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.
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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.

June 6, 2012

Analysis: Little to like about last week’s employment data

Posted in Banking, Big Banks, Economic Growth, Economy, Europe, Housing Market, recession, Unemployment tagged , , , , , , , , , , , , , , , , at 5:31 PM by Robert Barone

Worse yet, the March and April Establishment Survey reports were revised downward by 49,000, not an insignificant revision. So, employment has been much weaker than originally indicated for the past three months. Further, we’ve recently seen an upward pop in the weekly first-time applications for unemployment insurance.
 
The more comprehensive unemployment rate (U-6, which is the broadest measure of labor-market slack) rose to 14.8%, from 14.5%. We are seeing employers substituting part-time workers for full-time workers — again, a negative indicator.
 
Average weekly earnings fell 0.2% in May because of fewer hours worked, on average. This indicator has fallen in two of the past three months and is a harbinger of what we are likely to see in second-quarter consumption spending.
 
Construction employment, while up slightly in the actual number count, was negative when seasonal adjustment is applied. May normally shows positive hiring in the industry, but this May, hiring was significantly below expectations, thus the negative seasonally adjusted number. I suspect this is because of housing markets still struggling with falling prices and excess inventory (Nevada, Arizona, Florida and parts of California). Additionally, we have recently seen a fall in the number of building permits.
 
Downward revision to first-quarter gross domestic product, to 1.9%, from 2.2%, was mainly because of a weaker consumer. Given this poor employment report, second-quarter real GDP might barely be positive in the official reporting.
 
I have written about downward bias flaws in the reporting of official inflation indexes. That means real inflation is higher than what is reported. Those who buy gasoline and food already know this. The implication is that official real GDP numbers are biased upward. Think about that! If inflation is only 2% higher than that officially reported, then the recession that “officially” ended three years ago might be ongoing.
 
None of the above speaks to the potential future shock that might hit the U.S. economy from the fallout of the European banking and debt crisis and the deep recession unfolding there. Any contagion from Europe will only compound the issues identified above.
 
The only silver lining is that weakening demand so evident in the reports has pushed oil prices down precipitously. Thus, we can expect some relief at the pumps this summer. Otherwise, the report was abysmal.
 
 
Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives
of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.
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.
 
Universal Value Advisors, LLC is a registered investment adviser with the Securities and
Exchange Commission of the United States. A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, an SEC 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.

September 1, 2009

The Inflation/Deflation Debate – a Reconciliation

Posted in Banking, Finance, investments, Uncategorized tagged , , , , , , , , , , , , , , , , , at 4:23 PM by Robert Barone

The Treasury is on a wild spending spree with the Fed creating the money that can’t be placed at a targeted low interest rate.  Consequently, the Fed has more than doubled the monetary base in the past year.

Economists trained as monetarists are wringing their hands over the coming wave of inflation due to the excessive money creation.  After all, M*V = GDP (i.e., Money * Velocity), and since M has doubled, it is inevitable that prices have to rise (assuming that V doesn’t fall by half).  In normal times, of course, such actions would be immediately inflationary.  But, as I’ve seen so many commentators say, “these aren’t normal times”.

Let’s approach this from the demand side of things.  When jobs are being lost, aggregate income is falling.  When credit is tight and asset prices are falling, folks can no longer “supplement” their income by borrowing.  When folks are overleveraged, “disposable” income is “saved” to repay debt rather than spent on consumption.  The spending spree in D.C. will eventually have to be paid for by higher taxation which will put a further crimp on consumption.  So, on the demand side in the domestic economy, it appears that there are very powerful deflationary forces at work.

So, why the concern about inflation? The simple answer is that it comes about due to the excessive spending and debt creation in Washington, D.C., which is destroying the dollar’s value in the world.  Inflation will occur, not from the typical demand-pull of the consumer, but from the rising dollar cost of non-labor inputs into the production process.

As the dollar depreciates due to uncontrolled debt creation, then the dollar cost of natural resources and commodities demanded elsewhere in the world are certain to rise.  This includes the cost of goods manufactured outside the U.S., as dollars buy less.  At the same time, the downward pressure on American wages and incomes will continue as American jobs continue to erode.

It is important to distinguish what kind of inflation we will have.  It won’t be the “asset” inflation that we have had over the last decade (real estate and paper assets).  But it will show up as rising costs of commodities, natural resources, and energy.  On the other hand, since consumption will be on a flat to mild growth path, the profit margins of manufacturers selling in the U.S. will be squeezed as raw input costs rise but consumers balk at paying retail prices and retailers have to resort to large discounting to move inventory.  We have seen profits come in better than expected in the second quarter, almost exclusively due to cost cutting.  That’s usually good for one quarter.  So, consumer weakness along with rising raw input costs will impact the profit margins of domestic U.S. businesses.  We all know what that means for the prices of those stocks!

One must also realize that the coming inflation will not raise the value of other existing assets.  Real estate immediately comes to mind, both housing and commercial.  We have seen some stabilization in the prices of low to moderate homes, but there is little expectation that there will be any significant rise in prices anytime soon.  It also appears that high priced homes still have more downward price pressures to weather.  In the commercial sector, with the health of small business in question, rents will continue their downward trend thus pushing commercial real estate values lower.  I see no end in sight for these trends.

In the end, you can think of the inflation/deflation picture this way:  there will be inflation in the things we need/want to buy (based on rising input prices and a devalued dollar), but continuing deflation in the things we already own.  This is certainly true of real estate, and will be true of paper assets as the dollar devalues.  Some protection is available by owning some commodities (although volatile), some foreign currencies, and foreign companies, especially those with significant sales in the developing and emerging Asian economies.

Robert Barone, Ph.D.

September 1, 2009

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.