The Practical Economist

  • EDITOR'S LETTER - December 22, 2014

    Editor's Letter

    This will be our last Letter for the year.

    We updated the Global Scorecard a week earlier than we usually do because we will be on holiday next week.  (The next update will be on January 5, 2015.) 

    In this week's Economic & Market Analysis, the latter half of our column takes on a tone that we often use in this column.  Because the week's big economic data was fairly positive, we felt it could be misleading and putting it in perspective required us to take a broader view of the economy and market and where things are likely to go....more a domain, traditionally of our Domestic Scorecard or....the Editor's Letter.  Of course we think you'd be smart to read the Economic & Market Analysis every week because it will keep you on top of understanding the significant currents, but...this week, in particular will help you to orient your brain around some confusing data points, the most significant combination of which could be argued is the modification in the tone of the Fed's language (pointing to no change in monetary policy) with good hard economic data. 

    This is the column in which we most often meditate on or tell you about significant long-term issues and proclaim our economic forecast.  And sometimes we talk about investment opportunities and risks.

    But, to put it in a very colloquial way, there are investment opportunities and then there are investment opportunities!

    We've said it before, but, especially as we wind down the year, we're going to say it again and say it differently, as we attempt to look at the big picture.  The subject?  Commodities, and specifically crude oil.

    In every lifetime, there are generally three to six great investment opportunities that arise.  Sometimes they center around Real Estate/Housing.  Sometimes they center around Equities (such as in 2009).  Sometimes they might center around a particular currency (we wonder how many of you realize that the Swiss Franc appreciated almost 300% in the past 30 years....but our mind is wandering)...

    The right question to ask yourself is how to define a great investment opportunity, i.e. what might be the attributes that that opportunity would display so as to make it possible for you to identify it. 

    There are two key twin points to every great investment opportunity.  Not that we distinguish between investment opportunity and great investment opportunity. 

    The first attribute is that the opportunity will demonstrate some kind of disequilibrium that is sufficiently large that, if it pans out, your financial return will be far among the average return you'd expect over a long horizon.

    The second attribute is that most people don't recognize it as an opportunity.

    By its very definition, if most people identify the same opportunity, return will be significantly small than otherwise. 

    In other words, if you're looking to derive some comfort around the risk from being part of a crowd, you've got the entirely wrong mentality.  If everyone and his barber's cousin were investing in the same thing, the expected yield would be significantly smaller.  So, where does that take us?

    Crude Oil has been trading at or below $60.  Think about that.  We think you're looking, right now, squarely at one of those great, rare opportunities.  Now, you can choose to abdicate your responsibility toward your financial condition, but you need to be aware of what you're doing. 

    If you don't invest into $60 Crude Oil, you are indirectly betting that Crude Oil prices will either remain where they are for a very protracted period (and when we say "protracted" in this context, we mean something like 25 years) or that it will continue to decline and remain at lower levels. 

    Here's the point: even if the supply of carbon-based energy continues to remain abundant and/or alternative sources of energy continue to pop up, all that means, to our mind, is that a great investment opportunity will become a more hum-drum investment opportunity.  Do you really believe that the world's demand for oil is going to evaporate in a very short timeframe?

    You are looking at what we believe is one of those rare investment opportunities that comes along in a lifetime.  Keep this in mind, the Universe has no obligation to spread those opportunities out.  We had one in 2009, both with regard to Equities and Housing.  We're now looking at one with Crude Oil, we believe.  We are not prepared to bet that another one will come along at some evenly-spaced interval or that it will be flashing a neon sign that says "INVEST IN ME."  Remember this: many of the people who bought into Equities and Housing in 2009 did so despite a herd mentality that was still against it.

    You've been warned.

    The thing about great investment opportunities--they are great precisely because not everyone is jumping on them.  High demand does not equate to high yield.

    Think about that long and hard.

    Happy New Year

  • ECONOMIC & MARKET ANALYSIS - December 22, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims dropped 0.3%.

    S&P 500 Index - The Index finished at 2070.65, up 3.4% from last week.

    US Dollar Index - The Index finished at 89.59, up 1.4% from last week.

    Gold - Gold finished at 1195.00, down 1.8% from last week.

    Commodities - Spot Prices finished at 346.31, down 1.9% from last week. 

    Ten Year Government Bond Index - The Index finished at 2083.70, down 0.3% from last week.

    Industrial Production - The 12-month rolling average rose 4.6% in November.

    Capacity Utilization - The 12-month rolling average Index reading was 80.07 in November.

    Consumer Prices - Prices rose 1.5% in November.

