Monday, October 31, 2011

Spending, Transfer Payments, and Taxes

As the chart below shows, personal outlays (i.e. spending) has grown significantly faster than wages over the past decade. Even before the crisis, consumers spent more of what they earned.

Since the 2008 crisis, wages initially declined (and have since remained stagnant) and the level of savings has moved higher (both of which are negative for consumption on a stand-alone basis), but spending remains strong.

How is this possible?

Well, when one adds in transfer payments (i.e. money provided by the government) and subtracts less taxes from wages, we see a different story... growth that has actually outpaced consumption since the downturn.

The reduced tax burden is a result of lower incomes to tax, a lower tax rate via the progressive tax structure, and tax cuts enacted to stimulate demand.

Telling (to me) is that over the last 10 years, wages plus transfer payments less taxes have grown at pretty much the exact same rate as personal outlays, despite weak wage growth. Going forward, unless there is change in the austerity sentiment that has been the focus of both Republicans (less spending) and Democrats (higher taxes), expect the boosts we have seen, to soften.

If that happens, we'll likely need actual wage growth via an employment recovery in order for the consumption rebound to continue.

Source: BEA

Thursday, October 27, 2011

Economy Grows at 2.5%, Led by Spending and Investment

BusinessWeek details:
The U.S. economy grew in the third quarter at the fastest pace in a year as Americans reduced savings to boost purchases and companies stepped up investment in equipment and software.

Gross domestic product, the value of all goods and services produced, rose at a 2.5 percent annual rate, up from 1.3 percent in the prior three months, Commerce Department figures showed today in Washington. Household purchases, the biggest part of the economy, increased at a 2.4 percent pace, more than forecast by economists.
Looking at the chart below, another potential bright sign is the pickup in non-residential investment in the quarter showing that corporations may finally be using all that cash to reinvest in their businesses (though they also appear to have "paid" for this investment by delaying inventory purchases).

If the next step in this cycle is an inventory rebuild and (don't want to jinx it) hiring, we may be in business.

Source: BEA

Unsustainable... Transfer Payments

Transfer payments are defined simply as:
Money given by the government to its citizens.
As long-time readers know, I am all for government involvement / income distribution for projects / policies that attempt to provide:
  • Everyone (specifically youth) with the same chance
  • A needed shared service
  • A positive return on investment (education, security, infrastructure, etc...)
In addition, I do believe that a safety net (such as unemployment benefits) provides additional security that allows the broader system (in the case of unemployment benefits, the labor market) to work more efficiently.

BUT, many of these projects / policies have been extremely neglected (education, infrastructure are two easy examples) and/or are being threatened with further cuts, as a way to put off answering tough questions. Tough questions such as "should we be spending our national wealth on programs that will provide for the betterment of society in the future or should we use it to allow individuals to retire while they are still productive / to extend the life of a sick elder by another six months?".

As unfortunate as it may be... does anyone really think the chart above looks sustainable?

Source: BEA

Wednesday, October 26, 2011

The Rich Get "Slightly Less Baller"

Greg Mankiw points out that we've been forgetting about a demographic that has been hit extra hard by the economic downturn... the rich:
Here is a fact that you might not have heard from the Occupy Wall Street crowd: The incomes at the top of the income distribution have fallen substantially over the past few years.
That's right kids... in 2009, the top 1% of earners made only 13.2x more on average than the rest of the top 50% (i.e. by definition those that are themselves better off than the average), down from a peak of 16.3x in 2007. Ignore the fact that this is still almost twice the level seen in the early 1980's.

I should also point out that the title of his post is "The Rich Get Poorer", so before I sign off why don't we quickly take a look at the definition of poorer:
  1. Having little or no wealth and few or no possessions.
  2. Lacking in a specified resource or quality: an area poor in timber and coal.
  3. Not adequate in quality; inferior.
  4. Lacking in value; insufficient.
  5. Lacking fertility.
  6. Undernourished; lean.
  7. Humble.
  8. Eliciting or deserving pity; pitiable.
Way to show those Occupy Wall Streeters some perspective!

Tuesday, October 25, 2011

Monday, October 24, 2011

On the Seasonality of Equities

EconomPic has outlined the seasonal performance of the equity market (with a "secret sauce" twist) a number of times (most recently here).

