September 4, 2013

Hidden Inflation Slows Growth, Holds Down Wages

Posted in Inflation, Robert Barone, taxes, Uncategorized tagged , at 7:52 PM by Robert Barone

On Thursday, August 29th, fast-food chain workers conducted strikes in nearly 60 cities asking that chains like McDonalds (MCD), Burger King (BKW), Wendy’s (WEN) and Yum Brands (YUM) (which holds KFC and Taco Bell) boost their minimum hourly pay to $15/hour.

Meanwhile, the saga between Walmart (WMT) and the D.C. City Council continues with Mayor Gray having 10 days from August 30th to sign or veto legislation which requires Walmart (WMT) to pay a minimum wage of $12.50/hour while other employers are only required to pay the D.C. minimum wage of $8.25/hour.

The Income Gap

In 1980, wage earnings as a percent of Gross Domestic Income (GDI, the sister concept to GDP) were 49%. In the last GDI report, they were closer to 42%. Meanwhile, corporate profits are up 50% from about 8% of GDI in 1980 to about 12% today. There is no doubt that the income gap between the rich and the middle class is growing.

The Slide in GDP Growth

The accompanying table shows the Compounded Annual Growth Rate (CAGR) of Real GDP (as “officially” measured) from the bottom of each of the last four recessions to the following peak.

09.04.2013

Source: Department of Commerce

It is notable that the CAGR of Real GDP in today’s recovery (2.23%) is about half the pace in the recovery from the recession of the early ‘80s. Note that in each subsequent cycle since 1982, GDP’s CAGR has slid more than 50 basis points.

The “Official” CPI

In the mid-90s it was determined that demographics would become an issue regarding the cost of social programs like Social Security and Medicare. So, the CPI formulation was changed so as to slow down the “official” rate of inflation, which, in turn, slowed the cost of the social programs.

But there was also an unintended consequence, one not recognized by any politician or the main stream media today. Because the “official” CPI is widely accepted as “the” measure of inflation, and because “cost of living” raises for most of middle America are based on it, its manipulation over time has lowered the real incomes of wage earners (the middle class) with the resulting negative impact on the CAGR of Real GDP, because if the prices of goods and services are actually rising faster than incomes, then aggregate demand is negatively impacted.

I first published the accompanying graph on August 12th at TheStreet.com (“CPI Manipulation Has Exacerbated the Income Gap”). The 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 (SGS Alternative CPI, 1980-based), interrupted only by an occasional recession. There are several private sector measurements of true inflation including that published by John Williams. In each private sector survey, the cost of living is shown to be rising significantly faster that the “official” CPI.

09.04.20130 - 2

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

Conclusion

If the “official” CPI had accurately reported inflation over the past 20 years, it is likely that wage rates today would be significantly higher, that wage earnings would command a larger percentage of GDI, that aggregate demand would be more robust because a larger share of income would be in the hands of those with higher marginal propensities to consume, and that GDP would be growing faster.

For those in Washington D.C. waiting for Mayor Gray to make a political decision about wages for Walmart (WMT) employees, and for those disgruntled fast-food workers who conducted strikes in 60 cities in late August, be careful who you blame. The federal government has the power to remedy the wage situation and the income gap simply by being forthright about the real rate of inflation.

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 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.

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.

July 30, 2013

Universal Value Advisors – The Sad Truth Behind the SAC Indictment

Posted in Economy, Uncategorized tagged , at 4:23 PM by Robert Barone

Anyone with money in Steven Cohen’s SAC Capital Advisors would be foolish to keep it there, even if they are sure the company will beat the Justice Department’s indictment.

That’s because those funds could become subject to a forfeiture action.

The issue here is the very use of the indictment, not the veracity of the allegations. The Justicee Department knows that the use of indictment process itself is likely to shut down the hedge fund company.

The allegations themselves are packed with emotion, with U.S. Attorney Preet Bharara accusing SAC of being “a veritable magnet of market cheaters.”

