January 16, 2013

Headwinds Will Keep Interest Rates Low

Posted in Economy, Taxpayer Relief Act, Uncategorized tagged , , , , at 5:46 PM by Robert Barone

On Jan. 2 when President Barack Obama signed the American Taxpayer Relief Act of 2012, there was no pomp and circumstance that has been characteristic of this administration.

That seemed strange given the fact that the president got much of what he wanted in the so-called “fiscal cliff” bill. I expected to see several “middle-class” families at the signing ceremony, applauding the president for saving them from significant tax increases.

But they were strangely absent and with good reason. Like much of what comes out of Washington, the title of the legislation is 180 degrees opposed to what the legislation actually accomplishes, for this was not a taxpayer relief act! After two years of campaigning to tax only the “rich” and protect the middle class, there was no pomp and circumstance because the middle class got the shaft.

$125 billion






1040 Taxes

2012 (4.2%) Payroll Taxes

2012 Total Taxes

2012 Eff

Tax Rate





























1040 Taxes

2013 (6.2%) Payroll Taxes

2013 Total Taxes

2013 Eff

Tax Rate

Tax Increase

Tax Pct Change

























The table packaged with this column shows an estimate of the 2012 and 2013 taxes on Americans of modest means (middle class). These are wage earners married, filing jointly and making $48,000, $60,000 and $72,000 with adjusted gross income on their 1040 forms of $40,000, $50,000 and $60,000, respectively.

As you can see, taxes for 2013 have increased by 2 percentage points for the same income and AGI levels for the middle class (see the 2012 and 2013 Effective Tax Rate columns).

The amount of tax increase on a family making $48,000 with an AGI of $40,000 is nearly $1,000. For these middle-class folks, taxes have risen by 13 percent for a total reduction in disposable income of $125 billion, according to Michael Feroli, a JPMorganChase economist. Ouch! Such tax increases are sure to have an impact on consumption and economic growth.

Spending negotiations

While Congress and Obama reached a last-minute deal on taxes, the spending and debt ceiling issues remain unresolved. We can assume with a relatively high level of confidence that in the upcoming round of caustic negotiations, there will be some cuts to spending, even if they are out on the horizon.

But, for sure, immediate spending won’t be going up, and there likely will be cuts to programs for state and local governments. Such spending control, or even a semblance of it, will put downward pressure on economic growth. Generally, when growth is slow (and when the Fed is pushing easy money), interest rates remain low or are falling.

Housing headwind

Investors today are being told to stay away from fixed-income investments because interest rates are sure to rise. Given that rates are at historic lows, that statement undoubtedly is true. The question is, “When will they rise?”

Recognize that, besides the issues I have outlined, rising rates will create yet another headwind in the housing finance market.

Mark Hanson is a mortgage market specialist in the Bay Area. He recently said that “there is absolutely no doubt that the unprecedented 5.25 percent midyear 2011 to 3.5 percent midyear 2012 Fed-induced plunge in mortgage rates had a positive impact on refi volume, consumer cash-flow (emphasis added), home sales …”

Anything, he said, that reduces refi volume will have a large impact on consumer cash-flow. “If rates remain flat at 3.5 percent, refi burnout will take fundings down 33 percent … If 30-year rates hit 4 percent, at least half of all refis … will evaporate literally overnight.” That will significantly impact disposable income growth.

The Fed

During the first week of the year, the minutes of the Dec. 12 Federal Open Market Committee (i.e., Fed minutes) were released showing a dispersion of opinion among the FOMC members:

“Several others thought that it would probably be appropriate to slow or stop purchases (of securities for the Fed’s portfolio) well before the end of 2013 citing concerns about financial stability or the size of the balance sheet.”

The investment community became concerned and as a result, yields on 10-year Treasury securities rose from 1.7 percent to over 1.9 percent, and this has led to the concerns over fixed-income investments expressed above.

