The Practical Economist

  • EDITOR'S LETTER - November 24, 2014

    Editor's Letter

    We strongly considered leaving last week's Editor's Letter up for one more week to make sure everyone gets to read it.  If you haven't yet done so, we encourage you to go to the archives.  It has our rough forecast through late winter.  We never want to hear that a reader was surprised by turns in the economy.   

    Normally, this column treats a particular theme, and just one theme at a time.  This fortnight, we want to make sure we shed some light on a trio of things that we think deserve your attention.

    The first is not new, but it's a topic that we will continue to come back to, time and again, until the situation changes.  It's simply the fact, despite what you may hear elsewhere, that the economy is fundamentally ill. 

    We are now six years past the onset of the Financial Crisis.  And Industrial Production, to our mind the single strongest indicator of economic activity, is demonstrating gains on an annual basis of roughly 4%.  That's a growth rate that's pretty good.  In fact, if coupled with enough of other "right" indicators, it could be indicative of the start of expansion. 

    Now, hopefully everyone understands that the Fed's key tool to manipulate economic activity up or down is the setting of short-term interest rates (the Fed Funds rate, the rate at which Federal Reserve banks borrow from each other).  It is commonly understood that a normal rate of real return (short term rate adjusted for inflation) hovers around 1.5% - 2.0%.  Anything above that would normally be consistent with a strong and growing economy.   Anything below that would be associated with an economy that needs help.  That four percent growth in Industrial Production is good, yes, but not if real interest rates need to be hovering in negative territory, which they have been, for some time.  Short-term interest rates hovering at 0.25% and Inflation running at 1.7%?  You do the arithmetic.  This is an economy that has strong instability at its core.

    In this light, we were thrilled to hear Fed Chair Janet Yellen echo, recently, the words of the previous Chair.  Chair Bernanke characterized the federal government's fiscal policy as going in the opposite direction of monetary policy.  And now, very recently, Chair Yellen called fiscal policy "contradictory."  Such words from Chair Yellen are particularly sweet because there are those who would like to characterize Yellen as too abundantly accommodative.  Remember: it is due to Janet Yellen that the Fed adopted its secondary mandate of managing to a lower unemployment level.  In other words, no one can accuse Chair Yellen of being unusually hawkish.  So, when someone like this calls fiscal policy contradictory and starts hinting at higher rates, you can bet two things:  (1) she will not allow herself to be the Chair on whose watch Inflation becomes a problem and (2) as graciously-voiced as she is, she is not going to allow herself to be characterized as the country's economic problem.

    The second point we want to raise is one that may surprise.  Japan has been a leading light of the global economic picture for many decades.  Until not long ago, it was the second-largest economy, certainly as measured by economic currency zones.  And, if you disaggregate the countries of the Euro Zone, it's still the third-largest economy (China has taken over the second position). 

    Japan has had a peculiar place of importance because, despite its relatively small size and relatively small military compared to the U.S., the Yen has been a very strong reserve currency.  This is due in part to the size and resilience of its economy in the past, but...just as much to its unusually transparent political system.  You'd be hard-pressed to name a country that has a more transparent political system...and that gives investors tremendous confidence in the currency.  Our concern: Japan may be, we think, on the brink of a significant transformation.  In a word, we are concerned that the Japanese economy may be at the beginning stages of become unstable.  Why do we say this?

    For one thing, Industrial Production has slowed to a crawl.  For another, Business Investment, one of the primary drivers of Industrial Production, has slowed to a crawl.  And, the country's Budget's not's enormous.  To put this in perspective, while, three years ago, we characterized the United States' Deficit as enormous, which it was, it has come down very significantly, unlike that of Japan.

    Investors have taken Japan's place, most notably its currency's place, as granted for very long.  We think that may be changing.  Put especially in light of China's growing economic power, it's something to be very aware of...and to be prepared to plan for. 

    It's too early to be certain that such a condition will be permanent, so it's certainly too early to talk about what such a permanent condition might mean and how you should react,'s something to keep on your radar. 

    It isn't often that you get to live through the major transformation of a major player's economic transformation.  You know what they say: you've got to stay on your toes with the Mariyinsky Ballet.  It's interesting to speculate what country's currency could take on more prominence as a reserve currency if Japan does begin to falter in a long-term way.  We'll just let you speculate for now.

