What History Suggests About the Future of Stocks

Thursday, August 2nd, 2012

by Seth Masters, Chief Investment Officer, AllianceBernstein

Some experts today argue that the world has entered a “New Normal” condition in which stocks have permanently lost their return edge. We’ve heard this before. It was wrong then, and we think it’s wrong now, too.

In 1979, BusinessWeek published a cover story famously called “The Death of Equities.” Then, like now, stock market returns had lagged 10-year Treasury returns for a decade, although for somewhat different reasons.

Stock returns had been dragged down by the bursting of a bubble (the Nifty Fifty) and bleak economic conditions. OPEC had unleashed its second oil-price shock in five years. The so-called misery index—the sum of the unemployment and inflation rates—was 20% in the US, double its level today (because inflation is now very low). And corporate profits were very weak (today, they are very strong).

BusinessWeek was capturing widespread sentiment about the economic and market outlook. Nonetheless, stocks handily beat bonds over the 10 years starting in 1979.

As the ubiquitous legal disclosure says, past performance does not guarantee future returns. Indeed, performance often reverses sharply.

Between 1901 and the onset of the recent credit crisis, there have been 11 10-year rolling periods in which bonds beat stocks, all of them coinciding with the Great Depression or the stagflation of the 1970s. And after each and every one of them, stocks beat bonds for 10 years—on average, by 5.8%, as the Display below shows.

Because we are human, we all tend to expect the future to resemble the recent past—to become “anchored” in our recent experience. It takes guts to buck the trend. But at a September 1983 client conference, we cited good fundamental reasons in making “The Case for the 2,000 Dow.” The Dow Jones Industrial Average was then slightly below 1,300. It reached 2,000 in January 1987, about three-and-a-half years later.

Today, our median annual return projections for global and US stocks are about 8% over the next 10 years, far ahead of our projected 2% median return for 10-year Treasuries. At that rate, the Dow could hit 20,000 in five to 10 years. In the same time frame, the S&P 500, a more representative index, could hit 2,000. (It’s now around 1,300.)

Our projected stock returns may sound optimistic. They’re not. They are well below the long-term average for US and global equities, and are based on conservative assumptions about economic and market conditions.

Still, many pundits argue that stocks today are overpriced. My next blog post will assess stock valuations.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Seth J. Masters is Chief Investment Officer for Asset Allocation at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.

Tags: Businessweek, Chief Investment Officer, Corporate Profits, Credit Crisis, Different Reasons, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, Fundamental Reasons, Future Returns, Great Depression, Inflation Rates, Legal Disclosure, Market Outlook, Misery Index, Oil Price Shock, stagflation, Stock Market Returns, Stock Returns, Stocks Bonds
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ECB Warns Easy Money No Solution (Merk)

Friday, May 4th, 2012

by Axel Merk, Merk Funds

May 3, 2012

Axel Merk May 3, 2012

Central Banks around the world have been under pressure to cover shortfalls in fiscal policy. At his monthly press conference, European Central Bank (ECB) President Mario Draghi stuck to his guns, telling politicians to focus on structural reforms to stimulate growth, rather than raising hopes for more easy money from the ECB. Interest rates remain at 1%; the euro reacted positively to Draghi’s comments.

Pointing to the experience of how stagflation in the 1970s was overcome, Draghi points out structural reform, not increased spending, is the the proper course of action. Specifically, Draghi calls for: fiscal balances, fiscal stability and competitiveness. Having said that, the prepared introductory statement of the press conference mentions “growth” 13 times, stressing that “growth and growth potential in the euro area need to be enhanced by decisive structural reforms. In this context, facilitating entrepreneurial activities, the start-up of new firms and job creation is crucial. Policies aimed at enhancing competition in product markets and increasing the wage and employment adjustment capacity of firms will foster innovation, promote job creation and boost longer-term growth prospects. Reforms in these areas are particularly important for countries which have suffered significant losses in cost competitiveness and need to stimulate productivity and improve trade performance.”

Draghi also calls for a vision of how the Eurozone ought to look in a decade, so that such vision can be implemented. A fiscal compact, not a “transfer union” is the appropriate starting point of how fiscal sovereignty can be delegated over time to a central Eurozone authority. The press conference was ahead of this weekend’s national elections in France and Greece, as well as regional elections in Germany.

In our assessment, austerity is the easy part, structural reform is the tough part. With regard to monetary policy, Draghi was notably light. He shed cold water on the notion of re-activating the peripheral bond purchase program (Securities Markets Program, SMP). He also dampened expectations of a rate cut by emphasizing balanced inflation risks, as well as a gradual economic recovery, albeit with downside risks. He suggested the European banking sector is improving, not only visible in reduced intra-bank refinancing (repo) rates, but also apparent in an increase of the deposit base in peripheral Eurozone countries.

Curiously, just about all actions suggested by Draghi are really outside of the purview of the ECB. We may want to add a comment recently made by Bundesbank President Jens Weidmann: the higher cost of borrowing can also been seen as an encouragement to engage in reform. It appears that the ECB is in line with our view that the one language policy makers listen to is that of the bond market.

Please sign up for our newsletter to be informed as we discuss global dynamics and their impact on currencies.

Axel Merk
President and Chief Investment Officer, Merk Investments
Merk Investments, Manager of the Merk Funds

Tags: Austerity, Central Banks, Easy Money, Ecb Interest Rates, Ecb President, Elections In France, Elections In Germany, Employment Adjustment, Entrepreneurial Activities, Eurozone, Fiscal Policy, Fiscal Stability, Growth Prospects, Introductory Statement, Job Creation, National Elections, Product Markets, Regional Elections, stagflation, Trade Performance
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The Importance of Being Earnest (Columbia)

Thursday, April 12th, 2012

Tags: Bias, Bonds, Bulls, Columbia Management, Corporate Pension Funds, Dividends, Great Depression, Inclination, Market Gyrations, Maxim, Meltdown, Nasdaq, Oil Crisis, Portfolio Managers, Portfolios, Rich Rosen, Spite, stagflation, Trough
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Commodities Oversold For Now, Dollar Holds The Key

Tuesday, October 25th, 2011

by Dian Chu, market analyst, trader and author of the EconMatters blog.

