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  • ECONOMIC & MARKET ANALYSIS - January 26, 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 2051.82, up 1.6% from last week.

    US Dollar Index - The Index finished at 94.99, up 2.5% from last week.

    Gold - Gold finished at 1294.75, up 1.4% from last week.

    Commodities - Spot Prices finished at 323.06, down 2.2% from last week. 

    Ten Year Government Bond Index - The Index finished at 2129.38, up 0.2% from last week.

    Well, it's one of those rare weeks that happen two or, at most, three times a year in which no major economic data comes out.  If you like, you can consider this a nice time to rest your brain.

    But the Market always has something to tell us, and even though the particular pattern we got this week is pretty rare, it's easily decipherable.  First off, Bond prices rose...so, the Bond Market is telling us to expect continued low rates, or even lower rates.  And the Commodity Market confirmed that perspective, with the Spot Index falling 2.2%.  And Gold?  Well, it performed nicely, reflecting the mood of the Bond Market that slowing economic activity is likely to result in monetary policy that will lean toward diluting the money supply.

    Finally, the Dollar really soared in a little bit of a way, rising a strong 2.5%.  Does that seem counter-intuitive based on all that we just said?  It would be, except that the Dollar's performance this week is a reflection of continuing weakness in the Euro Zone and the announcement by the European monetary authority that it will embark on a roughly 18-month deep monetary easing of the Euro with the goal of driving down interest rates as well as spurring higher inflation...all by engaging in its own bond-buying program.

    None of this is really surprising.

    But back to resting your brain.  Not having any new economic data to work with is a bit of a blessing.  Why?  We have a question--perhaps the most fundamental that we deal with on an ongoing basis...and it's a question we want you to ask yourselves. 

    The 10-Year Government Bond is now trading at a yield of just below 1.8%.  Now, it's not particularly surprising tht bond traders would be working with an assumption that interest rates properly below in a lower range if for no other reason than low commodity prices...and an outlook for continued low prices for crude oil.

    The question we want you to struggle with this week is whether a yield of 1.8% on that 10-year bond is fully justified in full by the level of inflationary pressure you reasonably expect based on things like the lower Euro, higher Dollar, and restrained commodity prices.

    We have our answer.  We're not revealing it yet.  But here's a clue: accelerating economic activity cannot easily be associated with suppressed commodity prices and lower levels of energy consumption.  (Read that again....slowly.)

    Give it a good think.

  • INVESTMENT OUTLOOK - January 19, 2015

    Investment Outlook

    This month we're going to return to an area we have more than touched on in both this and other columns in the past few months.

    Remember when all the talk was about Greece likely having to default on its bond obligations, several years ago?

    Remember the stratospheric levels to which yields on Greek government bonds flew?

    Even with investors taking a haircut, do you believe that buying those bonds was anything other than a smart trading maneuver?

    And therein lies the point: great--not good--investment returns are a result of calculated contrariness.

    Calculated contrariness--think over what that means.

    It means running into a fire, but...only because you know it's about to start raining, for example.

    It's difficult to articulate the extent to which we think you're looking at a rare generational opportunity right now...in commodities, and specifically energy.

    If you want to take the view that oil prices have plummeted because of long-term fundamentals and that they will remain there, you're also likely someone who never earns anything other than the market return.  We think you have to bet the odds.  The odds say that several times in the past 40 years observers have remarked that this-or-that trend in commodities was here to stay, beginning with the false energy crisis in the mid 1970's.  That energy crisis was very real to people who could only buy gasoline on an odd or even day, but...how real was it, really?

    So we're going to take a look at some numbers, to help us wrap our brains around this phenomenon that's going on right now.

    The first relationship we want to look at is that between the US Dollar and commodities. 

    Now, it's normal for a stronger Dollar to result in downward pressure on the prices of commodities, but the extent to which commodities prices have fallen cannot be explained by the roughly 10% rise we've had in the Dollar over the past few months.  Another, more important way to look at it is this: it would be hard to justify a consistently rising Dollar in the face of falling commodity prices.  Expectation in a rising Dollar because of rising commodity demand is the expected norm.  Rising Dollar and falling commodities?  There's a disconnect inherent in that relationship.  For the past few years the ratio of the USD to the basket spot price of commodities has hovered between 0.15 and 0.20  It's now at 0.25.  Get the picture?  The Dollar is too high.  Either the Dollar must fall or commodities must rise.  While you won't find us bullish on the Dollar in any meaningful way, good luck betting on a Dollar that falls an amount sufficient to bring the relationship between the Dollar and commodities back into line.

    Now let's talk about Bonds (specifically the 10-Year Government Bond) and commodities.  Now, let's first establish the norm: if bond prices are low, that's a pretty indication that investors are sanguine on the economy  and so your expectation of commodity prices?  That they'd be relatively high, of course.

    What do we have right now?  Well, we have very high bond prices and very low commodity prices.  In other words, investors are anything but sanguine about economic prospects.  And commodity prices reflect that pessimism.  You want to buy commodities as an investment when economic optimism is high?  Go right ahead--but you'll have to explain to us how you expect to make a better than average return, how you expect commodities to still be priced at these levels.

    Lastly, let's talk about the stock market and commodities...specifically the global market, as measured by the Global Dow Jones Index.  If we look at the ratio of the price of that index to the spot basket price for commodities, we're getting a figure just above 7.0.  That figure hasn't been even close to 7.0 in years. That figure flirted with the low 4.0's in 2011 and in recent months has drifted into the high 6.0's.  The higher the number, the more highly priced stocks are relative to commodities.  Are you betting that stocks are going to come down or that commodities will move up?  We're not going to rule out a significant correction by the stock market, but you already know that there's no room for additional correction in the commodity market.  (And yes, that ratio does indicate that the stock market was undervalued in 2011.  Again, you could have bet the converse that commodity prices in 2011 would fall, which have done, but not until three years later while, all that time the stock market performed very well.)

