March 3, 2014

If You Build It, They Won’t Come: Opinion

Posted in business, Capital, cost of living, Economic Growth, Economy, Federal Reserve, generation, government, income gap, industrial economy, Inflation, investment advisor, investment banking, investments, job market, labor force, Labor Market, large business, medicare/medicaid, National Federation of Independent Business's, revenue, Robert Barone, small business, social media, social security, taxes, Unemployment, wages, Wall Street at 8:31 PM by Robert Barone

It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change.– Charles Darwin

I am often asked: “When do you think the economy will return to normal?”

My response: If by “normal” you mean what we had from the 1980s to 2008 — the “if you build it, they will come” economy — the answer is, not anytime in the foreseeable future.

The economic environment has permanently changed, and businesses that don’t adapt to the new environment will become extinct like dinosaurs. Think about Kodak and Polaroid. They were big, strong and probably smart, but they didn’t adapt.

Slower Growth

In the new business environment, economic growth will be much harder to achieve, the income gap will continue to grow and bigger and more intrusive governments at all levels will demand more revenue.

In mid-February, the Congressional Budget Office concluded that potential economic growth for at least the next 10 years will be much lower than what we have experienced for the last few decades. They attribute this to the health system known as Obamacare as well as disincentives to work.

A Growing Income Gap

The growing income gap is well documented. What’s not well documented are the causes.

There are two major ones starting with government policy. Federal Reserve money printing, for example, benefits the most affluent and Wall Street’s financial institutions. Government policy to under-report inflation (which began in earnest in 1994) reduces budget deficits by limiting payouts to Social Security and Medicare recipients and saves interest costs on the debt. But it has kept wage rates from keeping pace with inflation.

If inflation has been understated by just three percentage points per year since 1994, then wage earners, who have only received “cost of living” adjustments, have lost 55% of their purchasing power. No wonder both spouses have to work (some with two jobs) and still have a hard time making ends meet.

But, there is another factor at play here. In the Industrial Revolution, innovation benefited all workers. It wasn’t hard for workers with little formal education to learn how to operate machine tools, and they could master skills needed in the new industrial economy.

But, that is not true today. In fact, the National Federation of Independent Business’s surveys have for some time now shown an increasing trend that businesses cannot find the skills they need. As a result, jobs go unfilled. The jobs that are available require skills only learned through and intensive educational process, such as majoring in engineering or computer science at a university.

These are the folks who are getting the high paying jobs. Those with few or no skills must take much lower-paying service type or minimum wage jobs. In the latest unemployment survey, the unemployment rate among college graduates was 3.3%, for those with high school degrees it was 7.3%, and for those with less than a high school diploma, it was 11.1%. Thus, it appears that the nature of the new technology revolution is also contributing to the income gap.

Other Endemic Factors

For the past five years, multinational corporations have been hoarding cash. Capital expenditures are at their lowest growth levels in six decades. Perhaps these large businesses have recognized that growth will be slow and that revenue growth will be a function of acquisitions.

Finally, new laws, regulation and taxation strangle small businesses — the recognized driver of economic growth for the past 60 years. The stranglehold that regulators have on community banks that restricted lending to small businesses is just one example.

Unfortunately, instead of recognizing that government policies have both slowed the economy and widened the income gap, politicians are likely to use these as wedge issues. So it appears that more regulations and increased taxation on small businesses and higher income earners is certain.

The Survival Mentality

In such a tough, low growth environment, businesses must be more innovative. For instance, 80 million Millennials (those between 15 and 35 years old) will soon have more spending power than any other generation in history. The common characteristic of this generation is they make spending decisions only after consulting social media (friends, Web sites, comments from strangers).

Businesses have to recognize this and play in that space. This generation also has different attitudes toward such things as cars. They are more interested in convenience and access than ownership. In addition, the recognition that the more highly educated are likely to have the disposable income may dictate marketing strategy.

In conclusion, don’t expect a return of the “if you build it, they will come” economy. Without an approach that is fundamentally different from what has been the norm for the past 30 years, many businesses will become extinct.

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. Contact Robert Barone or the professionals at UVA (Joshua Barone and Andrea Knapp) 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.

February 4, 2014

Existing Public Policy Fosters a Growing Income Gap

Posted in business, Business Friendly, Dodd Frank, Economic Growth, Economy, Federal Reserve, Finance, income gap, Inflation, lending, Public Policy, Quantitative Easing, small business at 9:12 PM by Robert Barone

There is no doubt that the gap between the rich and the middle class and poor has widened in recent years. And the most recent studies confirm a continuation of that trend with capital gains playing a major role.

What is ironic is that public policies — some long practiced, some new, — contribute significantly to the problem. Recognizing and fixing such policy issues, however, is easier said than done.

