YTD Performance

The WSJ details:

Treasury and gold investors were rocked out of their recent torpor on Wednesday as a series of large trades in the futures markets sent prices tumbling.

At the Chicago Mercantile Exchange, an unusually big sale of more than 100,000 futures on U.S. government debt cascaded across traders' screens shortly after 10 a.m.

The selling spread to the cash markets where 10-year Treasury yields, which rise as prices fall, spiked to 1.99% from 1.93% in minutes.

The trades came just after the release of congressional testimony from Federal Reserve Chairman Ben Bernanke. Some traders said Mr. Bernanke appeared less focused on the prospect for a third round of asset purchases, known as QE3, than the market expected.

Not a good day for gold bugs.

Despite the huge sell-off in gold shown above (the largest in 3 years), gold (and other asset classes) are doing just fine. The only asset down year to date that EconomPic regularly reports on is long Treasuries (which were up more than 30% in 2011).

Source: Yahoo Finance

GDP Revised Up Slightly on Services Spend

CNN Money details:

Economic growth was stronger than originally thought at the end of 2011 as consumers increased their spending and businesses stocked up their inventories. Gross domestic product, the broadest measure of the nation's economy, grew at a 3% annual rate in the fourth quarter of 2011, the Commerce Department said Wednesday. The government had initially said the economy grew at a 2.8% rate. The Commerce Department estimates the GDP figures three times, and Wednesday's report was its second estimate.

Source: BEA

What Goes Up...

Source: S&P

Durable Goods Miss in January

Bloomberg details:

Orders for U.S. durable goods fell in January by the most in three years, led by a slowdown in demand for commercial aircraft and business equipment. Bookings for goods meant to last at least three years slumped 4 percent, more than forecast, after a revised 3.2 percent gain the prior month, data from the Commerce Department showed today in Washington.

The expiration at the end of 2011 of a tax incentive allowing full depreciation on equipment purchases may have prompted a slowdown in investment at the start of this year.

Caution always must be taken when analyzing monthly data in that it may just be noise (after all, December's figure and 2011 were strong), but this report was ugly none-the-less.

Source: Census

Revisting The Equity Side of Ugly Bond Math

A few weeks back I outlined the Ugly Bond Math that an aggregate bond index with a 2% yield to maturity means for investors:

It means that investors should not expect more than 2% annualized from your bond allocation over the next five years, UNLESS you are willing to reach for yield via lower quality credit, non-US exposure, or increased duration.

And what it means for an investor with an 8% overall expected return and a 60% equity / 40% bond mix.

It also means that if you have a 60% equity / 40% bond allocation, to reach an 8% all-in annualized return your equity allocation needs to return roughly 12% / year over the next 5 years.

Below we'll analyze if that 12% figure seems reasonable based on history and current valuations... it doesn't.

The first chart takes the yield to maturity of the aggregate bond index (shown in that previous post here) and backs into the required return on equities over the next five years to get an 8% all-in portfolio return. The current 12% figure is VERY high by recent historical standards.

The next chart details where equity valuations currently stand based on earnings yield. The historical earnings yield of the S&P 500 (data pulled from Irrational Exuberance) is simply the inverse of the price / earnings ratio (a price / earnings ratio of 20 equals an earnings yield of 1/20 = 5%). The cyclically adjusted figure takes a 10 year average of earnings to smooth extended earnings during cyclical peaks (and depressed earnings during troughs). By this measure, things are much improved relative to the rich levels seen early last decade, but nowhere near the 12% figure. Past analysis showing the relationship between earnings yield and forward returns can be found here.

The final chart outlines the difference between the earnings yield and equity returns required to reach the 8% return (i.e. the difference between the top two charts). It also shows how much growth is required for current earnings to get to that 12% return. By this measure earnings are 5.14% short and 7.33% short cyclically adjusted on an annualized basis. Possible? Yes, but it means an investor needs either earnings, the P/E ratio, or a combination of the two to increase by those levels each of the next five years (and remember that earnings are already near 3+ standard deviation relative to national income).

This means an investor likely needs to look outside a traditional stock / bond allocation to reach their investment goal... better yet, if possible, revisit the 8% target outright.

Note: for simplicity, the above analysis excluded the potential for accruing a rebalancing premium should equities and bonds continue to be negatively correlated. It also excludes fees associated with allocating to either asset class. I'll call that a wash for the average investor....

Source: Barclays / Irrational Exuberance

Mean Reversion

Source: Yahoo Finance

Relative Strength Update... Easy Money Edition

Below is an update of a relative strength chart I presented last August, a point which turned out to be right near the bottom of the summer's equity sell-off. At the time I noted that the chart:

Puts the dollar sell-off (commodities and gold are ripping) and risk-off (financials are sliding, Treasuries are rocking) in perspective.

This time around we've seen a remarkable recovery in risk assets, especially REITs (from 4th to the bottom to the top) and Financials (from the bottom to 4th from the top). Note also the continued strength in long treasuries (remaining third strongest).

The reason of course has been the Fed's easy money / quantitative easing that has pushed up asset values despite a lackluster recovery (especially helpful for bank balance sheets). Interesting to note that despite the response (or perhaps because of), the two weakest asset classes above are the Euro and EM currencies, showing that perhaps the massive response was not only helpful, but (a case can be made) required given the slowing economy and gridlock on the fiscal side in Washington.