    Given the fact of where the Commodities Spot Index is, you could do perfectly fine buying into that Index by buying a basket of commodities.  If you want to go a little further, however, you could focus on those specific commodities that are weighting the Index down.  Specifically, we're recommending that, if this is the route you want to go, you look very long at Crude Oil and Natural Gas primarily, and secondarily at Soybeans, Cotton, and Sugar.  Every single one of these is now priced in an advantageous way that is presenting what we consider rare windows for investment opportunity.   

    What about Gold and Silver?  Assuming your horizon is long-term, even despite the relatively strong performance by Gold in the past two weeks, we can endorse taking positions in these.  Both are selling at the lower end of recent ranges.  However, we think the real opportunity for these will occur when the fortunes of major economies turn and government budgets begin to turn toward the red.  Our advice?  Wait it out.

  • EDITOR'S LETTER - January 19, 2015

    Editor's Letter


    We think the message in our inaugural Editor's Letter for the year was so important that we came very close to leaving it up for a third week, which would be unusual for us.  And then something happened mid-week that was momentous enough that we thought it had signal lessons in it for our discerning readers.

    We're talking, of course, about the movement of the Swiss currency, the Franc. 

    Now, if you're interested enough in this subject to know that the Franc soared a bit Wednesday into Thursday, particularly against the Euro, you probably also know, by now, why that was the case.  The Swiss Government, for a long time, committed itself to restraining how high the Franc would rise against the Euro.  Why?  A higher and higher Franc puts pressure on Swiss exports.  So it had felt it had an interest in propping up the currencies of major trading partners, such as that of the Euro Zone.

    On Wednesday, the Swiss Government summarily waved away its commitment to that. Unleashed, the Franc showed what we have long known, that the Franc is one of the "big boys" when it comes to currency safe-haven reserves.

    In this regard, we strongly encourage you to read the most recent "You Asked" column in which we issued an opinion to a reader who wants to know about safe havens.

    Now, the point of raising all this is not to draw some meaningful insight into market opportunities, but rather the opposite: to add to our list of rules and lessons.  What can you learn from all this?  Well, here are the key lessons:  

    #1.  Never bet into a situation that has a person or organization losing money when that person or organization has the ability to effect the outcome.

    The corollary understanding here is that, as the Euro has continued to experience downward pressure, with the passing of time and no solutions in the Euro Zone being apparent, the Swiss Government was going to find itself holding greater and growing amounts of Euros, the future and value of which is becoming increasingly unknown.

    #2.  As long as there are fiat currencies, do not bet against the currency of a country whose government is more transparent than that of the U.S. and whose independence and neutrality are universally acknowledged and whose economy is relatively diverse.

    And yes, that describes Switzerland.  We get the feeling that the average person underestimates the diverse strength of Switzerland's economy.  Switzerland's economy has four major sectors:  tourism, agriculture/food, industrial, finance.  And, all four are strong.

    We hope that the point about the country's neutrality, independence, and transparency are already understood.

    We think they're good lessons.  Print them out, add them to your list, and read them at least once a month. 

    The Swiss Franc?  Is it the knee-jerk currency you go to when you think of making short-term trading profits?  Not necessarily.  But, oh, you make a long-term bet against the Franc...at your peril. 

  • ECONOMIC & MARKET ANALYSIS - January 19, 2015

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims rose 2.3%.

    S&P 500 Index - The Index finished at 2019.42, down 1.2% from last week.

    US Dollar Index - The Index finished at 92.64, up 0.8% from last week.

    Gold - Gold finished at 1277.50, up 4.9% from last week.

    Commodities - Spot Prices finished at 330.93, down 0.1% from last week. 

    Ten Year Government Bond Index - The Index finished at 2125.95, up 0.7% from last week.

    Retail Spending  - The 12-month rolling average rose 4.3% in December.

    Business Inventories - The 12-month rolling average of investment in inventories in November rose 4.7%.

    Industrial Production - The 12-month rolling average in December rose 4.7%.

    Consumer Prices - Prices in December rose at a 1.2% rate.

    On the face of it, you might think that Retail Sales is an excellent indicator of the current economic condition.  It is, actually, but you have to understand the data more carefully than with many other indicators.  The problem is that, even in sluggish economic times, it's rare--very rare--for Retail Spending to decline.  In other words, the scale by which you measure robustness is simply different than for other indicators of current conditions.

    That 4.3% increase in December, that's a respectable increase.  But it's only respectable.  And, in fact, it's the smallest increase since August.

    If we exclude the impact of auto-related sales, the story is almost exactly the same, except that core spending rose 3.4%, instead of 4.3%.

    Now, it might seem counter-intuitive to focus on changes to Business Inventories instead of Business Sales, but...it does make sense.  Business Sales are already factored, largely, into other sales-related measures, but...changes in inventories tells us an awful lot about business investment and business confidence.

    For November, the indicator rose 4.7%.  That's a figure that's on the low side of respectable.  In fact it's the slowest increase since April and the third consecutive month that the rate of growth declined. 

    Now, how about a rock 'em, sock 'em number?  We said last week that, if the economy turns the way we think it's going to, that Labor may be the last indicator to show it.  But, that statement may yet prove to be wrong because Industrial Output is coming in very strongly.  In December, the 12-month rolling average change was up 4.7%.  That's just a plain strong figure.  There's not even much we need or can say to provide mitigating insight.  It's just plain strong.  Yes, it's true that Industrial Production is a far better indicator of current conditions that it is a predictive indicator, but you'll be hard-pressed to demonstrate an economic slowdown without a slowdown in Industrial Production.  So...this is the place to hang your optimism.

    And now, let's talk about every consumer's favorite economic indicator: Inflation.  The 12-month rolling average shows that Inflation rose 1.2% in December.  That's the lowest it's been in 12 months.  Of course it's being pulled down by declines in energy costs.  Energy prices dropped 5.4%.  However, Core Inflation rose 1.1%, very close to the all-in figure. 