Below are trading range charts for 10 major commodities from the Bespoke Group. All 10 commodities are currently at or below the bottom of their trading ranges, which would suggest at the moment, a good opportunity to get in at oversold levels for investors looking to gain long-term exposure.

However, the U.S. dollar has been strengthening as investors fled the Euro debt and financial crisis seeking safety in the dollar. Since most commodities are priced in dollar, dollar movement will have considerable impact on commodity prices. EconMatters guest author, Frank Holmes at US Global Investors, estimates that a 5% appreciation in the dollar could be associated with a 25% decline in commodity prices, based on the relationship between the CRB Index basket of 19 commodities and the Dollar Index.

So if the U.S. dollar continues to strengthen, which is quite probable with the burning Athens, and the lack of leadership and clarity in the Euro Zone, it would most likely put downward pressures on commodity prices.

But on the other hand, the U.S. Federal Reserve has already telegraphed the intention of yet another round of quantitative easing (QE3). So the effect on the dollar, and thus commodities, would depend on how QE3 is implemented. We suspect that the Fed now understands how QE2 has artificially jacked up commodity prices as well as inflaiton (although they will never admit it in public), and most likely will strive for a “commodity neutral” QE3.

However, if QE3 does translate into a similar effect to QE2, then commodities would be artificially inflated even further, which would suggest stagflation, and hyperinflation could be expected in most of the developed countries, and developing economies, respectively.

Source: Dian Chu, EconMatters, October 20, 2011.

Tags: Author Frank, Commodities, Commodity Prices, Crb Index, Developed Countries, Developing Economies, Dian, Dollar Index, Euro Debt, Euro Zone, Frank Holmes, Global Investors, Guest Author, Hyperinflation, Market Analyst, Qe3, Range Charts, stagflation, Term Exposure, Trading Commodities, Trading Ranges
Posted in Commodities, Markets | Comments Off

Recession for Brazil and Canada?; Asian Exports Shrink; Global Economy Slows, BRICs First; Asian Stagflation; PIMCO Admits Error

Thursday, September 1st, 2011

by Mike “Mish” Shedlock, Global Economic Trends Analysis

In spite of all the denials, the US, Europe, and Australia are in recession. Brazil and Canada just entered the recession zone as well.

This economic turn of events has PIMCO CEO Bill gross admitting a mistake. Let’s take a look starting with Brazil.

62 of 62 Analysts Miss Call on Brazil Interest rates

Given that central banks most often telegraph their moves, the one place analysts are typically correct is on interest rate policy. That wasn’t the case this time as Brazil Cuts Key Interest Rate to 12% as Recession Risks Outweigh Inflation

Brazil’s central bank unexpectedly cut interest rates as the risk of recession in Europe and the U.S. shifted policy makers’ focus away from the fastest inflation in six years.

The bank’s board, led by President Alexandre Tombini, voted 5-2 to cut the benchmark rate a half point to 12.0 percent after raising rates at each of the previous five meetings. All 62 analysts surveyed by Bloomberg had forecast rates would be left on hold.

“Re-evaluating the international scenario, the Committee considers there was a substantial deterioration, reflected in generalized reduction of great magnitude in the growth projections for the major economic blocs,” policy makers said in their statement posted on the central bank’s website.

Stunning Reversal

That is a stunning reversal and I would not have gotten it correct either. Normally there is some sort or warning or at least a pause.

BRIC Growth Engine Dies

Bloomberg reports BRICs No Cure for Global Economy This Time

Stocks of international companies that depend most on emerging markets for sales show developing nations won’t be strong enough to buoy the global economy.

Goldman Sachs Group Inc.’s gauge of U.S. companies with the most developing-nation revenue fell 15 percent since April, the biggest drop since the bull market began in 2009. Avon Products Inc. (AVP), which gets at least 74 percent of operating profit from emerging markets, sank 15 percent in New York last month. Siemens AG (SIE), which doubled sales from the nations in five years, lost 21 percent in Frankfurt, the most since October 2008.

“The policy driven boom of the past couple of years will not be repeated any time soon,” said Stephen King, chief economist at HSBC Holdings Plc in London and author of “Losing Control: The Emerging Threats to Western Prosperity.” It’s “difficult to see how emerging nations can ride to the rescue once more,” he said.

Citigroup, the third-largest U.S. lender by assets, gets more than half its earnings from emerging markets, CEO Vikram Pandit said in March. While second-quarter revenue from the consumer bank’s Latin American and Asian units rose 13 percent to $4.46 billion, profit fell 14 percent. Shares of the New York-based bank retreated 19 percent last month, more than the 11 percent drop in the S&P 500 Financials Index.

Whirlpool, based in Benton Harbor, Michigan, relied on developing nations for at least 32 percent of its second-quarter revenue, according to data compiled by Bloomberg. The world’s largest appliance maker reported a 92 percent plunge in operating profit in Asia, more than the 62 percent decline in North America, the data show. Whirlpool’s shares fell 8.7 percent in August, extending this year’s retreat to 29 percent.

China Suffers Sharp Drop in Export Orders

Reuters reports Asia’s factories quieter as exports slip

The Purchasing Managers Indexes showed manufacturing contracted in South Korea and Taiwan as new export orders fell sharply. China’s official PMI increased slightly, the first rise since March, but it also reflected the effects of slowing demand in the United States and Europe.

China’s overall PMI rose to 50.9 in August from 50.7 in July, according to government data, a touch weaker than economists polled by Reuters had predicted. The new export orders index dropped to 48.3 from July’s 50.4.

