Obama's tipping point

I think we have seen the tipping point at which Obama's reelection prospects begin what could be a relentless decline. His policies were arguably the main reason the economy has done so poorly in recent years, and now we begin to see that the real problem is his total lack of understanding about how economies and markets work, compounded by an amazingly inept campaign. Romney should have no trouble convincing a majority of voters that he will be a better steward of the economy. Jennifer Rubin, an outstanding political observer writing for the Washington Post, makes this chilling point in her blog post today:

I confess that not in my wildest dreams did I imagine President Obama’s campaign would be so awful. Oh sure, I knew it would be “awful” in the sense of going negative, being disingenuous and blaming everyone for his failings. But I was taken by surprise by how “awful,” in the sense of incompetent and ham-handed, it has been. 

Virtually every gambit and issue (“war on women,” gay marriage, and now Bain) has gone haywire, arguably inflicting more damage to Obama than to Mitt Romney. 

Either Obama is preying on the public’s ignorance in a transparent effort to distract them from his rotten record, or he’s economically illiterate, soaked in the rhetoric of the left with no real feel for the American economy. (These are not mutually-exclusive explanations.)

Obama is at best an empty suit and ignoramus when it comes to our economy.

This chart of Obama's chances of winning reelection needs no further explanation:

UPDATE: As of June 4th, this prediction seems to be on track:

More signs of a housing upturn

Existing home sales in April were close to expectations, but as this chart shows, the pace of sales has been improving: sales are up 14% since last July.

It's also nice to see that prices are bottoming/improving as well; this chart shows the median price of existing single family homes, adjusted for inflation. Over the past year, real prices have jumped about 8%. The chart also suggests that real home prices have found support at levels that have prevailed over long periods. In short, the housing bubble has burst and prices have finally returned to sensible levels. The repricing of the U.S. housing stock has allowed the market to clear; we've seen the worst, and now things are beginning to improve on the margin.

But not only have prices become reasonable from an historical perspective, the cost of purchasing a home relative to median family incomes has now fallen to record-low levels, as shown in the chart above of housing affordability.

The evidence is becoming very strong that at the very least we have seen a bottom in the residential housing market.

Euro update

With the world's worst fears dominated by events unfolding in the Eurozone, and with the euro's continued existence a key question, I offer some charts which perhaps provide some useful perspective. Despite all the fears of cataclysmic outcomes, the euro has actually strengthened vis a vis the dollar since its 1999 inception, and the euro today is trading about 10% above its purchasing power parity relative to the dollar by my calculations. This suggests that the ECB has been doing a pretty good job of defending the euro—better even than the Fed.

The euro today is slightly higher against the dollar than it was at its inception. It's been a long roller-coaster ride, but I see nothing here that would point to an imminent collapse. What seems more likely is a further gradual decline of the euro vs. the dollar.

The euro (using the DM as a proxy going back prior to the inception of the euro) has been trending higher against the dollar for the past 40 years, primarily because inflation in Europe has been lower than in the U.S. Purchasing power parity theory conforms with this experience; the currency with lower inflation should outperform, over time, the currency with higher inflation (the inflation differential between the U.S. and the Eurozone is reflected in the green line on the chart). The inflation differential that has favored the euro is ultimately the result of tighter monetary policy in Europe. The gap between the blue and green line suggests that the euro is about 10% "overvalued" against the dollar, which means that an American tourist in Europe is likely to find that most goods and services cost about 10% more in Europe than they do in the U.S. By the same logic, European tourists to the U.S. are likely to find that things are about 10% cheaper here.

The ECB can take credit for maintaining the purchasing power of the euro even as the world's demand for euros has weakened as a result of the Eurozone crisis, even as the world's demand for safe-haven currencies has been intense, and even as the Eurozone financial crisis has required the ECB to inject massive amounts of liquidity to shore up its banking system. But the strains are showing, and I think the euro is likely to weaken some more.

This chart shows the price of gold in the world's three major currencies. Here again we see that the dollar has lost purchasing power against the euro (because the price of gold has risen more in dollar terms than it has in euro terms). The yen has been the strongest currency of all for the past several decades; the price of gold in yen today is still less than it was at the gold's peak in the early 1980s.