Year to date the strong performance outlined above is even more clear, as can be seen below. Basically, if you haven't made money in 2012 you're doing something wrong. All of the asset classes are up with the exception of Treasuries (and up by a lot, with minimal volatility, and with hardly a draw down across asset classes).

Hopefully six months from now I won't be posting an update outlining that this marked a near top.

Source: Yahoo Finance

Why I Hate Politics

The Mercury News details:

Rising gasoline prices, trumpeted in foot-tall numbers on street corners across the country, are causing concern among advisers to President Barack Obama that a budding sense of economic optimism could be undermined just as he heads into the general election.

White House officials are preparing for Republicans to use consumer angst about the cost of oil and gas to condemn his energy programs and buttress their argument that his economic policies are not working.

In a closed-door meeting last week, Speaker John A. Boehner instructed fellow Republicans to embrace the gas-pump anger they find among their constituents when they return to their districts for the Presidents Day recess.

The above article coincides with recent points I've heard conservative friends make regarding the connection between Obama and the price of gas (i.e. that Obama is solely to blame) and recent talking points from Santorum. One of my favorite (i.e. meaningless) points they've made is that gas was $1.67 / gallon when Bush left office 3+ years ago showing that this obviously is a result of Obama's policies.

As the chart below shows, while the $1.67 claim may be factually true it leaves out the following (important) fact...

When Bush left office the financial system was melting down and the global economy was at a standstill, one result of which was that commodity markets (and the price of oil and gas) were plunging. Thus, the $1.67 / gallon price was down from the more than $4 a gallon (i.e. the highest in history) from June of that same year.

So... rather than Democrats and Republicans working together to perhaps change energy policy or to determine the tradeoffs associated with going to war (economic or actual combat) with Iran, higher gas prices simply becomes a talking point for reelection / election.

Another reason why I hate politics.

Note that this does not in any way exempt Democrats from similar worthless talking points.

Source: EIA

Leading Economic Indicators "May" Have Risen 0.4%

The reason "may" is in the title is because by my calculations, leading economic indicators grew by 0.55% in aggregate, not the 0.4% listed by the Conference Board (if you want to see for yourself, the components that add up to 0.55% are listed in Table 2). Perhaps the 0.4% is what the leading indicators would have shown under the old methodology (the methodology changed just last month... see here for details).

Assuming the components are actually correct, the below chart shows that the "headline" (i.e. reported) LEI index continues to improve at a decent clip off of summer / fall lows, while "core" (i.e. those components not affected by the Fed) also continue to show expansion, albeit at a slower pace.

Source: Conference Board

Consumer Prices Continue to Cool-Off

Source: BLS

We're #1

Ahead of tomorrow's leading economic indicator release, let's take a look at economic indicators for the G-7 countries over the last twelve months.

A severe downturn for those without monetary control (correlation does not necessarily equal causation) and surprising strength in Japan (though it is important to note that indicators do not equal actual growth).

Source: OECD

China Now Owns Slightly Less than a Ton of Treasuries

The FT details:

China was a large seller of US Treasuries in December but sought higher-yielding mortgage securities amid expectations of more policy easing by the Federal Reserve.

Treasury flows were dominated by China selling $32bn in bonds, dropping its overall holdings to $1.1tn and extending a steady decline from July’s peak of $1.173tn, according to official data released on Wednesday.

The UK, a financial centre seen as a proxy for Chinese flows, experienced a drop in Treasury holdings to $415bn from $426bn. Hong Kong’s appetite for Treasuries rose to $112bn from $105bn.

China’s selling of Treasuries was accompanied by the purchase of $9.5bn in US mortgage debt, a sign that analysts said reflected expectations that the Fed would undertake another round of quantitative easing in coming months.

A $9.5 billion addition in mortgages, less $32 billion (decline associated with China) less $11 billion (decline associated with the UK) equals a $33.5 billion decline month over month according to the data. While this could be noise, the chart below shows what appears to be a decline over the past 3-4 months. Note the chart combines Treasury holdings for both China and the UK, which together more accurately reflect China's holdings (as the FT article details, China purchases through the UK and these flows are only later revised to show they are held by China).

While it will be important to see if the downturn the data has shown in China's holdings in recent months continues, my takeaway from the chart is the amazing speed at which Treasuries were accumulated.

From less than $100 billion a bit more than a decade ago, to more than $1.5 trillion today. While continued growth in $$ terms is certainly possible, as I mentioned last year (in that case I was referring to China's reserves) growth in percent terms will be mathematically impossible to continue at some point in the near future (to adjust the relative figures below to the amount of Treasuries China owns rather than reserves at that time, cut the numbers in half):

This level of growth will be mathematically impossible to continue at some point (in my view sooner than later). The current $2.85 trillion is a whopping 20% of US GDP and 5% of World GDP, but if growth were to continue at this pace it would grow to 50% of US GDP by 2015 and 125% by 2020 (assuming the US grows at a 5% / year nominal pace).

