Kudos to Harvey

A month ago, we were Democrats & Republicans, conservatives & liberals, blacks & whites, neo-Nazi's and Black Panthers.  Underneath all those pejorative labels, we are sometimes reminded that we're all Americans.  Watching the huge non-governmental response to Hurricane Harvey, we are reminded of that and should be proud of ourselves.  I salute all those thousands of volunteers who are helping the victims of Harvey.  We are there for each other!

But, there is more to this.  Underneath the pejoratives, we are Americans.  Underneath that, we are human beings first.  It is our nature as humans to protect our species -- other humans.  Why then does it take a crisis for us to act human?

From an economics standpoint, unlimited wants for limited resources will produce inevitable conflict.

Capitalism used to be called an economic system, but it is now a religious system and must be respected as such.  If loud, intrusive TV commercials can increase sales by even 1%, it is our duty to accept them as necessary.  If permeable surfaces increase construction costs by even 1%, it is unfair to expect builders to bear that cost.  If the worship of capitalism causes any problem, it is our duty to remember it is indeed the greatest economic system in history.

From a political standpoint, our leaders have been coarsened by the discrimination against moderates that is produced by gerrymandering.  Extremist leaders will not lead us to the same place as moderate leaders.  Extremist leaders have led us astray.

The next time you grimace at the news and tolerate the loud commercials, rejoice that our extremist leaders were freely elected (albeit from gerrymandered districts), and you are free to worship the greatest economic system in history.  If you find that insufferable, rejoice -- there is always the next crisis, when we can be humans again.

A Good Problem ?

There is a nation that is considered wealthy, where workers earn good wages.  There is another nation that is not wealthy, where workers earn lower wages.  For some reason, workers earning low wages migrate to the wealthy nation, where they can earn a better living for their families.  The leader of the wealthy nation becomes indignant, insisting these immigrants are taking jobs away from his higher-paid workers and accuses the non-wealthy nation of "social dumping."  The leader of the less-wealthy nation is offended and insults the intelligence of the other leader. calling him "arrogant."

You are forgiven, if you assume that we're talking about the United States and Mexico.  Instead, we're talking about France and Poland.  The latter has exported about 450 thousand of its Polish citizens to other EU nations, while France has imported about 175 thousand of the cheaper workers.  Germany has imported about 400 thousand cheaper workers from other EU nations.

We like to say that "capital flows to where it is most appreciated," meaning that capital leaves nations with low interest rates and goes to nations with higher interest rates.  So does labor - it flows to where it is more appreciated.  Poland has more workers than jobs.  Those workers then go where the jobs are.  This importing and exporting of workers is not new.  Slavery is but one example.  (Remember:  it is better to be a net importer of labor than an exporter.)

There are two differences.  First, since France and Poland are not contiguous, no "Great Wall" would help stem the flow.  Secondly, within the European Union, workers are allowed to migrate and are not "illegal" immigrants.  They are called "posted workers."  The economic demand for workers doesn't care if those workers are documented or undocumented.  There is an economic need to be met.

Laws usually prevail in the short run, but economics will prevail in the long run.

Slow-Motion Tragedy

It was a year after Katrina devastated New Orleans that we happened to attend a conference that was held in the French Quarter, which was almost untouched by the hurricane.  My wife said that unique aroma of the French Quarter was stronger but otherwise the same.  Knowing there was devastation all around us, we were offered a chance to extend our visit to spend a day helping with their recovery.  It was unforgettable.

We were taken to a small neighborhood of modest homes built on slabs.  There was almost no sound , with only a few birds.  It was mostly deserted.  A few homes had tiny trailers in their front yard, smaller than any camping trailer.  Each trailer consisted of one room, containing a bed, a refrigerator, a microwave, and a tiny bathroom without a shower.  At the house where we worked, we met Irene.  She was about 65-years-old, short and wide, and had obviously never been afforded an education.  The renovation of her home was relatively far long, and we spent the day, mostly painting fresh drywall.