The Justice Department is charging SAC of hiring employees who had access to people who might possess inside information, or of paying incentives for trading ideas that turned out to be profitable, as if these activities, in and of themselves, were crimes.

One allegation, that the firm failed to use effective compliance procedures to prevent the use of inside information, may be valid, as there have been several confirmed insider trading incidents, and the firm has agreed to a substantial $616 million fine as a result.

But, doesn’t the fine settle the issue? Isn’t that what a settlement agreement is all about? Is there sufficient provocation to wield power which, when used, is almost certain to shut the company down without real due process”.

Let’s go back to the Enron accounting scandal. In 2002, the Justic Department indicted accounting firm Arthur Andersen for obstruction of justice and obtained a conviction because Arthur Andersen had destroyed Enron documents at the conclusion of its audit.

The indictment itself effectively put Andersen out of business, and 28,000 jobs were lost.

In 2005, however, in an unusual unanimous decision, the Supreme Court overturned the “obstruction” conviction, indicating that Andersen was operating within its document-retention policy and that it could not be concluded that obstruction had occurred just because documents had been destroyed.

Because the Justice Department recognized that its indictment process alone had unintended consequences, it has since used something called a “deferred prosecution agreement” which suspends an indictment as long as the company works diligently to comply with laws or regulations.

Why isn’t the deferred prosecution agreement being used in the SAC case, especially since there is no indictment of Mr. Cohen himself and settlements have been reached in the insider trading allegations?

Just as an exercise, let’s compare the regulatory record of SAC Capital to that of JPMorgan Chase (JPM) (JPM). In March, SAC agreed to pay a record $616 million to settle insider trading cases.

But, that amount pales in comparison to the $16 billion that JPMorgan Chase has paid in litigation expense over the three years ended Dec. 31 as documented by Matt Taibbi in Rolling Stone. He catalogs no fewer than 13 prosecutions and settlements with regulators plus a multitude of settlements in civil actions.

“There have been so many settlements with so many agencies around the world … that they’re almost impossible to count,” he wrote.

Yet, despite these ongoing regulatory issues at JPMorgan Chase, CEO Jamie Dimon is President Obama’s “favorite banker” and was seriously considered to succeed Tim Geithner as Treasury Secretary.

I am not a fan of SAC Capital or any of Wall Street’s too-big-to-fail institutions and have frequently expressed my displeasure with their greed and abuses.

Here’s the question I’m asking: Is the Justice Department using brute-force indictment power on SAC in order to quell criticism that it has handled Wall Street with kid gloves and that no CEO on Wall Street has been prosecuted, much less convicted, since the financial meltdown five years ago? (Lehman Brothers, Bear Stearns, Washington Mutual, Wachovia, Merrill Lynch, MF Global.) The answer to the question appears to be: yes.

After all, SAC is a big name Wall Street firm, but it only has 1,000 employees. Shuttering it is not likely to have major consequences (although it does account for 3% of Wall Street’s trading volume). Not so for JPMorgan Chase. With more than 260,000 employees, the direct use of the indictment power would have systemic implications.

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.

July 22, 2013

Muni Investors Beware: Detroit Is Tip of Iceberg

Posted in Bankruptcy, Economy, Uncategorized tagged , at 9:43 PM by Robert Barone

When Detroit filed for bankruptcy protection last week, no one was shocked. It felt like it was inevitable. Now one has to ask whether analyst Meredith Whitney was correct but just early in her call in late 2010 on municipal defaults?
For Detroit, the real culprits in the bankruptcy were skyrocketing pension and health care costs, even though mismanagement and reduced state and federal aid also played a role.

Those same issues are at the root of most of the fiscal challenges faced by state and local governments. As I write, there is controversy over the legality of Detroit’s bankruptcy filing because state law prohibits such a filing if it contemplates a reduction in pension benefits.

