Friday, February 28, 2014

Paging Willie Nelson

We've previously discussed the problem of the Labor Force Participation Rate.  Fewer people are working.  Conversely, more people are not working.  Take a look at this graph and ask yourself why?

Republicans say this is a normal result from overly-generous worker's compensation and other entitlement programs.  Democrats allege that half of the decrease is due to the aging of America, especially the baby-boomers who are retiring in record numbers.  About a third of the decrease is cyclical, due to the weaker economy that simply does not need as many workers currently, and the remainder is due to workers simply giving up and living off others.  Over time, the percentage of Americans who choose to work AND can actually find work is expected to decrease.

If I can produce 100 Big Mac calorie and/or cholesterol bonanzas each day and only produce 80, then economists will say I have an "output gap" of 20.  The world would be better off (and less healthy) if I produced at my capacity.  This idea of an output gap applies to the economy as a whole.  Would America be better off if our Labor Force Participation Rate increased?  Our GDP would increase.  Our budget deficit would decrease.  Even the dollar would likely increase.  But, how would you do it?

You could try to un-do the cyclical weakness with deficit spending, but you would probably be hung-by-the-neck-until-dead by Congress.  You could try to convince those who have already given up that the American Dream is not truly dead.  Or, you could extend the retirement age.  Perhaps, that would be enough to kick-start a little cyclical recovery and draw a few discouraged workers back into the Labor Force.

Since this recession has been called a "man-cession," it is not surprising that an unusually large portion of the discouraged workers are relatively young males.  Maybe, we should fund a national shame campaign.  If you love your son, you'll throw him out of the house.  Maybe, Willie Nelson could even sing "Mothers, don't let your babies grow up to be slackers."  

Thursday, February 27, 2014

Sorry, Max!

I get about $30 thousand annually from Social Security, and I'm grateful to the kids & grand-kids of America for it.

We like to think of Social Security as an annuity, because we "paid into it."  (Indeed, I paid the maximum amount into it for many years.)  But, just try to buy such an annuity from an insurance company, and you will find it is not available.  They do not exist!  Any company selling annuities like Social Security would promptly go bankrupt.

Yes, there is a Social Security trust fund, but it is invested in U.S. Treasury bonds, which pay almost nothing in interest income and assumes repayment of those bonds.  And, who is going to repay those bonds?  My grandson is named Max, and he needs to be concerned.

From a the standpoint of an economist, it is more appropriate to think of Social Security as a transfer program from America's kids & grand-kids.

In 1970, there were 3.7 workers supporting each Social Security recipient.  Ignoring inflation and benefit level changes, that means each paid the old-timer $8,108 every year.  By 1990, there were only 3.4 workers, each of whom transferred $8,824 every year to the "Greatest Generation."  By 2010, there were only 2.9 workers, each of whom transferred $10,345 to somebody's grandparents every year.  It is estimated there will only be 2.2 workers by 2030, each of whom will be paying $13,636 to somebody like me every year.

The increase from $8,108 in 1970 to $13,636 in 2030 is 68%.

And, the really scary part is that the time bomb of Social Security is minor compared to the time bomb of Medicare/Medicaid..

Wednesday, February 26, 2014

The Ugly Side of Mirrors

The ugly step-sister of economics is politics, unfortunately.  I go to great lengths not to discuss politics, just as my father taught me.  Indeed, I can remember my first etiquette teacher telling me "in polite company, it is less unseemly to speak of bowel movements than political ones."  A bit graphic, perhaps, but a point well made.  Partisan speech pollutes political thought.  So, it is often refreshing to listen to non-partisan experts discuss the subject.

Today, I listened to Charlie Cook of the Cook Report and Greg Valliere of the Potomac Research Group.  While I have listened to them for many years now (and even sat next to Valliere at lunch a few years ago in Scottsdale), I still cannot tell if either has Republican or Democratic leaning .

They agreed nothing will happen this election year in Washington.  That means no talk of a shutdown and no concerns about a national debt default, which is good.  However, that also means there will be no work done on a "grand bargain" or tax reform, which is bad.

There is no possibility of Republicans losing control of the House and only the slightest probability of them gaining control of the Senate.  In other words, no change!

