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.

Minggu, 06 Oktober 2013

New blood coming to Congress?

The other day I had breakfast at the Dennys in San Clemente with Pat Maciariello, an energetic and level-headed conservative running for Congress in California's 45th District. (That's the Orange Country district adjacent to my district, the 49th, which is represented by the extremely capable Darrell Issa.) The 45th is currently represented by Rep. John Campbell (R), who is retiring, so it's an open race, and Pat is up against some seasoned pols, particularly Mimi Walters.

Pat brings a good deal of business experience to the table, plus a passion for free markets, limited government, lower taxes, and pro-growth policies—so you can see why I'm enthusiastic about his candidacy.

I'm also impressed with his willingness to take time out from a successful business career and use a good deal of his own resources to enter this fray. His motivation is simple: to change the world for the better, by helping to create a more favorable policy climate in Washington that promotes business, growth, and prosperity. He's an excellent listener, by the way, which tells me he is a good thinker and not an ideologue.

Our paths crossed thanks to a mutual friend and because Pat is the son of my favorite prof at Claremont Graduate University, Joe Maciariello. Since the days I was fortunate enough to work as the TA in his Benefit-Cost Analysis class, Joe has gone on to become arguably the world's foremost expert on the life and works of the renowned management expert Peter Drucker (whom I was also lucky to have as a prof). Pat's credentials are rooted in a solid academic background (Notre Dame, Columbia Business School) and the mentoring of a very capable father.

I'm compelled to admire and support someone like Pat, one of those relatively rare citizen politicians who feel the need to "give back" to the country that has enabled their success. We need more people like him who know how the world really works, and fewer of those who make a career out of politics. His enthusiasm is refreshing, and he reinforces my belief that the future holds the promise of better policies and more job opportunities than we have now.


Jumat, 04 Oktober 2013

Who needs government statistics?

So the federal government is shut down and the market is deprived of some key statistics, most notably the payroll employment report that we ordinarily would have gotten this morning. Is this a cause for concern? Not really, since there are lots of numbers out there that continue to come in on a daily basis from the market. These numbers are even better than government stats, since they are very timely, they aren't subject to seasonal adjustment, they will never be revised after the fact, and they reflect the cumulative knowledge and wisdom of hundreds of millions of investors and business executives all over the world. The message they send, at least as I see it, is that nothing much has changed of late, and the economy most likely continues to plod along at a disappointing slow rate. Nevertheless, the economy apparently is continuing to grow and improve, despite all the policy obstacles thrown in its way.

Here are just a few, in random order. All come from market-based indicators that are real-time as of today:

Corporate credit spreads reflect the market's perception of the default risk of the average business. Credit spreads today are about as low as they have been post-recession. The market, in other words, sees little reason to worry about default risk these days, and there is no sign of any deterioration of late.

2-yr swap spreads are excellent leading and coincident indicators of systemic risk in the economy. These spreads today are about as low as they have ever been. The market, in other words, does not detect anything bad going on. It would be highly unusual for the economy to deteriorate with swap spreads being this low. They tell us that financial markets are very liquid and transparent these days, and that is one very good reason to think that the economy is in decent shape and not suffering from any underlying deterioration.

The Baltic Dry Index is a measure of the shipping costs of bulk commodities. The index was quite low for most of 2012 and until this summer. But starting last June it began to pick up. It is now up 156% from the end of May. This likely reflects improving conditions in the Eurozone and Asian economies. At the very least it all but rules out any emerging weakness in the global economy. It's much more likely that the global economy is strengthening on the margin, given the rather impressive strength in this index of late.

The chart above shows the real yield on 5-yr TIPS over the past year. Yields have dropped about 50 bps in the past month, probably because the Fed failed to "taper" its quantitative easing program, and that in turn has caused the market to adjust downwards somewhat its expectations of future rate hikes. But yields are still up an impressive 120 bps from their lows of last April. I would argue that this is good evidence that the market believes that economic fundamentals have firmed.

C&I Loan growth (bank lending to small and medium-sized businesses) has slowed of late, but outstanding loans are still up some 30% in the past 3 years. This is good evidence of increased confidence on the part of both banks and businesses.

Commodity prices have been going sideways for the past several years, and remain at levels that are significantly higher than they were at the end of 2001. There doesn't appear to be any emerging weakness (or unusual strength) here.

The Vix index today is 17, and that's up quite a bit from the 12 it registered just two months ago. But as the chart above shows, that hardly moves the needle from a long-term historical perspective. The market is a little more worried right now (understandably, given what is going on in Washington these days), but the level of uncertainty is still relatively low. Whatever problems we are likely to face, as a result of the government shutdown and the upcoming debt ceiling negotiations, are, in the market's best judgment, probably minor.

