Friday, September 23, 2016

The view from Argentina

We're in Argentina this week and next, visiting friends and relatives and looking forward to a big wedding this weekend that will be attended by 500+ people. Spring has just arrived, and the people and food are fantastic as always. Food, wine, lodging and taxis are delightfully cheap for American visitors, and now you can easily pay for things with credit cards or withdraw pesos from an ATM (last year both methods were subject to an unfavorable exchange rate), since money is freely exchangeable at a single rate (currently about 15 pesos to the dollar).

There have been many welcome improvements since Macri took over the reins of government from Christina Kirchner late last year. Unfortunately, there are still many head-scratchers: Argentina has uniquely refused to allow Uber to operate within its borders (hint: the taxi cartel is very powerful); it's impossible for Argentines to buy books from Amazon (because customs officials must check each book mailed into the country to make sure there is not too much lead in the ink, and they have no budget to do that, thus "protecting" the domestic publishing industry but intellectually impoverishing everyone in the process); Apple can't sell iPhones in Argentina (because they aren't made in South America, which means that scads of tourists entering the country and Argentines returning to the country carry at least one new iPhone for a friend or for resale); and the great majority of Argentines refuse to acknowledge that the Falkland Islands are British (even though they have been a British Protectorate for over 100 years and unanimously voted to remain one not too long ago). Macri—a successful businessman, an advocate of free markets, and a decent person of the sort I wish Trump were—isn't a miracle worker, but he has accomplished more than most would have hoped for so far and he hasn't given up. He knows that Argentina must regain the trust of the world, the rule of law must be the law of the land, and inflation must be brought under control if capital is to return and businesses are to invest and the economy is to grow.

I've been following the markets throughout the past week, but can't come up with any new or informed observations about what's happening. However, there's nothing wrong with a recap of how I see the economy and the markets, so here goes:

The economy is likely continuing to grow at a disappointingly slow pace, but we might see some modestly stronger GDP numbers in the second half as compared to the first half of the year. There are several reasons for sluggish growth, but monetary policy is not one of them. Tax and regulatory burdens are excessively high; confidence is still lacking; and business investment is weak despite strong corporate profitsRisk aversion, a lack of confidence, and weak investment have sapped the economy's productivity. More recently, the tremendous uncertainty surrounding the November elections—which could give us even higher tax and regulatory burdens and four more years of sluggish growth under a Clinton presidency, or reduced tax and regulatory burdens and four years of stronger growth under a Trump presidency—is most likely convincing risk-takers that it is better to wait until next year before deciding to undertake new investments, and that in turn is contributing to keep growth weak, especially this year.

The Fed has not been "stimulative;" rather, the Fed has been accommodating the world's almost insatiable desire for money and safe assets with its Quantitative Easing program. Short-term interest rates are not artificially low, and thus they are not artificially inflating the prices of risk assets and/or bonds. Interest rates are low because the economy is sluggish, inflation is low, and the market holds out very little hope for improvement in the years ahead. Rates are low because the world's demand for safe assets is very strong. In particular, the very low level of real yields on TIPS, combined with relatively low implied inflation, strongly suggests that the market is very pessimistic about the long-run outlook for economic growth. The Fed is not too tight, because real yields are very low and the yield curve is positively sloped. Deflation exists primarily in the durable goods sector, and China has been one of the driving factors behind ever-cheaper prices for the electronics that have boosted our standard of living—there is nothing wrong with that.

Stocks are no longer cheap, but neither are they obviously expensive. The current PE ratio of the S&P 500 (~20) is above its long-term average, but not excessively high considering how low interest rates are on notes and bonds. Key indicators of systemic risk (particularly swap spreads) are relatively low and stable, and this—combined with the absence of tight money—suggests that the risk of recession is low for the foreseeable future. The unusually wide spread between the yield on cash and the yield on risk assets is a compelling reason to stay invested.

The dollar is reasonably valued against most other currencies, according to the Fed's Real Broad Dollar Index, and my analysis of the dollar's PPP value against other major currencies is largely in agreement with this. Raw industrial commodity prices are neither very high nor very low, but they have been trending higher this year and this suggests some firming in the global economic outlook—which, like that of the U.S., has been unimpressive of late, if not a bit troubling.

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In the meantime, Trump's chances are improving daily and I think the election will soon be his to lose. On Monday I'll be scrambling to find a TV down here that will let me watch the first debate, or, failing that, an internet connection fast enough to live-stream the action.

Friday, September 16, 2016

We're richer than ever

Today the Fed released its Q2/16 estimate of the balance sheets of U.S. households. Collectively, our net worth reached a new high in nominal, real, and per capita terms. We are living in the weakest recovery ever, and things could and should be a lot better, but it is still the case that today we are better off than ever before.


As of June 30, 2016, the net worth of U.S. households (including that of Non-Profit Organizations, which exist for the benefit of all) reached a staggering $89.1 trillion. To put that in perspective, it's about 40% more than the value of all global equity markets, which were worth $63 trillion at the end of June, according to Bloomberg. I note that household liabilities have not increased at all since their 2008 peak; the value of real estate holdings now slightly exceeds that of the "bubble" high of 2006; and financial asset holdings have soared since pre-crash levels, thanks to significant gains in savings deposits, bonds, and equities. 