In this post, I will discuss three such policies: 1) The asset inflation policies of the Fed; 2) The policy that significantly understates inflation; and 3) The policies that strangle lending to small business. There are many other public policies, such as work disincentives, that also have an impact, but I’ll discuss them another time

Fed Policy

Since the financial crisis, the Fed, through its “quantitative-easing” policies, has relied upon the “wealth effect” via equity asset price inflation to combat the so-called deflationary forces that had built up in the economy.

Each time a QE policy ended, there was a big decline in equity prices. Those declines prompted another round of QE.

As indicated above, capital gains have played a major role in the recent growth of the income gap. Those gains also played a major role in the dot.com and subprime bubbles of the recent past.

Inflation

In his Jan. 29 missive to clients, David Rosenberg of Gluskin Sheff, a wealth-management firm, said that “if we were to replace the imputed rent measure of CPI (consumer price index) with the actual transaction price measure of the CS-20 [Case Shiller home price index], core inflation would be 5.3% today, not 1.7% as per the ‘official’ government number…”

John Williams (www.shadowstats.com) indicates that, using the 1990 CPI computation, inflation in the U.S. was 4.9% in 2013; using the 1980 computation method, it was 9.1%.

Those of you old enough may remember that in 1980 the then new Fed Chairman, Paul Volker, began to raise interest rates to double-digit levels to combat an inflation that was not much higher than the 9.1% of today (if the 1980 methodology is used).

Over the years the Bureau of Labor Statistics has changed the computation method for CPI, in effect, significantly biasing it to produce a much lower inflation rate.

In a post I wrote last September (“Hidden Inflation Slows Growth, Holds Down Wages,” TheStreet.com, 9/13/13), I showed how the growth of wages earned by middle-class employees has hugged the “official” inflation trend.

If that “official” inflation trend understates real inflation by 3% per year (the difference between Williams’ computation using the 1990 methodology and 2013’s “official” rate is 3.1%), over a 20-year period, the real purchasing power of that wage would fall by more than 80%.

That helps to explain why both husbands and wives must work today, why the birth rate is falling and why the income gap is widening.
Once again, changing the inflation measurement problem is easier said than done. In the U.S., Japan, the U.K and the eurozone, debt levels are a huge issue. Lower inflation rates keep interest rates low, allow new borrowing (budget deficits) at low rates and keep the interest cost of the debt manageable (at least temporarily).

Also, a low official rate keeps the cost-of-living adjustments for social programs — Social Security, Medicare and government pensions — low. As a result, Social Security, Medicare and pension payments are significantly lower than they otherwise would be. Returning to the older, more accurate inflation measures would truly be budget busting.

Constraints on Small Business Lending

One of the reasons that the economic recovery has been so sluggish is the inability for small business to expand. Since the financial crisis, much of the money creation by the Fed has ended up as excess reserves in the banking system (now more than $2.3 trillion).

Small businesses employ more than 75% of the workforce. So, why aren’t banks lending to small businesses?

In prior periods of economic growth, especially in the 1990s and the first few years of the current century, it was the small and intermediate-sized banks that made loans to small businesses in their communities.

Today, for many of the banks that survived the last five years, there are so many newly imposed reporting and lending constraints (Dodd-Frank) and such a fear of regulatory criticism, fines or other disciplinary action that these institutions won’t take any risk at all. In earlier times, the annual number of new community bank charters was always in the high double digits.

But, since 2011, the FDIC has approved only one new bank charter that wasn’t for the purpose of saving an existing troubled bank. Only one!

In effect, the federal regulators now run the community banking system from seats of power in their far away offices.

Small businesses cannot grow due to the unavailability of funding caused by overregulation and government imposed constraints. This holds down the income growth of much of the entrepreneurial class and is a significant contributor to income inequality. Of the policies discussed in this post, this would be the easiest to change.

Conclusion

There is definitely a growing income gap, but, much of it is the result of public policy. New elections or new legislation won’t fix these policies. The first step is recognition. But, as I’ve pointed out, many of these policies are rooted in the fabric of government.

There is little desire on the part of those comfortably in power to recognize them, much less to initiate any changes.

 

 

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. Contact Robert Barone or the professionals at UVA (Joshua Barone and Andrea Knapp)
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.

 

December 30, 2013

8 U.S. business predictions for 2014

Posted in Auto Industry, business, Economic Growth, Economy, Finance, GDP, gold, government, Housing Market, Inflation, interest rates, investment advisor, investment banking, Labor Market, Manufacturing, Robert Barone, Unemployment, Wall Street at 8:45 PM by Robert Barone

The holiday season is the traditional time of year to prognosticate about the upcoming year. But, before I start, I want to make a distinction between short-term and long-term forecasts.