The Big Picture details equities seasonal phenomenon since 1959:
Here are the specifics of seasonality: Imagine we start with two $10,000 accounts, and use them to make investments in an S&P 500 Index fund. One account invests in one 6-month period, the other invests in the remaining 6-month period. Account A is invested from November 1st through April 30th each year, while Account B is invested from May 1st through October 31st.
Here are the numbers:

• Account A portfolio grew from $10,000 to over $438,967. That is a 42-fold increase.
• Account B portfolio barely doubled to $22,659.
A chart outlining the above phenomenon going back to 1959 can be found here, but I thought I'd take some alternative looks.... one that goes back further in time (all the way to 1871) to see when this seasonality started and one taking a look at the real return (i.e. after inflation) of each leg since 1959.

140 Year Rewind

Using S&P data from Professor Shiller's Irrational Exuberance site, I constructed the below chart going all the way back to 1871. The outperformance of the November - April time frame since 1959 can be seen, but interestingly enough before that date both periods had almost the exact same performance. Begging the question... what changed around 1959?

Real Seasonality (1959 - 2011)

You thought the original May - October figure looked bad in nominal terms? After inflation, total returns for that six month period over 52 years (312 months) were negative, while the November - April time frame posted annualized real returns ~10%.

Sunday, October 23, 2011

Below Trend Growth

The WSJ details:

It looks as if, despite everything, gross domestic product picked up in the third quarter, easing fears that the U.S. was on the cusp of another recession. But that doesn’t mean the economy is anywhere near where it needs to be.

Economists expect Thursday’s GDP report from the Commerce Department will show the economy grew at a 2.7% annual rate in the third quarter. That would still leave economic output 6.7% below what the Congressional Budget Office estimates its potential is. In other words, in a world where employment and economic activity were as high as they could be without the economy running into inflationary trouble, the U.S. would be producing about $900 billion more in goods and services a year than it is now.

Experts quibble about exactly where potential GDP is these days, and that’s especially true in light of all the damage the economy has suffered.
As the last portion of the article outlines, experts quibble where potential GDP is these days. I (a non-expert) will outline an alternative way to project potential GDP... past performance. While past performance does not guarantee future performance for investments, it also does not guarantee where the economy should be today. That said, it does represent a growth rate that Americans and American systems (tax levels, spending, debt accumulation) were used to dealing with / expected.

Below is a chart outlining just that... real GDP going back to mid-1971, along with what real GDP would look like today if it grew at the 3.1% pace of growth it saw on average between June 1971 and June 2007. In addition, the yellow line is the difference between the two.

In this case, the differences implies current GDP is 11% below potential.

Source: BEA

Friday, October 21, 2011

EconomPics of the Week


Economic Data

RIP Steve Jobs

And your video of the week. Sublime with Badfish.

Explaining the Retail Sales / Confidence Dislocation

My buddy Sami Mesrour (from Blackrock) had a write up earlier this month titled Follow What I Do, Not What I Say; Consumer Spending and Consumer Confidence that outlines the surprise rebound in retail sales (bold mine):

The US consumer is feeling down. Several indicators of confidence collapsed over the summer with the declines beginning in May as job growth slowed, and the bulk of the drop in sentiment occurring during August. It is likely that the intense focus on the country’s deficit problem and the attendant prospects of lower government spending going forward were the main drivers in the decline of consumer expectations. Forecasters are concerned over this development because of what it implies for the growth of consumer spending—historically sentiment has been a good reflection of sales in the US.
This time, however, something strange is going on: consumers are apparently saying one thing, but doing another
Very timely analysis, as this was ahead of last Friday's report that showed retail sales surprised, significantly, to the upside (September was up a 1.1%, while June and July were revised higher as well).

The year over year figure is even more impressive, up more than 8%.

Sami outlined (in detail - go to his report for more) the following four drivers:
  1. Borrowed time (ability for the consumer to once again borrow to spend)
  2. Income distribution (the rich keep getting richer and are driving spending, while individuals struggling are driving the confidence surveys lower)
  3. Transfer payments (outlined at EconomPic here)
  4. Foreclosures (squatters and those moving home with their parents are effectively not paying rent, increasing their ability to spend on goods)
I broadly agree with these points, especially #2 and #3, and I'll lay out a fifth... inflation. While inflation may be the best (and only) politically viable option to reduce the level of nominal debt in the system, there are always interesting implications.

The below chart outlines the nominal year over year change in retail sales, along with my best effort in matching the applicable inflation figures for each category (by all means imperfect). The real retail sales change is simply the difference between the two.

Building this out further with data going back to the mid 1990's, the below chart outlines the year over year change in the following consumption measures:
  • Nominal goods (very closely aligned with retail sales)
  • Nominal consumption (includes the less inflationary services sector)
  • Real consumption (i.e. less inflation)
  • Real per capita consumption
In addition, the dotted lines show the average for each category from 1996 to 2008 (i.e. pre-crisis).