Source: Treasury

Some More (Ugly) Bond Math

I've come across a number of forecasts for US Bond returns in the 4.5% - 6% range for the next 5 or so years.

Unfortunately, that is very wishful thinking.

The chart below shows that yield to maturity is awfully accurate in predicting five year forward returns for the aggregate bond index (this is because 5 years is roughly the universe of US bonds' duration). The unfortunate part is the current yield to maturity is a measly 2.06% as of today's close.

What does this mean?

It means that investors should not expect more than 2% annualized from your bond allocation over the next five years, UNLESS you are willing to reach for yield via lower quality credit, non-US exposure, or increased duration. It also means that if you have a 60% equity / 40% bond allocation, to reach an 8% all-in annualized return your equity allocation needs to return roughly 12% / year over the next 5 years. In addition, it likely means that correlation between bonds and equities are likely to increase over this time frame during times of turmoil, as bonds don't have room to appreciate in a flight to quality (more on that here).

In other words... don't expect much help from bonds (all that said, 2% still seems compelling relative to my 0% checking account).

Source: Barclays Capital

What Happened to the Great Consumer Recovery?

The Sun Times details:

Americans rebounded from a weak holiday season and stepped up spending on retail goods in January. The latest government report on retail sales pointed to a slowly improving economy.

Retail sales rose at a seasonally adjusted 0.4 percent last month, the Commerce Department said Tuesday.

Consumers spent more on electronics, home and garden supplies, sporting goods, at department and general merchandise stores and at restaurants and bars. They also paid higher prices for gas.

The last sentence is key... that 0.4% figure is in nominal terms (we'll find out what the real level is Friday when the consumer price index is released). The below charts convert retail sales from nominal to real (I am being conservative with a flat inflation rate for January, whereas a 0.1% increase is forecast).

What we see is a rebound from 2009 crisis lows in both real and nominal terms, but a recovery that has yet to make a new high in real terms.

On a year-over-year basis, it looks like the consumer recovery is slowing down in nominal and, even more so, in real terms.

Source: Census / BLS

EconomPics (and Links) of the Past Few Weeks

A quiet few weeks (unfortunately, get used to it) as I started a new gig in San Francisco (it only took two years to get here!) and I have a two month old that takes up a bunch of my non-work hours (zero complaining, just mentioning that fact).

What I did do this past week was consolidate some articles, posts, and charts that I found interesting and/or may want to revisit. Not sure if they would be of interest to you all, but I thought I would share (found below following my links since the last recap).

Asset Classes

• Bond Math: Duration Risk at the Zero Boundary
• Equity Valuation Based on GDP Growth 2.0

Economic Data

• Consumer Credit Continues to Rebound
• Employment Data Stripping Out Adjustments
• Breaking Down the Labor Report
• Productivity Data Shows No Inflationary Pressure
• Why is the Employment Situation Dragging? It's the Economy Stupid
• Manufacturing Expands in January
• One-Two Punch.... Equities and Bonds Rip It in January
• Checking in on Personal Consumption

Interesting (non-EconomPic) links....

Economic Data

The Housing Bottom is Here: New home sales forming bottom and nominal prices likely to follow (though real prices may have a few years left to decline)

Investing

JP Morgan Guide to the Markets: Pretty awesome presentation outlining returns by asset class for 2011 and Q4

Credit Suisse: Investment Returns Yearbook 2012: In depth review of global markets, containing returns, relationships across asset classes, and articles examining returns in various regimes (i.e. the ability of a variety of asset classes to hedge inflation)

Warren Buffett: Why Stocks Beat Gold and Bonds: Warren Buffet drops science

The Truth About Alternative Weighting Methodologies:

• Equal Weight = Small Cap

• Dividend Weight = Value Stocks
• Revenue Weight = Low Margin, High Debt
• RAFI Weight = Value Stocks

Chart

Buy and Hold vs. Dollar-Weighted Returns: i.e. investors suck at investing

And your video of the week... Less than Jake (one of my favorite bands circa 1997) with Never Going Back to New Jersey

Bond Math: Duration Risk at the Zero Boundary

There seems to be lots of confusion surrounding Bill Gross' latest Investment Outlook, Life and Death Proposition. First, some background of what Bill Gross stated...

Investors aren't only concerned with credit risk (i.e. the ability to get paid back), but also duration risk (the risk of lending for an extended period of time in fear that rates may rise).

In Bill's words:

What perhaps is not so often recognized is that liquidity can be trapped by the “price” of credit, in addition to its “risk.” Capitalism depends on risk-taking in several forms. Developers, homeowners, entrepreneurs of all shapes and sizes epitomize the riskiness of business building via equity and credit risk extension. But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight. Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns.

Investors had been willing to take on this duration risk because they would be compensated with additional yield AND (this is important) because bonds could appreciate if rates fell (i.e. when yields fall, bonds rise).

Back to Bill:

Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains.

And although the yield curve is steep, it is very low in nominal terms (i.e. there is less room for rates to move down).

Last time to Bill for his main argument:

Even if nodding in agreement, an observer might immediately comment that today’s yield curve is anything but flat and that might be true. Most short to intermediate Treasury yields, however, are dangerously close to the zero-bound which imply little if any room to fall: no margin, no air underneath those bond yields and therefore limited, if any, price appreciation. What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount. Duration risk and flatness at the zero-bound, to make the simple point, can freeze and trap liquidity by convincing investors to hold cash as opposed to extend credit.