Long-term trends are just that, and they unfold slowly. And, while I have great concerns about the long-term consequences of inflation, the dollar’s role as the world’s reserve currency, the bloated Fed balance sheet and resulting excess bank reserves, and the freight train of unfunded liabilities which will impact the debt and deficit, because these are long-term issues and simply don’t appear overnight, I do not believe there is anything contradictory about being optimistic about the short-term.

With that caveat, here are my predictions for 2014:

1. Real GDP will grow faster in 2014 (3.5%): The “fiscal drag” that caused headwinds for the economy has now passed with the signing of the first budget in four years in mid-December. Since 2009, governments at all levels have been shedding jobs. But, that has now all changed. The November jobs reports show that employment at all levels of government has turned positive.

No matter your view of the desirability of this for the long-term, in the short-term, those employees receive paychecks and consume goods and services. I predict the real gross domestic product growth rate will be more than 3.5 percent in 2014.

2. Manufacturing and trade are healthy and will get better in 2014: The Institute for Supply Management’s indexes, both manufacturing and non-manufacturing, are as high or higher than they were in the ’05-’06 boom. In November, industrial production finally exceeded its ’07 prior peak level.

Auto sales today are as frothy as they were in the pre-recession boom, and auto sales in the holiday buying period are destined to surprise to the upside. Online sales in the weekend before Christmas overwhelmed both UPS and FedEx, causing many gifts to be delivered on the 26th.

3. Housing, while not near its old bubble peak, has turned the corner: Part of the reason the economy is not overheating is housing. While November’s housing starts surprised to the upside, they still only represent 53 percent of their bubble peak. Nevertheless, because new home construction has been in the doldrums for the past six years, the resurgence evident in the economy has pushed the median price of homes to the point where many homeowners, who were underwater just a couple of years ago, can now show positive home equity on their balance sheets

While interest rates have risen and may be a cause for concern for housing, they are still very low by historic standards, and we have a Fed that, on Dec. 18, recommitted to keeping them down for a period much longer than the market ever anticipated.

4. The unemployment rate will end 2014 somewhere near 6%: Because the popular unemployment index is a lot higher today than it was in the ’05-’06 boom (7 percent vs. 5 percent), the popular media assumes that the labor markets are still loose. But, demographics and incentives to work have changed over the past seven years.

The labor sub-indicators imply much tighter labor conditions than the traditional unemployment index would lead one to believe. Recent data for nonfarm payrolls are equivalent to their monthly numbers in ’05-’06. Weekly new jobless claims are in a steep downtrend. The sub-indexes for layoffs and discharges are lower than they were in ’05-’06. And hard-to-fill-position and job-opening subindexes are in definite uptrends and are approaching ’05-’06 levels. As a result, expect a steady decline in the unemployment rate in 2014.

5. Investment in new plant & equipment will rise in 2014: For the past 5 years, large-cap corporations have hoarded cash and have not reinvested in their businesses. As a result, because equipment and technology is older, labor productivity has stagnated. This is one reason for the strong labor market. In 2014, I predict there will be an upturn in the reinvestment cycle. Beneficiaries will be technology companies and banks.

6. Inflation will be higher in 2014, both “officially” and in reality: While every individual player in the financial markets knows that everyday prices are rising, each espouses the Fed’s deflation theme, perhaps only to play along hoping the Fed will continue printing money.

Are we to believe that the jump of retail sales in October of 0.6 percent followed by 0.7 percent in November were all without price increases as the Bureau of Labor Statistics says? The “official” consumer price index says that airline fares have not increased despite the 18 percent growth of airline revenues in 2013 (bag check fees, etc.)? Should we believe that double-digit revenue growth rates at restaurants are volume-only and we are just eating more? I don’t know what the actual rate of inflation is, but it sure feels like it is higher than 5 percent. In 2014, it will be even higher than that.

7. Equity markets will rise in 2014: The fiscal headwinds are behind us; industrial production and sales are strong; housing is healing, the rise in home prices have generally raised consumer confidence; there appears to be the beginning of an upturn in the capital investment cycle; and, most important, the labor markets are strong. Any equity market corrections should be bought. Meanwhile, longer-duration bonds should be avoided unless there is an accompanying hedge instrument.

8. Gold — it should rise in 2014, but this is a tricky market: Every indicator points to a rise in the price of gold, especially since all of the world’s major central banks are printing money at record rates. But, contrary to logic, the price of gold has fallen in 2013 by nearly 30 percent.

The reason behind this lies with leverage and hypothecation — getting a loan using collateral — in the gold market. Once again, Wall Street has discovered that money could be made by leveraging; and the paper gold market is about 100 times larger than the physical market. When you have that kind of leverage, collusion, price fixing, or just plain panic can quickly move markets.

