before May all the way back to July 2013.

    You'll notice that it's slightly higher than it was four months ago, and that four months ago, it had dropped from a year ago.  It's all right there in the numbers.  What you're seeing is that the Model was telling us a year ago that the economy would begin to pick up steam very early this year, and that, just about the time the nice comfortable summer was getting underway, the seeds were being planted for a moderate slowdown.  What you see in this month's Score is a stabilization; that's what's reflected in the fact of the Current Month Score being moderately higher than four months ago...and, though you don't see it here, two points higher than last month. 

    So, what is going on?  Well, there's some good stuff going on, which is helping to keep the Leading Indicators' score from being negative.  That includes a modest improvement in the inflation picture, both actual inflation and near-term inflationary pressures.  While it's true that Capacity Utilization--a major input to Inflation--is reaching an inflationary threshold, it's also true that the Dollar is hitting some nice relative highs and that prices of most commodities, namely oil and natural gas, have been dropping.

    It's also true, though, that we continue to see some moderate deterioration in credit conditions.  Does that sound like a boring topic?  It's very important to the economic landscape.  What do we mean by credit conditions?  We mean the availability and use of credit at terms that are appropriate to economic activity.  When we say credit conditions are tightening, one of the things you can read into that is precisely that rates are rising disproportionately to other superficial indications of economic activity.  And that is precisely what is happening right now.

    Ready for a little more?  While retail and business sales continue to be fairly healthy, the truth is that sales have dipped a little in the past month...not a large amount, you understand, but yes, enough to affect the Model.

    For now, we're holding hard to our line: for the near term, the economy will continue to grow, but...at a diminished pace than we experienced over the summer.  And you can probably bet that it will take the larger business community 'til late fall to figure it out.  

    Current Scorecard - Global

    October 2014

    Full Scorecard:

                                                        Current                   Four                         12
                                                         Month                Mos. Ago                Mos. Ago

    OVERALL GRADE

                8

                 7 

               N/A

    Leading Indicators

               17

               15 

               N/A  

    Confirming Indicators

                5

                 5

               N/A

    Foundation

               -6

               -5

               N/A

     
    Unfortunately, everything you're hearing in the Business Press is...roughly true.  Europe and Japan are in a bit of an economic malaise, and there doesn't appear to be much change in the near term.  As we said last time--and it cannot be stated enough--Europe is, really a lynchpin to global economic health.  Because the Euro Zone is the single largest economic zone, by currency, in the world, there can be no sustained global recovery without a recovery in Europe and there can be no significant global downturn without a downturn in Europe. 

    When you think about Europe's economy there are two things that tower above all to remember: (1) the Zone has a strong anti-inflation bias and (2) the idea of breaking up the Euro Zone is distasteful to all members.  It's difficult to imagine how poorly things would have to get for there to be a breakup of the Euro Zone.

    Our opinion is that Europe's monetary policy has not been quite as accommodative as that of the United States, and its fiscal policy is at least as poor as that of the United States.  While we believe that the Euro Zone understands that failure is not an option, we believe strongly that economic conditions in the Euro Zone will have to deteriorate, still, by a significant amount for European leaders to take strong and growth-oriented action.

    You'll note that our leading indicator for the globe is on the low side of being moderately good.  It's a figure that has been stagnant for quite a few months.  Our Model is saying not to expect much in the way of improvement in the near- to medium-term.

    On the good side, Inflation has been trending down.  Likewise, credit conditions to be roughly positive.  On the other hand, we're not seeing improvement in the rate of employment and industrial production, while still growing, is growing at a far slower rate than it was growing the last couple of months. 

    In other words, what should you expect?  Very modest growth. 

    Understanding the Scorecards

    Domestic Scorecard

    The Scorecard is our concise means for measuring the current level of strength in the economy, where the economy is headed, and how sustainable expansion is.

    The components:

    1. Overall Grade is a consolidated measure of how strong the economy is now, where the economy is headed, and the risk factors that pose a threat.
    2. Leading Indicators provide a reading on the primary drivers of the economy.  
    3. Confirming Indicators are a good read on how things are at the moment.  
    4. Risk Factors measure significant threats to economic expansion.

