The Practical Economist

  • ECONOMIC & MARKET ANALYSIS - February 23, 2015

    Economic & Market Analysis

    Latest Economic Indications

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

    S&P 500 Index - The Index finished at 2110.30, up 0.6% from last week.

    US Dollar Index - The Index finished at 94.31, up 0.1% from last week.

    GoldGold finished at 1208.25, down 2.0% from last week.

    Commodities - Spot Prices finished at 332.70, down 1.7% from last week. 

    Ten Year Government Bond Index - The Index finished at 2100.76, down 0.4% from last week.

    Industrial Production  - Output rose 4.5% in January.

    Capacity Utilization - Factory Utilization rose at a 1.5% annualized rate in January.

    We weren't exactly overwhelmed with data this week, but what we got is just about the best indicator of current conditions:  Industrial Production.  Even in an economy that's heavily service-oriented, it's not a bad proxy for national incomeAnd it was good news.  Output rose at a 4.5% annualized rate in January.  This is the highest rate in roughly two and a half years.  And it's the fourth consecutive month that the rate of increase rose.  Plainly put, it's a figure and directionality that are consistent with expansion, particularly when coupled with low inflation. 

    And that's the cue to talk about one of the most important indicators of inflationary pressure:  Capacity Utilization.  The Capacity Utilization (or factory utilization) Index rose at a 1.5% annualized rate in January to a level just below a threshold we consider inflationary.  

    Plainly put, it's a fairly unusual thing to see Industrial Production rise at the rate it's been increasing with Capacity Utilization rising so moderately and remaining below an inflationary level.  This is a combination economists love to see. 

    But the fact that it's unusual is one of the key points to take away from this discussion.  For several months, every single commentary in the business media has opined that the Federal Reserve would be poised to raise short-term interest rates this coming summer.  If you've been reading our columns closely, you know that we disagree. 

    Current conditions are, overall, fairly good, but we have observed sufficient spots of weakness that we have not believed that an interest rate hike would end up being on the Fed's agenda until late this year at the very soonest.  We have held back, as you hopefully know, from making a formal forecast of economic softening, but...there are sufficient clouds gathering to make us anxious.

    While weak inflationary pressure is good for economic growth, the place from where the weakness comes from is extremely important.  As you should know by now, some of the downward pressure on inflation has been coming from a stronger Dollar.  But--it is very abnormal to have this disconnect between growth in Industrial Output and Capacity Utilization.  Typically, you want downward pressure on inflation to be coming from a rising Dollar ALONE, based on the fact that demand and output are both rising at similar rates.  The reality, of course, is that much of the Dollar's strength has stemmed from weakness abroad, not strength at home.

    Now, year-over-year growth in Industrial Output of over 4% coupled with growth of 1.5% in Capacity Utilization, especially when Capacity Utilization is still below what we consider a critical threshold for inflationary pressure?  That is a sign of underlying weakness.

    Capacity Utilization may be one of the economic indicators least known to the layperson, but trust us: it's one of the indicators that the Fed Chair most closely studies every month.  It may be, coupled with Industrial Output, the most important input into her thought process on interest rate levels.

    And--in the middle of this past week--you may remember that the Fed abruptly altered its language on raising interest rates, leaving open the probability that a rate rise may not be in the cards this summer, after all.

    One way to understand all of this is that when everyone says that something will happen, something else will most likely happen.

    Another way to understand all of this is to look closely at the variables that feed future economic conditions and handicap the economy (and the Fed's actions) based on them.

    Yet a third way to understand all of this?  Just keep reading The Practical Economist.

  • EDITOR'S LETTER - February 16, 2015

    Editor's Letter

    This week, we want to give you a good, solid reminder of what we're here.

    We did not choose the name, "The Practical Economist" lightly.  Yes, it's true that one of the requirements we made in choosing a name for our newsletter/venture was that it be catchy and be a brand that was easy to pronounce, remember, and repeat.

