Rabu, 16 Oktober 2013

Apple vs. Microsoft

One of the great comeback stories of all time, arguably sparked by one simple non-decision by Steve Jobs:

We argued with Steve a bunch [about putting iTunes on Windows], and he said no. Finally, Phil Schiller and I said 'we're going to do it.' And Steve said, 'Fuck you guys, do whatever you want. You're responsible.' And he stormed out of the room." - John Rubenstein

HT: John Gruber

One more twist: Apple's new "spaceship" headquarters building, which yesterday was approved by the Cupertino City Council, will be almost as big as the Pentagon.

Japan reflation update

Last January I noted that "one of the biggest things happening on the margin is the decline of the Japanese yen." The Bank of Japan was effectively pressured into a serious relaxation of monetary policy. After being extremely tight for many years—as reflected in zero/negative inflation, a relentless appreciation of the yen against virtually all other currencies, a very weak stock market and a moribund economy—the Bank of Japan has completely reversed course. This has had predictable and impressive results.

The above chart shows just how impressive the increase in Japan's bank reserves has been. Reserves are up 137% in the year ending September.

A genuine easing of monetary policy ought to result in a weaker currency, and that is exactly what has happened in Japan. The yen has gone from 78 to 99 vs. the dollar in the past year, a decline of more than 20%. And to the extent that Japan's weak economy in recent years was the result of deflationary monetary policy, then easier money and a weaker yen ought to result in a stronger equity market. And indeed, as the chart above shows, that is exactly what has happened. Japanese stocks are up over 60% in the past year in yen terms, and up 33% in dollar terms. Japan has apparently succeeded in reflating its deflated economy, and that is a good thing.

Inflation typically responds to changes in monetary policy with a lag, and that is exactly what is happening. As the chart above shows, Japan is now registering inflation of almost 1% in the past year, and it's likely to increase further over the next year. As inflation expectations increase, the desire of the Japanese to hold on to lots of yen declines, and the velocity of money increases, and that fuels faster nominal GDP growth. It's already apparent: inflation has accelerated (albeit only modestly so far), and in the first half of this year, Japan's annualized real GDP growth was almost 4%.

Japan's monetary policy has done a good job. Going forward, the key to real success will be Japan's commitment to genuine fiscal stimulus (e.g., limiting the growth of public sector spending, reducing regulatory burdens, and reducing tax burdens). Prime Minister Abe seems to understand this, but of course the proof will be in the pudding.

Senin, 14 Oktober 2013

Even Europe is recovering

The chart above is worth a thousand words, at least, but here's a quick summary. Note 1) the strong correlation between equity prices in the U.S. and in the Eurozone over the past two decades; 2) the huge degree (over 50%) by which U.S. equities have outperformed their Eurozone counterparts since 2009; and 3) the fact that Eurozone equities are still 46% below their 2000 highs, whereas U.S. equities are 10% above their 2000 highs. In short, the Eurozone economy has followed pretty closely the direction of the U.S. economy, but in the process has fallen way behind.

This may be changing.

The above chart is the ratio of the S&P 500 index to the Euro Stoxx index. The U.S. equity market clearly led the Eurozone by leaps and bounds from 2009 through mid-2012, with much of the "credit" likely going to the PIIGS sovereign debt crisis. But for the past year or so the Eurozone appears to be holding its own and even pulling ahead, as reflected in the declining ratio.

The relative improvement in the Eurozone economy has been showing up for most of the past year in the manufacturing and service sector purchasing manager surveys, as seen in the above charts. Europe suffered a two-year recession which has recently come to an end. Even though Eurozone growth still lags the U.S. significantly, the Eurozone is doing somewhat better on the margin, and better than expected.

Caveat: I'm not predicting that Eurozone stocks will continue to outperform U.S. stocks, as they have recently. My main point is simply that it appears that the Eurozone is no longer the laggard that it has been for so many years. That's good news for Europe, and it's good news for the U.S. as well, since a stronger Europe bolsters the outlook for global growth, and that is good for almost everyone.

Awesome durable goods deflation

Mark Perry has an interesting post which highlights the fact that over the past 20 years the effective cost of clothing, measured in hours worked, for the average worker has declined by almost 50%. In that same vein, I offer an updated version of a chart (first featured over 3 years ago here, with a detailed explanation of the role China has played in this here, ) which highlights the huge and growing disparity between the prices of durable goods and just about everything else:

Since the end of 1994, the average price of durable goods has declined by almost 30%, while the price of services has increased by 60% and the price of non-durable goods has increased by 50%. Over the same period, the average hourly earnings of private sector non farm workers has increased by 74%. This means that the average worker only needs to work about 40% as much today in order to buy durable goods (e.g., computers, cameras, cars, TVs) as he or she did 18 years ago. Put another way, one hour of work today buys about 2.5 times as much in the way of durable goods as it did in 1995. 