    The last point we want to make goes back to the Federal Reserve.  Just this week, William Dudley, President of the New York Federal Reserve, made comments to the effect that the major member banks have balance sheets that are now significantly stronger than they were in the past, largely due to higher capital requirements.  Our question to Dudley is this:  how much of those reserves are real? 

    If you're a regular reader, you're probably more informed than the average consumer, and you probably understand that a significant amount of the reserves that were built up in the past three years are literally fake, a result of the Fed's bond-buying programs.  What does it mean for these banks to have stronger balance sheets when a significant component of those assets is literally fake?

    Our point to you: be careful what you accept as wisdom.  How stable are these banks really?  The scary truth is that no one but the Federal Reserve Chair and her inner circle really know.  And they're not going to tell you.

    A trio of there a theme?  Perhaps there is: be skeptical.

  • ECONOMIC & MARKET ANALYSIS - November 24, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims rose 0.9%.

    S&P 500 Index - The Index finished at 2063.50, up 1.2% from last week.

    US Dollar Index - The Index finished at 88.28, up 0.9% from last week.

    Gold - Gold finished at 1203.75, up 3.0% from last week.

    Commodities - Spot Prices finished at 376.42, up 1.1% from last week. 

    Ten Year Government Bond Index - The Index finished at 2071.86, essentially unchanged from last week.

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

    Capacity Utilization - The 12-month rolling average rose 1.1% in October.

    Consumer Prices - Prices, in October rose, on average 1.7%, annualized.

    If you were hoping that this might be the week that disproves our forecast for the medium-term, you will be disappointed.  Let's talk about Industrial Production, which is certainly marquee data, and perhaps the most relevant indicator of current conditions.  Now, that annualized growth rate of 4.0% is a pretty solid one.  (Of course, adjusted for how low interest rates are, not only is it not impressive, it's lagging where it should be, but...on its own, it's a solid indicator of growth.)  There is a "however:" this figure is up 0.8 percentage points from a year ago, and it's even up 0.3 percentage points from six months ago, is the lowest rate of growth of the last four months...completely consistent with our forecast for a lower rate of growth.

    Remember our forecast:  not contraction, but a pace of growth that will be below that of the spring/summer period.

    Now, one of the bright spots of hope for the fall was supposed to be Inflation--the hope that it would trend lower enough to more than offset any slowdown in economic growth.  It's certainly true that the Dollar has risen nicely in the past two months and prices of commodities, namely crude oil and natural gas, took a beating.  So, what gives?  Well, first, let's look at one of the key indicators of inflationary pressure: factory utilization.  The Index is now reading 78.85, which is not a highly inflationary figure; we'd characterize it as being at the upper threshold of being tame, or on the lower threshold of being inflationary.

    However, to give a sense of the latent inflationary forces at work, the Index has either stayed the same or risen in every single month since November 2009.  And the last time the Index was this high was October 2008.  In other words, no matter what else you hear elsewhere, inflationary pressures are latent, but they exist.

    How did prices actually perform? 

    Well, we have some good news: prices for everything excluding food and energy rose 1.7% in October.  Why is that good news?  Well, it's down 0.2 percentage points from just three months ago.  But it's also true that it is only a drop of 0.2 percentage points.  What about prices in aggregate? On an aggregate basis, prices rose 1.7% in October and that's down just 0.1 percentage point from September (down 0.3 percentage points from three months ago). 

    In other words, we're getting some positive effect with regard to Inflation that everyone expected, as a result of the higher Dollar and lower commodity prices.  But, while energy prices actually fell a whopping 1.0 percentage point month-over-month, food prices are stubbornly under upward pressure.  Couple food price pressure with that that rather modest decline in core prices, and you don't end up with a picture of significantly depressed inflation.

    All around, it's not a bad picture, but it's not a picture of accelerating growth.

    What did the Market think?  The funny thing about the Market is that it would be very difficult to construct a quantitative model that would spit out accurate conclusions about the Market.  What makes constructing such a model difficult?  Well, the trends in a particular week that get the most emphasis often depend on not just the importance of the data that comes out, but lack of new information, as well, thus putting extra stress on the new data, even though that data, in the context of all relevant data, may not be very important.  But the Market works in any given week with what it's being given.