Beijing pinned the blame for the sharp fall in export orders at least partly on the debt crises in advanced economies. The National Bureau of Statistics said the export sector was “facing challenges.”

Taiwan’s PMI dropped to 45.2 in August, the lowest reading since January 2009, which was in the middle of the global financial crisis that crushed world trade. A reading below 50 indicates contraction.

China is battling inflation at a three-year high, and Premier Wen Jiabao said on Thursday that Beijing would try to engineer a bigger drop in consumer prices in the second half of the year. Chinese officials have said repeatedly that fighting inflation is the top priority despite sluggish growth abroad.

Thursday’s data showed input prices rose in China last month, suggesting price pressures remain acute.

Brazil unexpectedly lowered interest rates on Wednesday because of concern about a global economic slowdown.

China isn’t the only Asian economy struggling to contain inflation. In South Korea, the consumer price index hit a three-year high, up 5.3 percent in August from a year earlier, marking the eighth consecutive month that inflation has exceeded the Bank of Korea’s target.

Thailand’s CPI was also higher than expected.

This puts Asia’s central bankers in a bind. Hot inflation points to more interest rate hikes, but the darkening global outlook argues for a policy pause.

Asia Stagflation

Stagflation is one of those muddled terms that people debate over. The definition I prefer is inflation and recession at the same time. Using that definition, Brazil and parts of Asia are in stagflation now.

Recall that Keynesian theory stated recession and inflation at the same time were impossible. The 1970′s proved that theory to be rubbish.

Keynesianism should have died in the 70′s, totally discredited, but somehow it survived in academia where its nonsensical ideas still haunt us to this day.

Canadian Economy Contracts

The Globe and Mail reports Canadian Economy contracts for first time since recession

Canada now has its own two-speed recovery, with the domestic economy holding firm even as exports falter amid a slumping global rebound.

The economy shrank at an annualized rate of 0.4 per cent in the second quarter, the first contraction since the Great Recession, and a sharp reversal from the 3.6-per-cent growth rate of the first quarter, Statistics Canada figures showed. It’s a sign that Canada, envied by many countries as a bastion of stability since the financial crisis, is not immune to global economic malaise.

In fact, among the Group of Seven club of rich economies, only Japan had a worse second quarter.

Sales abroad staged their steepest drop in two years, with exports plummeting more than 8 per cent on an annual basis. The high-flying Canadian dollar made it harder for businesses to sell their goods to weakening markets in the United States and Europe. Also, Japan’s natural disasters created havoc in the automobile industry, while wildfires in northern Alberta and maintenance shutdowns in the oil industry curtailed energy production.

But there’s a bright side to Canada’s performance. Company purchases of machinery and equipment in Canada soared at a 31-per-cent annualized pace in the second quarter, the biggest surge since 1996.

That shows businesses remain upbeat about their prospects, but also illustrates the gulf in confidence between Canadian executives and their U.S. competitors, analysts said.

No Bright Side to Canada’s Performance

There is no bright side to Canada’s performance. The confidence is misplaced. The global economy is in complete shambles. The US, Eurozone, UK, Australia, Brazil, and parts of Asia are in recession.

Moreover, austerity measures are about to smack Europe, the Australia housing bust is in full swing, and Brazil just joined the recession party. To top it off, China and India are fighting huge inflation problems.

If Canada is ramping up productive capacity now, it is a huge mistake, not a bright spot. Moreover, Canada’s enormous property bubble will collapse and perhaps a global slowdown is just the right catalyst this go around.

PIMCO Admits Mistake

Reuters reports PIMCO says betting against U.S. debt was a mistake

Bill Gross, the manager of the world’s largest bond fund, feels like “crying in his beer” for having bet so heavily against U.S. government-related debt earlier this year, the Financial Times reported on Monday.

Showing a more bearish view on the U.S. economy, Gross said PIMCO had initially dumped all of its U.S. debt holdings in March as he expected economic growth to be higher, resulting in inflation down the road.

That decision greatly undermined the performance of PIMCO’s Total Return Fund. As Treasuries prices rallied, the fund lost 0.97 percent in the past four weeks, while the benchmark Barclay’s U.S. Aggregated Bond Index rose 0.23 percent in the same period, according to Lipper data.

So far this year, the fund has returned 3.29 percent, less than the 4.55 percent recorded by the Barclay’s benchmark index.

“When you’re underperforming the index, you go home at night and cry in your beer,” the Financial Times, in its online edition, quoted Gross as saying. “It’s not fun, but who said this business should be fun. We’re too well paid to hang our heads and say boo hoo.”

Gross, who oversees $1.2 trillion at PIMCO, said it was “pretty obvious” he wishes he had more Treasuries in his portfolio right now.

“I get that it was my/our mistake in thinking that the U.S. economy can chug along at 2 per cent real growth rates. It doesn’t look like it can.”

Six Reasons to Fade Bill Gross

Flashback March 10, 2011: Pimco Dumps All Remaining Treasuries in Total Return Fund; Six Reasons to Fade Bill Gross

Six Reasons to Fade Pimco

I view this setup as favorable for US Government bonds. For starters there is no Pimco selling pressure, only potential buying pressure when Gross changes his mind.

Second, everyone seems to think the end of QE II will be the death of treasuries. While that could be the case, sentiment is so one-sided that I rather doubt it, especially is the global recovery stalls.

Third, the US dollar is towards the bottom of a broad range and any bounce could easily wipe out gains in higher yielding emerging-market debt.

Fourth, the global macro picture is weakening considerably with overheating in China, state government austerity measures in the US, and a renewed sovereign debt crisis in Europe on top of a supply shock in oil. Emerging markets are unlikely the place to be in such a setup.

Fifth, chasing yield means chasing risk, and that is on top of currency risk. Chasing risk is highly likely to fail again at some point, the only question is when.

Sixth, several interest rate hikes are priced in by the ECB this year. Will all those hikes come? I rather doubt it, and if the ECB doesn’t hike, look for the US dollar to rally, perhaps significantly.