They pointed out the President offered some minor entitlement reform last year, but having gotten zero compromise from the Republicans on revenue, he has now withdrawn that offer.  So, we have actually lost ground achieving a grand bargain.

There had been an earlier session on the cost of NOT doing immigration reform, and Cook pointed out that there are many "Reagan" Republicans who would gladly vote with the Democrats to fix this problem but were afraid of a Tea Party challenger.  Because of this, he suggested there is a possibility of immigration reform AFTER the primary season.

Later in the day, we heard from Kevin Brady (R-TX), and our political thoughts got polluted.  This was a group of economists interested in his thoughts, as he is Chairman of the Joint Economic Committee, not a partisan political rally in Texas.  The only problem he saw was Democrats who were opposed to "the American Dream."  He made me appreciate Cook & Valliere and easily earned my vote as the least illuminating speaker of the conference.

Tuesday, February 25, 2014

News From The Marquee

Focusing just on the well-known speakers or marquee names of yesterday, here are some thoughts:

Larry Summers - this former Secretary of Treasury, who has never been known as a "warm & fuzzy" person, gave the most "academic" or boring speech.  He thinks the world has indeed changed, with equilibrium interest rates apparently stuck at zero, an unhealthy place.  To break out of this state of equilibrium, he advocates a typical Keynesian approach of massive government spending on infrastructure.

Alan Greenspan - this former Fed Head was pleasantly interviewed on stage.  He thinks interest rates will start rising this Fall.  His assessment of the economy is "more of the same," in the 1.5-2.0 percent range of GDP growth.  This disciple & personal friend of Ayn Rand advocates a typical Republican approach of reducing regulation and "simplifying" the tax code.  The basic problem with the American economy is that the American consumer consumes, as instructed by advertisers, instead of saves.

Alice Rivlin and Douglas Holtz-Eakin - both of whom have served as head of the Congressional Budget Office.  They tried to argue like the Democrat and the Republican they are.  However, because they were not holding public office and because they were talking to a pack of nerdy economists, they actually agreed on most things.  America would be better off if we allowed these two individuals to run the country for the next year.

Jean-Claude Trichet - the former head of the European Central Bank was awarded the lifetime achievement award.  He would not have been my choice.  I am thankful he retired in favor of Mario Draghi, who would get my vote.

There was also an interesting panel discussion about Obamacare.  While I expect there were an equal number of Republicans and Democrats, there was no broadside condemnation, just an acceptance that certain aspects of it need to be fixed.  As economists, they keep coming back to the counter-factual question of what would it be like without Obamacare, i.e. control by health insurance companies instead of control by a government?  Seriously, how would it be different without Obamacare?  (This makes Democrats happy.)

And, at a cocktail party in the Finnish Embassy last night, there was near universal agreement that our method of approving international trade agreements was worse than useless, and the President should have "fast track authority."  (This makes Republicans happy.)

And, that was just the first day!

In Pursuit of CE Hours

With several certifications to maintain, I am always in search of more Continuing Education (CE) hours and normally attend three different conferences each year.

First, there is the conference of the Investment Management Consultants Association (IMCA), which is a large number of aggressive young men dressed in very fitted Brooks Brothers suits.  The subject matter is a deep dive into the latest investment techniques, but they preach "Modern Portfolio Theory" like "old tyme religion."  And, they seem to murmur "don't get in my way."

Also, there is the conference of the National Association Personal Financial Advisors (NAPFA), which is a smaller number of older, white women dressed in the latest Sunday School collection from J.C. Penney.  The subject matter is a deep dive into the latest financial planning techniques, such as special needs trusts for handicapped people.  They seem to murmur "I take better care of my clients than you do."

Then, there is the conference of the National Association of Business Economists (NABE), which is a smaller number of older, white men whose ten-year old suits from Men's Warehouse would look somewhat better if they actually fit . . . but don't.  (They wear yellow sticky-notes inside their shoes that say "Do NOT tie to other shoe.")  While the subject matter is deeply intellectual, wrestling with the good of mankind, they seem to murmur "I am NOT an absent-minded professor."

It is like three parallel universes, but I have a passport to each!