David Rosenberg, a noted Wall Street economist, examined all the past FOMC minutes since the economic crisis and found similar language in the FOMC minutes of April 15; April 27, 2011; March 15, 2011; Nov. 3, 2010; and April 28, 2010. Each time the market reacted initially by pushing rates up proved to be a buying opportunity for fixed-income investors.


In the face of a significant rise in taxes for America’s wage earners, downward pressure on government spending and the hit to housing finance that rising rates would bring, it looks doubtful that interest rates can rise significantly anytime soon.

The Dec. 12 minutes didn’t contain any new information; we have seen it all before. So, fixed income investors should take heart; rates don’t look like they can rise significantly from here in the near term..

Taxes on American income levels

This table shows an estimate of the 2012 and 2013 taxes on Americans who are married, filing jointly and making $48,000, $60,000 and $72,000 with adjusted gross income on their 1040 forms of $40,000, $50,000 and $60,000, respectively.

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 31, 2012

Barone: 2013: Forecasts for the unsettled road ahead

Posted in Economy, Markets, taxes, Uncategorized tagged , , , at 7:59 PM by Robert Barone

Forecast 1: Slow economic growth in 2013’s first half; second half could be better.

Whether we go over the “fiscal cliff” or not, the first part of 2013 will be quite slow with the possibility that even the “official” numbers could show up as negative. At this writing, it does not appear that the Washington politicians will reach any sort of meaningful deal by year’s end. But, even if they do:

• Economic confidence already has plummeted.

• There are significant 2013 tax increases in Obamacare and a return to normalcy in the employee portion of the Social Security tax; furthermore, the end of extended unemployment benefits is a significant hit to consumer income.

• The job market remains weak; much of it due to a skills mismatch, which is a very long-term structural issue.

• Consumers’ real incomes continue to fall.

The second half of the year might be a different story. If some fiscal certainty is delivered in January, U.S. business investment spending, currently at a six-decade low, easily could pick up and spur the economy above the 1 to 2 percent growth rates we have seen in recent years.

Forecast 2: Nevada’s housing market will continue to struggle.

The housing market in Nevada appears to have been a bright spot for 2012. Realtors indicate that the rise in the median price is due to a shortage of supply, not an increase in demand. Nevada’s AB284, effective in October 2011, all but halted foreclosures. There remains a dearth of first-time and move-up homebuyers. I suspect this scenario will change in 2013 as the Legislature, prodded by the powerful banking lobby, deals with the technical issues in AB284 that now make it difficult and dangerous for mortgage holders to foreclose. That means more supply in 2013’s second half, and, perhaps, a plateau in home prices.

Forecast 3: Europe will sink further in 2013.

The markets are thrilled that Europe is uniting to save its insolvent banking system. While the immediate crisis has been averted through the injection of liquidity, the insolvency issues remain. The chosen path for Europe is to inflate its way out.

In 2013, the European Union will continue to be ensnared in a significant recession (depression in Greece, Spain and Portugal). France, considered to be part of the strong northern European core, also will enter recession in 2013. Even the mighty Germans will be hard-pressed to show more than a flatline.

Forecast: We have not yet seen the last of the European Union implosion. It has just been placed on the back burner with the European Central Bank’s adoption of Bernanke-style money printing policies.

Forecast 4: The Chinese miracle will continue in 2013.

China avoided a “hard landing” in 2012. The reason: A one-party political system doesn’t end up in policy gridlock. There is hot debate as to the sustainability of the current Chinese turnaround, but one thing is for sure: Economic policies, be they right or wrong, are carried out quickly and the economic impacts are felt with minimal time lags.

Forecast 5: The currency race to the bottom will intensify in 2013.

All of the world’s major central banks (the Fed, Bank of Japan, ECB and Bank of England) are printing money at breakneck speed.

The Fed is printing at least $85 billion per month, which, at least temporarily, allows the Washington politicians to shirk their fiscal responsibilities. After all, even if foreign demand for U.S. treasuries (i.e., Japan and China) dries up, the Fed will purchase any new debt due to the tax and spending imbalance.

