Our trading partner Chris Vermeulen just shared with us his take on what most traders are missing when it comes to market rotation. It's a great reminder of what so many of us did so wrong not to long ago. Let's play this different this time.
If you remember the dot com bubble as clearly as I do and are a technical analyst then you will recall the month which the NASDAQ broke down and confirmed a new bear market has started. The date was November of 2000.
You may be wondering why I bring this up. What do tech stocks have to do with commodities?
Good question because they have nothing in common. But the key here is that when a bull market ends in one asset class that money is shifted into another. That money moved into commodities and resource stocks and in a big way. Precious metals and miners exploded, surging an average of 1000% return (10 times ROI) over the next six years, topping out in 2008. In fact, these resource stocks bottom the exact month which the NASDAQ confirmed it was in a bear market on Nov 2000.
Compare Dot-Com Bubble & Burst to Precious Metals Stocks
Over the next couple of weeks, I will be sharing some of my top stock picks in the metals sector (gold, silver, nickel, and copper). If you missed the 2001 and 2008 metals bull market then you best pay attention and be sure you don’t miss what is about to happen.
Read Chris' entire post and chart work here > Time to Move Capital into Next Bull Market – Part I
Get our latest FREE eBook "Understanding Options"....Just Click Here!
Showing posts with label analyst. Show all posts
Showing posts with label analyst. Show all posts
Thursday, June 11, 2015
Thursday, November 20, 2014
Cut Trading Risk and Increase Reward with a Strategy I Know You're not Using
"Whoa, completely changed my mindset on ETFs"
Those are two quotes from people who watched John Carter's latest video on trading options on ETFs: John's Favorite Ways to Trade Options On ETFs
He shows you how his strategy allows you to cut risk, increase rewards, and grow your account [of any size we might add] using options on ETFs.
Don't worry...it's VERY clear and easy to apply (Watch Video)
John also shows you....
* Why trading options on ETFs cuts your risk so you can sleep at night
* How you can profit with ETFs from the unexpected move in the dollar
* Why you avoid the games high frequency traders play by trading ETFs
* Why most analysts have the next move in the dollar wrong and how to protect your investments
* What are some of the markets that will be impacted by the dollars next move
This is crucial information that I highly recommend you take the time to review...it's FREE after all.
Stream the video HERE
See you in the markets putting this to work,
Ray's Stock World
Get our latest FREE eBook "Understanding Options"....Just Click Here!
Labels:
analyst,
Dollar,
etfs,
John Carter,
options,
Simpler Options,
strategy,
traders,
Trading,
Video
Thursday, July 24, 2014
When All You Have Left Is the Cost of Breakfast at McDonald’s
By Dennis Miller
When I was 20 years old, I sat through my first day of a business law course at Northwestern University. The professor began by writing two words on the blackboard (in the prehistoric days of blackboards and chalk): Caveat emptor. He raised his voice and said, “Let the buyer beware!” I’m here to echo his warning, but this time it’s about annuities.Annuities are at the top of the list of complicated products that often profit insurance companies without adequately compensating the buyer in return. Put plainly, sometimes you don’t get what you thought you paid for.
And, while annuities are often described as a “transfer of risk,” which is basically correct, owning an annuity will not transfer the risk of one of the greatest hazard’s to a retiree’s financial security: inflation. Inflation isn’t the only risk to worry about—lack of liquidity and insurance company default should also top your list of concerns—but it can be the most treacherous for someone with an annuity heavy portfolio.
Will an annuity protect your lifestyle? In the short term, it might. If you believe the Federal Reserve when it says it will keep inflation at 2% or less, perhaps it will for a period of time. Even then, inflation will eat away at the buying power of your annuity payout fairly quickly. You are contractually guaranteed income; however, that does not guarantee your lifestyle.
To see the effect, my analysts and I charted the purchasing power of a single premium immediate lifetime annuity with installment refund, which pays $583.33 per month. We’ve compared several inflation scenarios: the currently tame 2% inflation rate; the long run average of about 3%; and the possibility of things getting considerably worse at 7% inflation. We’re not even talking about hyperinflation—just reasonable estimates.
Even at the low 2% inflation rate, your $583.33 benefit would only have the purchasing power of $392.56 after 20 years. In the 7% inflation scenario, the purchasing power would be down to $150.74. Let’s put this into context.
The average U.S. electricity bill is around $103.67. The average cellphone bill is $111. According to the USDA, an elderly household of two that’s being extremely thrifty could get its monthly grocery bill down to as low as $357.30 per month. In total, that’s $571.97 – leaving just enough for a McDonald’s breakfast.
Right off the bat, that isn’t so bad. The annuity takes care of the cellphones, the electricity, the groceries, and leaves a little extra. However, after 20 years at 2% inflation and a purchasing power of $392.56, the benefit would only be enough to pay for the thrifty grocery budget, leaving only $35.26 left over. Though your annuity benefits are the same, prices have risen, so now you have less purchasing power.
After 20 years of 3% inflation, it gets even worse. With $219.85 in purchasing power, you’ll have to weigh either purchasing 2/3 of your usual groceries against paying the electricity and phones. You won’t be able to do it all. By the third year, you will need to add funds to your annuity payment to cover those expenses.
And under the 7% scenario, you’ll only be able to pay for the electricity bill with less than $50 in purchasing power left over. That’s hardly the lifetime income most annuity buyers had in mind.
Furthermore, consider that our assumptions are a little optimistic. In all likelihood, your electricity and grocery bills will probably rise faster than the rate of inflation. If that’s the case, then you’d be in real trouble.
So, while annuities promise guaranteed income, they certainly do not guarantee what that income will afford you in the future.
Annuity policies can be structured with inflation protection, but those options are expensive in terms of the lower initial payments. With benefits starting so much lower, you would have to live an exceptionally long time to make them work out.
Depending on your circumstances, an annuity might play a useful role in your long-term financial plans. There is much to be said for transferring some risk to a quality insurance company. However, transfering one risk without planning for another could be catastrophic. Even something like a 5% inflation rider might not protect you if higher inflation rates become a reality. If a considerable portion of your portfolio is in annuities, then another portion needs to be balanced to fight inflation, with holdings such as precious metals.
While it’s impossible to make the risk of inflation go away, there are a few simple things you can do to minimize it:
- Never hold a very large portion of your portfolio in annuities. If high inflation picks up you could be entirely cleaned out.
- If you’re holding annuities, make sure that another part of your portfolio is geared to hedge against inflation.
Get the full truth on annuities by downloading your complimentary copy of Annuities De-Mystified today.
The article When All You Have Left Is the Cost of Breakfast at McDonald’s was originally published at Millers Money
Another must read from Adam J. Crawford....The Rise of Africa… and How To Play It
Labels:
analyst,
annuity,
Dennis Miller,
Federal Reserve,
hedge,
hyperinflation,
inflation,
McDonalds,
money,
portfolio,
rates,
Stocks
Tuesday, July 22, 2014
Beware of Flashy Stock Repurchases When The Market Is on The Rise
By Andrey Dashkov
Retail giant Bed Bath & Beyond just announced plans to buy back another $2 billion in shares, which the company will start doing after it completes its current share repurchase program. You’ve seen it before: Press releases emphasize that buybacks return value to shareholders, analysts sometimes rely on repurchases to spot a stock to write up next, and management likes to tout their focus on shareholder returns. But what’s the real story? Why would a company buy its own shares?There are but a few situations when returning cash to shareholders instead of paying dividends or investing in new projects is prudent:
- The company has largely exhausted investment opportunities that would generate a positive net present value (NPV).
- The stock is trading below its intrinsic value; or
- The tax on dividends is so high compared to the capital gains tax that it makes sense to boost the share price and let shareholders enjoy the extra return instead of receiving heavily taxed dividends.
First, management’s compensation is often based on share price performance or earnings based metrics like earnings per share (EPS), which buybacks are designed to boost.
Second, higher share price increases the value of a company’s options. Managers are often shareholders, too, but unlike you and me, they have direct access to the Treasury. When managers own a lot of their own company’s stock, they may have too much skin in the game. This may skew their preferences toward increasing the share price at the expense of long term business growth.
Third, share buybacks became a standard (and often abused) signal to the market that: a) the company’s stock is undervalued, and b) that management takes care of the shareholders. Both of these statements may be correct in isolation, based on the company’s fundamentals and management practices. Nonetheless, a buyback should not convince you that either is true.
One additional reason is often overlooked. Many a CEO has been fired for an acquisition that did not work out. When the decision is made to dump the acquisition, it is accompanied by a write off against earnings, sometimes worth billions of dollars. Wall Street armchair quarterbacks are quick to point out how much better off shareholders would have been if they had just paid out what they lost in dividends. Buying back company shares, with all the accompanied hoopla, is less likely to be a career threatening move.
