Posted by Don Martin on Fri, Apr 26, 2013 @ 06:53 PM
Will increased recognition of intangibles result in lower unemployment?
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The structural nature of the U.S. economy has been changing from manufacturing to service for many decades. Starting in July the Bureau of Economic Analysis in the Department of Commerce will calculate GNP using new measures for intangible services. This will artificially increase the GNP by 3%. To make things comparable they will adjust figures going back 83 years. The WSJ had an article about this.
The move highlights the fact that trying to forecast the economy is like aiming at a moving target. A good research scientist knows that one must constantly be willing to change their core beliefs if new evidence is uncovered and they must be willing to abandon cherished paradigms and embrace new ones when the old ones has become discredited. I see this as a move towards greater recognition of the job generating sector that produces intangible services. Economists need to move away from unbalanced calculations of the effect of unemployment in old declining blue collar industries and move towards identifying hidden positive news such as the increased use value of services. If a foreigner comes to the U.S. to go to college and pays full non-resident tuition then they are like a foreign consumer who is buying our exports, but it doesn’t show up in the export records. When the iphone is built in China most of the sales dollar goes to Apple and not to the Foxcon factory in China, so the importation of an iphone is not really that much of an foreign import. What is important is that service industries including chip design shops add more value and pay better wages than many blue collar industries. In some countries old smokestack industries are subsidized by the taxpayers to create jobs.
The point is that unemployment, which is clustered mainly with low skilled workers, is mis-measured because it should be weighted towards the income of the worker and not simply a binary question about does someone have a job or not. Service industries create jobs and wealth and continue to be under-calculated compared to tired old blue collar industries. As more recognition is given in this sector then perhaps economists will revise the definition of unemployment, especially the “natural rate” of unemployment.
According to economist David Rosenberg the “insured unemployment” rate is now 2.25% which is about at average level and not too far from full employment levels for that group. My opinion is that even though the general public has a 7.6% unemployment rate, what matters is the rate for mainstream breadwinners. Since more sophisticated measures of unemployment show we are close to full employment then it is only a matter of time before the Fed and the bond market vigilantes change their opinion and make interest rates go up. The key determinant of interest rates are unemployment and inflation.
When rates go up then stocks, bonds and real estate go down.
I have written an article “Employment better than appears”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Mar 28, 2013 @ 03:56 PM
Good news can be a hidden risk for investors
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Today the SP hit a new high beating the previous high of October, 2007. However, on an inflation adjusted basis the SP is roughly 10% below the old high, and there is no income tax adjustment for phantom gains caused by inflation. The risk that the U.S. economy has been and will continue to recover faster than expected could lead to sudden interest rate increases by the Federal Reserve. However globalization will suppress U.S. inflation by importing deflation from Europe and Japan. China’s and Brazil’s credit fueled booms may not be as simulative to the global economy as thought, thus reducing their inflationary impact.
A big misunderstanding is to incorrectly assume that stock prices are reflection of GDP and economic growth. Instead stocks are a reflection of the earnings capacity of the publicly traded companies. If the companies somehow manage to increase earnings in a recession then stocks will go up, assuming the Fed is stimulating the economy. When the economy shifts to a full employment mode that can actually hurt corporate earnings if costs for business go up too much. During boom times some businesses experience a crippling labor shortage and engage in bidding wars to get employees, but this ruins profits. I have seen it here in Silicon Valley in previous cycles and heard about it in the commodities industry where mining operations may experience a 25% annual inflation rate. So when the economy becomes hot then more rewards go to workers, not to companies, so stocks will have less reason to go up.
The threat of inflation from unemployed people getting jobs is minimal because these job seekers have minimal skills so when they do get hired they won’t have enough income to qualify for a loan. Getting a loan from a bank is what causes inflation because it increases the money supply. As the hard core unemployed people gradually find work they will be in low wage jobs which means they will patronize low margin discount stores, thus shielding the rest of the economy from the risk of a substantial increase in inflation. Also the increased spending won’t push up company earnings and stock prices, except for a few discount stores.
As U.S. interest rates normalize more investors including foreign Central Banks will tire of owning yieldless gold bullion so they sell gold and buy Treasuries. There was a significant increase in foreign Central Bank purchases of gold since the 2008 crash and an increase in purchases by retail buyers of gold ETF’s. There will be a great rotation out of inflation hedges ironically once interest rates rise because that will make the dollar more attractive and more credible and it will make the inflation hedges produce a negative return which will make people get out of the hedges. This will free up capital for more productive uses. Zero percent loans mainly help speculators with interest-only loans who buy high yielding stocks and bonds. By contrast a low rate loan with five year fully amortized payments may still cost a lot in the eyes of a consumer because of the amortization of principal actually rises as a percentage of the loan payment when rates go down. Thus most of the benefit of ultra-low rates goes to non-productive speculative margin loan uses by upper-class people , instead of facilitating a car purchase by ordinary people.