The US dollar has not significantly rallied yet, but otherwise I am pleased with what I said back in March.

Pettis 12 Predictions

I have to say that Michael Pettis’ Long-Term Outlook for China, Europe, and the World; 12 Global Predictions is looking fabulous now, and possibly way ahead of schedule, even in China.

If so, the much beloved BRICs and commodities in general (with the possible exception of gold), will not be the place to be.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Benchmark Rate, Bill Gross, Bloomberg Reports, Bonds, Brazil, Canadian, Canadian Market, Central Banks, Commodities, Global Economic Trends, Global Economy, Gold, Goldman Sachs, Goldman Sachs Group, Goldman Sachs Group Inc, Growth Projections, Half Point, India, Interest Rate Policy, International Scenario, Mish Shedlock, Outlook, S Board, S Gauge, Sachs Group Inc, stagflation, Stunning Reversal, Substantial Deterioration
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The Neverending Story of a “Gold Bubble”

Tuesday, August 23rd, 2011

Gold continued to make headlines last week, reaching nearly $1,900 an ounce on Friday before resting around the $1,850 level. Gold’s 15 percent rise to new nominal highs over the past month has rekindled “gold bubble” talk from many pundits. Long-term gold bulls have been forced to listen to these naysayers since gold reached $500 an ounce. If you would have joined their groupthink then, you would’ve missed gold’s roughly 270 percent rise since.

That said, gold is due for a correction. It would be a non-event to see a 10 percent drop in gold. This would actually be a healthy development for markets by shaking out the short-term speculators while the long-term story remains on solid ground.

Forty years ago this week, President Richard Nixon “closed the gold window,” ending the gold-backed global monetary system established at the Bretton Woods Conference in 1944 and kicking off a decade of stagflation for the U.S. economy.

At the time, $1 would buy 1/35th an ounce of gold. Today, $1 will net you about 1/1,178th an ounce of gold. Put differently, “One U.S. dollar now buys only 2 cents worth of the gold it could buy in 1971,” says Gold Stock Analyst. This means that consumers have lost roughly 98 percent of their purchasing power compared to gold over the past 40 years.

The U.S. dollar isn’t the only asset gold has outperformed during recent decades. The yellow metal has also seen periods of relative strength against the S&P 500. This chart from Gold Stock Analyst pits the performance of gold bullion against the S&P 500 since 1971—you can see that gold immediately rallied following Nixon’s announcement before peaking at $850 an ounce in 1980. At that price, one ounce of gold was 7.6 times greater than the S&P 500, according to Gold Stock Analyst. Gold’s relative performance then declined for the next 20 years, with the S&P 500 taking the lead in 1992 and peaking at 5.3 times the value of gold in 1999. Currently, gold’s value is roughly 1.6 times greater than the S&P 500.

What drove gold’s relative underperformance from 1980 to 1999? It was a shift in government policies, which have historically been precursors to change—a key tenet of our investment process here at U.S. Global Investors.

Gold Stock Analyst points out that Federal Reserve Chairman Paul Volcker began steering the U.S. economy toward positive real interest rates in 1980 and Volcker’s goal was met in 1992—the same year the S&P 500 overtook gold.

In order for gold’s relative value to return to 1979-1980 peak levels of 7.6 times the S&P 500, Gold Stock Analyst’s John Doody says gold prices would have to hit the $10,000 mark. Obviously that scenario is unlikely, but it does put all this “gold bubble” nonsense into perspective.

One point to pop the “gold bubble” talk is that negative real interest rates are poised to stick around for a while. We’ve previously discussed that negative real interest rates—one of the main drivers of the Fear Trade—have historically been a miracle elixir for higher gold prices. The magic number for real interest rates is 2 percent. That’s when you can earn more than 2 percent on a U.S. Treasury bill after discounting for inflation. Our research has shown that commodities tend to perform well when rates fall below 2 percent.

Take gold and silver, for example, which have historically appreciated when the real interest rate dips below 2 percent. Additionally, the lower real interest rates drop, the stronger the returns tend to be for gold. On the other hand, once real interest rates rise above the 2 percent mark, you start to see negative year-over-year returns for both gold and silver.

Tags: Bretton Woods Conference, Commodities, Global Monetary System, Gold, Gold Bullion, Gold Bulls, Gold Stock Analyst, Groupthink, India, Level Gold, Naysayers, Neverending Story, Ounce Of Gold, President Richard Nixon, Pundits, Purchasing Power, Relative Performance, Relative Strength, Richard Nixon, Speculators, stagflation, Taking The Lead, Value Of Gold
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GDP: Nothing Is Ever As It Seems

Monday, February 28th, 2011

This article originally appeared on The Daily Capitalist

The revised real GDP numbers for Q4 2010 were a disappointment for most economists who foresaw the third and fourth quarters to be much higher. The BEA’s advance report last month said GDP was up 3.2%. The new numbers show it was only up 2.8%. As I anticipated in my article on the advance report, I expected the numbers to be revised downward and they were. These facts fit into my thesis that we are headed into stagflation.

First, the details. The consensus Q4 estimate of economists was that GDP would be +3.4%. From the BLS release:

The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, and nonresidential fixed investment that were partly offset by negative contributions from private inventory investment [see this on durable goods orders] and state and local government spending [this has to be a positive].

Imports decreased which are a subtraction in the calculation of GDP.  The small fourth-quarter acceleration in real GDP primarily reflected a sharp downturn in imports, an acceleration in PCE, an upturn in residential fixed investment, and an acceleration in exports that were mostly offset by downturns in private inventory investment and in federal government spending, a deceleration in nonresidential fixed investment, and a downturn in state and local government spending.

Final sales of computers added 0.30 percentage point to the fourth-quarter change in real GDP after adding 0.29 percentage point to the third-quarter change.  Motor vehicle output subtracted 0.31 percentage point from the fourth-quarter change in real GDP after adding 0.49 percentage point to the third-quarter change.