    Also a requirement was that it be reflective of the point of what we were doing.  On some level, being practical is simply about common sense.

    In various columns on this site, we have talked about gathering clouds recently.  The important point there is that we are only characterizing them as gathering clouds.  We stand strictly by our Scorecard.  If it doesn't say it in the Scorecard and if we haven't made a formal declarative statement in this column, The Editor's Letter, then it's not a formal forecast, but rather a discussion.

    Now, regular readers probably know that one of our most heavily-weighted leading indicaors is the combined picture of what credit markets and inflationary pressures are telling us.  What do we mean?  We'll explain. 

    The bond market is startlingly accurate with regard to telling you the direction in which nominal interest rates are headed.  For example, if a year ago, the yield on the 10-year government bond was 3.0% and today it's at 2.0%, and if that trend/difference can be seen for, say, three consecutive months, you can bet your last sou that in roughly nine months time, interest rates will have declined...or, if they're already at 0%, that monetary policy will expand in a direction of further easing.

    But change in bond yields only tells you about the direction in nominal interest rates.  Alone, it doesn't tell you where the economy is headed.  For that, you have to factor in where bond investors think inflation is likely headed in the same time frame.  Where do you we look to get a handle on what bond investors think of inflationary prospects?  Well, we look at (1) change in the U.S. Dollar Index (2) change in industrial output (3) factory utilization and (4) changes in commodity prices.  These are the major components of how we measure where inflation is headed.

    And this is where the rubber hits the road, figuratively speaking.  If we believe that inflationary prospects are significantly diminished, it's possible that as much as a 1% decline in 10-year bond yields could actually presage an economic boom, since monetary easing could be justified simply on the basis of low inflationary pressure or even a deflationary trend.  If, on the other hand, investors are sending bond yields tumbling 1% in the face of rising inflationary pressure, you have a problem on your hands.  On a fundamental level: what sane bond investor would accept a lower rate of return in the face of rising inflation, which, other things being equal, would put upward pressure on interest rates?  That's right: the bond investor who is significantly bearish on the economy.

    And of course, the converse is true, as well, with regard to bond yield movements and inflationary pressures. 

    So, it's a question of weighing.  The question to wrestle with these last couple of months is what it means to have both declining bond yields AND declining levels of inflation.  The question is whether the downward pressure on inflation is strong enough to overwhelm the decline in bond yields and make an argument for strengthening economic growth.

    It's a tough question.  Fortunately we don't have to make a decision yet...simply because we only really have one solid month of significantly lower bond yields to work with.  That's not nearly enough on which to form a solid forecast.  We want to see at least three consecutive months of significantly changed yieds against which we can place an inflation picture.

    But here's the point we want to come to:

    1.  The Inflation picture has already subsided significantly.  It is hard to make a case that commodities prices will decline further.

    2.  In the face of problematic economies in Europe and Japan, the Dollar has had a nice ride northward, but it's still five points shy of hitting 100 on the U.S. Dollar Index...and it has now declined for three consecutive weeks.  Barring catastrophic developments overseas, it is very difficult to make a case for a persistent strengthening Dollar.

    3.  Over the past six weeks at least, major domestic economic data has come in at an increasingly declining rate.

    Do the math:  if you want to make a case that the economic picture for most of this year is going to be one of strengthening at an accelerating basis, you have to be making a case that either there will be a reversal in the trend of the major economic data the past two months and/or we will continue to experience a sustained cycle of disinflation.

    We'd like to hear how you make a case for a faster pace of growth in the leading economic data or for a continuing slide in inflationary pressure.

    We certainly can't.

  • ECONOMIC & MARKET ANALYSIS - February 16, 2015

    Economic & Market Analysis

    Latest Economic Indications

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

    S&P 500 Index - The Index finished at 2096.99, up 2.0% from last week.

    US Dollar Index - The Index finished at 94.19, down 0.5% from last week.

