The Independent Market Observer

1/31/13 – What the GDP Report Means for the Future

January 31, 2013

I wrote yesterday that “bad is good,” in that the poor results for fourth-quarter GDP actually concealed quite a bit of underlying good news. I still feel that way, but after taking a closer look at the numbers, I think it’s worth considering what the report means for the economy in the next couple of years.

There are two major things going on here: the recovery of the real economy, and the slow removal of federal fiscal and monetary stimulus.

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1/30/13 – Bad Is Good

January 30, 2013

So, gross domestic product—that is, the U.S. economy—declined a bit (by 0.1 percent, to be exact) for the fourth quarter of last year. Is this it? Is a recession starting? What about all the good news I’ve been discussing? Aaaaaaaaaaaah!!!

Okay, I feel better now. In fact, while no one wants to see a decline in GDP, if we have to have one, this is exactly how we want it to happen.

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1/30/13 – A Look at Unemployment Insurance Claims

January 30, 2013

Guest post from Peter Essele, CFA, senior investment research analyst

Every Thursday, the talking heads on CNBC make a big fuss about the initial claims numbers, pointing out whether they’ve moved up or down from the preceding week. Often, they eat up a good 10–15 minutes of airtime squawking over the fact that the newly released numbers are either above or below historical levels.

Although this makes for good entertainment, it does little to address the big picture. In order to draw some actual conclusions about how we look against historical norms, we’ve put together the following chart, which shows the number of initial claims for unemployment insurance divided by the total number of employed citizens. When the line moves north, it’s an indication that claims are increasing relative to the number of employed individuals. When it moves lower, it signals an improving employment picture (employment outpacing claims).

Currently, we’re at some of the lowest historical levels in terms of initial claims relative to the number of employed individuals. The prognosticators on CNBC like to compare the initial claims number with historical values in insolation, but, as the chart shows, the number of new claimants represents less than 0.3 percent of the total employment pool. In terms of employment health, this paints a pretty good picture.

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1/29/13 – Markets Are Strong—Will It Continue?

January 29, 2013

The S&P 500 Index recently closed above 1,500 and is making a bid to go up from there. Fund flows are starting to move away from bonds and back toward equities—for the past month, anyway. There is speculation that the “Great Rotation” away from bonds and back to equities is underway. Is it so? And if it is, what will that mean?

Quite possibly it is true, and if so it could mean a lot. Sentiment seems to have shifted substantially with respect to the stock market, with investor surveys at historically very high levels. When narratives shift, the effects can be big and lasting. But sentiment can only go so far, and so it pays to look at the underlying fundamentals as well.

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1/28/13 – How to Invest in Stocks: Applying the Knowledge

January 28, 2013

Last week, I discussed three books that offer a good basic overview of how to invest in stocks. The next step—and, in many ways, a more difficult one—is to figure out how to apply the conclusions you’ve drawn. How can you identify the stocks that meet your criteria?

There are several services that rate stocks. Value Line is one of the oldest and apparently has a great track record. Its rating system is fairly simple, and its data sheets present a lot of information very effectively. Many other screening systems rest on a Value Line base, selecting their stocks from among those that VL ranks highest for timeliness or other factors. Another significant advantage: The weekly hard-copy version of Value Line is available in many libraries for free, which is how I used to use it. It’s definitely worth a look.

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1/25/13 – Things Really Are Getting Better

January 25, 2013

I mentioned the other day that the narrative in our country has changed and that the focus now is on what is going right. The news today supports this notion yet again. New unemployment claims came in at a five-year low, and housing continues to strengthen.

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1/24/13 – How to Invest in Stocks

January 24, 2013

With the economy recovering, the market doing well, and the politicians seemingly getting down to the business of actually negotiating rather than yelling at one another, people are feeling more cheerful, especially about the stock market. Investor surveys are at very high levels for confidence, volatility is at historically low levels, and U.S. markets are closing in on all-time highs. What’s not to like?

