Jeremy McInerney (University of Pennsylvania) on thy parallels between Thucydides’ ancient Athens and the US in the modern era:
Bubble, Bubble, Toil and Trouble: The Costs and Benefits of Market Timing
The following article was originally published in Musings on Markets and is reproduced with kind permission of the author, Aswath Damodaran. Aswath is a Professor of Finance at the Stern School of Business at NYU and teaches classes in corporate finance and valuation.
The essay is lengthy, but shows great insight into the current discussion on market valuation, analyzing the motives of various groups (“bubblers”) who have been predicting the demise of the current bull market, and the relationship of Price-Earnings ratios (or its inverse, ERP) to long-term interest rates. His graph of Treasury Bond Rates and Implied ERP, particularly, demonstrates that current market valuations include a higher-than-normal risk premium. And his summation of the current state of affairs at the end is worth close attention.
Click on the images for a larger view. I hope that you enjoy it.
Monday, June 16, 2014
Bubble, Bubble, Toil and Trouble: The Costs and Benefits of Market Timing
If you believe that the stock market is in a bubble, you have lots of company. You have long-time market watchers, the New York Times and even a Nobel Prize winner in your camp. But what exactly is a bubble? How can you tell if you are in one? And if you do believe you are in a bubble, what is your best course of action? Not only are these questions difficult to answer, but the answers can vary across markets, investors and time.
The Bubble Machine
Every market has a bubble machine, though it is less active in some periods than others, and that machine creates an ecosystem of metrics and experts, as well as warnings about bubbles about to burst, corrections to come and actions to take to protect yourself against the consequences. In periods like the current one, when the bubble machine is in over drive and you are confronted by “bubblers” with varying credibilities, motives and methods, you may find it useful to first categorize them into the following groups.
- Doomsday Bubblers have been warning us that the stock market is in a bubble for as long as you have known them, and either want you to keep your entire portfolio in cash or in gold (or bitcoins). They remind me of this character from Winnie the Pooh and their theme seems to be that stocks are always over valued.
- Knee Jerk Bubblers go into hibernation in bear markets but become active as stocks start to rise and become increasingly agitated, the more they go up. They are the Bobblehead dolls of the bubble universe, convinced that if stocks have gone up a lot or for a long period, they are poised for a correction.
- Armchair Psychiatrist Bubblers use subtle or not-so-subtle psychological clues from their surroundings to make judgments about bubbles forming and bursting. Freudian in their thinking, they are convinced that any mention of stocks by shoeshine boys, cab drivers or mothers-in-law is a sure sign of a bubble.
- Conspiratorial Bubblers believe that bubbles are created by small group of evil people who plan to profit from them, with the Illuminati, hedge funds, Goldman Sachs and the Federal Reserve as prime suspects. Paranoid and ever-watchful, they are convinced that stocks are manipulated by larger and more powerful forces and that we are all helpless in the face of this darkness.
- Righteous Bubblers draw on a puritanical streak to argue that if investors are having too much fun (because stocks are going up), they have to be punished with a market crash. As the Flagellants in the bubble world, they whip themselves into a frenzy, especially during market booms.
- Rational Bubblers uses market metrics that are both intuitive and widely used, note their divergence from historical norms and argue for a correction back to the average. Viewing themselves as smarter than the rest of us and also as the voices of reason, they view their metrics as infallible and mean reversion in markets as immutable.
There are three things to keep in mind about bubblers. The first is that bubblers will receive disproportionate attention in the media, for the same reasons that a reality show about a dysfunctional family will have higher ratings than one about a more normal family. The second is that even the most misguided bubblers will be right at some point in time, just as a broken clock is right twice every day. The third is that being right is often the worst thing that can happen to bubblers, because it seems to feed into the conviction that they are always right and leads to increasingly bizarre predictions. It is no coincidence that every market correction in history has created its gurus (who called that correction right) and those gurus have almost always found a way to discredit themselves ahead of the next one.