The same scenario is true in Japan where the newly elected Prime Minister Shinzo Abe has successfully attacked the independence of the Bank of Japan, which now appears willing to print enough to cover the fiscal deficits on which Abe campaigned. Ditto for the U.K.

All of this money printing is really a form of mercantilism, i.e., policies aimed at producing a positive trade balance, resulting in higher factory output and employment levels at home. China is the world’s role model in this regard.

I call this the “race to the bottom,” because when every country does this, as is the current situation, not only is it a zero-sum game (i.e., no one wins), but there are significant unintended consequences. We see this throughout the world with zero interest rate policies penalizing seniors and savers.

Forecast 6: Precious metal, art and gem nominal prices will rise in 2013.

After 10 years of strong gains, the prices of precious metals recently have seen downward pressure due, in part, to profit taking ahead of inevitable capital gains tax increases in the U.S. in 2013. There also is a rumor of significant liquidations in a large hedge fund (Paulson), which has heavy gold investments.

Nevertheless, the underlying demand for precious metals, art, gems and other hard assets is strong, especially in the face of the “race to the bottom.” My forecast is for the nominal prices of these assets to continue their upward trajectory as every country in the industrialized world has chosen inflation over fiscal austerity.

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.

October 16, 2012

Why Jack Welch Has A Point About Unemployment Numbers

Posted in Economy, recession, Uncategorized, Unemployment tagged , , at 9:54 PM by Robert Barone

When the September employment data were released by the Bureau of Labor Statistics (BLS), depending on political persuasion, the news was either excellent or it was a sham. We saw reactions like those former General Electric CEO Jack Welch, who tweeted a suggestion of manipulation. On the other hand, the Obama administration has made political hay with the rapid fall in the unemployment rate in August and September.

Every month the BLS takes two surveys relative to employment, the Household Survey (officially titled The Current Population Survey), and the Establishment Survey (The Current Employment Statistics Survey). Both surveys have acknowledged flaws and both have a significant bias that pushes the number of jobs upward and the unemployment rate lower. To correctly interpret the data, one must understand how the statistics are calculated, how the biases are imparted, and the magnitude of those biases.

The Household Survey is used to calculate the various employment and unemployment indexes and rates. There are several of these indexes. Most of the public only hears about one of them, the one the BLS refers to as U-3 (7.80% seasonally adjusted (SA) for September). The public may be vaguely aware of one other one, the U-6. The numbers are produced from a monthly survey of 60,000 households. Here are some of the flaws:

•Because the sample of households is small relative to the total number of households, the series is notoriously volatile. In August, for example, the raw data (Not Seasonally Adjusted (NSA)) showed the number of jobs fell by 568,000. In September, that same number showed an increase of 775,000 jobs (NSA). The BLS reported this as 873,000 SA which is the number that the media got all excited about. Using the NSA data, over the two months, 207,000 jobs were created, or 103,500 per month on average. This leads to a very different conclusion from a single 873,000 data point.

•In 1994, the BLS changed the way in which it counts “discouraged” workers for the U-3 index. If one is unemployed for more than 52 weeks, even if one continues to look for employment, one is dropped from the labor force. A smaller denominator with the same number employed leads to a higher employment rate and a lower unemployment rate. Ask yourself how much sense this makes in today’s world where the average unemployment duration is 40 weeks and there have been several years where unemployment benefits last for 99 weeks.

•The definition of employment is biased. If one worked part-time in the last 30 days, even baby sitting for a few hours one time, one is counted as employed. There is no weighting for part-time work in the U-3 index.

•The biggest issue with the Household Survey is the seasonal adjustment (SA) process itself. Theoretically, for the year as a whole, the changes in employment by month should add up to the same number, i.e., the monthly SA and NSA changes should each add up to the same amount. And, theoretically, the SA should be calculated once at the beginning of the year. But, for the last few years, the BLS has adopted what they call a “Concurrent” SA process in which they recalculate the seasonal factors every month. The practical result of this method is that every month, all of the 12 seasonal factors change, which means that all of the year to date monthly SA data also changes. As a result, by December, the January number has changed 11 times, the February number 10 times, the March number 9 times, etc. Here’s the rub. The BLS will not publish the changed monthly data on the grounds that they don’t want to “confuse” the data users. Because they do this, the monthly change in the unemployment rate is not meaningful because the number it is being compared to has changed, but the BLS won’t tell us what it has changed to. The September 7.8% SA unemployment rate (U-3) as reported in early October is being compared to August’s 8.1% SA rate (reported in early September) despite the fact that August’s unemployment rate has likely changed due to the calculation of new seasonal factors. The BLS knows what the changed August number is, but they won’t publish it until January, 2013.