As inflation is recognized, the price of gold (both physical and paper) should rise. In a healthy economic year, as I predict for 2014, a collapse in the paper gold market is unlikely, and perhaps the price of gold will rise in response to rapidly expanding fiat money. But beware. The only safe gold is what you can hold in your hand.

December 27, 2013

Part II: The Long-Term Outlook – Even a Strong Economy Doesn’t Change the Ultimate Outcome

Posted in business, debt, Economic Growth, Economy, Europe, Finance, Foreign, Inflation, investment advisor, investment banking, investments, Markets, National Deblt, Robert Barone at 4:46 PM by Robert Barone

If you’ve read Part I of this year end outlook, you know that it is our view that the underlying private sector is healthy and, except for the fact that the real rate of inflation is much faster than the ‘official’ rate, we could well have a short period of prosperity.

Unfortunately, our long-term outlook is not as sanguine as our short-term view.  The eventual recognition of the inflation issue, the dollar’s role as the world’s reserve currency, the bloated Fed balance sheet and the resulting excess bank reserves, and the freight train of unfunded liabilities and its impact on the debt and deficit are issues that have large negative long-term consequences.  Remember, the long-term unfolds slowly, and we don’t expect that we will wake up one day to find that all has changed.  Still, the changes discussed below could very well take place over the next decade, and investors need to be prepared.

The Dollar as the Reserve Currency

The dollar is currently the world’s reserve currency.  Most world trade takes place in dollars, even if no American entity is involved.  Because world trade has rapidly expanded over the past 20 years, more dollars have been needed than those required for the U.S. economy alone.  As a result, the U.S. has been able to run large deficits without any apparent significant impact on the dollar’s value relative to other major currencies.  Any other country that runs a large deficit relative to their GDP suffers significant currency devaluation.  Current policy in Japan is a prime example.  A weakening dollar has implications for the prices of hard assets.

In addition, the Fed’s policy of Quantitative Easing (essentially money printing) has disrupted emerging market economies.  Zero rates and money creation caused hedge fund managers to leverage at low rates and move large volumes of money offshore to emerging nations where interest rates were higher.  The initial fear of “taper” in May and June caused huge and sudden capital outflows from those countries resulting in massive economic dislocation in those markets.  In India, for example, the Rupee was pummeled as the hedge fund investors, fearing that interest rates were about to suddenly rise, all tried to unwind their Rupee investments at the same time.  And now that ‘taper’ has officially started and longer-term rates are expected to rise, these issues will continue.  Those countries have all taken defensive measures.  India, for example, imposed taxes on gold imports, which has impacted the gold markets but has reduced India’s balance of payments deficit.

As a result of such tone deafness on the part of the Fed, and because there now appears to be enough dollars in the world for the current level of trade, the international appetite for U.S. dollars is clearly on the wane.  Japan and China, the two largest holders of Treasury debt, have recently reduced purchases.  Most emerging market nations and large players like Russia and China have vocally called for an alternative to the dollar as the world’s reserve currency.  This movement is alive and well.

The Fed’s Balance Sheet

As the economy expands, the size of the Fed’s balance sheet and the level of excess bank reserves will become a problem.  There are $2.3 trillion of bank reserves in excess of what are ‘required’  under the law and regulations.  (Required reserves for the U.S. banking system are $.067 trillion; so, the system has 34x more reserves than it needs.)  Under ‘normal’ conditions, and the way the system was designed to work, if the economy got too hot, the Fed could sell a small amount of securities out of its portfolio which would reduce bank reserves to the point where banks would have to ‘borrow’ from the Fed.  Because bankers are hesitant to do that, and because the Fed could raise the ‘discount’ rate, the rate charged for the borrowings, the Fed could control new lending and thus the economic expansion.  This isn’t possible today as the Fed would have to sell $2.2 trillion to cause banks to have to borrow.  Such a volume of sales would likely cause a crisis in the financial system, or even collapse.  Today, the only way the Fed has to stop the banks from lending is to pay them not to lend – this is exactly the opposite of the intent of the original legislation and the opposite of how the Fed has worked for most of its 100 year history.

Furthermore, given the growing lack of confidence in the dollar as the world’s reserve currency, if fiscal budget deficits grow in the future, the Fed may end up as the major lender (i.e., lender of last resort) for the U.S. Treasury.  That simply means more money creation.