Linking the two subjects together makes for nice copy; however, keep it in perspective. For example, a technology company that realizes their product line is becoming obsolete will often make acquisitions to increase their product line market share, or move them into a new business with long term potential. Buying back company stock, then having to go into the market and borrow at high interest rates, might be the exact wrong move. The key is making the right acquisitions for the company to continue to grow and pay dividends for the next generation.
In fact, managers have proven to be pretty bad stock pickers even when they have only one stock to pick. As my colleague Chris Wood showed in A Look at Stock Buybacks, managements have bought shares of their own companies at pretty bad times in the past. Moreover, the expectations of higher valuation based on higher EPS did not always materialize. Even though a lot of investors use P/E as their main gauge of value (which they shouldn’t), there is no convincing evidence that buybacks can support high valuation multiples in the long term.
Your Bottom Line
History has shown that the only value-creating buybacks were the ones carried out when stocks were deeply undervalued. In those instances, the repurchases helped companies outperform the market. But overall the optimism and confidence inducing press releases that accompany buybacks should be taken with a huge grain of salt.
As a rule of thumb, beware of increased buybacks when the market is on the rise (everybody is an investment guru when everything is going up) or when management compensation is closely tied to the share price performance or earnings based metrics. Companies with better corporate governance may fare better when it comes to managing conflicts of interest, but there is a significant vested interest there that investors should be aware of. Don’t mistake noise for a sign is all.
When it comes to returning value to shareholders, we appreciate companies that invest in long term projects—or pay dividends. Despite the potential tax implications, the yield strapped investors may be better served with a special dividend these days than with a promise of a better price in the future.
Learn more ways to cut through press rhetoric by signing up for our free weekly e-letter, Miller’s Money Weekly, where my colleagues and I share timely financial insight tailored for seniors and conservative investors alike.
Sign up here, and we’ll send a complimentary copy straight to your inbox every Thursday
The article Beware of Flashy Stock Repurchases When The Market Is on The Rise was originally published at Millers Money
Get the complete schedule for the Premier Trader University free trading webinars....Just Click Here!
Labels:
analyst,
Andrey Dashkov,
CEO,
Crude Oil,
Dividends,
earnings,
investing,
Miller's Money,
tax,
Trading
Wednesday, July 2, 2014
5 Simple Rules to Evolve Past the Hot Stock List
By Andrey Dashkov
If you’re a typical small time investor, chances are you prefer to let a team of analysts fuss about such irksome things as correlation and beta. Maybe you’ve bought a stock because your brother in law gave you a hot tip, maybe you heard something about it on a financial news show, or maybe you just loved the company’s product.Friends often ask me for “hot stock tips”—which is like walking up to someone at the craps table and asking what number to bet on. An accomplished craps player will have position limits, stop losses, income targets, and an overall strategy that does not hinge on one roll of the dice. You need an overall strategy long before you put money down.
So, what do I tell those friends asking for hot stock tips? Well, that they can retire rich with a 50-20-30 portfolio:
- Stocks. 50% in solid, diversified stocks providing healthy dividends and appreciation.
- High Yield. 20% in high yield, dividend paying investments coupled with appropriate safety measures. These holdings are bought for yield; any appreciation is a nice bonus.
- Stable Income. 30% in conservative, stable income vehicles.
The Art of the Pick
By the time an investment lands in our portfolio, we’ve already run it through our Five Point Balancing Test. When your boasting brother in law tempts you with a “can’t-miss opportunity” or some pundit touts a hot tech company on television, you can come back to these five points, again and again.
- Is it a solid company or investment vehicle? Investing your retirement money safely is a must. How do you know if a company is solid? Take the time to validate essential company information, particularly when the recommendation comes from a source with questionable motivation.
- Does it provide good income? A good stock combines a robust dividend and appreciation potential.
- Is there a good chance for appreciation? There are two types of appreciating stocks: those that rise because of general market conditions and those that rise further because of the way management runs the business. We want both.
- Does it protect against inflation? High inflation is one of the biggest enemies of a retirement portfolio.
- Is it easily reversible? Ask yourself, “Can I quickly and easily reverse this investment if something unexpected occurs?” The ability to liquidate inexpensively is critical to correcting errors.
Marking the Bull’s Eye So You Can Hit It
It’s worthwhile to write down your goal—including an income target and the price at which you’ll sell if things head south—with every investment. After all, if you can’t see the bull’s eye, how will you know if you’ve hit it? Buying any investment because a trusted adviser, newsletter, or pundit recommended it is not a good enough reason. Buying because your portfolio has a hole, you understand the company, the investment vehicle, the risks, and the potential is.
Remember, retiring rich means having enough money to enjoy your lifestyle without money worries. Do your homework on every investment and you’ll make that pleasant thought your life’s reality. Every week, the Miller’s Money team provides no nonsense, practical advice about the best ways to invest for your retirement in Miller’s Money Weekly Sign up here to receive it every Thursday.
The article 5 Simple Rules to Evolve Past the Hot-Stock List was originally published at Millers Money
Get your seat for our next free webinar "Low VIX and What It Means to Your Trading"....Just Click Here!
Labels:
analyst,
Andrey Dashkov,
dividend,
income,
investment,
newsletter,
portfolio,
stock,
Stocks,
yield
Wednesday, June 4, 2014
Investing in China....Looking at the Middle Kingdom with Fresh Eyes
By John Mauldin
I am writing this introductory note from London during a layover on my way to Rome, and I’ll append a personal ending tonight after I finally make my way back from dinner to the hotel.
Editors’ note: With John up to his eyeballs in prosecco and peaches there on the patio in Trequanda this morning and with Worth just getting the sleep out of his eyes in Houston, we are hereby making an executive decision to split this 22 page beast masterpiece right up its middle and bring you the second half next week … which will give both these guys some well earned rest! – Charley & Lisa Sweet
More Questions Than Answers
Although John and I spend hours every week searching for the truth in a murky stream of official and unofficial reports, we always reach the same conclusion about the People’s Republic: There is really no way to know what is happening in China today, much less what will happen tomorrow, based on widely available data. The primary data is flawed at best and manipulated at worst. Sometimes the most revealing insights lie in the disagreement between the official and unofficial reports… suggesting that official data is useful only to the extent that we think about it as state-sanctioned propaganda. In other words, it tells us what Chinese policymakers want the world to believe.
This shortfall in credible and actionable data from one of the global economy’s largest and most interconnected members leaves us with more questions than answers – especially in the presence of a massive Chinese credit bubble, with clear signs of overinvestment and unsustainably high debt-service ratios. These are troubling signs for all investors, in every asset class, everywhere in the world today… and everyone should be paying close attention.
(I should note that John has access to a massive amount of research from a very wide variety of both traditional and nontraditional sources… and I say that after having extraordinary access myself as the portfolio strategist for an $18B Texas money manager. I am seeing and reading things every day that I could only imagine before, and the information flow is addictive. John’s sources give us a big, if sometimes overwhelming, head start on thinking through all the implications for investing around the constant collisions of macroeconomic forces. While we legally and ethically cannot share some of the best research we see, we can share a lot of the core ideas and do our best to give you a head start, too. That’s what this letter is about.)
Read the Tea Leaves Carefully & Expect Miscues
Most China economists – who do the best they can to read the economic tea leaves by focusing on a handful of economic indicators ranging from gross domestic product (GDP), purchasing managers’ indices (PMI), consumer/producer inflation (CPI/PPI), total social finance, and industrial production – end up expressing a rather bipolar view on Chinese economic activity, with wild swings in their outlooks from quarter to quarter.
On this front, I was particularly impressed by an explosive letter (viewable by Over My Shoulder subscribers only) from our friends at Political Alpha, which remains one of the elite political intelligence/analysis firms on the Street. While China watchers tend to trade reactively around official and unofficial manufacturing PMI releases as monthly proxies for the broader economy, very few investors realize that “not only is manufacturing no longer the bellwether of the [Chinese] economy, more often than not it now performs counter cyclically.”
Although China is the world’s largest producer of value added manufactured goods, it has not been an export led economy for a very long time. As I detailed in last month’s letter, China’s growth has largely relied on extraordinarily high levels of fixed investment, supported by even higher levels of domestic savings and an unsustainable rise in private sector credit.

Source: Wayne M. Morrison, China’s Economic Rise: History, Trends, Challenges, & Implications for the United States. Congressional Research Service, February 3, 2014
Even so, industry experts often fall into the trap of extrapolating flash manufacturing readings into forecasts for the broader economy.
Our friends at Political Alpha describe one such situation where HSBC’s China team (which puts out the unofficial monthly PMI each month in partnership with MarkIt) “was forced to backpedal from its September 23rd announcement that the flash PMI data was ‘further evidence [of] China’s ongoing growth rebound’ to a much more somber conclusion just seven days later: ‘There are still a lot of structural headwinds ahead. This is as good as it gets for the time being…. [D]on’t expect too sharp an acceleration from here."