What we see is that while the "spike" in retail sales (via nominal goods consumption) is higher than pre-crisis, all other measures are below their historical levels of growth.

In other words, the growth in the amount that individuals are consuming is lower, but individuals are paying more for what they are consuming. For those individuals where food and energy are a higher percent of their consumption basket (i.e. those that earn less), this is an even bigger impact.

Makes a lot more sense why individuals would be unhappy.

Source: BEA / BLS / Census

Thursday, October 20, 2011

Leading Economic Indicators

Bloomberg details:

The index of U.S. leading economic indicators increased in September at a pace that suggests a slower rate of growth in the coming months.
The Conference Board’s gauge of the outlook for the next three to six months climbed 0.2 percent after a 0.3 percent gain in August, the New York-based research group said today. The September increase, the lowest since a decline in April, matched economists’ projections, according to the median forecast in a Bloomberg News survey.
A Federal Reserve survey published yesterday said the economy maintained its expansion last month even as more companies reported more doubt about the strength of the recovery. An acceleration in growth is needed to support the job gains that drive household spending, the biggest part of the U.S. economy.

Wednesday, October 19, 2011


Source: PPI / CPI

Monday, October 17, 2011

Industrial Production "Inflection" to Lead Equities Higher?

The WSJ reports:

U.S. industrial production grew in September but the gain was small, underscoring the economy's lack of vigor.

Production rose by 0.2%, with a modest gain in manufacturing and a sharp drop in utilities caused by moderating weather. The Federal Reserve report on Monday showed overall production was flat in August, revised down from a previously estimated 0.2% increase.
Manufacturers in the U.S. have been feeling the weight of a lackluster economy, hamstrung by high unemployment. While it is still growing, the factory sector has, with the overall economy, slowed.
While the rebound in industrial production may be lacking the ideal punch, the index (which tends to have a positive relationship with the S&P 500) did turn positive this month on a three year rolling basis.

More interesting (to me) industrial production appears to have led the S&P 500 higher when rolling three year industrial production turned positive (i.e. the "inflection" point). The below chart strips out the S&P 500 rolling returns and replaces it with the three year forward (annualized) performance of the S&P 500 following the inflection point.

Tuesday, October 11, 2011

It's All About Financials

The chart below compares the absolute return of an investment in the S&P 500 vs. the excess return of an investment in the investment grade financial bond index (as compared to Treasuries) over rolling three-month periods going back 10 years. Note that pre-financial crisis there was a small relationship (even less so the prior decade) with the return streams below showing an r-square from 1988-June 2007 of less than 0.20. Since that time, an investment in the S&P 500 and financial bonds have been remarkably similar in terms of performance with an r-square of 0.56.

Source: Barclays Capital / S&P

Monday, October 10, 2011

Emerging Market Rotation Strategy

Along with taking a deeper look at macro trends / releases to try to figure out this whole economy thing (in these all-too-interesting times), I spend quite a bit of my time creating (long-term oriented) trading models. The goal? To better allocate my investments by taking away some of my emotion.

The following model I will walk through is a simple model (available for download here) based on my friend Meb Faber's (of World Beta blog and Cambria Investment Management) Timing Model.

What is it...

It is an Emerging Market "EM" timing model that allocates between two EM sectors... fixed income and equities. As a way of background, since 1999 (I could only pull data for both indices as of December 1998 - due to the methodology below, the start of the model is 10 months later), both EM fixed income and equities have had very similar returns, but have had VERY different ways of getting there (see chart below). At a high level, EM equity tends to outperform when both are trending higher, but EM fixed income outperforms when EM beta struggles.

With that in mind... what is the model? On an end-of-month basis:
  • If EM Equity Total Return index > 10-Month moving average, allocate to EM Equities
  • If EM Equity Total Return index < 10-Month moving average, allocate to EM Fixed Income

The result? Over this time frame, the rotation strategy has significantly outperformed both EM fixed income and equities with volatility and drawdown levels right between the two (note that a 50/50 blend had returns of around 10.7% with slightly less volatility than the rotation strategy).

If anyone can pull data for EM indices going back further in time, please send my way as I'd like to see how this performs over the longer term.

Source: MSCI, JP Morgan, World Beta
Model: Download here

Friday, October 7, 2011

Employment Reports Mixed

PBS details:

According to the "establishment survey" of places that hire, the economy added more jobs than predicted: just over 100,000. More significantly, the last two months' numbers were revised upward by another 100,000 or so.

Yet when we turn to the "household survey" of actual people, the headline unemployment rate remains unchanged at 9.1 percent. How come?

The numbers suggest that the working-age population (16 and over) grew by 200,000 last month, and another 200,000 people rejoined the workforce - that is, are back looking for work. The household survey also shows that 400,000 more Americans were employed this month than last. So it's a wash.

