Archive for November 1st, 2012
Thursday, November 1st, 2012
SIA Equity Leaders Weekly (November 1, 2012)
Frequently we are asked about the state of the Canadian and U.S. Banks and Financial Services companies. For this weeks Equity Leaders Weekly we are going to take a look at a couple of comparison charts putting the two sectors up against each other.
iShares Dow Jones US Financial vs. iShares S&P/TSX Financial (IYG^XFN.TO)
In the first chart we are comparing the two financial services sectors against each other using a 1% comparison chart. This chart is looking at the shorter timeframe relationship between the two sectors. We can see that the larger trend has been moving downwards in favor of the CAD Financials, but there have been a few movements back towards the downward trendline that have been in favor of the U.S. Financials. Currently the U.S. have now peeked up and through the downward trendline, showing relative strength in favor of the U.S. Financials.
Click on Image to Enlarge
iShares Dow Jones US Financial vs. iShares S&P/TSX Financial (IYG^XFN.TO)
Knowing what the short term trend is between two positions is always good to know, but it is also important to examine the longer term trend. The chart to the right is comparing the same two ETF’s, but this time using a 3% comparison chart, giving us that longer outlook that is required. We can see that going back over 10 years, with the exception of some sideways consolidation or equality between these two, it has been all CAD Financials in terms of relative strength.
Being able to put things into different perspectives can help us to make sure we are always on the right side of the trend and help us to manage our positions. Short term we see favoritism towards the U.S. but the longer term outlook still favors Canada.
Click on Image to Enlarge
Thursday, November 1st, 2012
Is Economic Growth Good for Investors?
Jay R. Ritter
University of Florida
August 7, 2012
The cross-country correlation of GDP growth per capita and inflation-adjusted stock returns is negative when long periods are analyzed. This is surprising, since economic growth, and especially unexpected growth, is presumably good for profits. The result holds for both developed countries and emerging markets. Economic growth comes partly from increased inputs of capital and labor, which don’t necessarily benefit the stockholders of existing companies. Economic growth also comes from technological change, which does not necessarily lead to higher profits if competition between firms results in the benefits being passed to consumers and workers. Realized growth has both an expected and unexpected component.
Apparently investors overpay for expected growth, and this overpayment more than offsets the benefits of unexpected growth.
Acknowledgements: This paper is being written for the Journal of Applied Corporate Finance. This paper updates and extends the results, through 2011, that were contained in my 2005 Pacific-Basin Finance Journal article on “Economic Growth and Equity Returns.” Please see this earlier article for a more complete list of citations and references. I want to thank Leming Lin for excellent research assistance, and the editor, Don Chew, for extensive suggestions and guidance.
Read the entire paper in the slidedeck below, or download it using the link in the frame:
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Thursday, November 1st, 2012
by Michael ‘Mish’ Shedlock, Global Economic Trends Analysis
Here is the question of the day: What’s Behind Gross Inequalities In Income Distribution?
I ask the question after reading three incorrect answers in the article Inequality and the Second Gilded Age on the Real-World Economics Review Blog.
Misguided Notions on Commodity Values
Writer David Ruccio kicks things off by stating “The only way you can answer that question is based on a theory of value — a theory of how commodity values are determined and how the resulting flows of value are distributed to different participants in the economy.”
Ruccio gets off on the wrong foot because there is no such a thing as “commodity value” that can be measured.
Here are a few snips straight from chapter 2 “On the Measurement of Value” from The Theory of Money and Credit by Ludwig von Mises.
Although it is usual to speak of money as a measure of value and prices, the notion is entirely fallacious. … Acts of valuation are not susceptible of any kind of measurement. … But subjective valuation, which is the pivot of all economic activity, only arranges commodities in order of their significance; it does not measure this significance.
Misguided Notions on Skill-Based Technology
Ruccio goes on to state “Brad DeLong, who admits that he was wrong to presume that the late-20th century America would be ‘a much more equal place than early 20th century America,’ focuses on exogenous factors such as winner-take-all markets in an increasingly globalized world and skill-based technical change to explain growing inequalities in the Second Gilded Age.”
Clearly there is a “winner-take-all” concept in the markets, but it should be equally clear that winner-take-all is not primarily based on technical skills.
Did Mitt Romney really have any “technical skills” or did he learn how to use leverage to his advantage? Most top executives of financial companies have no “technical skills” to speak of although many do have “analytical skills”.
Many one-percenters were nothing more than huge gamblers. Get enough people gambling, and the law of averages says some will strike it big. Some were just plain lucky.