Actually, there are a lot of reasons to be concerned—which I have written about in the past and will do so in the future—including the fact that high levels of bullishness are themselves contrary indicators. Today, however, is about how to invest in individual stocks, rather than about the market as a whole, and here there are encouraging signs.

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1/23/13 –“India Warns Kashmiris to Prepare for Nuclear War”

January 23, 2013

When I saw the above headline in today’s New York Times (page A3), I have to admit I was taken aback. All of the discussions I have heard about nuclear war recently have been metaphorical, typically centering on how Congress is dealing with something. This one isn’t. Reading the article is scarily reminiscent of civil defense drills that I am just old enough to remember—when we stood in the central hallway of the school, facing the wall with our hands over our heads.

I couldn’t have asked for a better reminder that even as economic risks recede—and they are receding—there are a number of geopolitical risks that will come back to fill that worry-space. The relationship between India and Pakistan is certainly one risk; another is Japan and China, where, as of yesterday, both countries were sending fighter jets to the disputed Senkaku/Daioyu islands.

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1/22/13 – They Didn’t Blink

January 22, 2013

I hope everyone enjoyed the long weekend as much as I did. My son, Jackson, and I built a small working wooden catapult and a fire-dog house using his cardboard blocks. And he went skating and to a SteveSongs concert with his mom.

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1/18/13 – Past Performance Is No Guarantee . . .

January 18, 2013

A popular talking point these days is that the deficit over the past several years has been the worst since World War II. That’s absolutely true, as you can see from the chart below, but the statement misses a key point.

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1/17/13 - Another Look at China

January 17, 2013

China has been in the news quite a bit recently, and it is past time to take another look at what is going on in the second-largest economy on the planet, especially since it is one of the keys to global growth going forward. China matters, as everyone knows, but it may matter for different reasons going forward than it has to date.

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1/16/13 – Narrative Economics

January 16, 2013

One of my favorite authors is Terry Pratchett, best known for a series of novels about the Discworld, a fantasy world (very) loosely based on medieval London and Europe. When you hear “fantasy,” though, don’t think unicorns and rainbows; instead, think folklore and Charles Dickens. Pratchett’s writing is an interesting combination of Dickens and Douglas Adams (The Hitchhiker’s Guide to the Galaxy), with more than a bit of P. G. Wodehouse thrown in. The series is worth a look, but the later books are better than his earlier ones, in my opinion.

One of the tropes of Pratchett’s universe is “narrative causality,” the notion that stories are entities that actually shape behavior in the real world. As he writes in The Last Continent, “. . . the proliferation of luminous fungi or iridescent crystals in deep caves where the torchlessly improvident hero needs to see is one of the most obvious intrusions of narrative causality into the physical universe.” Obviously, narrative causality doesn’t extend into the physical universe here, but it does extend into the behavioral universe. Therefore, it’s worth considering in terms of economics, which, after all, is just human behavior writ large.

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1/15/13 – Employment: Stronger Than You May Think

January 15, 2013

Following on the review of how well the housing market is doing, I thought I would take a look at employment.

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1/15/13 – A Closer Look at the Housing Recovery

January 15, 2013

As I’ve been talking about the housing recovery for some time, I thought it would be worth giving it a more detailed look. I don’t intend to get very quantitative here, but there are a number of charts that illustrate just how far we’ve come. First, let’s take a look at housing affordability.

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1/14/13 – Looking into the Abyss

January 14, 2013

One of the wonderful things about the digital age is the emergence of mash-ups, where people combine elements of existing art in new ways. The idea has been around for decades, of course, but the Internet and digital technology have made it even easier to create and distribute.