That said, there is no doubt that Detroit, with more than $18 billion of debt, cannot pay its creditors. Of that debt, the city owes $3.5 billion to its pension plans. The answers that Detroit will deliver to the marketplace regarding the distribution of its assets will be based on forthcoming judicial decisions that will determine which group of creditors skates and which ones get savaged. Detroit may well become the model for how the courts treat the creditors of future municipal bankruptcies. The credit markets are certain to take note, and there are certain to be reactions and price adjustments as a result.

Detroit may be just the beginning of the spate of municipal bankruptcies that Meredith Whitney forecast more than two and a half years ago. In the last month, studies have shown that municipal fiscal problems are much worse than previously believed. Actuarial estimates of unfunded liabilities have risen, not only because governments have failed to properly fund the plans under the old guidelines, but because the guidelines have changed.

A couple of years ago, Morningstar estimated the funding status of each state’s pension program. The 2011 results ranged from 43.4% (Illinois) to 99.8% (Wisconsin). That study showed that only 30% of state programs were at least 80% funded. But now, those estimates have all changed as, in late June, Moody’s introduced new measurement methodologies. Not surprisingly, Illinois was still at the bottom. What is significant is that Moody’s found that the median state must now devote 45% of its annual revenue just to fund and catch up with its existing pension obligations.

At the same time that Moody’s concluded that retirement costs have been vastly underreported, the Government Accounting Standards Board (GASB) was introducing new accounting rules for municipalities to increase transparency and reduce that underreporting. Significantly, last September, a report by the U.S. Senate’s Joint Economic Committee (JEC) estimated that underfunding to be as high as $3.5 trillion.

Artificially low interest rates have a lot to do with pension underfunding. If actual pension plan investment returns are lower than the actuarial return assumptions, there won’t be sufficient assets to pay the retirees. In July, Moody’s reduced the return assumptions for CALPERS from 7.5% to 5.5%, causing the funding status of CALPERS to fall from 82% to 64%.
As you can imagine, the new studies and reporting rules are playing havoc with the interest rates that municipalities must pay. Much of the recent rise in rates in the muni markets have been blamed on Federal Reserve Chairman Ben Bernanke’s “tapering” pronouncements, which had a huge impact on the Treasury yield curve. But there can be little doubt that much of the recent increase in Muni-Treasury spreads was the result of the Moody’s study and the new GASB rules.

Although a financial meltdown was avoided in 2009, the crisis clearly isn’t over. State and local budget issues are going to have a significant impact on economic policy going forward. Their recognition may even delay the start of the Fed’s “tapering” program.

Muni investors, be forewarned: There is volatility ahead in the marketplace. As it turns out, the much maligned pronouncements on the health of state and local government finances by Meredith Whitney in late 2010 were actually prescient. Even the JEC agrees with her conclusions, as they reported that “some state pension funds will run out of assets in as little as five years.”

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.

July 16, 2013

It’s a struggling world amid economic recovery

Posted in Economy, Inflation, Uncategorized tagged , at 5:33 PM by Robert Barone

Despite tax increases and sequestration, the U.S. economy managed to officially grow 1.8 percent in the first quarter and likely at a similar rate in the second.

Strangely, despite the lack of growth, the equity markets were up almost 16 percent in the U.S. in 2013’s first half. With the release of the June employment data, there is now no doubt that the job market is actually growing jobs, although questions remain as to the quality of those jobs (with part-time jobs growing and full-time jobs contracting).

While June’s official U3 unemployment rate held at 7.6 percent, the more comprehensive U6 measure (includes some discouraged workers and those holding part-time jobs but desiring full-time) rose from 13.8 percent to 14.3 percent, quite a large single-month jump.

Thus, four full years after the recession ended, the “recovery” in the U.S. remains fragile and uncertain. Nevertheless, it does not appear that a new recession is approaching.

Reality inflation

One reason for the fragility is the fact that household income has continued to lag real inflation.
According to Ed Butowsky, founder of Chapwood Investments, while household incomes have risen at a rate at or slightly above the “official” U.S. rate of inflation, the real cost of living rose at double-digit rates in nearly every one of America’s 50 largest cities.