Three things have stuck with me.  First, she had a small shed in the back yard with asphalt shingles for a roof.  Yet, a limb with a 3 inch diameter pierced that shingle roof at a 90 degree angle.  It is hard to imagine such wind power.  Another mental image was her one-piece fiberglass bath tub.  The scum line was about a foot from the 7 foot ceiling, which meant the water was six feet deep inside her house.  It was a wonder that the house survived.  The house next door was boarded-up with condemned signs posted on it.

But, the strongest memory is Irene, probably a victim of discrimination and poverty all her life.  She was so thankful, so appreciative, such a sweet lady.  It was an honor to have helped her in some small way.

Today, I will break my 24/6 rule to avoid news on Saturday.  I know there must be many thousands of "Irenes" in coastal Texas.  I care about them and pray they stay safe from the hurricane and the inevitable flooding afterwards.  As I look out my window over the Chesapeake Bay, I mutter under my breath . . . "there, but for the grace of God . . ."

Still A Healthy Mind

There are many pundits and thought leaders that I listen to, but I have a certain fondness for one in particular, i.e., Jeremy Siegel of Wharton.  Unfortunately, he is having serious health issues, and he is in my prayers.  During his treatments, he is visited weekly to capture a few thoughts for those of us who appreciate him.  Here are two of his latest:

"Professor Siegel still believes that there will be corporate tax reform this year—personal tax reform is going to be much harder with all the sacred cows on deductions that will need to be negotiated. Siegel also believes Trump will sign any tax legislation the Republicans put in front of him—so the key is for the Republicans to get past the debt ceiling discussions in September and then hammer out the details of these tax plans.

On the economic front—retail sales news came in above expectations and Michigan Consumer Sentiment index came in very strong—highest levels since January."

His first point, about tax reform, is not surprising, and I agree.  His second point about the retail sector is more important.  Stocks in the retail sector have been badly trashed this year.  It may be time for some bottom-fishing . . .

How Many Is Enough?

2,388 -- That's the number of American mothers who lost their sons in Afghanistan.

One of the first things taught in the Special Forces Officers Course was that the ultimate weapon is not the atomic bomb.  It is the guerilla -- small, agile, and capable of a thousand pin-pricks.  In order to win the war, conventional forces must win battles.  In order to win the war, guerilla forces must not lose battles.  Guerillas can just run away and live to fight another day.  It is much cheaper to maintain guerilla forces for long periods, compared to the cost of maintaining conventional forces for long periods.   It has been sixteen years already in Afghanistan at a cost way over a trillion dollars.

4,497 -- That's the number of American mothers who lost their sons in Iraq.

Maybe, there is some reason to believe we can "win" a war with conventional forces, where the conventional forces of Britain and the Soviet Union were defeated.  I have not heard that reason yet.

58,226 -- That's the number of American mothers who lost their sons in Vietnam.

No president wants to accept the loss of a war during their watch, and I understand that.  At some point, however, accepting the obvious is better than breaking the hearts of any more mothers.

Faint Praise

I have been a member of the National Association of Business Economics (NABE) for many years.  While it is strictly a non-partisan organization, it is on the more conservative end of the political spectrum, especially compared to the more liberal American Economics Association, which is favored by academic economics.  NABE is a voice for working economists, outside of academia.

In their latest quarterly review, only 14% of NABE respondents believe the President's executive actions on immigration will be beneficial for the economy, while 65% believe those actions will hurt the economy.

When asked about the President's executive actions on foreign trade, only 13% of the respondents believe those actions will help, while 59% believe those actions will hurt the economy.

Obviously, few economists are part of the President's "core supporters."

24/6

Sometimes, I feel like a nag.  You don't need to watch the news 24/7.  It is unhealthy, especially now that the news has devolved from partisan bickering to complex investigations to the President's moral compass.  Like all things, moderation is the key.  Take a 24-hour vacation from the news.  Watch Netflix.  Read a book.  Take a walk.  Take time to find out what your spouse or kid really thinks.  Whatever you do, stop watching the news 24/7!  Take the day off . . .