Now my oversimplified explanation using two interest rate scenarios...

Scenario one... bonds yielding 5%.

In this scenario, bonds with maturities 1 year through 5 are yielding 5%. Should rates stay at 5%, the bonds are worth PAR (i.e. $100) in all scenarios. However, the bonds have the potential to appreciate should yields move lower. In fact, should rates fall all the way to 1% (a huge decline, but this is meant to illustrate the point), the bonds actually appreciate almost 20% in the case of the 5 year Treasury. Compare that to the one year Treasury that gained less than 5%.

In other words, in a flight to quality scenario there is a HUGE incentive to own the longer duration bond when yields have room to compress.

Scenario two... bonds yielding 1%.

In this scenario, bonds with maturities 1 year through 5 are yielding 1% (yes the yield curve is upward sloping in "real life", but this isn't far off). Should rates stay at 1%, the bonds are again worth PAR (i.e. $100), but in this case they have limited room to move due to the zero boundary. Should rates move all the way to 0%, the five year bonds don't appreciate 20% like in scenario 1, they appreciate only 5%, while the one year Treasury appreciates around 1%.

In other words, in a flight to quality scenario the potential benefit of a longer duration Treasury is 75% lower than in scenario one and only 4% higher than the one year maturity bond.

The example above is close to current rates (as of this writing, a five year bond yields 0.82%). The result, as Bill Gross points out, is a lack of incentive for a lender to lend and take that risk as they can get roughly the same yield just putting their money in a mattress without the risk of rates moving higher (0% isn't far from 0.82%). In addition, for an investor that is allocating to bonds to diversity their equity holdings, fixed income will no longer appreciate in a flight to quality scenario to offset equity losses. As a result, businesses should in theory be having a hard time getting money for their businesses outside of equity financing.

But, the evidence doesn't point to any of this being an issue. As far as I know, investors are still willing to extend the duration of their investments to pick up this incremental yield. And why not? The Fed has made it clear there is zero risk that rates will rise going out to at least 2014. So why not pocket that additional 82 bps regardless of the lack of capital appreciation?

Equity Valuation Based on GDP Growth 2.0

This is based on my post Equity Valuation Based on GDP Growth with a slight twist.

As I've outlined previously, over the long run equity valuation and earnings both grow at roughly the pace as nominal GDP. If earnings (for example) grew faster, then earnings would eventually become larger than the entire economy, which is not possible.

With that in mind, here goes...

The below chart shows:

• Blue: the S&P index (pulled via Irrational Exuberance)
• Yellow: the value ending in 2011 equal to that of the S&P 500 index, then brought back in time by the nominal GDP growth rate (GDP data is available at the Bureau of Economic Analysis)

This is an attempt to compare historical S&P 500 valuation (relative to the size of the US economy), relative to the current valuation level. For example... if the S&P 500 (blue) is below the nominal GDP line (yellow), then the S&P 500 was cheaper then (on this relative measure) than it is now. It also means when the lines cross, valuation levels were equal to today.

The relevance: The chart below shows the relative valuation for each year from 1929 through 2001 (in December 2011 terms), then shows the subsequent 10 year forward change in the S&P 500 (note this does not include dividends).

This chart shows that if this valuation metric can forecast the future (I am not saying it will, but it seems useful), then equity markets may be a decent buy here. At relative value zero (i.e. today's measure) the trend-line goes through 0% on the x-axis at roughly 7.5% annualized (before dividends).

Source: Irrational Exuberance / Bureau of Economic Analysis

Consumer Credit Continues to Rebound

Bloomberg details:

Consumer borrowing in the U.S. rose more than forecast in December, driven by demand for auto and student loans.

Credit increased by $19.3 billion to $2.5 trillion, Federal Reserve figures showed today in Washington. The gain topped the $7 billion median forecast of economists surveyed by Bloomberg News and followed a $20.4 billion advance the prior month.

Consumers “are willing to take on this debt because there is some increasing degree of confidence in the economy,” said Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio, who projected credit would climb by $15 billion, the highest in the Bloomberg survey. “Consumers over the past several years have done a pretty good job of repairing their balance sheets.”

I've been waiting for a private sector balance sheet to step in for the government's balance sheet for a while now and although I wish it were corporations rather than individuals, this isn't so bad. The reason being that about 40% of the two month jump in consumer credit ($16 billion of the $40 billion) has been consumer credit in the form of student loans, which to me is an investment rather than a loan simply buying more crap.

Over the past twelve months, consumer credit excluding student loans is still negative in nominal terms (down quite a bit relative to personal income), which means the consumer (excluding students) have still been in balance sheet repair mode. But, this is likely to flip positive in year-over-year terms next release, which would be good for the short-term recovery. Longer term we need corporations to step to the plate and hire, which would allow consumer credit to shrink as a percent of personal income, even if it grows in nominal terms.