Unfunded Liabilities-

The U.S. Treasury officially recognizes $85 trillion as the amount of unfunded liabilities of the Federal Government.  Other professionals set this number near $120 trillion.  For comparison, the annual U.S. GDP is about $16 trillion.  The budget deficit reported in the media is a cash flow deficit (tax collections minus expenditures).  The budget deficit doesn’t include promises made for future payments (Medicare, Medicaid, Social Security, government pensions) which have been running between $4 and $5 trillion annually for the past few years.  These amounts simply get added to the ‘unfunded’ liability number.

As the population ages, these payments will have to be made, and the budget may become overwhelmed. (You see the relevance of the remark made above about the Fed being the lender of last resort for the Treasury.)   This is the heart of the debate about ‘entitlements’ that has been front and center for the past decade.

 Solutions (none of which you will like)

 Philipp Bagus is a fellow at the Ludwig von Mises Institute in Europe.  He is well known in Europe for his work on financial issues there.  In a recent paper, Bagus says that there are several possible ways out of the current money printing predicament.  Any one or a combination is possible.  We have put them in an order of most likely to least likely to be used:

  •  Inflation – this is the natural outcome of printing money;
  • Financial Repression – this is current Fed policy; savers and retirees bear a disproportionately large burden as inflation eats at their principle but there is no safe way to earn a positive real rate of return;
  • Pay Off Debt – this means much higher levels of taxation, and is definitely a real possibility.  In Europe, the International Monetary Fund (IMF) has proposed a one-time 10% wealth tax.  As the unfunded liabilities push up the federal deficit, expect such proposals in the U.S.;
  • Bail-In – In ’08-’09 we saw ‘bail-outs’ where the government saved GM, Chrysler, AIG and the Too Big to Fail banks by buying stock or otherwise recapitalizing them.  A ‘bail-in’ refers to the financial system.  Banks and other depositories have liabilities called deposits.  The depositors do not consider themselves ‘lenders.’  But, in a ‘bail-in,’ it is the depositors who lose.  Their deposits are ‘converted’ to equity in the bank.  When they try to sell their bank shares, they find that it will fetch only a fraction of the value of their deposits.  A variant of this is what happened in Cyprus in the spring of 2013.  Because of the distaste the public now has for ‘bail-outs,’ if there is another financial crisis, this is likely to be the method used;
  • Default on Entitlements – when we talk about ‘entitlement reform’ in the U.S., we really mean at least a partial default.  It is likely that some people simply won’t get what they were promised.  We put this low on the list because we have witnessed a political process that won’t deal with the issue;
  • Repudiate Debt – Because the government can simply print money to pay it debts, this is the least likely of all of the possibilities in the U.S.

The long-term issues are serious.  And not addressing them simply means a higher level of pain when addressing them is required.   Remember, these are long-term issues.  They are all not likely to occur at the same time, nor will they simply appear overnight.  The first signs of trouble will occur when markets begin to recognize that the ‘official’ inflation rate significantly understates reality, or that the inflation data become so overwhelming that they can no longer be masked.  Even then, markets may come to tolerate higher inflation, as after 100 years of fighting inflation, the Fed and the world’s major central banks have embraced it as a good thing.

Meanwhile, as set forth in Part I of this paper, the immediate outlook for the economy is upbeat.  Enjoy it while it lasts.

December 20, 2013

Robert Barone, Ph.D.

Joshua Barone

Andrea Knapp Nolan

Dustin Goldade

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  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.

Part I: The Short-Term Outlook – A Strong and Accelerating Economy

Posted in Banking, business, Economic Growth, Economy, Federal Reserve, Finance, Housing Market, investment advisor, investment banking, investments, Markets, mortgage rates, Robert Barone at 4:41 PM by Robert Barone

Those who read our blogs know that over the past 6 months or so, we have turned positive on the underlying private sector of the U.S. economy.  We have had comments from several readers about this apparent change of heart, some of them almost in disbelief.  So, let us dispel any doubts.  There is a huge difference between the short-term and the long-term outlooks.  Let’s realize that long-term trends are just that, long-term, and that they take a long time to play out.  As you will see if you read through both parts of this year end outlook, our long-term views haven’t changed.  But, since the long-term doesn’t just suddenly appear, there really isn’t anything contradictory in being optimistic about the short-term.  As a result, we have divided this outlook up into its two logical parts, the short-term and the long-term.

Let’s start with the short-term.  First, at least through 2014 and probably 2015, the ‘fiscal drag’ that caused headwinds for the economy has now passed with the signing of the budget deal in mid-December.  In his December 18th press conference, Fed Chairman Bernanke indicated that four years after the trough of the ’01 recession, employees at all levels of government had grown by 400,000; but at the same point today, that number is -600,000, i.e., a difference of a million jobs.  Think of that when you think about ‘fiscal drag.’  The November jobs data shows that jobs at all levels of government have now turned positive.  No matter your view of the desirability of this, those employees receive paychecks and can consume goods and services.  So, from a short-term point of view, the ‘fiscal drag’ has ended, and, all other things being equal, this will actually spur the growth rate of real GDP.