What is a bubble? The lazy definition is that any time you see a large market correction, it is the result of a bubble bursting, but that is neither a useful definition, nor is it true. To me, a bubble reflects a market disconnect from fundamentals, where prices go up steeply, with no help from the fundamentals. The best way of illustrating this is to go back to an intrinsic value model, where the value of stocks can be written as a function of three fundamentals: the base year cash flows that investors are receiving, the expected growth in these cash flows and the risk in the cash flows:
If cash flows increase, growth rates surge, risk free rates drop or macroeconomic risk subsides, stocks should go up, and sometimes steeply, and there is no bubble. At the other extreme, if stock prices go up as cash flows decrease, growth rates become more negative and risk free rates and equity risk increase, you have a bubble. It is far more likely, though, that you will be faced with a more ambiguous combination, where shifts in one or more fundamentals (higher growth, higher cash flows, a lower risk free rate or lower macroeconomic risk) may explain the increase in stock prices and you will have to make judgments on whether the increase is larger than warranted.
Detecting a Bubble
The benefits of being able to detect a bubble, when you are in its midst rather than after it bursts, is that you may be able to protect yourself from its consequences. But are there any mechanisms that detect bubbles? And if they exist, how well do they work?
a. PE and variants
The most widely used metric for detecting bubbles is the price earnings (PE) ratio, with variants thereof that claim to improve its predictive power. Thus, while the conventional PE ratio is estimated by dividing the current price (or index level) by earnings in the last year or twelve months, you could consider at least three modifications. The first is to clean up earnings removing what you view as extraordinary or non-operating items to come up with a better measure of operating earnings. In 2002, in the aftermath of accounting scandals, S&P started computing core earnings for US companies which can differ from reported earnings significantly. The second is to average earnings over a longer period (say five to ten years) to remove the year-to-year volatility in earnings. The third is to adjust the earnings from prior periods for inflation to get a inflation-consistent or real PE ratio. In fact, Robert Shiller has a time series of PE ratios for US stocks stretching back to 1871, that uses normalized, inflation-adjusted earnings.
In the graph below, I report on the time trends between 1969 and 2013 in four variants of the PE ratios, a PE using trailing 12 month earnings (PE), a PE based upon the average earnings over the previous ten years (Normalized PE), a PE based upon my estimates of inflation-adjusted average earnings over the prior ten years (My CAPE) and the Shiller PE.
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| Normalized PE used average earnings over last 10 years & My CAPE uses my inflation adjusted normalized earnings. Shiller PE is as reported in his datasets |
While the Shiller PE has become the primary weapon wielded by those who believe that we are in a bubble, perhaps because of the pedigree of its creator, the reality is that all four measures of PE move together much of the time, with a correlation of close to 90%. (If you are wondering why my time series starts in 1969, I use the S&P 500 and earnings on the index and I was unable to get reliable numbers for the latter prior to 1960. Since I need ten years of earnings to get my normalized values, my first estimates are therefore in 1969.)
To examine whether any of these PE measures do a good job of predicting future stock returns and thus market crashes, I computed the correlation of each PE measure with annual returns on the S&P 500 over one-year, two-year and three-year periods following the computation.
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| T statistics in italics below each correlation; numbers greater than 2.42 indicate significance at 2% level |
First, the negative correlation values indicate that higher PE ratios today are predictive of lower stock returns in the future. Second, that correlation is weak with one-year forward returns (notice that none of the t statistics are significant), become stronger with two-year returns and strongest with three-year returns. Third, there is little in this table to indicate that normalizing or inflation adjusting the PE ratio does much in terms of improving its use in prediction, since the conventional PE ratio has the highest correlation with returns over time periods
Defenders of the PE or one its variants will undoubtedly argue that you don’t make money on correlations and that the use of PE is in detecting when stocks are over or under price. For instance, one rule of thumb suggests that a Shiller PE above 15 would indicate an over valued market, but that rule would have kept you out of US equities since 1988. To create a rule that is more reflecting of the 1969-2013 time period, I computed the 25th percentile, the median and the 75th percentile of each of the PE ratio measures for this period.
