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.
Advertisements

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.

May 21, 2013

Learning to live with uncertainty’s economics

Posted in Economy, Finance, Uncategorized tagged , , , at 7:37 PM by Robert Barone

Everyone lives with uncertainty.
 
We don’t know the future, but there are times when uncertainty is more prevalent —during natural disasters or in a combat zone, for example. And during such times, one tends to avoid what would be a normal routine.
 
The same is true when there is uncertainty about the economy and economic policy. Spending patterns tend to change in these environments.
 
Consider what happened to corporate cash flows at the end of 2012. Because it was uncertain what the 2013 tax rates would be, many companies paid extra dividends before the end of 2012 and gave their employees early bonuses.
 
Today, economic policy uncertainty continues to have a dramatic impact on economic activity. Three academics, two at Stanford and one at the University of Chicago, recently unveiled a measure of U.S. economic policy uncertainty and found that uncertainty has been significantly higher than normal for the past two years, resulting in a dramatic impact on economic
growth.
 
Using this research, the Vanguard Group estimated that such uncertainty has created a $261 billion drag on the economy ($800 per capita).
Over the past two years, they say, this has reduced the growth rate of real GDP by at least 1 percentage point and by 45,000 jobs per month (that’s over 1 million jobs in the two-year period).
 
Corporate America’s cash glut
 
It is well known that there are record amounts of cash on the books of America’s major corporations. Apple and GE have more than $100 billion each; Microsoft has more than $70 billion; and Cisco and Google each have more than $50 billion.
 
But because much of this cash has remained offshore for tax reasons, it is not available for investment or job creation here in America. Despite its huge cash hoard, Apple recently borrowed $17 billion to pay dividends to its shareholders and to repurchase stock because its offshore cash is subject to significant taxation if repatriated to pay for these transactions.
 
A dearth of capital expenditures
 
In the past five years, the rate of growth in U.S. corporate capital expenditures has been the slowest in at least 50 years. The tax code and other issues surrounding fiscal policy, including the debt and deficits, and regulatory issues like Obamacare keep corporations from investing,
expanding and creating jobs in America.
 
Uncertainty, regulations and part-time employment
 
The most recent headline (U3) unemployment rate was 7.5 percent (April). In the Household Survey, the number of people employed grew by 293,000, which appears to be quite positive (that number was a negative 206,000 in March).
 
Unfortunately, of those 293,000, 278,000 were part-time jobs. Because the U3 unemployment measure counts part-time and full-time jobs equally, the unemployment rate appeared to decline in April from its reported 7.6 percent level in March.
 
But the U6 unemployment measure, which assigns different weights to part-time and full-time jobs, rose to 13.9 percent from March’s reported 13.8 percent. To confirm the movement to part-timers, the average workweek declined 0.3 percent in April.
 
Should we be concerned that 95 percent of the jobs created were part-time, or is this just an anomaly?
 
I’ve seen reports that because of Obamacare, Taco Bell, Applebee’s, Denny’s and Olive Garden are moving some employees from full- to part-time status. And, the state of Virginia, the city of Long Beach, Calif., and Youngstown State University have mandated that their part-time workers cannot work more than 29 hours per week, thus saving them millions of dollars
in potential Obamacare costs. Consider that there are still 7.5 months until Obamacare is fully implemented. Could this movement toward part-timers be just the start?
 
Uncertainty and the tax grab
 
It is no secret that every federal, state and local government is looking for revenue. The result has been an explosion of rules and regulations, and the fees and fines that go with them.
 
This is choking small businesses. The Internet sales tax is one such example. How is a small Internet-based business going to cope with more than 9,000 taxing jurisdictions, all with different and sometimes contradictory rules?
 
Can you imagine having to do such accounting, and then create a payment stream for several hundred such governmental entities per month, all of which would have the right to audit your books? Don’t be fooled. This has nothing to do with “fairness,” as is being touted. It has everything to do with increased taxation to fund government. Until such uncertainty subsides, the creation of new Internet-based small business will be stifled.
 
Conclusion
 
This growing concern —that America will not be able to achieve a long-term plan to deal with its debt, deficits and the monetization of such —has frozen the business sector like deer in the rapidly approaching headlights.
 