Manufacturing and Trade

The institute for Supply Management’s (ISM) indexes, both manufacturing and non-manufacturing, are as high or higher than they were in the ’05-’06 boom period.  This is shown in the chart immediately below.

pic 1

Shown in the next chart is industrial production, which in November, finally exceeded its ’07 peak.

Pic 2

Now look below at the auto chart.  Sales are as frothy today as they were in the pre-recession boom.  Sales for the holiday buying period are destined to surprise to the upside.

Pic 3 

Housing

Part of the reason that the economy is not overheating is housing.  The chart clearly shows that housing starts are significantly lagging their ’05-’06 levels.  But, recognize that ’05-’06 was the height of the housing bubble.

Pic 4

November’s housing starts surprised to the upside.  But, they are still only 53% of their bubble peak.  Nevertheless, because new home construction has been in the doldrums for the past six years, the resurgence evident in the economy has pushed the median price of a new home north of what it was then.  In addition, the lack of construction has put the months’ supply of new homes at less than 3.  In the housing bubble, when everyone was in the market, the average level of supply was 4 months.  So, in some respects, the current housing market is hotter than it was at the height of the bubble.  And, while interest rates have risen and are a cause for concern, they are still very low by historic standards, and we have a Fed that on December 18th recommitted to keeping them down for a period much longer than the market had anticipated.

 Labor Markets

Because the popular unemployment index is a lot higher today than it was in the ’05-’06 boom (7% vs. 5%), the popular media assumes that the labor markets are still loose.  But, demographics and incentives to work have changed over the past seven years.  The labor sub-indicators imply a much tighter labor market than the traditional unemployment index would lead one to believe.  Recent new nonfarm payrolls are equivalent to their monthly gains of ’05-’06.  The weekly Initial Jobless Claims number for the week ending 11/30 was 298,000.  Except for one week this past September, you have to go all the way back to May ’07 to find a number that low.  The first chart below shows the definite downtrend in new and continuing jobless claims.

Pic 5

The next chart shows that layoffs and discharges are lower than they were in ’05-’06 and that both the “Job Openings” and “Jobs Hard to Fill” sub-indexes are in up trends and are approaching ’05-’06 levels.

Pic 6 

The Aggregates

So, while auto sales are booming, the labor markets are tight, and manufacturing and services are expanding at or near boom levels, why do the aggregates (Real GDP, for example) appear so depressed?  One explanation that we think has some credibility, is that there has been an expansion in the underground economy (barter; working for cash, etc.).  The ‘fiscal drag’ headwinds discussed earlier, have, no doubt, had a large impact on the sluggish growth in the aggregates.  On a positive note, the latest revisions to Q3 ’13 Real GDP show a growth rate of 4.1%, which, on its face, supports our short-term optimism.  And until mid-December, the markets had discounted this as resulting mainly from growth in unwanted inventories.  But Black Friday and Cyber Monday sales along with upbeat ongoing retail reports tell us something different, i.e., the inventory growth was not unwanted at all.  While the markets expect a 2% Real GDP growth for Q4 ’13, don’t be surprised if it is much higher.

Short-term Implications

The underlying data, at least for the next 6 to 12 months, point to a strengthening economy.  Certainly, a stock market correction is possible.  We haven’t had one for more than 2 years.  But, while possible, a significant downdraft like those of ’01 or ’09, don’t typically occur when the economy is accelerating (1987 is an exception) without an extraneous and unanticipated shock.  With the signing of the first budget deal in four years, and with the Fed clearing the air about tapering and actually extending its announced period of zero interest rates, almost all of the short-term worries appear to be behind us, except one.

 Inflation – The Potential Fly in the Ointment

The ‘official’ Consumer Price index (CPI) was flat in November, dominated, as it has been all autumn, by the fall back in gasoline prices.  Somehow, while we all know that everyday prices are rising at a significant pace, the markets have bought into the deflation theme.  Perhaps the belief is that if the markets play along with the Fed’s low inflation theme, the Fed will remain easier for longer.

In his December 16th blog, David Rosenberg (Gluskin-Sheff) has the following to say about inflation:

I have a tough time reconciling the ‘official’ inflation data with what’s happening in the real world… the .7% jump in retail sales in November on top of +.6% in October – these gains were all in volume terms?  No price increases at all?  Restaurants are now registering sales at a double-digit annual rate… No price increases here?  The BLS tells us in the CPI data that there is no pricing power in the airline industry and yet the sector is the best performing YTD within the equity markets…  global airline service fees have soared 18% in 2013… these [fees] are becoming an ever-greater share of the revenue pie and one must wonder if they are getting adequately captured in the CPI data.