    The signal economic event of the week for investors was the announcement by China that it would be cutting rates in an attempt to stimulate growth.  The Market, as a result, clearly is showing confidence that accommodative (and perhaps lower) interest rates will be the trend all around for the short- to medium-term. 

    If there's one takeaway, this week, for the novice layperson, it's the growing importance of China to the world economy.  We wouldn't call it a lynchpin, but...based on current trends, it soon will be so.  It will be several decades, at least, before the economies of Japan, United States, and the Euro Zone are not of monumental importance in the world economic picture,'s also safe to say that none of them is so important as to be able to unilaterally significantly determine global economic direction at this point.  (Note that we said, "determine," not "influence.")  You will note the Market's response to China's action, in this regard.

    China is steadily moving toward that state.  We think that an extended column on how China's role is changing is in order fairly shortly.  For now, understand this: China's economic levers have the ability to effect, not simply affect, how the Market perceives the global economic picture will go.   

  • ECONOMIC & MARKET ANALYSIS - November 17, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims rose 2.2%.

    S&P 500 Index - The Index finished at 2039.8, up 0.4% from last week.

    US Dollar Index - The Index finished at 87.53, down 0.1% from last week.

    Gold - Gold finished at 1169.00, up 1.3% from last week.

    Commodities - Spot Prices finished at 372.48, down 0.2% from last week. 

    Ten Year Government Bond Index - The Index finished at 2070.84, essentially unchanged from last week.

    Business Inventories - The 12-month rolling average rose 5.3% in September.

    Retail Sales - The 12-month rolling average rose 4.4% in October.

    Even if we were to put much stock in the number and trend of Initial Jobless Claims as a significant labor indicator (which we don't, except to the extent that others do, thereby influencing their behavior and perception), we would still be under pressure to explain that fairly whopping increase in claims of 2.2% this past week (on a four-week rolling average basis).  We're not really going to explain it, actually.  Fact is: this is a signal demonstration of why you can't put too much stock in this indicator...not just the standard week-over-week data, but even the four-week average.  Remember this very important point: to the extent that job rolls are already relatively low, the ability of employers to lay off more workers becomes increasingly thin.  Got that?  And--keep this in mind, as well: the sum effect of other leading indicators is a far better predictor of sustainable employment and the economy than merely new jobless claims.

    Now, on to the more "meaty" data for the week.  We got a nice blend of data types this week.  One, Business Inventories, is more forward looking, and the other, Retail Sales, is a better indicator of the moment.  First, Retail Sales---

    It's a pretty good confirming indication of the change we said we'd be getting in the fall...Retail Sales came in good, but not great.  And the figure of growth in the 12-month rolling average is essentially unchanged from last, add it together: first you have a figure that, on its own, is just barely north of average, in terms of growth, and then also figure that isn't growing faster.  If we look at the Core figure, i.e. with auto-related sales stripped out, the story is the same, but even more sober, with growth at 3.5% and unchanged from last month.

    Business Inventories is one of the three categories of indicators that comprise our aggregate measure of Business Investment, which is one of the two or three most powerful classes of indicators that tell us where things are going.  What did we get this month? 

    Businesses added to their inventory levels at an annualized rate of 5.3%.  That's a respectable figure, but on the modest side of good.  The problem?  It's the lowest of the last three months.  Again, not a picture of contraction, but not a picture of expansion, either.

    And what did the Market think?  Well, what you have is a picture of a Market that expects a continuance of accommodative monetary policy.  That's the only significant takeaway from the market data.

    However, it's worth taking note of a couple of movements in the data.  The U.S. Dollar fell for the week.  Those who bet into the idea that there would be a sustained rise in the Dollar had a view that we couldn't understand, and sure enough, late in the week, a tiny bit of strength in the Euro hit the Dollar ever-so-slightly.  We're the first to admit that we were relatively late to the view that Europe's problems might stick around longer than we thought, but...even if you wanted to bet on the Dollar based on the recent experiences Europe has been having, to bet that that trend would continue is about an amateurish a move as we can imagine.

    Does that mean that Europe is on its way back?  Not necessarily; what it means is that it's foolish to bet into a continuing trend when the data is already at a relative low and there's a myriad of variables that factor into the result.

    Band wagons are for instruments, not for jumping on once the show is underway.