The dollar is weak against the great majority of the world's currencies, and the Fed's Real Broad Dollar Index shows indeed that the dollar is very near its all time lows. But the euro's resilience in the face of great adversity, and the dollar's rather extreme weakness in general, don't mean the dollar is doomed. I've been arguing for awhile that the dollar was likely to rise this year against other developed currencies, because I think the economy is going to end up doing better than expected, and I continue to believe a stronger dollar is likely. The ECB is going to have a tough time maintaining its tight-fisted stance (relative to the dollar, that is), since the Eurozone financial system is still far from being out of the woods, and the Bank of Japan already is making a real effort to keep the yen from appreciating further. If the ECB and the BoJ have to further expand their balance sheets to achieve their goals, this could result in additional supplies of euros and yen relative to the dollar, thus supporting the dollar's value in a relative sense. And if the U.S. economy continues to beat expectations, then demand for the dollar could strengthen, and that in turn could provide a tailwind for the Fed's efforts to drain liquidity as the economy improves.

Eurozone update

It's time to look once again at the key indicators of risk in the Eurozone, especially since Eurozone fears are at the epicenter of the fears roiling world markets these days.

First, however, let's check in on the status of fears in the U.S. As the above chart shows, bond yields have fallen back to the levels they hit in late September, when the Eurozone crisis was heating up and there was lots of talk about an imminent U.S. recession. (10-yr Treasury yields hit a new all-time low of 1.7% yesterday.) I interpret this to be the result of a scramble by investors around the world to get into the safest asset that still has a measurable yield, and that sort of demand can only be driven by deep-seated fears of an extended global recession likely triggered by a Eurozone financial implosion. But: although the S&P 500 has taken a hit, it is still almost 20% above its Oct. 3rd low. Why haven't stocks tracked bonds? That's easy: earnings have continued to surprise on the upside, and the U.S. economy has shown no sign of the expected double-dip recession. Equity investors here are rattled, but they aren't nearly as fearful as global bond investors; equities have gotten a lot cheaper relative to Treasuries. Treasuries have never been more expensive. Never. I should also note that the Euro Stoxx index is now very close to its recession-era lows. Add this all up and it says that the biggest economic risks are still relatively isolated, and they can be found mainly in the Eurozone.

According to swap spreads, systemic risk in the U.S. is up a bit, but not nearly as much as in the Eurozone. There is fear of Eurozone contagion, but it's not intense by any means. Interestingly, Eurozone swap spreads are lower today than they were at the peak of the last Eurozone crisis late last year. So swap spreads are saying things are not critical at all in the U.S., and not yet catastrophic in the Eurozone. Yet 10-yr bond yields reflect an extreme degree of concern. The world's demand for Treasuries is exceptionally strong, and seems out of line with other indicators of risk.

The charts above compare 2-yr yields in various Eurozone countries. Both charts make it clear that near-term default risk in the Eurozone has declined dramatically from what it was at the end of last year. Note how the outlook for France has barely budged; the recent elections were not a surprise and the market feels moderately comfortable with near-term prospects there.

On a longer-term horizon, this chart of 5-yr CDS spreads shows that default risk in most Eurozone countries is elevated, but nevertheless equal to or lower than the default risk of the average high-yield corporate bond issuer in the U.S. (high-yield CDS spreads currently average about 700 bps). That's bad considering we're talking about the sovereign debt of developed countries, but from a global perspective it's not exactly the end of the world. Markets can live very comfortably with high-yield debt risk.

This chart helps sum things up. Europe is really struggling, but the U.S. equity market has suffered what appears to be just a correction. So far there are no signs that the U.S. economy has been dealt anything more than a glancing blow by all the turmoil in Europe. And despite all the hand-wringing and the flight to Treasuries and the Eurozone bank runs, key indicators of risk are saying that the fundamentals are not catastrophically bad by any means. I think there's a good chance the world will survive the Eurozone crisis.

What TIPS say about the future

As the world agonizes over a Greek default/banking implosion spreading to the rest of the Eurozone, I thought it would be good to revisit what is going on in the TIPS market. The first chart above compares 10-yr TIPS to 10-yr Treasuries, while the second looks at the 5-yr version of each. Nominal and real yields are on the top of each chart, and the bottom line is the difference between the two, which is the market's expectation for annual inflation over the life of the bonds.

