Wednesday, August 31, 2011
Tuesday, August 30, 2011
Calculated Risk posted some great recession measure "drawdown" charts:
Sunday, August 28, 2011
My recent post Corporate Profits, Economic Growth, and Equity Valuation outlined that equity performance can be quite volatile, but over the long-run tends to mean revert back to its underlying factor... economic growth.
I took all of the historical market performance of the S&P 500 (including dividends) and invented a hypothetical long-term bond that matched the market’s monthly gains step-for-step.
I assumed that it’s a bond of infinite maturity and pays a fixed coupon each month.
While I expected a strong relationship between the above chart with forward equity returns (the model is driven by equity performance, but accounts for the market being rich / cheap to its long-term trend and normalizes returns using backward and forward looking performance), I was surprised by how closely it tied (data was pulled from Irrational Exuberance).
There’s one hitch, though. I have to choose a starting yield-to-maturity for the beginning of the data series in December 1925. So this isn’t a completely kosher experiment because the starting point is based on my guess.
I personally think the administration did a great job.Much like Y2K, the preparedness leads to the letdown. Lack of preparedness leads to panic if things go wrong. Lower Manhattan dodged this by mere inches. Loads of coastal areas did get sacked.
Among those of us who price risk for a living there is a saying: "buy 'em when you can, not when you have to." Bear-runs and short-squeezes are actions of the well capitalized trying to beat the ever-loving-shit out of the unprepared. No one is more well capitalized than Mother Nature.
Friday, August 26, 2011
A relatively quiet week at EconomPic, but posting a weekly recap because I simply wanted to share a song that I can't get out of my head (love this tune):Corporate Profits, Economic Growth, and Equity Valuation
Scott Grannis asks:
Corporate profits are fantastic—what's wrong with equity prices?
President Barack Obama on Friday warned Americans to take Hurricane Irene seriously and urged them to obey orders to evacuate from the path of what is likely to be an "extremely dangerous and costly" storm.
"All indications point to this being a historic hurricane," Obama said in a statement to reporters from the farm where he is vacationing on this island off the Boston coast.
Thursday, August 25, 2011
The Street outlines that continuing claims are continuing to trend down:
The total number of Americans filing for unemployment look a bit better than the initial claims data. Continuing claims for the week ended Aug. 13 fell to 3.641 million from 3.721 million, reaching the lowest level since September 2008. Economists were expecting the reading to come in at 3.7 million.While this is not in itself a bad thing, it requires additional research to determine if it is in fact a good thing. The problem is that individuals are losing coverage as the length of many of those unemployed has extended well past the length they can receive benefits. In addition, the number of newly unemployed is unlikely to grow at the same pace even if the economy remains under pressure, as the overall number of individuals employed is smaller and "low hanging fruit" (apologies to anyone that is unemployed) were already laid off.
To account for some of this issue, the chart below shows the level of continuing claims since 2007 (which shows the peak in continuing claims in 2009), plus the increase in the number of individuals not in the workforce over that time to account for those no longer collecting unemployment.
Source: DOL / BLS
Wednesday, August 24, 2011
FT Alphaville asked if this two day decline in the price of gold was the Kiss of Death for Gold?, while Nouriel Roubini compared the recent run up to the Nasdaq bubble. Others simply noted that the two day decline gets prices all the way back to where they were... last week.
Expect more pressure over the next few days as the CME Group ups margin requirements to match the recent run up in the price of gold. Per Bloomberg:
CME Group Inc. raised the margin requirements on gold trading at its Comex unit for the second time this month, after prices surged to a record above $1,900 an ounce and then plunged today by the most since March 2008.I am in Nouriel Roubini's camp in that I do believe the gold run (i.e. bubble) will pop in impressive fashion, but I am not ready to claim that moment is about to occur when gold continues to make new highs each month. As I said back in March 2009:
The minimum cash deposit for borrowing from brokers to trade gold futures will rise 27 percent to $9,450 per 100-ounce contract in the speculative Tier 1 category at the close of trading tomorrow, Chicago-based CME said in a statement. On Aug. 11, the increase by the exchange was 22 percent to $7,425.
Source: Yahoo Finance
I've learned my lesson with the Internet Bubble (and recent housing bubble) that most people are illogical and invest based on fear (sometimes fearing loss, sometimes fearing they will miss out on the next big thing) and money can be made even if the premise makes absolutely no sense in the long run. As long as fear reigns supreme and equity markets remain volatile, there will be plenty of people convinced gold is the only "safe" investment.