Disturbingly, our U-7 number actually went UP. How so? Because -- and here's the bad news in this month's numbers -- the total number of workers toiling part-time, but looking for FULL-time work, jumped by 400,000, about 5 percent. Since "part-time for economic reasons" are included in our U-7, the number rose from 18.26 percent to 18.41 percent, the third highest month since we inaugurated U-7 back in December.

Source: BLS

Thursday, October 6, 2011

More on Chinese Investment

Yesterday, I posted about China's Investment Conundrum (specifically, that China can't keep growing their investments at the torrid pace we've seen due to simple math). Below is a comparison of the composition of China's economy vs. that of the U.S., as well as growth in each component from 2001-2010.

To show this in a different way, below is just U.S. and Chinese investment. Combined, they have grown at a ~4.5% annualized clip, which not coincidentally is just about the pace of global GDP growth over that time frame. In other words, China has been taking production market share (a lot of it) from the U.S. (and developed world). At some point in time there isn't any more market share to take (or in theory the outsource trend could reverse), thus the entire consumption pie (including Chinese consumption) needs to grow at a faster pace in order for China to maintain the outpaced growth seen.

Source: BEA / Chinability

Wednesday, October 5, 2011

China's Investment Conundrum

The chart below was created using data from a table within a recent Michael Pettis newsletter (his great blog China Financial Markets will produce a condensed version of the newsletter within a week or so) that outlined the composition of China's GDP by year (broken out by C, I, G, and NX) and multiplying the component percents by the size of the Chinese economy for each year.

What the chart shows is the remarkable growth across all the components, but the unreal growth in investment which now makes up almost 50% of China's economy (the fact that consumption grew by 75+% likely allowed for the other components to grow even faster as the citizens saw their lifestyles dramatically improve, allowing for the flexibility needed with central control by the government).

But, much like the exponential growth in China's currency holdings this investment growth is not sustainable, especially in a world that appears to have more than enough supply for the current (and waning) level of aggregate demand globally. So this begs the question... if there will be a rebalancing away from investment, will it happen due to the pace of Chinese consumption simply increasing (i.e. will China "save" the global economy) or will investment growth (and the Chinese economy) slow substantially?

Source: Chinability

RIP Steve Jobs

The 5 iPods, 3 iPhones, iPad, and 2 Macs currently in my home attest to the fact that I believe Steve Jobs' was brilliant. And at times he was more than a "computer guy" and truly inspirational. The below video is one of those times (his now famous Stanford Commencement Speech).

Finance and Government... Such a Drag (On Jobs)

Businessweek details:

U.S. employers announced the most job cuts in more than two years in September, led by planned reductions at Bank of America Corp. and in the military.

Announced firings jumped 212 percent, the largest increase since January 2009, to 115,730 last month from 37,151 in September 2010, according to Chicago-based Challenger, Gray & Christmas Inc. Cuts in government employment, led by the Army’s five-year troop reduction plan, and at Bank of America accounted for almost 70 percent of the announcements.

While the bulk of firings are not “directly related” to economic weakness, they “could definitely be a sign of more cuts to come,” John A. Challenger, chief executive officer of Challenger, Gray & Christmas, said in a statement. “Bank of America is not the only bank still struggling in the wake of the housing collapse, and the military cutbacks are probably just the tip of the iceberg when it comes to federal spending cuts.”

Quarterly Job Cuts

Job Cuts by Sector

Monday, October 3, 2011

Manufacturing Expands in September

What respondents are saying:

  • "The economy continues to be a drag on our business outlook. We are trying to deal with new and additional FDA regulations which are costing significant dollars. It is hard to recoup any of these additional costs in our pricing levels without losing significant sales volumes." (Chemical Products)
  • "Market is cautious, but still steady." (Electrical Equipment, Appliances & Components)
  • "Global demand for semiconductors is down and maybe not yet 'bottomed out.' Inventory reduction activities are a priority." (Computer & Electronic Products)
  • "Still strong automotive demand." (Fabricated Metal Products)
  • "Orders remain consistent and steady — no sign of lower demand." (Paper Products)
  • "Japan supply chain issues are over, but exchange rates and raw material prices are hurting our profit." (Transportation Equipment)
  • "We sense a weakening in demand, but it is not extreme at this point." (Plastics & Rubber Products)
  • "Overall, business is improving with a measurable uptick in orders this month. Part of that is due to pre-holiday season orders." (Miscellaneous Manufacturing)
  • "Business continues to be sluggish." (Furniture & Related Products)

Source: ISM