Saturday, February 22, 2014

An Intellectual Feast

One of the great intellectual feasts I attend each year is the annual Policy Conference of the National Association of Business Economists in Washington, and we leave tomorrow.  Our speakers include Alan Greenspan, Alice Rivlin, Larry Summers, and Jean-Claude Trichet.  I'm always excited by this conference.

So, it is with some irony that I'm currently reading new research suggesting everybody should fire their economist.  This research studied the relationship between investment returns and country-wide predictions made by economists.  They looked at 85 countries between 1972 and 2013.  In conclusion, when economists tell you that a particular country is in trouble, then you should buy stock of companies in that country.  (I can argue with this conclusion, as the data certainly does not "fit well.")

Of course, this research ignores the job of the investment strategist, who translates economic analysis into usable investment decisions.  In fact, it was silent on the subject, suggesting a lack of information on the part of the researchers.  Still, it helps set the mood for our conference.  There are few pursuits as humbling as economics, and this latest research is a reminder of that as we enter the conference.

Stay tuned for next week's blogs . . .

Friday, February 21, 2014

A Tax By Any Other Name

All taxes are hated, and I expect no tax is hated more than the "death tax."  After all, death is certainly something we hate, especially if our loved ones might be taxed on it.  Indeed, it has been a common misconception that the death tax burden could force the sale of the family farm, leaving grandma nowhere to live.

I first became a trust officer in 1972, and that has never been true.  Common misconceptions die slowly.  For most of that time, if the primary asset of a family farm or family business was more than a certain percentage of the total estate, then the estate could pay the tax bill over a ten-year period.  Recently, the IRS held that if an asset was more than 35% of the total estate, the resulting tax could still be paid out over ten years, but that ten-year amortization period would not begin for another 5 years.  In other words, you would have 15 years to deal with the problem.

And, in case you haven't noticed, a married couple now doesn't have to pay any tax until their combined estate is well over $10 million.  In 1972, it was a mere $120 thousand.

I doubt that will cause the tax to be any less hated, but I would hope we could at least call it by the correct name, which is the Federal Estate tax . . . it was never named a death tax.  If common misconceptions die slowly, how long does it take a derogatory nickname to die?

Thursday, February 20, 2014

Embracing Squid

A few years ago, Rolling Stone magazine described Goldman Sachs as a vampire squid on the face of mankind, sucking the life out of it.  I thought there was so much truth to that statement that it must certainly appear somewhere in the Bible??  As a result, I am intellectually unable to stop using it.  However, they do have a great research department, and I follow them closely.

Their latest analysis expects weakness in the first half will be a little greater than expected, partly because the second half of last year was better than expected.  And, of course, there is the unknown impact of the unusually bad weather.  But, the Q4 earnings beat estimates by a respectable 5.8%, revealing no weakness.  They expect the economy is hitting a minor pothole, not taking a swoon.

They also emphasize the stumbling emerging markets are two speeds.  Countries like Brazil, Indonesia, India, Turkey, and South Africa are doing the stumbling while most other countries are still emerging.  This is important, as well as a good reminder why ETFs of individual markets tend to be greater risks than a mutual fund of emerging markets, generally speaking.

Interestingly, they have done some research showing there is a 57% probability of a 10% downturn in any given year but a 63% probability when the market is high, like now.  As I have said, downturns are normal healthy in the long turn.  Embrace the downtowns . . . but not vampire squids!

Sunday, February 16, 2014

U-shaped Asset Allocation

Freshly-minted financial planners invariably are taught that a worker should begin saving for retirement by heavily weighting stocks, not bonds . . . 80% stocks/20% bonds.

As they approach middle age, workers should remove some equity risk from their portfolios by reducing their exposure to stocks . . . say, 60%/40%.

As they approach retirement, it should drop even more . . . say, 40% stocks/60% bonds.

Some recent research published in the Journal of Financial Planning suggests the allocation to stock should begin increasing at some point after retirement.  The most critical period for retirees is the few years prior to retirement, when the stock market might crash at the worst possible time for them, plus the first few years after retirement, when they must cope with income decreasing faster than expenses.  The research cited several examples, but I think the assumptions drove the results and therefore discount the research.