Feel free to compare the clips yourself:
On a side note, I don’t mean to disparage the China research team at HSBC or question their competency by reprinting the comments above. I’m sure they get up each morning (just like I do) with a genuine intent to understand changing economic conditions as best they can and to help their clients protect and grow their savings. If anything, this example is a broader indictment of investors’ widespread reliance on a handful of flawed or misunderstood data points in the absence of credible Chinese economic data.
I don’t mean to be cute or coy on this issue. The lack of transparency of the Chinese economy is not just a problem for individual and institutional investors who make the choice every day to put their money at risk; it also carries enormous policy implications for central bankers and elected politicians in a highly unstable global system where total debt-to-GDP has risen across the world’s major economies by nearly 35% since 2008… and continues to rise.

Source: Hoisington Investment Management Company, May 2014
As you can see in the table above (which Dr. Lacy Hunt was kind enough to share with us at this year’s Strategic Investment Conference), China has seen its total debt to income ratio jump by more than 100% (another full turn of GDP) in the last five years… more debt growth than any other major economy on the planet, including Japan.
Pulling Back the Bamboo Curtain
Fortunately, my last letter on China’s debt build up sparked a flurry of introductions and fresh conversations with investors, economists, and policymakers from around the world – in places like London, Spain, South Africa, Singapore, Dubai, Australia, Hong Kong, and Finland. Of course, John has also eagerly introduced me to many of his close friends (who happen to be serious A-list economists and money managers)… so needless to say, it has been an incredibly fun and enlightening couple of months.
But John introduced me to one man, in particular, who was able to pull back the curtain on the Chinese economy in a way I had not imagined… and it feels like I am looking at the Middle Kingdom with fresh eyes.
Meet Leland Miller, President of China Beige Book International. Along with Dr. Craig Charney, who oversees the firm’s vast research efforts, Leland spearheads the effort to supply the world’s elite institutions (from central banks and heads of state to multinationals, mega banks, and hedge funds) with a comprehensive look into China’s economy, by applying the same survey methodology employed by each of the regional U.S. Federal Reserve Banks in preparing their submissions for the national Beige Book.
Aside from the fact that Leland is an Oxford-educated China historian, a brilliant economist, and a genuinely nice guy, what first caught my attention was his remarkable track record of contrarian calls since the inaugural issue of the China Beige Book in Q1 2012… from the initial slowdown; to unexpected bounces in economic activity; and even the June 2013 cash crunch where interbank interest rates spiked dramatically in a matter of weeks, signaling that a wave of defaults was on the way. (I should note that John has sat on China Beige Book International’s advisory board and has worked closely with Leland for most of the firm’s history.)
Before we proceed, here is a short but important description of the history and methodology behind the China Beige Book. Although survey data has its limits in any economy, this is as good as it gets for a semi-closed economy like China’s.
I cannot share the report in its entirety or reveal too much of its contents, but Leland did give me permission to share part of the regional overviews and research highlights from the Q1 2014 report. If you are able and willing to pay the six figure annual subscription fee, Leland’s work will blow your mind and dramatically change your perspective. For the rest of us, the following excerpt can at least point us in the right direction… and I am discovering that Leland’s media interviews and tweets (@ChinaBeigeBook) are quite telling, as well. (You can also follow John and me on Twitter at @JohnFMauldin and @WorthWray, respectively.)
Growth Is Slowing But Not Collapsing (So Far…)
After reading through the latest report, consulting with friends who are also familiar with the research, and bombarding Leland with a never-ending stream of questions for the last month, John and I still cannot claim to have enough information to make a directional call on the world’s most powerful (and least understood) macro force… but we know more about the inner workings of China’s economy than we did when we wrote to you a couple of months ago.
Great data often has that effect – it’s like shining a light into the shadows (including China’s shadow banks). We can see the nuanced regional contrast in economic activity, the modest (but still insufficient) rebalancing between sectors, and pressure points in the credit markets that suggest last summer’s interbank volatility may return in 2014.
We also see a far more mixed picture of economic activity than a lot of the widely followed headline data suggests. The overall pace of Chinese economic growth is clearly slowing but not collapsing. The credit transmission mechanism is obviously broken, as you can see in the chart below (with government and government-sponsored borrowers in zombie industries consuming the majority of the country’s credit… in turn forcing households to borrow through shadow banks at massive risk premiums); but so far, the credit bubble is not imploding.
On that note, China Beige Book International is the only independent research firm in the world that tracks the non-bank (shadow) lending rates not just nationally, or by region, but for every sector in every region over time. Leland and his team have essentially solved the most difficult China puzzle of all: what is true cost of capital in the Chinese economy, and who is able to actually access it?

Source: Wei Yao, “China: A whiff of debt deflation.” Societe Generale Research, May 9, 2014
Of course – and Leland was emphatic on this point – China’s greatest challenge will lie in deleveraging the economy while also rebalancing toward a consumption-driven growth model for the first time in modern history. That cannot happen as long as households remain repressed by unequal access to credit markets or intentionally suppressed exchange rates, which essentially represent a transfer of household wealth from workers to state-favored firms. But reforming the system will require a greater slowdown than China’s policymakers are letting on. And, Leland warns, Beijing runs the risk of blowing its credibility and instigating capital flight if the divergence between official forecasts and China’s actual economic experience grows too large.
To be continued next week
Trequanda, Nantucket, New York, and Maine
It is very early Saturday morning here in Rome (still late Friday night in the US) as I finish this letter, or at least my part of it. Worth is still up and reworking this piece (I really can’t keep up with him); then the editors, Charley and Lisa Sweet, will do their final runs; and then a whole team will make sure you get your letter. A far cry from the early days when your humble analyst did everything. And the mistakes I made showed up in print far more often. I am grateful to have a whole group of dedicated people working to keep the machine humming.
In a few hours I will meet George Gilder at the train station. I will buy a few local phones (I already have local sim cards for the iPads from the airport yesterday), find some cash, and have lunch before we hop the train to Chiusi with my daughter Melissa and some friends and then meet Tiffani and Lively, who are already there with the cars. We’ll drive to Sinalunga to shop for groceries and other stuff for the week before going the last short leg to Trequanda.
Other guests will come and go over the next few weeks, using the villa as a base to explore the Tuscan region; but I will probably stay “home,” reading and thinking and working out, doing some preliminary writing on my next book, and trying to take the speed of life down a gear or two. Vacation for me is being in the same place for an extended period. And getting to talk with Gilder in the evenings about our books is such a treat. He is one of the finest philosophical/sociological/economic/technological minds in the world (in my opinion), and having him to talk with in the evening will help me lay the proper intellectual framework for my book, though I have to work on not distracting him too much.
Last night I had dinner arranged here in Rome with my friend Steve Cucchiaro, his daughter (who was celebrating her birthday), and his son. My group was running late, even though our driver from the airport was driving like we were in a Formula One race. That is typical, but it was not long before we realized he was also drunk and half mad, talking and gesturing to himself the entire time. Obviously, we survived. When we got to our hotel, I was busy getting people to get ready ASAP so we would not be too late. I asked the concierge for directions, and he gave them to me but then said, “Signor Mauldin, you cannot wear that to the Imago restaurant. It is a very nice place.” I pointed out that I had not brought a tie, and he offered me one. So I went to the room and called Steve to tell him we would be a little late. He said jackets were required but no ties.
It turned out he had booked one of the finest places in Rome and got the corner window table overlooking the Spanish Steps and St. Peter’s, with a spectacular sunset/nighttime view. Another special night for the memory book.
It is time to hit the send button, as trains will not wait. I will report from Tuscany next week, by which time Worth and I should have China all figured out – not! But we’ll keep after it. Also, I hope to summarize the speech I did in San Diego. Until then have a great week!
Your thinking I need to get to China analyst,
One of the few consensus ideas that I took away from the Strategic Investment Conference is that China has the potential to become a real problem. It seemed to me that almost everyone who addressed the topic was either seriously alarmed at the extent of China’s troubles or merely very worried. Perhaps it was the particular group of speakers we had, but no one was sanguine. If you recall, a few weeks back I introduced my young colleague and protégé Worth Wray to you; and his inaugural Thoughts from the Frontline focused on China, a topic on which he is well versed, having lived and studied there. Our conversations often center on China and emerging markets (and we tend to talk and write to each other a lot). While I’m on the road, Worth is once again visiting China in this week’s letter, summing up our research and contributing his own unique style and passion. I think regular TFTF readers are going to enjoy Worth’s occasional missives and will want to see more of them over time. Now, let’s turn it over to my able young Cajun friend.