Misguided Notions on Changing Attitudes Towards Unions
The worst explanation comes from Mark Thoma who emphasizes “the changing political tide over the last few decades, and how that has altered public policy towards institutions such as unions that were able to help workers get a fair share of the output they produce.”
Good grief. If you are looking for someone who is 180 degrees wrong and is not even in the correct ballpark, then look no further than Thoma.
The fact of the matter is unions, especially public unions have bankrupted cities states and municipalities by driving up costs far more than politicians were willing to hike taxes to pay for them.
Many police and firefighters make more in retirement than they did working. Moreover, a majority of them get to retire at age 50 or so, provided they put in 20 years.
Those benefits may not be in the top 1% but they are probably in the top 5%. Who has to pay for that? The bottom 95%, that’s who.
Framework For Discussion
Let’s step away from the misguided notion of “value” and reflect on the last two major boom-bust cycles.
In 2000, there was an internet boom of epic proportion followed by an equally large bust. Who benefited from that? Clearly it was not the 1%.
From 2002 through 2006 there was a housing boom, the biggest the world had ever seen. Who benefited from that? Clearly it was not the 1%.
Many one-percenters (with zero technical skills) amassed fortunes during the housing boom. Some lost it all back. Others (with zero technical skills) made fortunes betting against the bubble. Still others went broke betting against the boom too early.
Some gamblers won and some lost. Technology had nothing to do with any of it. Countrywide Financial CEO Angelo R. Mozilo cashed out $1 billion in stock options in that time frame. The company itself became nearly worthless!
If one really wants to understand “gross inequalities in income distribution” one needs to understand precisely how and why that happened.
Here’s a hint. Lack of unions had nothing to do with it. Fiat money does. So does fractional reserve lending.
Reflections on the Effects of Fiat Money
My good friend, Hugo Salinas Price touches upon the root cause of income distribution inequity in his latest article Reflections on the effects of War as compared to the effects of Fiat Money.
I encourage you to read the entire article because he provides excellent historical perspective, but here is one critical snip.
The apparent prosperity of the developed nations of the world today has been sustained by credit expansion, not by savings. The West has been living like an heir to a great fortune, wasting away its inheritance. It is now bankrupt. The continuance of a whole way of life is now in danger of collapse, because it is becoming impossible to expand credit any further. The Chinese are in no better situation: their supposed prosperity will crumble when the policy of expanding credit in the West has to come to a halt and the markets which China has supplied fade away.
Fiat money is the child of the arrogance of human intellect, which has sought to invalidate the laws of human nature which have regarded the precious metals as money for thousands of years, and sought to substitute an intellectual construct for the real thing. Now we are going to pay for that arrogance.
What now? Nobody knows. Unquestionably, we are headed straight into fearful problems never seen before. At least, owning physical gold and silver may be help some of us survive.
Inflation Targeting Non-Solution
Fed Chairman Ben Bernanke would have you believe deflation is a bad thing. Common sense says otherwise. So clearly Bernanke is devoid of common sense.
Ask anyone on the street if they want lower food prices, lower energy prices, lower rentals, lower health-care costs, or lower education costs.
100% of the 1% would want exactly that!
Yet Bernanke wants prices to go up by 2% a year. Here is a chart and commentary from my post World Economic Forum Endorses Fraud
Inflation Targeting at 2% a Year
click on chart for sharper image.
Many bad things can happen with Bernanke’s 2% inflation target.
- Wages do not keep up.
- Asset bubbles build
- Rising asset prices make it appear debt is sustainable
- Wage growth is disproportionate to debt
- Wealth concentration
- By the time bubbles are spotted it is already too late
- Recessions happen
Take a good look at that first bullet point.
Did wages rise to keep up with inflation? They did for a while. Then what? Then manufacturers decided to move jobs to China.
Then we had boom bust cycles of immense proportion as Bernanke saved the banks and the bondholders (the wealthy) at the expense of the 1%.
The 1% knew all along Bernanke would do that because Bernanke carried out the same fatally-flawed moral-hazard “too big to fail” policies as Greenspan.
Bernanke also slashed rates to 0% and paid banks on “excess reserves”. This is free money for the wealthy but yields 0% interest for those on fixed income.
Now Bernanke is so trapped in his academic ivory tower that he cannot figure out that he personally is part of the problem.