Two Good Legs . . . only

I've been expecting a significant market correction since Spring and used a tripod to explain it.  One leg supporting the market is economic data, which has been reliably good.  That data has not been great -- just good enough to be sustainable over a long period.  We have examined the numerous economic cycles but concluded they are irrelevant in this economic environment, where normal market forces have been suspended by the Fed.

The second leg is stock market data.  Stock valuations or PE ratios are high but not historically high.  Trading volumes have been relatively modest, which suggests the market is vulnerable to a downdraft, but that is not predictive.  Sure, the S&P 500 is approaching its 50-day-moving average, but that usually just indicates a buying opportunity.  While some attribute the market's record performance since the election to being simply a "Trump Bump," I note that corporate earnings have been increasing strongly since Q3 of last year.  Corporate profits remain strong, although comparisons will start to suffer with Q3 earnings of this year.  There is also an obscure technical indicator called the Hindenburg Omen, indicating a market crash, but it has little obvious logic and a bad reputation for predicting crashes that never happened.  More than anything, I worry about a Minsky Moment, when the debt balloon bursts, and the only protection from that is to sell quickly once it starts.

The third leg is geopolitical information.  The turmoil in the White House has spooked the stock market for sure but not as badly as I expected.  The market was unnerved by the loss of support from CEOs but not badly.  If cabinet members start resigning, the stock market will be very unhappy.  We have studied the market impact from impeachment and found no consistent pattern.  The stock market will applaud when certainty is restored.  If the President resigned this weekend, for example, and the Vice President took over, the legislative agenda would be unchanged and, more importantly, no longer unrealistic.  That's probably good for a 500-point jump in the Dow.

An important component of geopolitical information is international.  Don't forget the lesson of  South Korea during the 1990s, when its economy suddenly shifted gears from booming to staggering, because it was blindsided by currency problems in Thailand.  We too can be blindsided from abroad.  The good news is that the rest of world is experiencing solid economic growth and are not likely to push their problems into our economy.  Of course, it is unclear how badly affected our economy would be impacted by a nuclear skirmish with North Korea, but it would be temporary.

I think the combined weight of the White House woes and the possible conflict on the Korean peninsula is all the weight that the geopolitical leg can handle.  As that leg weakens, the stock market weakens.

"Amazonization"

Many people believe that Amazon is consuming a larger and larger share of retail sales, leaving small retailers vulnerable. (The President is among those people.)  Small retailers have long been an important part of the economy but are declining.  Yesterday's retail sales report seemed to confirm that, because it showed that online sales increased 1% in June, 1.3% in July and up 10.3% year-over-year.  Online retailers like Amazon are doing very well.

But, the best segment was small retailers, whose sales rose 1.8% in July after declining 1.7% in June.  Of course, one month does not make a trend, but there are other reasons to be optimistic.  Furniture sales were up nicely in both June and July, as well as food & beverage sales, health & personal care, and hobby stores.  Healthy small retailers suggest Amazon may not be as anti-competitive as some fear.

But, what about large retailers, who also have been suffering the past year?  Today, Target released their Q2 report, which shows sales and profits were better than expected, both at the corporate level and the same-store level.  Hopefully, this will continue, especially among department stores.  Dick's Sporting Goods says the retail market is still awful.

Increasing retail store sales is a prime indicator of the financial health and the confidence of the consumer, the biggest single component of GDP.  This improved retail outlook suggest that the currently estimated GDP growth rate of 2.8% is too low.  If it hits 3.0%, you can expect to hear champagne corks popping on Wall Street.

Don't worry, Mr. Bezos, a healthier economy is good for Amazon too!

Memories . . .

I truly miss . . .

President George W. Bush and . . .

President George Bush and . . .

President Ronald Reagan and . . .

President Gerald Ford and even . . .

President Richard Nixon!