U.S. policymakers seem oblivious to the implications that continued policy uncertainty has on economic growth.
 
We’ve adopted European-style policies, and today our economic growth rate is what Europe had five years ago. Perhaps Europe’s negative growth rate today is a harbinger of our own future.
 
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.

May 8, 2013

Volatility, gold on Wall Street

Posted in Finance, Uncategorized, Wall Street tagged , at 10:05 PM by Robert Barone

There are two truths all investors need to remember about Wall Street.

No. 1: Whenever Wall Street is involved, markets become volatile, even unstable. Many examples exist including the meltdowns of 2001 and ’09. Last year, we had the “flash crash” and the issues surrounding Facebook’s IPO. The week of April 15 produced both the three-minute AP/Twitter meltdown (the “Tweet Retreat”), and the dramatic fall in the price of gold.

No. 2: The reason for such volatility is “greed” and “fear” on the part of the large Wall Street players. Greed can be seen in the widespread use of leverage, margin, derivatives, futures and options, all of which multiply the returns on committed capital. Once greed drives prices to heights that can’t be justified, the slightest jolt causes fear and a cascade of sell orders as all the major players, seeing leverage work against them, rush for the exits at the same time.

The recent gold meltdown, underlying fundamentals

Clearly, fear gripped Wall Street’s holders of gold on April 12 and 15. The closing price on April 11 was $1,550 per ounce. On April 15, it was $1,352 per ounce, a 12.8 percent decline. At this writing (April 27), it has recovered about half of the loss, closing at $1,462 per ounce on April 26.

Because we are talking about something that trades on Wall Street, no one can say for sure that the selling pressure is over. But there are some fundamental issues that investors need to understand regarding the yellow metal:

• Gold was not in a speculative bubble. Its rise in price since the turn of the century has been based on the fundamentals of fiscal and monetary malfeasance on the part of many western industrial nations including the U.S., the U.K., the European Union and Japan.

• The 12.8 percent rapid fall in gold’s price was not based on a shift in those fundamentals but was just a bout of Wall Street “fear.” In fact, since April 15, reports from all over the world (including India and China) indicate a massive amount of gold buying by main street consumers. The U.S. Mint sold out of its physical coins immediately after April 15. Clearly, main street knows a bargain when they see one.

• Volatility in the price of gold is nothing new. Can’t remember such volatility? Try 2008. From March 17 to 20, 2008, the price of gold fell 5.8 percent (from $1,000 per ounce to $943 per ounce). It then proceeded to fall to $710/oz. in November of that year, a 29.1 percent total drop. That is almost exactly the magnitude of the 28.2 percent fall from gold’s Sept. 2, 2011 peak of $1,884 per ounce to the recent nadir.

Gold’s historic outperformance

Yet, gold has been a spectacular performer since the turn of the century with much higher returns and lower volatility than stocks. Such performance relative to both inflation and equities is shown in the accompanying tables.

Table 1 shows the annualized returns of gold if purchased on Dec. 31, 1999, and held to March 31, April 15 or April 26 of this year. Also shown are the returns of the S&P 500 (including reinvested dividends). For good measure, I threw in the official annualized inflation rate (CPI-Gov’t), and a more realistic inflation rate (CPI — 1980) calculated by John Williams of Shadowstats.com using the 1980 CPI methodology. As you can see, gold was the asset class to hold throughout this period.

Table 1: Annualized Returns of Gold, Stocks & Inflation

From: 12/31/99 To: 3/31/13 To: 4/15/13 To: 4/26/13
Gold

13.8%

12.4%

13.0%

CPI – Gov’t

2.5%

 

 

CPI – 1980

9.6%

 

 

S&P 500

0.5%

0.4%

0.6%

 Table 2 shows the returns of stocks and gold from the stock market lows of March 9, 2009. If you were not gripped with “fear” in March 2009 (the vast majority of Wall Street players were) and you bought at the lows, you did great. However, if you bought gold then, your portfolio also performed, just not quite as well.