My expectation is that eventually the golden bubble will run its course and come crashing back down to earth. If the economy gets worse, people will realize you can't eat the stuff and investors will sell their stakes to pay for necessities. On the other hand, if the economy recovers, investors will have much better opportunities with their capital… as I mentioned Tuesday, asset inflation, especially in precious metals, serves no economic purpose in the long run.
Interesting day. Equities, fixed income, and gold reversed course for the second day in a row after huge runs in the other directions the previous weeks / months, but commodities, EM (equities and fixed income), and non-US currencies didn't participate in the festivities.
I still don't understand these markets at this time (I feel like I would simply be speculating the impact of Bernanke's Jackson Hole comments), so I am largely sitting on the sidelines until I have a better framework for how to play this.
Source: Yahoo Finance
Sunday, August 21, 2011
I know some readers will point out that an individual can always choose to add more risk to increase their returns, but what happens if that investment doesn't work out? An even higher level of savings, which they may not be willing or able to do.
Friday, August 19, 2011
Inflation (Not Yet) a Concern
And the EconomPic song of the week; one of the best mashups I've heard in a while... Jay-Z + Toto = Girlfriend in Africa
Let's rewind... the Economist detailed back in November:
Even before the Federal Reserve unveiled its second round of quantitative easing (QE) on November 3rd, critics had already denounced it as ineffectual or an invitation to inflation. It cannot be both and it may not be either.
The announcement of “QE2” was hardly breathtaking. The Fed said it will buy $600 billion of Treasuries between now and next June, at about $75 billion a month, although it also said it could adjust the amount and timing if need be. That was about what markets expected but far less than the $1.75 trillion of debt it bought between early 2009 and early 2010 in its first round of QE. Yet QE2 seems already to have exceeded the low expectations it has aroused. Since Ben Bernanke, chairman of the Fed, hinted at it at Jackson Hole on August 27th, markets have all done exactly what they should. Under QE the Fed buys long-term bonds with newly created money. This lowers long-term yields and chases investors into riskier, alternative investments.
On the basketball court that is. ESPN details:
Georgetown's tour through China turned ugly Thursday when a game between the Hoyas and the Bayi Rockets, a Chinese professional team, ended in a bench-clearing brawl.
Mex Carey, Georgetown's sports information director, told ESPN.com that the game was "very physical," with 57 free throws taken by Bayi to just 15 for Georgetown, and quickly spun out of control.
According to the Washington Post, coach John Thompson III pulled his team off the court with the score tied at 64 midway through the fourth quarter after the teams exchanged punches.
Thursday, August 18, 2011
So.... is there a value in comparing the relative attractiveness of equities to fixed income? Sure. I would say the likelihood of equities outperforming Treasuries over the next eight years is high. But don't confuse relative attractiveness and attractive. Ten year Treasuries are currently yielding just 2%, so the 4% "excess" yield of the S&P translates to only 6% on a non-cyclically adjusted basis (using cyclically adjusted earnings it's less than 5%). As the chart above indicates, there have been plenty of occasions where equity performance has significantly under performed its yield, even over extended periods.
The AFP details:
Inflation roared back in July at the fastest pace since March, squeezing consumers just as the economy appears to be veering toward recession, government data showed Thursday.
The inflation numbers came amid a batch of worse-than-expected data on the jobs market, manufacturing and housing, and as US and European stocks markets plunged on rising recession fears.
A sharp rebound in gasoline prices and continued increases in food prices drove last month's inflation surge, the Labor Department said Thursday.While I am concerned with excessive inflation over the longer term if the Fed determines they should pursue an "inflation or bust" policy (the alternative as I see it is painful deflation... a lose lose if you ask me), the latest figure does have me less concerned with inflation over the nearer term. As can be seen, the higher than targeted inflation level is almost solely due to higher crude prices feeding into gas prices. This has already reversed in part this month.
Wednesday, August 17, 2011
Updated version (the charts only) of my October 2010 post On the Value of Gold:
I've been a gold bull for a while now (see my post Ready to Ride the Golden Bubble from March 2009), but my rationale was more behavioral in nature. But now, Crossing Wall Street has a fascinating post on a possible model (or at least a framework) for the price of gold, which indicates we are nowhere near the peak.
I highly recommend reading the full post as it provides a nice background for why the model may work, but to the magic formula:
Whenever the dollar’s real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%. It’s my contention that this was what the Gibson Paradox was all about since the price of gold was tied to the general price level.
Now here’s the kicker: there’s a lot of volatility in this relationship. According to my backtest, for every one percentage point real rates differ from 2%, gold moves by eight times that amount per year. So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate (that’s been about the story for the past decade). Conversely, if the real rate jumps to 3%, then gold will drop at an 8% rate.I wanted to see for myself, so I took Eddy's model and updated real T-Bill rates with historical T-Bills rates and historical CPI figures going back to 1951, then sized it so the output matched the current price of gold (this was not resized in the updated post).