All in all, the U-3 unemployment number is deeply flawed and should not be relied on as the business media and even the capital markets do. A better (though still flawed) indicator of labor market conditions is the U-6 measure. For both August and September, U-6 showed an unemployment rate of 14.7%. Unlike U-3, U-6 adds back to both the labor force and to the unemployed “discouraged’ and “marginally attached” workers, i.e., those who have stopped looking for work but still want a job, and accounts for part-time workers who want full time employment. The flaw is that U-6 removes the long-term discouraged worker after 52 weeks of unemployment. Nevertheless, it is still a much better indicator than U-3. John Williams estimates that if U-6 counted the long-term discouraged workers, the unemployment rate would be 22.8%.

The Establishment Survey collects data from more than 141,000 businesses and government agencies. The sample is about one-third of all nonfarm payroll employees in the U.S., and, as such, it is much less volatile than the Household Survey. Normally, the business media concentrates on this survey. This survey suffers from the same seasonal adjustment issues as the Household Survey except that BLS reports the current number (141,000 SA for September) and the revised data from the immediate past two months. It does not report the changes from earlier months, so it is possible that jobs reported in the current month were “borrowed” from earlier months, which aren’t reported until the next January. In fact, Mr. Williams contends that this is precisely what happens in the second half of each year.

Besides the transparency issue in the SA process (which can lead some to the manipulation conclusion) which the BLS could easily remedy simply by publishing the changed data on a monthly basis, the Establishment Survey suffers from a significant upward bias, known as the Birth-Death model. In the 80s, the BLS was constantly embarrassed that it was under reporting the number of jobs in the Establishment Survey by approximately 50,000 jobs per month. That occurred because more small businesses were being established than were being closed. And, one could probably argue that this was also true in the 90s during the tech boom. As a result, BLS adds approximately 50,000 jobs per month to the Establishment Survey report. That seems inappropriate in today’s world.

From all of this, it is clear that the U-6 measure is a lot more reliable than the U-3, the one that is most widely reported. In addition, when dealing with the Establishment Survey, be wary of the 50,000 jobs bias.

When I began work on this paper in early October, I was skeptical that there could be actual manipulation of the data. Mr. Williams has documented at least three cases of manipulation which he says have been confirmed by employees or former employees going all the way back to the 1960s. That is not a lot. Yet, one must worry about the lack of transparency in BLS’s reporting. After all, for the years 2010 and 2011 for which we have final numbers released in January of the following year, there were much lower levels of job creation than originally reported. Unfortunately, the media pays no attention to such revisions, and the bias goes unnoticed.

In an October 9 Wall Street Journal op-ed, Jack Welch defended his tweet, indicating that the economy would need to be growing at breakneck speed for unemployment to drop from 8.3% to 7.8% over two months. While this is quite different from the “manipulation” charge, it does make sense. The fact is, almost all other underlying data point to weaker, not stronger jobs numbers. New part-time jobs dominated the Household Survey data in September. Goods producing jobs actually fell. The National Federation of Independent Businesses index of employment softened in September as did Monster’s employment index. All of this seems to be in direct conflict with a SA increase of 873,000 jobs in September (Household Survey), the largest increase since 1983. The data also show that in August and September, governments added 602,000 new employees. Anyone following state and local government finances knows that number has to be far from accurate.

While there is no direct proof of manipulation, there are a lot of sound reasons, based on flawed methodologies, and based on nearly every other underlying employment data series, not to trust the headline making unemployment data.

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.