This kind of deflation is awesome. Thanks to durable goods deflation, as Mark notes, "the standard of living for most households has actually increased significantly over the last 20 years, when measured in what is ultimately most important: household consumption and the affordability of life’s basics." 

Jumat, 11 Oktober 2013

"Equities are grinding lower"??

Sometimes you have to take the advice of the "experts" with a grain or two of salt. Case in point: Mark Zandi, in written testimony today to the Joint Economic Committee: "equities ... have been slowly grinding lower since mid-September." Zandi, a reliable source for quotes that reaffirm Keynesian economic logic and avoid ruffling consensus feathers, is trying to make the case that Congress should end the shutdown and reverse the sequester in order to boost the economy. That without these actions, the stock market is telling us that the economy is doomed to deteriorate.

Here's what "grinding lower" looks like in fact (as I write this, the S&P 500 is down 1.4% since mid-September):

I'd say a more accurate description of the equity market is just the opposite: equities have been grinding higher for the past four years or so, despite the many obstacles—like the shutdown and the sequester—that have been thrown in its path. The economy has been slowly improving as well, despite a degree of "fiscal austerity" over the past four years that would have led any Keynesian to predict a recession.

The economy's disappointingly slow growth, in my view, has almost nothing to do with fiscal austerity. Rather, it has to do with policies that are smothering the private sector: e.g., higher taxes, increased regulatory burdens, increased subsidies and transfer payments, and Obamacare.

Reversing any or all of these policies would almost surely do more for the economy than reversing the sequester.

Rabu, 09 Oktober 2013

Tracking important market prices

Last week I argued that the lack of government-provided statistics was not really a problem, since there are lots of real-time, market-based prices out there that speak volumes about the state of the economy. Here's an expanded list, with up-to-date charts, of the indicators I think are the most important to watch.  On balance, I don't detect anything going on that's particularly disturbing or encouraging, which means the economy is probably continuing to expand at a relatively slow pace.

1-mo. T-bill yield:

Yields on 1-mo. T-bills have jumped this month by about 25 bps, whereas yields on bills maturing in 3 and 6 months remain quite low. This reflects a modest degree of concern that the current government shutdown and debt ceiling debate may remain deadlocked and result in a temporary "default" on federal debt. If the risk of default were major and lasting, yields on all maturities would have spiked, but that is not the case, at least so far. This is akin to a tiny ripple on the pond of risk.

2-yr swap spreads:

2-yr swap spreads are about the best leading indicator of systemic risk that I'm aware of. (For more detail on what swap spreads are, see here.) Today, swap spreads in the U.S. are about as low as they have ever been, while swap spreads in the Eurozone remain somewhat elevated. This reflects almost a complete absence of any degree of risk in the financial and economic fundamentals in the U.S., and a modest degree of risk in the Eurozone economy. Conditions have not changed materially in the past year.

5-yr TIPS real yield:

As the first of the above charts shows, real yields on TIPS tend to track the real growth of the U.S. economy. Real yields have moved substantially higher in the past six months, and that is a good indication that the market believes the economic fundamentals of the U.S. economy have improved. But real yields are still quite low, suggesting that the market now expects the U.S. economy to grow at a sub-par rate whereas before the market was concerned about the potential for a double-dip recession. As the second chart shows, real yields have dropped about 50 bps from their recent high, reflecting a) some disappointment with the economy and b) less likelihood of a near-term Fed tapering. Under the new leadership of Janet Yellen, the Fed is probably less likely to taper and less likely to tighten aggressively. Real yields would have to decline further before I would worry that economic fundamentals were deterioriating.

Breakeven inflation spreads:

The above chart shows the market's implied inflation expectations for the 5-year period beginning in 5 years, which are derived from the yields of 5- and 10-yr TIPS and Treasuries. This is the Fed's preferred measure of forward-looking inflation. As the chart shows, inflation expectations today are almost exactly the same as the average of the past four years. Nothing much going on here—inflation is likely to remain subdued for the foreseeable future.

Gold vs. real yields:

The price of gold has been remarkably well correlated with the inverse of 5-yr TIPS yields (which is equivalent to saying that gold has been positively correlated with TIPS prices). I've argued that this is a sign that the world's demand for safe assets is beginning to decline. Not much has changed here in the past month or so, but this remains one of the more intriguing relationships I follow, especially since the demand for money and safe assets has been extraordinarily strong for the past 5 years. Strong money demand has led to a major decline in the velocity of M2, and has all but compelled the Fed to adopt its Quantitative Easing policy. As I've argued before, the primary function of QE is not to "print money," but to swap newly created bank reserves (functionally equivalent to T-bills) for bonds. Since there is no evidence of any increase in inflation as a result of the Fed's QE efforts, we can infer that the Fed's provision of bank reserves was likely just enough to satisfy the world's demand for safe assets. When the supply of money equals the demand for money, there are no inflationary consequences.

