Monday, December 30, 2013

Be It Resolved . . .

When I was a boy or young man and did something stupid, as boys and young men are prone to do, my father would console me with the reminder that "there was only one perfect man, and look what happened to him," referring to Jesus being crucified.  His point was that being perfect is over-rated and that you can forgive yourself for your mistakes.

On the other hand, my mother insisted that I also learn from my mistakes.  One favorite technique of hers was for me to make New Year's Resolutions each year to deal with those mistakes and not make the same mistakes again.  "Unless you are already perfect, you always need to work on your imperfections."

I soon began to think the only reason for New Year's celebrations was to make New Year's resolutions.  Yet, that is no longer fashionable, and I wonder why?  Imperfect people are missing a real opportunity!

Over the years, my annual resolutions have become increasingly mundane and boring, but I still make them.  For 2014, I have just two resolutions, i.e., to have my eyes examined and to take a refresher course in econometrics.  It is pretty dull stuff, but they will be done!  New Year's resolutions will even force the procrastinator to act!

Now, what is your New Year's resolution?  What . . . you think you're perfect ?? 

Sunday, December 29, 2013

Economists vs. Americans

By a large margin, most economists and strategists agree that the economy is doing much better.  Yet, according to the latest poll by CNN, 68% of Americans think the economy is doing poorly and 38% think the economy will still be doing poorly in another year.

I think this difference in perspective shows how much more important the jobs market is to Americans than to economists and strategists.  Americans cannot see past the lousy jobs market to the overall economy.  It is the old story of parties on Wall Street and poverty on Main Street.

Remembering that consumer spending is two-thirds of GDP, the critically important consumer confidence is still rising more slowly than business confidence.  It is dampened by the jobs market.  As the late Lee Atwater said, "perception is reality" . . . sometimes.

The good news is that the latest monthly unemployment rate dropped to only 7%, but I suspect this rate will be adjusted upwards when the next jobs report is released January 10th.  Still, job creation is expected to average about 200 thousand monthly in 2014, which is a long way from losing 600 thousand a month, as we were in early 2009.  Economists have been arguing we need at least 250 thousand new jobs each month to accommodate normal growth in the labor force.

But, something else is happening in the labor force.  Back in the dark ages of the year 2000, almost 65% of Americans between the ages of 16 and 65, who were not in school, were either working or looking for work.  Rather dramatically during the Great Recession of 2008-9, that rate dropped to only 58% and has remained there since then. This is called the "labor force participation rate."  Republicans use that data to to argue that Americans have lost interest in working and that unemployment payments should not be extended.  Democrats use that data to argue that baby-boomers are retiring faster than expected,  even though many were retired involuntarily. They see a need to reinforce entitlement spending to protect these new retirees.   Also, given the lack of jobs, many younger people have delayed entering the work force, most often pursuing higher education.  Still, there is no definitive answer to why fewer people participate in the labor force.

If that labor force participation rate returned to normal as suddenly as it declined, the unemployment rate would increase significantly, which means our current level of unemployment is really much higher than 7%.  

Maybe, Americans know something that economists and strategists don't know?

Saturday, December 28, 2013

2014 Forecast

Sometimes, there is a long wait before something appears in the newspaper.  This is especially true for "feature" articles.  Inside Business is currently preparing such a feature article, compiling 2014 forecasts from various business leaders for publication in early January.  For loyal readers, here is the forecast I submitted on December 19th:

Behavioral economists always warn about “recency bias,” which is the natural tendency to predict more-of-the-same of whatever has been happening recently.  The latest survey of economists by the National Association of Business Economists (NABE) just forecast more long, slow but improving growth in the economy.  GDP will grow from 1.8 percent in Q4 of 2013 to 3.0 percent in Q4 of 2014.  Job growth will continue about 197 thousand monthly.  The majority do not expect another government shutdown or, more importantly, a default on Federal debt.  Continued slow tapering of quantitative easing will raise the benchmark 10-year Treasury rates only slightly, from 2.9 percent to 3.25 percent by the end of 2014.  Inflation will remain tame.