    Now, lower rates of Inflation, other things being equal, translate to higher rates of economic growth.  Even though Industrial Production is displaying strong growth, the rate of increase in that growth has slowed considerably, so...remember this: when the government calculates its GDP data for December, the growth you're going to see?  It will have come far more from decline in Consumer Prices than increases in Output.

    While energy prices have declined significantly, keep in mind that Inflation is far from non-existent. And therein lies the critical point about Inflation.  Government policy types can theorize all they want about the benefit of higher inflation, but keep in mind that, even at 1.2%, your wealth is being eroded at the rate of 1.2% a year. 

    Remember that.

    And the Market?  Well, it was another one of those lovely weeks in which the tea leaves are remarkably consistent and make for simple analysis.  Bond prices up, Commodities down, Dollar up, and Equities down?  This is a picture of a Dollar that is up on Yen and Euro weakness, not on U.S. economic strength.  In fact, the rising demand for Bonds is, if anything more of a continuation of a belief that a large-ish slowdown is on the way.

    This is an interesting week that stresses our growing perspective that, in fact, a slowdown is quickly upon us.  As we said, Industrial Output is a better indicator of the present than the future.  Even as strongly as the result was, it's not demonstrating increasing strength...and we need a whole lot of data to contradict what the Credit Markets are telling us and the direction in which Business Investment is trending.  Industrial Production isn't quite enough to do that.

    We think we'll have a definite forecast through mid-summer by month-end.

     

  • ECONOMIC & MARKET ANALYSIS - January 12, 2015

    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 2044.81, down 0.7% from last week.

    US Dollar Index - The Index finished at 91.92, up 0.8% from last week.

    Gold - Gold finished at 1217.75, up 3.9% from last week.

    Commodities - Spot Prices finished at 330.49, down 0.2% from last week. 

    Ten Year Government Bond Index - The Index finished at 2111.77, up 0.9% from last week.

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

    Employment - The 12-month rolling average of Net Newly Employed rose 10.4% in December.

    When you think of New Business Investment, one of the key inputs that should come to mind is Private Construction Spending.  The good news:  it rose in November.  It rose by just 0.6%, however.  Except for the past two months, movement has been either marginal or unchanged.  In fact, that increase of 0.6% is roughly half the rate of increase we had last March for example, with then six consecutive months of diminishing increases following that.

    The Labor data this month is a little trickier to put in context.  In a word, assuming the economy is moving in the direction we think it's moving, it will probably be the last of the major economic indicators to take a turn for the worse.  Generally speaking, it was a pretty strong month on the Labor front: the number of the ranks of the Net Newly Employed (this is a figure we created that adjusts new hires for those who have lost their jobs) rose a strong 331,000.  It's also the third consecutive month in which the rate at which we added jobs fell.  Yes, you read that correctly. 

    Does this sound like a slightly mixed week?  Mixed because the Labor data came in strongly?  Yes, and while it's true that we don't consider the raw number of jobs added as a leading indicator, we do view the change in direction of jobs added as a strong leading economic indicator.  If you want to use Labor change as a proxy for Income, the data is telling you that consumers are going to continue to get "richer," but at a slower rate.

    And what did the Market have to say?

    When we sit to analyze the market data, the first place we usually stop to look is at how 10-Year Government Bonds performed.  As if Bond Prices weren't high enough already, traders sent the yield down further.  The 10-Year Bond is now trading below 2.0%, meaning that bond prices are soaring.

    Combine that with a stock market that fell, lower commodity prices, and higher Gold in the face a higher Dollar, and it's not a picture of optimism.  It's a picture of large fears of a slowdown, with the Dollar up only as a function of weakness in Japan and Europe and with Gold up, primarily as a result of a belief that extended monetary easing will more likely be the theme for the Federal Reserve than monetary tightening.

    Coming on the heels of general media euphoria (if not happy hysteria) over the third quarter GDP results, these developments, if continued, are going to place us at a very sobering place come mid-winter.

    Most of the time reading the tea leaves on what the Fed is likely to do with short-term interest rates is not hard.  We think that the forecast on the Fed's stance is increasingly becoming trickier.  By this time next month, we expect to have a good handle on being able to issue a strong forecast through summer at a minimum.

  • EDITOR'S LETTER - January 5, 2015

    Editor's Letter

    We debated what to lead off the first column of the new year with.  The Domestic Scorecard was updated this week, and there's plenty in the wind that we think is changing, so we could touch on that.  But then, we considered that, if things keep going the way we think they're going to go, we'll have plenty we'll need to talk about on that score in a month's time. 

    Then we considered that it might be fun to do as some popular outlets do and make our predictions for how investment classes are likely to perform best this year.

    We didn't completely shelve that idea.  In a fortnight, when we update this column, our plan is to do precisely that: give you our ideas about how the major investment classes are going to perform and why.

    What we did settle on is something that's of over-arching importance we think...something that we think will inform the economic environment in a very significant way.  

    That something?  DEBT

    In your lifetime, Gentle Reader, every major economic or market downturn has been set off, to some degree, by an unsustainable level of debt. 

    The signal example, of course, is the Lehman Brothers bankruptcy, which really sparked the Financial Crisis in 2008.  And while it's true that levels of debt to income have declined since the onset of the Financial Crisis, the reality is that they have not declined to levels that allow for borrowing to grow.

    Please read that last sentence a second time.

    If you can point to a sustained expansion in any economy around the world that has occurred without an expansion in credit, we'd like you to show it to us.  You can't.

    And therein lies a fundamentally thorny problem.

    Yes, it's true that economic growth has been positive.  It's also true that the economy is so un-strong that short-term interest rates are still hovering around 0.10%.  For you kids who are still young enough that this is all you've known in your lifetime, this is not a "normal" interest rate.  Given "normal" levels of inflation, short-term interest rates should be hovering somewhere in the 3.0% - 5.0% range.  In other words, real interest rates continue to hover below 0% when they should be ranging from 1% to 3%.

    So, let's take a quick look at the data to back up on our thesis.  And we're going to look at the data in a fairly simple way that gets us what we want to know.  After all, we are practical.