    We are living in very interesting times.  If you were to ask us for one of the most basic ways of measuring rising economic growth, we'd tell you that you can't go wrong seeing rising Industrial Output coupled with a rate of Inflation that either rises at a diminishing rate or trends downwardly.  And this month, in a fairly significant way, that's exactly what you've been looking at.  And that's, to a very great degree, what's been informing the Fed's language around upward pressure on short-term interest rates.  

    There are no "ifs, ands or buts" about it: Industrial Production is continuing to produce strong numbers.  In November, the result we got is the third consecutive month of increasing output.  But if you're looking hard at the Inflation data, which is tame, and questioning the Fed, this week's data also has a clue as to why the Fed seems to be almost looking for excuses to raise interest rates.  And that's Capacity Utilization.

    If you're a regular reader, you know that, partly due to the input of Capacity Utilization, we've been saying that inflationary pressures are trumping deflationary pressures.  In point of fact, the extent to which factories are utilized is an excellent barometer of demand.  Despite what we see as some early warning signs of an economic downturn next year, you have to keep in mind that that's not a forecast we have formally least not yet.  And Capacity Utilization is arguing against it.  For the first time, in recent months, the Capacity Utilization Index is staying solidly above 80.  So, now, not only do we have a picture of rising utilization (1.6% on an annualized basis in November), it's now at a level that starts to actually become inflationary.

    And that gives us a perfect opportunity to talk about actual inflation and where that fits into the picture.  Let's talk figurative turkey:

    1.  Commodities prices have fairly plummeted.

    2.  Prices actually declined for core goods and services (by 1.7%), month-over-month (on an annualized basis).

    3.  Energy prices declined a whopping 4.6% in November.

    4.  Aggregate Inflation rose at a declining rate in November.

    So...where's the argument for inflationary pressure?

    1.  While it's true that energy prices have been plummeting, that has been, so far, over a limited timeframe.  Time will tell if it continues.  And we need more than one or two months of data to draw any meaningful conclusions.

    2.  Growth in Personal Income is lagging gains in Employment, but both are gaining, particularly the latter.

    3.  If Consumer Prices in November rose at a diminishing rate, it's important to keep in mind that prices did rise.

    What does this mean for our early concerns about the economy for next year?  One of three things will happen.  In one scenario, Commodities prices will not only remain subdued, but will decline further, while at the same time Employment and Income will make further gains.  This scenario essentially nullifies what our early warnings indicators are saying.

    Another possibility is that regardless of how commodities prices behave (and we're fairly convinced that these basement-level prices are temporary), improvement in the economy tapers off significantly.

    Yet another possibility would hold that global political tensions create a situation in which demand for the Dollar becomes insistent, driving bond yields and consumer prices down further.

    Frankly, we discount the first scenario.  We firmly wedded to the notion that the current slump in prices for commodities, namely crude oil is a temporary phenomenon.  And while Industrial Production continues to nudge northward, Industrial Production is is not a very significant leading indicator.  We look more closely to credit markets and business investment and, as we've said, the early warning signs are not auspicious.

    The second scenario is a possibility, but...we need to see a directional change in Capacity Utilization, and the fact is that while we consider Capacity Utilization an excellent leading barometer, it's not a very early barometer--that is, it's an indicator that can change quickly and is capable of giving no more than a two-month warning.

    What about the third scenario?  That's a likely possibility with global tensions the way they are.  However, given how low Inflation already is, it's arguable that lower levels of Inflation would be beneficial for the U.S. economy.  And, more importantly, it's easy to argue that, in such a scenario, global economic activity would be hit fairly hard by such a rise in global tensions.

    You see the problem:  if business investment and credit conditions are already starting to look murky and if you believe that the current slump in commodities is temporary and if you believe that global tensions are more likely to rise than not, it's hard to get too excited about what appears to be a temporary condition of rising Industrial Production and diminishing gains in Inflation.

    And the Market--what did it think this week?  It's very lucky when the Market puts on a display that fits into a very neat category, like this week.  The Market is....simply, confused.  This is a picture of a reaction to some reassuring data points for investors, making investors believe that monetary easing might be ending, based on strength, but not in the very near future, get twin results:  both a higher Dollar and a higher Equity Market.

    However, the Fed released the results of its most recent meeting this week, and the language both startled and pleased investors.  Why?  While the Fed continued to talk about continuing improvement, it appeared to place the probability of monetary tightening a little further into the future.  The Market liked what it heard.  However, do the math: the Fed seemed to place monetary tightening further into the future.  That is not code for "the economy is strengthening at least as fast as we said it was."  That is code for saying that the economy is strengthening...but NOT as fast as we said it was.  And it leaves open the possibility of unchanged monetary policy for the time being.