As much as I would like, I cannot disagree that both the economy and the stock market will make continued improvements during next year.  We can eliminate strong economic growth as a possibility, due to the fiscal drag from our dysfunctional Federal government.  In all probability, we can also eliminate recession, as recent economic data has been stronger than expected. 

From a historical standpoint, there is an old Wall Street adage that a great year is followed by a good year, but watch out after that.  2013 was a great year.  Also, in the last 114 years since 1900, the stock market has dropped 30 percent or more -- thirteen times.  The current recovery is far shorter and far weaker than the average.  Historically, neither the economy nor the stock market is due for a recession.

Slow, steady growth in the economy is the default prediction, with the S&P 500 closing 2014 over 2000, compared to about 1800 now.

However, there are more landmines to this prediction than normal.  First, Europe is looking better all the time.  Ireland has now exited its austerity program, and Greece has returned to the international bond market.  Although the probability is decreasing, I will raise cash if there is a derivatives blow-up in Europe, which would be a very bad sign.  Second, if there is another “flash crash,” where the Dow drops 600 points in five minutes, like it did May 6, 2010, I will do nothing.  It will recover in the short term, but I will be raising cash in the long term.  Third, if it looks like the U.S. will actually default on its debt, I’ll start reducing risk by increasing cash.

Otherwise, enjoy the ride in 2014 – hopefully, the S&P 500 will reach 2014!

Thursday, December 26, 2013

Ten Predictions From The Vampire Squid

Goldman Sachs has delivered their "Ten For 2014, " and here they are:

1.  GDP growth will improve as the fiscal drag from reduced government spending falls from 1.5% to only 0.5%, which is a full point of additional GDP growth.  It sounds small but is a big deal!

2.  Unemployment will drop to 6.5% in mid-2014 from 7.0% now.  Further, it will drop to 6.0% in mid-2015.  This suggests much less support from the Fed, which is good in the long run, if not the short run.

3.  From any historical perspective, inflation will remain low, due to the amount of slack in the labor force as well as in industrial capacity.  This is good news for bonds.

4.  The Fed will complete its tapering or end quantitative easing by the end of 2014.  This makes libertarians happier than other Americans.

5.  The S&P will end 2014 up modestly to 1,900 and end 2015 at 2,100 -- compared to 1,830 now.

6.  Interest rates will continue to rise.  The 10-year Treasuries will rise from 2.9% now to 3.25% next year and 3.75% in 2015.  (Remember:  rising interest rates are a double-edged sword.)

7.  The dollar will weaken against the Euro, meaning European vacations will get more expensive.

8.  Oil prices have hit bottom but gold, cooper, and soybeans will continue to fall.

9.  An increase in oil prices will not derail our continued economic recovery, indicating the strength of this recovery.

10.  "Hot" themes to watch are 3D printing, LED lighting, E-cigarettes, cancer immunotherapy, and "big data."  3D printing is already doing well for commercial usage, if not residential.  I thought E-cigaretters were already done but will have to study that some more.  Just imagine being immune to cancer???

Overall, this set of predictions is not significantly different from their previous one, except that it does continue into 2015.  However, one interesting point is that their prediction of S&P ending 2014 at 1,900 is lower than most other forecasters.  But, don't confuse the vampire squid with the thundering herd!

Monday, December 23, 2013

Happy Holidays . . . to all !!

Most religions and cultures enjoy some early winter celebration, in preparation for the long, dreary winter weather.  So, Merry Christmas and Happy Hanukkah and Blessed Kwanzaa and Warm Winterfest to each and everyone of you!

Spring will be here soon . . . ??

Here Comes Santa Claus?

In a predictable world, we know that the stock market usually weakens in the first half of December as the hedge funds sell out to "lock-in" their investment gains (read:  bonuses) for the year and enjoy the holidays.  Mutual funds do not have that option.