Hillbilly Retirement

Long before JD Vance wrote the groundbreaking Hillbilly Elegy last year, my cousin referred to Social Security Disability Insurance (SSDI) program as the "hillbilly retirement system."  She noted her family relatives in the Appalachian region looked forward to "getting on disability" since there were so few jobs worth having.  Sadly, she was right!

In 1997, there were less than 4.5 million Americans receiving disability.  In 2015, there were almost nine million Americans receiving disability.  This is costing us about $150 billion each year.  Plus, after two years on disability, the former workers become entitled to Medicaid, which is already costing us $80 billion each year.  The runaway growth of the SSDI entitlement began with a loosening of the appeals process, where a full 70% of SSDI denials are now being reversed by the administrative law judges, who have lifetime appointments.  Drive through the Allegheny region, and you will see countless billboards advertising legal help in navigating the disability process.

In 2015, more than a hundred police officers in New York City were charged with defrauding SSDI by alleging they have "anxiety issues," justifying disability payments equal to 75% of their base salary.

There is no good idea which cannot be abused!

Each person receiving disability payments is removed from the unemployed, which reduces the unemployment rate, which is already very low.  At the same time in the same country, there are more job openings than anytime in our history.

"Structural unemployment" is the name for the unemployed who are in the wrong place or have the wrong education and is the most difficult to reduce . . . unless you put them on disability.

Not Now . . . Later

The Volatility Index or VIX is an option allowing investors to make bets (as opposed to investing) on the volatility of the stock market.  It is often called the "Fear Index" - as fear rises, so does the VIX.

The VIX has been low and boring since the November election.  But, it suddenly spiked almost 50% last week -- actually in just two days -- before declining somewhat by closing on Friday.  Obviously, this increased volatility (fear) was a result of fear over Korea.

I recall reading an econometric analysis a few years ago predicting the stock market would decline 10-15% with an outbreak of war on the Korean Peninsula, before beginning the inevitable recovery.  That analysis, as I recall, assumed it would be a conventional war with South Korea doing most of the fighting.  It dismissed any analysis of a nuclear event, because there is so little economic data following nuclear events.  That is truly unknown territory.

What is interesting to me is the willingness of other nations to get involved.  It is reminiscent of two bellicose spoiled-brats on the playground  -- bumping chests, with more ego than brains.  Eventually, the adults show up to de-escalate the situation.  In this case, China and Russia showed up and are actually being constructive.  It is clear that China has much to lose, but Russia's involvement is less understandable.  It is certain that other nations are working in the background.  It is rumored that even Germany's Merkel is working hard behind-the-scenes.  She is an adult and not trigger-happy!

I remember that Hitler decided to begin World War II when Germany was cut off by the bond market.  That meant that Germany could no longer borrow money to make their military stronger.  When his military reached maximum strength, he invaded Poland.  Assuming they are enforced, the latest sanctions against North Korea approved by the U.N. Security Council will begin a slow strangulation of that country, until Kim Jung Un feels his military strength will begin to wane.  Why wouldn't he launch a war at that point?

My expectation is that the spoiled-brats will be separated at this point, but that a future war is inevitable.

Getting Normal Again

Imagine a tsunami of corn, for example, being dumped on the market.  The value of corn per bushel would plummet because supply greatly exceeded the demand for corn.  That is one of the worries overhanging the bond market right now.  The Fed could release a tsunami of government bonds on the bond market IF they suddenly reduced their balance sheet to a more normal level.  And, what happens when the value of bonds drop?  Interest rates are forced up, in order to be competitive and sell the bonds.

When the global financial crisis began in 2008, the Fed's balance sheet was only about $800 billion, roughly the amount of currency-in-circulation.  Then, there was quantitative easing I (QE1), followed by quantitative easing II (QE2) and quantitative easing III (QE3).  By then, their balance sheet had swollen to an astronomical $4.5 TRILLION.  They had acquired the $2.7 trillion of bonds issued by the Federal government to fund the massive deficit spending during the global financial crisis, as well as another $1.8 trillion of mortgage bonds to keep interest rates low on home mortgages, supporting the huge housing market.