For the entire year of 2010:

Real GDP increased 2.8 percent in 2010 (that is, from the 2009 annual level to the 2010 annual level), in contrast to a decrease of 2.6 percent in 2009.  The increase in real GDP in 2010 primarily reflected positive contributions from private inventory investment, exports, PCE, nonresidential fixed investment, and federal government spending.  Imports, which are a subtraction in the calculation of GDP, decreased [-12.4%].  The upturn in real GDP primarily reflected upturns in exports, in nonresidential fixed investment, in PCE, and in private inventory investment and a smaller decrease in residential fixed investment that were partly offset by an upturn in imports.

Prices as measured by the GDP Price Index continued their climb:

The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 2.1 percent in the fourth quarter, the same increase as in the advance estimate; this index increased 0.7 percent in the third quarter.  Excluding food and energy prices, the price index for gross domestic purchases increased 1.2 percent in the fourth quarter, compared with an increase of 0.4 percent in the third.

The price index for gross domestic purchases increased 1.3 percent in 2010, in contrast to a decrease of 0.2 percent in 2009.  Current-dollar GDP increased 3.8 percent, or $538.8 billion, in 2010.  In contrast, current-dollar GDP decreased 1.7 percent, or $250.1 billion, in 2009.

Just looking at spending measures, you can see the impact of the drop in imports. While real person consumption expenditures (domestic goods only) were up 4.1% in Q4 (versus 2.4% in Q3), real gross domestic purchases — purchases by U.S. residents of goods and services wherever produced — decreased 0.6% in Q4, in contrast to an increase of 4.2% in Q3.

If you need charts to see the stagflationary trend, here:

These charts show a flattening of output and a steady increase in prices. One might ask, with all of the monetary and fiscal stimulus efforts by the Fed and the Administration, why is output flattening out while prices are increasing? The quick answer is that their policies have failed, notwithstanding their protests to the contrary (“Yeah, but things would have been much worse … blah, blah, blah.”).

Is this a trend? I believe so. As I said in my article on the first release:

The bottom line is that we are seeing monetary inflation and it is impacting prices. Real savings is still in short supply and that is inhibiting growth. Spending will not revive the economy, but an inflated money supply will give the impression of economic improvement, but it will be an ephemera. It will further negatively impact real savings. I would expect weaker GDP numbers in Q1 2011 (wait until the revised Q4 come out to see if I’m right). Unemployment will remain high. This is a recipe for stagflation.

There is a new wrinkle in this forecast: oil.

As David Rosenberg said Thursday, rising oil prices reflect a “geopolitical risk premium” which is why bonds jumped this week:

Rosenberg pointed out what is going through the minds of oil traders:

It is estimated that as much as 1 mbd of output has been taken out of the system from the Libya crisis and the outsized move in the oil price is testament to the view of just how tight the global supply-demand backdrop has been. Imagine where the price would be if it weren’t for the spare capacity out of Saudi Arabia. Analysts at Nomura are saying $220 a barrel is achievable if more production is halted in Libya and Algeria. …

Saudi Arabia has the capacity to fill the void left by Libya, but that misses the point. The risk of further unrest is rising, especially with sectarian issues in full force in Bahrain. This means that oil prices at a minimum will retain a geopolitical risk premium — most oil experts now peg this at $10-$15 a barrel. If countries start to stockpile more crude in light of current events, one can expect the oil price premium to rise even further even if the situation calms down overseas. So no matter what, barring a sudden downturn in demand, and the one thing about oil (food too) is that demand is relatively inelastic over the near term, the risk is that we will see further increases in the price of crude even from current lofty levels.

Friday on Bloomberg TV, Rosenberg said he sees rising oil and food prices taking 1% off GDP. He said that 2 of the 3 times that oil and food went up together resulted in a recession. It didn’t happen in 1996, he says, because of the forces of the tech boom.

It all depends, as they say. The issue is: how long will political roiling in the Middle East continue? ¿Quien sabe? My point is that we will see stagflation regardless of oil. As I pointed out in “A Note on Inflation: It’s Here,” the forces of inflation are already in motion and its effects are starting to show up, one of which is price inflation.

Again, we need to be mindful of what is “inflation:” it is always an increase in money supply. One of the effects of inflation is price increases. Other effects, even more serious, include the destruction of real capital (that is, capital saved from production or labor, not from printing fiat money). The destruction of real capital accompanying inflation is the only explanation for stagflation.

The result of an oil shock will add to our economic woes, compounding the recessionary side of stagflation.

There has been a lot of buzz about stagflation in the mainstream media lately. Most economists pooh-pooh the idea. The reason is that they don’t understand inflation, mostly confusing price increases as a cause of something bad rather than aneffect of something bad.

Mr. Rosenberg is one of those who make this mistake. He points to low wages and low capacity utilization as the reason why we can’t have stagflation. Unfortunately that wasn’t the case in the late ’70s and early ’80s. (See this chart showing low cap/u and high inflation at the same time.) Other economists like this fellow have entirely no understanding of the issue:

“The old way of thinking used to be that you’d have a jump in crude-oil prices, leading to an increase in inflationary expectations, and that would push the long end of the yield curve higher,” said Howard Simons, strategist at Bianco Research near Chicago. “Nice theory, but it hasn’t worked over the last 10 or so years.”

The thing I want to leave you with is Fed Vice-Chair Janet Yellen. Ms. Yellen gave a speech Thursday on improving the Fed’s communications and thus our expectations of what the Fed will do. This is the Blah, Blah Theory of economics. The bottom line is that she and the Fed believe they can “jaw” their way to a better economy. By telling us that they are going to continue to be “accommodative” (i.e., “print” money) we will believe them and lend and buy and things will magically improve.

Don’t believe a word she says. This is the arrogance of a central planner talking, believing that she and her co-workers control the economy. Pull a lever here and there, and voila! things are all better. The econometrician’s dream.