Source: Federal Reserve

Employment Data Stripping Out Adjustments

As I detailed yesterday, over the past few years:

the population grew at a much faster rate than previously expected

The result is that while employment data continued to improve, the number of individuals not in the labor force is much higher than previously thought. The following chart strips out the adjustment made for that higher population to show the change in employed, unemployed, and not in the labor force during the month of January.

What we see is a HUGE amount of revision, but an improving underlying situation. As an example, the number of individuals no longer in the labor force is more than a million higher than previously thought (very bad), but the number not in the labor force actually came down in January from December (as seen in the blue dot, which is a good thing).

So... what does this tell us? It tells us things were worse than we thought (and we thought things were bad), but if this new information is accurate it shows things are significantly improving.

Source: Calculated Risk

Breaking Down the Labor Report

Good News

The LA Times details the good news coming out of this morning's jobs report:

The unemployment rate fell for the fifth straight month after a surge of January hiring, a promising shift in the nation's outlook for job growth.

The Labor Department says employers added 243,000 jobs in January, the most in nine months. The unemployment rate dropped to 8.3 percent from 8.5 percent in December. That's the lowest in nearly three years.

Employers have added an average of 201,000 jobs per month in the past three months. That's 50,000 more jobs per month than the economy averaged in each month last year.

In addition, as Calculated Risk predicted yesterday, there were revisions to past months employment data.

The change in total nonfarm payroll employment for November was revised from +100,000 to +157,000, and the change for December was revised from +200,000 to +203,000. The total nonfarm employment level for March 2011 was revised upward by 165,000.

Not So Good News

The Washington Post detailed, yesterday, the not-as-good news:

"On the face of it, a lower unemployment rate sounds good,” but the recent declines reflect not only an uptick in job growth but also the exit of thousands of potential young workers from the labor force.

When people stop looking for work, they are no longer counted as part of the labor force or “unemployed.” Evidence suggests that many of the young dropouts, who proved to be instrumental in Mr. Obama’s election in 2008, are continuing their schooling to avoid the tough job market and to increase their skills and chances of eventually securing employment.

The actual data shows this to be exactly what has happened (and at an increasing rate) as the population grew at a much faster rate than previously expected. As a result, according to the household survey, even though employment increased at an even faster rate than the payroll survey, there is a much larger portion of the population that is no longer in the labor force. In addition, looking at the details below.... it appears this is really having an increased affect not only on students, but especially on women (although employment among women jumped, meaning there are millions more women out there than previously thought... teen boys everywhere rejoice).

If they are all going back for more education, this should pay off over the long-run. If not, then the headline improvement in the labor market may be inflated.

Source: BLS

Productivity Data Shows No Inflationary Pressure from Labor Market

Bloomberg details and defines unit labor costs:

Unit labor costs in nonfarm businesses increased 1.2 percent in the fourth quarter of 2011, as productivity grew at a slower rate (0.7 percent) than hourly compensation (1.9 percent). Unit labor costs rose 1.3 percent over the last four quarters. Annual average unit labor costs increased 1.2 percent from 2010 to 2011.

BLS defines unit labor costs as the ratio of hourly compensation to labor productivity; increases in hourly compensation tend to increase unit labor costs and increases in output per hour tend to reduce them.

The good news... there is no inflationary pressure whatsoever at the moment in labor. The bad... this is because the labor market is soft (though hopefully we see some more positive signs tomorrow morning).

Source: BLS

Why is the Employment Situation Dragging? It's the Economy Stupid...

Bloomberg outlines the latest employment news coming from ADP ahead of this Friday's official details:

Companies added 170,000 workers in January, reflecting job gains in services and at small businesses, according to a private report based on payrolls.

The increase was less than forecast and followed a revised 292,000 rise the prior month that was smaller than previously reported, the report from the Roseland, New Jersey-based ADP Employer Services showed today. The median estimate in a Bloomberg News survey of economists called for an advance of 182,000.

Better than nothing? No doubt. But, what do we need for jobs to really bounce back? Easy.... economic growth (the question lies in whether jobs need to precede economic growth to spur consumption or growth itself will cause firms to hire).

The below charts outline the relationship / importance.

The first chart below shows (in yellow) the ratio of the change in number of those employed over a five year period over the change in real GDP over that same five year time frame. If the yellow line is over 1, that means more people were hired over that time than the increase in the population (very rare). Over the past 60 or so years, the ratio has been a bit more than 0.60 (i.e. 60%), which is basically another way of saying the employment-population ratio has been roughly 60% (we can clearly see how bad the latest recession was).

The next chart shows the same data, but makes the relationship even clearer. You want to add jobs at the "normal" 0.60 rate? Grow the economy consistently by more than 3%. You want to grow the economy by more than 3%? We need people to work.

Source: BLS / BEA

Manufacturing Expands in January

ISM Outlines:

WHAT RESPONDENTS ARE SAYING ...