    This week's market round-up has been a little long, but here's the very important point:  sound economies and investment markets don't need to depend on the prospect of ongoing and protracted monetary easing.

    Think about it long and hard. 


  • COMMENTARY - December 15, 2014


    If you're a regular reader, you know that one of the points we come back to every few months is the fact that it's been impossible, for a couple of years, for anyone other than Fed insiders, to get a solid handle on how solvent the U.S. banking system is.

    Oh, there's a ton of data that's made publicly available, but data on reserves are simply published as "reserves."  There is no way for anyone but the Fed to parse out those reserves that are fake.

    Presumably you are aware that some portion of the reserves on the banks' balance sheets is fake.  You do know that, correct?

    For those of you who haven't been paying attention or haven't been regular reader, yes, that's what the Fed's bond-buying program was about.  The Fed literally created money--fake money--that made the member banks' balance sheets look more robust than they are.

    Non-governmental analysts like The Practical Economist have no way of specifically knowing how solvent the big banks are because we don't have access to the Fed's data.  We have to get round the subject...and that's where we think our posture of getting at the answers in a practical way comes in very helpful.

    This column is not specifically about how solvent the banking system is.  To be frank, we haven't come to a conclusion yet.  But that's half of the point: no one but the Fed does know how solvent it is.

    What we do know is that the Fed has been requiring banks to carry higher and higher levels of capital against its obligations.  In effect, what the Fed is doing is buying time.  In the short term, it's banking on (1) investors' and consumers' confidence and (2) nothing going wrong...and at the same time, slowly requiring the banks to ramp up their capital reserves so that by the time something were to go awry, the banks would truly have sufficient capital.

    Practically speaking, one way to understand this is that if the Fed is as concerned about insufficient capital requirements as it is, you can bet all but your last sou that, if the banking system isn't insolvent, it sure isn't as solvent as it needs to be.

    And that leads to a specific application of this that hit the news recently: that JPMorgan Chase has a capital gap to fill....a gap of $50 billion.  Now, that's a really large amount.  A bank like JPMorgan Chase would have little difficulty filling a gap of oh, say, $3 billion.  It would simply sell some stock to a few investors or it would float a bond issue.  But $50 billion? 

    The first question to ask yourself is just how the bank will raise that much capital...and, if some significant portion of it means selling stock to investors--and particularly foreign investors--what does this mean for how the bank is controlled?

    The second question is, if JPMorgan Chase has a gap of $50 billion, how much of a gap does the banking system, in aggregate, have?

    The third--and we think, obvious--question is: just how insolvent is the banking system?

    And, the fourth--if the member banks don't raise the needed capital in a reasonable period of time, what does that mean for the ongoing risk of the banking system?

    We don't know the answers, but we don't think they're all uniformly good.

    What does it mean for you, if the answers aren't uniformly good? 

  • SCORECARDS - December 15, 2014

    Current Scorecard - Domestic

    December 2014

    Current Scorecard:   18 

    Consumer Confidence:  2                                                                            

    Full Scorecard:

                                                                                                 Current                     Four                          12
                                                                                                  Month                  Mos. Ago                Mos. Ago

     OVERALL               3             6                 6
     LEADING & CONFIRMING SCORE              18            22                26
     Leading Indicators               1             5                  0 
     Confirming Indicators              35            40                53 
     Foundation             -48            -48               -61

    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.

    And, like last month, there are no surprises this month.  

    Our combined Leading & Confirming score is down a tad and that's a reflection, primarily, of change in the Leading Indicators.  For all intents and purposes, our Leading Indicator score is flat, similar to our Consumer Confidence score.  In other words, you should be confident in expecting no change in the economic growth rate for the next several months.

    Is there good news?  Yes.  As almost everyone knows by now, the Labor picture has been brightening somewhat strongly.  Adding to that is a declining inflation rate, although we need to state the stark facts, which are at odds with perception.  Inflation is not actually declining as aggressively as the average person on the street has been led to think.  Prices of imported energy?  Yes, but Food Inflation is almost more than offsetting that.

    It doesn't help that Industrial Production has taken to growing at a slower rate, either.  And, as if that weren't enough, while the ranks of the employed are growing very nicely, Personal Income is not growing at anything remotely like an expansionary rate.

    Other issues?  Well, there are a few we should go over.  For one, credit conditions are deteriorating.  And that doesn't spell good things for Business Investment, one of the strongest factors behind economic growth.  The unfortunate fact is that both Business Inventories and Orders for Durable Goods are growing at much slower rates than they were just a few months back.