However, in this strange market, I agree with their conclusion, i.e., holding a large allocation of stocks in a retiree's senior years is not imprudent.  Interest rates will not provide enough for retirees to live on, whereas dividends on a portfolio rich in high-dividend stocks, master limited partnerships, real estate investment trusts, and closed-end funds just might give them that income . . . as well as the courage to face retirement.

Historical Un-Cycles ?

One of the books I read last week was Next Time Will Be Different:  Why Economists Can't Predict Financial Panics and Crisis written by Brendan Moynihan, who is an executive with Marketfield Asset Management.  Obviously, I HAD to read this book!

Economists can predict almost nothing, because they are always looking for a model or a similar historical precedent, forgetting that "similarity is not sameness."  We should simply look at the facts in front of us and then make our predictions; guided but largely unrestrained by history.

He emphasizes this point with emphasis on the phrase used by every scoundrel to explain some crooked investment scheme -- it is different this time.  He is highly critical of the work by Reinhart & Rogoff, which was discussed in this space a year ago.  They argue that there are predictable patterns to economic history while admitting "we are fully aware that, in such a broad synthesis, we are inevitably obscuring important nuances surrounding historically diverse episodes."  Then, what's the point?

In addition, Moynihan does an impressive review of American recessions/depressions, pointing out the differences from popularly accepted models and the failures of public policy.  Clearly, the review shows similar economic conditions but never the same economic conditions.

He explains the weakness of models and historical precedent is that they ignore the single most important determinant, which is contemporary human behavior.  Economists want to believe economics is a science, when it is really an art.

Maybe, I should study art cycles. . .  instead of economic cycles??

Thursday, February 13, 2014

82 Degrees of Guilt

It is with mild existential amusement whenever I listen to my Baptist friends compete with my Catholic friends over which faith requires the greatest guilt.  However, this concept of guilt is seldom helpful.  Unless there is an object lesson involved, the mere carrying of guilt is absurd.

Nonetheless, my inner hypocrite is feeling guilty this morning, as I sit in Key West with a sunny 82 degrees and gentle ocean breezes, while my friends, clients, and neighbors sit in near-arctic conditions back home.

I should just feel thankful to be sitting here, not guilty.  I should be feeling regret my loved ones are cold, not guilt.  Nonetheless, I feel guilt.  In fact, I'm carrying guilt . . . right now . . . for awhile . . . until I head downstairs to the pool.

Wednesday, February 12, 2014

Where Did We Fail Them?

Some colleges are now offering an interesting new major called generational studies, which obviously looks at the differences between generations.  Frankly, it strikes me more as an amusement than anything of serious study.

The generation before me and the one after me have different tastes in music and style, which is fine.  They also have different approaches to religion and, to some extent, politics, which is also fine.  But normally, values are more constant, i.e., parents love their kids, life is better than death, kicking puppies is not cute, etc.

I thought privacy was such a value, but I was wrong.  Having privacy is no more important than not having privacy.  It is not a value.  The primary users of Facebook are young people intent on sharing the minute details of their life. They shrug their shoulders over the NSA scandal.  (Have you noticed how few people with gray hair insist on using their cell phones to broadcast a personal conversation?)

If the loss of my privacy is not important, then why makes kicking a puppy important?  Maybe, one is a value and one is not.  And, aren't values supposed to be taught by parents anyway?

Tuesday, February 11, 2014

Thru The Looking Glass

Warren Buffett has said the second most important man in his life, after his father, was Benjamin Graham, who is also known as the father of securities analysis and even wrote the definitive first work on the subject, appropriately titled Security Analysis.  He believed in the exhaustive analysis of financial statements, including detailed study of all footnotes.  Trendlines in earnings-per-share or liquidity ratios, for example, were vital in understanding any and every stock.  He was strictly "bottoms-up," painstakingly building a portfolio one stock at a time.

Graham died in 1976 but must be rolling over in his grave (whatever that means?), when he observes modern day stock market movements, where the market rises or falls by hundreds a point in a day, simply because of what some bureaucrat says.  The market has been treading water for days, waiting for today's Congressional testimony by Fed Head Janet Yellen.

If she is modestly optimistic, like Ben Bernanke, then the market will rally modestly.  If she is modestly pessimistic, then the market will sink badly.  The market is primed to hear only good news.