The stock market still appears to be in an uptrend, but not in a bubble, as it was in the late 1990s and early 2000s.

Given all this, I think it's reasonable to conclude that despite the current lack of government-provided statistics, the economy continues to grow at a modest pace.

Kamis, 03 Oktober 2013

Eurozone economy picks up

If anything stands out in today's ISM service sector report, it is the pickup in the Eurozone. The Eurozone economy is clearly picking up, after suffering from a two-year recession. This improves the outlook for the global economy, and removes one of the many drags on the U.S. economy.

The U.S. service sector report was a bit weaker than expected (54.4 vs. 57), but it's been jumping around for the past several years so that is not unusual. As the second chart above shows, conditions in the service sector have been modestly positive on average, and last month's report was only modestly lower than the post-recession average. While there are no big changes underfoot in the U.S. economy, the Eurozone economy is experiencing a welcome revival, and that is big news on the margin.

Announced corporate layoffs have been very low for the past three and a half years. No sign of any deterioration in the outlook here.

Weekly unemployment claims have fallen significantly over the past several years, and are now about as low as we could hope to see. An important part of every recovery is the tightening of business belts: cutting costs, laying off nonessential personnel, scaling back expansion plans, etc. It's good to know that process is now essentially complete. What's missing, of course, is the scaling up of expansion plans and a wave of new hiring. That's going to require a better policy environment, and unfortunately we're not likely to see one any time soon, unless Obamacare is postponed for another year and revamped in the process.

The threat of another recession is still very low, and thanks to the pickup in the Eurozone, there is more reason to remain optimistic about the future. With the yield on cash still stuck at zero, it's thus very difficult for investors to justify a defensive posture. Sitting in cash can only be rewarded if economic conditions deteriorate more than is already priced in.

As the three charts above suggest, the market is still braced for very week growth conditions. PE ratios today are about average, even though corporate profits are at all-time highs—a clear indication that the market expects the corporate profits outlook to deteriorate. 5-yr TIPS real yields are still negative, which suggests the market expects U.S. growth to be very weak for the foreseeable future.

Selasa, 01 Oktober 2013

Gold, commodities, and iOS 7

In a post last April, I introduced the thesis that gold's "second great rally" was over, and that gold prices would probably realign with commodity prices at a much lower price.

With gold down some $40 today, it's as good a time as any to revisit this issue. As I read the chart above, it continues to suggest that as a first approximation, gold prices are headed to $900-1000/oz.

When gold prices reached $1900/oz. two years ago, I think it was because the market was betting that all sorts of things would go wrong: the Fed's QE would create hyperinflation, the dollar was going to crash, and/or debt defaults in the Eurozone and possibly in the U.S. would lead to another financial Armageddon. Since then, it's been a case of the "dog that didn't bark." Nothing terrible has happened: inflation is quite low, the dollar has picked up somewhat, the Eurozone economy is once again growing, and debt default concerns have faded.

Today we've seen that yet another shutdown of the U.S. government has (so far) proved to be a nonevent. (See above chart: financial conditions have rarely been so tranquil as they are today.) No one seriously believes the U.S. will fail to pay its debts. Even though federal spending represents 20-21% of GDP, fully two-thirds of that spending comes in the form of transfer payments—taking money from one person and giving it to another, and that doesn't get shut down. Abstracting from transfer payments, which unfortunately lead to perverse incentives (those who pay are generally more productive than those who receive), the federal government only consumes about 7% of GDP. By its gargantuan size and nature, government is already a big drag on the economy, and a bit less government can't be such a bad thing.

The big news, however, is that the debate over the shutdown centers around the role of government. Should the federal government be pushing us all into a government-controlled healthcare system? Can government ever hope to efficiently manage the entire healthcare industry? Republicans are in a sense trying to save the Democrats from their own healthcare folly by conditioning a Continuing Resolution on a one-year postponement of Obamacare, a massive and intrusive program that is simply not ready for primetime, as I discussed last week. But since the Democrats are determined to ignore the huge flaws in their program, and since Obama refuses to negotiate, we're in a stalemate. As Ilya Somin points out, "there is considerable symmetry between the two sides’ positions."

There's not much symmetry, however, to be found between the government's rollout of Obamacare exchanges and Apple's rollout of iOS 7, contrary to Obama's assertion today. As Obamacare exchanges—over three years in the making and targeted to a mere 30-40 million U.S. residents—today opened for business, failures and shutdowns were widespread and predictable, preventing millions of users from signing up—and that is just the first of what are sure to be many more glitches and disasters. If Apple had bungled a software or hardware rollout to the same extent as HHS has, its stock would have tanked, and for good reason.