Table 2: Annualized Returns Since Stock Market Lows of ‘09

From: 3/9/09 To: 3/31/13 To: 4/15/13 To: 4/26/13
Gold

14.6%

9.9%

11.9%

S&P 500

23.0%

22.4%

22.8%

Table 3: Annualized Returns 12/31/99 to Stock Market Lows of ‘09

From: 12/31/99 To: 3/9/09
Gold

12.4%

S&P 500

-7.5%

 
It isn’t fair to look at Table 2 without a look at Table 3, which shows what the returns on the two asset classes were in the nine-plus years from the turn of the century to the S&P 500 lows. Note that if you held the S&P 500 during that entire period, your annual return was a large negative (-7.5 percent), while gold produced a large positive annual result (+12.4 percent).
 
 
Conclusion

The price of gold is volatile because Wall Street is involved. Nevertheless, its volatility hasn’t been as great as that of stocks in this century. The returns produced by gold have beaten inflation by anyone’s measure and have whipped the returns produced by stocks, unless you invested heavily on March 9, 2009.

Despite Wall Street’s recent tantrum, the underlying fundamentals for owning gold haven’t changed, as can be seen from the overwhelming demand for the yellow metal coming from main street consumers since that tantrum ended.

The mention of securities/commodities, such as gold, 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.

April 23, 2013

What trends on Wall Street, Main Street mean

Posted in Economy, Finance, Uncategorized tagged , , at 6:04 PM by Robert Barone

In trying to make sense of what is going on in the economy, both on Wall Street and Main Street, the most important thing to remember is in the “new normal” paradigm, one cannot use recent historical perspective.
 
Simply put, in the past five years, the structural changes in the U.S. economy have been so dramatic that today’s economy more closely resembles that of Europe or Japan than it does our own of 2007. As a result, to my way of thinking, a return to 4 percent real economic growth and a 5 percent noninflationary unemployment rate virtually looks impossible.
 
The underlying data
 
Despite the disappointing March employment numbers (88,000 net new jobs in the Establishment Survey and -206,000 in the Household Survey), there was a reduction in the unemployment rate to 7.6 percent because nearly 500,000 people “dropped” out of the labor force in March.
 
Based on this data and using the “old normal” paradigm, it is easy to conclude that there still is a lot of slack in the economy. After all, from an historical perspective the unemployment rate still appears high at 7.6 percent, or 13.8 percent, depending on which measurement you look at.
The underlying emerging facts, however, are quite different.
 
• In the April 9 Bureau of Labor Statistics release of the Job Openings and Labor Turnover Survey, the number of job openings rose by 314,000 for the month of February, despite the fact that hires were nowhere near that level. This is the second-highest level of new openings since April 2010, and the level of unfilled jobs now stands at 3.1 million, where they were in 2006. That number is up from about 2.2 million in the middle of 2009.
 
• While volatile month to month, the level of firings is near an all-time low. And, more people are confident enough in their skills and in their job prospects that the level of voluntary quits (an Alan Greenspan favorite) also is at a five-year high.
 
• On a weekly basis, the BLS issues a series called Initial Jobless Claims, a measure of newly fired or laid-off workers. This series shows a marked downtrend from more than 420,000 per week in the middle of 2011 to under 350,000 in six of the past nine reports; 350,000 per week is about the 2004-07 average.
 
Interpreting the data
 
There clearly is a skills mismatch as openings are rising much faster than hirings. The decline in firings and in the Initial Jobless Claims series imply that employers are holding onto their employees. And, the rise in the voluntary quits says a lot about job prospects for those with skills. So, at 7.6 percent, or whatever the actual unemployment rate really is, the labor markets appear to be extremely tight.
 
Implications of the data
 
One would never arrive at such a conclusion using the historical perspective of the “old normal.” For the first time in at least five years, we are about to see rising wage rates. This is really good for Main Street, as it will give the working class more disposable income. But, it is not good for Wall Street. Labor productivity has declined during the past nine months due to a lack of new investment from businesses and the inability to find qualified help. As a result, as the cost of production rises, profit margins will get squeezed, and we will see the beginnings of cost-push inflation, as businesses vie for the few applicants with skills. This will not be good for equity prices.
 
The view from the Fed
 
In December, with the announcement of 0 percent interest rates and quantitative easing until the unemployment rate reaches 6.5 percent, the Fed has returned to the discredited Phillips Curve concept used in the 1970s under the guidance of then-Fed Chairman Arthur Burns.
The concept was that the unemployment rate could be reduced if there was just a little bit more inflation. Sound familiar to the 6.5 percent unemployment rate and 2.5 percent inflation rate now being targeted?
 