    In the past 20 years (looking at September of each year), the lowest the percentage of debt to income was at any time was 39.4%.  That was actualy 20 data points ago, in September 1995.  Snce that time, up until about September 2009, it has steadily grown.  In September 2009, it reached its zenith at 57.6%.  In 2008 it was 55.5%, at the start of the Financial Crisis.

    Now, prior to the cycle that led into the 2008 Financial Crisis, the highest that ratio reached was 46.5%, and that was in 2001, just about the time the market had a sort of crash and economic activity seized up.  Coincidence?  No.

    So, how to evaluate debt-income ratios? 

    Our view is that debt-income ratios that are below 45.0% are perfectly compatible with increased borrowing and economic growth.  Of course, the lower the ratio, the better, which explains why the growth we had in the mid 90's was so explosive.  We haven't had ratios in the low 40's since that time.

    Ratios that hover at 45.0% or just above begin to put pressure on the system.  And that's where following the trend becomes of paramount importance.  If the trend bounces around but stays within a range of, say, 44% - 47%, you can manage to stay out of what we call the "danger zone."

    But a ratio that flirts with, or goes above, or stays above 50.0%?  That's a problem. 

    As we said, the debt-income ratio reached its height in 2009, at 57.6%.  The following year it dropped a pretty whopping five percentage points to 52.4%.  And the following year, in 2011, it fell again, to 50.8%.  Last year, it fell a smaller amount, to 50.1%.  And this past September, it fell yet a smaller amount again, to 49.9%.

    Do the arithmetic:

    1.  The ratio is getting lower at a diminishing rate.

    2.  The ratio is too high to permit the kind of borrowing that you need for a true economic expansion

    These two things are true despite several rounds of monetary easing, significant intervention by the Government to clean up banks that were failing by guaranteeing the purchases of bank assets by investors, direct bailouts to banks, and significantly lower levels of lending.

    Despite all this, the ratio of debt to income is still simply too high.

    This is the single-biggest issue that is going to weigh on the ability of the economy to grow and it's the single biggest factor that's going to inform every major investment class.

    And it's the single-biggest reason that any kind of euphoric rejoicing about a short-term economic pick-up is very premature.

    This unsustainable level of debt is going to be the issue hiding behind every single economic and investment development this year.

    Be sure to let us know when you hear the major press outlets discussing this issue.  We think you'll be waiting a long time.

  • ECONOMIC & MARKET ANALYSIS - January 5, 2015

    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 2058.20, down 1.5% from last week.

    US Dollar Index - The Index finished at 91.16, up 1.2% from last week.

    Gold - Gold finished at 1172.00, down 0.3% from last week.

    Commodities - Spot Prices finished at 331.02, down 2.5% from last week. 

    Ten Year Government Bond Index - The Index finished at 2093.76, up 0.7% from last week.

    Durable Goods Shipments - The 12-month rolling average rose 4.9% in November.

    New Single-Family Housing - The 12-month rolling average in value of new homes sold rose 6.9%.

    Case-Shiller Housing Price Index - The Index of prices of previously-owned homes rose 4.9% in October.

    Disposable Personal Income - The 12-month rolling average, per capita, rose 3.1%, in November.

    Consumer Spending - The 12-month rolling average, per capita rose 3.2%, in November.

    Hopefully you're a regular reader.  And, hopefully, because you're a regular reader, you'll have recognized the Press's exuberant rejoicing in the third-quarter GDP data as unsurprising.  You probably also recognized that it's not particularly indicative of where things are headed.  In case you're actually confused, this is a good week to be paying attention to this column.

    First, let's talk about executed orders for Durable Goods.  We haven't said it in a long time, so now's a good time:  the amount and trend of orders and shipments of Durable Goods are excellent economic indicators.  Why?  First, products that are considered "durable," i.e., they are expected to have relatively long lives, are typically items that have higher ticket prices than most consumer products.  Second, more so than with other consumer products, it's common for some portion of these goods to be purchased on credit.  Thus, expansionary trends in shipment of Durable Goods augur good things for economic expansion.

    So, how did November turn out?  Well, the increase for all durable goods was 4.9%, on an annualized basis.  That's a respectable increase, though not close to what we'd characterize as expansionary, and it's the lowest increase since June.  And here's the real nut: if you exclude transportation-related items (e.g. airplanes), there was no increase at all.  In fact, excluding transportation, November was the third consecutive month that the result either stayed the same or declined.

    We have long said that though, we don't consider it a leading indicator--and it's hardly the primary indicator of housing that most analysts rely on--the change in the value of new single-family homes correlates extremely well with economic direction.  And the November data is very telling.

    The good news?  The value of new housing (volume x price) rose 6.9% in November.  The bad news?  That's the slowest rate since July, and the slowdown came in both volume of sales and price.

    And what about the Case-Shiller Index?  Well, the well-known index that measures the price level of previously-owned homes rose at a 4.9% annualized rate in October.  That's a respectable increase, but it's the eleventh consecutive month in which the price index rose at a diminishing rate.

    And now for a word about Spending and Income.  Consumer Spending in November was moderate, but respectable...but the key way to understand it is that there was no acceleration in spending in November over October.  It was similar for Income.  To give you a sense, Income rose 3.5% in both June and July...this contrasts with 3.1% in November.  In November, both Spending and Income were essentially flat over October.

    You put all of that together and how does it sound?  Okay, but pretty ho-hum, right? 

    Now what did the Market think?  The easy take-away is that the Market is simply concerned about a slowdown, particularly in the rest of the world, thus the reason for that Dollar rise, as well as a drop in Commodities that is greater than the rise in the Dollar.  But--take a look at how 10-Year Government Bonds performed.  Traders continue to pummel the yield on the 10-Year Bond.  Is that the picture you associate with what every popular observer (but us) says is of a rising short-term interest environment?  The dichotomy between the performance in Bonds and the performance in the Dollar is the most important way to understand the Market's feeling about the investment environment, this week.

    With every passing week, in our view, the case for higher short-term rates is fading, and the Bond Market...well, it appears to be in agreement.