If the Fed sold all $4.5 trillion of bonds suddenly, the bond market would certainly crash, taking the stock market down with it.  This is NOT news, and there is no chance the Fed will actually do this.  However, the Fed must start normalizing its balance sheet at some point.  Their plan is to start selling  about $10 billion per month and to increase that amount quarterly.  If the market cannot handle that, the Fed will stop the selling, but I'm confident it can handle a relatively modest amount like that.

The Fed said they might begin late this year but is more likely to begin next year.  It is expected to take about five years to get the balance sheet down to the $1.5 - 2.0 trillion, which would again be about the level of currency in circulation.

It is going to happen.  The amounts will be modest.  It can be stopped at any time.  Still, the market is quite worried about it.  I'm not!

Small Blog for a Big Number

6,160,000

Six million, one hundred-sixty thousand -- think about that number a while.

That's the number of job openings in the United States.  It is the highest in history.  There has never been so many jobs available.  It is no wonder that our unemployment rate is only 4.3%.  In fact, hiring is decreasing only because the supply of available workers is shrinking.  There would be more hiring if our labor force was larger.

Think about that number of people, over six million souls, whose lives would be greatly improved if they had one of those jobs.  (The population of Virginia is barely 8.4 million.)  Now, I'll bet there is somebody in your family who cannot find a job??

America's Tolerance

We took a road trip recently.  Like any long-suffering but loyal fan of the Dallas Cowboys football team, I was wearing a white golf shirt, with a blue star on the left side,  At the first stop for coffee, I was standing at the coffee bar pouring a cup, when an older man leaned over to quietly whisper in my ear "Be careful -- this is Redskins country!"  I turned to see him smile and then walk away.

At a pit stop in Hardee's (which is the only reason to ever go to a Hardee's), I heard a thunderous voice announce "hey you, you better get yourself on out of here!  We don't serve your type here!"  I turned to see a large woman behind the counter laughing, along with her co-workers.  When I left, I told her I was going someplace that would serve my type.  She laughed and waved good-bye.

At the last stop, I was waiting in line to pay, when a large man with a large belly and even larger smile, wearing a Redskins tee-shirt, poked his finger into the star on my chest, saying "That's a girl's team.  Real men love the Redskins."  I laughed, saying "Yeah, but they're not America's Team!"  He laughed and walked outside.

Later, I wondered how the day would have been different if I had been wearing a shirt that said "I'm a Democrat" or "I'm a Republican."  Football, like most team sports, celebrates our differences.  Politics doesn't!

What is more important than religion?  Yet, we don't get incensed whenever we meet a Protestant, a Catholic, or a Jew.  Religious differences are better tolerated than political differences . . . why?  Maybe, it is because the media doesn't push breathless 24/7 coverage of our religious differences?  Maybe, it is because political differences are about power, and that's far more important than religion?

Economic Fortune-Telling

My first course in economics was during my junior year of high school.  It was the first time the course was offered at that school and should be required in all high schools.  However, the teacher was often less-than-serious.  He once joked that the reason you never see fortune-tellers and economists together is because they are the same people.  Of course, he was the only one who laughed.  Yet, it made the point that there is some perceived relationship between the two, i.e., fortune-telling and economic forecasting.

Then, he tried to teach economic cycles, explaining that it is easy to forecast if you know where you are in the economic cycle.  I knew that was too simplistic and was determined to learn more.  I learned there is no one agreed-upon economic cycle.  There are short inventory-related cycles every 3-5 years called Kitchins.  There are longer cycles of 7-10 years called Juglars, which reflected the level of fixed investment.  There are even longer infrastructure-related cycles every 15-25 years called Kuznets.  And, there are very long technology-related cycles of 45-60 years, called Kondratiev cycles.  Maybe, forecasting based on economic cycles was more complicated than my high school economics teacher realized?

