Economy Archives - Page 66 of 135 - the patient investor

August 22, 2014

Putin antics fail to impress markets

For all his macho posturing, Vladimir Putin has demonstrated an inability to move financial markets with his antics in Eastern Ukraine. His latest incursion towards Luhansk, with white-painted military trucks bearing aid to the rebel-held city, unchecked by the Red Cross, passed barely noticed. Instead markets are intently focused on nuances from a 68-year old Jewish mum at Jackson Hole, who also happens to chair the Federal Reserve.

I would have loved to call Janet Yellen a “grandmother”, but son Robert Akerlof — himself a PhD in Economics — does not claim any offspring on his CV. The apple doesn’t fall far from the tree. Husband, George Akerlof, is a Nobel prize-winning economist and professor emeritus at University of California, Berkeley.

The image below highlights the differences between the Fed and the ECB:

European unemployment is nearly twice the rate in the U.S.: http://t.co/ELXH1YcCcw pic.twitter.com/i5FQ1YvXBk

— Bloomberg News (@BloombergNews) August 22, 2014

The Fed’s more stimulatory approach has paid dividends in terms of economic growth and employment while inflation expectations remain muted. The inflation breakeven rate — 10-year Treasury yield minus the yield on equivalent inflation-indexed securities — continues to range between 2.0% and 2.50%.

Inflation breakeven rate

The ECB’s more austere approach, on the other hand, has caused a world of pain.

Market update

S&P 500 tests 2000.
VIX continues to indicate a bull market.
DAX hesitant rally.
China bullish.
ASX 200 faces strong resistance.

The S&P 500 hesitated after making a new high on Thursday, but there was no dramatic fall in response to news from Eastern Ukraine. Expect retracement towards 1950, followed by another test of 2000. 21-Day Twiggs Money Flow is likely to re-test the zero line, but respect would indicate strong buying pressure. Breach of support at 1900, warning of a reversal, remains unlikely.

S&P 500

* Target calculation: 1500 + ( 1500 – 750 ) = 2250

Declining CBOE Volatility Index (VIX) indicates low risk, typical of a bull market.

S&P 500 VIX

Germany’s DAX rallied above 9300 on the weekly chart, but 13-week Twiggs Money Flow warns of continued selling pressure. Reversal below support at 8900/9000 would warn of a primary down-trend.

DAX

* Target calculation: 9000 – ( 10000 – 9000 ) = 8000

Shanghai Composite Index is testing resistance at 2250. Breakout would confirm a primary up-trend, signaling an advance to 2500*. Rising 13-week Twiggs Money Flow indicates medium-term buying pressure. Respect of resistance, however, would suggest further consolidation.

Shanghai Composite Index

* Target calculation: 2250 + ( 2250 – 2000 ) = 2500

Tall wicks on ASX 200 daily candles indicate strong resistance at 5650. Respect would suggest retracement to 5550, while follow-through would be a strong bull signal, suggesting an advance to 5850*. Another 21-day Twiggs Money Flow trough above zero would indicate long-term buying pressure. Reversal below 5450 is unlikely, but would warn of a test of primary support.

ASX 200

* Target calculation: 5650 + ( 5650 – 5450 ) = 5850

August 22, 2014

Bank chiefs in last-ditch plea to David Murray on tougher rules | The Australian

From Richard Gluyas at The Australian:

THE four major-bank chief executives have each made an eleventh-hour appeal to members of the Murray financial system inquiry ahead of Tuesday’s closing date for final submissions, as concerns mount that the sector could be forced to hold even higher levels of bank capital due to the inquiry’s emphasis on resilience. The closed-door meetings with the inquiry panel members come as Steven Munchenberg, chief executive of peak lobby group the Australian Bankers’ Association, said the industry was “jittery” about the inquiry’s focus on balance-sheet resilience because more onerous capital requirements would affect the banks’ ability to lend and serve the economy.

I disagree. Banks with strong balance sheets are better able to serve the needs of the economy. Highly leveraged banks leave the economy vulnerable to a financial crisis and are more likely to contract lending during periods of economic stress.

The shrill outcry may have something to do with the impact on bankers bonuses. Incentives based on capital employed would shrink if shareholder’s capital is increased.

Bank shareholders on the other hand are likely to benefit from stronger balance sheets. Reduced default risk is likely to enhance market valuation metrics like price-earnings multiples. Reduced risk premiums will also lower cost of funding and enhance lending margins. And shareholders are also likely to benefit from enhanced growth prospects. Analysis by the Bank for International Settlements in the post crisis period shows banks with higher capital ratios experience higher asset and loan growth.

August 22, 2014

Bank Watch: US Tsy’s OFR Finds Risk Weighting Has No Clothes | MNI

Denny Gulino writes on recent research commissioned by Treasury Department’s Office of Financial Research (“OFR”) to investigate the validity of using risk-weightings to determine bank capital requirements:

On risk weighting, OFR commissioned researchers Paul Glasserman at Columbia University and Wanmo Kang of the Korea Advanced Institute of Science and Technology to examine the subject from the ground up. As much as the practice has been incorporated in regulatory parlance, they were able to find very little other research on the validity of the weighting methodology.