During the latter half of December, mutual funds needs to "window-dress" their balance sheets before the year-end statements are prepared.  This normally means they want investors to see they were fully-invested and holding very little cash on December 31st.  In addition, a great deal of qualified plan contributions are made just prior to year-end, which also have to be invested quickly.  Lastly, the omnipresent gloom on Wall Street lifts during this season of glad tidings, reducing the number of sellers.

The result is a monthly see-saw -- the market drops the first half of the month but rallies the second half.  This is called the "Santa Claus" rally.  Last week, we saw the best week for the market in three months.

Oh, yeah . . . Santa Claus is coming Tuesday night!

So, enjoy the season of capital gains!!

Sunday, December 22, 2013

Improbable But Appropriate

In Army Basic Training, we were taught that, if we were ever captured by the enemy, we can only release our name, rank, and serial number.  In Officer Candidate School, we were taught to choose death over dishonor.  In Special Forces, we were taught techniques to better withstand torture, such as deep breathing and the mental game of disassociation.  If that failed, remember the pain you're absorbing would go to your family if you talked.  You take the pain for those you love.

Not surprisingly, my knee-jerk reaction when I head about Edward Snowden leaking secrets was that he must be captured and executed as quickly as possible.  With the passage of time, my worst fears about government snooping have been realized, although it does seems to be more pervasive but less invasive, at least so far.  There is a reasonable argument that Snowden has done the world a favor by exposing the government snooping, which is even more insidious than Google.

So, is Snowden a hero . . . or scum . . . or both?  My suggestion is that he be awarded the Presidential Medal, the highest civilian medal, in recognition for the awareness he has created.  Then, he should be promptly executed!

To paraphrase Benjamin Franklin, he who would trade security for privacy will have neither.  I look forward to tight, new controls on the zealots of NSA!

Thursday, December 19, 2013

Welcome Home, Prodigal Son!

Sometimes, the stock market is like The Prodigal Son that comes from a good family, then becomes foolish, asinine, and unreasonable for awhile, before finally returning to their House of Reason.

Twice, the stock market has suffered from a "taper tantrum," losing billions of dollars of investor money, because it was afraid the Fed would begin tapering or reducing the amount of its monthly purchases of Treasury bonds and Mortgage-Backed Securities (MBS), which is known as quantitative easing.  I have argued that it was an unreasonable reaction, because the Fed will not begin that s-l-o-w process -- until the economy is stronger.  And, since when does the market collapse because the economy gets stronger?

Yesterday, the Fed reduced uncertainty by announcing it would only buy $75 billion monthly instead of $85 billion.  Immediately, I could almost hear a distant submarine sounding "DIVE, DIVE" as the Dow dropped 61 points in a heartbeat.  Then, the Prodigal Son returned home to the House of Reason, as the Dow ended the day UP a whopping 292 points, closing at a new record high!

Another reason I suspected tapering would begin yesterday was that it would be Bernanke's last chance to begin unwinding the huge "stimulus" program he began.  Like everyone in office, he has his detractors, primarily that he didn't foresee the financial collapse and then did TOO MUCH to save the nation's financial system.  He wanted to start reducing what he began, just to answer his detractors.  From their standpoint, Bernanke was also a Prodigal Son, who did "wild & crazy" things before reversing course at the end.

History will be kind to Dr. Ben Bernanke!

Tuesday, December 17, 2013

No Dog In This Fight

Sometimes, I have trouble getting my nose out of books and looking out the window instead.

The classical school of economics makes it clear that any increase in the cost of unskilled labor will cause a decrease in the demand for that type of labor.  Therefore, increasing the minimum wage will cause unemployment to increase.  Of course, the U.S. economy is too complex to be that easily explained.  Since the minimum wage was first imposed in 1938, the demand for unskilled labor has increased greatly, although it does beg the question of how much MORE demand would have increased, if we still paid workers a minimum wage of 25 cents per hour like we did in 1938?

Some pundits argue that the government must establish a minimum wage, since unskilled workers don't have the benefit of unions to protect them.  They also argue that the time to raise the wage is when the economy is improving and business has greater ability to absorb the increased costs by increasing prices, which would be now.