    Gold - Gold finished at 1232.50, down 0.7% from last week.

    Commodities - Spot Prices finished at 338.35, up 3.2% from last week. 

    Ten Year Government Bond Index - The Index finished at 2109.77, up 0.3% from last week.

    Retail Sales  - Retail Spending rose 3.6% in January.

    Business Inventories - Inventories rose 4.3% in December.

    Last week, we reported on the latest figures for Construction Spending, one of the key components of Business Investment.  If you remember, the figure came in moderately. While the figure wasn't robust, it wasn't unrespectable, either.

    This week, the Government released data on business spending on inventory build-up.  This is another leg in what makes up Business Investment.  The simplest and best way to understand this measure is that business spending is a good proxy for business confidence in the future as well as the spending, itself, spurring economic growth.

    How did the data come in?  Well, we see an annualized growth rate of 4.3% in December, and that's modest.  And that's the best thing that can be said of it.  Not only is it the lowest the figure has been in nine months, but it's the fifth consecutive month that the rate of increase declined. 

    Now, Retail Spending isn't the best leading indicator of where the economy is going, but it is a pretty good indicator of the current condition.  In January, Retail Spending rose at an annualized rate of 3.6%.  If we exclude the effect of auto-related sales, the figure rose 2.6%.  This are very modest numbers, not closely to be associated with expansion.  And...: both figures are the smallest they've been in nine months.

    If there's one takeaway from that, it's that consumer confidence is not nearly as robust as the widely published indexes would have you believe. 

    The Market wasn't dour on the economy in a way that you'd think would be commensurate with this data.  What we got was a picture of investors being mildly optimistic, but it's only mildly.  You will note that, though the stock market had a winning week and that bond prices fell ever-so-slightly (falling bond prices tend to correlate with investor confidence in the economy), the Dollar fell.  What makes it less rosy is that the Dollar fell in a week in which investors' fears over the Euro Zone's trouble were least for now, over noise that Greece and the rest of the Euro Zone will come to an understanding. In other words: it's hard to make a case that investors are truly sanguine when the Dollar falls.  It's even harder when the Dollar falls because of confidence in the Euro.

    Like we always say: look a little deeper.  In point of fact, was the Market that much at odds with the week's economic data?  Not really.


  • ECONOMIC & MARKET ANALYSIS - February 9, 2015

    Economic & Market Analysis

    Latest Economic Indications

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

    S&P 500 Index - The Index finished at 2055.47, up 3.0% from last week.

    US Dollar Index - The Index finished at 94.65, down 0.2% from last week.

    Gold - Gold finished at 1241.00, down 1.5% from last week.

    Commodities - Spot Prices finished at 327.91, up 1.8% from last week. 

    Ten Year Government Bond Index - The Index finished at 2117.02, up 0.8% from last week.

    Private-Sector Construction Spending  - In the private sector, construction spending rose 0.7% in December.

    Disposable Personal Income - Income rose 4.1% in December.

    Consumer Spending - Consumer Spending rose 3.8% in December.  

    Employment - The Employment Rate ticked up 0.1 percentage point to 59.1% in January.

    When we think about Business Investment, Construction Spending is one of the key three inputs that make it up.  That makes it a significant input to how we view where the economy is headed.  This past December, spending rose at a 0.7% annualized rate, and the best way to characterize that is to call it a moderate rate of growth.  The best thing that can be said about that rate of increase is that it's a tick up from last month.  In fact, it's the highest it's been in six months.  And, not only is it lower than it was six months ago, but it's lower still than any of the four months March through June, which contributed strongly to the comfortable summer we had.  Good, but uninspiring.

    The good thing about dull news is that it means no downturn is on the immediate horizon.  The thing about dull economic results is that it also means no acceleration is in the offing, either.  Such is the case, this month, with Income and Spending.  With increases of 4.1% and 3.8%, respectively, you're looking at results that are merely good, not strong, not weak.