Looking at the Middle Kingdom with Fresh Eyes
By Worth Wray (Houston, TX)
In my Thoughts from the Frontline debut this past March (“China’s Minsky Moment?”), I highlighted the massive bubble in Chinese private sector debt and explored the near term prospects for either (1) a reform induced slowdown or (2) a crisis induced recession. Unfortunately, it was not an easy or straightforward analysis, considering the glaring inconsistencies between “official” state compiled data and more concrete measures of real economic activity.
Although John and I spend hours every week searching for the truth in a murky stream of official and unofficial reports, we always reach the same conclusion about the People’s Republic: There is really no way to know what is happening in China today, much less what will happen tomorrow, based on widely available data. The primary data is flawed at best and manipulated at worst. Sometimes the most revealing insights lie in the disagreement between the official and unofficial reports… suggesting that official data is useful only to the extent that we think about it as state-sanctioned propaganda. In other words, it tells us what Chinese policymakers want the world to believe.
This shortfall in credible and actionable data from one of the global economy’s largest and most interconnected members leaves us with more questions than answers – especially in the presence of a massive Chinese credit bubble, with clear signs of overinvestment and unsustainably high debt-service ratios. These are troubling signs for all investors, in every asset class, everywhere in the world today… and everyone should be paying close attention.
(I should note that John has access to a massive amount of research from a very wide variety of both traditional and nontraditional sources… and I say that after having extraordinary access myself as the portfolio strategist for an $18B Texas money manager. I am seeing and reading things every day that I could only imagine before, and the information flow is addictive. John’s sources give us a big, if sometimes overwhelming, head start on thinking through all the implications for investing around the constant collisions of macroeconomic forces. While we legally and ethically cannot share some of the best research we see, we can share a lot of the core ideas and do our best to give you a head start, too. That’s what this letter is about.)
Read the Tea Leaves Carefully & Expect Miscues
Most China economists – who do the best they can to read the economic tea leaves by focusing on a handful of economic indicators ranging from gross domestic product (GDP), purchasing managers’ indices (PMI), consumer/producer inflation (CPI/PPI), total social finance, and industrial production – end up expressing a rather bipolar view on Chinese economic activity, with wild swings in their outlooks from quarter to quarter.
On this front, I was particularly impressed by an explosive letter (viewable by Over My Shoulder subscribers only) from our friends at Political Alpha, which remains one of the elite political intelligence/analysis firms on the Street. While China watchers tend to trade reactively around official and unofficial manufacturing PMI releases as monthly proxies for the broader economy, very few investors realize that “not only is manufacturing no longer the bellwether of the [Chinese] economy, more often than not it now performs counter cyclically.”
Although China is the world’s largest producer of value added manufactured goods, it has not been an export led economy for a very long time. As I detailed in last month’s letter, China’s growth has largely relied on extraordinarily high levels of fixed investment, supported by even higher levels of domestic savings and an unsustainable rise in private sector credit.
Source: Wayne M. Morrison, China’s Economic Rise: History, Trends, Challenges, & Implications for the United States. Congressional Research Service, February 3, 2014
Even so, industry experts often fall into the trap of extrapolating flash manufacturing readings into forecasts for the broader economy.
Our friends at Political Alpha describe one such situation where HSBC’s China team (which puts out the unofficial monthly PMI each month in partnership with MarkIt) “was forced to backpedal from its September 23rd announcement that the flash PMI data was ‘further evidence [of] China’s ongoing growth rebound’ to a much more somber conclusion just seven days later: ‘There are still a lot of structural headwinds ahead. This is as good as it gets for the time being…. [D]on’t expect too sharp an acceleration from here."
Feel free to compare the clips yourself:
- HSBC release on 9/23: http://www.cnbc.com/id/101053388
- HSBC release on 9/29: http://www.cnbc.com/id/101071631
On a side note, I don’t mean to disparage the China research team at HSBC or question their competency by reprinting the comments above. I’m sure they get up each morning (just like I do) with a genuine intent to understand changing economic conditions as best they can and to help their clients protect and grow their savings. If anything, this example is a broader indictment of investors’ widespread reliance on a handful of flawed or misunderstood data points in the absence of credible Chinese economic data.
I don’t mean to be cute or coy on this issue. The lack of transparency of the Chinese economy is not just a problem for individual and institutional investors who make the choice every day to put their money at risk; it also carries enormous policy implications for central bankers and elected politicians in a highly unstable global system where total debt-to-GDP has risen across the world’s major economies by nearly 35% since 2008… and continues to rise.
Source: Hoisington Investment Management Company, May 2014
As you can see in the table above (which Dr. Lacy Hunt was kind enough to share with us at this year’s Strategic Investment Conference), China has seen its total debt to income ratio jump by more than 100% (another full turn of GDP) in the last five years… more debt growth than any other major economy on the planet, including Japan.
Pulling Back the Bamboo Curtain
Fortunately, my last letter on China’s debt build up sparked a flurry of introductions and fresh conversations with investors, economists, and policymakers from around the world – in places like London, Spain, South Africa, Singapore, Dubai, Australia, Hong Kong, and Finland. Of course, John has also eagerly introduced me to many of his close friends (who happen to be serious A-list economists and money managers)… so needless to say, it has been an incredibly fun and enlightening couple of months.
But John introduced me to one man, in particular, who was able to pull back the curtain on the Chinese economy in a way I had not imagined… and it feels like I am looking at the Middle Kingdom with fresh eyes.
Meet Leland Miller, President of China Beige Book International. Along with Dr. Craig Charney, who oversees the firm’s vast research efforts, Leland spearheads the effort to supply the world’s elite institutions (from central banks and heads of state to multinationals, mega banks, and hedge funds) with a comprehensive look into China’s economy, by applying the same survey methodology employed by each of the regional U.S. Federal Reserve Banks in preparing their submissions for the national Beige Book.
Aside from the fact that Leland is an Oxford-educated China historian, a brilliant economist, and a genuinely nice guy, what first caught my attention was his remarkable track record of contrarian calls since the inaugural issue of the China Beige Book in Q1 2012… from the initial slowdown; to unexpected bounces in economic activity; and even the June 2013 cash crunch where interbank interest rates spiked dramatically in a matter of weeks, signaling that a wave of defaults was on the way. (I should note that John has sat on China Beige Book International’s advisory board and has worked closely with Leland for most of the firm’s history.)
Before we proceed, here is a short but important description of the history and methodology behind the China Beige Book. Although survey data has its limits in any economy, this is as good as it gets for a semi-closed economy like China’s.
Beginning in early 2010, our team set out to craft a Chinese analogue of the US Federal Reserve’s Beige Book. Over the next twelve months, we conducted a study of the Beige Book and the methods used to prepare it, including contact with officials at each of the regional Federal Reserve Banks involved in its preparation. We then worked to develop a method that would be similar, but more comprehensive and systematic, in its approach to the world’s second largest economy – a Beige Book “with Chinese characteristics.”
Our approach triangulates three methods, repeated every quarter: a quantitative survey of over 2,000 leading firms from key sectors across the country; qualitative one-on-one in-depth discussions with C-Suite executives in the same industries across every region; and a separate, targeted banker survey of loan officers and branch managers, designed to home in on the complexities of both the official and shadow economies. With the data from this approach, we are able to compare regions and industries within a quarter, as well as track changes over time, both in near and real time.
The result of these efforts is the largest and most comprehensive survey series ever conducted on a closed or semi-closed economy…
China Beige Book, Regional Overview (Excerpts from the Q1 2014 report)
China Beige Book regions [listed below]
Region 1: Shanghai, Jiangsu, Zhejiang
Growth slowed – retail & real estate gains weakening sharply – despite stability in manufacturing and pickups in services, transport, and agriculture. Borrowing was stable with rates down at banks and up at non-bank lenders. Hiring slowed, as did margin growth. On quarter weakness was modest, but the on-year drop was worrisome.
Region 2: Guangdong, Fujian
Despite the national slowdown, Guangdong’s pickup continued, driven by manufacturing and transport. Growth was steady in retail, off in services and property. Wage growth remained high but costs inflation eased, boosting margins. Borrowing ticked up, with bank rates steady and shadow rates up. The export power-house found an encouraging second wind.
Region 3: Beijing, Tianjin, Shandong, Hebei
The capital region saw Q1’s worst results, due to trouble in services and manufacturing. Property and mining were stable, retail slightly better. Margin growth suffered. Borrowing was stable and moved to banks, on the country’s lowest interest rates. Beijing is leading the national economic slowdown.
Region 4: Heilongjiang, Jilin, Liaoning
The Northeast slowed as mining contracted and manufacturing, property, and farming growth eased. Services was stable and retail saw a pick-up. Hiring and wages strengthened, while pricing weakened, pressuring margins. Borrowing ticked up, rates easing. Rebalancing does not look easy in this old industrial region.