The demand school or Keynesian school of economics argues that increased spending by unskilled labor will help business, thus creating more demand for unskilled labor.

A recent analysis by Bloomberg concluded that the current debate about increasing the minimum wage is a great deal of words and emotions spent on something that is really not very important.  Increasing the minimum wage doesn't help unskilled workers as much as expected nor hurt small business profits as much as expected.  I think that is correct.

As for me, if 76% of Americans approve of helping the 2% of Americans who are actually earning the minimum wage, then why should an economic agnostic like myself preach classical economics?

Sunday, December 15, 2013

Distant Thunder

Because commission-based salesmen are typically not reliable sources of good information, I seldom study any analysis by stockbrokers.  However, Merrill Lynch has just released an interesting analysis, entitled A Transforming World.  Instead of focusing on what the economy and the stock market will do next year, it focuses on three major transformations in the world economy and stock markets over the next few decades.

"First, amid rapid strides toward energy self-sufficiency, we're seeing a surge in U.S. business and technological innovation that has the potential to revitalize the economy and spark another long-lived bull market."  This paper discusses the impact of "fracking," the reduced cost of labor in the U.S. (minimizing outsourcing), the long-term housing recovery, and increased spending on R&D.  The U.S. is 75% of global venture capital!

"Second, far-reaching shifts in the financial markets are presenting investors with unprecedented opportunities - as well as unanticipted risks."  It points out that the flow of funds into mutual funds has shifted from bond funds into stock funds, probably beginning a "Great Rotation" into stocks, which is great for the stock market.  Both interest rates and inflation remain relatively low.  Minor increases are easily manageable.  While investing globally is finally getting the respect it deserves, "values-based investing" (VBI) is also becoming more practical.

"At the same time, a massive rebalancing of the world's economic, political, and social power is under way."  This paper emphasizes the impact of doubling the global middle class over the next twenty years, which will produce more consumer economies and fewer export economies.  The increased burden of aged populations in developed countries, like the U.S., will shift huge advantages to the developing world or emerging markets.  "By 2020, the U.S. is expected to have twice as many workers over age 55 than those 24 and under."  (This worries me . . . a lot!)  The demand for natural resources, such as water, will increase to a dangerous point.  Lastly, due to the limitations of democracy and the impotency of central governments, economic power has shifted to central banks, like the Federal Reserve.

While this was an excellent analysis and should be "required reading," it is primarily geared toward the "buy and hold" investor, who has a high tolerance for the inevitable bear markets that will occur.  And, I don't know many of those.  Of course, this report is what one would expect from "the thundering herd."

After all, everything is an opportunity, isn't it?

Saturday, December 14, 2013

Same Song, Different Chorus

Wells Fargo was never known as a powerhouse economics shop, but that changed when the giant bank bought and absorbed Wachovia, whose economics department was highly respected.  Here is a peek at their "combined" forecast for next year:

1.  GDP will continue to increase next year and into the following year as well -- yea, no recession.
2.  Inflation will remain tame, ending next year at 2.0% and 2.2% the following year -- good news.
3.  Capacity utilization remains relatively constant at 79.1% now to 80.8% - reinforcing the lack of inflation.
4.  The Federal budget deficit was $668.5 billion this year, decreasing to $538.5 billion next year -- good.
5.  The dollar will strengthen next year, making exports more difficult -- good and bad news.
6.  Unemployment drops to 6.5% by end of next year and 6.2% the following year -- slow but good news.
7.  Short term interest rates remain unchanged next year but rise sharply in the second half of 2015 -- good.
8.  Long term rates (10-year Treasuries) rise from 2.85% now to 3.2% at the end of next year -- OK news.
9.  Interest rates will rise more rapidly in England, suggesting a stronger pound -- visit England now.
10. GDP will grow faster in Korea, China, India, Mexico, and Russia than in the U.S. by 2015 -- old news.