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1/14/13 – Inflation Part 4: Distant Early Warning

January 14, 2013

Looked at in financial terms, the Federal Reserve (Fed) has done its bit by expanding the monetary base. There is quite a bit of money ready to go, and when it gets put into the economy, we will see inflation. But first, we need consumers and business to borrow and spend that money. That hasn’t happened yet; when it does, then we’ll need to worry about inflation. So it gives us a list of things to watch for:

  1. The unemployment rate decreases. As excess labor is absorbed, companies will be forced to raise wages, which in turn will increase spending power. This is a necessary condition for inflation to move significantly higher, barring a rise in input costs, such as an oil shock. This will also signal increased growth, which should lead businesses to start investing again.
  2. Banks start lending/consumers start borrowing again. This will probably lag increased employment, as people won’t/can’t, borrow without jobs, but once employment recovers, borrowing will most likely be close behind.
  3. Growth in gross domestic product (GDP) ticks up. This will be an inevitable consequence of 1 and 2, but it is still worth watching as a leading indicator. Growth absorbs labor, materials, and everything else, and by increasing demand, it will certainly stoke inflation.

Even when some or all of these occur, inflation will not necessarily be on the immediate horizon, as there is still quite a bit of slack to work through—but it will be getting close. At that point, we should also see bond yields start to increase, which brings us to the investment implications.

Because we know inflation will increase eventually, any investments intended for more than a year or so should bear that in mind. For fixed income, shorter durations both limit the price risk and provide the opportunity to reinvest sooner at potentially higher rates. For equities, buying stocks that may potentially respond favorably to inflation, such as real estate investment trusts or commodity stocks, might make sense. For people who own or plan to buy homes, it would make sense to lock in today’s low rates.

None of this is to say that inflation is imminent—it is not. At some point, though, growth will resume, and the excess capacity that we presently have will be used up. As I have said, I believe that the U.S. economy has started a sustainable recovery, and if it is not derailed by actions from Washington, DC, that recovery may well result in inflation sooner than anyone now thinks. If so, that will actually be a very positive outcome, as it will mean we are finally through the aftermath of the financial crisis and into a more normal world.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs, and international economic, political, and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Real estate investments are subject to a high degree of risk because of general economic or local market conditions; changes in supply or demand; competing properties in an area; changes in interest rates; and changes in tax, real estate, environmental, or zoning laws and regulations. REIT units/shares fluctuate in value and may be redeemed for more or less than the original amount invested.

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1/11/13 – Inflation Part 3: The Fed Solves the Deflation Problem?

January 11, 2013

The economic slowdown on the financial crisis, combined with rapidly declining asset values, put the economy at risk of deflation. For reasons I discussed in the last post, the Federal Reserve (Fed) is actually trying to create inflation as a preferable alternative to deflation.

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1/11/13 – A Good Friday

January 11, 2013

There is not a lot in the way of breaking news today, which is a good thing, but I think two articles are worth a look. They illustrate that there really is a healing process under way and that, despite all of the kvetching (of which I am certainly guilty), we really are making progress.

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1/10/13 – Inflation Part 2: Deflation Becomes the Problem

January 10, 2013

In part 1 of this post, I talked about what inflation is and how a moderate level has actually been good for the economy over the past couple of decades. That changed in 2008. Asset prices, particularly in housing, had inflated to an unsustainable level. The inflation measure the Federal Reserve (Fed) had been watching was based more on consumer consumption prices and less on asset prices. The asset price inflation got out of control and eventually collapsed. Because much of the financial system at that time was exposed to those asset prices, a financial crisis ensued.

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1/10/13 - Planning for Failure: The Trillion-Dollar Coin

January 10, 2013

I’ve said it before and will say it again: the debt ceiling debate, coming shortly, is the real thing we need to worry about. The deal over the fiscal cliff settled the immediate risk to the economy—although everyone’s taxes went up, they went up much less than they could have, and spending power was therefore preserved. Spending cuts, which will hit at the same time as the debt ceiling, will also be a headwind to the economy, but they are necessary and can be phased in to cause minimal harm. The one thing that could really blow us up is failure to resolve the debt ceiling issue. This is why it is actually encouraging to see active planning for failure. Given the risk, we should have a plan.