  • COMMENTARY - November 17, 2014

    Eyes on the Ball

    There are a few topics we circle back to every few months simply because their importance in the grander scheme of things is simply too great.  Among these is what we have called that disconnect between monetary and fiscal policy.  And we are provided, this week, with a segue that's too delightfully elegant for us to have imagined that it could have been provided us.  But it was provided us.

    We're willing to bet a lot of money that most of you missed a comment that Fed Chair Janet Yellen made to the Press this past week.  It was to the effect that the country is working with extraordinary monetary policy and "contradictory fiscal policy."  The words in quotes are precisely as she put them.

    It's hard to believe that leading economists and political leaders can be universally so short-sighted, but such is the case.  Nearly all major players in the global economic picture have Central Banks working with very accommodative monetary policy.  And how many have crafted fiscal policies that, in our opinion, support economic growth?  In all seriousness, none...but one.

    If this sounds familiar, it should.  It's an echo of a recent Editor's Letter, but the message bears reminding.

    Where is this fantastic place?  Brazil

    We think that all of the major monetary variables for strong growth are in place...and yes, fiscal policy is different; it is positioned to engender an increasing level of capital formation. 

    It's also true that Brazil is subject to a number of factors beyond its immediate control.  For example, Brazil is a country that relies heavily on exports of commodities...and prices of such is one such factor beyond its control.  Another is demand...and, to the extent that other major global players keep in place economic policies that hamper economic growth, demand for some of Brazil's commodities will flail, as well.

    But--at least, they're doing what they can.

    We're glad, for them, that they're getting their act together.  Our recommendation: as you gaze at the world economic data from time to time and look at the biggest players--Japan, Europe, United Kingdom--take a look at Brazil and contrast them across various dimensions  We think the comparison will be enlightening.

  • EDITOR'S LETTER - November 10, 2014

    Editor's Letter

    We've been dancing around the topic for several weeks, but it's time to finally a forecast, roughly for the next quarter, or through late winter.

    Our forecast is essentially in line with what we hinted the data was suggesting, but...there are few things more foolish than committing to an economic forecast after just one or two weeks of data.

    The first thing we need to say and reinforce is that there's a difference between the pace of growth and how the pace of growth feels.

    We often tend to compare how things are based on how they feel at the moment to how they most recently felt.  But that's not necessarily a good indicator of how things are progressing.  And likewise, how things are, in fact, progressing, are not necessarily good indicators of how things feel.

    We're going to try to make the difference understood.

    So, what do the next four months hold out for us? 

    The most prominent economic indicator to everyone at the moment is Inflation.  With the prices of some of the  most important commodities at multi-year lows, it's extremely difficult to forecast anything but extremely tame Inflation and possibly Disinflation for the next month or two.  Understand that low and declining Inflation is a very powerful input to stronger economic growth--simply put, it gives consumers more spending power. 

    As we have said previously, we are far from optimistic about the likelihood for an extended period of Inflation remaining so tame.  For one, we don't think that the key reasons for over-supply in these key commodities is a scenario that's likely to continue for long.  For another, there are already indications that Food Inflation (especially based on rising prices for food-based commodities) is rising. 

    Then there's the U.S. Dollar.  The Dollar has been flirting with relative highs that are going to help keep import prices down.  That argues for lower Inflation, yes.

    If you want to bet that the higher U.S. Dollar is going to keep Inflation under control, you're also betting that the higher Dollar is going to remain so for an extended period.  That means that you're discounting the fact that some of the run-up in the Dollar is a response to the Fed's curtailing its bond purchase program.  Input to the Dollar from this source is only temporary.  And, we must remember that the value of the Dollar with regard to Inflation is only important with regard to imported goods and services. 

    You combine all of these factors and the outlook for sustained Disinflation is not a good one...and we think it puts us in good company with the Fed whose language on the outlook for both Inflation and pressure on interest rates echoes ours.

    In other words, the effect on the economy from Inflation?  It's possible it will have a surprisingly positive effect through late winter, but we think smart money says it doesn't go quite that far.

    What about the rest of the picture?