Steve Keen Chimes In
Australian economist Steve Keen chimed in on my inflation targeting post with Mish Mashes the WEF
The American mathematician Andrew Bartlett claims that “The greatest shortcoming of the human race is our inability to understand the exponential function”, to which I’d add that that shortcoming almost defines neoclassical economics. 2 percent per annum doesn’t sound like a lot, but over 36 years that means the ratio doubles, over 72 it quadruples, over 144 it becomes 8 times what it was, and so on.
Mish provides some nice graphs to illustrate this process.
For the record, the actual rate of growth of the private US debt to GDP ratio was roughly 2.9% p.a. from 1945 till 2008. That means that the ratio doubled every 25 years, from 45% in 1945 to 90% in 1970, 180% in 1995, and if it had kept going, it would have been 360% in 2020.
Instead it fell over in 2008, and is now going backward at a rate of knots. Here’s an extrapolation of the trend that the WEF says is “nothing unsustainable about”, from the time period they should have started their analysis—not 2000 but 1945—and focusing on the key problem—private debt:
I’ll let Mish take over from here.
Three Credit Questions, Three Answers
- Who has first access to credit? Answer: The banks, the political class, and the already wealthy.
- Who benefits the most from inflated asset prices? Answer: The banks, the political class, and the already wealthy.
- Who gets hammered in real terms by rising inflation? Answer: The bottom 10%, then the next 20%, then the lower middle class, then the upper middle class.
The Biggest Academic-Sponsored Fraud in History
Inquiring minds may be wondering “Is deflation really a problem?”
The fact of the matter is deflation is the natural state of affairs is deflation. Productivity improvements over time lead to lower prices. Attempts to prop up prices only benefits those in unions, those holding assets, and government bureaucrats who want to raise taxes.
Deflation is only perceived to be a problem because of the reckless expansion of credit that preceded it.
Look at it this way: If deflation caused a downward spiral in which everyone held off purchases expecting lower prices tomorrow, not a single computer would have been sold since 1990!
Yet, the price of computers, memory cards, wide-screen TVs, and in fact everything technological has been dropping like a rock for ages. Every day such items are bought. That would not be happening if Fed and academic theories regarding the downward spiral of deflation were remotely true.
Moreover, and as noted above, the unseen effect of the Fed’s attempt to prop up wages and prices directly led to a loss of jobs to China.
The “deflation is bad” theory is the biggest academic-sponsored fraud in history.
Fractional Reserve Lending as the Great Enabler
Here is a crucial fifth question: What is the enabler of rapidly rising credit?
The answer is fractional reserve lending.
However, fractional reserve lending and expansion of base money supply by the Fed does not guarantee expansion of credit (a point Keen would agree with).
Nonetheless, fractional reserve lending does serve as the enabler to massive credit expansion (a point Keen may dispute).
Many Austrian economist make a huge mistake by assuming that money supply will quickly come pouring back into the system expanding 10-times or more, causing massive price inflation.
The reality is banks lend if and only if both of the following are true.
- They are not capital impaired
- They have credit-worthy borrowers willing to borrow.
For a discussion please see Can Bernanke Force Banks to Lend by Halting Interest on Excess Reserves?
Before you object to point number 2, please read Reader Questions on “Credit-Worthiness”: Did Banks Give Mortgages to Non-Creditworthy Borrowers?
Role of Government
We are still not quite there. Let’s not ignore the role of government in this mess.
- Numerous “affordable housing” programs helped send housing prices to the moon.
- President Kennedy authorized collective bargaining of public unions, driving up costs to cities, states, and taxpayers. Unions and politicians benefited. Everyone else lost purchasing power due to rising taxes.
- Student loan programs made debt slaves out of kids for life.
In short, government interference into the free markets exacerbated the problem of Fed bubble-blowing policies.
We can now finally answer the question.
What’s “Really” Behind Gross Inequalities In Income Distribution?
- Fractional Reserve Lending
- Inflation targeting by the Fed
- Moral hazard policies of the Fed that encourage winner-take-all speculation
- Government interference into free markets
- Public unions
The result of all five practices is the hollowing out of the middle class from the bottom up.
The solution is sound money, elimination of the Fed, the end of public unions, and minimal government interference in the free markets, not income rules, not misguided regulation of banks, and not more debates about how to measure something that cannot be measured.
Mike “Mish” Shedlock
Thursday, November 1st, 2012
SIA Charts Daily Stock Report (siacharts.com)
Yamana Gold Inc (YRI.TO) – Yamana Gold Inc (YRI.TO) has jumped to the 6th spot of the SIA S&P/TSX 60 Report after golds recent rise on Friday. YRI.TO is up against resistance at $16.74 and the downward trend line. Further resistance is above at $18.12, the previous high from March. Support is found at $15.16 and $14.28.