In the ’70s, the result of this policy was “stagflation,” a term coined to describe little or no economic growth but high inflation. Inflation (measured more accurately then than now) was more than 13 percent, and many readers might remember that it took Paul Volker as Fed chairman and many months of 20 percent short-term interest rates to stop stagflation.

 
Nevertheless, it appears that today’s Fed is still using the historical perspective of the “old normal” paradigm in thinking that it can get the real economic growth rate back to 4 percent and significantly reduce unemployment without causing inflation.
Emerging facts are telling us that today’s labor and capital market structures are such that real economic growth of about 2 percent and unemployment rates near 7.5 percent are about all that can be accomplished without significant inflation. (Truth be told, the common experience today is that inflation is much higher than the official 2 percent numbers.)
 
What it means
 
The dusting off of the discredited Phillips Curve concept clearly indicates that Ben Bernanke is much closer to Burns in philosophy than he is to Volker. I lived through the Burns and Volker eras, and I am sure that someday, someone will say to Bernanke, “When it came to fighting inflation, you were no Paul Volker!”
 

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.

 

April 9, 2013

Inflation could be closer than we think right now

Posted in Economy, Finance, Uncategorized tagged , , at 10:14 PM by Robert Barone

Mohammed El-Erian of PIMCO coined the phrase “new normal” in 2009 to describe what he observed to be a new, slower growth, a paradigm for the U.S. economy.
 
Now, El-Erian, A. Gary Shilling and others are forecasting an end to the “new normal.” One can presume that means a return of the “old normal,” where the non-inflationary level of unemployment is about 5 percent and potential economic growth is 3.5 to 4 percent.
 
Return of ‘old normal’
 
We have experienced the weakest recovery from a recession in the post-World War II era with average growth since mid-2009 of 2.2 percent versus a 4.2 percent average for the previous seven recoveries.
 
The unemployment rate is 7.7 percent (U.3); if short-term discouraged workers are included, it is 14.3 percent (U.6). During the past five years, the growth rate of the private capital stock has been the slowest of any five-year period for the past six decades.
 
Thus, it appears easy to infer that there is plenty of slack in the labor markets and that firms do not see any need to expand capacity. So, to return to the “old normal,” all we need is an increase in demand, something the huge federal budget deficits or 0 percent interest rates have failed to produce. But, if demand were to rise, because of excess capacity, we will then have a period of rapid growth with little or no inflation.
 
What if ‘new normal’ is permanent?
 
I always thought that “new normal” meant we simply couldn’t rely on pre-great recession historical perspective to tell us where we might be headed.
 
Can we really expect the unemployment rate to return to 4.5 percent like it was in 2006-07? What if labor shortages and inflationary pressures begin to appear when the unemployment rate is between 7 percent and 7.5 percent? What if the industrial base in the U.S. already is using its most efficient means of production, and rising demand means using older, less efficient productive processes or having to go to more expensive second shifts?
 
Labor, capital market conditions
 
The National Federation of Independent Business recently found that from the lows of about 10 percent of survey respondents, the trend of those not able to fill positions has been upward such that today about 20 percent of respondents cannot find qualified applicants.
 
In the pre-recession period, that number hovered around 25 percent. The Capacity Utilization rate, at 79 percent, is equal to the pre-recession peak. That indicates that any rise in demand will be met with capacity issues.
 
Potential economic growth
 
Looking at markets today, even at the so-called anemic post-recession economic growth rates we have experienced, both labor and capacity appear to be constrained.
 
So, maybe in today’s “normal,” the potential noninflationary growth rate of the economy is closer to 2 percent-2.5 percent.
 
Last year, the Congressional Budget Office put out a missive estimating that potential GDP growth was 2.9 percent, a number that the markets, the media and most economists simply ignored. If that is correct, then the 2.2 percent average post-recession growth in this recovery is not all that shabby. Released on March 15, the Economic Report of the President also argues that potential GDP today is much lower than what we might otherwise consider “normal.”
 
Is inflation close?
 
If the “new normal” conditions of the past four years apply, both labor markets and capacity constraints could mean that we will begin to see inflationary pressures if economic growth approaches even 2.5 percent.
 