Region 5: Hubei, Henan, Chongqing, Sichuan, Anhui, Jiangxi
Growth slowed sharply, slipping in retail, services, property, farming, and mining, with only manufacturing stable. Hiring was steady but input costs grew faster, narrowing margin gains. Borrowing slid again, with lower interest rates in both formal and shadow finance – not an encouraging trend.
Region 6: Shaanxi, Shanxi, Inner Mongolia, Ningxia
Growth took a hit, gains slowing in this crucial mining sector. Manufacturing, real estate and, especially, retail weakened. Services and transport were the bright spots. Hiring and margin growth both eased. Borrowing was flat as rates went up. The North remains dependent on struggling mining.
Region 7: Guizhou, Guangxi, Yunnan, Hainan, Hunan
Again out of sync with the rest of China, the Southwest sped up. Manufacturing, transport, and mining improved, but retail, services, and real estate saw growth slow. Hiring and input costs picked up, but so did pricing and margins. Borrowing ticked up, as shadow lenders’ rates moved back above banks’ rates.
Region 8: Xinjiang, Tibet, Gansu, Qinghai
The West again boasted China’s best overall growth, though manufacturing, retail, and services slowed. Only property picked up, with mining and transport stable. Hiring and input cost growth were steady, but pricing and margin growth eased. Borrowing remained China’s least frequent as rates jumped.
China Beige Book, Research Highlights (Excerpts from the Q1 2014 report)
Manufacturing is fine, yet the economy is not
The pace of Chinese economic expansion has painfully slowed. Revenue, sales, profit, and wage growth are all weaker than a year ago. The slowdown is particularly steep in the North [region 6] and Northeast [region 4] and also pronounced in Beijing [region 3] and Central China (region 5).
By sector, stable first-quarter growth in manufacturing confirms our long-standing thesis that it is no longer the economy’s bellwether...
A bounce-back later this year is possible
The worst performer according to CBB figures, both on-quarter and on-year, is real estate and construction. While property companies are getting crushed, the sector is also notoriously unstable for both structural and political reasons. It would be no surprise if real estate were to rally before the end of the year.
More immediate reason for optimism: Growth in new domestic orders was solid (save in the Northeast), and domestic orders and export orders were both stronger in powerhouse Guangdong. The results do not indicate a boom later in 2014, but they do suggest that linear forecasts of continued deterioration are overly simplistic.
Financial segmentation is profound
The ongoing debates about monetary policy assume that anticipated loosening or tightening applies across the spectrum of borrowers. CBB data say otherwise, and in multiple ways. First, while the number of firms reporting that they borrowed stabilized in Q1, it did so at a very low level. Shoving more liquidity at the credit market will have limited effects until participation expands. This includes RRR cuts – though of course these may occur for political reasons.
Second, shadow finance may be revving up for a comeback. CBB numbers show a recovery in the sales of wealth management products (WMPs), likely due to competition from online banking. This is cash leaving the traditional banking sector and, while non-bank lending did not pick up in the first quarter, the groundwork is being laid for it to do so.
Online banking may be encouraging riskier behavior
Online lenders are typically viewed as a force for liberalization, as well as a potentially healthier alternative to unregulated shadow finance. Yet our data show their proliferation would impart significant costs as well…
What appears to be happening is the higher returns available in online banking are forcing banks to move more transactions off-balance sheet, in order to avoid the interest rate cap. While this may accommodate policy goals in the short term, an uptick in off-balance sheet funding portends more shadow bank lending down the line.
Interest rate spread between banks & shadow banks highest in a year
Bank loan rates and bond yields eased slightly this quarter, but the cost of capital increased again for those borrowing from non-bank lenders. While the shifts were not dramatic, the spread between bank and non-bank loan rates nationwide is now the largest since Q1 2013. This highlights the still more challenging road for those firms, principally domestic private entities that are pushed outside formal lending channels.
After reading through the latest report, consulting with friends who are also familiar with the research, and bombarding Leland with a never-ending stream of questions for the last month, John and I still cannot claim to have enough information to make a directional call on the world’s most powerful (and least understood) macro force… but we know more about the inner workings of China’s economy than we did when we wrote to you a couple of months ago.
Great data often has that effect – it’s like shining a light into the shadows (including China’s shadow banks). We can see the nuanced regional contrast in economic activity, the modest (but still insufficient) rebalancing between sectors, and pressure points in the credit markets that suggest last summer’s interbank volatility may return in 2014.
We also see a far more mixed picture of economic activity than a lot of the widely followed headline data suggests. The overall pace of Chinese economic growth is clearly slowing but not collapsing. The credit transmission mechanism is obviously broken, as you can see in the chart below (with government and government-sponsored borrowers in zombie industries consuming the majority of the country’s credit… in turn forcing households to borrow through shadow banks at massive risk premiums); but so far, the credit bubble is not imploding.
On that note, China Beige Book International is the only independent research firm in the world that tracks the non-bank (shadow) lending rates not just nationally, or by region, but for every sector in every region over time. Leland and his team have essentially solved the most difficult China puzzle of all: what is true cost of capital in the Chinese economy, and who is able to actually access it?
Source: Wei Yao, “China: A whiff of debt deflation.” Societe Generale Research, May 9, 2014
Of course – and Leland was emphatic on this point – China’s greatest challenge will lie in deleveraging the economy while also rebalancing toward a consumption-driven growth model for the first time in modern history. That cannot happen as long as households remain repressed by unequal access to credit markets or intentionally suppressed exchange rates, which essentially represent a transfer of household wealth from workers to state-favored firms. But reforming the system will require a greater slowdown than China’s policymakers are letting on. And, Leland warns, Beijing runs the risk of blowing its credibility and instigating capital flight if the divergence between official forecasts and China’s actual economic experience grows too large.
To be continued next week
Trequanda, Nantucket, New York, and Maine
It is very early Saturday morning here in Rome (still late Friday night in the US) as I finish this letter, or at least my part of it. Worth is still up and reworking this piece (I really can’t keep up with him); then the editors, Charley and Lisa Sweet, will do their final runs; and then a whole team will make sure you get your letter. A far cry from the early days when your humble analyst did everything. And the mistakes I made showed up in print far more often. I am grateful to have a whole group of dedicated people working to keep the machine humming.
In a few hours I will meet George Gilder at the train station. I will buy a few local phones (I already have local sim cards for the iPads from the airport yesterday), find some cash, and have lunch before we hop the train to Chiusi with my daughter Melissa and some friends and then meet Tiffani and Lively, who are already there with the cars. We’ll drive to Sinalunga to shop for groceries and other stuff for the week before going the last short leg to Trequanda.
Other guests will come and go over the next few weeks, using the villa as a base to explore the Tuscan region; but I will probably stay “home,” reading and thinking and working out, doing some preliminary writing on my next book, and trying to take the speed of life down a gear or two. Vacation for me is being in the same place for an extended period. And getting to talk with Gilder in the evenings about our books is such a treat. He is one of the finest philosophical/sociological/economic/technological minds in the world (in my opinion), and having him to talk with in the evening will help me lay the proper intellectual framework for my book, though I have to work on not distracting him too much.
Last night I had dinner arranged here in Rome with my friend Steve Cucchiaro, his daughter (who was celebrating her birthday), and his son. My group was running late, even though our driver from the airport was driving like we were in a Formula One race. That is typical, but it was not long before we realized he was also drunk and half mad, talking and gesturing to himself the entire time. Obviously, we survived. When we got to our hotel, I was busy getting people to get ready ASAP so we would not be too late. I asked the concierge for directions, and he gave them to me but then said, “Signor Mauldin, you cannot wear that to the Imago restaurant. It is a very nice place.” I pointed out that I had not brought a tie, and he offered me one. So I went to the room and called Steve to tell him we would be a little late. He said jackets were required but no ties.
It turned out he had booked one of the finest places in Rome and got the corner window table overlooking the Spanish Steps and St. Peter’s, with a spectacular sunset/nighttime view. Another special night for the memory book.
It is time to hit the send button, as trains will not wait. I will report from Tuscany next week, by which time Worth and I should have China all figured out – not! But we’ll keep after it. Also, I hope to summarize the speech I did in San Diego. Until then have a great week!
Your thinking I need to get to China analyst,
The article Thoughts from the Frontline: Looking at the Middle Kingdom with Fresh Eyes was originally published at Mauldin Economics
Get our "Beginner's Guide to Trading Options"....Just Click Here!