Yet, despite the income challenges, somehow the American consumer has managed to find enough resources to step up purchases with both credit card debt and auto sales showing near-record increases in June.

Some say that consumer deleveraging has ended. In reality, it is the cost of servicing debt as a percentage of disposable income that is key, and this cost is at a modern-day low.

So, while the level of debt remains high, as long as rates are low the consumer can still comfortably service that debt. This is no different than the home purchase equation. A lower interest rate means that, for a given income level, the consumer can afford a more expensive home.

The world

When we look outside the U.S., we see two different camps with differing equity market results: those with activist central banks and those without.

It appears that, in 2013’s first half, the equity markets in the higher-growth areas of the world (China, Russia, Brazil) did poorly (China, -11 percent; Russia, -11 percent; Brazil, -18 percent) while the low-growth areas (Japan, Europe, U.S.) had positive performance (Japan, +32 percent; Switzerland, +15 percent; U.S., +14 percent).

This strange phenomenon can be explained by the money printing binge of the central banks in the U.S., Europe (including Switzerland) and Japan. The central banks in the rest of the developed world have not printed. Thus, the equity markets in areas with activist central banks are clearly responding to money printing while those in the rest of the world appear to be responding to fundamental economic growth.

Headwinds

Going forward, the headwinds for growth in the U.S. and the world are significant:

• Economic growth is consumer dependent (70 percent of GDP in the U.S.). Money printing cannot last forever and the Fed has already announced plans to “taper” its printing. As a result, we have seen interest rates spike up, and a growing economy means that interest rates will rise further.

This can’t be good for a consumer still struggling with job quality and income rising more slowly than the reality of inflation.

• Europe remains mired in recession with the debt and budget issues of the EU periphery (Portugal, Spain, Italy, Greece, Cyprus …) not yet resolved and in some cases, not yet addressed.

Central Banks in Europe and England recently reaffirmed easy money policies well into the future. But politically, no progress has been made on a banking union, a move that is quite critical to establishing financial stability for the euro.

• GDP growth rates in every part of the world have fallen since their initial bounce after the financial meltdown in 2010. This includes developed economies, developing economies and the BRICS (Brazil, Russia, India, China, South Africa) economies.

China’s officially projected 7.5 percent growth rate is now completely discredited. Marc Faber (The Gloom, Boom and Doom Report) recently opined on Bloomberg TV that China’s growth rate had fallen to 4 percent at a maximum. The prices of raw materials and shipping manifests back up the theory that a huge growth slowdown has occurred there.

• Besides the growth issue in China, a political crisis has erupted in Brazil, one of the BRICS’s stalwarts. The coup in Egypt, unrest in Turkey and the ongoing civil war in Syria all threaten tenuous Middle East stability, to say nothing of Iran’s ongoing nuclear program.

Conclusion

The headwinds worldwide are strong and significant. A growing U.S. domestic economy with the Fed stepping back from Quantitative Easing implies rising interest rates which, given the state of consumer finances, could prevent the economy from attaining “escape velocity” and keep it growing at subpar levels.

Furthermore, attaining that “escape velocity” has become more difficult with inflation reality much higher than official inflation figures and slower worldwide growth.

One obvious conclusion: The world’s political and economic systems appear as unstable as at anytime in the past 25 years. I don’t know what will cause the next crisis or when it might occur, but I do know that now is not the time to take a lot of risk.