And, she will not mention corporate balance sheets, income statements, earnings-per-share, or corporate revenue projections.  Not even once!  Benjamin Graham would feel like Alice in Wonderland.

Saturday, February 8, 2014

Opening The Cover

For once, Wall Street did not make the mistake of judging a book by its cover, when the Jobs Report was released Friday.  Expecting that approximately 170-180 thousand jobs were created in January, the stock market promptly dropped when the Bureau of Labor Statistics announced only 113 thousand jobs had been created.  This follows the awful 75 thousand created in December, which set off the month-long slide on Wall Street last month.

However, to quote one analyst, this jobs report was simply "weird."

There are two techniques for counting the number of unemployed.  One is that employers are required to file certain reports with the government each month.  This is the number most often cited by the press.  The other technique is called the household report, in which standard polling techniques of calling a representative sample size of phone numbers and asking if they have a job.  This second technique tells a different story, i.e., that the job market actually improved significantly last month.

In addition, the labor force participation rate tells us how many people have given up and are no longer looking for a job.  It has been trending down since the recession began in 2008.  Four out of ten able-bodied workers have given up.  But, last month, that also improved.  This participation rate greatly influences the normal rate of unemployment that the press reports.  As people come back into the labor force, it causes the rate of unemployment to drop, and that is exactly what happened last month, as it dropped to only 6.6%.

Lastly, the dreaded U-6 level of unemployment, which includes the unemployed and those forced to work part-time instead of full-time, dropped to "only" 13%.  It has been stubbornly high for a long time.  Take a look at these long term trends:


The trend line is clear, albeit much too slow.  This slow pace sounded the alarm on Wall Street that Janet Yellen of the Fed might come to the rescue by slowing the taper of quantitative easing and maintaining our "sugar-high."a little longer.

So, for once, Wall Street didn't run too far with the mere headline number of 113 thousand but actually opened the cover and found there is some good (even if weird) news buried deep inside the jobs report.

But, why don't the American people believe the job market is improving?

Friday, February 7, 2014

The Problem With Economics

I've been in Tarpon Springs, Florida, this week, which has a very strong Greek population.  Several stores bragged about being part of a 1953 movie called Beneath the 12 Mile Reef, which I saw as a boy.  What I remember about the movie was the remarkable underwater photography.  (Indeed, it led to a 30-year love affair with scuba diving that took me all over the U.S., including Hawaii.)

What the movie-going public remembered about the movie was a Romeo-Juliet story, where a beautiful daughter of the Greeks falls in love with a handsome young son (played by a very young Robert Wagner) of the warring Anglos.

As a adult economist, I instead became curious why they were warring.  It seems the Anglos were hunting for conch and sponges in the Florida Keys when there was some environmental event, like a Red Tide, making it uneconomical to harvest either conch or sponges.  So, they migrated to Tarpon Springs, much to the chagrin of the Greeks who were already harvesting there.  A "war" promptly and understandably broke out.  The supply of harvesting grounds was fixed, but the demand to use those grounds increased.  Voila, War !

Now, that's the problem with economics.  You become blind to both beauty and love, in favor of simply understanding economic motivations.  How sad . . . maybe, there should be a program like AA for recovering economists? 

Wednesday, February 5, 2014

Monthly Spring-Loaded Drama

Easily, the most watched economic report each month is the "jobs report" issued by the Bureau of Labor Statistics on the first Friday of each month, which would be this Friday.  It can actually move markets.

Last month, the report showed only 74 thousand jobs had been created in December, even though 200 thousand jobs had been expected.  (It also showed the rate of unemployment had dropped from 7% to only 6.7%, but that has become an almost meaningless number.)  The media emphasized the small number of jobs created in December but ignored the fact that the number of jobs created in October and November were revised sharply upwards.  At the time, I wrote that number of only 74 thousand jobs would also be revised upwards, and we'll find out Friday if that is true.

In fairness, estimating the number of jobs created during the winter is the most difficult season to make such estimates due to the unpredictable weather, and it is probably even more difficult this winter.  Unfortunately, the stock market still reacts the same to the number.