    We are not altering our forecast for the economy through the late winter.  However, there are early indications that the timeframe from late winter into late spring could be significantly different, i.e. we think there are early signs that the growth rate could significantly diminish in that timeframe, and yes, there's a chance that the economy could contract.  However, these are only early signs.

    In this context, we strongly suggest that, if you haven't, you take a look at the Editor's Letter, published December 8 in which we point out two signs that we think point to the economy now being in a "bubble," or put, more formally, being in a state that is not sustainable.

    If we haven't made our concerns strongly enough, consider these two very important points:

    1.  In our view, housing prices are no longer in an advantageous ratio to personal income.

    2.  The Fed's requirement for higher capital ratios of member banks is going to continue to have a strongly dampening effect on lending.

    In our view, these are very significant inputs to the how likely economic expansion is.

    Again, our forecast for the near term is that of essentially unchanged, modest growth.  When will we have a sense of the timeframe immediately following late winter?  Judging from how our Model has worked in the past, we can be certain that we'll be able to opine about the spring by the February scorecard, at the latest, to make a strong statement about what the spring will feel like.  But we think it's highly likely that we will know as soon as next month, January. 

    Current Scorecard - Global

    December 2014

    Full Scorecard:

                                                        Current                   Four                         12
                                                         Month                Mos. Ago                Mos. Ago





    Leading Indicators




    Confirming Indicators








    It's a slightly interesting picture this month, but not for good reasons.  Globally, Inflation is not much of a problem at the moment, and Unemployment, though still very high, is not changed from last month.  Industrial Production, however, while positive, is only modestly positive, and, is down slightly from last month.

    When we look at our Leading Indicators, we see a mixed picture.  Inflation is changing in a positive direction for consumers, i.e. it's increasingly tame.  And, Unemployment is moving--very slightly--in the right direction.  But, the pace of growth in Business Investment is tapering off, and that's an important warning signal. 

    Credit markets are tepidly flashing a warning signal, as well, but it's a confusing picture because while indications are that that the bond market believes that rate will contract (reflecting a slowing economy and accommodative monetary policy), it's also true that at the moment, Inflation is declining at a speedy rate. 

    How to reconcile the two?  Our view is that how you reconcile these two depends entirely on your view of the forces that are driving Consumer Prices down.  We believe that these forces (namely oil prices that have plummeted) are temporary.  (We think it's silly, in any event, to conclude that low and lower prices will continue for an extended period based on no indication that such will be the case--we must try to remember that it is a fact that prices have plummeted and that a situation in which the price per barrel of oil sits under $60 is highly unusual.) 

    If you believe that prices for crude oil will remain in the neighborhood they now are, and that prices of all other commodities will remain in the neighborhood of where they now are (if not lower), you are in a good position to believe that the outlook will be modestly rosy at least.  That is not the view we are taking.  Our view is that if anyone needs to provide a strong argument for their perspective on commodities prices, it's the camp that believes that prices will continue at their current levels or drop. 

    In other words, we believe that, within two months, our Global Model will be telling us to dress for figurative rain. 

    A couple of other quick points:

    1.  There has been no particular improvement special to the Euro Zone.  You should always bear in mind that Europe is sufficiently large that, along with the United States, Japan, and China, there can be no global positive outlook without a positive outlook for Europe.  Without a significant monetary or fiscal policy change in Europe, it's extremely difficult to see how Europe advances.

    2.  Presumably, most readers are aware that there is something akin to a currency crisis afoot in Russia at the moment.  The Ruble is tumbling in value by orders of percentage points each day.  This is going to put tremendous upward pressure on the Dollar, the Euro, and the Franc.  This is going to do nothing positive to the monetary effects that the European Central Bank or the Swiss Central Bank is trying to bring about.  If you thought Europe was worried about Deflation before, get ready to see some real hand-wringing shortly.

    To repeat how we ended this page last month, 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.   

    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 - December 15, 2014

    Economic & Market Analysis

    Latest Economic Indications

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

    S&P 500 Index - The Index finished at 2002.33, down 3.5% from last week.

    US Dollar Index - The Index finished at 89.36, up 1.3% from last week.

    Gold - Gold finished at 1217.00, up 1.9% from last week.

    Commodities - Spot Prices finished at 353.03, down 1.3% from last week. 

    Ten Year Government Bond Index - The Index finished at 2090.61, up 0.9% from last week.

    Retail Sales - The 12-month rolling average rose 4.5% in November.

    Business Inventory Spending - The 12-month rolling average rose 5.0% in October.