“Risk weights implicitly assign prices in terms of additional capital to asset categories and thus inevitably create incentives for banks to choose some assets over others,” they wrote.

“Surprisingly,” they went on, “the ideal risk weights turn out to have little to do with risk and are instead proportional to the profitability on each asset.”

August 22, 2014

Paul Krugman: Hawks Crying Wolf | NYTimes.com

According to a recent report in The Times, there is dissent at the Fed: “An increasingly vocal minority of Federal Reserve officials want the central bank to retreat more quickly” from its easy-money policies, which they warn run the risk of causing inflation…

…The Times article singles out for special mention Charles Plosser of the Philadelphia Fed, who is, indeed, warning about inflation risks. But you should know that he warned about the danger of rising inflation in 2008. He warned about it in 2009. He did the same in 2010, 2011, 2012 and 2013. He was wrong each time, but, undaunted, he’s now doing it again…

August 17, 2014

The Joseph Cycle: 7 Fat years and 7 lean years

George Dorgan writes:

Since both the positive and the negative phases of a financial cycles take around seven years, financial cycles are sometimes called “Joseph cycle“, from the biblical prophet Joseph that speaks of seven good and seven bad years. The financial cycle connected to expectations about real estate prices, is also called credit cycle…..After the bust of dot com bubble in 2001, the Fed lowered interest rates. Credit was easily available and private debt strongly increased. Government debt remained relatively stable.

Only in few countries like Germany, Japan or Switzerland people were far more cautious, because they had seen a real estate bubble bust in the 1990s. The leveraging phase finally ended in 2011, in China and in some other emerging markets…..

We think that the reduction of debt will continue to be the main driver of global economies during the next Joseph cycle, in the next seven years. After the US lowered debt levels until 2011/2012 it is now time for Europe except Germany and Switzerland and Emerging Markets….

August 17, 2014

GOLDMAN: Here’s The Simple Reason We’re Probably Not About To Have Another Huge Crash | Business Insider

From Joe Weisenthal:

Historical analysis of past big busts done by top economist Jan Hatzius and Sven Jari Stehn shows that while there is growing risk of a stock market drop because of the big rally we’re missing one of the key preconditions needed for a true bust: high credit growth.

They write: “[C]redit growth is the most important predictor of house price busts, especially when we focus on busts that involve a recession. House price busts have also tended to follow periods of high inflation, high equity volatility and large current account deficits, although all of these effects become less pronounced when we focus on recessionary busts….”

via GOLDMAN: Here's The Simple Reason We're Probably Not About To Have Another Huge Crash | Business Insider.

August 15, 2014

Secular stagnation?

Economic recovery after the Great Recession has been disappointing.

Employment levels remain low. Official unemployment figures ignore the declining participation rate. Employment levels, in the 25 to 54 age group, for males remain roughly 6%, and females 5%, below their previous peaks. Using the 25 to 54 age group eliminates distortions from student levels and from baby boomers postponing retirement.

Employment levels

Manufacturing earnings, as would be expected, are also weak.

Manufacturing earnings

Sales growth remains poor.

Sales growth

And real GDP growth is slow.

Real GDP

US Headwinds

Stanley Fischer, Vice Chairman at the Fed, in his address to a conference in Sweden, attributed slow recovery in the US to three major aggregate demand headwinds:

The housing sector

The housing sector was at the epicenter of the U.S. financial crisis and recession and it continues to weigh on the recovery. After previous recessions, vigorous rebounds in housing activity have typically helped spur recoveries. In this episode, however, residential construction was held back by a large inventory of foreclosed and distressed properties and by tight credit conditions for construction loans and mortgages. Moreover, the wealth effect from the decline in housing prices, as well as the inability of many underwater households to take advantage of low interest rates to refinance their mortgages, may have reduced household demand for non-housing goods and services. Indeed, some researchers have argued that the failure to deal decisively with the housing problem seriously prolonged and deepened the crisis.

A slow housing recovery is unfortunately the price you pay for protecting the banks. By supporting house prices through artificial low interest rates, you prevent markets from clearing excess inventories.

Fiscal policy

The stance of U.S. fiscal policy in recent years constituted a significant drag on growth as the large budget deficit was reduced. Historically, fiscal policy has been a support during both recessions and recoveries. In part, this reflects the operation of automatic stabilizers, such as declines in tax revenues and increases in unemployment benefits, that tend to accompany a downturn in activity. In addition, discretionary fiscal policy actions typically boost growth in the years just after a recession. In the U.S., as well as in other countries — especially in Europe — fiscal policy was typically expansionary during the recent recession and early in the recovery, but discretionary fiscal policy shifted relatively fast from expansionary to contractionary as the recovery progressed.