Not surprisingly, both charts show the same patterns. The dominant pattern is that real and nominal yields are moving down at pretty much the same pace, with the result that inflation expectations are not much different today than they have been on average over the past 15 years. The important trend here, then, is the decline in real yields, which is being tracked by the decline in nominal yields; since inflation expectations haven't changed, nominal yields must follow the decline in real yields. Real yields are falling because the market's implicit expectation for real growth is falling. Back in the year 2000 you could buy 10-yr TIPS with a 4% real yield because the market thought the economy was going to be going gangbusters forever; real yields on TIPS had to compete with the market's very bullish expectations for real economic growth.

Today, of course, things are just the opposite. Real yields are now negative, and that means the market has almost no hope for any meaningful economic growth for as far as the eye can see. Why buy 10-yr TIPS with a negative real yield (thus ensuring you will lose purchasing power with your investment, since the total return on TIPS will be less than the rate of inflation) when you could buy an equity index fund and gain exposure to the rise in corporate profits which should be at least equal to the increase in nominal GDP over time? You would be indifferent to these two choices only if you held out no hope for there being any real growth over the next 10 years. Put another way, it's as if the market is saying that since the risk of big losses on everything is huge (e.g. there may be a global depression around the corner), then risk-free TIPS which will deliver a guaranteed real loss are better than investing in anything else because at least you know that with TIPS your real loss will be limited.

If that's not a pessimistic market, I don't know what is. But maybe it's just the case that Europeans are panicking en masse, and they will pay any price for a security backed by the U.S. government. Even so, TIPS and Treasuries are priced to something like a depression. This is a replay of sorts of what we saw at the end of 2008, only this time the market is not expecting any deflation; worrying about deflation now doesn't make sense when Greece might default and the euro might disappear, and maybe confidence in currencies collapses and that all leads of course to inflation.

So: anyone who buys TIPS and Treasuries today is effectively endorsing the view that a deep recession or depression—with average inflation—is the most likely outcome.

If you think that view is too pessimistic, then that effectively makes you an optimist.

Weekly jobs data just keeps getting better

It may be boring, because it's gone on so long, but the news from the labor market just keeps getting better. The trends towards fewer layoffs and fewer people collecting unemployment insurance are still in place after more than 3 years. There were 18% fewer people collecting unemployment insurance last week than there were a year ago, and 11% fewer people were fired last week than were a year ago.

Fewer layoffs and fewer people on the dole don't equate to growth, of course, but they do say a lot about the health of the economy and the incentives that those still unemployed are facing. Businesses are laying off fewer people because business is getting better and it's harder and harder to find ways to cut costs. Fewer people collecting unemployment insurance mean more people are getting hired, and those who aren't have a greater incentive to find and accept a job going forward. With these trends still in place it's hard to see the economy entering another slump, and there's no evidence whatsoever in these numbers of any incipient economic weakness. That's important, because the market today is priced to the expectation that there will be weakness.

In short, markets are worried about what might happen tomorrow because of all the turmoil in Europe, not about what is happening. To date, the economic fundamentals of the U.S. economy continue to slowly improve, and as the above chart suggests, if this improvement continues, the market is going to have to shrug off its Eurozone concerns and get back into rally mode.

Argentina debriefing

On our flight back to the states last week, I picked up a copy of La Nación, one of Argentina's most-respected newspapers. One article jumped out at me: "Buenos Aires, the most expensive and the cheapest city in the world." This is a perfect description, since Argentina is a fascinating study in contrasts, and you can indeed find things there that are incredibly cheap and incredibly expensive, just as you can find the very modern and the very rustic and primitive.

Right next to the the article I was reading was an ad for the Alfa Romeo Giulietta, a 2-door subcompact that is not for sale in the U.S., but that has received good reviews in Europe. Because of tight controls and high tariffs on imported goods, Argentines need a down payment of $20,400 (dollars) plus 36 fixed monthly payments of 3,360 pesos (equivalent to $660 at today's rate). That's the kind of financing you get in Argentina, where in effect you are making a down payment equivalent to half the car's price.

A 15-minute taxi ride in Buenos Aires can cost less than $8. Giving a taxi driver a $1 tip in Tucumán will earn you a big thank-you, and a $4 tip will prompt looks of incredulity, since most taxi rides around the city don't cost much more than that. A giant steak—a bife de chorizo—can be had for $10, and a bottle of good wine averages $10 at most restaurants. Good hotels in Buenos Aires can be found for $100-200 per night; we spent a little over $200/night at the charming Miravida Soho boutique hotel in Palermo. At Don Abel, the hotel we stayed at in Tucumán, we had a comfortable suite for only $100 or so a night, including breakfast. The toll road from Ezeiza airport to downtown Buenos Aires costs only $1.25. The toll road from Tucumán to Salta costs a ridiculous $0.60, which, given the relatively light traffic, might possibly be enough to pay the wages of the toll collectors. In short, anything with pure local content is very cheap.