Labels:
analyst,
Beige Book,
China,
Crude Oil,
economy,
GDP,
investment,
Mauldin Economics
Wednesday, April 23, 2014
Hoisington Investment Management Quarterly Review and Outlook, First Quarter 2014
By John Mauldin
In today’s Outside the Box, Lacy Hunt and Van Hoisington of Hoisington Investment have the temerity to point out that since the Great Recession officially ended in 2009, the Federal Open Market Committee (FOMC) has been consistently overoptimistic in its projections of U.S. growth. They simply expected QE to be more stimulative than it has been, to the tune of about 6% over the past four years – a total of about $1 trillion that never materialized.
Given that dismal track record, our authors ask why we should believe the Fed’s prediction of 2.9% real GDP growth for 2014 and 3.4% for 2015 – particularly with QE being tapered into nonexistence. A big part of the reason the Fed has been so steadily wrong, say Lacy and Van, is its overreliance on the so-called “wealth effect,” which posits that an increase in consumer wealth – through higher stock prices or home values, for instance – will lead to increased consumer spending.
The wealth effect has been both a justification for quantitative easing and a root cause of consistent overly optimistic growth expectations by the FOMC. The research cited below suggests that the concept of a wealth effect is in fact deeply flawed. It is unfortunate that the FOMC has relied on this flawed concept to experiment with over $3 trillion in asset purchases and continues to use it as the basis for what we believe are overly optimistic growth expectations.
Hoisington Investment Management Company (www.Hoisingtonmgt.com) is a registered investment advisor specializing in fixed-income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $5 billion under management and is the sub-adviser of the Wasatch-Hoisington U.S. Treasury Fund (WHOSX).
It is been a busy day for me here in Dallas. Besides nonstop meetings and conversations and my usual reading, I had the privilege of going to the Dallas branch of the Federal Reserve and watching President Richard Fisher make loans to a group of budding entrepreneurs to build lemonade stands. It is part of a fabulous organization called Lemonade Day. The basic concept is to enable young children to learn about entrepreneurship and capitalism by helping them launch a lemonade stand. Youth who register are taught 14 lessons from their entrepreneurial workbook, with either a parent, teacher, youth organization leader, or other adult mentor supervising. At the conclusions of the lessons, they are prepared to open their first business… a lemonade stand. Local businesses and banks volunteer to empower these kids by making them a $50 loan and helping them set up their business. By the time they come to talk with the “banker,” they have a business plan and a set of goals as to what they will do with them profits they make. Watching these kids respond to adults asking them about their plans brings joy to your heart.
On May 4, in some 35 cities across the country, 200,000 young people will be building lemonade stands and trying to turn a profit. If you drive by a lemonade stand, stop and support America’s future entrepreneurs. If you are in one of those 35 cities (click here to find out), make a point to find a few lemonade stands and support America’s future. And if you don’t have a lemonade stand in your city, consider following in the footsteps of local heroes (and my good friends) Reid Walker and Robert Alpert, who decided to launch Lemonade Day here in Dallas. This should be a spring ritual in every city in the country.
Buoyed by the kids and their enthusiasm, I then went to dinner with Richard Fisher and Woody Brock and a few other associates of Ray Hunt, who hosted us for a fabulous and thought-provoking session, talking economics, geopolitics, and even a little politics. There was an interesting mix of pessimism and optimism in the room about the future of our country, but there was not a person who was not concerned with the direction in which we are headed. Gerald Turner, the president of SMU, talked to us about how fiscally conservative and socially liberal his students are. That kind of mirrors my own children. The world is changing faster, both technologically and demographically, than many of us in the Boomer generation are comfortable with. But we’d better get used to it.
It’s been a tumultuous last few days, and tomorrow morning I have to leave early for San Francisco to do a video shoot with my partners at Altegris, before going right back to the airport and flying home to speak to a local group of investment advisers and brokers brought together by Peak Capital Management. It is late and time to hit the send button, because the alarm clock will go off early. Have a great week
Your wondering where all the time goes analyst,
John Mauldin, Editor
Outside the Box
Outside the Box
Stay Ahead of the Latest Tech News and Investing Trends...
Each day, you get the three tech news stories with the biggest potential impact.Hoisington Investment Management – Quarterly Review and Outlook, First Quarter 2014
Optimism at the FOMC
The Federal Open Market Committee (FOMC) has continuously been overly optimistic regarding its expectations for economic growth in the United States since the last recession ended in 2009. If their annual forecasts had been realized over the past four years, then at the end of 2013 the U.S. economy should have been approximately $1 trillion, or 6%, larger. The preponderance of research suggests that the FOMC has been incorrect in its presumption of the effectiveness of quantitative easing (QE) on boosting economic growth. This faulty track record calls into question their latest prediction of 2.9% real GDP growth for 2014 and 3.4% for 2015.
A major reason for the FOMC’s overly optimistic forecast for economic growth and its incorrect view of the effectiveness of quantitative easing is the reliance on the so-called “wealth effect”, described as a change in consumer wealth which results in a change in consumer spending. In an opinion column for The Washington Post on November 5, 2010, then FOMC chairman Ben Bernanke wrote, “...higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.” Former FOMC chairman Alan Greenspan in a CNBC interview on Feb. 15, 2013 said, “The stock market is the key player in the game of economic growth.” This year, in the January 20 issue of Time Magazine, the current FOMC chair, Janet Yellen said, “And part of the [economic stimulus] comes through higher house and stock prices, which causes people with homes and stocks to spend more, which causes jobs to be created throughout the economy and income to go up throughout the economy.”
FOMC leaders may feel justified in taking such a position based upon the FRB/US, a large- scale econometric model. In part of this model, employed by the FOMC in their decision making, household consumption behavior is expressed as a function of total wealth as well as other variables. The model predicts that an increase in wealth of one dollar will boost consumer spending by five to ten cents (see page 8-9 “Housing Wealth and Consumption” by Matteo Iacoviello, International Finance Discussion Papers, #1027, Board of Governors of the Federal Reserve System, August 2011). Even at the lower end of their model's range this wealth effect, if it were valid, would be a powerful factor in spurring economic growth.
After examining much of the latest scholarly research, and conducting in house research on the link between household wealth and spending, we found the wealth effect to be much weaker than the FOMC presumes. In fact, it is difficult to document any consistent impact with most of the research pointing to a spending increase of only one cent per one dollar rise in wealth at best. Some studies even indicate that the wealth effect is only an interesting theory and cannot be observed in practice.
The wealth effect has been both a justification for quantitative easing and a root cause of consistent overly optimistic growth expectations by the FOMC. The research cited below suggests that the concept of a wealth effect is in fact deeply flawed. It is unfortunate that the FOMC has relied on this flawed concept to experiment with over $3 trillion in asset purchases and continues to use it as the basis for what we believe are overly optimistic growth expectations.
Consumer Wealth and Consumer Spending
Many episodes of rising and falling financial and housing asset wealth have occurred throughout history. The question is whether these periods of wealth changes are associated in a consistent and reliable way with changes in consumer spending. We examined, separately, percent changes in real consumption expenditures per capita against percent changes in the real S&P 500 index (financial wealth) and against percent changes in Robert Shiller’s real home price index (housing wealth). If economic relationships are valid they should work for all time periods, regardless of highly different idiosyncratic conditions, as opposed to an isolated subset of historical experience. As such, we conducted our analysis from 1930 through 2013, the entire time period for which all variables were available.
Financial Wealth. Chart 1 is a scatter diagram of current percent changes in both real per capita personal consumption expenditures (PCE), the preferred measure of spending, and the real S&P 500 stock price index. It is made up of 84 dots, which constitutes a robust sample. Over our sample period, as with most extremely long periods, time will tend to link economic variables to each other; population is a key factor that can cause such an association. By expressing consumption in per capita terms, trending has been reduced, and in turn, an artificially overstated degree of correlation has been avoided.

If financial wealth drives consumer spending, an unambiguous positively sloped line should be evident on this scatter diagram. Larger gains in the S&P 500 would be associated with faster increases in spending; conversely, declines in the S&P 500 would be tied to lower spending. If there was a strong positive correlation, the large gains in stock prices would be associated with strong gains in spending, and they would fall in the upper right quadrant of the graph. In addition, sizeable declines in the S&P would be associated with large decreases in consumer spending, and the dots would fall in the lower left quadrant, resulting in an upward sloping line. For the relationship to be stable and dependable the dots should be packed in an around the trend line. This is clearly not the case. The trend line through the dots is positive, but the observations in the upper left quadrant of the graph and those in the lower right exhibit a negative rather than positive correlation. Furthermore, the dots are not clustered close to the trend line. The goodness of fit (coefficient of determination) of 0.27 is statistically significant; however, the slope of the line is minimally positive. This suggests that an approximate one dollar increase in wealth will boost real per capita PCE by less than one cent, far less than even the lower band of the effect in the Fed’s model.