Yamana Gold (YRI.TO)has had a nice week in the Favored zone of the SIA S&P/TSX60 Report moving up over 10% in the past week. Resitance can be found overhead at $21.82. Support can be found below at $18.62 and again in the $16.87 area. An SMAX score of 10 out of 10 is showing signs that YRI.TO may continue its current run of new all-time highs.
Green – Favoured Zone
Yellow – Neutral Zone
Red – Out of Favour Zone
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Thursday, November 1st, 2012
Submitted by Jim Quinn of The Burning Platform
The Tremendous Economic Benefits Of Superstorm Sandy
The public relations propaganda campaign to convince the ignorant masses that Sandy’s impact on our economy will be minor and ultimately positive, as rebuilding boosts GDP, has begun. I’ve been hearing it on the corporate radio, seeing it on corporate TV and reading it in the corporate newspapers. There are stories in the press that this storm won’t hurt the earnings of insurers. The only way this can be true is if the insurance companies figure out a way to not pay claims. They wouldn’t do that. Would they?
It seems all the stories use unnamed economists as the background experts for their contention that this storm will not cause any big problems for the country. These are the same economists who never see a recession coming, never see a housing collapse, and are indoctrinated in Keynesian claptrap theory.
Bastiat understood the ridiculousness of Keynesianism and the foolishness of believing that a disaster leads to economic growth.
Bastiat’s original parable of the broken window from Ce qu’on voit et ce qu’on ne voit pas (1850):
Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son has happened to break a pane of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—”It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?”
Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.
Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.
But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, “Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.”
It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.
Economists and MSM faux journalists don’t want you to think for yourself. If you just consider some basic situations that are happening or will happen to average people throughout the Northeast, you’ll understand that this storm will have a huge NEGATIVE impact on the economy.
- Small stores, restaurants, and thousands of other businesses were shut down for at least two days and some will be closed for a week or more. These businesses employ hundreds of thousands of hourly workers. These businesses earned no revenue, therefore their profits were reduced. The hourly workers did not get paid. Therefore, they have less money to spend for clothing, tech gadgets, food, etc. Both the business and the workers will pay less taxes to the government.
- The reduced revenue at retailers due to being closed and reduced spending by customers will cause them to layoff more workers or in the case of smaller retailers, go out of business altogether.
- The damage caused by the storm will result in insurance companies providing billions in claim payouts. This will reduce their earnings, causing them to layoff employees in order to meet their quarterly earnings expectations. Some smaller insurance companies may go out of business.
- Anyone with a tree down in their yard, damage to their fence, roof damage, etc that is not covered by insurance will have to spend hundreds or thousands of dollars on fixing the damage. This is money they won’t spend on Christmas presents next month.
- Many people do not have the savings to fix the damage to their houses. They will put the costs on their credit cards paying 15% interest to the criminal Wall Street cabal.
- Politicians and government drones will declare we must rebuild and help those in need. They will approve $20 billion of “Federal” disaster relief. But, we all know the $20 billion does not exist. It will be borrowed from future generations. It will just be added to our current $16.3 trillion tab. We will pay interest on this $20 billion FOREVER. The true cost of the $20 billion relief will be $30 billion after decades of accumulated interest. It’s like an ignorant American taking a $20,000 vacation, putting it on their credit card and making the minimum payment for eternity.
You may realize that the only beneficieries of this tragedy will be the issuers of debt. That’s right, the criminal Wall Street banks will earn more interest as desperate Americans have to use credit cards to survive. The destroyed automobiles will be replaced with autos financed by Wall Street. Businesses and homeowners will go further into debt making repairs.
Considering the country has been in recession since June, this disaster will be the final straw that breaks the camel’s back. The powers that be will try to keep the broken economy fallacy going as long as they can, but anyone capable of thinking realizes the country is in the shitter. The mood continues to darken. The storm clouds continue to swirl and a bad moon is rising. But don’t worry, unnamed economists say everything is just fine. Fix that window and boost the economy.