    Before we leave economic data for the week, we need to talk about the Labor picture.  And it's an interesting picture.  Needless to say, the Labor figures are among the most awaited by every observer.  And this month's labor report may be the most representative of the economic picture at the moment.  To start with, the Employment Rate ticked up 0.1 percentage point to 59.1%.  Yes, it's only 0.1 percentage point and yes, it's the first increase in several months, and yes...the Employment Rate is still far closer to the low during the recession than where it should be in "normal" times, is an improvement. 

    The more descriptive story is in looking at the change in the number of those employed.  Remember: just as jobs are added, there are, job that are lost, as, our major measure in this regard is what we call Net Newly Employed.  On a 12-month rolling basis, the rolls of those Net Newly Employed rose quite a nice 5.3% rate in January.  That's a very respectable increase, but there is a minor cloud to consider...: (1) it is the smallest increase in 12 months and (2) it's the third consecutive month in which the measure has declined.  We say that that pretty much sums up the state of the economy at the moment.

    And what did the Market say?  It was not a particularly interesting week in terms of providing insight.  While we think that the Market rarely, as a whole, gets the picture wrong, there are weeks in which the Market's tea leaves aren't particularly illuminating. The picture we get this week is mild investor optimism, mainly demonstrated by bond prices declining and stock prices rising. 

    However, a key question an observer has to ask is why the Dollar, then, declined.  Was it on Euro or Yen strength?  Hardly. 

    There are weeks in which our best advice is to ignore what the Market has to say because it's not helpful; this is one of those weeks.

  • SCORECARDS - February 9, 2015

    Current Scorecard - Domestic

    February 2015

    Current Scorecard:   15 

    Consumer Confidence:  4                                                                            

    Full Scorecard:

                                                                                                 Current                     Four                          12
                                                                                                  Month                  Mos. Ago                Mos. Ago

     OVERALL               4              5                 13
     LEADING & CONFIRMING SCORE              15             16                28
     Leading Indicators              22             22                32 
     Confirming Indicators                7              8                23 
     Foundation             -43            -47               -48

    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.

    For some weeks now, we've been seeing enough negative data to have a strong suspicion that, by now, there would be a more complete picture of a significant economic softening in the immediate future.  The good news is that that has not materialized.  If you've been reading faithfully, you know that enough critical data points have come in stable enough (and positive in a few cases) to make a case for continued modest growth for the very near future. 

    Note the wording we're using:  "modest growth."  If you want to refine that to a more granular level, we'd have to conclude that growth will tend toward the very modest, as well, i.e. more modest than it's been the past few months.

    What's keeping the economy afloat?  After all, it is not universally robust.  Remember: in most cases, it's a matter of key variables coming in in a stable way, not more strongly.  This is particularly true of some sectors of Business Investment.  It's holding up.  It's not growing, but it is holding up. 

    What else is driving a positive economic outcome for now?  Well, declining levels of inflation, particularly in the energy sector, have been an enormous boost.  Lastly, Industrial Output is, plainly put, very strong.  In fact, it's the strongest it's been in more than four years.   There you have the case for continued growth, however modest. 

    On the other hand, we have seen a noticeable softening in the Housing picture, specifically demand.  This is particularly important because, in our view, housing is no longer underpriced relative to income.  In other words, we don't think that there's very far the housing sector can go without putting stress on the stability of that sector...unless income begins to rise at a faster rate.

    And, while some sectors of Business Investment have held up, weakness in demand for durable goods is a little worrisome. 

    Last, but not least, if a significant input into why the economy is holding up is declining levels of inflation, we need to understand that an economy cannot continue to expand for a long period simply because of declining inflation.  You cannot drive economic expansion on lower inflation.