  • SCORECARDS - January 5, 2015

    Current Scorecard - Domestic

    January 2015

    Current Scorecard:   14 

    Consumer Confidence:  4                                                                            
          

    Full Scorecard:

                                                                                                 Current                     Four                          12
                                                                                                  Month                  Mos. Ago                Mos. Ago

     OVERALL               1             18                 14
     LEADING & CONFIRMING SCORE              14             36                34
     Leading Indicators               7             25                19 
     Confirming Indicators              21             47                50 
     Foundation             -47            -48               -59



    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.

    A few months ago, we told you that the conversation that you'd be hearing in the Business Press, starting around the September/October time frame, would be different from what you'd been hearing in the late spring and early summer.  Well, we were wrong.  We underestimated the shortsightedness of the Business Press, apparently.

    At the moment, all you hear is euphoria....euphoria over the third quarter GDP.  If you've been hearing--but hopefully not subscribing to--the euphoria, you're hopefully also reading what we have to report on actual economic data, which, while positive is neither robust nor trending higher.

    And in the last few words of that sentence you have it in a nutshell.

    We don't want to overstate the idea that things are merely improving at a slower pace, however.  It's not something everyone is feeling with immediacy, but current conditions have fallen off a bit.   Does that sound wrong? 

    Well, yes, increases to the rolls of the employed have continued to grow, and both consumer spending and income have continued to rise, nicely, as well.  And yes, Industrial Output has continued to grow, as well.  And--lastly, housing prices have continued to grow.  But--looking just at current conditions for the moment, it's also true that growth in housing prices has come down steeply, and Business Sales have fallen off.  If you're trying to explain that drop-off in our score from 47 four months ago to 21 this month, it's pretty much right there in that explanation.  But there's something else, as well.  The ratio of home prices to income has now reached slightly beyond the peak of what we consider a fair ratio.  In other words, while it's possible for housing prices to continue rising, we need to understand that the conditions that are creating this ratio will start to put long-term pressure on how sustainable it is without either higher improvement in income.

    What about our Leading Indicators?  We can't hide behind that pretty dismal figure of 7.  It's a figure that's telling you to expect all but stagnation in the near future.  And yes, we're going to stand behind it.  We think it's accurate.  Let's talk about some positive things that are keeping that figure positive.  Hiring has, in recent months, continued at a rising rate.  And, not only is short- to-medium-term inflation pressure low, the rate of Inflation has declined.  And that keeps more money in the consumer's pocket for spending and/or saving. 

    There is a large, "but," however.  First off, Business Investment, one of the most powerful of economic inputs, has fallen in recent months, fairly substantially.  No, it's not just a matter of Business Investment rising at a slower rate.  It has actually fallen.  Second,  and an equally important input, is Credit Conditions.  They're still good, but we see some clouds on the horizon.  They're not deeply negative....at the moment, "sobering" might be the right word.  To be more technical, they are in negative territory, but only by roughly 10 points. 

    As you can see, it's a mixed picture. 

    Our forecast through late winter is unchanged.  We think January's economic data is likely to be very telling.  Our guess is that January's data is going to agree with the warning clouds we've started to see, but....we do want to see one more month of data before we make a forecast for the spring.  

    Current Scorecard - Global

    January 2015

    Full Scorecard:

                                                        Current                   Four                         12
                                                         Month                Mos. Ago                Mos. Ago

    OVERALL GRADE

                2

                 3 

               N/A

    Leading Indicators

                4

                4 

               N/A  

    Confirming Indicators

                5

                7

               N/A

    Foundation

               -8

               -6

               N/A

     
    This is going to be one of the shortest updates on the global picture you ever see here.  Why?  It's misleading.

    In short order, while it's obviously clear that our Leading Indicators are not very positive (neither are Confirming Indicators), we believe the real picture is actually more negative than the scorecard shows.  What's buoying the figures is Inflation.  Inflationary Pressure has been quite negative, i.e. the trend has been toward lower prices.  This is having the effect of boosting consumer spending power and inflating the effect of all economic output. 

    However, the critical points are that (1) most of the reason economic output looks as decent as it does is precisely because of low inflation, not because of real economic growth and (2) it's extremely unlikely that Inflation will continue to rise at a declining pace for a prolonged period.

    As if to underline it all, Business Investment is trending negatively for the first time in many, many months.

    We think that in no less than two months' time, the Scorecard will be showing us a different picture.  Does that mean we think we need to revisit our Scorecard methodology?  Perhaps.  Perhaps not.  It's a matter of the timing.  The Scorecard is, in fact, accurate, for the short-term timeframe.  It's that time frame that's three months out and further that's worrisome.

    We shall see.   

    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.

     

  • Editors Letter

    Are you a practical economist?      

    When we started to write this column this week, we began in a very different vein, but, were quickly put in mind of something by the Government’s downward revision of fourth quarter Gross Domestic Product.  We think it merits some meditation.

    No, we’re not going to harp on our traditional theme, that GDP is not the right measure for gauging the size of the economy.  (For those who are late to that point, the essential idea is this: GDP is a measure of spending…not income and not output.)

    Even though GDP is not the right measure, it does bear some strong correlation with the right measures: if your goal is to measure the sum of economic activity, you could go far worse than measuring Industrial Output and Retail Sales together.  And because output and sales correspond somewhat closely to spending, ultimately, GDP has some worth, and more to the point, it’s the single biggest measure that most people use to understand the size of the economy.

    So…what’s prompting all this?

    Simply this: it’s best to take the Government’s measure of GDP with a proverbial grain of salt until that figure is at least two quarters behind. 

    Yes, the standard procedure is for the Government to produce a first-round draft for a calendar quarter.  Roughly two-three weeks later, the Government issues a second revision.  And again, after another two or three weeks, the Government will issue its third and final revision.

    Traditionally, it’s the belief that, while the first and second revisions are usually different, they’re rarely very different.