Don't plan to buy much at the Duty Free in Ezeiza airport. Most prices are off-the-charts expensive. I got the impression that a good portion of the sales they do make are the result of tourists like me spending their leftover pesos in the knowledge that they are worthless once you leave the country. (Reminds me of an old Argentine joke: "Why is the peso like a pair of pajamas? Because you can only use them indoors.") And though you will be tempted by the displays in the boutiques of trendy Palermo Soho, the prices will cool your ardor real fast. Electronics and appliances, most of which are imported, cost upwards of twice what they cost in the U.S. I was told that a person holding a non-Argentine passport could make a living shuttling back and forth between Miami and Buenos Aires, buying iPhones and MacBook Airs and selling them for a 50% profit in Buenos Aires. It's a lot tougher for Argentines to pull this off, because they are thoroughly searched for such items when they return to the country and must pay a steep tax. It's a safe bet that most returning Argentines have purchased new suitcases in the U.S. to hold mountains of new clothes and multiple small electronic items, all purchased for a fraction of what they cost in Argentina. Most sought-after item in Argentina: a new, unblocked iPhone 4S.

Since the government is restricting people's ability to change pesos for dollars, there is a black market in dollars. Despite signs outside showing the official exchange rate, tourists can walk into just about any Casa de Cambio and sell their dollars (clean $100 bills are preferred) for about $5 pesos each, or 10-15% more than you can get at the "official" rate of 4.45, which is what you'll get at a bank. That's a lot better, by the way, than using your ATM card to get peso cash, or using your credit card for routine purchases, since the bank will translate the pesos at the official exchange rate and often add a extra charge for the  trouble. So if you're going to Argentina, you'll want to carry lots of $100 bills with you, and I hasten to add that they are accepted as payment at many restaurants and hotels, but not always at the "black market" rate. Argentines wanting to get large amounts of money out of the country without having to carry wads of $100 bills in their briefcase can do so only via a financial transaction called something like the "blue-chip rate," but they must pay upwards of 5.85 pesos per dollar to do so, which represents a 30% premium. (Bloomberg subscribers can find this by typing .IMPARS G Index) I keep close track of this rate, since the higher it goes the higher the risk of an eventual economic collapse and/or large devaluation of the peso. If you have a friend in Argentina you're going to be visiting, you can facilitate his desire to get money out of the country by offering to bring him, say, a new iPhone (or 2 or 3) in exchange for him giving you pesos to spend when you arrive.


In prior posts I've mentioned the disturbing parallels between the policies of President Kirchner and President Obama. Once again I'll add that every time I described the key features of Obama's policies to an Argentine friend, the immediate response was wide-eyed amazement: "that's exactly what Kirchner is doing!" Radical left-wing political tactics; strong support of unions; industrial policy which favors some industries at the expense of others; nationalization of key industries (e.g., GM and YPF); contempt for capitalists/banks; pitting rich against poor, or, more generally, acquiring political power via divide and conquer strategies; political cronyism to reward friends, collaborators, and contributors; higher taxes on the rich; massive income redistribution; and socialized medicine, to name a few. In the U.S. it's called Chicago-style politics, and in Argentina it's called peronism.

Kirchner's economic policies are doomed to fail, it's just a question of when. The government is fudging the inflation statistics and restricting access to dollars, and that just feeds the fires of capital flight and an eventual currency devaluation. Import restrictions are going to choke off economic growth. Price caps and controls on energy are going to result in energy shortages. The nationalization of YPF and probably other industries is going to result in sharply lower foreign direct investment, which in turn will aggravate the shortage of dollars. Corruption at all levels of government is undermining popular support for the regime. It will end in tears and a big devaluation.

When I went there I expected to see more signs of stress, but I was wrong. Things aren't too bad, but they are slowly getting worse. There might be another year or so to go before things start to really collapse. In the meantime, there's plenty to enjoy in Argentina, since living standards are rising and the economy is growing (but nowhere near as fast as the government claims). The mood of the people is generally good, things are peaceful, the planes fly on time, and we didn't see a single protest/strike/shutdown such as we have seen on previous trips.