    Well, there are two key areas we want to focus on...the first is credit markets.  Some of you presumably pay attention to business press commentary on market meanderings.  If you listen closely enough you've probably noticed that the smart commentators look closely at how credit markets perform.  As we've said before, bond traders are the smartest people on the planet.  So what is the Credit Market saying to us right now?  Well, to echo something we wrote in this week's Economic & Market Analysis, bond prices are roughly stable at the moment...and they're also rather depressed.  The yield on the 10 year Treasury Bond was 2.7% six months ago, and it's 2.3% today.  One of two things is true based on that information:  either the Bond Market is expecting Disinflation to be the order of the day for an extended period and is increasingly optimistic about the economic outlook based on lower Inflation (otherwise Bond prices would have declined) or Bond investors have no confidence in an extended period of Disinflation and are phlegmatic about the prospects for growth.

    Which do you think we think it is? 

    Secondly--when you think of the key drivers to economic stimulus, you should be thinking about Business Investment.  Business Investment, i.e Capital Formation, correlates extremely strongly with general economic growth.  And when we think of Business Investment, we look primarily to three key measurable areas:  Durable Goods, Construction Spending, and General Business Inventories.

    The composite picture isn't bad, but it's not strong, either.  Very recent changes to the three?  Durable Goods are flat, Construction Spending is down significantly compared to where it was in the early spring, and spending on General Inventories is down, as well....compared to what we saw in the early spring before the nice surge we had this past summer.

    Put it all together, and it's a picture of what we're going to characterize as modest growth...leaning toward very modest growth.  That is a picture of growth, though yes, modest.  In reality, how will it feel?  Especially compared with that relatively lush economic summer, we're making a strong bet that the December and January months are going to feel starkly different...some will opine that it feels like a contraction, but it won't actually be will be the contrast that might make it feel so.

    There you have it...our forecast through February 2015.

    Oh, and as usual, we expect that the conventional Business Press will get caught unaware.  We expect that the effect of all this will start to be felt as soon as the last week in November.

    Our practical advice: don't wait to start tightening your belt.

    Stick with The Practical Economist. 

  • ECONOMIC & MARKET ANALYSIS - November 10, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims fell 0.8%.

    S&P 500 Index - The Index finished at 2031.92, up 0.7% from last week.

    US Dollar Index - The Index finished at 87.64, up 0.8% from last week.

    Gold - Gold finished at 1154.50, down 0.8% from last week.

    Commodities - Spot Prices finished at 373.29, down 0.1% from last week. 

    Ten Year Government Bond Index - The Index finished at 2071.68, unchanged from last week.

    Private Sector Construction Spending - The 12-month rolling average rose 0.5% in September.

    Employment - The 12-month rolling average of Net Employed rose 1.9% in October.

    Personal Disposable Income - In September, the 12-month rolling average rose 4.3%.

    Consumer Spending - In September, the 12-month rolling average rose 3.6%.

    Construction Spending, in the private sector, is one of the key areas to which we look as a defining measure of business investment and economic stimulus.  The news, in September, wasn't very heartening.  Spending rose at a 0.5% annualized rate, which is not a terrible figure, but we can't call it moderate, either.  It's definitely just plain low and, in fact, is the lowest since January. 

    The Labor picture?  Well, it's a dual picture this week.  On the one hand, we're seeing a nice increase in the ranks of the Net Employed in October.  (For those unaccustomed to how we measure, "Net Employed" is a measure of how many more people are newly employed, adjusted for those who have left the Labor Force.  When the figure is positive, it's a sign of a strengthening labor picture).  So, why is it a dual picture?  Well, while it's always encouraging to see that figure be positive, the rate of growth in the Net Employed fell rather dramatically.  To give you a sense, the annualized rate of increase fell roughly 0.5 percentage points in October from September.  That's a decline of roughly 25% in the growth rate.  To make it even clearer, here's another way to understand it:  we had a net increase of 19,000 jobs in October.  That contrasts with a figure of 54,000 six months ago, just as we were about to enter the very comfortable summer, as we like to put it.

    A quick word about Income and Spending.  Both are closer to being Confirming Indicators than Leading Indicators, so keep that in mind.  This month's numbers?  Well, we couldn't ask for the data to better mirror our description of the landscape.  In the case of Income, the result is respectable, though not strong.  The key point here is that it's the second consecutive month that the change in Income has risen at a declining rate.