    There are two points we want you to keep in mind:

    1. While, historically, the revisions are rarely significant, it’s foolish to assume that they never will be significant…and the point there is that it’s difficult to know which drafts are more susceptible to being wrong than others.  A case in point is specifically third-quarter GDP for 2013.  If you’ll remember, the Government’s third and final issue was a notably upward revision from the previous two statements.  (If you’ll remember—we endorsed the upward revision, based on the fact that Inflation was trending down and Industrial Output had been trending up).  The point: recent drafts may be as wrong as they may be right.
    2. Though the Government characterizes its third statement for a quarter as final, the fact is that GDP is usually revised subsequently, though to be fair, by that point, the revisions would truly rarely have anything like a significant revision.

    Because we’re The Practical Economist, the last thing we want to do is encourage you to focus on things that don’t generate a lot of return in knowledge, but…some common sense is called for.  The Government just downwardly revised its first pass at first quarter GDP and the revision is fairly significant…on the order of roughly 1.2 percentage points. 

    To be honest, we were a little alarmed at the Government’s first pass at the first quarter.  Why?  Not that we don’t want the economy to pick up, but the growth rate the Government published was quite a bit above what we had expected.  The second pass revision?  Much more in line with our expectation for very modest growth.

    Like we always, say, this is where to come when you’re tired of the noise. 

    Next week, we’ll summarize our conclusions for the fourth quarter and give you our best estimate at where the first quarter is likely to come out. 

  • You Asked

    Q:  You’ve effectively  shown just how ineffective the Fed’s huge “printing money” campaign of buying back bonds from the big banks has been to stimulate the economy and to get more people employed.  I like your analysis of why that did not happen.  My question (actually your question):  “what happens to Industrial Production if most of the stimulus that the Fed is providing were to be taken away?”  You’ve proven that the Fed’s stimulus is virtually nil.  Why expect any effect?

    A:   First, thank you for paying attention. 

    At first, we nearly finished a very lengthy reply, meant to trace the evolution of the Fed’s policy so that all the dots would be connected nicely and neatly.  Then we realized that such a recap might be an excellent review for all readers, especially at year-end with this change in the Fed’s tactics.  So, that’s exactly what we’ve done. 

    But, for you we will give a more succinct answer here. 

    Why expect any effect?  We have been terribly vocal about the inadequacies of the Government’s various stimulus programs.  The irony—and we touched on this a few weeks back—is that the Fed’s bond-buying program is doing more harm, on a net basis, to the economy, than help.  Yes, really.  In other words: the effect we expect is actually positive. 

    To understand why requires just a modicum of background.  The bond-buying programs are creating reserves for the banks.  But they’re false reserves made of money that doesn’t exist and that banks can’t lend.

    Secondly, understand that since the onset of the Financial Crisis, the Fed began paying banks interest on its reserves….yet another disincentive to lending.

    And, with regard to Real Estate, even before the Fed began its bond-buying programs, mortgage rates were already at historic lows.  How many people do you think are taking out real estate loans because rates are 0.75% lower than they were before the programs were put in place?  Exactly…not many. 

    In other words, the bond-buying programs have been a canard of sorts.  The real purpose of the programs…?  Prepare yourself: they’re about bank recapitalization.  Yes, we said it already, by saying it’s about the banks ‘ balance sheets, but it sounds worse when you say it this way, doesn’t it?  Banks are getting a recapitalization.  How is the Consumer getting recapitalized?  There’s a corollary to this, by the way, and it’s significant.  Banks have had a built-in profit-making tool during all of this.  They borrow at roughly 0.10% (short-term rates), buy government bonds, and sell them back to the Government.  If you don’t think the banks aren’t making money on this operation, on money borrowed at 0.10%, well, we can’t help you.

    Yes, the irony is that, the removal of the bond-buying programs will actually facilitate economic growth.   Removing the programs will remove the incentive to the banks to hoard cash.  Do not be surprised if you see Lending grow as the banks’ built-in money-making operation with the Government vanishes and they need to put their cash to work.

    Ironically, yes, we expect an effect as a result of eliminating the programs.  But the effect, we believe, will likely be…positive.  What’s said is that, as the economy picks up a tiny bit more steam (as it probably will), too many observers will attribute it to the success of the Fed’s various quantitative easing programs.

    Bah, humbug.  Nothing could be further from the truth.

  • Scorecards

    Current Scorecard - Domestic

    January 2014
                       
    Quick View

    Weighted Average:             6
    Current Month:                  27

    Consumer Confidence

    Current Month:                  31
    Last Month:                       33
                                                              
         
    Full Scorecard:
                                         Current           Four                  12
                                         Month           Mos. Ago        Mos. Ago

    OVERALL GRADE

                13

                8

                 0

    Leading Indicators

                31

               25  

                26 

    Confirming Indicators

                25

               20  

                 7

    Foundation

               -49

              -51 

               -68 

    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.

    We have also added a new feature, Consumer Confidence.  It's our attempt to measure, not how Consumers feel, or even what their expectations are, but how likely they are to spend based on objective criteria.  

    One of our favorite measures is what we call the Weighted Average; we think it’s a very accurate measure of how things feel at a point in time to the average person.  At a reading of 6, what it’s telling us is that your sentiment about your situation is extremely moderately good…extremely moderately.  Objective figures about the economy are not something we would ever want to eschew, but there’s really nothing like getting at the heart of how the economy affects the typical American. 

    And the good thing about our Consumer Confidence measure?  Even though you fool as though things are barely improving, your outlook for the near term appears to be good.  That’s our best indication that the average Consumer is likely to continue spending at a moderately good rate.

    We’d be pretty silly if we held to dogmatic positions and looked for selective facts to back them up.  We hope that’s not what you find here.  We were effusive in our acknowledgment last month that the economy showed a bit more life, what with Industrial Production and Consumer Spending picking up, even as Inflation trended down.  That’s good stuff.  And, in fact, as look over the figure for our Leading Indicators, you’re probably deriving a bit of comfort from it.  At 31, that’s a comfortable number…and yes, we believe it’s a real number.  Our Confirming Indicators are satisfactory, but just so, no more, at an aggregate score of 25.  And therein lies the clue to how you should be thinking right now. 

