August 27, 2013

If the Fed Were Publicly Traded, Wall Street Would Savage Its Stock

Posted in Economy, Stocks, Uncategorized tagged , at 4:12 PM by Robert Barone

In early 2006, in testimony before the U.S. Senate, Fed Chairman Ben Bernanke told the senators that the subprime crisis had been “contained.”

If the Fed were a publicly traded company, Wall Street would trash its stock based on the credibility of management, the failure of its policies, the loss of confidence of major constituencies and a weak — if not insolvent — balance sheet.

Reason 1: Some of the FOMC Members Don’t Get It

From the minutes of the July 30-31 meeting of the Federal Open Market Committee, we find the following excerpt: “…several participants expressed confidence that the housing recovery would be resilient in the face of the higher rates….”

Thirty-year fixed mortgage rates (Freddie Mac) rose from 3.35% in May, before the Fed’s tapering announcement, to 4.58% on Aug. 22. That’s a 36.7% increase. The median price of a new home in July was $257,200, up $7,500, or 3%, from $249,700 in June. (The Fed, by the way, doesn’t believe that there is any inflation in today’s economy.)

If the typical U.S. family buying the median-priced home had purchased in May at $250,000 with a 20% down payment with a Freddie Mac 30-year fixed-rate loan, the principal and interest payment would have been $881 a month. By August, the principal and interest payment on a similar home costing the same amount with the same down payment would be $1,023 a month.

Thus, it isn’t any wonder that new home sales (based on contracts signed) plunged by 13.4% between June and July. One has to wonder about the economic competence of those “several participants.”

Reason 2: QE Has Flopped as a Growth Stimulator

A study by two Fed economists (Curdia and Ferrero), published by the Federal Reserve Bank of San Francisco Aug. 12, concludes that “asset-purchased programs, [i.e., , quantitative easing] appear to have, at best [emphasis added], moderate effects on economic growth….”

The authors found that in the QE2 program, the asset purchases alone added only .04 percentage points to GDP. That’s about $6.4 billion — not much considering that QE3 purchases are currently $85 billion each month.

Reason 3: Foreigners are Unloading U.S. Treasuries

In June, foreign investors, believing that interest rates would continue to rise, unloaded U.S. Treasuries to the tune of $56 billion. For the same reason, U.S. commercial banks sold $20 billion. In that month, bond mutual funds and ETFs had net outflows of $25.5 billion. (July’s outflow from the mutual funds and ETFs was $15 billion.)  <story_page_break>

Market participants have to be asking the question: What happens if the U.S. budget deficit rises back toward $1 trillion, as expected, and foreigners and the public have stopped buying?

The Fed is either going to have to allow rates to rise to the point where foreigners and the public will buy again, or the Fed will have to continue the QE program and become the major purchaser of the Treasury’s debt.

Those of us old enough remember that in the early ’80s, when then-Fed Chairman Paul Volcker allowed rates to rise, two recessions resulted (January 1980-July 1980, and July 1981-November 1982).

If we’ve reached this point, one must question the credibility of the Fed’s policies.

Reason 4: The Fed May Be Technically Insolvent

The Fed announced in March that it intended to hold all the securities on its balance sheet to maturity.

In an Aug. 1 post, Scott Minerd of Guggenheim Investments said that the duration of the Fed’s securities holdings is 6.5 years, and that the recent run-up in yields has wiped out “all of the unrealized gains that the Fed had accumulated since it began to implement quantitative easing in late 2008.”

The Fed has its own accounting principles and does not record mark-to-market losses. But, what if the Fed had to tighten policy by selling assets, i.e., traditional open market operations? It would have to record the losses.

With rates at current levels (as of Aug. 25), it is likely that the $55 billion of Fed equity capital (as of July 24), which is a mere 1.5% of assets, has already been wiped out on a mark-to-market basis. 

My conclusion can be only that with a dysfunctional and confused Federal Open Market Committee, strategies that have failed to achieve stated objectives, a loss of confidence by major constituencies and a weak if not insolvent balance sheet, if the Fed were a publicly traded institution, Wall Street would savage its stock.

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.

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August 19, 2013

The Fed’s Bizarro World

Posted in Banking, investments tagged , at 10:33 PM by Robert Barone

The Seinfeld TV comedy series (1989-1998) had a set of episodes, known as Jerry’s Bizarro World, where everything “normal” was turned upside down and inside out. The Fed seems to have accomplished something similar with its experimental Quantitative Easing (QE) policies.
For the first time in a long time, underlying economic fundamentals are turning positive. Ordinarily, this would be good news for investors. But in today’s upside down, topsy turvey, bizarre markets, “good” news is bad for investors. The blame for this is squarely on the Fed’s QE policies and similar policies adopted by other central bank mimes.