    Does this sound like a mixed picture?  It is.  As we have said before, we hesitate to make economic forecasts past six - nine months.  The Scorecard's Leading Indicators, very specifically, look toward a timeframe that's three to six months out.  And, while it's not a formal forecast yet, our belief based on very deep fundamental indicators, is that toward the tail of that time frame, we think a more significant weakness will develop.  This belief comes from a reading of trends in credit markets, trends that are an input to our Leading Indicators, but at the moment are being mitigated by some more positive indicators.  If we're correct, we will begin to see signs of that in the Scorecard in roughly the April or May Scorecard.

    Want a reason to be anxious?  The yields on the U.S. government 10-year bond continues to hover below 2.0%.  Consider that carefully: investors are willing to part with money for ten years to receive 2.0% (and less) on their investment.  What does that suggest about income and demand?

    We are not smart enough to second-guess bond traders.

    Current Scorecard - Global

    February 2015

    Full Scorecard:

                                                        Current                   Four                         12
                                                         Month                Mos. Ago                Mos. Ago





    Leading Indicators




    Confirming Indicators








    The most important way to understand this month's Global Scorecard?  The figures are not significantly different than they have been recently. 

    The good news is that Industrial Output, worldwide, has continued to trend up.  That has been coupled with declining upward pressure on Inflation.

    Ask any rational economist, and they will tell you: there's no formula for economic growth quite like increaseing Industrial Output coupled with declining Inflation. 

    More good news: the Employment picture, while not good overall, is stable. 

    What we have, however, as well, however, is a declining level of Business Investment, and that portends troubling things for mid-year we think.  The effect is showing up numerically in this month's numbers, but it's still being offset by the positive developments we just mentioned.

    Keep this in mind: while declining Inflation makes for a more robust economy, a strong economy is not made and sustained on low inflation.

    It is very difficult, in addition, to make any kind of rational forecast for continuing declining levels of inflation.  That means that the greater likelihood is for either stable prices or....rising prices.

    Couple that picture of stable/rising prices with a strong believe by the bond market that interest rates will shortly be trending down, and that's an odd picture.  A change in inflationary pressure from very low to more moderate is not a change you associate with declining yields in government bonds.  We do favor the time-frame orientation of the Scorecard, which points Leading Indicators to a time-frame that's roughly three months out, but...our long-term radar tell us to expect

    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.


  • EDITOR'S LETTER - February 2, 2015

    Editor's Letter

    When the year began, we first thought we'd have some fun and go the popular route, committing ourselves to positions for several investment classes for the 2015 calendar year.  And then, as you know by now, we thought better and decided to opine first on what we think the most significant theme for the year will be (Debt), and then a surprise lesson we learned from the Swiss Franc.

    Is this kind of guessing game silly?  It can be.  For one, a calendar year is an arbitrary choice of time frame since it has no necessary relation to economic winds.  And of course trying to forecast out 11 - 12 months is hardly easy.  And let's face it: after the fact, who's ever held to their "predictions?" 

    We contemplated all this and then we decided that there was a strong reason to leap into this territory because it will reinforce some other points that we think are important.

    It's more than difficult--not to mention stupid--to try to disentangle what we think the most significant theme of the year will be...from how investment classes will perform.

    When you think about what we mean by Debt, you should be thinking of two things:  (1) debt rising, in general and (2) debt rising faster than income.

    With regard to the former, it means that, even if income rises in the short-term (as it will), as debt continues to rise, as well, it makes global economies more vulnerable to minute changes in countries' own economic policies (we are thinking here most specifically of monetary and fiscal (read: tax) policies).

    In other words, such situations will limit the options given to governments.

    With regard to the latter, it means that, a continuation and extension of current loose monetary policies is more likely than less likely to be the trend in central banks around the world.

    With all that in mind, there is one investment class that should be staring you right in the face:  Gold

    [Newer readers who are cynical about Gold are directed to reading our essay on the topic in the section, 'Hot Topics.']

    If you don't believe that Gold will perform well, this year, you are implicitly making a wager that economic growth will continue, in a fairly widespread way around the globe.    You will make that bet without us, based on the state of deep weakness already present in many developed countries, especially given how aggressively loose monetary policy is in most of those countries, already.