I have written an article “Counterintuitive approach to Back Swan risk”.
Investors should seek independent financial advice.
Posted by Don Martin on Sat, Nov 10, 2012 @ 03:41 AM
Election analysis: does the repudiation of free market politics mean the U.S. is a less attractive place to invest?
The election reflected the fears of moderate income people that globalization will or has taken away their job.
In the era before globalization when a recession hit eventually the business cycle would recover, but with loss of old style moderate income jobs there is no solution for moderate income semi-skilled workers. For Republicans to tell people that more free enterprise would create more growth and jobs was not enough for them to win the election because it was perceived as an inadequate solution to unemployment. Yes, more free enterprise with lower taxes would create a boom but it might primarily be a continuance of the benefits from globalization which include more professional new tech style jobs rather than a source of employment for semi-skilled people. The critical problem of this era is that unemployment rates increase geometrically as skill sets decline. The unemployment rate for college graduates is half that of the national average. The unemployment rate for high school dropouts or for people under age 30 is far worse than the national average.
The problem with globalization reducing U.S. employment began in 1998 when real wages started to shrink. The problem was camouflaged by the great tech stock bubble euphoria of 1998-2000 and re-camouflaged by the real estate bubble of 1997-2007. Then when Lehman went bankrupt in September, 2008 and the stock market crashed then the camouflage was washed away by a powerful storm. The suffering job seeker could no longer pretend that there was a magic way to augment his income with stock or real estate speculation. For 14 years U.S. real wages have declined due to globalization. This occurred despite enormous stimulus from the credit market which enabled consumer debts to increase far faster than inflation or economic growth. The decline is further masked by the mixture of high skilled and low skilled workers. Highly skilled workers are needed to facilitate the complexities of globalization; thus their rising wages pull up the average worker’s wage. This means those who are below average are hurting even more than the average person.
This is a fundamental generational problem; it is not something that can be solved in a few years. Thus the majority of voters may feel a need to align themselves with a socialist, anti-free market party, which explains why the Republicans did so badly in the elections despite the fact that voters had reason to be dissatisfied with the Democrats. The implication is that we are in for a repeat of the 20 year Roosevelt-Truman era where the masses of people supported the left wing of the Democratic party and the Republican party was powerless.
No amount of salesmanship or marketing including becoming more diverse, multi-cultural, etc. can fix the Republican party’s problems because of the problem caused by globalization. The Republicans’ only hope is to educate people that they can cope with this by encouraging more free enterprise and growth and by encouraging more job skill training, etc. They need to demonstrate that the socialist policies of the left will only makes thing worse and that therefore workers are better off with a free market style government instead of a socialist government. However some semi-skilled workers may not be able to learn (even with free training) complex skills that will enable them to be a qualified candidate in the work force of the future. I think the economic pressures are so great that some workers can’t become relaxed and objective to weight the facts between the choices of the free market versus socialism so there will be a strong anti-business prejudice that the Republicans can’t overcome.
For hundreds of years American workers could look forward to sharing an ever-expanding economic pie with the bosses. Then in 1929 the Great Depression started. Congress legislated benefits for workers so their share of the national income increased. During the postwar recovery of 1945-1973 the economy grew so that workers were distracted from looking at how big a share of the pie they got. People got distracted from income distribution during the tech and real estate bubble eras of 1997-2007. Now those eras of legitimate growth or bubbles are over and the worker has no distractions and has become aware that his real income has declined for 14 years.
American workers are special, compared to workers of other countries. They are more sympathetic to free enterprise and less of a believer in class warfare-jealousy than people in other countries. The American workers have contributed to a pro-free enterprise political culture that has made America an attractive place for capital to flee to as a safe haven. This in turn lowered the cost of capital and lowered the unemployment rate. Now that virtuous cycle is at risk of reversing course as American workers, after suffering from a 14 year decline in real income and a five year Soft Depression with a 15% real unemployment rate (counting discouraged workers) may become like European voters with anti-free market tendencies.
The implication of the U.S. changing from a workforce of pro-free market workers to sullen, poor work quality European style socialists is that America will be a less friendly place for capital and thus capital will flee and the cost of capital will rise. Couple this with the eventual need for the Federal Reserve to raise interest rates to “normal” levels and the result will be that a higher hypothetical “discount rate” will be assigned by the market to assess the value of investments. This means investments will have a lower value as a result of a higher discount rate. This means a lower stock market, lower real estate values, less economic growth, less employment growth and a tendency towards a Japan-style Soft Depression.