    Things have been not exactly expansionary until the last month or two, when they picked up a little.  A little bit of a pick-up is not the same as expansionary, and to beat a dead horse, if economic activity has picked up, it’s a far cry from where it should be given how low real interest rates are, and for long they’ve been so low.

    And therein lies the elephant in the room.  Fact is, the economy is receiving a net stimulus from the Central Bank, but, after factoring in that drag, the net stimulus to the economy is not very high.  On our scale of -100 to +100, you care to guess where it comes in?  At 25, just 25

    The fact is that were you to subtract the stimulative effect of the rising Equity Market, you’d be left with an economic picture that would be struggling.  That’s right: our model’s result is being informed disproportionately by the Stock Market.  So that raises the obvious question: whither the Stock Market this year?  We will talk more about the Market in the Investment Outlook and the Editor’s Letter as we go along, but…the fact is that our outlook for the Stock Market, while positive, is not as robustly positive as others have it.  There are two points to be made here:  (1) most commentators choose to foresee a booming Market this year based on the most recent GDP data and rhetoric out of the Central Bank and (2) the expected return from the Market is starting to get hammered down…in our opinion, the Market is not terribly far away from a point at which greedy investors will have made the Market overvalued and be looking for alternative, riskier investments. 

    Here’s another way to understand it.  Third quarter GDP came in pretty darn strong, mostly a result of both higher Industrial Production and Retail Sales coupled with a lower Inflation rate.

    The most recent month?  The results are a wee bit different.  First, Industrial Production came in moderately strong, with a 3.3% year-over-year result.  That’s better than what we got almost all year, but it’s not as good as where the figure was coming in during 2011 and more importantly, it’s lower than the increase we got in October.  The story is much the same with Retail Sales.  At a year-over-year increase of 4.3% in December, the figure is moderately good.  The three-month average of the 12-month rolling average is 0.3%, which is moderately good, but not only is that figure the same as it was in November, it’s slightly below the 0.4% figure we received the previous four months.

    So far, you have a composite picture of the Industrial and Retail Sectors that are good, but a mite slower than the third quarter.

    Then you factor in Inflation, which at 1.2% in December is low, but…while that number is among the lowest rate of Inflation during the previous 12 months, it’s a mite higher than Inflation was running in October. 

    Having said all that, and there was a lot there, looking forward, we think you have reason to be cautiously optimistic.  It’s true that the net stimulus the economy is receiving is not very strong; on the other hand, it hasn’t declined in the last month or two, either.  Likewise, the pace at which Equities has climbed has remained fairly steady.  Both of these augur stable things for where Industrial Production and Retail Sales will come in for January…: expect very moderate growth.  But here’s the kicker: unless we miss our guess, we think that Inflation will trend down slightly in January from in December.  Why?  The reason is both downward pressure on the Employment Rate in December coupled with a Dollar that strengthened slightly.

    Whenever you can make a case either for stronger spending and stable inflation or stable spending and lower inflation, that’s a recipe for an incremental amount of growth. 

    And that’s where we think January will come out.

    Of course, obtaining net growth by virtue of lower rates of Employment is not exactly the way you get to the winner’s circle.

    Though, on a more positive note, the tapering in the Fed’s bond-buying program should lead to an uptick in Lending, which should have a stimulative effect on the economy. 

    Yes, that means that between the change in the Fed’s tactics, the net monetary stimulus, and a solid Consumer Confidence figure, you have license to be optimistic about the near- to medium-term.

    bout the near- to medium-term.


    The Current Scorecard - Global

    December 2013
                                                                     
                                                                        Current             Four Mos.                 Year   
                                                                          Month                   Ago                    Ago

    OVERALL GRADE

    8

     N/A

    N/A

    Leading Indicators

    17

     N/A

    N/A

    Confirming Indicators

     5

     N/A

    N/A

    Risk Factors

     -4

      N/A

    N/A

     

    The good news: the Global Scorecard is pointing upward.  It’s taking a lot of fuel by the world’s central banks, however, as the chief driver of the global recovery is accommodative monetary policy.  The chief secondary driver, a beneficiary of monetary policy, is the Equity Market, which continues to create wealth.  If there’s a warning in here, it’s not even the disconnect we talk about, between monetary policy and effect, but…the amount of monetary stimulus in play.  The fact is that monetary policy, globally, is, indeed, providing a net stimulus, but…the amount of that stimulus is not particularly robust.  The amount of stimulus we’re getting: enough to keep the economy afloat and growing very modestly.

    No problem then, right?  Wrong.  Our Confirming Indicators, chiefly led by Industrial Production, are very modest.  In other words, it wouldn’t take a lot for economic activity to take a bit of a dive, and this is in context of monetary policy that is already aggressively accommodative.  If the net stimulus to the global economy is modest, as we have measured it to be, that's a function not of how modest aggressive monetary policy is, but of the disconnect between policy and effect…of how unwell the global economy fundamentally is.

    As we said last month, we believe that the mechanism that ties monetary policy to economic effect is losing its efficacy faster and faster.  The implications for policy and effect are a little scary, we believe, because the entire point of monetary policy is to provide a stimulus for the economy, not to become the economy.  We are starting to face the prospect that the global economy begins to become a sophisticated pyramid scheme in which real growth no longer exists but consists of a system of continually propping up prices/wealth by printing money and relying on people's habit in believing in fiat currency.  

    The beneficiaries?  Governments that are heavily in debt as artificially-supported economies generate tax revenues and Governments print money by issuing and buying its own debt. 


    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.

  • Commentary

    If Ever a Clarification Were Needed

     

    It is our hope and belief that both new and regular readers come to this site with an open mind, expecting us to display an unbiased perspective. 

     

    We hope you think that’s what you get.

     

    Unfortunately, we have seen people sometimes confuse political ideology with economic analysis.

     

    Until extremely recently, we have not waded into a commentary on economic tools and trends that were reflective of a political perspective.