It is likely that labor shortages will first appear (and, remarkably, we already see these in the construction industry) which will rapidly translate into rising wages. On the industrial front, rising wages, the need to employ older capital, second labor shifts, or to hire and train less-than-qualified candidates reduces profit margins and puts upward pressure on prices.
 
Fed stuck in the ‘old normal’
 
Will the Fed recognize this and take away the spiked punch bowl?
 
There is that possibility, i.e., that interest rates will soon begin to rise in anticipation of higher inflation. But the Fed’s own history of mishandling the yield curve says “no.”
 
Federal Reserve Chairman Ben Bernanke himself missed the recession when the economy was already in it, and, of course, he told us that the “sub-prime” housing issue had been contained. Under “new normal” conditions, the 6.5 percent unemployment rate target that must be met before the punch bowl is removed and the Fed tightens may very well be much lower than the noninflationary unemployment rate.
 
There is even a movement on the Federal Open Market Committee to lower that unemployment objective to 5.5 percent. In addition, Bernanke’s likely replacement, should he decide to retire in 2014, is Janet Yellen, whose views on money printing might be even more liberal than Bernanke’s.
 
So, there is clearly no thinking at the Fed that the “new normal” is permanent. Either that or the Fed never embraced the “new normal” and has continued to use “old normal” guidelines to set policy.
 
Conclusion
 
It is, therefore, a good bet that if the economic paradigm is still governed by “new normal” guidelines, inflation will be well-entrenched long before the Fed recognizes it.
 
Let’s hope that El-Erian and Shilling are right and the “old normal” soon returns. But, I would caution: “Hope” is not a good investment strategy.

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.

 

March 28, 2013

Dow hits a new record, so what?

Posted in Finance, Uncategorized tagged , at 9:36 PM by Robert Barone

By Sheyna Steiner · Bankrate.com
 
Wednesday, March 27, 2013
 
Start whistling a happy tune because happy days are here again. Right? The Dow Jones industrial average closed at a record high again. On Tuesday, it topped off at 14,559.65.
 
The more relevant index, Standard & Poor’s 500 index, closed just 2 points shy of its all-time high of 1565.15 set in October 2007, Reuters reported in Tuesday’s story, “Wall Street climbs on economic data; S&P near record close.”
 
There seems to be a lot of preoccupation in the financial media with record highs. Sure, it makes a snazzy headline. But what does it mean?
 
For proponents of technical analysis, certain prices seem to be harder to break through than others — either on the way up or the way down. They’re known as levels of support or resistance and represent psychological barriers. They tend to be numbers around which investors make decisions either for or against a certain security.
 
For the rest of us, record highs may not be as significant. The stratospheric heights the indexes are reaching these days indicate two things, according to Robert Barone, chief economist and portfolio manager at Universal Value Advisors in Reno, Nev.
 
“It tells us one thing for sure: Don’t fight the Fed,” he says. One side effect, bug or feature of the quantitative easing programs from the central bank has been to inject vast quantities of money into the financial system — much of which has gone into equities.
 
“The Fed has liquefied at least the U.S. if not the whole world, and we have a lot of money sloshing around looking for a return,” says Barone. Read more about that in “How the Fed fuels stock prices.”
 
Monetary policy may not be the only driver. It could be part of the so-called new normal, the post-financial-crisis reality. Relatively sluggish economic growth may be par for the course now, says Barone. Instead of looking back to 2006-2007 and saying that gross domestic product and unemployment should be at those levels, maybe the economy simply doesn’t have the growth potential that it once did.
 
“Job openings are rising but the jobs aren’t being filled. There is a shortage of skilled labor. Capacity utilization in the industrial sector is approaching what it was in ’07,” says Barone.
 
“But we’re not happy because we have 7.5 percent unemployment, and we think it should be 4 percent or 5 percent. Putting it all together, it tells you that maybe the stock market isn’t too high,” he says.
 
What do you think? Is it too high? Where should it be? What’s going on? There are so many questions.
 

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.

 

March 27, 2013

Is the market’s record high just another bubble?

Posted in Economy, Finance, Uncategorized tagged , , at 3:53 PM by Robert Barone

The Dow Jones Industrial Average hit a new all-time high on March 5 of 14,254,
surpassing its old peak of 14,164 set on Oct. 9, 2007, and has continued to advance to still higher levels.