Theoretically, lagged changes are preferred because when current or coincidental changes in economic variables are correlated the coefficients may be biased due to some other factor not covered by the empirical estimation. Also, lags give households time to adjust to their change in wealth. As such, we correlated the current percent change in real per capita PCE against current changes as well as one and two year lagged changes (expressed as a three-year moving average) in the S&P 500. The lags did not improve the goodness of fit as the coefficient of determination fell to 0.21. An increased dollar of wealth, however, still resulted in a one cent increase in consumption. We then correlated current percent change in real per capita PCE with only lagged changes in the real S&P 500 for the two prior years (expressed as a two year moving average), and the relationship completely fell apart as the goodness of fit fell to a statistically insignificant 0.06.
Housing Wealth. Chart 2 is a second scatter diagram, relating current percent changes in real home prices to current percent changes in real per capita PCE. Once again, the trend line does have a small positive slope, but there are so many observations in the upper left quadrant that the coefficient of determination does not meet robust tests for statistical significance. The dots are even more dispersed from the trend line than in the prior scatter diagram.

As with the analysis on financial wealth, when current changes in consumption were correlated against the lagged changes in home prices (both the three-year moving average and the two-year moving average), the goodness of fit deteriorated significantly and was not statistically significant in either case.
Correlations, or the lack thereof, indicated by these scatter diagrams do not prove causation. Nevertheless, economic theory offers an explanation for the poor correlation. If a person has an appreciated asset and wishes to increase spending, one option is to sell the asset, capture the gain and buy something else.
However, the funds to make the new purchase comes from the buyer of the asset. Thus, when financial assets are sold, money balances increase for the seller but fall for the buyer. The person with an appreciated asset could choose to borrow against that asset. Since new debt is current spending in lieu of future spending, the debt option may only provide a temporary boost to economic activity. To avoid an accentuated business cycle, debt must generate an income stream to repay principal and interest. Otherwise any increase in debt to convert wealth gains into consumer spending may merely add to cyclical volatility without producing any lasting benefit.
Scholarly Research
Scholarly research has debated the impact of financial and housing wealth on consumer spending as well. The academic research on financial wealth is relatively consistent; it has very little impact on consumption. In “Financial Wealth Effect: Evidence from Threshold Estimation” (Applied Economic Letters, 2011), Sherif Khalifa, Ousmane Seck and Elwin Tobing found “a threshold income level of almost $130,000, below which the financial wealth effect is insignificant, and above which the effect is 0.004.” This means a one dollar rise in wealth would, in time, boost consumption by less than one-half of a penny. Similarly, in “Wealth Effects Revisited 1975- 2012,” Karl E. Case, John M. Quigley and Robert J. Shiller (Cowles Foundation Discussion Paper #1884, December 2012) write, “The numerical results vary somewhat with different econometric specifications, and so any numerical conclusion must be tentative. We find at best weak evidence of a link between stock market wealth and consumption.” This team looked at quarterly observations during the 17 year period from 1982 through 1999 and the 37-year period from 1975 through the spring quarter of 2012.
The research on housing wealth is more divided. In the same paper referenced above, Karl E. Case, John M. Quigley and Robert J. Shiller write, “In contrast, we do find strong evidence that variations in housing market wealth have important effects upon consumption.” These findings differ from the findings of various other economists. In “The (Mythical?) Housing Wealth Effect” (NBER Working Paper #15075, June 2009), Charles Calomiris, Stanley D. Longhofer and William Miles write, “Models used to guide policy, as well as some empirical studies, suggest that the effect of housing wealth on consumption is large and greater than the wealth effect on consumption from stock holdings. Recent theoretical work, in contrast, argues that changes in housing wealth are offset by changes in housing consumption, meaning that unexpected shocks in housing wealth should have little effect on non housing consumption.”
Furthermore, R. Glenn Hubbard and Anthony Patrick O’Brien (Macroneconomics, Fourth edition, 2013, page 381) provide a highly cogent summary of the aforementioned research by Charles Calomiris, Stanley D. Longhofer and William Miles. They argue that consumers “own houses primarily so they can consume the housing services a home provides. Only consumers who intend to sell their current house and buy a smaller one – for example, ‘empty nesters’ whose children have left home – will benefit from an increase in housing prices. But taking the population as a whole, the number of empty nesters may be smaller than the number of first time home buyers plus the number of homeowners who want to buy larger houses. These two groups are hurt by rising home prices.”
Amir Sufi, Professor of Finance at the University of Chicago, also indicates that the effect of housing wealth is much smaller than assumed in the policy models and earlier empirical research. Dr. Sufi calculates that an increase of one dollar of housing wealth may yield as little as one cent of extra spending (“Will Housing Save the U.S. Economy?”, April 2013, Chicago Booth Economic Outlook event). This is in line with a 2013 study by Sherif Khalifa, Ousmane Seck and Elwin Tobing (“Housing Wealth Effect: Evidence from Threshold Estimation”, The Journal of Housing Economics). These economists found that a threshold income level of $74,046 had a wealth coefficient that rounded to one cent. Income levels between $74,046 and $501,000 had a two cent coefficient, and incomes above $501,000 had a statistically insignificant coefficient.
In total, the majority of the research is seemingly unequivocal in its conclusion. The wealth effect (financial and housing) is barely operative. As such, it is interesting to note its actual impact in 2013.
Where Was the Wealth Effect in 2013?
If the wealth effect was as powerful as the FOMC believes, consumer spending should have turned in a stellar performance last year. In 2013 equities and housing posted strong gains. On a yearly average basis, the real S&P 500 stock market index increase was 17.7%, and the real Case Shiller Home Price Index increase was 9.1%. The combined gain of these wealth proxies was 26.8%, the eighth largest in the 84 years of data. The real per capital PCE gain of just 1.2% ranked 58th of 84. The difference between the two was the fifth largest in the 84 cases. Such a huge discrepancy in relative performance in 2013, occurring as it did in the fourth year of an economic expansion, raises serious doubts about the efficacy of the wealth effect (Chart 3).

In econometrics, theoretical propositions must be empirically verifiable. Researchers using numerous statistical procedures examining various sample periods should be able to identify at least some consistent patterns. This is not the case with the wealth effect. Regardless if examining a simple scatter diagram or something far more sophisticated, the wealth effect is weak and inconsistent. The powerful wealth coefficients imbedded in the FRB/US model have not been supported by independent research. To quote Chris Low, Chief Economist of FTN (FTN Financial, Economic Weekly, March 21, 2014), “There may not be a wealth effect at all. If there is a wealth effect, it is very difficult to pin down ...” Since the FOMC began quantitative easing in 2009, its balance sheet has increased more than $3 trillion. This increase may have boosted wealth, but the U.S. economy received no meaningful benefit. Furthermore, the FOMC has no idea what the ultimate outcome of such an increase will be or what a return to a ‘normal’ balance sheet might entail. Given all of this, we do not see any evidence for economic growth as robust at the FOMC predicts.
Without a wealth effect, the stock market is not the “key player” in the economy, and no “virtuous circle” runs through the stock market. We reiterate our view that nominal GDP will rise just 3% this year, down from 3.4% in 2013. M2 growth in the latest twelve months was 5.8%, but velocity should decline by at least 3% and limit nominal GDP to 3% or less.

The Flatter Yield Curve: An Opportunity for Treasury Bond Investors
The Fed has indicated that the federal funds rate could begin to rise in the next couple of years, and the Treasury market has moderately anticipated this event. Similar to the 2004-2005 federal funds rate cycle, long before the federal funds rate increased short Treasury rates began their ascent (Chart 4). Interestingly, once the federal funds rate did begin to rise in 2004, long Treasury rates fell over the next two years. From May of 2004 until Feb. 2006 the federal funds rate increased by 350 basis point (bps) and the five-year note increased by 80 bps, yet the 30-year bond fell by 84 bps as inflation expectations fell. If the Fed follows through with its forecast and short rates rise, the dampening effect on inflation expectations should again cause long rates to fall. On the other hand, should economic activity continue to moderate then the downward pressure on inflation will continue. The prospect for lower Treasury yields appears favorable.
Van R. Hoisington
Lacy H. Hunt, Ph.D.
Like Outside the Box?
Sign up today and get each new issue delivered free to your inbox.
It's your opportunity to get the news John Mauldin thinks matters most to your finances.
The article Outside the Box: Hoisington Investment Management Quarterly Review and Outlook, First Quarter 2014 was originally published at Mauldin Economics
Sign up for one of our Free Trading Webinars....Just Click Here!
Labels:
analyst,
banks,
capital,
Federal Reserve,
FOMC,
Fund,
future,
investment,
John Mauldin,
Mauldin Economics,
treasury
Thursday, January 30, 2014
Gold Stocks Are About to Create a Whole New Class of Millionaires
By Jeff Clark, Senior Precious Metals Analyst
Bear markets always end. Has this one?Evidence is mounting that the bottom for gold may be in. While there's still risk, there's a new air of bullishness in the industry, something we haven't seen in over two years.
