March 28, 2013

Dow hits a new record, so what?

Posted in Finance, Uncategorized tagged , at 9:36 PM by Robert Barone

By Sheyna Steiner · Bankrate.com
 
Wednesday, March 27, 2013
 
Start whistling a happy tune because happy days are here again. Right? The Dow Jones industrial average closed at a record high again. On Tuesday, it topped off at 14,559.65.
 
The more relevant index, Standard & Poor’s 500 index, closed just 2 points shy of its all-time high of 1565.15 set in October 2007, Reuters reported in Tuesday’s story, “Wall Street climbs on economic data; S&P near record close.”
 
There seems to be a lot of preoccupation in the financial media with record highs. Sure, it makes a snazzy headline. But what does it mean?
 
For proponents of technical analysis, certain prices seem to be harder to break through than others — either on the way up or the way down. They’re known as levels of support or resistance and represent psychological barriers. They tend to be numbers around which investors make decisions either for or against a certain security.
 
For the rest of us, record highs may not be as significant. The stratospheric heights the indexes are reaching these days indicate two things, according to Robert Barone, chief economist and portfolio manager at Universal Value Advisors in Reno, Nev.
 
“It tells us one thing for sure: Don’t fight the Fed,” he says. One side effect, bug or feature of the quantitative easing programs from the central bank has been to inject vast quantities of money into the financial system — much of which has gone into equities.
 
“The Fed has liquefied at least the U.S. if not the whole world, and we have a lot of money sloshing around looking for a return,” says Barone. Read more about that in “How the Fed fuels stock prices.”
 
Monetary policy may not be the only driver. It could be part of the so-called new normal, the post-financial-crisis reality. Relatively sluggish economic growth may be par for the course now, says Barone. Instead of looking back to 2006-2007 and saying that gross domestic product and unemployment should be at those levels, maybe the economy simply doesn’t have the growth potential that it once did.
 
“Job openings are rising but the jobs aren’t being filled. There is a shortage of skilled labor. Capacity utilization in the industrial sector is approaching what it was in ’07,” says Barone.
 
“But we’re not happy because we have 7.5 percent unemployment, and we think it should be 4 percent or 5 percent. Putting it all together, it tells you that maybe the stock market isn’t too high,” he says.
 
What do you think? Is it too high? Where should it be? What’s going on? There are so many questions.
 

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

 

March 27, 2013

Is the market’s record high just another bubble?

Posted in Economy, Finance, Uncategorized tagged , , at 3:53 PM by Robert Barone

The Dow Jones Industrial Average hit a new all-time high on March 5 of 14,254,
surpassing its old peak of 14,164 set on Oct. 9, 2007, and has continued to advance to still higher levels.

From this indicator alone, one would think that “we’re back!” Unfortunately, a review of the underlying fundamentals tells a different story, at least about the state of the economy. With weak fundamentals and high and rising stock prices, the logical question is, “Is the stock market in a bubble?”

In the accompanying table, besides the Dow Jones itself, only corporate profits per capita are better. That really has been the story for five and a half years. One might argue that corporate profits alone are enough to boost the market.

But, the markets always look forward, and today, a majority of reporting companies have guided downward for either top line, bottom line or both.

Indicator October 9, 2007 March 5, 2013 (Better (+) or Worse (-)
DJIA

14164

14254

+

Gasoline/gallon

$2.76

$3.74

GDP growth rate

2.5%

1.6%

Unempl Rate (U3)

4.7%

7.7%

Employed (non-farm)

138 mill

135 mill

US Debt

$9.0 trill

$16.4 trill

US Debt/GDP

64%

104%

US Budget Deficit

$162 bill

$1.1 trill

US Deficit/GDP

-1.2%

-8.5%

Food Stamp Recipients

26 mill

48 mill

Corp Profit per capita

$4,247

$5,521

+

Real DPI per capita

$32,816

$32,483

Why the equity market is rising

David Rosenberg (Gluskin-Sheff) has research indicating that, since 2007, the correlation between the Fed’s balance sheet and the S&P 500 index is 87 percent. The two major market dips since the great recession came when QE1 and QE2 ended.

According to Rosenberg, since the Fed now has another QE with no end date (QEnfinity),
the market is continuing higher. As a result, he said, the rise in stock prices has been based on a P/E multiple expansion, and such a multiple expansion is solely based upon the Fed’s QE policies of money printing.

The evidence is that money printing is not about to stop any time soon despite market worries that some Federal Open Market Committee members are beginning to question the Fed’s easy money policies, which caused quite a stir in the bond market in late February.

In a March 1 address at the Federal Reserve Bank of San Francisco, Bernanke said,

“ … At the present time, the major industrial economies apparently cannot
sustain significantly higher real rates of return; in that respect, central
banks — so long as they are meeting their price stability mandates — have little
choice but to take actions that keep nominal long-term rates relatively low…”

Why some bond managers worry and others don’t

Stan Druckenmiller, the famous hedge fund manager of Duquesne Capital, in a Bloomberg TV interview and again on CNBC in early March, commented that the coming onslaught of the entitlement promises will overwhelm the fiscal system unless something is done now.

He also said something that scared a lot of people. He said that as soon as the Fed sells the first security from its portfolio, every bond manager and investor will rush for the exits at the same time, which will result in chaos in the bond markets and is bound to spill over to equities. He points to the FOMC minutes and the market reaction in late February as proof.