• "Still seeing raw materials pricing moving down in general, but expect inflation later in the quarter." (Chemical Products)
• "Year starting a little slow, but customers are positive about increased business in 2012." (Machinery)
• "Once again, business continues to be strong." (Paper Products)
• "Pricing remains in check with the demand we are seeing. Supplier deliveries are on time or early." (Food, Beverage & Tobacco Products)
• "The economy seems to be slowly improving." (Fabricated Metal Products)
• "Business lost to offshore is coming back." (Computer & Electronic Products)
• "Business remains strong. Order intake is great — more than 20 percent above budget." (Primary Metals)
• "Indications are that 2012 business environment will improve over 2011." (Transportation Equipment)
• "Market conditions appear to be improving, with the outlook for 2012 better yet." (Wood Products)

Source: ISM

One-Two Punch.... Equities and Bonds Rip It in January

The Dow and S&P 500 posted their best January returns since 1997, while Emerging Market equities had their best start since 2001 (expect to hear a lot about this the next day or two). What likely won't be in the news as much is the remarkable run bonds had during the month (i.e. in other words, it was hard to lose money this past month).

Speaking of a one-two punch (my apologies for the horrendous transition, but I REALLY wanted to show these dunks), perhaps the best two dunks of the past 12 months happened within a day of one another. The Reformed Broker pointed readers to Lebron James literally jumping over John Lucas III on an alley-oop.

But, this dunk was somehow outdone just one day later by perhaps the biggest "posterization" in years by Blake Griffin on Kendrick Perkins.

Update:

Three times a charm... a reader sent in the following dunk by Paul George in last night's Pacers / Nets game. George goes DOMINIQUE!

Source: Barclays Capital

Checking in on Personal Consumption

Reuters details

U.S. consumer spending was flat in December as households put the largest rise in income in nine months into their savings, potentially signaling slower consumption early in 2012. It was the weakest reading on spending since June, the Commerce Department said on Monday, and it followed two tepid gains in October and November.

The slow fourth quarter pushed the year over year real per capita spending (i.e. the amount of actual spending per person adjusted for inflation) down to 0.7%, the lowest reading since the crisis and the lowest reading since the early 1990's recession excluding the crisis.

Source: BEA

EconomPics of the Week (1/27/12)

Your EconomPic links for the past two weeks...

Economic Data

• GDP Print Okay, Composition Disappointing
• Durable Goods Grip It and Rip It in December
• The New (and Improved) Leading Economic Indicators
• European Manufacturing Feeling the Downturn
• CPI Steady in December
• Do Initial Claims Matter?
• China's Growth in Perspective
• Checking In on Capacity Utilization

Asset Classes

• S&P 500 / VIX Matrix
• The Treasury Rally that Keeps on Trucking
• China Still Buying Treasuries
• The Impact of Low Rates Through 2014
• Apples Numbers Were B-A-N-A-N-A-S
• Existing Home Sales Rise

And your video of the week... a song I can't get out of my head. Gotye with 'Somebody That I Used to Know' (found it from this viral video cover of the song)

GDP Print Okay, Composition Disappointing

Peter Boockvar (via The Big Picture) details this quarter's GDP print (slightly edited / reformatted):

After three quarters (in a row) that averaged just 1.2%, fourth quarter GDP grew 2.8%, a touch below expectations of 3.0%, but Nominal GDP grew well below forecasts. Because the price deflator was up just 0.4% vs the estimate of 1.9%, Nominal GDP was up 3.2% vs the estimate of 4.9%.

• Personal Consumption rose 2.0% vs the forecast of 2.4%.
• Fixed Investment rose 3.3% (helped by a 5.2% increase in equipment and software spending and residential construction rose by 10.9%).
• Trade was a slight drag on GDP growth and government spending was as well, led by a 12.5% decline on national defense spending.
• State and local government spending fell by 2.6%.
• Inventories added almost 2% to growth and, taking out this influence, Real Final Sales rise just 0.8% vs 3.2% in Q3.

Thus, inventories were a large swing factor in the Q4 rebound. Bottom line, Real GDP was near estimates, but nominal GDP was the weakest since Q3 ’09 and Real Final Sales were the 2nd softest since Q1 ’10.

Details below... we can see the HUGE impact of inventory rebuild (potential is there for this to be a HUGE drag in Q1 '12) and the continued drag of local government (i.e. austerity measures).



The below chart shows the longer term breakdown of GDP, showing the importance of consumption on growth. We can see the huge shift in consumption from goods (i.e. things) to services (i.e. outsourcing of "actions" to make out lives easier). Of note, for all the chatter about how large government has become, the Federal government (excluding defense) has not really become a larger as a component of GDP.

Source: BEA

Durable Goods Grip It and Rip It in December

Reuters details:

New orders for U.S. manufactured goods rose in December and a gauge of future business investment rebounded, showing the U.S. economy ended the year with more momentum than previously thought.

Commerce Department data showed orders for durable goods climbed 3.0 percent last month. That was likely boosted by a surge in orders at aircraft builders like Boeing. Economists had forecast orders rising 2.0 percent.

Strong month, but note that excluding the highly volatile nondefense aircraft component, the index would have been up a (still healthy, yet not as impressive) 1.6%.

Source: Census

The New (and Improved) Leading Economic Indicator Shows Expansion

Bloomberg details:

The Conference Board’s gauge of the outlook for the next three to six months increased 0.4 percent after climbing 0.2 percent in November, the New York-based group said today. The median forecast of 44 economists surveyed by Bloomberg News called for a gain of 0.7 percent.

