Archive for the ‘The Economy’ Category

The Markets Need Psychotherapy

Monday, December 15th, 2014

“The whole idea that the stock market reflects fundamentals is, I think, wrong.  It really reflects psychology.  The aggregate stock market reflects psychology more than fundamentals.”

Robert Shiller, Nobel Prize-winning economist

Tired of low returns?  You may be a bond investor.

Bond investors have been “growing tired of low returns, the endless warnings that rates are about to rise, and constant reminders of the dangers of riskier bonds,” according to Jeffrey Matthias, CFA, CIPM of Madison Investment Advisors.

At the same time, they’ve watched the stock market continue to break new records every time there’s another sign that a central bank somewhere may buy a few bonds or lower interest rates into negative territory.

“None of us have ever lived through this kind of extreme, long-lasting suppressed rate environment,” Matthias wrote, and, as a result, those bond investors who are mad-as-hell-and-are-not-going-to-take-it-anymore have been frustrated enough to take on a lot more risk for a little more yield. Central Bank Assets

When you chase yield, you catch risk.  It’s a dangerous reaction to the yin and yang of investing – fear and greed.

“Typically, when markets are moving higher,” Matthias wrote, “most investors turn greedy and want more.  Should an investor’s more conservatively positioned portfolio produce lower returns when the market surges, the investor may regret not having taken more risk.  In contrast, should a riskier portfolio drop significantly in market value, the opposite may happen and an investor may begin to regret (his or her) decision to have invested in risker assets.  This can be accompanied by a fearful overreaction.”

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Baby Boomer Bust

Friday, August 15th, 2014

Each day, another 8,000 baby boomers turn 65.

The U.S. Census Bureau says there are more than 77 million baby boomers, defined as those born between 1946 and 1964.  By 2030 all boomers will be over 65 and will represent about 20% of the population.

So, given the growing number of boomers who have reached retirement age, why is the unemployment rate still so high?Over 65 retirement

Based on the official U-3 statistics, unemployment is still at 6.2%.  That’s much better than the 10% rate we had in 2009, but it’s considerably higher than the 3.9% rate the U.S. enjoyed in 2000 – which was long before baby boomers even thought about retirement.

If Americans are retiring at 65, that should open up more than a quarter million new jobs per month – on top of job growth caused by economic recovery.  So when the Bureau of Labor Statistics reports that 205,000 jobs were created in July 2014, it’s not exactly a sign of prosperity.

The U-6 unemployment rate, which includes those who have given up looking for work, is still 12.2%, which is practically European.

So why is the unemployment rate still stubbornly high?

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Only a Half Trillion Dollars

Thursday, July 24th, 2014

It’s a sign of how much trouble we’re in when a budget deficit of a half trillion dollars seems like fiscal restraint.

It is progress, given that annual budget deficits were running above $1 trillion a year throughout President Obama’s first term and have been as high as $1.4 trillion.  And it could have been worse.  Recall the effort made by President Obama to stop the automatic spending cuts that took place when sequestration was adopted.

But a half trillion dollars is still a mountain of money.  It helps to give the number some context.CBO Chart

To reach a half trillion dollars, you would have to spend $8 per second beginning with the year 0 and continue spending through today.  If you had a stack of $1 bills adding up to $500 billion and were able to put them one on top of another, the stack would be 34,000 miles high.

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The QE Apocalypse

Friday, July 11th, 2014

The end is near.

The Federal Reserve Board has now put a date on the quantitative easing apocalypse, letting us know that bond buying will end in October – unless the central bank changes its mind, of course.

The October ending is not unexpected.  The Fed has been cutting back bond purchases by $10 billion a month since last year and it doesn’t take a math wizard to figure out that there will be nothing left to taper post-October.

Yet this news, reported in the just-released minutes to last month’s meeting of the Federal Open Market Committee, is being treated as a revelation.  It was, for example, the lead story in The Wall Street Journal, which typically doesn’t lead with news that was discussed last year and made official at a meeting that took place a month ago. Portugal

The real news, though, is what wasn’t discussed – the end of near-zero interest rates.  As a result, rather than pushing yields up and bond prices down, release of the meeting minutes had the opposite impact.

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Sprinkling the Fairy Dust of Illusory Riches

Thursday, July 3rd, 2014

When the Bank for International Settlements (BIS) calls central bank market rigging “the fairy dust of illusory riches,” it’s time to pay attention.

The BIS is the central banks’ central bank.  Its role is “to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks.”

To provide the statement with some context, and to alert you about what else you can expect from central banks moving forward, we provide a summary of other key points made in this year’s BIS annual report, which is appropriately titled, “In Search of a New Compass.”Compass

First, there’s recognition that easy money policy has gone far enough.  That’s self-evident, but of special interest when you consider the source.  BIS notes that despite a pickup in economic growth, the world economy “has not shaken off its dependence on monetary stimulus.  Monetary policy is still struggling to normalize after so many years of extraordinary accommodation.”

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Prozac Nation

Friday, June 27th, 2014

It’s all stress-free bliss these days … at least for anyone who’s not paying attention.

Has someone been putting anti-depressants in the water supply?  That’s one way to explain Wednesday’s non-reaction to the report that the economy shrank by 2.9% in the first quarter – not the 1% drop previously reported.

It would also explain continued investor complacency reported last week, with the VIX (volatility index) approaching single digits.  And it would explain the plunge in junk bond yields to 5.6%, which is a full 3.4% points lower than the decade-long average of 9%.

GDP GrowthYet investors showed that they still have a pulse, when they took the Dow down 100 points after James Bullard, president of the St. Louis Federal Reserve, announced that an interest rate hike may take place in the first quarter of 2015.