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| PE measures: 1969-2013 |
I then broke my sample down into four quartile classes with each PE ratio, from lowest to highest, and computed the annual stock market returns in the years following:
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| One-year and Two-year stock returns |
The predictive power improves for PE ratios with this test, since returns in the years following high PE ratios are consistently lower than returns following low PE ratios. Normalizing the earnings does help, but more in detecting when stocks are cheap than when they are expensive. Finally, the inflation adjustment does nothing to improve predictive returns.
Note, though, that this test is biased by the fact that the quartiles were created using data from the period on which the test is run. Thus, the conclusion that you can draw from this table is that if you had known, in 1969, what the distribution of PE ratios for the S&P 500 would look like for the next 45 years (which would suggest amazing foresight on your part), you could have made money by buying when PE ratios were in the bottom quartile of the distribution and selling in the top quartile.
b. EP Ratios and Interest Rates
One of the biggest perils of using the level of PE ratios as an indicator of stock market pricing, as we have in the last section, is that it ignores the level of interest rates. If interest rates are lower, PE ratios should be higher and ignoring that relationship will lead us to conclude far too frequently (and erroneously) that stocks are over priced in low-interest rate environments. The link between PE ratios and interest rates is best illustrated by looking at how the EP ratio (the inverse of the PE ratio) moves with the T.Bond rate over time. In the figure below, I graph the movements of all four variants of EP ratios as the T.Bond rates changes between 1969 and 2013:
It is clear that EP ratios are high when interest rates are high and low when interest rates are low. In fact, not controlling for the level of interest rates when comparing PE ratios for a market over time is an exercise in futility.
This insight is not new and is the basis for the Fed Model, which looks at the spread between the EP ratio and the T.Bond rate. The premise of the model is that stocks are cheap when the EP ratio exceeds T.Bond rates and expensive when it is lower. To evaluate the predictive power of this spread, I classified the years between 1969 and 2013 into four quartiles, based upon the level of the spread, and computed the returns in the years after (one and two-year horizons):
The results are murkier, but for the most part, stock returns are higher when the EP ratio exceeds the T.Bond rate.
c. Intrinsic Value
Both PE ratios and EP ratio spreads (like the Fed Model) can be faulted for looking at only part of the value picture. A fuller analysis would require us to look at all of the drivers of value, and that can be done in an intrinsic value model. In the picture below, I attempt to do so on June 14, 2014:
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| Intrinsic valuation of S&P 500: June 2014 |
It is true that this intrinsic value is a function of my assumptions, including the growth rate and the implied equity risk premium. You are welcome to download the spreadsheet and try your own variations.
If your concern is that I have used too low an equity risk premium, you can solve, as I do at the start of each month, for an implied equity risk premium (by looking for that equity risk premium that will give you the current index level) and then comparing that value to historical values for that input:
The current implied ERP of 4.99% is well above the historic average and median and it clearly is much higher than the 2.05% that prevailed at the end of 1999.
Are we in a bubble?
In the table below, I summarize where the market stands today on each of the metrics that I discussed in the last section:
If you focus on PE ratios, it is true the current levels in the market put it in the danger zone, given past history. However, bringing the level of interest rates into the measure (in the EP spreads) reverses the diagnosis, since stocks look under valued on these measures. Finally, expanding the assessment to look at growth and risk as well in the intrinsic value and ERP measures reinforces suggests that stocks are fairly valued.
While there are some who are adamant in their belief that the market is in a bubble, I remain unconvinced, especially given the level of rates today. To those who argue that earnings could drop, growth could turn negative, interest rates could go up or that there could be another global crisis lurking around the corner, has there ever been a point in time in stock market history where these concerns have not existed? And even if they do exist, the reason we demand an equity risk premium in the first place is for the uncertainty that we feel about macroeconomic variables driving value.