While economic forecasts are not the same as stock market forecasts, there is a "stretchy" relationship.  The currently bullish stock market reflects a bullish outlook for the economy, notwithstanding a dysfunctional government and the withdrawal of stimulus by the Federal Reserve.  That is a big difference from last year.

There is surprising uniformity to the 2014 economic forecasts that I've been studying, probably reflecting a "recency bias," which is a common error of forecasters to forecast a continuation of what has been happening recently.

Thursday, December 12, 2013

Disconcerting Conversations

I have one friend who is a very senior hospital administrator and another friend who has spent his whole career in health insurance.  Both are lifelong Republicans, and both opposed Obamacare.  In separate conversations, they both said that healthcare is now so hopelessly complex that it will certainly fail.  Both said the only way out of this mess will be a single-payer system, like Europe where universal health care is provided to everybody by the government.  They agreed there is no going back - "you can't unbreak an egg."

I pointed out to each friend that the President originally wanted a single-payer healthcare system but was forced to settle for "Romneycare."  Each of them just nodded in agreement and warned me that the process of getting from an unacceptable healthcare system, where 30-40 million people received minimal healthcare, to a real healthcare system -- requires a painful detour through Obamacare.  I jokingly asked if we were going through Purgatory in route to Heaven.  Neither thought that was funny!

If that is the case, what is the time horizon?  What does that suggest for the stock of health insurance companies?  For other medical related companies?  For medical research?

And, how does either political party benefit from this?

Wednesday, December 11, 2013

Harder To Hate

My mother taught me that hate is a four-letter curse word that should never be used.  Therefore, I cannot say that I hate Google!

The reason is that I greatly resent their 24/7 snooping of our private lives, especially the granularity of their snooping.  For example, they know whether you need a blue shirt or a white shirt, because you clicked on a website selling such items, and Google then sells that information to advertisers selling shirts.

However, with the recent discovery of NSA spying on Americans, Google's spying does seem a little more trivial.  In addition, I see that Google is now donating $250 thousand to put a holiday wreath on all 120 thousand gravestones in Arlington National Cemetery, which is a truly noble gesture.

I know, I know, even Al Capone supported an orphanage in Chicago, but I have a weak spot for veterans.  From now on, I will just deplore Google!

Now, A Word From The Pros

The National Association of Business Economists annually surveys members on their outlook for the next year.  Their 2014 economic outlook has just been released, and here are some of the more salient points:

1.  GDP growth will accelerate, with a full year growth of 2.8%.  This is lower than Q3 of this year but indicates their belief in slow growth . . . but still growth -- no recession.

2.  Job creation will continue at 200 thousand per month, with a full-year average unemployment rate of 7%, which is exactly where it is now.  No good news for the desperate.

3.  The S&P 500 will end 2014 at 1,850.  (It is already over 1,800 now.)  If there is a bear market, they expect it to be short-lived.

4.  Export growth will double from 2.5% this year to 5% next year.

5.  There is only a 20% probability of another government shutdown.  (Of course, announcement of the latest budget deal suggests it is probably even lower.)

6.  Tapering of quantitative easing will definitely begin in the first half of next year -- duh!  Since the ridiculous "taper tantrum" of the stock market last summer, it does appear that the market is finally starting to realize that tapering is a good thing.  But, we'll have to wait before seeing if the good economic news becomes good financial news again.

7.  Short-term interest rates will remain low, but the longer term rates (10-year Treasuries) will rise somewhat from 2.8% to 3.25% next year.

8.  Inflation was only 1.5% this year and is expected to rise modestly to 1.8% next year -- hardily worrisome!

While I haven't gone back to last year's forecast, I'll bet it was almost identical to this one.  The irony is that, while it was somewhat pessimistic last year, it was still basically correct . . . slow, steady growth.  I expect it will also be right this time . . . slow, steady growth.

I sure miss the good, old days when 4.0% GDP growth was routine!