Investors should be careful to avoid taking excessive risk and to consider that capital flees to safe havens and that they may need to do the same. Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jul 23, 2012 @ 09:02 AM
Overcoming some economic prejudices to get better investment results
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There are some incorrect myths that can greatly mislead investors. One myth is that it is normal for interest rates to be between 5 to 9% for long term Treasuries. A second myth is that recessions only last a year and then everything goes back to normal. A third myth is that during a period of excessive government debt that interest rates rise to compensate for the increased risk of lending to an over-indebted government.
Myth 1. Inflation is normal and is a risk with a higher probability than depression.
The fact is: The history of the U.S. before the 1930’s was one of constant crashes and long term depressions lasting 15 to 25 years. Only after the start of WWII did the U.S. switch to a long era of inflationary Keynesian debt financed demand managed economy, culminating in a near hyperinflation in the 1970’s. Most people can only recall the past 71 years since the start of WWII. They need to see that Keynesian inflationary debt bubble methods are discredited and they need to consider the deflationary and depression experiences from 1790 to 1941. We had long term depressions in the 1830’s, 1870’s, 1890’s, 1907-1922, and 1929-1941. If the Central bank and Congress can’t stimulate the economy then the best guide to what will happen is the pre-1941 era.
Myth 2. Recessions only last a year and then everything goes back to normal.
Fact: Unfortunately the current recession is a Japan-style Soft Depression that will last a long time. Bond bull markets where interest rates go lower and bond prices go higher can last up to 25 years. Since the ultra-high rate era of Volcker was an aberration then the beginning of the current bond bull market should be marked from the time in 1997 when Asian countries encountered a crisis and Greenspan and the world’s credit markets lowered interest rates in response. The bond bull market could last until 20 years after 1997 which is 2017. Many bearish commentators have felt that is when the economy would get better, so that may be when the bond bull market ends.
Myth 3. During a period of excessive government debt that interest rates rise to compensate for the increased risk of lending to an over-indebted government.
Fact: As things get worse people panic and engage in a bidding war to buy seats on a financial lifeboat, which are Treasuries. The worse things get for the private sector the more the tax collector (who also has a printing press and debts denominated in the local currency) looks like the only reliable credit risk to lend money to.
Once investors learn to be unprejudiced about credit market myths then they can invest correctly.
I wrote an article “Deleveraging to continue”.
Investors should seek independent financial advice. 
Posted by Don Martin on Fri, Jul 06, 2012 @ 04:31 PM
Today’s non-farm employment report
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Today’s Labor department non-farm payroll employment report came in at 80,000 jobs versus the consensus forecast of 100,000, thus confirming we are in a recession. When adjusted for the need to create 125,000 new monthly jobs for population growth that means in real terms that the unemployment increased by 50,000. At an annualized rate that would be a 0.5% increase in the unemployment rate. Of course, one month’s results are not a very reliable indicator, however the trend has been weak for several months. I had forecast 100,000 jobs and I’m bearish; as a bearish advisor I was surprised it was worse than I expected.
The age 55 and up cohort actually increased the amount of jobs that they hold, while other age groups lost jobs. This implies that the most experienced people are taking jobs away from less experienced with the youngest workers suffering a severe increase in unemployment. Since young people are the first-time homebuyers who are a critical part (the foundation of the pyramid) of the home buying “food chain” then less of them can buy starter homes and thus other people will be unable to sell and move up to bigger homes.
A symbol of the amount of real wages increase
There was a slight increase in real wages but that could be explained by employers laying off mediocre low productivity younger workers and replacing them with more experienced and expensive older workers who might do more work in a lesser amount of hours. Thus the notion of real hourly earnings rising needs to be carefully checked, because in this case the alleged increase in real wages didn’t occur. Further, this could be warped by the top 5% of the most skilled workers getting raises while the rest got nothing.
The unemployment rate is the foundation on which rests the cause of inflation which in turn is the foundation of bond market values. (Although part of what moves Treasury bond prices is a flight to safety factor). When unemployment rate is worsening then that is deflationary. Today gold and foreign currency went down, as did stocks, and commodities .
I wrote an article “Jobless rate to show no real improvement” and “Unemployment will take years to fix”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 10, 2012 @ 06:36 PM
Very weak economy hints at 2012 stock crash
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The first quarter GDP was so weak that 1.6% of its 2.2% growth was due to automobile purchases. (This is 73% of growth). And if the inventory rebuild was removed then the GDP growth was 1.6%. So removing both of these would imply that excluding both inventory rebuild and automobile sales the economy grew by 0.43%, which is far below stall speed.