And while he is not trying to explain 100% of gold's movement, but rather the factors that drive that movement... the result in itself is rather impressive to say the least.
His six takeaways (summarized):
- Gold isn’t tied to inflation, but rather tied to low real rates (not always one in the same)
- When real rates are low, the price of gold can rise very, very rapidly
- When real rates are high, gold can fall very, very quickly
- Gold should not (and does not) have a long-term relationship with equities
- Low rates are likely to last for a long period of time
- Gold price is political; central bankers can crush the price if desired (i.e. raise rates)
US PPI increased 0.2% in July, following a -0.4% drop in June, according to data released by the Bureau of Labor Statistics. The result is a notch higher than the expected 0.1%. On an annual basis US PPI increased slightly in July to 7.2% in comparison with 7% registered in June. Analysts expected the indicator to remain unchanged at 7%.
US PPI excluding Food and Energy moved up from 0.3% in June to 0.4% in July, exceeding expectations of a 0.2% rise. On an annual basis US PPI excluding Food and Energy increased to 2.5%, after growing 2.4% in June and above forecasts of 2.3%.
Tuesday, August 16, 2011
Industrial production advanced 0.9 percent in July. Although the index was revised down in April, primarily as a result of a downward revision to the output of utilities, stronger manufacturing output led to upward revisions to production in both May and June. Manufacturing output rose 0.6 percent in July, as the index for motor vehicles and parts jumped 5.2 percent and production elsewhere moved up 0.3 percent.While output and capacity utilization increased, they are both still well below pre-2008 crisis levels pointing some (including me) to think inflation will be a lesser concern, than most, as there is still plenty of capacity. My own personal devil's advocate is the below chart that compares current capacity utilization levels to rolling ten year averages (call it the cyclically adjusted capacity utilization... through "CACU" doesn't have a ring to it).
The output of mines advanced 1.1 percent, and the output of utilities increased 2.8 percent, as the extreme heat during the month boosted air conditioning usage. At 94.2 percent of its 2007 average, total industrial production for July was 3.7 percentage points above its year-earlier level. The capacity utilization rate for total industry climbed to 77.5 percent, a rate 2.2 percentage points above the rate from a year earlier but 2.9 percentage points below its long-run (1972-2010) average.
On this basis, two of the three sectors are at or above their CACU. If capacity was taken offline (i.e. is not really there) due to the downturn, this would indicate that we would be much closer to a capacity shortage than comparing to previous levels.
Monday, August 15, 2011
The WSJ details:
Private foreign investors sold a record amount of U.S. Treasurys in June as the U.S. debt-ceiling debate intensified.While it may be easy to blame selling on the debt ceiling issue, that really wasn't an issue until July. The broader selling likely occurred due to issues that were unrelated to the debt ceiling (supply of debt coming to market, the end of the QEII program, expectations for decent global growth).
That said, the scale of the actual selling is interesting (back to the WSJ).
Private foreign net purchases of long-term Treasury bonds and notes fell by $18.3 billion in June, following a $16.4 billion increase in May, according to the monthly Treasury International Capital report, known as TIC. The previous record drop was set in June 2000, when private foreign investors sold $16.5 billion in Treasuries.Sales were concentrated in the Caribbean (i.e. insurers / private wealth). The way I would interpret this is that these investors sold Treasuries UNTIL the debt ceiling issue, which combined with concerns over Europe caused the flight back into Treasuries (i.e. if there was no debt ceiling issues, there would have been less demand in July / August).
Immune to this whipsaw was China.
China's holdings actually rose in June, by $5.7 billion to $1.166 trillion, following net buying of $7.3 billion in May. Analysts caution the data may not reflect the full spectrum of China's activity in the market, however. The Treasury recently adjusted its estimate of China's holdings based on use of proxies in other countries.The below shows the combined purchases by China (direct) and the UK (where China purchases indirectly).
Until something drastically changes, expect a continued rise in the above chart regardless of net purchases / sales from other foreign entities.
Friday, August 12, 2011
After I wrote my post on Monday about the huge divergence in yields between stocks and bonds, I wondered just how historically unprecedented this divergence was. And now, with the help of this fabulous chart (many thanks to Nick Rizzo, Dan Burns, and Stephen Culp), it’s pretty easy to see: we’re at levels which match those at the height of the financial crisis, and which are otherwise historically utterly unprecedented.
Indeed, from 1985 through about 2002, it was just as common for the S&P earnings yield to be lower than the Treasury yield as it was for the yields to be the other way around. The two tracked each other, and the spread between them almost never moved beyond 2 percentage points either way.