From this indicator alone, one would think that “we’re back!” Unfortunately, a review of the underlying fundamentals tells a different story, at least about the state of the economy. With weak fundamentals and high and rising stock prices, the logical question is, “Is the stock market in a bubble?”

In the accompanying table, besides the Dow Jones itself, only corporate profits per capita are better. That really has been the story for five and a half years. One might argue that corporate profits alone are enough to boost the market.

But, the markets always look forward, and today, a majority of reporting companies have guided downward for either top line, bottom line or both.

Indicator October 9, 2007 March 5, 2013 (Better (+) or Worse (-)
DJIA

14164

14254

+

Gasoline/gallon

$2.76

$3.74

GDP growth rate

2.5%

1.6%

Unempl Rate (U3)

4.7%

7.7%

Employed (non-farm)

138 mill

135 mill

US Debt

$9.0 trill

$16.4 trill

US Debt/GDP

64%

104%

US Budget Deficit

$162 bill

$1.1 trill

US Deficit/GDP

-1.2%

-8.5%

Food Stamp Recipients

26 mill

48 mill

Corp Profit per capita

$4,247

$5,521

+

Real DPI per capita

$32,816

$32,483

Why the equity market is rising

David Rosenberg (Gluskin-Sheff) has research indicating that, since 2007, the correlation between the Fed’s balance sheet and the S&P 500 index is 87 percent. The two major market dips since the great recession came when QE1 and QE2 ended.

According to Rosenberg, since the Fed now has another QE with no end date (QEnfinity),
the market is continuing higher. As a result, he said, the rise in stock prices has been based on a P/E multiple expansion, and such a multiple expansion is solely based upon the Fed’s QE policies of money printing.

The evidence is that money printing is not about to stop any time soon despite market worries that some Federal Open Market Committee members are beginning to question the Fed’s easy money policies, which caused quite a stir in the bond market in late February.

In a March 1 address at the Federal Reserve Bank of San Francisco, Bernanke said,

“ … At the present time, the major industrial economies apparently cannot
sustain significantly higher real rates of return; in that respect, central
banks — so long as they are meeting their price stability mandates — have little
choice but to take actions that keep nominal long-term rates relatively low…”

Why some bond managers worry and others don’t

Stan Druckenmiller, the famous hedge fund manager of Duquesne Capital, in a Bloomberg TV interview and again on CNBC in early March, commented that the coming onslaught of the entitlement promises will overwhelm the fiscal system unless something is done now.

He also said something that scared a lot of people. He said that as soon as the Fed sells the first security from its portfolio, every bond manager and investor will rush for the exits at the same time, which will result in chaos in the bond markets and is bound to spill over to equities. He points to the FOMC minutes and the market reaction in late February as proof.

On the other hand, Jeffrey Gundlach of Doubleline Funds, another famous and prescient fixed income manager, doesn’t believe the Fed will sell a single security in the current investment time horizon (which I interpret to mean several years).

Gundlach says questions about Fed tightening are the wrong questions to be asking. The
Fed will keep interest rates low, not for months but for years because the math shows that if rates rose by any significant degree, the interest cost of the debt will overwhelm the federal.

Think about it. The Fed has observed the markets’ reaction to the FOMC minutes. Clearly, the Fed knows what the market reaction is likely to be if it began sales from its balance sheet.

So, I believe that Gundlach has the correct approach. However, Gundlach did issue a warning. The Fed, he said, might be able to print money for a while without any apparent consequences, then something dramatic happens. But, that eventuality still appears to be outside of the current investment time horizon.

Conclusions

Economic fundamentals remain weak. The stock market appears to be tied to the Fed, and
as long as the Fed continues to print, the markets will have an upward bias.

While there could be equity market corrections, it appears that as long as the Fed continues its current policies, and as long as the economy at least continues to “muddle through,” then no serious bear market downdraft in equities is likely to occur.

The same is true for bonds, especially if the economic undertone and labor market conditions remain weak. So, the answer to the question “Is the stock market a bubble?” appears to be yes. But, it isn’t one that is likely to deflate any time soon.

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.

Previous page · Next page