I can tell you with some certainty that if things get worse, and if unemployment stays high, which is what I believe is happening, they will panic and pull out all the stops.

Copyright (c) The Daily Capitalist

Tags: Acceleration, Advance Report, Deceleration, Downturn, Durable Goods Orders, energy, Fourth Quarter, GDP, government spending, Inventory Investment, Negative Contributions, New Numbers, oil, Percentage Point, Personal Consumption Expenditures, Private Inventory, Q4, Real Gdp, stagflation, State And Local Government, Subtraction, Upturn
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Shanghai Plunges Again as China Contemplates Price Controls as Hot Money Inflows Stoke Inflation

Tuesday, November 16th, 2010

by Trader Mark, FundMyMutualFund

It appears the increase in inflation in China from 9%ish to 11%ish mid 3%ish to low 4%ish is causing all sort of havoc. [Nov 12, 2010: Even China Accuses China of Fibbing about Inflation] [Sep 13, 2010: BW - What's China's Real Inflation Rate?  (What's China's Real Anything?)] Amazing what “half a percent” of additional inflation can do. ;)  Chinese markets plunged anew, this time to the tune of 4%… following up Friday’s 5%+ dip.  (China really needs a premarket ‘urgent buyer’ to help stop these selloffs)  This chart is one day below but the Shanghai index closed just below 2900, taking it right to the 50 day moving average.  In the snap of a finger.

Thus far the flood of central banker liquidity is playing out as expected – creating price increases (potential early stage bubbles) in commodities and emerging markets as healthy economies attract all the hot, speculative money.  Therefore Bernanke and cohorts are doing a great job of creating inflation… in all the wrong places (where there is velocity of money).  For stagflation to really take root in the U.S. (ex food and energy), the Chinese would need to offset the hot money by increasing wages, prices et al.  Then the U.S. would import the inflation in a great circle of life.  Then instead of higher prices in only food and energy, the middle and working class can enjoy substantial price increases in all things Walmart and Target….  aka “success” in the Bernanke plan.

However we have a wrench in that outcome – China appears to be imposing price controls, at least on food.  Not surprising considering the % of income devoted in the bottom 2/3rd to 3/4ths of Chinese on foodstuffs is tremendous, and hence is a big political issue.   So for now it appears the Chinese will eat the bill.

U.S. markets were off substantially overnight threatening to break substantially below the 200 week moving average (game changer), but the ‘urgent’ buyer has been working his magic all morning and things are more benign as I type.  We’ll see what happens this morning on the open – S&P 1192 remains the key level.

Via Bloomberg:

• China’s stocks fell, driving the benchmark index to the lowest in a month, on speculation the government will intensify measures to curb accelerating inflation including higher interest rates and price controls.
• “Speculation that the central bank will tighten monetary policy continues to dog the market,” said Wang Cheng, a strategist at Guotai Junan Securities Co. in Shanghai. “The market will be under pressure for the coming three to 12 months from the threat of measures to cool inflation.”
• The Shanghai Composite Index, which tracks the bigger of China’s stock exchanges, tumbled 119.88, or 4 percent, to 2,894.54 at the close, the lowest since Oct. 14.
• The index has plunged 8 percent in the biggest loss for a three-day period since Sept. 1 on speculation policymakers may raise rates for the second time in two months to curb gains in consumer prices.

Shanghai Plunges Again as China Contemplates Price Controls as Hot Money Inflows Stoke Inflation

Posted by TraderMark at 8:52 AM TweetThis

It appears the increase in inflation in China from 9%ish to 11%ish mid 3%ish to low 4%ish is causing all sort of havoc. [Nov 12, 2010: Even China Accuses China of Fibbing about Inflation] [Sep 13, 2010: BW - What's China's Real Inflation Rate?  (What's China's Real Anything?)] Amazing what “half a percent” of additional inflation can do. ;)  Chinese markets plunged anew, this time to the tune of 4%… following up Friday’s 5%+ dip.  (China really needs a premarket ‘urgent buyer’ to help stop these selloffs)  This chart is one day below but the Shanghai index closed just below 2900, taking it right to the 50 day moving average.  In the snap of a finger.

Thus far the flood of central banker liquidity is playing out as expected – creating price increases (potential early stage bubbles) in commodities and emerging markets as healthy economies attract all the hot, speculative money.  Therefore Bernanke and cohorts are doing a great job of creating inflation… in all the wrong places (where there is velocity of money).  For stagflation to really take root in the U.S. (ex food and energy), the Chinese would need to offset the hot money by increasing wages, prices et al.  Then the U.S. would import the inflation in a great circle of life.  Then instead of higher prices in only food and energy, the middle and working class can enjoy substantial price increases in all things Walmart and Target….  aka “success” in the Bernanke plan.

However we have a wrench in that outcome – China appears to be imposing price controls, at least on food.  Not surprising considering the % of income devoted in the bottom 2/3rd to 3/4ths of Chinese on foodstuffs is tremendous, and hence is a big political issue.   So for now it appears the Chinese will eat the bill.

U.S. markets were off substantially overnight threatening to break substantially below the 200 week moving average (game changer), but the ‘urgent’ buyer has been working his magic all morning and things are more benign as I type.  We’ll see what happens this morning on the open – S&P 1192 remains the key level.

Via Bloomberg:

• China’s stocks fell, driving the benchmark index to the lowest in a month, on speculation the government will intensify measures to curb accelerating inflation including higher interest rates and price controls.
• “Speculation that the central bank will tighten monetary policy continues to dog the market,” said Wang Cheng, a strategist at Guotai Junan Securities Co. in Shanghai. “The market will be under pressure for the coming three to 12 months from the threat of measures to cool inflation.”
• The Shanghai Composite Index, which tracks the bigger of China’s stock exchanges, tumbled 119.88, or 4 percent, to 2,894.54 at the close, the lowest since Oct. 14.
• The index has plunged 8 percent in the biggest loss for a three-day period since Sept. 1 on speculation policymakers may raise rates for the second time in two months to curb gains in consumer prices.

