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.

 

 

 

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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.

July 20, 2009

Recession’s End Doesn’t Mean the Stock Market Is Out of the Woods

Posted in Banking, Finance, investments tagged , , , , at 10:20 PM by Robert Barone

Jobless claims and continuing claims have peaked. Housing has bottomed. Auto sales are turning up. The alphabets (ISM, LEI, NAPM, MBA purchases, ICSC retail sales, etc.) are improving. The recession has bottomed. Hurrah.

Now what?

Historically, the past recessions since WW II had textbook stock recoveries. The recession ends and stocks rally as the economy recovers. The last recession ended in November, 2001. However, the stock market subsequently plunged. It hit lows in July, 2002 and October, 2002. It finally bottomed in March 2003, almost 1.25 years after the recession officially ended.

The last 2001 recession wasn’t even a recession (did we even have 2 consecutive down GDP months?). It lasted only 8 months. Yet, the S&P dropped 49% from peak to trough from March 2000 to March 2003. Three years.

Can we duplicate another housing, consumer spending, home equity withdrawal boom to recover as we did from 2003-2007?  We must remember that 70% of the GDP is dependent on the American consumer. How is he doing?

It has been one year and 8 months since the October 2007 market top. Only one year and 4 months to go to equal the last bear market duration. Greenspan kept fed funds below 2% for 3 years. Can Bernanke continue to just pin rates at near zero for years until we recover? Why not?  Seems so easy, doesn’t it?   Has the government pumped in enough money to mark the S & P stock market the low in March at 666?  

Fred Crossman, J.D, C.P.A.

 

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