The Good News

In the labor markets, job openings continue to be hard to fill (JOLTS report), layoffs and firings are at levels not seen since ’07 (Initial Jobless Claims week of August 10), and Voluntary Quits (“Take This Job and Shove It”) are rising. The consumer appears to be holding her own (retail sales) and deleveraging appears to be on its last legs (rising credit card and auto debt). Europe looks like it has bottomed (positive Q2 GDP growth) and the news from China shows higher growth levels than penciled in by the pundits. Normally, such news would be accompanied by rising equity prices. But not this time. In the U.S., the U.K., Europe, and Japan, recent positive economic data has been met with equity market sell offs. On August 15th, the Dow Jones sold off 218 points despite 5 year lows in jobless claims, a continuation of positive retail sales trends, and high and rising home builder confidence, a good leading indicator of future home sales.
The table shows the performance of the world’s equity markets with activist central banks for the year until the Fed’s “tapering” announcement on May 22nd, and then from May 22nd to August 15th, the date of this writing. Note that until May 22nd, the markets with activist central banks performed quite well despite relatively stagnant economies, but after the “tapering” announcement, equity prices have been less than stellar. Normally, during the first signs of a change in policy toward tightening, what we find is both rising interest rates and rising stock prices because monetary policy tightening means a strengthening economy.

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The Bizarro World

David Patterson of Brandywine Trust Group, in an August 15 Wall Street Journal piece, opined that markets no longer move on fundamental economic data, but on anticipated Fed policy moves. In fact, it isn’t so much the policy change itself that moves the markets, but whether or not that change was more or less than anticipated (i.e., the 2nd derivative).
Patterson’s premise is that the market knows that the Fed is counting on the “wealth effect,” via a rise in equity prices, to have an impact on consumption, and anticipates and discounts Fed actions to achieve that “wealth effect.” If the Fed acts (or fails to act), and its actions (or lack thereof) disappoint market expectations, equity prices react negatively. As a result, because “good” fundamental economic data means a stronger economy and less need for monetary accommodation, we now have the bizarre world where “bad” fundamental economic news moves the markets higher, while “good” news does the opposite. That is, “bad” is now “good,” and “good” is “bad.” Patterson sums up the Fed’s Bizarro World as follows.
The process can at some point turn powerfully negative, if the monetary stimulus stops, or is expected to stop, or becomes ineffective, which it will if it is expected to become ineffective, because it is only effective based on what the market expects. (emphasis added)
There are no special attributes of wisdom that are automatically imparted to the Fed’s Chair at his/her swearing in ceremony. The non-traditional policies adopted by the Bernanke Fed, and mimicked by other major central banks, are experimental. Going in, they did not know what the unintended consequences would be. But now we are getting a glimpse. At this writing, we do not know how the Fed’s September decision about the “tapering” of its QE program will impact the equity markets. Will it disappoint, or not? But, what we do know is that in the Fed’s new bizarro world, whatever that decision may be, and whether it disappoints market expectations or not, market reaction will not be tied to economic reality.

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.

August 12, 2013

CPI Manipulation Has Exacerbated the Income Gap

Posted in Robert Barone, Uncategorized tagged , at 9:18 PM by Robert Barone

While the “official” CPI inflation rate appears low today, it is based on flawed methodology, which, over time, has caused it to be close to meaningless as a measure of the cost of maintaining a standard of living. In 1983 and again in 1995/96, the calculation of the CPI was modified by the then sitting governments to reflect a much lower inflation rate. The object was to save the government a huge sum in entitlement costs over the ensuing years, and, indeed, it has accomplished that goal. An inflation rate even 2 percentage points higher over the 30 year period would mean that the cost of the ongoing entitlement programs would be about 80% higher. Today, these are over $2 trillion annually. So, the math implies that the cost, at an inflation rate of 2 percentage points higher, would be about $3.6 trillion, or $1.6 trillion more than today. Both John Williams at Shadowstats.com and Ed Butowsky at Chapwood Investments have done work on the inflation bias, and both conclude that inflation reality is much higher than that reported by the official CPI.

One of the biggest issues in the political world is the growing gap between the incomes of the wealthy and the middle class. The data presented in what follows builds a very strong case that an unintended consequence of the policy of reporting a downwardly biased CPI has a lot to do with this growing gap. Think of the scenario where employees at major corporations are given “cost of living” increases each year equal to the “official” CPI. If the CPI underreports inflation, the employees actually lose purchasing power. At the same time, if the corporations raise their prices equal to the real rate of inflation, the corporations actually increase their margins and profits.

One way to look at this is to look at the share of national income from wage earners and from corporate profits. The first graph shows a definite uptrend in corporate profits’ share of Gross Domestic Income (GDI – the income counterpart of Gross Domestic Product), especially since the mid-1990s, and the downtrend in wage earnings as a percent of GDI which appears to be long-term in nature.The relationship between wage earnings and corporate profits, while a lot more volatile, shows a definite long term downtrend.