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. Read the rest of this entry »

July 1, 2013

Market proof: Hooked on the liquidity drug

Posted in Economy, Uncategorized tagged , , at 10:44 PM by Robert Barone

The reactions of the stock and bond markets to the mere mention of a slower rate of money printing shows how those markets have become hooked on such injections.
The consequences of the first baby-step change of policy toward something more normal evoked violent market reactions not only in the U.S. but worldwide.
Those reactions may quash the nascent private sector recovery, will certainly risk short-term negative effects of a stronger dollar on imports and exports, will likely have negative consequences on housing values and sales, and will exacerbate the long-term issues of the size and cost of the debt.
While the Fed didn’t actually take any steps at all with regard to a reduction in money printing, the markets reacted just to the fact that they were thinking about such action.
The wealth effect
The “wealth effect” has been studied for decades with the universal conclusion that its overall economic impact is marginal, i.e., the wealthy simply have a low marginal propensity to consume.
The benefit of higher stock prices (the rich get richer) appears to be the only benefit of the massive quantitative easing programs. As documented by two revered market pundits, Rosenberg and Gundlach, QE has a near-90 percent correlation with the equity markets.
In recent weeks, we saw the violent reactions in both equity and fixed-income markets to the mere concept of “tapering,” which is not tightening, but simply less easing (a change in the second derivative). Clearly, just the thought of lesser ease has begun to reverse the small success that massive QE has had. Since May 22, when Federal Reserve Chairman Ben Bernanke announced that the Fed was thinking about “tapering,” the S&P 500 fell nearly 6 percent as of June 24 and daily volatility spiked, a sign of high uncertainty.

Housing

One bright spot in the U.S. has been a recovery in home prices. While suspect because of a lack of first-time buyers, the run-up of 71 basis points, or .71 percentage points, in the 30-year fixed mortgage rate is sure to have an impact on home values.
Those who could afford the $1,144 monthly payment for a $250,000 home in May can now only offer $229,000 for the same property to maintain the same payment. That’s an 8.4 percent reduction in affordability and is sure to negatively impact the sector.

Deflation

Deflation is a worldwide issue even among emerging industrial powers like the BRICS. China’s economy, which has been the world’s economic growth engine for the past half-decade, appears to be slowing significantly despite its official purported 7.5 percent growth rate.
The government’s attempt to control real estate speculation has resulted in a credit crunch in the banking system which is likely to have a negative impact on China’s lending growth.
Marc Faber, author of the “Gloom, Boom and Doom Report” newsletter, opined on Bloomberg TV on June 21 that China’s growth rate was, at a maximum, 4 percent. That is just a little more than half of official estimates and, if true, is a shock to the world’s economy.
The underlying data tell the story, including depressed raw commodity prices, excess high seas shipping capacity, the value of the currencies of commodity producing countries like Australia and a falloff in exports from lower-cost producers like South Korea. The Asian equity exchanges have been pounded hard this year, a sign that economies in that part of the world are struggling.

Debt costs

The rising cost of U.S. debt, much of which is financed by foreigners, makes even a small move toward normal monetary policy highly risky for U.S. fiscal policy.

The U.S. public is unaware that the true deficit, using Generally Accepted Accounting Principles, which all of corporate America is required to use, has exceeded $5 trillion for the past five years.
Instead, the $1 trillion cash flow budget deficit is viewed as the issue. Nevertheless, as time passes the already built-in additional $4 trillion per year of promises will become current obligations.
I have seen several estimates of the cost of that future debt in rising interest rate scenarios. None is pretty. The most recent from Jeffrey Gundlach of Doubleline estimated the cost of the debt and deficit at $2.5 trillion by 2017 if the 10-year rate were to rise gradually from a 2.1 percent level (the level when he calculated the estimate) to 6.0 percent. As of this writing, the 10-year rate is near 2.6 percent.
By then, Gundlach says, the debt itself will be $26 trillion. Such deficits and debt levels risk not only inflation, but the dollar’s role as the world’s reserve currency.

Conclusion

The consequences of rising U.S. interest rates could be dire.
Within the U.S., home values are likely to stop rising and could easily begin falling again. Stock prices have become more volatile and bond prices have been hard hit. The rise in consumer confidence, largely due to home and stock values, could reverse, impacting consumer spending and employment. Rising interest rates in the U.S. will exacerbate worldwide deflation and could have dire consequences for U.S. fiscal policy.
The size and rapidity of the rate rise was probably a surprise to the Fed. I suspect that if the summer’s economic data shows softness in the economy, the Fed will jawbone rates to lower levels.
Nonetheless, this episode has revealed the truly difficult road ahead for the Fed, as one of the unintended consequences of the Fed’s massive experiment in money printing is the equity market’s addiction to 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.