My favorite economic indicator is unemployment, especially the employment to population ratio which went down 0.1% last month (a downward move means there are fewer people working).
The economy will feel as worthless as this coin during the crash
The “stall speed’ for the economy to keep from stalling and falling like an airplane is about 2% growth. If growth excluding automobiles and inventory rebuild was 0.43% annualized and the job market got worse last month then that is bearish news which justifies the recent significant drop in long term Treasury yields., which are now near a 12 month low.
If stocks crash then fund managers and MBS packagers will move some assets to Treasuries causing demand to rise for Treasuries (so yields will fall). The massive 5% fiscal drag starting with 2013’s tax increases is only 7.5 months away.
I trust the wisdom of the bond market’s collective judgment but not the stock market’s judgment. Stock prices are often driven by the actions of naïve, emotional retail investors; by contrast the bond market is considered so boring that it drives away those type of investors leaving the decision making to seasoned, wise professional investors.
I wrote an article “Recession to come in 2012 not 2013” and “Sell in May and go away”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Oct 07, 2011 @ 03:22 PM
Does the report say the economy is OK?
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Today the unemployment report was released showing 103,000 net new jobs. However to keep pace with population growth we need 125,000 to 150,000. And at two years after the bottom of recession it is typical to have 200,000 net new monthly jobs each month, so we are operating below “stall speed” where the economy is like an airplane flying so slowly that it will stall out (where the wing’s airfoil loses the ability to generate “lift”) and go down.
The Verizon strike settlement resulted in 50,000 people going back to work, which was half of the 103,000 new jos, so realistically, new jobs were only about 53,000, which is one thrrd of the amount needed just to meet population growth.
What is risky about depending on today’s report is that a naïve reader of the report may assume that any positive number is OK, but we need 125,000 to 150,000 monthly net new jobs to breakeven due to population growth and 300,000 to recover the lost jobs to get back to normal. So a careless reader may fail to grasp how serious the situation is and further there is no sign of any new driving engine of growth. So if we are below stall speed then the economy will fall back into recession.
Open the lock to uncover the secret
The U-6 measure that includes all types of unemployed, including those who have given up looking for work, is at the highest of 2011 at 16.5%. The WSJ has an excellent color coded heat map of unemployment since 1948 shows the current recession is the deepest since 1948 and is still near the worst point in the recession.
If Baby Boomer generation is trying to save more and spend less, then that act of saving will be deflationary, which when added to the jobless problem, means that very low bond yields are legitimate and not simply a temporary bubble or panic.
I have written “Tomorrow’s unemployment report may be the start of something terrible” and “Recession coming".
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Oct 06, 2011 @ 08:51 PM
Are we in a recession even though GDP has been rising?
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Tomorrow, on Friday, October 7 the monthly unemployment figure will be released. It is the most important monthly economic number in the world. One French investment company, GaveKal, said last week that the U.S economy has been getting weaker and if this number that is to be released October 7 fails to show a substantial increase of jobs then that means the world is heading into recession. The news media has forecasted 100,000 jobs increase, half of which is due to the end of a Verizon strike, so it would really be a 50,000 increase. However, to get out of the recession we need a long, sustained period of monthly increases of 300,000 of jobs, not the 100,000 forecast for tomorrow. The U.S. has added only about 25,000 jobs a month since the recession officially ended in June 2009, which is over two years is what should be done every two months. So the economy is only creating jobs at one-twelfth the speed that we need to get back to normal. Part of the need to create 300,000 new jobs each month for several years is due to a 0.8% annual population increase.
A recession is not simply “two quarters of negative GDP”, rather it is a complex series of symptoms: no growth in real personal income, excessive joblessness, lack of increase in industrial production, inability to reach new highs in real sales. We are in a big, bad recession and there is nothing on the horizon that is a potential engine of growth. We have only regained 20% of the lost jobs that were lost in the 2008-09 crash.
The GDP and various broad indicators sometimes incorporate some intangible measures such as stock prices or low interest rates and that can make the broad economic indicator look better than it really is. But the “real world” of jobs, sales, personal income (excluding government transfer payments) is what should count, not a statistic that can be manipulated (and is potentially a bubble) statistic like stock prices or interest rates. We have seen the irrational judgment of stock investors during the 2000 Tech stock bubble, so using stock prices to determine whether or not we are in a recession is often worthless. Congress passed a law in 2009 forcing CPA’s to switch from “mark to market” to “mark to model” for banks so this created false valuations of bank loan portfolios that were legislatively imposed, so how can stock prices be useful information?