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Sources: Bloomberg, & Federal Reserve Bank of St. Louis

The second graph shows the growth rates in the official CPI, Average Hourly Earnings, Corporate Profits, and the Shadowstats (John Williams) computation of inflation. As you can see from the graph, wages have only kept pace with “official” CPI, but corporate profits have grown more in line with the Shadowstats inflation rate, interrupted only by an occasional recession. It is also clear from the graph that the real divergence between the series began in the mid-1990s, about the time the government began to seriously manipulate the computation of inflation.

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Sources: Bloomberg, Federal Reserve Bank of St. Louis, & Shadowstats.com

The growing gap between the wealthy, as represented by corporate profits, and the middle class, as represented by wage earnings, has been, in no small part, caused by the understated rate of inflation. The political class, of course, rails against this growing gap. Nevertheless, it appears to be an unintended consequence of the policy of that political class, which understates inflation so as to slow the increasing cost of entitlements, that is an underlying cause of that widening wealth gap.

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.

August 6, 2013

Stagflation Is Here: Today’s Unspoken Truth

Posted in Economy, Inflation tagged , at 7:02 PM by Robert Barone

By Robert Barone, Ph.D

“Stagflation” is a term coined in the ‘70s. It means high levels of inflation in a stagnant or sputtering economy. Sadly, while unrecognized by today’s media and political factions, Stagflation is a reality.

Ingrained Inflation
The following appears in the Federal Reserve’s (Fed) policy committee statement following the late July meetings:

[I]nflation between one and two years ahead is projected to be no more than a half percentage point above the committee’s 2 percent longer-run goal…

The fact that today’s Fed is actually espousing inflation is truly scary. Their traditional role is that of inflation fighter, not inflation enabler. Worse, the inflation measure used is significantly biased to the downside.

The accompanying table shows the impact of various levels of inflation over 10 and 20 year periods.

Dollars Needed to Purchase One 2013 Dollar in

Rate of Inflation 10 Years 20 Years
2.0% $1.22 $1.49
2.5% $1.28 $1.64
3.0% $1.34 $1.81
5.0% $1.63 $2.65
10.0% $2.59 $6.72

As seen from the table, even low rates of inflation lead to unacceptable results over time. But the 5% and especially the 10% scenarios are true wealth killers.

While the “official” CPI inflation rate appears low today, it is based on a flawed methodology, which, over time, has caused it to be close to meaningless as a measure of the cost of maintaining a standard of living. In 1983 and again in 1995/96, the calculation of the CPI was modified to reflect a much lower inflation rate. While this has saved the government a huge sum in entitlement costs, the recipients of such entitlements have suffered significant standard of living reductions (see the work of John Williams at Shadowstats.com and Ed Butowsky at Chapwood Investments for details on how the CPI understates true inflation).

Ed Butowsky and his firm, Chapwood Investments, regularly survey the top 500 items on which Americans spend their after tax dollars. According to Butowsky, “the CPI increase from 2008-2012 was a total of 10.2%, but our research has shown that for many cities, the cost of living increase was more than that for just 2012.” Look at the 10.0% row in the table to see the devastation that a continuation of this level of inflation will cause.

Stagnation
Inflation is bad enough, but it is worse when inflation is rapid and there is no economic growth. In July the “official” U.3 Unemployment Rate fell from 7.6% to 7.4%, not because there was a lot of job creation, but because of the way long-term discouraged workers are counted and because the labor force participation rate shrank to 63.4% from 63.5%. Had the labor force participation rate remained at the pre-financial crisis level (66%), the U.3 Unemployment Rate would be 11%! July’s U.6 Unemployment Rate, which recognizes the part-time issue, stands at 14%.

Non-farm payroll employment including both full-time and part-time jobs, is still two million below the ’08 peak. As played up on several blog sites (e.g. Zerohedge) and even in the mainstream media, of the 953,000 jobs created in 2013, 731,000 or 77% were part-time. Some blame this on the approaching full implementation of Obamacare. While proof is only by association, it appears that the part-time issue has worsened as the full implementation date draws near.

Stagflation
Inflation appears already ingrained with double digit rates common in most major metropolitan areas. With a biased CPI measurement, there is little media mention of rising prices. Unfortunately, both monetary and fiscal policies continue to promote higher inflation levels, while the economy continues to sputter, barely producing positive growth (if, indeed, even those numbers are to be believed). The labor market, the real measure of the country’s economic engine, continues in neutral, at best.

As in the 70s, today we have “stagflation.” Back then, political campaign buttons read “W.I.P.” – “Whip Inflation Now,” as the politicians recognized a need for action. Today, we are told that the labor markets are strengthening and that inflation is benign. Clearly there is little recognition of the stagflation issue and even less resolve to combat 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.