Anemic exports

A third headwind slowing the U.S. recovery has been unexpectedly slow global growth, which reduced export demand. Over the past several years, a number of our key trading partners have suffered negative shocks. Some have been relatively short lived, including the collapse in Japanese growth following the tragic earthquake in 2011. Others look to be more structural, such as the stepdown in Chinese growth compared to its double digit pre-crisis pace. Most salient, not least for Sweden, has been the impact of the fiscal and financial situation in the euro area over the past few years.

Supply-side

Fischer also cites the weak labor market, declining investment and disappointing productivity growth as inhibiting aggregate production.

While I agree with his view of the labor market, we should not use the heady days of the Dotcom bubble as a benchmark for investment. Private nonresidential investment is recovering.

ASX 200 Corrections

Productivity is also growing.

Productivity

Other factors

There are two factors, however, that Fischer did not mention which, I believe, go a long way to explaining slow US growth.

Crude oil prices

In the last 4 decades, sharp rises in real crude oil prices have coincided with falling GDP growth and, in most cases, recessions. Crude prices remain elevated since the Great Recession and, I believe, are retarding economic growth. The blue line on the graph below plots crude oil (WTI) over the consumer price index (CPI).

WTI Crude

Currency manipulation

China continues its aggressive purchase of US Treasuries in order to maintain a competitive advantage of the Yuan against the Dollar. Inflows on capital account — not only from China — include roughly $5 trillion of federal debt purchased since 2001. This keeps the US uncompetitive in export markets and places domestic manufacturers at a disadvantage when competing against imports.

Foreign Holdings of US Federal Securities

Recent purchases of federal debt are sufficient to drive 10-Year Treasury yields through support at 2.40%/2.50%.

10-Year Treasury Yields

Glass half empty or half full?

Bears will no doubt seize on the headwinds to support their prediction of another market crash. I am reassured, however, that the economy has recovered as well as it has, given the difficulties it faces. None of the headwinds are likely to disappear any time soon, but progress in addressing these last two issues would go a long way to solving many of them.

August 10, 2014

European Depression | Business Insider

Joe Weisenthal quotes Carl Weinberg of High Frequency Economics:

For Euroland, the big picture is that the economy is in its seventh year of depression. On our estimate of a 0.7% contraction in the second quarter, GDP was still 3.2% lower than it was in the first quarter of 2008, when the depression began. Euroland’s economy actually contracted in the first quarter of this year when you exclude Germany’s unexpected surge to a 3.3% annualized rate of growth. Only people who were misled by Markit’s untested and unproven PMIs believed that such growth was real and sustainable. Our estimate of second quarter GDP for the Euro Zone includes a contraction of Germany’s economy at a 2% annualized rate, reversing the windfall in the unexplained and inexplicable first quarter spurt. If our forecast proves correct, average GDP growth for Germany in the first half of 2014 will work out to 0.7% at an annualized rate, clearly less than potential but very much in line with the experience over the last few years. Our estimate for France’s economy is a more horrible contraction of 1.1% for the quarter, or 4.3% at an annualized rate.

The European Central Bank (ECB) has been shrinking its balance sheet since 2012 while the Fed has been expanding. Not hard to figure out why the Monetary Union (EMU) is undergoing a contraction.

ECB Total Assets

Especially when private (nonfinancial) credit is contracting.

Euro Area Private Nonfinancial Credit from Banks

August 10, 2014

Is a Hard Life Inherited? | NYTimes.com

Nicholas Kristof writes in the New York Times:

ONE delusion common among America’s successful people is that they triumphed just because of hard work and intelligence. In fact, their big break came when they were conceived in middle-class American families who loved them, read them stories, and nurtured them with Little League sports, library cards and music lessons. They were programmed for success by the time they were zygotes.Yet many are oblivious of their own advantages, and of other people’s disadvantages.

….This crisis in working-class America doesn’t get the attention it deserves, perhaps because most of us in the chattering class aren’t a part of it.

There are steps that could help, including a higher minimum wage, early childhood programs, and a focus on education as an escalator to opportunity. But the essential starting point is empathy.

August 10, 2014

Australia’s Major Banks Say The Murray Enquiry Used The Wrong Numbers… | Business Insider

From Greg McKenna:

The AFR reports ….the Australian Bankers Association CEO Steven Munchenberg said the banks are “concerned that if some of the statements in the interim report – that Australia’s capital is middle of the road, that housing is a systemic risk – are allowed to remain unchallenged and are then taken out of context that is going to cause us a lot of future grief”.

Munchenberg says the Inquiry hasn’t calculated the capital ratios correctly.

“The approach was simplified and didn’t take into account the complexities and nuances of how capital is determined in Australia, including deductions required by APRA and some of the areas where APRA has adopted a more conservative approach, and as a result underestimated the amount of capital in Australia relative to overseas”, he told the AFR.

Forget the nuances and comparisons to the plight of other banks. Australian banks need to almost double their capital and adopt a more conservative approach to home mortgage lending if they are to withstand future shocks. 3 to 5 percent capital against total exposure doesn’t get you very far. The history of low mortgage failures over the last 3 decades, in an expansionary phase of the credit market, is unlikely to be repeated during a contraction.