Copyright © The Burning Platform
Posted in Markets | Comments Off
Thursday, November 1st, 2012
by William H. Gross, PIMCO
So I pulled out my magic lamp that for some reason works only every October 22nd, and rubbed until the Genie appeared in his red and white checkered cloak with a 10-inch diameter Flavor Flav clock hanging ceremoniously around his neck. Being a rather forward, although not disrespectful Genie, he immediately said, “Mr. G, instead of the yield on the 10-year Treasury, perhaps this year you should wish to know who is going to win the Presidential election?” After some thought I replied, “Nah, I need some breaking news, Mr. Genie, something that will make a difference, something that will shock the world, like when does the iPhone 6 come out?” Obama/Romney, Romney/Obama – the most important election of our lifetime? Fact is they’re all the same – bought and paid for with the same money. Ours is a country of the SuperPAC, by the SuperPAC, and for the SuperPAC. The “people” are merely election-day pawns, pulling a Democratic or Republican lever that will deliver the same results every four years. “Change you can believe in?” I bought that one hook, line and sinker in 2008 during the last vestige of my disappearing middle age optimism. We got a more intelligent President, but we hardly got change. Healthcare dominated by corporate interests – what’s new? Financial regulation dominated by Wall Street – what’s new? Continuing pointless foreign wars – what’s new?
I’ll tell you what isn’t new. Our two-party system continues to play ping pong with the American people, and the electorate is that white little ball going back and forth over the net. This side’s better – no, that one looks best. Elephants/Donkeys, Donkeys/Elephants. Perhaps the most farcical aspect of it all is that the choice between the two seems to occupy most of our time. Instead of digging in and digging out of this mess on a community level, we sit in front of our flat screens and watch endless debates about red and blue state theologies or listen to demagogues like Rush Limbaugh or his ex-cable counterpart Keith Olbermann. To express my discontent, Genie, along with my continuing patriotism, I’ve created a modern-day version of our Pledge of Allegiance. Place your hand over your clock and recite after me:
I pledge allegiance to the flag of
the fragmented state of America,
and to the plutocracy for which now it stands,
a red and blue nation,
under financial gods
with liberty and justice for the 1(%).
“Well,” said the Genie, with a little bit less respect in his voice, “you sound a little discouraged Mr. G – a tad cranky perhaps and showing all of your 68 years.” I suppose, I agreed. But during all those years, I’ve liked Ike and despised Bush Junior, been enraptured with Kennedy and enraged by Johnson, been put to sleep by both Ford and Carter and then invigorated by Reagan. And now – well, we’ve got the best government that money can buy, but I ain’t buying it. Now get back in your lamp and come up with something meaningful I can use this time come October 2013. And don’t fake me out with a picture of a skinnier but faster iPhone 6. I’m still trying to buy the “5” with the .01% interest on my money market account.
Perhaps I should have asked Flavor Flav something more important. iPhones and next year’s 10-year Treasury yield aside, the biggest bet being wagered in financial markets these days is the bet on “financial repression,” “quantitative easing,” and the ultimate effect of both on the real economy. Of course even a genie couldn’t come up with a simple answer to that complex question. Sounds like something to be asked of a shrink from a couch, as opposed to a genie in a bottle. Whatever. But let me try and answer the repression and QE question with a little anecdote that I tell visiting clients.
About four years ago I opened up our family brokerage statement and searched with some effort to find the yield on our money market account. Interest rates, as I knew from my desk in Newport Beach, were plunging and I wondered just how much of a penalty we were being charged for the privilege of holding cash. My eyes finally fixed on the appropriate disclosure – hidden though it was – and it said “.01%.” Impossible! I thought. There must be a mistake here. Surely the decimal point was misplaced. Wasn’t “.01%” really 1% or even .1%, but definitely not “.01%.” That was close to nothing! Having counted cards at the blackjack table in my youth, I quickly calculated that over the next 12 months, our $10,000 balance would earn exactly $1.00. “Buy yourself a pair of shoes,” I said to Sue standing near my shoulder, “a pair of sandals at the weekend garage sale.” The remark was not well received. It seemed Sue was as sensitive about shoes as I was about interest rates. Note to self: Do not mention shoes with Sue except in the phrase “what a cute pair of shoes.”
Anyway, I quickly drifted back to my childhood days when I had a passbook at the local bank. Deposit rates were usually 4% or so back then, so I wondered how much money I would have needed then to produce the same $1.00 of interest I was receiving now. Twenty-five bucks! Whoa, $25 vs. $10,000! Seems like it was much better to be a saver back in 1958 and much better to be a spender in 2012. I could now take the $9,975 difference, spend it, and still have the same $1.00 of interest that I had back then! And that, Mr. Genie, with the Flavor Flav clock, is what is known as “financial repression.” By lowering interest rates to near zero through Fed Funds policy and quantitative easing, Ben Bernanke and his fellow central bankers are trying to force all of us to spend money.