Bubble Belief to Bubble Action: The Trade Off
While I believe that the risk that we are in a bubble is over stated by PE ratio comparisons, you may come to a very different conclusion. Even if you do, though, should you act on that belief? The answer is not clear cut, since there are two ways you can respond to a bubble. The first, which I will term the passive defense, is to reduce the amount of your portfolio allocated to equity to a lower number than you would normally hold (given your age, liquidity needs and risk aversion). The second which I term the active defense is to try to profit off the market correction by selling short (or buying puts). The trade off is then between the cost and the benefit of acting:
- The cost of acting: If you decide to act on a bubble, there is a cost. With the passive defense, the money that you take out of equities has to be invested somewhere safe (earning a risk free rate, or something close to it) and if the correction does not happen, you will lose the return premium you would have earned by investing stocks. With an active defense, the cost of being wrong about the correction is even greater since your losses will increase in direct proportion with how well stocks continue to do. (Note that using derivatives to protect yourself against market corrections or for speculation will deliver variants of these defenses.)
- The benefit of acting: If you are right about the bubble and a correction occurs, there is a payoff to acting. With the passive defense, you protect your investment (or at least that portion that you shift out of equities) from the drop. With the active defense, you profit from the drop, with the magnitude of your profits increasing with the size of the correction.
The trade off then becomes a function of three variables: how certain you feel about the existence of a bubble, how big a correction you see occurring as a result of the bubble bursting and how soon you see the correction coming.
To illustrate the trade off, consider a simple (perhaps simplistic) scenario, where you are fully invested in equities and believe that there is 20% probability of a market correction (which you expect to be 40%) occurring in 2 years. In addition, let’s assume that the expected return on stocks in a normal year (no bubble) is 7.51% annually and that the expected annual return if a bubble exists will be 9% annually, until the bubble bursts. In the table below, I have listed the payoffs to doing nothing (staying 100% in equities) as well as a passive defense (where you sell all your equity and go invest in a risk free asset earning .5%) and an active defense (where you sell short on equities and invest the proceeds in a risk free asset):
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| Future value of portfolio in 2 years (when correction occurs) |
If you remain invested in equities (do nothing), even allowing for the market correction of 40% at the end of year 2, your expected value is $1.0672 at the end of the period. With a passive defense, you earn the risk free rate of 0.5% a year, for two years, and the end value for your portfolio is just slightly in excess of $1.01. With an active defense, where you sell short and invest int he risk free rate, your portfolio will increase to $1.3072, if a correction occurs, but the expected value of your portfolio is only $0.9528, which is $0.1144 less than your do-nothing strategy.
If you feel absolute conviction about the existence of a bubble and see a large correction coming immediately or very soon, it clearly pays to act on bubbles and to do so with an active defense. However, that trade off tilts towards inaction as uncertainty about the existence of the bubble increases, its expected magnitude decreases and the longer you will have to wait for the correction to occur. I know that I am pushing my luck here but I tried to assess the trade off in a spreadsheet, where based upon your inputs on these variables, I estimate the net benefit of acting on a bubble for the passive act of moving all of your equity investment into a risk free alternative:
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| Payoff to Passive Defense against Bubble (Correction of 40% in 2 years) |
The net payoff to acting on a bubble generates positive returns only if your conviction that a bubble exists is high (with a 20% probability, it almost never pays to act) and even with strong convictions, only if the market correction is expected to be large and occur quickly.
On a personal note, I have never found a metric or metrics that allow me to have the combination of conviction that a bubble exists, that the correction will be large enough and/or that the correction will happen within a reasonable time frame, to be a market timer. Hence, I don’t try! You may have a better metric than I do and if it yields more conclusive results than mine, you should be a market timer.
Bubblenomics: My perspective
It is extremely dangerous to disagree with a Nobel prize winner, and even more so, to disagree with two in the same post, but I am going to risk it in this closing section:
- There will always be bubbles: Disagreeing with Gene Fama, I believe that bubbles are part and parcel of financial markets, because investors are human. More data and computerized trading will not make bubbles a thing of the past because data is just as often an instrument for our behavioral foibles as it is an antidote to them and computer algorithms are created by human programmers.
- But bubbles are not as common as we think they are: Parting ways with Robert Shiller, I would propose that bubbles occur infrequently and that they are not always irrational. Most market corrections are rational adjustments to real world shifts and not bubbles bursting and even the most egregious bubbles have rational cores.