Eventually, all this led me into the world of Joseph Schumpeter, an Austrian-born professor at Harvard who died in 1950.  Eleven years later, his classic The Theory of Economic Development was published posthumously.  He argued that these cycles are not synchronized.  When one is down, another will be up.  This creates a stationary state in the economy.  While he believed each of these cycles existed, the only one he felt worthy of concern was the super-long Kondratiev cycle of 45-60 years.  Now, assuming the Great Depression began with the Crash of 1929, then we were due for another in 1989 . . . oh, well.

While the business cycle cannot be "repealed," cycles have become less obvious in recent years.  Most economists would agree this is primarily due to improved economic information creating better economic forecasting.  I would add that the world of Schumpeter was very different from the world of today.  The government has a much larger role in the economy today, especially the Fed.  It is clear to me that 2008 could have been the start of another depression, except for the ongoing transfer payments, which supported the level of consumer demand, and the Fed, which supported the level of liquidity.  It was a different world.

Increased governmental involvement will not "repeal" the cycles, but it may have lengthened the cycles.  However, it is unknown whether it increases the severity of the cycles.

The Wisdom of Ancients ??

Three scholars -- Brinson, Hood, & Beebower -- published a study in 1986 of 91 large pension funds' investment performance from 1971-1983.  They consolidated individual investments into asset classes, i.e., stocks, bonds and cash.  They found that 93.6% of their investment performance resulted from their asset allocation, i.e., the percentage allocation to stocks, to bonds, and to cash.  Investment performance was not a function of wise investment in individual securities, like a particular stock or bond.  It was a function of asset allocation.  In 1991, they repeated that study again and found it was only 91.5% -- very convincing indeed!

It was like daybreak in the investment world and passive investing or index investing was born.  The buzz words of "asset allocation" became sacrosanct.  That study quickly became the "conventional wisdom" among many investors, which is unfortunate, because it made the fatal assumption that bonds were a safe investment.

Importantly, that study was conducted in a normal interest rate environment, unlike today's super-low interest rate environment.  When interest rates rise, the market value of bonds fall.  So, what happens to the 60/40 investor whose 40% is invested in AAA-rated long-term Treasury bonds?  Answer:  He gets crushed.

The problem is magnified for the income investor, who needs to maximize income from the portfolio.  In a normal interest rate environment, he would increase his allocation to bonds, because that is where the income should be.  Unfortunately, that is not true in this environment..

Likewise, the problem is magnified for the investment advisor, who carefully helps his client complete a risk questionnaire, which then suggests more bonds for conservative investors, creating certain losses in market value when interest rates rise -- for a conservative investor.  A large allocation to bonds in this interest rate environment is NOT conservative.  Even worse, regulators are schooled in the conventional wisdom and expect advisors to practice conventional asset allocation.

To my knowledge, the famous "BHB" study has not been replicated, but it needs to be suspended until we finally return to a normal interest rate environment. 

AU Breakout?

Gold has enjoyed a nice run so far this year.  Technicians believe gold may soon enjoy another run up.  Take a look at this graph:

Technicians see that the price approached the red line of resistance once last year and once again this year.  Each time it approaches that line, it is more likely to break that line than the time before.

I'm not inclined to believe that, as gold is a hedge against inflation, which doesn't exist.  Or, gold is a safe refuge during a crisis, like a major war.  Or, gold is simply a 5% part of the normal asset allocation in a portfolio.  I don't see any reason for another bull run, and I'm not buying any gold at this point.  Of course, I'll always keep an eye on this chart.

One Tough Kid

He was as tough as anybody I ever met,
as tough as any crusty Special Forces sergeant.

Yet, he was only 19 when he died last week,
barely five feet tall and still wearing diapers.

A victim of severe Autism and probably Down Syndrome,
he could not walk and barely recognized his own name.

A survivor of countless surgeries, treatments, and procedures,
he never complained.

Always happy to see people,
his smile could melt an iceberg.

He "graduated" from high school,
even taking the head cheerleader to the prom.

Hundreds of people showed up for the visitation,
to say good-bye.

What an inspiration!
It was a privilege to have known him!