Using interest rates to measure the economy or their maturity spreads is very worthless because of the Fed’s absurd hyper-manipulation of them. For example if it were practical to have negative nominal short term rates then the yield curve would be very steep, but it is not practical to have negative nominal rates. (That would require legislation imposing mandatory fees and price controls on interest rates for all bank depositors to transfer 2% a year from zero yield savings accounts to borrowers, since in normal situations a bank can’t offer a savings account with negative rates.)
Be open minded to new viewpoints
Personal income has been declining
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The private sector has had no real (inflation adjusted) increase of personal income since 1998. Stock prices are the same as in 1998 (lower if adjusted for inflation). A graph I saw pointed that real personal income for men has declined since the 1960’s; for women it has increased but at much lower amounts in absolute dollars. The women’s increase was probably due to the women’s lib movement as women moved from clerical work to professional occupations that pushed the gender average. Presumably the blue collar women have suffered the same fate as men’s income as jobs have been moved offshore.
With these negative items there is no chance of inflation coming and high chance of Japan-style Soft Depression with the fair value of a ten year Treasury at a 1.5% yield. Of course buying long term debt is risky since I could be wrong and somehow inflation could surprise and that could make bond prices go down. But I don’t see how inflation can happen, unless Congress legislates truly massive Keynesian deficit spending and at the same time the Fed monetizes the new debt. How can that happen given the recent budget fight led by Tea Party Congress members?
I have written “Recession coming” and “Is economic recovery possible even if housing remains depressed?”
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Sep 16, 2011 @ 04:06 PM
Regarding gold, during a deflation, it should go down with other metals, and if one uses a 10 year inflation adjusted Shiller-style average of gold centered around the January, 1980 nominal high of $885, then the one year average would be a $612 nominal price and the ten year average between 1975-1985 would be about $325 nominal, which if adjusted for inflation, would be about $893 to $1,680 current dollars as a fair value for gold.
If we add a post WWII 1942-47 inflation of 70% (to show the effect of inflation after WWII price controls were removed, and to make an analogy between that inflation and the possible future inflation needed to inflate the world out of its troubles) then that would imply gold at its peak would be 1.7 times a fair value range of $893 to $1,680 or about $2,200 which is not far from its current level. However, that may be double counting since the marketplace has already priced in a 70% crisis premium then I doubt yet another 70% premium should be added to the price. Looking the difference between the ten year average of 1975-1985 and the one year average of $612 during the 1980 the price temporarily was at an 88% premium, which is an interesting analogy with WWII inflation.
(My ten year average is a crude figure that is not adjusted for each individual year’s inflation in the 1975-1985 period, thus the difference in real terms between the 1980 one year average and the 1975-1985 ten year average is actually smaller.)
Thus I doubt gold could go higher and I worry it could go down 50% from current levels as it did after the January, 1980 peak.
The problem with investing in inflation sensitive assets is that they tend to get over-bought by panicky speculators who over-pay for them, thus alleged inflation hedges are risky and may be overpriced.
Open the secret to valuation
See the 8-27-2011 Barron’s article about gold or the article in the May 9, 2011 Economist magazine.
I have written “What is the proper value of gold?" and "Evaluating gold".
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Jun 10, 2011 @ 11:15 AM
Dow in worst slump in nine years
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Today the WSJ said “Dow Jones Industrials fell below 12000, pointing to a sixth straight weekly decline that would be blue chips' longest slump since 2002.“
Rob Arnott, a Pimco fund manager, said that the U.S. private sector GDP in “real” (inflation adjusted terms) terms has not increased since 1998. Wages have slightly decreased in “real” terms during the past decade. So this implies that stocks should be priced at about what they were in 1998 when the Dow was around 10,000. That would imply another 20% drop in the Dow.
However, a better way to analyze stocks is to use the Shiller PE 10 and that implies that the SP has a PE ratio of 23. Since a PE of 15 or 16 is fair value then that implies stocks are roughly 50% overpriced even with recent declines. Further, since stocks may go down and momentum could build in a downtrend where they go beyond fair value then stocks could go even lower. One prominent bearish advisor, David Rosenberg, has said the SP has fair value at about 900.
Unlock the combination to the mystery of the market
Assuming that the economy falls into a growth slowdown and near recession and that there is no stimulus, no QE3, and that the Euro debt crisis gets worse then long term U.S. Treasuries could increase in value (and their yields would go down).
I wrote in April "Bears should not capitulate".
More news stories are being written about the attractiveness of Emerging Markets Bonds. Important: Get more information in my free Special Report about emerging market currency investing.
Investors should seek independent financial advice.