On the other hand, Jeffrey Gundlach of Doubleline Funds, another famous and prescient fixed income manager, doesn’t believe the Fed will sell a single security in the current investment time horizon (which I interpret to mean several years).

Gundlach says questions about Fed tightening are the wrong questions to be asking. The
Fed will keep interest rates low, not for months but for years because the math shows that if rates rose by any significant degree, the interest cost of the debt will overwhelm the federal.

Think about it. The Fed has observed the markets’ reaction to the FOMC minutes. Clearly, the Fed knows what the market reaction is likely to be if it began sales from its balance sheet.

So, I believe that Gundlach has the correct approach. However, Gundlach did issue a warning. The Fed, he said, might be able to print money for a while without any apparent consequences, then something dramatic happens. But, that eventuality still appears to be outside of the current investment time horizon.

Conclusions

Economic fundamentals remain weak. The stock market appears to be tied to the Fed, and
as long as the Fed continues to print, the markets will have an upward bias.

While there could be equity market corrections, it appears that as long as the Fed continues its current policies, and as long as the economy at least continues to “muddle through,” then no serious bear market downdraft in equities is likely to occur.

The same is true for bonds, especially if the economic undertone and labor market conditions remain weak. So, the answer to the question “Is the stock market a bubble?” appears to be yes. But, it isn’t one that is likely to deflate any time soon.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

March 25, 2013

Where burden of higher minimum wage falls

Posted in Economy, Finance, Uncategorized tagged , , at 8:58 PM by Robert Barone

In an era in which unemployment is the biggest problem facing the economy, raising the minimum wage likely is to exacerbate the issue. Economics 101, taught at every college and university in the free world, instructs us that free markets clear where demand and supply intersect. However, if artificial constraints are imposed and raise the price of the good or service, the demand for the good or service (in this case, labor) falls.
 
Consequences of fixing prices
 
Labor, capital and raw materials are inputs in the productive process. To an employer, especially a business that employs low-skilled labor, raising the minimum wage is like adding a tax to an input, just as if the raw materials were taxed. What if the government passed a law that said the minimum price of a gallon of gasoline is $5.75, i.e., $1.75 higher than the existing $4 a gallon? There certainly would be people who would not be impacted (the 1 percent), but for most, the higher price significantly would impact discretionary spending and economic growth would be negatively affected, as most consumers would cut back on auto travel. Just as the tax on gasoline would impact the demand for it, so, too, raising the minimum wage significantly would impact those businesses that rely on low-skilled labor.
 
How about $100 an hour?
 
If it is really beneficial to raise the minimum wage from $7.25 to $9 an hour, why stop there? Why not raise it to $100 an hour? “Absurd,” you say. Of course, such an idea is absurd. Much of the employed population would be laid off as employers couldn’t afford to keep employees whose hourly production doesn’t yield a margin before wages and benefits of $100. So, why is this different from $9 an hour? For one, most folks already earn more than $9 an hour. So, massive layoffs won’t occur. But, there are some employers who either will lay off the low-wage worker or simply will not hire if those workers produce less than the required $9 an hour margin needed by the business. While the impact of the $9 an hour minimum wage won’t be as obvious as the leap to a minimum of $100 an hour, there still is an impact.
 
Negative consequences of past minimum wage jumps
 
Those who get a $1.75 an hour raise, from the current $7.25 to $9 an hour, clearly benefit. But, the least educated and least skilled likely are victims. Who are these? Generally, teens. According to a Feb. 15 Wall Street Journal editorial titled “The Minority Youth Unemployment Act,” 85 percent of the academic studies find negative consequences on low-skilled workers — usually teenagers — from mandated minimum wage increases. The studies include a recent one by William Dunkelberg, chief economist for the National Federation of Independent Businesses. Dunkelberg found that 600,000 teen jobs disappeared in the six months following the July 2009 minimum wage increase (to $7.25 an hour), a period in which the gross domestic product was rising. In the previous six months, when the GDP rapidly was contracting, Dunkelberg said that only half that many teen jobs disappeared.
 
Redistribution within low-skilled ranks
 
It is clear that those keeping their minimum wage jobs benefit from the higher wage rate, but it also means that those who would have gotten jobs at the lower wage rate remain unemployed. This, in effect, is a redistribution of income within the segment of the labor force having the lowest level of skills and education, and it puts the burden of the higher wages earned by those keeping minimum wage jobs directly on those who cannot now find employment at the higher minimum wage. In economic jargon: Those making the incremental difference in the minimum wage are being subsidized by those who cannot find employment at these higher-wage levels but would be able to do so at the lower-wage level. This is similar to a union that refuses to accept lower wages and benefits in hard economic times, forcing layoffs of union employees. The burden is felt entirely by those who are laid off instead of it being spread among all.
 
Manipulation of populist sentiment
 
Those, of course, who do benefit think this is a good idea. Those who can’t find jobs simply aren’t aware that it is the rise in the minimum wage rate that is the issue, as there generally is no direct and recognized measurement of this phenomenon. As a result, populist sentiment could very well think this is a good idea. But, from the standpoint of trying to reduce the unemployment rate, especially for teens, this is a bad idea. For the past 150 years, students have learned this in Economics 101. But, for at least the last half of that 150-year period, sound economic theory has been ignored by policymakers and legislators.
 
Implications for investors
 
In the end, raising the cost of labor, albeit at the low end, will, like all taxes, fees, rules and regulations on businesses, especially small businesses and those relying on low-skilled labor, reduce output and constrain economic growth at a time the economy can ill afford it.
 
Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.