    And Spending?  That 3.6% increase is simply okay at best...we can't even characterize it as respectable.  To give you a sense of how to interpret it in the context of recent history, it's the lowest increase since May of this year.

    Simply put, i's very difficult to paint a more accurate picture of a slowdown than diminishing gains in both Income and Spending.

    And the Market?  The Market data was pretty plain this week.  What it's showing you is a picture of investors being fairly optimistic.  It's not insignificant that the Bond Market was roughly unchanged.  Prices of Natural Gas and Crude Oil dropped this week, but Bond prices were roughly unchanged.  One of two things is true based on that information:  either the Bond Market is expecting Disinflation to be the order of the day for an extended period and is increasingly optimistic about the economic outlook based on lower Inflation (otherwise Bond prices would have declined) or Bond investors have no confidence in an extended period of Disinflation and are phlegmatic about the prospects for growth.

    We think it's the latter.  

  • SCORECARDS - November 3, 2014

    Current Scorecard - Domestic

    November 2014

    Current Scorecard:   19 

    Consumer Confidence:  -2                                                                            

    Full Scorecard:

                                                                                                 Current                     Four                          12
                                                                                                  Month                  Mos. Ago                Mos. Ago

     OVERALL               1             6                 11
     LEADING & CONFIRMING SCORE              19            26                23
     Leading Indicators              -3            11                  2 
     Confirming Indicators              42            41                42 
     Foundation             -48            -48               -63

    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.

    No surprises this month.  What we've been telling you for six weeks at least, is that the outlook in the spring that made way for the comfortable summer would change quickly in early September.  That is unchanged.  The economy is stumbling around, but it's settling into a lower pace of growth.  Where are the main signs of change?

    For one, it's in credit conditions, which though not very different from last month, are significantly different from six months ago.  One of the minor indicators that is helping the Consumer out is a lessening of Inflationary Pressure, as shown in the recent near-collapse in commodity prices.  But the other side of this coin is that the near-collapse in commodity prices is, to some extent, a reflection that demand Is not keeping up with supply.  In other words, declining inflation isn't always as positive a trend as it appears to be.

    Secondly, while we continue to experience net growth in hiring, the pace at which hiring has been occurring in September and October is at a significantly diminished rate from the late spring and early summer. 

    Lastly, we're seeing that changes to business investment, ie. capital formation and spending, are at a reduced rate than it was in the previous quarter.  You can almost draw a straight line between the level of change in business investment and corresponding economic effect.  

    So, looking at the numbers, the outlook appears to be pretty clear: the outlook is for one of slow, moderate growth.  Notice that we are not using the word, "modest," which would denote a slower rate of growth.  But we are also modifying with the word, "slow," given what our leading indicators are telling us.    

    One word about this month's Consumer Confidence figure.  Our Consumer Confidence statistic is probably the one single figure that we think tells you what to expect over the coming months, as it's calibrated not to tell you what consumers are feeling at the moment, but how they're likely to feel shortly.

    At -1, the figure isn't very inspiring, and contrasts with a figure of 6 from last month.  This contrasts with a figure, from six months ago, of 32.  That should give you a pretty good idea of things:  first, the figure from six months ago, we'd say, is a pretty strong confirming indicator of how well our model is working.  Secondly, though, that drop from 32 to -1 is pretty steep.  It's telling you that it's becoming probable that the winter months are setting up for a more severely weaker period of growth than we expected.  

    [One word of reminder about the scale: unlike most index of consumer confidence that use a scale of 0 to 100, our entire model uses a scale of -100 to 100, so that anything north of 0 indicates some forward momentum.  If you feel like you want to convert our scale to the conventional scale, this is what to do:  (1) divide our score by two (2) add 50...and you will have an equivalent score.]

    Current Scorecard - Global

    November 2014

    Full Scorecard:

                                                        Current                   Four                         12
                                                         Month                Mos. Ago                Mos. Ago





    Leading Indicators




    Confirming Indicators








    Unfortunately, not a lot has changed from last month.  If anything the situation is worsening, slightly.  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. And--"distasteful" is an understatement.

    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 notice that our leading indicator for the globe is barely even neutral anymore.  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 and will probably continue to do so for the near term, at least, certainly on a global scale.  Credit conditions to be roughly stable, but (1) they're not very strong and (2) they're not trending in a positive way, either.   Employment is trending down a bit, and perhaps most importantly, our outlook for Business Investment, based on the leading credit conditions, is not auspicious.