An ever growing number of industry insiders and investment analysts believe the downturn has come to a close. If that's true, it has immediate and critical implications for investors.
Doug Casey told me last week: "In my lifetime, the best time to have bought gold was 1971, at $35; it ran to over $800 by 1980. In 2001, gold was $250: in real terms even cheaper than in 1971. It ran to over $1,900 in 2011.
"It's now at $1,250. Not as cheap, in real terms, as in 1971 or 2001, but the world's financial and economic state is far more shaky.
"Gold is, once again, not just a prudent holding, but an excellent, high-potential, low-risk speculation. And gold stocks are about to create a whole new class of millionaires."
Just a couple of months ago, you would have had a hard time finding even one analyst saying something positive about gold and gold stocks—even some of the most bullish investment pros had gone silent.
But that's changing. Case in point: When Chief Metals & Mining Strategist Louis James and I attended last week's Resource Investment Conference in Vancouver, we witnessed quite a few very optimistic speakers.
Take Frank Giustra, for example, a self-made billionaire and philanthropist who made his fortune both in the mining sector and the entertainment industry. He's the founder of Lionsgate Entertainment, which is responsible for blockbuster movies like The Hunger Games, but he was just as heavily involved with mining blockbusters such as Iamgold, Wheaton River Minerals, Silver Wheaton, and others.
More Upturn AdvocatesHere's a quick scan of the growing number of voices that think the decline is over, some of which are outright bullish:"The worst is over with gold. It's time to call your broker." —Frank Holmes, US Global Investors "Sentiment is as black as night on gold, so I’m actually long on some gold miners." —Jeffrey Gundlach, bond guru and DoubleLine Capital founder "We'll see a gradual recovering throughout the year, because all the negative factors are already in the price." —Eugen Weinberg, head of commodities research at Commerzbank "Looking ahead, the downside risks seem to be diminishing, and overall we feel that the big shocks we've seen over the last two or three years are done..." —Marc Elliott, Investec "The mainstream narrative on gold is changing, indicating a possible bottom." —Bron Suchecki, Perth Mint "Orthodox investments are working on a cyclical peak, as precious metals are working on a cyclical bottom. The big pattern could be fully reversed by February-March, with gold becoming one of the best-performing sectors through the rest of 2014. The advice is to seriously reduce exposure in stocks and bonds and get fully invested in the precious metals sector. This should be completed in the first quarter." —Bob Hoye, Institutional Advisors |
"I'm telling you, you've seen the bottom of the gold market," he told the rapt audience at the conference, offering a bet to the Goldman Sachs analyst who claimed gold is going to $1,000.
The stakes: Whoever loses has to stand on a popular street in downtown Vancouver dressed in women's underwear.
Tom McClellan, editor of the McClellan Market Report, stated in a recent interview on CNBC: "The commercial traders are at their most bullish stance since the 2001 low, and they usually get proven right. It's a hugely bullish condition for gold, and I'm expecting a really large rebound.
"The moment we see a major gold producer announce that it's curtailing production or it's going out of business," McClellan continued, "that'll be the moment we mark the low in gold. I expect to have one of those announcements any minute. We're getting down to the production price of gold right now, and they won't continue producing gold at that level for very long."
Are they just guessing? To answer that, first consider the historical context of this bear market—it's getting very long in the tooth:
- The current correction in gold stocks is the fourth longest since 1879. The decline of 66% ranks in the top 10 of recorded history.
- In silver, only two corrections have lasted longer—the ones that ended in 1936 and 1983.
- Gold formed a double bottom last year, hitting $1,180.64 on June 28 and $1,182.60 on December 31, a convincing six-month span.
- Silver formed a higher low: $18.20 on June 28 vs. $18.72 on December 31, a bullish development.
- Gold stocks (XAU) formed a slightly lower low: $82.29 on June 26 vs. $79.73 December 19, 2103, a difference of 3.2%. However, as our friend Dominick Graziano, who successfully helped us earn doubles on three GLD puts last year, recently pointed out…
- The TSX Venture Index, where most junior mining stocks trade, has stayed above its June low. In fact, it recently soared above both the 50 day and 40 week moving averages for the first time since 2011.
As Dennis Gartman, editor and publisher of The Gartman Letter, says, "It's time to be quietly bullish."
The smart money, like resource billionaire Rick Rule, is not just quietly bullish, though—they are actively buying top-quality junior mining stocks at bargain-basement prices to make a killing when prices rise.
To make sure that you can invest right alongside them, we decided to host a sequel to our 2013 Downturn Millionaires event, titled Upturn Millionaires—How to Play the Turning Tides in the Precious Metals Market.
Back then, we made a strong case for this once-in-a-generation opportunity—but it was still undetermined when the bottom would be in. It looks like that time is now very near, and we believe it's time to act.
On Wednesday, February 5, at 2 p.m. EST, resource legends Frank Giustra, Doug Casey, Rick Rule, and Ross Beaty, investment gurus John Mauldin and Porter Stansberry, and Casey Research resource experts Louis James and Marin Katusa will present the evidence and discuss the possibilities for life changing gains for investors with the cash and courage to grab this bull by the horns.
How do we know the absolute bottom is in? I'll answer that with a quote from a recent Mineweb interview with mining giant Rob McEwen, former chairman and CEO of Goldcorp:
"I'd say we're either at or extremely close to the bottom, and as an investor I'm not prepared to wait to see if the bottom's there because it's very hard to pick it. Because … if you're not taking advantage of it right now, you're going to miss a big part of the move. And when you look at the distance these stocks have to travel to get to their old highs, there's some wonderful numbers in terms of performance that I think we're going to see."
After all, once "Buy gold stocks" is investor consensus, we'll be approaching the time to sell.
Our Upturn Millionaires experts believe that our patience is about to be rewarded. And when that happens, gold stocks will be easy doubles—and the best juniors potential ten baggers.
Don't miss the free Upturn Millionaires video event—register here to save your seat.
Even if you don't have time to watch the premiere, register anyway to receive a video recording of the event.)
Labels:
analyst,
casey research,
economic,
Gold,
investment,
Investors,
Jeff Clark,
metals,
optimistic,
precious metals,
Silver,
Video
Wednesday, November 27, 2013
Fundamentals Rendered Irrelevant by Fed Actions: Probability Based Option Trading
The fundamental backdrop behind the ramp higher in equity prices in 2013 is far from inspiring. However, fundamentals do not matter when the Federal Reserve is flooding U.S. financial markets with an ocean of freshly printed fiat dollars.
As we approach the holiday season, retail stores are usually in a position of strength. However, this year holiday sales are expected to be lower than the previous year based on analysts commentary and surveys that have been completed. This holiday season analysts are not expecting strong sales growth. However, in light of all of this U.S. stocks continue to move higher.
Earnings growth, sales growth, or strong management are irrelevant in determining price action in today’s stock market. In fact, the entire business cycle has been replaced with the quantitative easing and a Federal Reserve that is inflating two massive bubbles simultaneously.
Through artificially low interest rates largely resulting from bond buying, the Federal Reserve has created a bubble in Treasury bonds. In addition to the Treasury bubble, we are seeing wild price action in equity markets as hot money flows seek a higher return. Usually fundamentals such as earnings, earnings estimates, and profitability drive stock prices.
However, as can be here the U.S. stock market is being driven by something totally different......Read "Fundamentals Rendered Irrelevant by Fed Actions: Probability Based Option Trading"
Get our "Options Trading Test Drive Today"
As we approach the holiday season, retail stores are usually in a position of strength. However, this year holiday sales are expected to be lower than the previous year based on analysts commentary and surveys that have been completed. This holiday season analysts are not expecting strong sales growth. However, in light of all of this U.S. stocks continue to move higher.
Earnings growth, sales growth, or strong management are irrelevant in determining price action in today’s stock market. In fact, the entire business cycle has been replaced with the quantitative easing and a Federal Reserve that is inflating two massive bubbles simultaneously.
Through artificially low interest rates largely resulting from bond buying, the Federal Reserve has created a bubble in Treasury bonds. In addition to the Treasury bubble, we are seeing wild price action in equity markets as hot money flows seek a higher return. Usually fundamentals such as earnings, earnings estimates, and profitability drive stock prices.
However, as can be here the U.S. stock market is being driven by something totally different......Read "Fundamentals Rendered Irrelevant by Fed Actions: Probability Based Option Trading"
Get our "Options Trading Test Drive Today"
Labels:
analyst,
bond,
bonds,
earnings,
equity,
Federal Reserve,
financial,
growth,
quantitative easing,
Stock market,
treasury
Subscribe to:
Posts (Atom)