The article also outlines a change in a major component of the index (the first change in the index since 1996):

Changes in the components of the leading index were announced earlier this month. Instead of the inflation-adjusted money supply, the Conference Board used its own Leading Credit Index, which aggregates measures of the yield curve, interest- rate swaps and the Fed’s senior loan officer survey. The Institute for Supply Management’s supplier deliveries gauge was replaced by the group’s index of new orders.

The change from money supply to credit index is a major change, removing a component that was directly in the hands of the Fed (money supply), with one that is only partially in the hands of the Fed (credit index). Note that in past months, EconomPic has removed the money supply component, as well as stock and interest rate components, for an index excluding Fed involvement.

A comparison of the new (revised) index, the old index, and the "EconomPic" index that excluded Fed control is shown below. What we see is the new index is much more aligned with one excluding the Fed's control and shows the index likely overstated underlying economic strength over the summer.

Source: Conference Board

The Impact of Low Rates Through 2014

Bloomberg details the latest from the Fed:

Chairman Ben S. Bernanke said the Federal Reserve is considering additional asset purchases to boost growth after extending its pledge to keep interest rates low through at least late 2014.

Policy makers are “prepared to provide further monetary accommodation if employment is not making sufficient progress towards our assessment of its maximum level, or if inflation shows signs of moving further below its mandate-consistent rate."

The immediate market reaction was a risk asset rally, a huge rally in gold (per Calculated Risk: Bernanke made it clear that even if inflation moved above the target - and unemployment was still very high - the Fed would only slowly pursue policies to reduce the inflation rate), and a rally at the belly of the yield curve (the yield curve flattened out to five years... shorter rates couldn't fall as they are already at or near zero). Why? The "late 2014" date is much later than the June 2013 date previously projected by Bernanke last summer.

The impact of this announcement (and the previous projected rates) can be seen in the chart below that shows the Fed Funds rate curve (implied by EuroDollar futures) for March 2013 through December 2014, as of various dates over the past year.

What do we see? We see an initial drop between March and June of last year as Bernanke indicated low yields for the foreseeable future, then a huge drop (mid-summer) after Bernanke stated rates would remain zero through June 2013. Today's announcement really did nothing through June 2013 (that was already projected), but was felt further out along the curve.

The key question is what is the Fed trying to accomplish?

In "normal" times, low yields = cheap financing = increased consumption (it creates an incentive for individuals to borrow and banks to lend), but in today's zero-bound world the impact is minimal. Increased consumption is limited as individuals are trying to rebuild their own balance sheets and those that might benefit most from borrowing, don't necessarily have the credit to qualify for a loan. In terms of impact on unemployment, GYSC (of Economic Disconnect fame) states:

Unemployment is a structural problem, not a cyclical one, but the FED is still stuck in the past.

In addition, there are some theories that consumption may actually be negatively impacted by zero bound rates. As I outlined over the summer, I think it is possible that negative real interest rates may actually cause individuals to save more, while Kid Dynamite outlined yesterday that low rates forecasted may cause individuals to hold off from making a loan fueled purchase:

Let me explain: right now, one appealing factor of home buying/selling decisions is that interest rates are very low – you can afford to buy more house. If I think that interest rates are going to remain low for a long period of time, I will be in no hurry to lock in this low rate on the debt I’m borrowing – I will be in no hurry to go out and buy a house.

So what is it then? Corporations!

There is one sector that I think will be positively impacted by the latest announcement.... corporations. Don't let their record profits as a percent of GDP (while personal income is at record lows) fool you into thinking they don't need help at the populations expense. Seriously though... my initial reaction upon hearing that rates would be held down near zero through 2014... buy credit... WITH duration out to around ten years (the secondary impact is positive for equities, as explained below).

While Treasury yields are at all-time lows, corporate spreads remain at elevated levels (when yields fell during the summer when we had to deal with the US downgrade and Europe, spreads widened significantly).

In "normal" times, when markets calm these spreads would be expected to narrow, which I still believe is the case. One would also "normally" expect Treasury yields to rise as investors shift out of Treasuries, causing the hard interest rate component of corporate yields (rate + spread = yield) to rise, but this risk has been removed for the foreseeable future out to around ten years. The result is that corporate bonds seem like a very safe investment. This decreased risk should mean even cheaper financing for longer dated maturity corporate bond issuance.

So will this finally set off a round of corporate fueled expansion? If they don't see aggregate demand improving, then I don't see how this will impact the underlying economy. But, with the cost of equity high (i.e. what I perceive as fair to cheap equity valuations) and cost of debt low (i.e. these lower yielding corporate bonds), we may see significant change in capital structures (perhaps via private equity).

Source: Barclays Capital

European Manufacturing Feeling the Downturn

Marketwatch details:

Industrial orders in the 17-nation euro zone fell 1.3% in November after a 1.5% rise in October, the European Union statistics agency Eurostat reported Tuesday. Compared to November 2010, orders fell 2.7%, the agency said. Economists had forecast a 2.3% monthly decline and a 2.8% year-on-year fall.

Since the European crisis re-emerged in mid-summer, the European core has seen a rather sharp drop off in new industrial orders, while Emerging Europe (and the UK / Ireland) have shown strength (note that Greece didn't release data for November, but was down 5% from July through October).