    If you're hoping that this week's data will demonstrate a radical change from our winter forecast, you will be disappointed.   For the month of November, Retail Sales rose 4.5% and that's a respectable growth rate.  But it's not demonstrating any acceleration in the growth rate.  This rate of growth is very close to where it's been for six straight months.  And, if we exclude auto-related sales, the growth rate falls to 3.7%, again similar to where it's been for roughly six months.

    Now, you really can't much of a better indicator of how consumers feel at the moment than Retail Sales, but that's precisely the point: it's a great indicator of the current condition, not where things are headed.  headed.  On the other hand, business spending on inventories is a key input to Business Investment, a key leading indicator and thus has a place of prominence among our Model's leading indicators.  So, how did things measure up in October?  Well, we got an increase of 5.0%, which is on the moderate side of good. It's certainly consistent with something between "modest" and "moderate" growth.  Here are the "howevers:"  (1) that rate of growth is the lowest since April (2) this month is the third consecutive month that the rate of increase declined.

    And what did the Market think?  Well, some weeks the Market just makes it so easy.  Commodities down, Dollar down, stocks down, bonds up, and Gold up---every piece of market data is combining to tell you one thing: that investors are fearful of an economic slowdown that will...result in currency devaluation that will accompany monetary easing.

    That is precisely the picture that this data is making.  Now, in our most recent Domestic Scorecard, we add a small note that our Model is flashing small early warning signs that the timeframe of spring into summer could hold for us a fairly noticeable economic slowdown--and possibly contraction.  Market data like this doesn't exactly contradict that. 

    But, if there is a significant takeaway from this week's picture, it has to do with Gold.  Ask yourself how many media outlets and prominent commentators discount the value of Gold as holding a significant place in your portfolio?  Nearly every outlet we pay attention to, in recent weeks, has opined--in pretty certain language--that Gold is headed lower.  And, if you don't already know it, you should remember that economic weakness combined with monetary easing does not correlate well with weakness in Gold.  It's not insignificant that Gold rise in price this week.

    The upshot?  Well, there's a three-fold response to this that should be triggered in your mind.

    1.  When everyone is saying the same thing, you should beware.

    2.  Gold is still the ultimate store of value.

    3.  Gold, as the ultimate store of value, is the most significant way and accessible way in which financial assets can maintain their value.

    The more things change, the more they stay the same.

    If you have not yet gotten around to our essay on Gold under "Hot Topics," now would be as good a time as any to read it.

  • EDITOR'S LETTER - December 8, 2014

    Editor's Letter

    We debated what topic to treat in this column this week.  We were going to talk about Gold and its odd movement in the business week ending December 5.  Then we considered that it would be better to do so in a grander context of fiat currencies.  And then it occurred to us that that would be a more suitable topic for a Commentary piece (that will be forthcoming shortly).

    In recent weeks, we gave you our economic forecast through the winter.  In this week's Investment Outlook, we take a look at the landscape of Real Estate/Housing in this country.  Given our relatively apocalyptic prediction that Japan is likely to begin to fall gently into a permanent decline, we considered leaving the existing Letter up one more week.

    And then it occurred to us.  We tell you pretty frequently that the fundamental underpinnings of the economy aren't strong.  And we go through some of the data-driven reasons why. 

    Regular readers know that one of the most critical of touchstones with regard to economic health is the ratio between the levels of industrial production and short-term rates (or real interest rates, if you like).

    That ratio has been out of whack since the onset of the Financial Crisis.  It's a little better than it was, but it's still way off and not remotely indicative of a healthy economy.

    Since the onset of the Financial Crisis the value of the domestic stock market has more than doubled.  Yet, that ratio is still out of whack.  In other words, to put our more phlegmatic explanations about the risk of the stock market to one side, yes, the stock market is now in a bubble, to use the convenient vernacular.  That's right--some of the gains in the stock market, especially in the '10-'12 timeframe were about economic gains, but since that time, they've been largely about investors despairing about places to get any kind of decent return. 

    More than doubling in the stock market when real interest rates continue to be negative after SIX years? 

    That's bubble #1, gentle reader.

    And now, in the past couple of weeks, we have another such indication.  Now, understand, this analysis is less than scientific---

    In the past couple of weeks, someone paid $44 million for a painting by Georgia O'Keeffe.  Now, artistic tastes differ wildly, and we make allowance for such.  But we dare to state that $44 million for an O'Keeffe paining is very far beyond the bounds of what is remotely a reasonable appraisal.  Forty four thousand?  Yes.  Four hundred and forty thousand?  Okay, maybe.  Even $4.4 million, though a big stretch, is something we could see.  But $44 million?  No, it's just an absolute no.  It reminds us of the $40 million an investor paid for Van Gogh's "Irises" in the 1980's.  To our mind, it a clear sign of an economic bubble...a bubble in which investors believe that the recession is over, that the economy has regained its footing, and that as the economy becomes wealthier, values of such pieces of art can only climb higher and higher?  From $44 million to where...?