- Bubbles are more clearly visible in the rear view mirror: While bubbles always look obvious in hindsight, it is far less obvious when you are in the midst of a bubble.
- Bubbles are not all bad: Bubbles do create damage but they do create change, often for the better. I do know that the much maligned dot-com bubble changed the way we live and do business. In fact, I agree with David Landes, an economic historian, when he asserts that “in this world, the optimists have it, not because they are always right, but because they are positive. Even when wrong, they are positive, and that is the way of achievement, correction, improvement, and success. Educated, eyes-open optimism pays; pessimism can only offer the empty consolation of being right.” In market terms, I would rather have a market that is dominated by irrationally exuberant investors than one where prices are set by actuaries. Thus, while I would not invest in Tesla, Twitter or Uber at their existing prices, I am grateful that companies like these exist.
- Doing nothing is often the best response to a bubble: The most rational response to a bubble is to often not change the way you invest. If you believe, as I do, that it is difficult to diagnose when you are in a bubble and if you are in one, to figure when and how it will dissipate, the most sensible response to the fear of a bubble is to not change your asset allocation or investment philosophy. Conversely, if you feel certain about both the existence of a bubble and how it will burst, you may want to see if your certitude is warranted given your metric.
Europe leads markets lower
Summary:
- Europe retreats as the Ukraine/Russia crisis escalates.
- S&P 500 displays milder selling pressure and the primary trend remains intact.
- VIX continues to indicate a bull market.
- China’s Shanghai Composite is bullish in the medium-term.
- ASX 200 may experience a secondary correction, but the primary trend displays buying support.
European leaders are waking up to the seriousness of the menace posed by Russia in the East, summed up in a recent Der Spiegel editorial:
Europe, and we Germans, will certainly have to pay a price for sanctions. But the price would be incomparably greater were Putin allowed to continue to violate international law. Peace and security in Europe would then be in serious danger.
Vladimir Putin will not alter course because of a light slap on the wrist. President Obama is going to have to find Teddy Roosevelt’s “big stick” — misplacement of which is largely responsible for Russia’s current flagrant disregard of national borders. And Europe is going to have to endure real pain in order to face down the Russian threat in the East. Delivery of French Mistral warships, for example, would show that Europe remains divided and will encourage the Russian bear to grow even bolder.
Russian Deputy Prime Minister Dmitry Rogozin said, however, that he doubted France would cancel the deal, despite coming under pressure from other Western leaders: “This is billions of euros. The French are very pragmatic. I doubt it [that the deal will be canceled].”
— The Moscow Times
The whole of Europe is likely to have to share the cost of cancelling deals like this, but it is important to do so and present a united front.
Markets reacted negatively to the latest escalation, with Dow Jones Europe Index falling almost 6% over the last month. 13-Week Twiggs Momentum dipped below zero after several months of bearish divergence, warning not necessarily of a primary down-trend, but of a serious test of primary support at 315. Respect of 325 and the rising trendline would reassure that the primary trend is intact.
The S&P 500 displays milder selling pressure on 13-week Twiggs Money Flow and the correction is likely to test the rising trendline and support at 1850/1900, but not primary support at 1750. Respect of the zero line by 13-week Twiggs Money Flow would signal a buying opportunity for long-term investors. Recovery above 2000 is unlikely at present, but breakout would offer a (long-term) target of 2250*.
* Target calculation: 1500 + ( 1500 – 750 ) = 2250
CBOE Volatility Index (VIX) spiked upwards, but remains low by historical standards and continues to suggest a bull market.
China’s Shanghai Composite Index broke resistance at 2150, suggesting a primary up-trend, but I will wait for confirmation from a follow-through above 2250. Rising 13-week Twiggs Money Flow indicates medium-term buying pressure. Reversal below 2050 is unlikely at present but would warn of another test of primary support at 1990/2000. The PBOC is simply kicking the can down the road by injecting more liquidity into the banking system. That may defer the eventual day of reckoning by a year or two, but it cannot be avoided. And each time the problem is deferred, it grows bigger. So the medium-term outlook may be improving, but I still have doubts about the long-term.