    Is it possible that the Stock Market performs positively this year?  Absolutely.  We are not making a call for a year-over-year decline in the Market.  But, there isn't a lot of call for aggressive economic performance (including in corporate profits) and as we've said so many times, stocks are still overpriced relative to return.

    Commodities?  Well, you should know by now where we stand on Commodities.  We think you're at the threshold of a generational opportunity, but it's not at all clear that that opportunity will be consummated this year.

    Bonds?  All we can say about Bonds, given how very highly priced they are right now, is that if you think Bonds are even close to being the best-performing asset class this year, you must have an extraordinarily dismal view of the economic picture at the end of the year.  We're not particularly sanguine, but a fresh plunge into Bonds would have to be predicated, we think, on a view that we are about to descending into an economic depression.  A possibility?  Yes.  A bet you should be making first?  No.

    US Dollar?  This is probably the most intriguing of the other investments.  The Dollar has sustained quite a run-up in its value the past two months, and yet it's still several percentage points below Par of 100 on the US Dollar Index.  And let's be honest: most of the reason for the recent run-up is weakness in the Euro Zone and in Japan.   Do you want to bet that the Dollar will have a spectacular year based on continued significant weakness in those (and other) regions?  We hope you're not betting that the Dollar will have a spectacular year based on stellar economic performance at home.  The scenario that has the U.S. Dollar being an outsized performer is a scenario in which investors flock to it as a safe haven because of extreme volatility and anxiety over global political tensions.  That's far too speculative for us.

    You see what we mean?  Could our timing on Gold be slightly off?  Absolutely.  When you think of Gold, you should be thinking of red ink, figuratively, that is.  We think the case for bookkeepers having to switch from black to red ink is a strong case, based on what leading indicators are telling us at the moment.

    Could we be wrong about our chief investment opportunity for the year?  Sure, but that means either that you believe that the global economy is going to perform well or that there will be widespread deflation for a sustained period or that there will be some kind of spiking inflationary pressure that would require central banks to raise interest rates in a spiking and precipitous way.

    You'll make that bet without us.

    The theme for the year?  Debt

    The investment class for the year:  Gold

    There you have it.  We expect you to hold us to it.

  • ECONOMIC & MARKET ANALYSIS - February 2, 2015

    Economic & Market Analysis

    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims fell 2.7%.

    S&P 500 Index - The Index finished at 1994.99, down 2.8% from last week.

    US Dollar Index - The Index finished at 94.80, down 0.2% from last week.

    Gold - Gold finished at 1260.25, down 2.7% from last week.

    Commodities - Spot Prices finished at 322.13, down 0.3% from last week. 

    Ten Year Government Bond Index - The Index finished at 2145.68, up 0.8% from last week.

    New Single-Family Home Sales - The value of Sales rose at an annualized rate of 13.5% in December.

    Case-Shiller Housing Price Index - The Index of the value of previously-owned homes rose 4.5% in November.

    Durable Goods Sales - The value of the Sales of Durable Goods rose 1.6% in December.

    The Market, this week, displayed one of the rarest patterns you'll ever see.  Stocks, commodities, and the Dollar all fell.  But Gold fell.  That's counter-intuitive.  If anything, the kind of across-the-board sentiment with regard to weakness that you see here should result in stronger feelings about monetary easing by the central bank and thus, stronger pro-Gold sentiment.  And, the Bond Market clearly disagreed as well with Gold investors, as well, sending the yield on the 10-Year Government Bond down further, to just above 1.6%.  Markets don't have the force to push the economy in a particuar direction, but more often than not, the Market gets economic direction right.  This week, the Fed made tepid noises about raising rates no sooner than mid-year.  But Gold investors heard the message wrong.  Instead of hearing that the Fed won't be raising rates soon, what it decided to hear was that raising rates is on the horizon.  