    It's rare that we issue a longer forecast for the globe, but we're going to make a modified statement of a forecast.  There is simply too much going wrong in major global economies.  In our opinion, you need to see a positive development in a minimum of two of the three following factors to see a reversal of fortune:  (1) inflation needs to tick higher (it will help bring about lower real interest rates and help spur investment) (2) the major economies need to align their fiscal policies with positive economic growth outcomes and (3) the major global banks need to strengthen their balance sheets.   

    Barring movement in this direction, we're afraid that the long-term outlook for the globe, in aggregate, is not very good.

    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 - November 3, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims fell 0.1%.

    S&P 500 Index - The Index finished at 2018.5, up 2.7% from last week.

    US Dollar Index - The Index finished at 86.92, up 1.4% from last week.

    Gold - Gold finished at 1164.25, down 5.6% from last week.

    Commodities - Spot Prices finished at 373.48, up 1.0% from last week. 

    Ten Year Government Bond Index - The Index finished at 2070.45, down 0.3% from last week.

    Durable Goods - The 12-month rolling average of Orders rose 7.3%.

    Case-Shiller House Price Index - The Index of previously-owned homes rose 6.6% in August.

    Each week, we hope we shed a light on the most critical of the market data.  Sometimes the Market demonstrates a reflex action in response to superficial data; sometimes the Market sees ahead.  The biggest clue is usually to be found in looking for patterns that don't normally correlate.  In this past week, that's the case if we look at the performance of Commodities versus the U.S. Dollar.  The Dollar rose, rather strongly, by 1.4%, on optimistic views for moderate growth, and Gold, predictably, fell.  But--Commodities, in aggregate, rose.  And that's counter-intuitive.

    Now, it's not impossible for Commodities and the Dollar to both increased economic growth quite naturally translates to greater demand for commodities.  The question to be asked is whether this price rise in Commodities is due more to Demand...or changes in Supply.  If there is one piece of economic data that has been widely misanalysed and reported in the Business Press, it's the cause of the recent drop in Commodities.  The point:  don't let a natural curtailment in overabundance of Supply relative to Demand confuse you about the strength of Demand.  Just about everyone knows, by now, that most commodities began to fall into a price decline about two months ago.  We have argued strongly that you should not bet that that decline was indicative of a long-term pattern.  Are we surprised that Commodities are starting to rise so "soon?"  No.

    Now, regular readers know the stress we place on Durable Goods Orders.  This month's figure is plainly very fact, based on this result, Orders for Durable Goods, as an economic indicator, may be the single-most important reason to be sanguine about continuing growth.  Understand this: this figure is down from last month's (August), but...that makes for two months of strong data, and these figures are both higher than any since April 2012.  With most of our economic indicators down significantly since April, Orders for Durable Goods is clearly now one of the key lynchpins in making a case for continuing growth.

    Based on a myriad of other data, we strongly suspect that this strength in this particular category of business investment will not continue.

    Now, let's talk about housing.  We hope that the slowdown in housing price growth is not coming as a surprise, as it's something we talked about for months before it began to set in.  Of course, this annualized increase of 6.6% in the Case-Shiller Index is perfectly nice and respectable,'s the smallest increase since December 2012, with the pace of growth down significantly. 

    All around, it was a slightly mixed week.   

    Remember our forecast for the near term?  Continuing growth, but at a level diminished from the summer?  It's fairly encapsulated in this week's data.

  • INVESTMENT OUTLOOK - November 3, 2014

    Investment Outlook

    Unless you've been living under a rock, you've been aware of the anxiety with which the professional investing community has awaited the Fed's announcements about monetary policy.  Every time the Fed meets, it's the same drill: investors breathlessly wait to hear whether the Central Bank is going to raise short-term interest rates.

    Now, assuming you're someone who's been in the camp that has been continuing to believe in the Equity Market for short-term trading purposes, you're probably in the same anxious camp as these investors. 

    Here's the thing: if your decision to invest in a particular class is heavily swayed because of your inability to obtain the yield you want in the investment you want, you have a problem.