June 20, 2013

Domestic and Foreign Events Are Tying the Fed’s Hands

Posted in Federal Reserve, Finance, Uncategorized tagged , , at 10:29 PM by Robert Barone

NEW YORK (TheStreet) — Despite apparent emerging strength in the U.S. economy, the Fed is faced with serious consequences, if it moves toward a reduction of policy ease. Those consequences include:

           • A potential violent market reaction;
           • the quashing of the nascent private sector animal spirits;
           • the short-term negative consequences of a stronger dollar on imports and exports; and
           • the long-term issues of the size and cost of the debt.

The Wealth Effect

The “wealth effect” has been studied for decades with the universal conclusion that its overall economic impact is marginal; i.e., the wealthy simply have a low marginal propensity to consume. Yet, this appears to be the only benefit of the massive QE programs, which — as documented by two revered market pundits, David Rosenberg and Jeffrey Gundlach — has a nearly 90% correlation with the equity markets.

In recent weeks, we saw the violent reactions in both equity and fixed-income markets to the mere concept of “tapering,” which is not tightening, but simply less easing (a change in the 2nd derivative). Clearly, a move to lessen ease risks the small success that massive QE has had to date.

Deflation

Deflation is a worldwide issue, even among emerging industrial powers like the BRICS. China’s economy, which has been the world’s economic growth engine for the past half decade, appears to be slowing significantly, despite its official purported 7.5% growth rate. The underlying data tell the story, including depressed raw commodity prices, excess high seas shipping capacity, the value of the currencies of commodity-producing countries like Australia, and a falloff in exports from lower-cost producers like South Korea.

Except for Japan, in April, the IMF significantly lowered its growth forecasts for every industrial economy. Thus, any tightening move by the Fed would only exacerbate worldwide deflationary pressures.

Debt Costs

The high and rising cost of U.S. debt, much of which is financed by foreigners, makes abandonment of easy money highly risky for U.S. fiscal policy. The U.S. public is unaware that the true GAAP deficit has exceeded $5 trillion for the past five years. Instead, the $1 trillion cash-flow budget deficit is viewed as the issue. Nevertheless, as time passes, the already built-in additional $4 trillion per year of promises will become current obligations.

I have seen several estimates of the cost of that future debt in rising-interest-rate scenarios. None are pretty. The most recent from Jeffrey Gundlach of Doubleline estimated the cost of the debt and deficit at $2.5 trillion by 2017, if the 10-year rate were to rise gradually from its current 2.1% level to 6.0%. By then, Gundlach says, the debt itself will be $26 trillion. Such deficits and debt levels risk not only inflation, but the dollar’s role as the world’s reserve currency.

Conclusion

The consequences of rising U.S. interest rates are dire. They would exacerbate worldwide deflation, play havoc with the nascent U.S.economic recovery, reverse the limited positive impact of the wealth effect via U.S. equity markets and have dire consequences for the dollar and U.S. fiscal policy. Rising rates will inevitably occur, but don’t count on them anytime soon. 

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. 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 Company where he chairs the Investment Committee.

Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521.

Ph: (775) 284-7778.

June 19, 2013

Taking in those ‘ah-ha’ moments, then and now

Posted in Economy, Uncategorized tagged , , at 9:01 PM by Robert Barone

Everyone has “ah-ha” moments, when something that was murky in one’s mind becomes crystal clear. It could be about a relationship or a career changing event. When such moments occur, things are never the same.
 
Recent ‘ah-ha’ moments
 
In the first few years of this century, when home prices were rapidly rising, few recognized that the trend couldn’t last unless either incomes kept up with prices or interest rates continued to fall. From 2000 to 2006, while incomes rose 2 percent, home prices rose 100 percent. Lesson learned?
 