    Given the way the data has continued to come in, particularly what we view as real inflationary pressure against what the Bond Market is telling you about where rates are headed should tell you a lot.  And the Bond Market is continuing to push yields to levels that we think are lower than are justified by inflationary pressure, which is greater (though still small) than Gold investors, in this case, would have.

    So, what about the week's economic data?  As we have often said, as silly as this indicator seems on the surface, trends in the Sales of New, Single-Family Homes are often very telling.   After all, it's difficult to see a contraction in the face of rising sales, and it's very difficult to see an expansion in the face of contracting sales.  So, what did we get in December?

    It's a decent picture.  It's an increase of 13.5%.  That's a good figure, but it's not as good as it might sound.  In context, it's only moderately good.  It's not what you'd particularly call an expansionary figure.

    And the picture there carried over to the larger housing market of previously-owned homes for sale.  The Case-Shiller Index rose 4.5%.  That's a respectable increase, but (1) it's not large enough to be remotely associated with a strong housing market and (2) this increase is the smallest increase since December 2012. Regular readers will recognize this as consistent with recent remarks we made that we would be embarking on a softening in the housing sector about now.

    Now, let's talk about Durable Goods Orders, one of our favorite leading indicators of economic direction.  The good news?  Orders increased in December.  The bad new?  They increased by only 1.6%, which was the smallest increase since February 2014.  And, if you exclude the impact of transportation-related goods, Sales actually....declined, by 1.3%.

    You now have a better idea of why the stock market, the Dollar, commodities, and bonds performed the way they did.

    The Domestic Scorecard will be updated next week.   


  • Economic & Market Analysis - Feb. 26, 2014

    What keeps Janet Yellen up at night?

    This is probably one of the top three questions that you should be asking yourself at any point in time, that is, if you want to develop a good sense of the risks and potentialities for the economy.

    To answer that question, let’s go back first a little. 

    How many times have we reinforced the fact of the disconnect between monetary policy and effect?  Too many, perhaps?  Well, we’re going to encourage you to think a little differently about that this week.  Fact is, that disconnect is pretty darn big.  And the fact is also that most of the factors that we believe have led to that disconnect have stabilized.  No, that doesn’t mean that we believe that the disconnect will necessarily lessen, it just means that the factors that we think have been weighing on capital formation and job growth have bottomed out.


    If you ask nearly every commentator in the business media the question that we posed above, the answer will come back something like, “Deflation.”




    Deflation was a great threat coming out of the Financial Crisis and it was a threat last year as Japan and the Euro Zone settled into a recession.  But that’s essentially over now.


    Japan and Europe are showing more than tentative signs that they’re on the mend…as was to be expected.


    The first thing your mind should be turning to as you ponder that is downward pressure on the Dollar.  Yes, for almost all of last year, the Dollar was stable, and actually trended up slightly.


    For three consecutive weeks now, the Dollar has finished slightly lower than the previous week.  And that, we project, will continue to be the case as Japan and Europe continue to rally.


    No, the point is not to adopt a bearish investment position on the Dollar.  The point is that upward inflationary pressure is on the horizon in the United States. 


    Now, normally, Janet Yellen wouldn’t mind a little higher Inflation, especially considering how subdued it has been.  After all, other things being equal, if Inflation starts to get out of hand, the Executive Committee of the Federal Reserve can tighten monetary policy.


    That’s in a world in which everything is equal.  But everything is not equal.


    The Labor picture is not good, and by ‘not good,’ we mean that Unemployment is far below the level at which it should be for the level of Industrial Output we’ve attained.


    What does the Fed Chair do if Inflation starts to hit levels of 3.5% and 4.5% but Employment is still lagging in a very large way?


    Echoes of the mid 1970’s?


    The Fed Chair would probably have no compunction about raising interest rates even in such an environment, as Paul Volcker did in the late 1970’s/early 1980’s IF the situation were akin to what the nation faced in the early 1980’s….and that was a situation in which fiscal policy was very different.