Apple likely had less than 2 years to prepare for its software rollout, which was targeted to upwards of 700 million users, and, save for one minor glitch which affected no one's ability to use the new software, had to be ready to go in dozens of languages around the globe from day one. As it turned out, over 200 million were able to successfully download and use Apple's new software in just two days, and well over half of Apple mobile devices have been upgraded to date.

Though terribly inapt on Obama's part, his comparison may prove to be very beneficial, since with more time we will discover more Obamacare problems, and with more time we'll discover that the economy can survive without the myriad ministrations of the federal government. Apple has already exceeded the expectations of hundreds of millions of users in a matter of days, whereas Obamacare will almost certainly fail to deliver on any of its promises in the next few months and years. Moral of the story: we'd likely be better off with less government intrusion, lower tax burdens, fewer regulations, and a healthcare system that relied more on private sector initiatives and less on government mandates to cut costs and expand coverage.

Perhaps the gold market is beginning to understand that the sound and fury coming out of Washington could be the beginning of the end of Big Government. Between now and next November, political discussions are almost certainly going to be dominated by the issue of whether or not our government has become too vast to function effectively. The failure of Obamacare to work as advertised, contrasted with the overwhelming success of Apple's iOS7 launch, will hold lessons aplenty for years to come. Would you entrust your health to government the same way you entrust Apple with the management of your digital life? I sure wouldn't, and maybe millions of others will come to agree with me. We didn't create the federal government to compete with private enterprise and individual initiative; we created government to ensure that private enterprise and individual initiative can flourish.

If, as a result of all this mess, government is more likely to shrink than increase in size and influence, then the outlook for the economy, I would argue, has improved. And that does not support a gold price that is still more than double its average, inflation-adjusted price over the last century.

Manufacturing conditions are improving

The September ISM manufacturing report was consistent with a firming and improving manufacturing sector and a pickup in economic growth in general.

The last two months of the ISM manufacturing report are consistent with economic growth of at least 4%, which would be a clear improvement from what we have been seeing over the past year or so.

A decent employment report suggests that manufacturers are somewhat more confident about future conditions.

As the three charts above show, there has been a welcome and overdue improvement in conditions in the Eurozone economy. The Eurozone manufacturing has been above 50 for the past three months, after being in recession territory since mid-2011. Eurozone swap spreads have proven once again to be a good leading indicator of economic conditions, having predicted improvement in the Eurozone economy for the past year. As the last chart shows, the Eurozone economy has indeed pulled out of its 2-year slump, registering positive growth in the second quarter of this year. It's quite likely that the Eurozone economy continued to improve in the third quarter. What's good for Europe is good for the world.

There is nothing in these reports that would justify the need for a continuation of extremely accommodative monetary policy from the world's major central banks. At the same time, there is nothing here to suggest that extremely accommodative monetary policy has been a source of great stimulus. It's more likely the case, as I've suggested before, that monetary policies have not been designed to be stimulative in the first place. The main point of the Fed's Quantitative Easing program was to supply safe assets to a world that has been very risk-averse; to accommodate the world's huge demand for safe assets. The world probably doesn't need much more QE, if any, at this point.

Senin, 30 September 2013

Stocks on solid ground

Reasonable people can disagree about whether stocks are overvalued, or whether the Fed's massive QE purchases of bonds have distorted interest rates and asset values. I'm on record as suggesting stocks are attractive and QE hasn't artificially stimulated the economy or the markets. With that in mind, I offer a collection of charts that show how the behavior of stock prices has been commensurate with various measures of improvement in the economy.

The chart above compares unemployment claims (inverted), to show that stocks have fairly closely tracked the decline in unemployment claims.

The chart above compares the inflation-adjusted level of the S&P 500 to an index of truck tonnage carried, itself a proxy for the physical size of the economy. The chart suggests (correctly, when viewed after the fact) that stocks were very expensive in 2000, having "overshot" the improvement in truck tonnage, and that stocks were very cheap in early 2009, having contracted by more than the decline in truck tonnage. 

The chart above compares the level of factory orders to the S&P 500. Post-recession, stocks have increased by almost exactly the same order of magnitude as factory orders.

It should not be surprising that corporate profits tend to rise in line with the growth of the economy. (What should be surprising, however, is that since 1975 the S&P 500 tends to be a constant multiple of after-tax corporate profits.) This chart shows that, since 1959, stock prices (excluding dividends) have increased by a factor of 30, while after-tax corporate profits have increased by a factor of 54, with most of the difference attributable to the period prior to 1975. Once again, the overvaluation of stocks in 2000 is quite evident.

The economy is doing better, and so are stocks. There is no sign here of any irrational exuberance on the part of stocks.