Key wording:

• Central Bank Governor Zhou Xiaochuan said today China is under “pressure” from capital inflows as a state newspaper said price controls could be imposed to cool the fastest inflation in two years.
• “Some emerging economies have grown quickly and face some pressure of capital inflows” as growth in developed nations has slowed, Zhou said. Rising prices in China need attention and officials should “strengthen liquidity management and maintain moderate growth in credit and money supply,” he said.
• China will introduce measures to control rising food prices, including limits on how much products may be sold for and subsidies, the China Securities Journal reported, citing an unidentified person.

• Corn prices in China jumped to a record today and rice also reached an all-time high.
• “Governments usually tend to adopt some form of price control measures when inflation becomes a social issue,” said Peggy Chan and Vincent Chan, analysts at Credit Suisse.
• “Inflation is very high and the government acknowledges that,” Andy Xie, an independent economist, said in a Bloomberg Television interview in Hong Kong. “They will raise interest rates soon.”

Tags: Bernanke, China, Chinese Markets, Circle Of Life, Cohorts, Commodities, Foodstuffs, Half A Percent, Hot Money, Inflation In China, Inflation Rate, Ish, Moving Average, Price Increases, Selloffs, Shanghai China, Shanghai Index, stagflation, Substantial Price, Target, Velocity Of Money, Walmart
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From Quantitative Easing To Stagflation?

Monday, November 1st, 2010

By Dian L. Chu, Economic Forecasts & Opinions

The United States economy grew at a sluggish annual rate of 2 percent in the third quarter, the Commerce Department reported last Friday. On the bright side, the economy is growing faster than the 1.7 percent growth in the second quarter and has registered the fifth straight quarter of expansion.

But here comes the dark side – the growth rate is far from sufficient to impact jobs. And the most disturbing piece of information is that the U.S. economy is still smaller than it was when the recession began–more than a year after the recession officially ended, which makes even a “jobless recovery” seem uncertain.

QE – The Silver Bullet?

Doubts about the scale and effectiveness of an expected Federal Reserve second quantitative easing (QE2) has roiled financial markets of late. So, the latest dismal GDP data probably will cement an official kick-off of Fed’s buying long-term U.S. Treasury debt when they meet on Nov. 3.

However, will the long awaited QE2 be the silver bullet as the market expects?

90% Debt-to-GDP Threshold

As of October 10, 2010, the total public debt outstanding reached 94 percent of the annual GDP, and will be larger than U.S. GDP, around $14.2 trillion a year, in 2012, according to the International Monetary Fund (IMF).

Obviously, the U.S. debt level has already crossed the ominous 90% GDP threshold–part of the findings of a recent study published by C.M. Reinhart and Kenneth Rogoff. The two economists’ study on the relationship between debt and growth finds that when public debt exceeds the 90% threshold, a country’s growth is significantly less–4% on average–than its lower debt counterparts.

That suggests the debt level of the United States seems to have reached a saturation point where more monetary easing would have very limited effect, and could even retard growth.

QE Unlikely to Cure Credit Crunch

Asset purchases by the central bank theoretically would push down real long-term interest rates and spur more lending, boost stock prices, and business confidence thus fueling growth.

However, we have learned from the first round of QE – record-low interest rates, and $2.05 trillion in securities holdings on Fed’s balance sheet, while benefiting the biggest U.S. companies, aren’t trickling down to the smaller business—i.e. no spending, no hiring.

In the 12 months through August, banks pared commercial and industrial lending—loans typically used by companies without access to the bond market—by 11.3 percent. It is still under debate whether the decline is driven by the supply issue–the balance sheet constraints of lenders, or from the demand side–simply the lack of it.

Regardless, I believe the private lending decline seems mostly a manifestation–from both the supply and demand side–of business confidence lost, and the uncertainty over new regulatory rules, which QE2 along is unlikely to rectify, and thus would have limited positive impacts on the economy.

Where’s The Inflation?

There’s also a distinct risk of inflation associated with back-to-back QE’s on a global scale. I think the prevailing deflation fear is quite misguided, and the Fed could be caught ill-prepared when inflation erupts.

As the liquidity works through the system, the time lag between the increase in the money supply and inflation rate is generally 12 to 18 months. Typically, the following are two instances where more money printing would not turn into rampant consumer inflation

• When the liquidity goes into creating asset bubble(s) (e.g. the Dot Com bubble, and the current U.S. bond bubble)
• Able to buy cheap imported goods to essentially export inflation

In addition, as describe in the previous “credit crunch” section, there’s a lot of the cash being held at banks to shore up their balance sheet, and corporations are also hoarding cash as ‘safety net” due to the gloomy and uncertain business climate.

So, these are some of the reasons that the U.S. has not seen much inflation spilling over to the consumer side yet, to the point that the policy makers are even having high anxiety over deflation.

Ripe for Stagflation

Well, heads up, Mr. Bernanke.

With wages rising in almost all low-cost exporting countries, it will become more difficult for the U.S. to contain inflation via cheap imports. Then, as more quantitative easing could further dilute the value of the dollar, pushing up the commodity prices, the system could be pushed beyond its limit into a possible “Demand-pull stagflation” scenario.

Tags: Asset Purchases, China, Commerce Department, Commodities, Credit Crunch, Debt Level, Dian, Economic Forecasts, ETF, ETFs, Gdp Data, International Monetary Fund, International Monetary Fund Imf, Jobless Recovery, oil, Public Debt, Qe, Qe2, Reinhart, Saturation Point, Silver, Silver Bullet, stagflation, Straight Quarter, U S Treasury, United States Economy
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Doug Kass: “Screw-flation” and Market Valuations

Thursday, October 14th, 2010

The following is a transcript of the October 12, 2010 Bloomberg interview with Doug Kass, Managing Partner, Seabreeze Partners [Hedge Fund].