Monday, December 9, 2013

Page Three News

A few months ago, the budget talks in Congress were page one news, until the can was kicked down the road once again.  However, we should get some idea of any budget deal late this week.  But, where is the news coverage?  Normally, that is a good sign - a sign that things were going well.  Then again, I always see a half-empty glass as 51% full . . .

To stay focused on the importance of any budget deal, please take another look at and, more specifically, study the "Largest Budget Items" on the left side.  While sequestration was successful in reducing the deficit, it did nothing to improve these items.  Sequestration only impacted discretionary spending, like infrastructure -- cutting muscle, not fat.  We need a real budget compromise, which actually deals with the "800-pound gorilla."

I would gladly pay another dollar in tax . . . if entitlements could be cut by ten dollars!

Friday, December 6, 2013

A Plain Vanilla Jobs Report

Economists did a good job predicting today's all-important "Jobs Report."  They predicted 185-200 thousand jobs were created in the private sector during November, and the report showed . . . drum roll, please . . . 196 thousand.  The futures market immediately spiked but then dropped back to exactly where it was.  Actually, this is also the three month average of jobs being created, which means their prediction was actually a safe one -- the best type of predictions to make!

Unemployment dropped from 7.3% to 7.0%, compared to the Virginia unemployment rate of 5.5% and Virginia Beach of 5.3%.  Earlier, the Fed said they would begin reducing monetary stimulus or QE when unemployment dropped to 6.5%.

The question is whether today's report triggers an action by the Federal Reserve to begin tapering or reducing the amount of Federal bonds they buy each month, known as quantitative easing.  A strong jobs report on the tail of a very strong GDP report suggests that tapering could begin sooner.  When the market believes tapering will begin soon, we can expect another "taper tantrum" like we saw last summer.  Both the stock market and the bond market will then fall . . . but not too far nor too long.

Remember:  the Fed will not begin tapering until it thinks the economy no longer needs the training wheels of QE, which means the economy is strong enough to grow without help from the Fed.  That means the stock market should begin growing again . . . but not until after it has a taper tantrum.

It is possible that tapering will begin this month, but I don't expect that to happen before March or so.  Until then, enjoy the ride and be ready to invest remaining cash during the taper tantrum.

Thursday, December 5, 2013

Not A Birthright

Following the destruction of World War II the Allies in general and America in  particular were in a position to re-make much of the world, including international trade.  Meeting in Geneva, it was no accident that the official language of such trade and international contract law became English.  As the dollar was then backed by gold, it was natural that the world also gravitated to the dollar as the world's reserve currency.  This has given us many benefits, guaranteeing a large demand for our currency, which drives up its value, keeping the dollar strong for decades.

A few months ago, China raised the obvious possibility that the world needs another reserve currency, like the renminbi, of course.  Few Americans have ever lived when the dollar was not world's reserve currency.  Most don't take the risk of losing our privileged status very seriously, but it is not a birthright.  Take a look at this graph of history:

So far, the reserve currency has always been from a western nation, but there is nothing preventing an eastern nation like China from taking our place.  While that would not be good for us economically, it would NOT be a disaster.  Politically, it would be much more damaging worldwide.  

I suspect American neo-cons would lose their sanity, as that would be the death of American exceptionalism.

Wednesday, December 4, 2013

Americans versus Investors

Last month, the ADP estimated 130 thousand jobs were created in our country during October.  Economists expected a improvement in November, with maybe as many as 170 thousand jobs being created.  Instead, ADP says 213 thousand jobs were actually created.  Economists cheered!  Americans cheered!

Investors didn't cheer . . . in fact, Dow futures immediately dropped 25 points.  Why?

Investors expect the Fed will start cutting back on quantitative easing (QE) when the economy improves, especially when the job market improves.  If you don't think QE is pumping up the stock market with cheap money, the stock market says you're wrong.

Of course, the Fed knows this but expects that the "wealth effect" or good feelings generated by both the rising stock market and the continued low interest rates will encourage more risk-taking, which jump-starts the economy.

So, who are you rooting for:  America or Wall Street?  In the short-term or long-term?