* Target calculation: 2000 – ( 2150 – 2000 ) = 1850
The ASX 200 is likely to retrace to test the rising trendline around 5450, but 13-week Twiggs Money Flow holding above zero continues to indicate buying support. Recovery above 5600 is unlikely at present, but would present a target of 5800*. Reversal below 5050 would signal a trend change, but that is most unlikely despite current bearishness.
* Target calculation: 5400 + ( 5400 – 5000 ) = 5800
What caused the Dow sell-off?
Dow Jones Industrial Average fell 1.88% to close at 16563, breach of 16750 warning of a secondary correction. Decline of 21-day Twiggs Money Flow below zero would strengthen the signal. Breach of primary support at 15500 is unlikely and the trend remains upward.
* Target calculation: 16500 + ( 16500 – 15500 ) = 17500
The S&P 500 also fell sharply. Reversal below 1950 warns of a test of medium-term support at 1900. Breach of primary support at 1750 again appears unlikely.
* Target calculation: 1500 + ( 1500 – 750 ) = 2250
The CBOE Volatility Index (VIX) spiked up, but remains below 20 — values normally associated with a bull market.
What caused the sell-off? Commentators seem puzzled. Theories advanced vary from Argentinian default to developments in Eastern Europe. Neither of these seem to hold much water: the market has been aware of the risks for some time and they should be largely discounted in current prices. My own preferred theory is the expectation of a rate rise from the Fed. With good GDP numbers and falling unemployment the Fed may be tempted to tighten a lot sooner than originally expected. Even oil prices are falling. High crude prices is one of the reasons for the cautious Fed taper so far.
Which makes me suspect that this correction is going to end like the last “taper tantrum” — with a strong rally when the market realizes that economic recovery will lift earnings.
Treasury market volatility climbs
From Susanne Walker and Lucy Meakin, Bloomberg:
Treasuries dropped, with 10-year note yields reaching the highest level in three weeks, as monthly jobless claims at the lowest level in eight years added to evidence the employment market is strengthening.
U.S. government debt was poised for the biggest monthly drop since March on bets the Federal Reserve will raise interest rates after second quarter economic growth surged past analysts’ forecasts.
The stock market frets that interest rates may rise ….because the economy is recovering and unemployment is falling. And this is bad news?
Read more at Treasury market volatility climbs.
Shilling: Big Banks Shift to Lower Gear | The Big Picture
Gary Shilling describes how US regulators are getting tough with big banks:
Break-Up
Like unscrambling an egg, it’s hard to envision how big banks with many, many activities could be split up. But, of course, one of the arguments for doing so is they’re too big and too complicated for one CEO to manage. Still, there is the example of the U.K., which plans to separate deposit-taking business from riskier investment banking activities – in effect, recreating Glass-Steagall.
In any event, among others, Phil Purcell believes that “from a shareholder point of view, it’s crystal clear these enterprises are worth more broken up than they are together.” This argument is supported by the reality that Citigroup, Bank of America and Morgan Stanley stocks are all selling below their book value Chart 5. In contrast, most regional banks sell well above book value.
Push Back
Not surprising, current leaders of major banks have pushed back against proposals to break them up. They maintain that at smaller sizes, they would not be able to provide needed financial services. Also, they state, that would put them at a competitive disadvantage to foreign banks that would move onto their turf.The basic reality, however, is that the CEOs of big banks don’t want to manage commercial spread lenders that take deposits and make loans and also engage in other traditional banking activities like asset management. They want to run growth companies that use leverage as their route to success. Hence, their zeal for off-balance sheet vehicles, proprietary trading, derivative origination and trading, etc. That’s where the big 20% to 30% returns lie – compared to 10% to 15% for spread lending – but so too do the big risks.