From July ’82 to August, ’00, the S&P 500 rose 1,400 percent while GDP, a proxy for economic output, rose 305 percent. Of course, the “ah-ha” moment came in 2000, when the stock market began giving back nearly half of its value over the next two years. A similar scenario was repeated from the 2002 lows to the 2007 highs. Lesson relearned?
 
From these experiences, it would be rational to conclude that rapid growth in the nominal value of assets that is not matched by a similar expansion in the economic fundamentals is simply not sustainable. It is called a “bubble.” Given the popping of several such bubbles since the turn of the century, it should be logical to conclude that we have learned to recognize such phenomena.
 
Recognizing current bubbles
 
In the first quarter of 2013, real disposable personal income continued its long-term decline, a trend that began in the ’70s and accelerated around the financial meltdown and housing bubble pop of the Great Recession.
 
According to official government data, real average weekly earnings (using the CPI as the deflator) have fallen 18 percent since their peak in the early ’70s. Yet, despite the fact that the consumer, representing 70 percent of the economy, is still struggling, the S&P 500 rose 10 percent in the first quarter, and through the end of May is up 14 percent for the year. (Ah-ha!)
 
It is clear that the stock market is being driven by the Fed’s quantitative easing (QE) policies. The Fed has injected liquidity by buying huge quantities of treasury and mortgage backed securities, and, so far, that liquidity has simply chased stock prices. Is it any wonder that the stock market falls when there is any indication that QE will be scaled back?
 
QE’s unintended consequences
 
The consequences of QE are much deeper than a correction, even a significant correction, in equity prices. The following is Milton Friedman’s famous tautology (meaning it is always true by definition).
 
MV=PQ
 
This says that the money supply (M) times its velocity (V) (the number of times money changes hands) must equal the number of physical goods bought that year (Q) times the average price paid for those goods (P). It stands to reason that if M*V grows faster than Q, then P must rise.
 
Since the recession and the beginning of QE, the Fed nearly has quadrupled the size of its balance sheet (from $848 billion in August 2008 to $3.0 trillion in April, and growing at $85 billion per month). The Fed’s balance sheet translates directly into bank reserves, and when banks have excess reserves, they can loan those reserves out.
 
Of course, when they do, the money supply grows. There is growing evidence today that consumer deleveraging has ended. Bank loans and commercial paper outstanding are up significantly, as is credit card debt. At the same time, state and local governments spending is once again increasing (just look at the budget recently passed in the Nevada Legislature). During the past year, the monetary base (currency + excess bank reserves) has risen by 18 percent. And, more importantly, M1 (currency + checking account balances) is up 12 percent.
 
Are we approaching another ‘ah-ha’ moment?
 
Bernanke himself knows that inflation appears with long and variable lags. He and co-authors published a paper in 1999 that concluded there are long and variable lags between inflation-causing policies and the inflation itself.
Q is growing at less than 2 percent; M is growing at a double-digit rate. Consumer deleveraging is ending and state and local government spending is rising. This means that velocity (V) has stopped falling. Despite the current consensus among economists and market participants who say inflation is nonexistent, when M*V rises faster than Q, P has to rise! (Ah-ha!)
 
The Fed is targeting inflation and the unemployment rate, both lagging economic indicators. By the time inflation shows up in these laggards, it will be well ingrained.
Worse, Bernanke, Yellen and other Fed governors have embraced the belief that some inflation (2 percent-plus) is desirable even after fighting it for years. I fear the Fed will actually praise the early onset of inflation, which will limit any negative reaction to it by both the Fed and the market.
 
As we learned in the ’70s and ’80s, once inflation becomes ingrained, it is awfully difficult to shake (three years of double-digit interest rates), especially in an economy with growth problems. Inflation destroys the value of your investments. The cost of protection today is cheap.

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.