Right now, the market is expecting 170 thousand jobs were created in January.  If the report says anything less than 150 thousand, the market will sink.  If it says anything more than 190 thousand, the market will rally.  The monthly ADP report of jobs created in the private sector was released this morning, and it was slightly disappointing at 175 thousand but down substantially from the 238 thousand jobs created in the private sector in December.  That will likely reduce expectations from 170 thousand to something lower, and the range will move lower as well.

Until the Friday morning release, the stock market normally just treads water . . . waiting . . .

Tuesday, February 4, 2014

The Old One-Two Punch

The stock market certainly took a drubbing yesterday.  Of course, as an investor who embraces such corrections as good for the long-term health of the market, I'm not losing any sleep at all.

But, I have been thinking about the depth of this correction.  Technically, it is not a correction until the market has fallen 10%, and I've been expecting a 5-10% dip.  However, in addition to a normal, healthy correction, the market is getting hit with worries about emerging markets.  This suggests it may be a 10-15% correction, instead of a 5-10% one.

This is one reason.  So far this year, the Dow is down about 7%, while the S&P is only down 5%.  The small and mid-cap stocks are down even less.  In other words, the mega-big multi-national companies are getting hurt worse than smaller companies, reflecting their greater exposure to emerging markets.

That suggests the Dow is only halfway down, and some people will undoubtedly lose some sleep, which is unfortunate.  At this rate, that means another month of bad news.  It also suggests that growth investors should hide in small caps for awhile.

The good news is that there is still no evidence of a financial crisis, maybe a currency crisis or even a good old-fashioned recession . . . but no financial crisis . . . Whew!

Monday, February 3, 2014

China Rising . . . more slowly

One of the reasons the stock market has been lackluster so far this year is fear of a slowdown in China, having a ripple effect on other emerging markets.  Their PMI (Purchase Managers Index) has been signaling a mild slowdown.  The world is afraid of a big slowdown.  I don't think that will happen.  Take a look at this nugget from CNBC:

The important thing to notice is that the share of GDP held by exports is decreasing and the share of consumption spending by people is increasing.  As we've said in this space before, China is wisely trying to shift their economy from being export-oriented to consumption-oriented.  This normally causes GDP growth to stall temporarily.  While we will probably never see 10% growth rates again in China, we are more likely to see 7% growth than 2% (which is where the U.S. has been for many years).

Also,  while their debt is raising fast, don't forget they have a trillion dollars worth of U.S. Treasury bonds, they can use to pay down the debt. Of course, they will have to exchange the bonds for the debt, rather than selling the bonds, but the point is that they can handle their debt. And, there is evidence they are reducing the growth of their debt.

Don't worry about China having a "hard landing."  However, if you do want to worry, then worry about the currency crisis that is building among the emerging nations, which some analysts believe is related to the reducing level of quantitative easing.

(Normally, I worry a great deal about the opaque derivatives market, where nobody knows who is betting how much against whom or what nor when.  Currency derivatives are less opaque than traditional ones, which means I worry less.) 

Saturday, February 1, 2014

The January Effect ?

The old Wall Street adage is that "as January goes, so goes the year."  In other words, 2014 will be a losing year because January was a losing month.  Let's hope that was not true, as the S&P 500 lost 3% this January, which was the first January loss since 2009 and the largest decrease in eight months.  (The Dow lost 5%.)

So, how reliable is that old adage?  Well, it has been right 73% of the last 85 years.

Those are great betting odds!  But, should you bet against it being right this year?

History also teaches us that 5-10% corrections are actually healthy for the stock market, pushing it even higher.  I've been hoping to see that correction soon and think we are now in it.  In addition, given the big increases in stock values last year, prudent investors stopping selling their stock late in the year, in favor of taking their taxable capital gains in January, pushing down the market temporarily.

Recent history does cause me a little loss of sleep.  Remembering the Spring of 2010 and again in 2011, our stock market was improving nicely, when we were ambushed by the slow-motion-train-wreck that was Ireland-Greece-Europe-Cyprus.  Right now, I expect the currency crisis in the emerging markets will merely slow down the growth rate of multi-national large-cap companies and do not expect any significant damage to the overall economy or the stock market.  But, it is worth watching carefully.

Stay tuned . . .