So consider this in context.  In addition to the slumping economy, we have Russia’s continued takeover of Ukraine, which is now being overshadowed by the continued takeover of Iraq by Muslim terrorists known as ISIS and the possibility of U.S. military intervention.  We have civil war continuing in Syria and continued nuclear development in Iran, in spite of the lifting of sanctions.  We have U.S. veterans in need of medical treatment being ignored while the Veterans Administration fudges numbers.  We have the missing e-mails of Lois Lerner and six other IRS employees who allegedly targeted conservative groups.  We have continuing fallout in the healthcare industry from the pains of implementing Obamacare.  We have a stock market so overblown that price-to-earnings ratios are at levels higher than they’ve been through 89% of the history of the S&P 500.

So what’s moving the market?  A statement made by a Fed board member that repeats a statement he previously made.

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Polar Vortex or Recession Redux?

Friday, May 30th, 2014

The recovery that wasn’t a recovery may have come to an end, as the Bureau of Economic Analysis reported that gross domestic product dropped by 1% during the first quarter of 2014.

Even with the drop in GDP, lower housing sales and continued high unemployment, no one is saying the economic is in a recession.  Perhaps when a recovery is as insignificant as the one we’ve experienced for nearly five years, the distinction between recession and recovery is insignificant.

The economy was in sad shape five years ago and it’s in sad shape today, in spite of record stimulus spending, bond buying, and warm and fuzzy messages from the President, Congress and the Fed.

Quarter-to-Quarter-Changes-in-Real-GDP-Percent-Change_chartbuilder-1But fear not.  The bar is so low now, even a baby step over it will look like a high jump.  At least that’s the opinion of PNC Chief Economist Stuart Hoffman who wrote, “I believe this real GDP decline, mostly due to the polar vortex, coiled the ‘economic spring’ even tighter for a sharp snap-back (boing!) this quarter, where I have an above-consensus forecast for a 4.0% annualized rise in real GDP.”

In other words, bad news for the first quarter is good news for the second quarter.  Stop me if you’ve heard that story before.

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Household Income Shows Troubling Outcome

Friday, May 23rd, 2014

Hold off on the victory dance.

The 2014 “Economic Report of the President” and many media reports indicate that the U.S. economy has finally recovered.  But has it?

One measure of economic health is household income.

Historically, America has prospered, as each generation typically has earned more inflation-adjusted income than the generation that preceded it.  The American Dream is not just to succeed yourself, but to provide your children with a better life.

A better life means more than money, of course, but money enables the next generation to do more, live more comfortably and worry less about making the mortgage payments.  Materialistic though it may be, it’s part of the American Dream.

So it’s alarming to see the drop in income that has taken place since 2007, when the financial crisis began.  Median household income has dropped from $56,000 to $51,017, which is a dip of nearly 10%.

We’ve had dips before, as the chart below shows, particularly during the “stagflation” years of the late ’70s and early ’80s.  But this has been the most dramatic drop in income in recent history.

Household Income

Household Income

When household income shrinks, some in the middle class risk sinking down to the lower class and those on the cusp of becoming middle class no longer are able to achieve that status.  As the lower class grows, government expenditures grow, resulting in higher taxes and even further erosion of discretionary income for those in the middle class.

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The Fed Goes Long

Friday, April 18th, 2014

Few investors today would consider investing in long-term Treasury bonds.

The yield curve, which measures the spread between interest rates for short-term and long-term bonds, is not as flat as it has been in recent years, but that’s faint hope for investors.

A 10-year Treasury is still yielding less than 3% interest.  If the Federal Reserve Board achieves its goal of pushing inflation up to 2%, the real interest on a 10-year bond purchased today will be under 1%, payable at maturity.yield-curve-investwithalex

If the Fed overshoots its goal and inflation moves higher, which is highly likely, a 10-year bond would produce a negative yield.  What’s the probability that inflation will remain lower that the current yield on a 10-year Treasury over that entire period?

The U.S. has not had a period when inflation remained below 3% for a 10-year period since the days of the Great Depression.  During the period of recession then slow growth that we’ve experienced since the financial crisis began in 2008, inflation has remained low and the Fed’s focus has been on fighting deflation.  But when the economy improves and normal growth returns, inflation is likely to move significantly higher, as higher inflation is a byproduct of a healthy economy.

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Good Market Rigging vs. Bad Market Rigging

Friday, April 4th, 2014

“The markets are rigged. … These firms make their money by front-running trades. They’re using their speed advantage to buy shares first and then selling them back at a higher price. The result is higher prices for investors in those shares. That’s rigged.”                                                                                                                                      Michael Lewis

Based on the Federal Reserve Board’s actions of the past five years, you may have thought that “market rigging” was a good thing.  After all, a great deal of wealth has been created from the Fed’s bond buying – although, granted, almost all of it went to those who were already wealthy.

But suddenly, high-frequency trading is being charged with rigging the markets and it’s creating a bit of a furor.  Apparently the Fed is responsible for good rigging and HFT is responsible for bad rigging.  Consider this week’s HFT-related news:

  • Michael Lewis, author of Moneyball, was interviewed by “60 Minutes” in advance of publication of his book, Flash Boys, in which he makes the case that HFT rigs the markets against the small investor.

  • There was the heavy backlash from those who disagree with his conclusion … that is, the people who make money off of high-frequency trading.  Supporters contend that HFT has created liquidity and reduced the cost of trading for small investors.  In other words, the market is rigged against small investors, but it costs them less to make a trade.  Yippee!!
  • Then there’s The Wall Street Journal’s announcement this week that HFT is being investigated by the FBI – not the Securities and Exchange Commission (although it is participating in the investigation), the FBI.  You know, the guys who investigate bank robberies, money laundering, drug cartels and the Mafia.  And now you can add high-frequency trading to that list.  Apparently, insider trading was already taken. (more…)