Inflation could be the fly in the ointment for 2014.  As long as the markets play along with the Fed’s deflation theme, as we expect they will as long as they can, the economy and markets will do just fine (this doesn’t mean there won’t be a correction in the equity markets, as we haven’t had a meaningful one for two years).  But sooner, or later, something will have to be done about inflation.  We will close this Part I with a quote from Jim Rogers, the commodity guru (Barron’s, October 12, 2013):

The price of nearly everything is going up.  We have inflation in India, China, Norway, Australia – everywhere but the U.S. Bureau of Labor Statistics.  I’m telling you, they’re lying.

December 20, 2013

Robert Barone, Ph.D.

Joshua Barone

Andrea Knapp Nolan

Dustin Goldade

 

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 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.

 

 

October 8, 2013

Investors May Ultimately Thank Washington for Gridlock 10.08.2013

Posted in business, Robert Barone, Uncategorized tagged , at 3:47 PM by Robert Barone

The markets have been fixated on the political standoff in Washington, D.C. Through Friday, October 4th, the S&P 500 was down in 9 of its last 12 sessions. The uncertainty, especially over the debt ceiling and possible “default,” has made investors hesitant to make longer-term commitments with their investible funds. Nevertheless, the data from the private sector, especially of late, has been much stronger than earlier in the year.

Consider:

The manufacturing sector is hot. The Institute for Supply Management (ISM) manufacturing index was 56.2 in September, the highest in nearly 2.5 years. In the U.S., we are seeing a manufacturing renaissance as labor cost increases in China and much of Asia are running in excess of 10% annually. As an example of what is going on in manufacturing, 9 of GM’s 17 production plants are operating flat out on an around the clock (3 shift) schedule. In 2008, at the last auto peak, only 3 of the then 20 plants were operating at full capacity. In August, auto sales were 16.1 million units (SAAR – seasonally adjusted annual rate), a level not seen since before the financial crisis. Sales fell back in September to 15.3 million units (SAAR) but only because the Labor Day holiday was on Monday, September 2nd and some weekend sales were pulled into the August numbers. The average of the two months, 15.7 million units (SAAR) isn’t anything to sneer at.

In the labor markets, employers are having a hard time finding qualified applicants. This is quite a different market than it was even 2 years ago. First time filers for unemployment insurance are at levels not seen since ’07, and this particular economic series has a high inverse correlation with stock prices, i.e., when claims fall, stock prices rise. Voluntary quits are also up significantly indicating that current employees are getting more confident that they can find new employment. And, despite the secular downtrend in the labor force participation rate, a labor shortage is developing.

While suffering a setback due to higher mortgage rates this summer, the housing market still suffers from a lack of supply. This isn’t surprising given that we have had only minimal new housing construction for the past half decade while population growth has continued. As a result, there has been a double digit rise in home values over the past 12 months, which makes middle class homeowners more confident and more willing to spend and take on debt. We see this in the consumer sentiment surveys, in the growth of credit card debt, and in new auto financings

The U.S. economy is mainly service based, so the ISM non-manufacturing index is an important indicator of economic health. In August, that index hit 62.2, the highest level since early 2011, a time when GDP was expanding faster than 3%. Not to get too excited, the index fell back to 55.1 in September. Nevertheless, that is still a healthy result. By definition, anything over 50.0 signals growth.

The worry over China (which embodies Australia, Canada, and others which supply China much of its raw materials) now seems overdone. While economic growth is much lower than in the past decade, 7.5% is still much faster than anything the mature economies could hope for. There was no “hard landing” there, and indications are that growth has resumed. This is positive for exports and international large cap companies. In addition, Europe’s economy appears to have bottomed.

Meanwhile, the Federal Reserve and other central banks have kept the monetary spigots open, and, because of the so-called “crisis” issues in Washington, D.C., it seems unlikely that Bernanke will begin to “taper” money before year’s end. In addition, and just as an historical note, in the post-WWII era, every recession has been preceded by a significant “tightening” of monetary policy (i.e., yield curve inversion where short-term rates are higher than long-term ones). As indicated above, it appears we are a long way from that. Normally, when the economy grows and monetary policy is still easy, stock prices rise.

Don’t get me wrong. The long-term outlook is still clouded. Middle East tensions persist, terrorism, led by Al-Qaeda, is not dead, and U.S. influence in the world is waning. In addition, the long-term struggle with debt, its costs, and entitlements in the U.S. and Europe still hasn’t been dealt with. Nor has risk in the financial system been removed. This is true for the U.S., but especially true for Europe.