Thursday, August 11, 2011
Wednesday, August 10, 2011
The chart below shows the ten year Treasury yield over the last 100 years combining monthly data from Irrational Exuberance and daily data from the Federal Reserve once available. 17 more basis points away from the all time low of 1.95 (that was a monthly print... not sure how low it got intra-month).
The below shows the Price / Earnings ratio for all components of the DJIA excluding financials (don't have a clue as to whether their earnings are legitimate, let alone sustainable), as well as the Price / Earnings ratio excluding cash and short-term investments. All data was pulled from the latest figures as presented within their last quarters financial statements.
I understand the counter to some of those insanely cheap looking earnings:
Source: Yahoo Finance
Tuesday, August 9, 2011
Monday, August 8, 2011
While this will certainly not be the top data point investors are digesting, the AP detailed on Friday that consumers are once again leveraging up:
Americans borrowed more money in June than during any other month in nearly four years, relying on credit cards and loans to help get through a difficult economic stretch.
The Federal Reserve said Friday that consumers increased their borrowing by $15.5 billion in June. That's the largest one-month gain since August 2007. And it is three times the amount that consumers borrowed in May.
The category that measures credit card use increased by $5.2 billion -- the most for a single month since March 2008 and only the third gain since the financial crisis. A category that includes auto loans rose by $10.3 billion, the most since February.
Total consumer borrowing rose to a seasonally adjusted annual level of $2.45 trillion. That was 2.1 percent higher than the nearly four-year low of $2.39 trillion hit in September.
Borrowing is usually a sign of confidence in the economy. Consumers tend to take on more debt when they feel wealthier. But an increase in credit card debt could also signal that people are falling on harder times.
Sunday, August 7, 2011
Friday, August 5, 2011
The WSJ details:
After two hours of analysis, Treasury officials discovered that S&P officials had miscalculated future deficit projections by close to $2 trillion. It immediately notified the company of the mistakes.
S&P officials later called administration officials back to say they agreed about the mistakes, though they didn't say whether it would affect the rating. White House officials remained waiting Friday evening to see what the company would do.Which brings me to a simple question (ignoring the mess that the U.S. truly is in) after mucking up ratings on mortgages (i.e. thinking housing prices could only go up / being in bed with the originators), then throwing the babies out with the bath water (i.e. downgrading even high quality non-agency mortgage securities) once they realized they missed the ball the first pass, how is it possible that S&P (and one sure to be fired analyst) has this much power over the U.S. and the global financial system?
After quite incredible reports of miscalculations, it happened. The thing that is perversely both meaningless and full of meaning was announced on Friday evening New York time. The United States of America is now rated AA+ with negative outlook by Standard & Poor’s.
Private hiring, which excludes government agencies, climbed 154,000 last month after an 80,000 gain. It was projected to rise by 113,000, the survey showed.
Government payrolls decreased by 37,000 in July, the ninth straight drop. Employment at state governments fell 23,000 last month, almost entirely due to a partial shutdown of the Minnesota government.The below chart outlines the bifurcation seen recently between the private and public sectors (per the nonfarm payroll survey). The chart shows that while the private sector is rebounding from an extreme "drawdown", the public sector is likely to continue its more recent decline on austerity measure being pushed through.
The chart below shows the change in employment via the household survey (the survey used to calculate the unemployment rate). What it shows is the unemployment rate dropped due to a decline in the number of individuals in the workforce rather than an increase in the number employed.
Thursday, August 4, 2011
As I've detailed over the last month, market volatility appeared suppressed due to all the liquidity thrown at the problems:
Monday, August 1, 2011
Peter Boockvar (via The Big Picture) details:
July ISM manufacturing index at 50.9 was well below expectations of 54.5, down from 55.3 in June and the weakest since July ’09. New Orders fell below 50 at 49.2 for the 1st time since June ’09. Backlogs fell 4 pts to 45 and importantly, employment fell 6.4 pts to 53.5, the lowest since Dec ’09. Export Orders did rise 0.5 points to 54, but off the slowest since July ’09.Inventories at both the manufacturers and customer levels fell. Prices Paid fell 9 pts to 57, the lowest since July ’10. Of the 18 industries surveyed, just 10 saw growth. ISM summed up July with this, “despite relief in pricing, however, several comments suggest a slowdown in domestic demand in the short term, while export orders continue to remain strong.”Bottom line, we saw softening in almost all of the regional manufacturing surveys over the past few weeks with today’s only question being to what degree. As I mentioned last week, what today and last week also proves, its the economy that is driving markets and the politics of debts and deficits are just awful noise in the background right now.
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