    We have argued—and we will continue to do so—that the single biggest impediment to economic expansion at this point—and the reason for that disconnect between monetary policy and growth—is Fiscal Policy….the orientation of the Federal Government toward creating incentives for capital formation and business creation.  Simply put—and to parrot Chair Bernanke’s words—Fiscal Policy is going in the opposite direction of Monetary Policy.


    This is what keeps Chair Yellen up at night. 


    Barring a significant change in governmental orientation toward Fiscal Policy, the Chair is facing the prospect of a large problem: low employment coupled with rising inflation, in an environment of stifling capital formation.


    It’s a problem we wouldn’t want to have to be responsible for, and we don’t wish it on Fed Chair Yellen.  


    Latest Economic Indications

    Initial Jobless Claims - The four-week moving average of initial claims rose 0.5%.  (Note that this is the fourth consecutive week in which initial jobless claims rose.)

    Consumer Prices – Prices in January rose at a 1.4% annualized rate.


    What It Means

    Yes, yes, yes, Inflation is still subdued.  But, you need to know that at an annualized rate of 1.4%, Inflation is running the fastest it has since last September.  What’s particularly interesting about that is that while you will hear most media outlets attribute this rise to energy prices (which rose faster than food or core products and services), core inflation did rise at a 1.7% annualized rate, i.e. faster than the all-in rate that includes food and energy.  Are you getting the picture?


    Yes, Food and Energy Inflation can be very damaging to the economy.  But there’s a reason we separate them out for the purpose of understanding the larger picture. 


    Of course prices for food and energy tend to be much more volatile than for any other product category.  And when Core Inflation starts to rise faster than General Inflation, it’s a sign that things are heating up. 


    Now, that’s not necessarily a terrible thing, especially when Inflation is still relatively low.


    What it does mean is that you had better have a commensurate increase in economic activity (think Industrial Output and Retail Sales).


    We’ve said it before: in measuring economic growth, there’s little that’s more important than the relationship between these three: Inflation on the one hand, and Industrial Production and Retail Sales on the other.


    So where does that put us, considering that we reported Industrial Output and Retail Sales last month?


    It puts us in an “okay” place, but no more.  Why?  Yes, rates of growth in Industrial Output have been moderately good and Retail Sales have been modestly good.  Truly, the rates of growth are respectable.  However, those rates of growth have been fairly stable, i.e. unchanged, for three months, whereas the annualized monthly rates of Inflation have risen for three consecutive months. 


    Now, let’s be clear: a combination of rising Inflation with stable Output/Sales is not nearly as much of a concern to us as rising Inflation with declining Output/Sales, but it’s not a recipe for accelerating real growth and most definitely denotes a slowing rate of real growth. 


    As we say, what keeps Janet Yellen up at night is not Deflation, but the risk that Inflation starts to overtake overall economic growth. 


    The Board of Governors of the Federal Reserve voted to require foreign banks with assets over $50Bn that operate in the United States to hold greater capital reserves, in line with regulations maintained for U.S. chartered banks.


    No banks failed this week.



    Think of it as a that will make it easy for you to keep score at home.  We selected these nine indicators because of their great importance in showing us economic trajectory.  Here's how it works.  Assign a point of +1 or -1 to each indicator depending on whether its most recent trend is positive (green) or negative (red).  The figures represent the most recent three-month average of the change in the 12-month rolling average (with the exception of the S&P 500 where we measure the current month-end against the two-year median price).

    Assign a weight of two points to the S&P 500 Price Level, Retail Sales, Industrial Production, and Inflation.

    Have you done the arithmetic?  You should have a score of +6 out of a possible 12.  You should consider a score of +8 as strong and any score less than -5 as bearish for the economy. 

    Retail Sales


    Durable Goods Orders


    Industrial Production  




    Capacity Utilization




    S&P 500 Price Level


    Case-Shiller Price Index


    Disposable Personal Income