    Yes, to our mind, that is the second sign of a bubble.

    We think we're on safe ground to state that once we collect all three bubbles in the game, that a Black Swan will be in our near future.  What will that third bubble be, should it arrive?  We don't know yet.  We can hardly wait to find out ourselves. 

    So, this couldn't be a better time to test your risk-reward appetite.  Are you so afraid to miss out on reward that others are enthusiastically counting on that you have to follow?  Do you derive comfort from the madding crowd?  Our perspective: most people are much more afraid of losing out on gains than actually losing money.

    It's really a good time to think long and hard about your personal investment policy and philosophy.

  • INVESTMENT OUTLOOK - December 8, 2014

    Investment Outlook

    This month we want to talk about Real Estate, specifically Housing and specifically Domestic Housing.

    Our first and guiding rule when it comes to Housing is that your home is your home.  You should not primarily think of it as an investment.  That doesn't mean, of course, that there aren't better and worse times to time your home-buying decision, not so as to maximize your return, but to minimize financial risk and exposure.

    The picture, at present, is very interesting.  It presents something for both Sellers and Buyers.

    On the one hand, it's very hard to make much of a case for anything like significant price appreciation in the short- to-medium-term.  But then, if your intention is to buy a home, you shouldn't care much about price appreciation in the short term.  However, if your intention is to buy Housing for purposes of trading, you probably do care very much about that.  Now, why do we say that price appreciation probably isn't in the cards in the short term?  Simple--

    Our most significant indicators with regard to Housing are two:  (1) ratio of home prices to income and (2) ratio of inventory to sales.

    The former is very much under control at the moment, meaning prices are not sitting in a bubble (i.e. overpriced) relate to income, nor are they depressed relative to income as they were in the '09-'10 timeframe.  So, it's hard to see any price movement based on the market being over- or undervalued. But what about that ratio of inventory to sales?  Let's give you some numbers.

    That ratio of inventory to sales in October 2012 was 5.1.  The following October it was just a notch higher at 5.2.  And just two months ago, in October of 2014, the ratio had floated north to 5.8.  Understand: higher ratios are an indication of slackening demand.  What these numbers are telling you is that the Housing Market, right now, is the softest it's been in over two years.  (Contrast these figures to October 2010 when the ratio sat at 8.7, significantly higher...that declining ratio from 2010 to 2012 told you a lot about how the Housing Market was healing.)

    If you're a Seller, the bad news is that no, terrific price appreciation isn't on the horizon.  The good news, though, is that the ratio, while several notches above where it was two years ago, is on the low side, historically.  If you're looking to sell and hoping that that ratio makes it down to the low 5's or even into the 4's, we think you're going to have wait a long time.  The economic indications to support a view for a heating-up economy just aren't there.  In a nutshell, it's just not a bad time to sell a home.

    On the other hand, if you're a potential buyer, the good news is that because an accelerating economy isn't on the horizon, you have a liberal timeframe to work with.  You have the comfort of several months to shop around and find the right home.  The bad news?  Well, to the extent that the Market become soft and softer, it's safe to guess that many potential Sellers will delay listing their homes for sale.  And, as inventory dries up, so do opportunities for the Buyer to bid competitively.

    See what we mean?

    How to reconcile these apparently divergent points of view?  Well, it's simple.  Most Sellers usually have a primary agenda item of either needing to sell their home or looking for money.  Is there a grand opportunity around the corner for bonanza profit in selling your home now?  No, but neither is the bottom likely to fall out of the market as that ratio of inventory to sales is historically fair and suggests that Sellers can get fair-market prices.

    And, on the other hand, while prices aren't sorely undervalued, with no significant price appreciation on the horizon, Buyers are going to have a great luxury of time over the next few months to shop.

    But this column is The Investment Outlook, so....there is one other word we must add. 

    It's not the first time we've seen this wave since the onset of the Financial Crisis...: foreign investors are picking up U.S. housing and real estate at a fast clip right now.  The good news is that because of the dynamics around the way foreign investors find and buy real estate (i.e. through private channels and networks and with offer structures that are so strong that their bids don't usually factor into competitive situations), their buying activity is probably not going to interfere, in a material way, with most domestic buyers' activities.  Having said that, it will provide some extra price support. 