Capital Restoration
….the vast majority of banks, big and small, have restored their capital….Nevertheless, the FDIC and Federal Reserve are planning a new “leverage ratio” schedule that would require the eight largest “Systemically Important Banks” to maintain loss-absorbing capital equal to at least 5% of their assets and their FDIC-insured bank subdivisions would have to keep a minimum leverage ratio of 6%. This compares with 3% under the international Basel III schedule. Six of these eight largest banks would need to tie up more capital. Also, regulators may impose additional capital requirements for these “Systemically Important Banks” and more for banks involved in volatile markets for short-term borrowing and lending. The Fed also wants the stricter capital requirements to be met by 2017, two years earlier than the international agreement deadline….
CEO remuneration is largely driven by bank size rather than profitability, so you can expect strong resistance to any move to break up too-big-to-fail banks. Restricting bank involvement in riskier enterprises — as with UK plans to separate deposit-taking business from riskier investment banking activities — may be an easier path to protect taxpayers. Especially when coupled with increased capital requirements to reduce leverage.
Read more at Shilling: Big Banks Shift to Lower Gear | The Big Picture.
Canada: TSX 60 at 2008 high
Canada’s TSX 60 is testing its 2008 high at 900. Rising 13-week Twiggs Money Flow troughs above zero indicate strong buying pressure. Expect resistance at 900, but this is unlikely to hold. Reversal below the rising (secondary) trendline is not expected, but would warn of a correction to 800/820.
Dow and S&P 500 remain bullish
Dow Jones Industrial Average found support at 16950, with long tails indicating short-term buying pressure. Recovery above 17075 would indicate a fresh advance; above 17150 would confirm. A close below 16950 is less likely, but would warn of a correction to 16500. The decline of 21-day Twiggs Money Flow indicates mild selling pressure typical of a consolidation.
* Target calculation: 16500 + ( 16500 – 15500 ) = 17500
The S&P 500 also displays a long tail indicative of buying pressure. Recovery above 1985 would indicate another attempt at 2000. Further consolidation below the 2000 resistance level is likely. Reversal below 1950, however, would warn of a correction to 1900.
* Target calculation: 1500 + ( 1500 – 750 ) = 2250
The CBOE Volatility Index (VIX), trading at low levels last seen in 2005/2006, is typical of a bull market.
Is unemployment really falling?
US unemployment has fallen close to the Fed’s “natural unemployment rate” of close to 5.5%. Does that mean that all is well?
Chart: The unemployment rate vs. Fed's measure of "natural" unemployment rate (NAIRU) over the past 20 years – pic.twitter.com/zq2fxtcHLt
— SoberLook.com (@SoberLook) July 28, 2014
Not if we consider the participation rate, plotted below as the ratio of non-farm employment to total population.
Participation peaked in 2000 at close to 0.47 (or 47%) after climbing for several decades with increased involvement of women in the workforce. But the ratio fell to 0.42 post-GFC and has only recovered to 0.435. We are still 3.5% below the high from 14 years ago.
When we focus on male employment, ages 25 to 54, we exclude several obscuring factors:
- the rising participation rate of women;
- an increasing baby-boomer retiree population; and
- changes in the student population under 25.
The chart still displays a dramatic long-term fall.
A compassionate conservative: Arthur C. Brooks
Bill Moyers interviews the American Enterprise Institute’s president Arthur C. Brooks on how to fight America’s widening inequality.
“The problem is we have a bit of a conspiracy between the right and left to have people now who are tending to be more part of the machine…We need a new kind of moral climate for our future leaders.”
Bill Moyers seems a bit light on the economics of the Walmart situation. Raising the minimum wage would reduce welfare payments to Walmart employees, but WMT is a rational entity with the primary goal of maximizing profits and shareholder value. An increase in the minimum wage would increase the appeal of automation and result in a reduction in staff numbers, causing an increase in unemployment, or alternatively WMT will pass on the additional cost in the form of increased prices to consumers, causing a rise in inflation. The only sustainable long-term solution is not an easy one: to increase economic growth and employment so that market-driven wage rates rise. Interference with the pricing mechanism in a market — whether through legislated minimum wages, price controls or Fed interest rates — is misguided and unsustainable. It may defer but also amplifies the original problem.