Admittedly, the Fed’s theoretical foundation takes a different route to the same destination than does mine. Chairman Bernanke would say that by lowering yields, investors would logically sell their bonds to the Fed (QE I, II and III) and invest in something riskier and higher returning (high yield bonds, stocks and real estate). My $10,000 then, would do what capital has always done – gravitate to the highest reward/risk ratio available and in the process, stimulate investment and create jobs. The theoretical $9,975 that I might have chosen to “spend” in my first example would in the Chairman’s construct be eventually spent as well but in this case via investment and job creation, which in turn would lead to a virtuous cycle resembling the “old” as opposed to the “new” normal.
The difference between these two hypothetical models is critical. Is the money that is being made “available” through zero-based interest rates and quantitative easing being “spent” – or is it being “invested?” If it’s being spent, then at some point the game will come to an end – my $9,975 will have provided me and the economy some breathing room and some time to kick the future “big R” or “little d” down the road; but it will end. If it is being invested and invested productively, then we might eventually see the Old Normal on the horizon, reduce unemployment to less than 6% and return prosperity to the middle class.
Well, as President Obama might tell Governor Romney – “just do the math.” Or as Chris Berman might say on ESPN – “let’s go to the tape.” In the past three years of quantitative easing and financial repression, can we see a noticeable effect on investment as opposed to consumption? Is the Bernanke model working or is the $9,975 being spent on consumption? At first blush, an observer might vote for the Bernanke model. After all, the stock market has doubled in three-plus years, risk spreads are at historical lows, and housing prices are moving up – 10% higher in Southern California alone. Yet the real economy itself seems no different – still in New Normal gear. Surely by now, if the Bernanke model was as advertised, we would be seeing a pickup in investment as a percentage of GDP and a willingness to start saving “seed corn” as opposed to eating “caramel corn.” As Chart 1 points out – we are not. At the same time, we continue to consume at an “Old Normal” pace as shown in Chart 1 as well.
To confirm the point, let me introduce additional evidence for the prosecution, a chart that is periodically presented to our investment committee by PIMCO’s Saumil Parikh, who is turning out to be potentially a Pro Bowl replacement for recently retired All-Star Paul McCulley. It’s a little complicated sounding – “net national savings rate,” but it really speaks to the heart of the question. Net national savings is the amount of government, household and corporate savings that is left over after our existing investment stock is depreciated. Think of a building decaying and depreciating over 30 years so that you’d need to save each and every year to build and pay for a new one three decades down the road. If you don’t save, you can’t buy one: Net national savings.
Well, Chart 2 confirms the evidence. Over the past three years, our net national savings rate has been negative, and lower than it has ever been in modern history. The last time this occurred was in the Great Depression.
Aside from a little squiggle back close to 0% over the last year or so, there is no evidence that investment is being incented by quantitative easing. All of the money being created and freed up is elevating asset prices, but those prices are not causing corporations to invest in future production. Admittedly, the chart shows this downward spiral has been underway for decades, but financial repression and quantitative easing were supposed to be the extraordinary monetary policies that kick-started the real economy in the other direction. They have not. We have been using the lower interest rates, the $9,975 of free money, to consume as opposed to invest.
To be fair, Ben Bernanke has been operating with one arm behind his back and has been calling for cooperative stimulation from the fiscal side of this government. He has received little response – not from Democrats, not from Republicans. They have all focused on re-electing themselves as opposed to constructively plotting a way forward. That is why Election Day seems like such a futile gesture to me. Red/Blue; Republican/Democrat. What kind of choice do we have when we pull the lever? If monetary policy has shown its impotent limits, can we now trust Washington to constructively reverse a downward slide in our net national savings rate? I suspect not. I doubt if either Obama, Romney, or many of their economic advisors even know what the definition is, let alone how to reverse it.
Investors should recognize that asset and currency prices ultimately rest on the ability of a real economy to grow. If growth cannot be boosted by monetary policy, and fiscal policy is in the hands of a plutocracy more concerned about immediate profits as opposed to long-term vitality, then no Genie or Flavor Flav with a magic clock can make a difference. If, therefore, real economic growth is stunted in the United States and globally, then portfolio strategies should acknowledge bite-sized future returns and the growing risk that the negative consequences of misguided monetary and fiscal policy might lead to disruptive financial markets at some future point. The approaching fiscal cliff might be the first of a series of future disruptions. Although PIMCO expects a middle ground fiscal compromise from Washington, when that is combined with the fading influence of QE monetary policies, it leads only temporarily to 2% real growth in the U.S. at best – growth that is clearly not “Old Normal.” We are in a “New Normal” world where the negative effects of private sector deleveraging are only being weakly addressed by monetary and fiscal authorities. If so, then Treasury yields should stay low and my money market fund should continue to read “.01%.” The “cult” of equity – or better yet the cult of “total return” – for both bonds and stocks – is over, if that definition presumes a resumption of historical patterns anywhere close to double digits. The era of financial repression continues.