    It also suggests this for Buyers: understand that nearly all foreign buyers buy domestic real estate for long-term investment purposes.  This suggests that housing they buy will remain, for most intents and purposes, off the available market for the length of your lifetime.  And that only services to tighten inventory and create upward price pressure in the medium- to-long term.

    In other words, don't out-smart yourself.  If buying a home is on your radar, we think that the sooner you can get to finding a home and financing structure that is feasible, the sooner you should act on that purchase decision.


  • ECONOMIC & MARKET ANALYSIS - December 8, 2014

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims rose 1.6%.

    S&P 500 Index - The Index finished at 2075.37, up 0.4% from last week.

    US Dollar Index - The Index finished at 89.36, up 1.3% from last week.

    Gold - Gold finished at 1194.00, up 1.0% from last week.

    Commodities - Spot Prices finished at 357.57, down 0.7% from last week. 

    Ten Year Government Bond Index - The Index finished at 2072.50, down 0.6% from last week.

    Employment - The number of net newly employed rose 378,000 in November.

    Construction Spending - The 12-month rolling average rose 0.6% in October.

    Lending - The 12-month rolling average of all lending rose 6.2% in October.

    Let's get right to everyone's favorite marquee data point: labor.  November's labor report was just plain good.  We have a lot of confidence in our primary measure: Net Newly Employed adjusts the number of new people working for how many people are no longer working.  Thus, we think it's a pretty clean indicator.  And this figure is nothing if not very strong.  Also encouraging is the trend in the Employment Rate.  Yes, the Employment Rate is still very low, very far off what we consider a normal level, November the Rate ticked up 0.1 percentage point.  It's not a big move, but it's a move in the right direction. 

    Now, if there's one thing you need to keep in mind as you digest this nice information it's that the strength we got in the labor market in November is not an increasing trend up.  What do we mean?  Well, out of the 12 most recent months, there are six months in which the pace of growth in hiring was higher and five in which it was lower, and yes, you'd be correct in assuming that last month's data point was not one of the lower ones.  In other words, last month's growth was higher.  So, yes, jobs are being added at a quick pace, but not a faster pace over the last few months than say, just a few months earlier.  This outcome is more in line with our forecast than it would appear: remember the key point of our forecast: it's not that the economy would slow down so much as that the pace of growth would slow down. 

    Now, when you think about that all-critical aggregate indicator of Business Investment, one of the sub-categories you should think of is...Construction Spending.  The result in October.  It's respectable, but it's the lowest since January of this year and nearly half the rate of growth in March.

    Something else that's interesting also popped up this month.  One of the biggest surprises in a long time of any kind is the results we see this month in bank lending.  The figures are consistent both for banks chartered by the Federal Reserve and those that are domiciled abroad but do business here.  And the upshot is that...lending is up pretty strongly.  The 12-month rolling average in October was 6.2%, and that's unquestionably a strong growth rate.  Growth in lending has some correlation to economic expansion, so what's going on?

    Well, it took a little digging, but we think we have the answer.  Consumer lending is up just 3.8%, but Real estate lending is up 25%.  And therein lies the clue.  Now does this mean that Real Estate is about to experience some dizzy market activity?  We wouldn't completely bank on it.  Again, this is a development that perplexed us at first, but...we solved the puzzle.  No, the domestic economic picture hasn't suddenly become much rosier.  All that real estate lending?  It's to foreign buyers of real estate in the United States.  Do we hear you questioning why a strong buying spree by foreign investors wouldn't drive prices up in general?  Oh, gentle reader, it's a completely different story when you think about foreign buyers of real estate.  For one thing, these buyers often (and when we say "often," we mean "usually") have ties to the United States that direct them to buying opportunities.  Foreign buyers are not randomly working with real estate agents who scour listings for opportunities, so no, the general market isn't touched nearly as much in terms of bidding activity.

    Secondly, foreign buyers by the dint of the characteristics that make them look riskier to domestic sellers, usually present offers that are significantly stronger than those that domestic home buyers do (remember: there's more to an offer than simply the price that's bid).  So, again, that window of bidding doesn't really exist. 

    It's tempting to interpret this big pick-up in lending as an early harbinger of economic expansion, but...we don't think it's so.  Of course, if the data points in other key leading indicators move sharply up in the next month or two, that will be a different story, but...we don't think that's likely.

    And what did the Market think? 

    Well, it was an odd week.  Most of the market data points to investors thinking well of economic prospects: that was fueled in large part by the labor report.  Commodities fell, and that's slightly incongruous, even in face of the higher Dollar, given the higher stock market; we attribute that to ongoing over-supply issues in the cases of crude oil and natural gas.  That's easy enough.  Bond prices fell...and that makes perfect sense.