 

 

 

June 4, 2013

The age-old challenge: Buy low or sell high?

Posted in Economy, Finance, Uncategorized tagged , , at 7:00 PM by Robert Barone

Buy low; sell high. Sounds simple, but easier said than done.
 
Because of “fear,” when assets are “on sale,” few investors buy, thinking that asset prices can still go lower. It is a fact that only a handful of investors actually buy at the low or sell at the high. The odds of you being one of them are quite remote.
 
In the end, one has to have confidence in one’s view of the future to sell when you think the assets are overpriced and to buy when they appear underpriced.
 
Given the rise in equity prices we’ve seen since last November, you might conclude that this column is about selling at the highs. But, it is actually about the other pole — buying at the lows.
 
To set the stage, I need to discuss the two major views of the macroeconomic landscape that exist today among major market players.
 
Two views of the economy
 
View 1: Underlying economic factors are getting stronger, and soon we willsee much-improved economic growth. Pundits here point to a housing market that appears to be healing (prices are once again rising), to a consumer confident enough to continue to consume despite increasing taxes, to record-setting corporate
profits and to a stronger employment market.
 
• View 2: The basic economy is weak and is being propped up by money printing. The
Fed has targeted the equity markets, hoping the “wealth effect,” via rising equity prices, will translate into increased consumption and economic growth.
 
The Fed is committed to the money-printing policy untilsignificant economic growth occurs. Pundits here point to a housing market dependent on historically low interest rates, a consumer not capable of borrowing, record-low capital expenditures on the part of businesses which have and hold a record amounts of cash, and a continuing fall in real income.
 
Europe is in an intense recession, and China’s economy markedly has slowed. In addition, the job creation numbers, they say, are misleading. Of the 293,000 jobs created in April, 278,000 were part time and 309,000 were from self-employment. That means that full-time payroll employment fell by 294,000.
 
Those who hold view 1 believe that the stock market will go higher yet. View 2 holders believe that the equity market is overvalued and, as soon as there is a signalfrom the
Fed that the money printing willslow, that market will correct.
 
The role of monetary policy
 
One thing is for sure:If we don’t get robust economic growth, both in the U.S. and on a globalscale, we are going to see a continuation of the money-printing policies by all of the major central banks CentralBank, Bank of England, Bank ofJapan), at least until “recognized” inflation becomes an issue.
 
The policymakers at those central banks have told us so. Both our Fed and the Bank ofJapan have set inflation targets. And, while the targets appear low (2.0 percent in the U.S. and 2.5 percent in Japan), we all know from common everyday experience (and from private sector studies) that the realrate of inflation is much higher than officially recognized.
 
Monetary policy, by the way, operates with a long and variable lag as we were taught during the inflation experience of the late 1970s and early 1980s. So, by the time an inflation is officially recognized, it is wellestablished and quite hard to quell.
 
We should also acknowledge that we have never had monetary policy conducted with such experimental tools and don’t yet know the unintended consequences.
 
Finally, the independence of the central banks from their respective governments is now questionable, especially since the Abe government in Japan browbeat that central bank into submission to its money-printing views.
 
Is anything low?
 
Remember buy low? Because of the slow growth worldwide, all of the equity prices of naturalresource and commodity stocks and of the commodities themselves are at or near cyclical lows. Copper, coal and agricultural commodities are good examples in the raw commodity space, while in the equity area we have cyclical lows in mining stocks and iron and steelstocks. Oil and natural gas, on the other hand, both are at lows because ofslack demand and because of the large new supplies coming online in the U.S.
 
Under either view 1 or view 2, these look attractive. Can their prices go lower? Of course. In all my years of trading, I think I bought at the printed low only a handful of times.
 
If view 1 turns out to be correct, demand for basic materials and commodities willrise along with their prices.
 
Under view 2, either we will get economic growth or inflation.
If we end up with the latter, commodities and basic materials act as inflation protection hedges.
 
The mention ofsecurities/commodities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals.
 
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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