Source: Eurostat

Apples Numbers Were B-A-N-A-N-A-S

Before jumping on the Apple bandwagon, I'll turn it over to Tadas of Abnormal Returns fame who summarized Apple's blow out earnings with the following powerful statement:

Apple’s results highlight this simple fact: no one knows nothing. The most followed (and analyzed) company in the world was able to exceed even the most bullish analysts’ estimates by a wide margin. If this can happen, then it should remind us that anything, good or bad, can happen in the markets. Any one telling you they know something will happen for certain, just remind them about Apple 2012 Q1 results.

Now to the blow out earnings.... just a part of the exponential growth the firm has seen over the past eight or so years.

Data shown is from quarterly financial statements

Billions of this size is hard to grasp, so the following chart attempts to put it in perspective. Apple's sales over the last twelve months are equal to almost 1.2% of all U.S. personal consumption over that time (yes, I know Apple has sales outside of the U.S., but think about how much stuff 1.2% of everything U.S. citizens consume is) and around 2% of last quarter's consumption.

Data shown is rolling twelve month

Source: BEA / EDGAR

Existing Home Sales Rise

Bloomberg details:

Sales of previously owned U.S. homes rose for a third month in December to the highest level since January 2011, a sign the housing market ended last year with momentum.

Purchases increased 5 percent to a 4.61 million annual rate, the National Association of Realtors said today in Washington. The pace was less than the 4.65 million median forecast of economists surveyed by Bloomberg News. The gain helped push down the inventory of homes for sale last month to the lowest level since 2005. Purchases in 2011 climbed 1.7 percent from a year earlier as prices fell.

Historically low mortgage rates and a pickup in employment may be giving Americans the confidence to purchase homes that have fallen in value. At the same time, another wave of foreclosures may inhibit a faster recovery in real estate as more distressed properties are put on the market.

Looking at the data, it appears sales are on the rise as prices are creeping lower (to a level where demand is finally meeting supply). My guess is the reason higher priced home sales are less is two-fold... they don't qualify for conforming loans and prices are being reduced (i.e. houses formally in the $500k-$750k "bucket" are now in the $250k-$500k bucket).

Source: Realtor.org

CPI Steady in December

CNN Money details:

Inflation overall held steady last month, as declining gas prices balanced out higher prices for other items.

The government's key measure of inflation, the Consumer Price Index, showed prices were virtually unchanged from November to December. It marked the second month in a row CPI has barely moved.

In the past 12 months, prices rose 3%, a slowdown from a 3.4% annual inflation rate in November. The numbers are seasonally adjusted.

Source: BLS

Do Initial Claims Matter?

Fox Business details:

New applications for unemployment benefits dropped to a near four-year low last week, a government report on Thursday showed, pointing to continued improvement in the labor market.

The Labor Department said initial claims for state unemployment benefits dropped 50,000 to 352,000, the lowest level since April 2008 and the biggest drop since September 2005. The prior claims data was revised up to 402,000 from the previously reported 399,000.

Good news, no doubt. BUT, initial claims SHOULD be falling (and falling dramatically). According to the BLS, we still employ less than 5 million people from the peak employment achieved in late 2007. Initial claims simply tell you the number of new people filing for unemployment benefits (i.e. those just laid off). If you have already shed 5 million people, this number SHOULD be falling (there are less people to lay off) even without an improved underlying economy.

The following chart in no way is intended to be a good measure of normalized initial claims, but it is meant to make that point. It shows the initial claims figures (through December) as an absolute figure and relative to the number of new jobs made over the previous 95 months (an arbitrary number that is the length of time from the bottom in employment during the '01 - '02 recession and the latest recession) and shows that the reduction in initial claims is less apparent when you take in account the sluggish employment growth.

So do initial claims matter? You sure don't want to see them rising. But. there is only a limited amount of information in the data when an economy has experienced the type of employment recession the US has faced the previous 4 years.

Source: DOL / BLS

Checking In on Capacity Utilization

Source: BLS / Federal Reserve

China Still Buying Treasuries

I feel like a broken record, but once again the mainstream media and fear-mongering finance blogs get the Chinese Treasury holdings data wrong. Here's Zero Hedge:

Today's TIC data confirmed what Zero Hedge readers have now known for quite some time: namely that foreigners are selling US paper. And while we have used contemporaneous Custody Account data from the Fed to present that in the past 7 weeks foreigners have sold a record amount of bonds, we now get confirmation via TIC that in November the selling continued, especially at the biggest non-Fed holder of US paper, China, which saw its holdings down to $1,132.6 billion, the lowest in the past year.

As EconomPic readers know, China's purchases are just flowing through the United Kingdom (and are later revised to China... see here, here, and here for a few examples).

I did note last month that:

The pace of growth in Chinese purchases of Treasuries has declined rather dramatically (in percentage terms). This may prove to be a smaller issue for the U.S. in terms of Treasury demand (the smaller percent is off a larger base, so in $$ terms the growth is still significant), but it may reflect the difficulty China may have growing their export driven economy at the scale required to prevent social unrest, as global aggregate demand has waned.

Source: Treasury