I must explain these things to my Genie, I fear. Despite his New Age appearance, his forecasts seem to be a bit old-fashioned and out-of-date.
William H. Gross
P.S. Flavor Flav just made an extraordinary appearance on October 31st. He told me to write that no matter who is elected, you can’t keep the U.S. down for long, and that while Sandy was a monster storm, America is a gigantic positive force whether Red or Blue.
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Thursday, November 1st, 2012
2013 … A Return to Investment Normalcy?
by James Paulsen, Chief Investment Strategist, Wells Capital Management
If the last two economic cycles are any guide, the capital markets may soon jump to a new risk-reward frontier quite different from the trade-off exhibited by balanced portfolios so far in this recovery . During the early-1990′s recovery and again early in the post dot-com 2000′s recovery, stock and bond market volatilities (risk) were significantly elevated. Both times, however, once the economic cycle broadened and matured providing investors with a sense of sustainability and economic normalcy , the financial markets calmed and return volatilities dropped to very low levels for a number of years. Moreover , during these periods of “investment normalcy” the risk-reward frontier (the relationship illustrating the trade-off between higher returns and added risk as portfolio weightings between stocks and bonds are altered) differed radically from its character the rest of the time. Consequently , similar to the last two recoveries, if investment normalcy emerges again (perhaps in 2013?), investors may want to prepare for a jump to a new risk-reward frontier.
Defining Investment Normalcy
When are markets normal and when are they abnormal? While there is no widely accepted definition, old investment hacks may simply define it as—“we know it when we see it.” Certainly , the silver market of the late-1970s, the great stock market crash of 1987, the sur ge in bond yields in early-1994 which blew apart Orange County, the Asian panic in 1997, and the Great Recession crash of 2008 would qualify as abnormal. Perhaps financial market panics and periods of investment normalcy are best defined by the VIX and MOVE Indexes (illustrated in Charts 1 and 2). Both measure implied option price volatility— the VIX Index for the stock market and the MOVE Index for the bond market. Financial market panics are typically reflected by a spike in price volatilities whereas low VIX and MOVE readings signal periods of investment normalcy.
Chart 3 illustrates a geometric weighting (approximates an equal weighting) of the VIX and MOVE Indexes since 1990. Market volatility spiked in all three recessions—1990, 2001, and 2008. Financial markets also became abnormally agitated during other mini-panics including the 1994 Orange County crisis, the 1997 and 1998 Asian and Russia debacles, and during the eurozone flares in 2010 and 201 1. What is also noticeable from Chart 3, however, is both recovery cycles since 1990 exhibited a multi-year period of investment normalcy when stock and bond price volatilities declined and persisted at subpar levels.
The three straight lines in Chart 3 represent the mean price volatility level since 1990 and a range about this mean equal to one standard deviation. During the 1990s recovery , by at least 1992, investment market volatility declined below average and with only brief exceptions (e.g., the 1994 bond market panic) remained mostly below average until 1997. A much more consistent period of investment normalcy is recognizable during the 2000’s recovery when price volatility remained below average continuously from the end of 2003 until the start of 2008. In similar fashion, will investor sentiment eventually calm in the contemporary recovery? Indeed, does the recent decline in financial price volatility evident in Chart 3 already suggest investment normalcy is returning? And, if so, what does this imply about future investment trends?
A Changing Investment Landscape Financial markets in panic mode react very dif ferently than they do in normal times. This is best illustrated by the examining the market’s risk-reward frontier shown in Chart 4. Since 1990, the riskreward frontier exhibits traditional characteristics. The all-bond portfolio provided a lower return with lower risk compared to the all-stock portfolio. Moreover , also traditional, as stocks initially were added to the portfolio, the expected return rose and risk declined since adding some exposure to stocks diversified the portfolio and mitigated volatility. Eventually, however, in this case around the 30 percent stock/70 percent bond portfolio, additional stock exposure while boosting returns also increased return volatility. Overall, for the entire period since 1990, the portfolio risk-reward frontier has a very traditional C-shaped pattern. This frontier, however, is really the product of two distinct investment characters—one derived from periods of investment normalcy and one from the rest of the time.