    During true "boom" times, investors don't fret over rising interest rates.  During these times, rising rates are reinforcements of how strongly the economy is performing.  The two key points are:

    1.  If you need economic news to remain tepid so that equities look appealing as a haven for obtaining yield, you have a weak and vulnerable investment strategy.

    2.  Your decision to be invested in equities as a trading strategy should primarily be about corporate earnings.

    In a nutshell, if you needed proof that the Equity Market is vulnerable, the proof is the fact that investors have become reliant on the fact of ridiculously low short-term interest rates to make that class continue to look desirable.

    The fact is that rising interest rates is an eventuality.  It's not a question of whether, but when.  Our suspicion is that many people have got Janet Yellen all wrong.  Chair Yellen is committed to monetary policy that supports the economy,'re a fool if you think she's going to abandon her primary mandate, which is price stability.

    You can bet that Chair Yellen won't let Deflation take hold, but the prospect of Deflation is remote.  You can also bet that Chair Yellen will not allow herself to be known as the Chair under which Inflation ran wild.

    For the very immediate term, Inflation is not much of a concern.  The Dollar has been on a bit of a tear the past month, and commodity prices are in the proverbial basement.  But, do you really want to bet that that's going to continue or that a month's strengthening in the Dollar is going to have a lasting effect?

    In a word, Chair Yellen is not going to do Congress and the President's work for them, i.e. she is not going to sacrifice price stability and monetary policy for what fiscal policy isn't doing.  She just isn't. 

    This is not to say that we are as equally unsanguine about equity markets all around the globe.  For the most part, yes, most equity markets are in a similar situation as that of the U.S.  One that stands out particularly as highly risky to us is Japan.  Credit conditions are tepid at best, equities are overpriced relative to bonds, and returns (based on how highly the market is priced) aren't compensating you sufficiently for risk.

    On the other hand, we're going to keep our eyes on the Hungarian Stock Market where the situation is, essentially, the exact opposite.

    It should not surprise that when stocks are very dear, that bonds, as a class, start to look more attractive.  Some spots where we would advise looking closely toward making investments in 10-year government bonds are South Korea and Brazil.  It's a simple matter of relatively high yields coupled with favorable pricing relative to stocks...and, of course the relative fiscal credibility you get from these particular emerging markets, which make their yields look "real."

    We also want to reinforce a favored investment pick of ours for those who are particularly fearful of the Equity market:  

    Floating-Rate Notes of Investment-Grade Companies

    That's right: our strongest medium-term investment recommendation until at least such time as real interest rates begin to approach a level of normalcy, say around 1.5%, is to take a moderate position in a security that invests in buying the floating-rate notes of investment-grade companies.

    What are these?  AT&T is an example of an investment-grade company.  Some of its borrowing is done based on an interest rate that floats with an index, say, Treasury Bills.  Yes, it's true that rising rates put pressure on earnings.  Though, do you really believe that AT&T, faced with a situation of rising interest rates on its borrowing, even if the general economy doesn't pick up in a commensurate way, is going to default on its debt?

    If you do, you probably don't belong in Equities anyway, and should probably be stockpiling Gold.

    But, you get the point, and a word to the wise is, hopefully sufficient.

    We think this sub-class of securities is going to be one of the best performing over the next 24 months.

    This is also a good time to reinforce a message we placed in our Editor's Letter a few weeks back.  Right now, we're living in a window of unusual opportunity.  True opportunities, in terms of market pricing, don't come along that often.  In this context "opportunity" refers to what we believe is high probability for above-average yield over the long-term, not merely short-term trading profits.  And that opportunity lies in commodities, most specifically oil and natural gas.  Across the board, in aggregate, Commodities are unusually low-priced.  If you like, you can take the position that you believe that this is a function of weak demand and/or that it's related to the development of new, alternative sources of energy that are going to replace oil and natural gas completely in the next couple of years. 

    That is not a credible position.  By definition, "opportunity" is a scenario in which most people don't see the probability for profit.  As Warren Buffett is alleged to have said, you should be greedy when people are fearful.

    A word to the wise is sufficient  How long will this window last?  No one knows.  Our guess is that the window is short-term.  Not that we expect prices to rise fast in the medium-term, but we do think that it's not likely that prices will move much lower.  To do so, you have to be betting that demand will continue to fall relative to supply and that the Dollar will continue to strengthen.

    You'll make that bet without us.