    The grades: 

    The grades are not unlike school grades.  The scale goes from -100 to +100.  Anything within a range of -16 to +16 roughly indicates a maintenance of the status quo, though, with higher or lower figures indicating the direction in which the economy is trending.   

    Global Scorecard

    Our Global Scorecard uses the same numerical scale as the Domestic Scorecard.  It includes the United States.

     

  • ECONOMIC & MARKET ANALYSIS - October 6, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims fell 1.4%.

    S&P 500 Index - The Index finished at 1967.90, down 0.8% from last week.

    US Dollar Index - The Index finished at 86.69, up 1.2% from last week.

    Gold - Gold finished at 1195.00, down 2.0% from last week.

    Commodities - Spot Prices finished at 373.04, down 1.0% from last week. 

    Ten Year Government Bond Index - The Index finished at 2057.7, up 0.4% from last week.

    Disposable Personal Income - In August, the annualized rate of increase was 4.5%.

    Consumer Spending - In August, the annualized rate of increase was 3.7%.

    Case-Shiller Housing Index - The Index rose, in July at a 7.7% annualized rate.

    Employment - The number of those employed, in September, rose at an annualized rate of 1.5%.

    While data on Income and Spending are, perhaps surprisingly, not the most important inputs to our model (we don't consider them leading indicators), they are crucial to confirming if we're heading where our model said we were headed.  Not surprisingly, these figures dovetail very comfortably with the idea that the summer was, in a word, comfortable.

    More specifically?  Well, that figure for Income is pretty strong.  It's especially strong compared with where Income was hovering last winter, but...even in the context of what you'd expect an expansionary economy to produce it's rather strong.

    Is there a "however?"  Yes.  Consider: August's figure is actually lower than either of the two previous months.  Just keep that in your head the next few months.

    What about Spending?  Well, that's interesting.  The figure that came in is strong, but what we'd call moderately strong, not quite at the level Income came in.  And, August's Spending is the lowest of the past three--not just two--months.

    Context and perspective are important.  Figures that are strong are nice, but you want to see consistency and a trend upward.  

    Here's something else: the Case-Shiller Housing Price Index...that annualized rate of 7.7% is very good, but...it is the smallest rate of increase since February 2013.

    Of course, the Labor data is really the marquee data of the week.  So, let's take a close look at what happened in September.  The good news?  The rank of the employed rose at an annualized rate of 1.5%, and yes, that's a pretty strong figure.  To put it in perspective, it's almost double the rate it was last October, 11 months ago.  And, of course there's a "however."  For one thing, that rate of increase, as good as it is, is unchanged since April.  In other words, while Labor indications are showing that things are improving, they are not now improving at an increasing rate...and that's completely consistent with what we're forecasting for the fall for the economy, in general.

    And, of course, our most important indicator of Labor health: the Employment Rate...it's holding steady at 58.8%.  If you're new to this site and this indicator, it's one of the most important indicators that the general press doesn't talk about.  To put it in a nutshell, when the economy is healthy, this Rate hovers around 62.0%.  In the wake of the Financial Crisis, the worst the indicator fell to was 58.2%.  In other words, it is now just 0.6 percentage points higher than the low, but still 2.2 percentage points off what would be considered healthy. 

    Now, if we look at the Market's antics this week, they're painting a picture not unlike last week...a picture of fear of global slowdown and political instability.  This week, however, everything can be neatly summed up quickly:  this is the fourth consecutive week in which the Dollar rose but the price of the 10-year government bond rose, as well.  When the Dollar rises out of a belief in a strengthening economy, you would expect demand (and prices) on the 10-Year Government Bond to fall.  In other words, why are investors continuing to flock to bonds?  Your clue is that, except for one week, the Equity Market, has ended each week lower, out of the past four weeks.  In other words, the Dollar is not reflecting economic strength, but political instability and the weakness of other major currencies.

    We have previously issued more warnings about the investment environment than we think you could possibly stand.  Yes, there are various segments of the economy that improved nicely this summer.  And, the outlook, for now, is one of moderate growth.  Do not forget: when the Employment Rate is 58.8% and when short-term interest rates have to be essentially at 0% to bring about the moderate growth we're having, the economy is fundamentally on a shaky foundation.  Keep that in mind.