    What's harder to interpret is higher Gold pries.  If Gold had risen a minute amount, that also would be easily explained by changes in supply.  But a 1.0% move?  Some things are harder to explain.

    We will say this: it's very important, we think, to remember to look to see the forest instead of the trees once in a while.  Despite what the mainstream press will tell you, there is a sub-segment of trading in Gold that is independent of weekly economic indicators and is a reflection of cultural and sovereign priorities.  If there is a person reading this who doesn't understand China, India, and Russia as viewing Gold as the ultimate store of value, they need to go back to read our HOT TOPICS and do some reading on cultural standards in those countries.

    In fact, our belief is that, not only that Gold should be viewed and analyzed in context of a week's other economic moves, but it should be understood in the context of not just regional political tensions, but changing sovereign debt landscape and stability of the economic infrastructure.

    And it's a fact that there's been significant "noise" coming out of Russia that is probably starting to cause concern among investors with regard to international tensions and conflicts.  We'll be first in line to agree that it's basically impossible to come up with quantitative model that can completely explain Gold's price movements.  But never, never forget that one of the key variables behind Gold's performance is political stability. 

    The more things change...the more they stay the same.

  • ECONOMIC & MARKET ANALYSIS - December 1, 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 2067.56, up 0.2% from last week.

    US Dollar Index - The Index finished at 88.22, down 0.1% from last week.

    Gold - Gold finished at 1182.75, down 1.7% from last week.

    Commodities - Spot Prices finished at 359.95, down 4.4% from last week. 

    Ten Year Government Bond Index - The Index finished at 2085.99, up 0.7% from last week.

    Durable Goods Shipments - The 12-month rolling average rose 6.9% in October.

    New Single-Family Home Sales - The 12-month rolling average of the value of sales rose 21.6% in October.

    Existing  Housing - The 12-month rolling average of the Case-Shiller Index rose 5.6% in September.

    Disposable Personal Income - Income rose 3.1% in October.

    Consumer Spending - Spending rose 2.9% in October.

    Just a quick note of housekeeping for long-time readers.  We have adjusted our Model to weight more heavily Shipments of Durable Goods instead of Orders.  As regular readers know, trends in spending on durable goods is a tremendous indicator of economic direction.  Now, orders are nice, but that figure doesn't mean a lot if an order is canceled. 

    Looking at Shipments, we got a pretty good number in October. If we look at core goods (i.e. excluding transportation-related goods, which tend to distort the total), that figure of 6.9% growth is simply strong.  However, it's important to note that it's also the lower than the previous two months. 

    Now, if you've been reading between the lines, you probably understand our perspective that direction in housing is more of a confirming indicator than a leading indicator of things.  Strength in housing doesn't necessarily translate to ramped-up economic activity, but it does tend to preclude the probability of contraction.  Now, the growth rate in the value of single-family homes sold in October is very strong.  What's interesting about it is that if you parse the data, the result you get is a result, not so much of higher volume of sales as it is of higher average prices.  That's an important point: if you're looking to use this figure as support for an economy that's building strength, you really want to see strength in both price and volume.  There's a second thing to note, as well.  While the result we got is very strong, most of the strength coming through in the number is not from the month of October, but rather from September, spilling over, as we average the annualized rates over three months to smooth out anomalies. 

    It's a similar story if we look at the trend in the prices of previously-owned homes, as measured by the well-known Case-Shiller Housing Index.  The Index rose 5.6% in September.  And while that's a respectable figure, it's certainly problematic as well: contrast it with a growth rate of 11.8% six months ago and with 12.4% a year ago.  In fact, what we got is the lowest rate of growth since December 2012.

    Now, while we don't consider Income and Spending leading indicators, they're awfully good indications of where things stand and how consumers feel at the moment.  This month's numbers?  In a word, they're good...not very good, though, though more than merely fair.  But again, reinforcing our forecast, in the case of Income, we see a growth rate that's the lowest in four months.  In the case of Spending, it's the lowest in six months.

    And what did the Market have to say about all this?  Well, the key data combination to focus on this week is the fact that bond prices rose as commodities fell.  What is this telling you?  This is a picture of investors' concern about economic slowdown.  Are they going to get an argument from us?  Not at all.

    In a nutshell, there was absolutely nothing new to learn about the short-term economic picture in this week's data.  Everything is pointing precisely the way we said it would: a slowdown in the rate of growth.  If we had to choose a word or phrase to characterize the next three months, it would probably be "modest."

    Grading the week?  B