In real terms, household net worth has grown at about a 3.6% annualized rate for the past 65 years. 


On a real per capita basis (i.e., after adjusting for inflation and population growth), the net worth of the average person living in the U.S.has  reached a new all-time high of $277K, up from $62K in 1950. This measure of wealth has been rising, on average, about 2.4% per year since records were first kept beginning in 1951. Life in the U.S. has been getting better and better for generations. 


The ongoing accumulation of wealth is not a house of cards built on a bulging debt bubble either, regardless of what you might hear from the scaremongers. The typical household has cut its leverage by over 30% (from 22% to 15%) since early 2009. Households have been prudently and impressively strengthening their balance sheets over the past seven years. Unfortunately, our Federal government has more than doubled its debt burden over that same period, as I noted in a post earlier this week.

Wednesday, September 14, 2016

Perspective on the recent market turmoil

It's interesting that in the past week both stocks and bonds have sold off, since previous selloffs have typically seen stock prices drop while bond prices rose. In today's market, bonds don't serve their traditional role as a hedge against weakness in stocks and/or the economy.

What's happening is certainly interesting, if not disturbing (it's always bad when all prices fall). But to be honest I can't find any unifying theme or explanation for what's happening. If I had to give a quick answer, I'd say simply that not much has happened in the past week when viewed from an historical perspective. This may all be much ado about not very much.

In any event, the following charts let you see for yourself whether there are any significant or obvious patterns out there:


It does look like stocks have run into another "wall of worry," but it's a pretty minor one according to the chart above. The Vix index jumped from a low of 12 to a high of just over 20 in the past week (indicating increased fear and uncertainty), but this was offset by a rise in 10-yr yields from 1.5% to 1.7% (which might possibly mean the market is less pessimistic about the economy's ability to grow, which is not necessarily a bad thing at all). In any event, stock prices so far have only dipped modestly, and that tends to happen quite often in fact.


Real yields are up almost 40 bps in the past few months (a sign that the market is more optimistic about the economy's ability to grow), but they haven't changed much at all in the past week. Gold prices are down a bit in the past week and they have been relatively flat for the past few months. Together they signal that the market is slightly less pessimistic or slightly less concerned about disturbing things happening in the future. But it's hard to build a big case around these modest changes.


10-yr Treasury yields, shown in the chart above, have indeed jumped in the past week and in the past few months. But they are still quite low relative to where they've been in the past year or so. If anything, I'd say this shows the market has become slightly less worried about weak economic growth—less worried than it was in the immediate aftermath of Brexit, which occurred in late June.


The chart above compares 5-yr Treasury yields to 5-yr TIPS yields; the difference between the two is the market's expectation for what the CPI is going to average over the next 5 years. Inflation expectations are relatively low, and they haven't changed much at all of late. We're not in the presence of anything like an inflation scare. The economy remains in slow-growth mode and the market is priced to a 20% chance the Fed will raise rates next week. This is not a Fed-related panic. Why should the Fed push rates up if the economy is weak and inflation expectations are low and stable?


The chart above compares 10-yr Treasury and 10-yr TIPS yields, and the market's expectation for what the CPI will average over the next 10 years: a very modest 1.5%. Nothing much going on here.


The chart above shows the CRB Metals Index. It fell a bit in the past week, but it is still up almost 30% since the end of last year. If anything, this says that global economic fundamentals have firmed a bit year to date, and that's encouraging.

Given the revelations about Hillary Clinton's health in recent days, it's not surprising that her poll numbers have weakened. Trump has managed to become a bit more presidential of late, and a bit less off-the-wall, so it's not surprising that his poll numbers have improved. But I don't think we're yet at the point where the market is going to start pricing in a Trump victory. Hillary is still the odds-on favorite, though not by as much as she was a few weeks ago.

Regardless, the outlook for changes in fiscal and regulatory policy remains highly uncertain at this point, as I noted early last week. In the presence of uncertainty, economic actors are more likely than not to postpone major investment decisions, and that is going to keep the economy weak for the time being (although it wouldn't be surprising to see third quarter GDP come in a bit stronger than first and second quarter). And even if Trump's prospects improve dramatically, I don't think the market is going to be quick to conclude that a Trump presidency promises a vigorous economy. If anything, the likelihood of a Trump presidency could unnerve many people all over the globe. Until, that is, it becomes clear that he is bound and determined to lift the burdens of taxation and regulation that have been acting like a ball and chain around the economy's legs for the past seven years.

And even if it becomes clear that Trump will win and will pursue healthy tax and regulatory reform, the prospect of a stronger economy brings with it the likelihood of a significant rise in interest rates. It's going to take the market a while before it embraces the notion that stronger growth, rising profits, and higher interest rates are all of a piece. I've argued for years that higher rates won't threaten growth, because they will be the by-product of stronger growth. I have also argued for years that stock prices have not been inflated by "easy money" or artificially low interest rates, because the Fed hasn't been pushing rates down; the Fed has been lowering interest rates in response to a weak economy, lots of risk aversion, and strong demand for money. Thus it's logical to conclude that a stronger economy, declining risk aversion, and falling demand for money would all go hand in hand with higher interest rates. A stronger economy would also mean a lower deficit, and that would mitigate the impact of rising rates on the federal government's debt burden. In short, I'm not worried about the implications of a Trump win, but it might take the market awhile to digest it.