Gold vs commodity prices:

Gold and industrial commodity prices have tended to move together over long periods. The most striking thing in the chart above, in my opinion, is the degree to which gold "overshot" the rise in commodity prices coming out of the Great Recession. I think this reflected very strong demand for safe assets, very deep concerns over the potential for QE to be inflationary, very deep concerns about the long-term value of the dollar, and deep-seated concerns about global financial stability. But since these fears have not been realized, gold has begun to fall back in line with commodity prices, which have been relatively stable for the past few years. Not much has happened to gold in recent months, but if the world continues to avoid a disaster then I would expect gold prices to move lower. Relatively stable commodity prices tell me that there are no material changes in the strength of the global economy.

Dollar vs. other currencies:

As the first of the two charts above shows, the inflation-adjusted value of the dollar relative to a trade weighted basket of currencies is still unusually weak. However, the dollar has managed to increase somewhat in the past two years, which I take as a sign that the U.S. economy has done somewhat better than expected (or perhaps it's better to say "not as badly as expected"). The second chart looks at the nominal value of the dollar vs. major currencies for the year to date, and here we see that the dollar has only recently found a bit of support after declining from last summer's highs. There's not much love out there for the dollar, but neither is the dollar disastrously weak. On the bright side, there's a lot of room for improvement in the dollar if the outlook for the U.S. economy were to improve.

Baltic Dry Index:

This measure of shipping costs for bulk commodities has staged a remarkable comeback in the past four months. While it's difficult to draw firm conclusions from this (the index can be affected not only by demand for commodities but by changes in available shipping capacity), I think it's safe to say that global economic activity is not deteriorating, and may even be firming.

Credit default swap spreads:

CDS spreads are a very liquid proxy for the default risk of corporate bonds. That spreads are still very close to their lowest levels since the recession is a sign that the market detects no deterioration in the economic outlook. Spreads are still meaningfully higher than their pre-recession lows, however, which signals that the market is still relatively risk averse.

Vix Index:

The Vix index has jumped of late, a clear sign of increased market jitters. But from a longer-term perspective, it is still relatively low. The market is obviously concerned about the ramifications of the current government shutdown, but not terribly so. This is a contributing factor to the general mood of risk aversion that pervades most market indicators.

S&P 500 Index:

The first of the above two charts shows the PE ratio of the S&P 500 index. It's up from the lows of 2010, but is not unusually high. In fact, PE multiples today are almost exactly in line with long-term averages. I think this shows that the market is at the very least not overvalued. Indeed, since corporate profits currently are at record levels in both nominal terms and relative to GDP, I think this shows a remarkable lack of optimism. In other words, I take this as a sign that the market is still relatively risk averse, and that explains why the demand for safe assets is still relatively strong.

The second chart shows the index itself, which has been on an uptrend ever since March, 2009. Prices are near all-time highs, but valuations are still relatively subdued. There is still lots of upside potential if the market should start to feel less concerned about monetary and fiscal policy, and/or should the economic fundamentals improve.

Senin, 07 Oktober 2013

Two Americas: one works, the other doesn't

Glenn Reynolds, AKA Instapundit, AKA the grandaddy of all bloggers, and arguably one of the most prolific and valuable contributors to the internet, has written an outstanding op-ed in today's USA Today. Here's the first part, but be sure to read it all:

There are two Americas, all right. There's one that works -- where new and creative things happen, where mistakes are corrected, and where excellence is rewarded. Then there's Washington, where everything is pretty much the opposite. That has been particularly evident over the past week or so. One America can launch rockets. The other America can't even launch a website. 

The silver lining to the Obamacare cloud (whose failure to launch after three years and billions of dollars of preparation makes Apple's iOS 7 "glitch" seem laughably insignificant) and to the federal government shutdown is that maybe, if we're lucky, the voters are going to take notice. Government can't do things nearly as well as the private sector can, and anyway, the government shouldn't even try. Perhaps more importantly, we are finding out that our economic life goes on just fine without the daily ministrations of the many millions of federal employees that are now officially considered to be non-essential. We should all be asking ourselves—just days after the 100th anniversary of the ratification of the 16th Amendment authorized the income tax—whether our federal government is really worth one-fifth of our collective incomes, even though it almost cost us one-fourth just four years ago.

If we're lucky, Obamacare may prove to be the "tipping point" that finally marks the end of Big Government as we know it. Republicans are probably doing us a disservice by insisting that Obamacare be de-funded or postponed. Instead, they should just let it happen and let it fail spectacularly, because it is guaranteed to fail no matter what. Government of the size we have today has reached the limits of its effectiveness. Government is now too vast to be efficient, too vast to be controlled, and too vast to achieve all the many objectives of its constituents. Republicans would be wise to wait until the Democrats beg to have Obamacare postponed. Then perhaps we can have a proper dialogue on the subject.

If you don't read Glenn on a daily basis, you should.