DOUG KASS, GENERAL PARTNER AT SEABREEZE PARTNERS, talks about equity markets on Bloomberg Surveillance.

OCTOBER 12, 2010

SPEAKERS: DOUG KASS, GENERAL PARTNER, SEABREEZE PARTNERS

TOM KEENE, EDITOR-AT-LARGE, BLOOMBERG NEWS

KEN PREWITT, HOST, BLOOMBERG NEWS

7:07

TOM KEENE, EDITOR-AT-LARGE, BLOOMBERG NEWS: Let’s bring in Doug Kass of Seabreeze Partners, Florida. Doug, good morning.

DOUG KASS, GENERAL PARTNER, SEABREEZE PARTNERS: Hi, Ken and Tom. How are you – time, long time.

KEENE: Yes, way too long.

KASS: What a great week, huh? Yankees win a sweep, JETS, Jets, Jets, Jets and futures are down.

KEENE: Well, the Jets were fine. Can we have him on as a guest again if he mentions the Yankees? I guess so. You mentioned Bill King here, the King report. I like it. Quantitative wheezing. This is like the Detroit Lion fans cheering for losses so they can get another high draft pick. That’s brilliant. Why is quantitative easing a challenging proposition?

KASS: Well, you know – Tom, you can call me from Missouri, but the Fed is the same group that missed the tech bubble, the real estate bubble, the debt bubble. But it thinks it now can fine tune interest rates, fine tune job growth and economic activity by printing massive gobs of money. If you go back two years ago, we got QE1, shock and awe, A-W-E. I think today we’d get shucks and aww, A-W-W. And I think it’s going to be very hard for this quantitative wheezing, what I call it in early November to meaningfully move the needle of domestic economic growth. And it’s only going to have a limited impact upon the jobs market, which is plagued by structural unemployment, on housing which is haunted by this large shadow inventory and obviously -

KEENE: Is it -

KASS: I’m sorry -

KEENE: Doug, if this indicates inflation, which clearly we’re seeing different markets show right now, does that benefit equities or not?

KASS: I don’t think it does. I think you know we used to have stagflation 25 years ago. I think we’re getting screw-flation. Grain prices are rising -

KEENE: Can we say that?

KASS: Yes, sure you can.

KEENE: Okay.

KASS: Insurance premiums rising. My son’s tuition at Northwestern is rising. Corn is up 65 percent since the beginning of summer. Cotton’s up 50 percent. Gasoline’s up $0.15 in the last two weeks. This is killing the middle class. And quantitative easing is alluring to the benefits of the largest corporations in the world, which are already flush with cash enabled because of this cheapened and hospitable debt market, public debt market to refinance. So you know, I think it’s not going to change confidence when mired in such uncertainty regarding regulatory and tax policy and it’s undermined by high unemployment. And as I said before, housing is haunted by a large shadow inventory and certainly low interest rates have done little to improve that situation and this mortgage gate situation at best spending two hours with Mark Hanson of Real Estate Fame on a conference call yesterday did moratorium on foreclosures is going to impede economic growth. You know you look back two years ago, interest rates were already low. Now look where interest rates are. So what is the marginal benefit?

KEN PREWITT, HOST, BLOOMBERG NEWS: Well, you know -

KASS: Two years ago – two years ago, Ken, we had global cooperation, everyone was all-in. Now we have austerity in Europe and everyone’s going different directions.

PREWITT: We’re talking about this yesterday, you know with gasoline up, rice up, corn up, meat up. Social Security checks not up for the second year in a row. I mean that’s 58 million people.

KASS: Yes. And that’s – therein lies the problem, real disposable incomes [during] the last decade of – have gone down. Large corporations have flourished, they’ve cut jobs and this schism that created the Democratic tsunami in 2008 led to the Tea Party in 2009 and 2010 and now we have an election coming up. And we’ve never had such disdain toward the wealthy and the large corporations in this country. As a consequence, you get this populist policy and in the market we have this tension between the cyclical tailwinds of monetary and fiscal stimulation, low interest rates against all these secular headwinds, all these non-traditional forces; structural unemployment, populist policy, marginally higher tax rates, costly regulatory burdens and of course these unprecedented fiscal imbalances at the local, state and federal levels. And this is the tension that’s created, that’s basically created and likely to continue to call for arranged market. Great for traders, but not great for investors.

PREWITT: Speaking of kind of quantitative easing, or wheezing, as you put it. Jan Hatzius at Goldman Sachs, put a number on it. He says about $500 billion of treasury purchases through about the middle of next year and an indication they’re ready to buy more. Are you pretty much in line with that?

KASS: I suspect so. He’s a lot smarter than I am. Look, this economy is very fragile. It’s still characterized by excess industrial capacity, a surplus of labor. If this is was a sound and non-jeopardized economy, the Fed wouldn’t be having QE2 discussions and the Administration wouldn’t be seeking these extreme fiscal solutions. So, in my view we’re in a contained recession and while containment efforts continue the efficacy of those efforts appear to waning.

KEENE: With us from Seabreeze Partners, Douglas Kass coming to us today from Florida. This, folks, with futures negative 7. Doug, how do you play this? In terms of investments, you were climbing the wall of worry. You were one of the lonely bulls out there for much of what we’ve seen in this rally to 11,000. I get the sense your research notes have not become negative, but certainly more cautious. How are you positioned right now?

Tags: Bill King, Bloomberg News, Commodities, Debt Bubble, Detroit Lion, Doug Kass, Draft Pick, Early November, Economic Activity, Fine Tune, Flation, General Partner, Gobs, Hedge Fund, Jets, Market Valuations, Prewitt, Real Estate Bubble, Seabreeze Partners, Shock And Awe, stagflation, Structural Unemployment, Time Keene, Tom Keene
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