Jumping Portfolio Frontiers
From Chart 3, assume periods of investment normalcy are defined by price volatilities which are at least one-half a standard deviation below normal (i.e., when price volatility is below the lower range line). Using this definition, since 1990, financial markets have reached “normalcy” about one-third of the time. Based on this definition, Chart 5 illustrates the portfolio risk-return frontiers since 1990 when investment normalcy reigns (black squares) and the portfolio frontier for the rest of the time (gray circles). Obviously, the character of the financial markets as evidenced by these two portfolio frontiers could not be more different. Perhaps it is only sensible when financial price volatilities are either average or far above average (i.e., market panics) that markets possess a very dif ferent character compared to when price volatility is very low, market sentiment calms and confidence dominates.
As shown in Chart 5, since 1990, when investment normalcy was evident (i.e., price volatilities from Chart 3 are below the bottom range line), the relationship between stock and bond returns (illustrated by the black squares) exhibited a normal C-shaped portfolio frontier , annualized returns from stocks exceeded returns on bonds (by a wide mar gin of about 11 percent) and stock price volatility exceeded bond price volatility (only by about 2 percent—about 10 percent compared to about 8 percent). Moreover, adding stocks to an all-bond portfolio did provide good diversification results (by lowering risk while raising returns) up to about a 40 percent stock/60 percent bond portfolio.
By contrast, as shown by the gray circles in Chart 5, when investment normalcy was not in force, the portfolio frontier was an “inverted” C-shape, bond returns actually exceeded stock returns, stock volatility was almost double bond volatility (i.e., annualized standard deviations from the all-stock portfolio was about 22 percent compared to only about 1 1 percent from an all-bond portfolio) and finally diversifying with stocks worked in reducing volatilities up to only about a 20 percent stock/80 percent bond portfolio.
Moving Towards Investment Normalcy?
As the U.S. economic recovery broadens and slowly shows more signs of sustaining (e.g., in the last year, the unemployment rate is declining faster than ever before), the U.S. labor force is rising at its fastest pace of the recovery, the household debt service burden has declined close to record lows, bank lending is steadily rising again, housing activity is finally increasing, home prices are finally rising, consumer confidence is at a five-year high, and the stock market is close to new all-time highs) overall confidence is slowly being resurrected calming the financial markets. Indeed, as Chart 3 shows, with only a brief exception, financial market volatility has declined and persisted at a very low level this year (i.e., volatility has persistently been below the lower range line). Therefore, an important question for investors to consider, like each of the last two recoveries since 1990, is whether the financial markets have entered a new period of “investment normalcy” which may persist for a few years?
If so, as Chart 5 illustrates, portfolios may require adjustment to better align with and to take advantage of what may be a very dif ferent financial market character. While we are not suggesting the next few years will produce a risk-return frontier which is perfectly portrayed by the squares in Chart 5, we are suggesting a potential jump from a frontier whose character is approximated by the gray circles to one whose character is more similar to the black squares. This is a relatively unique opportunity for investors since it has only occurred about one-third of the time since 1990.
Most of the time, as suggested by the gray circles, the investment environment has been portrayed by stock and bond returns which are nearly equal, where risk or volatility from stock holdings is extremely high and where there has been very little diversification benefit from adding stocks to the portfolio. However, if we have indeed entered a period of “investment normalcy ,” a calmer financial market demeanor may cause a jump to a financial frontier which produces higher returns in the next few years from both asset classes (although this seems unlikely from Treasury bonds whose yields are currently near record lows), much lower volatility (risk) in both the bond and stock markets, and finally much improved inter-class diversification attributable to adding a higher proportion of equities.
Despite a litany of ongoing fears this year (e.g., a slow growing U.S. recovery , eurozone issues, a weak China, an uncertain election and the impending fiscal clif f), the financial markets have remained remarkably calm as evidenced by persistently low readings for the stock market VIX and bond market MOVE Indexes. Similar to the past two economic cycles, the contemporary recovery may be entering a multi-year period of “investment normalcy” whereby economic confidence improves producing a calmer financial market sentiment.
In the past, this has led to a much more “risk-on” friendly investment climate where stock returns improve significantly, financial market volatility decays, and inter -class diversification returns. Perhaps it is a good time for investors to tweak portfolios accordingly as we head into 2013.
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