But, if the debt ceiling is raised without a U.S. default (which is the highly likely scenario), markets will have a relief rally, and, at least for the short-term, concerns over those nasty long-term issues will be put on the back burner. Remember, rising markets often climb a “wall of worry.” Perhaps, the political antics now playing out in Washington, D.C., especially if they push the default issue to the precipice, will ultimately give investors a buying opportunity in the equity markets.

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.

December 17, 2012

The Demonization of Corporate Tax Avoidance

Posted in business, Corporate Tax, Uncategorized tagged , , at 9:28 PM by Robert Barone

Like a doctor who takes the Hippocratic oath always to put his patients’ best interests first, so, too, a director of a company, especially a large or publicly traded one, has, under the law, a fiduciary duty always to serve the best interests of its shareholders. Profits always have been an important measure of the health of a company, and it is an accepted norm that shareholders are better off when profits are higher than when they are lower.

As a result, there is a high correlation between rising profits and rising stock prices. So, why, I ask, is there now a movement to vilify boards of directors and managements if they opt legally to minimize corporate taxes? Isn’t that in the best interests of the shareholders (i.e. higher profits)? In fact, why would anyone (corporate or individual) pay more taxes than they have to?

The movement to demonize legal corporate tax avoidance exists on both sides of the Atlantic. One manifestation is the vilification for holding cash in low tax countries. Another is for paying out dividends in 2012 to avoid the inevitably higher dividend tax rates on shareholders beginning Jan. 1.

The Wall Street Journal ran an article featuring the huge cash hordes of major U.S. corporations held offshore (“Top U.S. Firms Are Cash-Rich Abroad, Cash-Poor at Home,” Linebaugh), including household names such as Apple, GE, Johnson & Johnson, Microsoft, Oracle and Staples.

•On Dec. 4, the New York Times (“British Lawmakers Accuse Multinationals of  Avoiding Taxes”) reported that “the British government announced plans … to  crack down on tax dodgers (emphasis added) as a parliamentary report criticized United States companies for what it described as tax avoidance (emphasis added).”

Margaret Hodge, chair of the Public Accounts Committee of Parliament wrote: “Global  companies with huge operations in the U.K., generating significant amounts of  income are getting away with (emphasis added) paying little or no corporation tax here. This is outrageous (emphasis added) and an insult to British businesses and individuals who pay their fair share (emphasis added).” (Note the tone of the emphasized words!) Companies named by Hodge include Amazon, Google and Starbucks, which  legally use lower tax jurisdictions within Europe (Ireland, Luxembourg and Switzerland) to record much of their revenues.

Let’s first examine the large cash hordes held offshore, both for the U.S. and the U.K. The cost of bringing that cash back must be examined in the context of the cost of pursuing other avenues of access to cash. In the U.S., for example, it would cost those large corporations, in taxes, 35 percent of the cash repatriated, while borrowing costs can be had for interest rates in the very low single digits. If the political class in the U.S. really desires to have the cash repatriated to spur economic growth, perhaps it should consider, at least temporarily, a lowering of the 35 percent cash repatriation tax. Getting 3 percent in repatriation taxes is better than nothing; and, oh, by the way, we might even see some job growth as a result of that cash being deployed domestically!

For Hodge of Great Britain, the answer is the same. Who has control of the tax policy that drives the cash offshore? It is you, Madam Hodge, and your fellow pols. No board or management of a privately held corporation is going to pay more than it must. It is its duty legally to avoid such payments! Just think what any rational person would think of AT&T if he or she complained that those other, smaller telecom companies were undercutting AT&T’s pricing, and that it was unfair or unethical. Yet, this is the argument that Hodge is making. What’s wrong, U.K.? Can’t compete anymore?

The very concept that legally avoiding such taxes is unfair is a direct attack on capitalism and free markets. The tone of the language used by Hodge, and also present here in the U.S. (“tax dodgers,” “tax avoidance,” “getting away with,” “outrageous,” “fair share,” “shared sacrifice”) all imply that the behaviors of the corporations, their managements and the boards of directors somehow are immoral or unethical. The “profit motive,” Adam Smith’s “invisible hand” (i.e. free markets), and economic opportunity and self-interest propelled the U.S. and the western industrialized societies to the highest living standards in history in the 20th century. With “profit” now a dirty word and legal use of competitive jurisdictions with lower tax rates now under frontal attack by
overspending and uncourageous governments, it isn’t any wonder that living standards in these societies are now plunging.

Investors should be encouraged that the multinational corporate sector displays such behavior. The appropriate response by government should be to figure out how to become more competitive internationally. On the other hand, investors should be wary of investing in countries where they see governments restrict the free flow of capital in order to confiscate taxes, as this is always an act of desperation by politicians who have no idea about how economies work or the unintended consequences of their actions.

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.