     

    And, they’re still not.  We fear, however, that some may interpret our recent remarks—and position—on the Federal Government’s fiscal policies as politically-based.

     

    We urge you to read the Editor’s Letter more than once if you fall into that category.

     

    We understand that a populace may elect to erect laws for a greater purpose than a merely economic one.

     

    Our purpose is economic.

     

    We hope that our readers understand the difference.

     

  • Outlook

    Investment Environment 

    Here are the key points of housekeeping we want you to keep in mind this month:

    Point 1:  On a global basis, economic growth, in aggregate, still continues to be barely north of stable.  

    Point 2:  Nearly all of the growth at the moment is in China, the United States, and, ironically, Japan, which while struggling, is making strides in coming out of its recession.

    Point 3:  There is a very large disconnect between the amount of monetary easing in place by the major Central Banks and the follow-through effects.

    Point 4:  Monetary stimulus, across the board, is sufficient to ward off a true global recession.

    About two month ago, we were privately asked how we felt about the predictions about a coming slow-down in China.  We essentially laughed at the idea.  China is far exceeding everyone else in terms of growth.  The biggest risk to China's continued growth is if Inflation kicks in and puts pressure on the People's Bank of China to tighten its monetary policy.  

    Last month, we used the example of Australia to alert you to coming dangers.  That has not changed.  It would be fun to believe that the major commodity exporters, or at least their currencies, are relative safe havens.  Nothing could be further from the truth.  

    If we have one touchstone indicator of the health of an economy it's the relationship between the Real Interest Rate and the current level of Industrial Output.  Across the board, those ratios are deeply in negative territory...except in China.  

    As well, keep in mind that Inflation is fairly moderate and that Inflationary Pressures are roughly flat, as well.

    In most respects, today's investment picture is not unlike the picture in early 2009...except that, if anything, the commodity exporting countries are more vulnerable than they were then.  

    Short-term and real interest rates rates still at historical lows, and in many places Bonds are enjoying very high valuations.  The most notable thing about today's investment picture?  In most countries, the lack of high fiscal credibility erases some of the benefit that appears to be achievable by latching onto relatively high long-term interest rates.  However, this is not true across the board...and despite the fact that Equities are already enjoying high valuations as well, they continue to be the easiest place for most investors to get yield, in the absence of fiscal policies that encourage capital to invest in the real economy.  Read on... 

    Investment Classes 

    Equities: It's very hard to forecast a collapse in the short-term, as long as the Federal Reserve continues to be successful in pumping money into the economy, which they are, despite that inefficient connection between monetary easing and effect.  But with the Market at new highs, mixed corporate profits, high Margin Debt, and the return of the retail investor, it's hard not to avoid the sense that a Black Swan is out there, just waiting.  

    Nevertheless, the global low interest rate environment continues to make Equities attractive to investors.  

    The market that stands out the most is...China.  Not only is the market reasonably priced relative to expected return, the Government is being very successful in stimulating the money stock in a large way.

    To a lesser extent, we encourage you to take a long look at Russia where the same factors that make China look attractive make Russia attractive, just to a lesser extent. 

    On the other hand, we advise you to stay especially wary of Brazil, Mexico, and South Africa, all spots on which we're moderately bearish, first because their respective central banks have curtailed monetary easing and expected returns are sub-par.   There is a long list of countries on whose equity markets we are very mildly bullish.  We are not publishing that list for now, given how moderate our bullish positions are and how pivotal the current climate is.

    Bonds:  Because of China's strong economic position, if there's one spot in which bonds especially can be expected to perform poorly, it's China. 

    Ironically, there are a number of spots now where we think that long-term bonds have a fair chance.  This is in part because yields are above par.  It's also because, in our view, monetary policy, has tightened to a point beyond simply keeping Inflation in check, and is having an adverse effect on the economy.  If you bet against bonds in these places, it's because you think the Central Banks are smart and fast enough to take care of the situation.  We're not so sure we want to take that bet; nevertheless, if you do invest in these securities, you have to be prepared to get out fast, as well.  So, where are bonds looking good?  Take a long look at Hungary, Poland, Sweden, South Korea, Thailand, Colombia, and Mexico.

    Currencies:  What an ugly mess it is!  It's not exactly a race to the bottom, especially since the theme right now is one more of stagnation rather than weakening.  But, we'd like to hear from you if you think you can make a convincing case for a bullish stance on any one currency.   Based on Inflation concerns, we think that you're going to see some interest rate rises in Brazil, India, and Turkey.  Does that spell bullish things for these currencies?  No because in all three cases, growth is suppressed enough that we're predicting that in all three cases, Central Banks are going to initiate programs to sell their local currencies to encourage export growth.  In fact, the list of countries that we think are going to resort to dumping their own currencies is growing.  Add to those already mentioned Hong Kong, Mexico, Indonesia, Thailand, and South Africa.  These are all places where Inflation is picking up but Industrial Output is restrained.

    The list of currencies on which we at least very modestly bearish is actually rather long, but we'll focus on those that we think carry the most opportunity.  These include Chile, Colombia, and Mexico among the best candidates.  You'll notice that all three are emerging commodity exporters and that we previously have identified commodity exporters in the present environment at being more vulnerable than we'd expect.  

    Real Estate:  Our belief is that the chief drivers of Real Estate are low interest rates, rising Inflation and rising income.  

    Our belief is that the recovery in Real Estate in the United States has begun slowing down and will continue to do so.    

    Commodities: We think there's a moderately positive outlook for Steel, Coffee, and Cotton.  

    Our view is that prices of these are lagging relative to major indicators of demand, and by enough of a margin to counteract minor strenghtening in the Dollar, should that occur.

    We have done a fairly comprehensive review of our positions and are now mildly bearish-to-neutral on all other major commodities, despite the fact that prices have already declined a lot.  Two things are to be kept in mind:  (1) it's difficult to forecast anything like a surge in economic growth in the near future (2) it's also difficult to forecast anything a substantial decline in the Dollar.