I talked in a previous post about the political options —how the Senate has, twice now, cut a deal with White House approval and essentially dared the House to vote it down. That remains, in my opinion, the most plausible option, but there are others, which range from the serious to the absurd. Let’s start with the serious:

  1. A Senate deal forced through the House. This has been done successfully before, but it looks more questionable this time, as the House will be expecting it. Each time, it has been more difficult and resulted in a shorter-term solution. There may be one more bite on the apple, but it is not certain. Feasibility: Medium to high, but any solution would be short term and probably partial.
  2. Scrip could be issued instead of actual cash payments once the Treasury hits the wall, enabling operations to continue despite the debt ceiling. The scrip would not be debt because it would not pay interest and would not mature, but it would be a cash alternative that would be transferable, probably to financial institutions, at a high percentage of face value. This method was used by California in 2009. Although there would certainly be problems with this solution, there is precedent—it worked in California—and there appear to be no insurmountable constitutional problems. This proposal is detailed in an article in today’s New York Times. Feasibility: Pretty high.
  3. The trillion-dollar coin. Among others, Paul Krugman has proposed that a platinum coin with a denomination of $1 trillion be issued and deposited at the Federal Reserve, which would then transfer the money to the Treasury’s account. Voila! No more problem. There is apparently a clause (intended for commemorative coins) that allows the Treasury to mint platinum coins of any value it wants. It’s tough to know even where to start discussing the problems with this option, but it does seem to be legal, and economically it is not that different from what we are doing now. The problems would be political, and they would be big. Feasibility: Low.
  4. The president could plausibly invoke the 14th Amendment to lift the debt ceiling, based on the language “the validity of the public debt of the United States . . . shall not be questioned.” The White House recently ruled this out, but it could remain an option if necessary. The downside? The questionable legality, the almost certain legal challenge, and the potential constitutional crisis would not really reduce the uncertainty. Feasibility: Very low.
  5. A grand bargain. Both sides could come together on a deal that raises the debt ceiling and has a credible mix of spending cuts and tax reform to create a sustainable solution over time. Feasibility: Very low, unfortunately.
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1/9/13 – What Should We Do?

January 9, 2013

There has been a lot of uncertainty in the economy and a lot of volatility in the financial markets. Recently, that has been good; the bump after the fiscal cliff deal took us to a five-year high. Clearly, the expectation in the stock market is that uncertainty has been reduced, problems have been solved, and we have clear sailing ahead.

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1/9/13 – Inflation Part 1: What Does It Mean and Should We Be Worrying Now?

January 9, 2013

One question that has come up repeatedly when I talk with advisors and clients is whether inflation is coming. The answer is simple, if perhaps unexpected: hopefully, it is. What? Why on earth would we want inflation?

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1/8/13 – Financial Regulation and Why It Matters

January 8, 2013

Over the past couple of weeks, significant progress in financial regulation has been made at both the U.S. and international levels, and most people don’t care. (Nor should they, in many ways.) Yet, there have been a couple of developments that are relevant to the average person.

First, though, let’s look at a broad picture of why banks matter. If the country had to operate with each individual or business using its own assets, growth would be very limited. Banks (or other lending institutions, but let’s keep it simple) allow those with extra capital to provide it, for a fee, to those who need the capital and are willing and able to pay for it. The bank acts as an intermediary and takes its own fees. Everyone benefits: the depositor, who gets paid; the borrower, who gets access to capital; and the bank, which also gets paid.

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1/7/13 - January 2013 Market Thoughts Video

January 7, 2013


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1/7/13 - It Starts Today

January 7, 2013

“The tax issue is finished, over, completed.” — Mitch McConnell

“The tax issue is resolved.” — John Boehner

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1/4/13 – A Different Way to Look at Nonfarm Payroll Sectors

January 4, 2013

Guest post from Peter Essele, senior investment research analyst

Traditionally, to make prognostications concerning the direction of the economy, investors and economists alike tend to look at the total change for nonfarm payrolls on a monthly basis. Commonwealth’s Asset Management team has developed the metric shown here, which is a slightly different way of looking at the same data.

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1/4/13 – Underlying Economy Continues to Improve

January 4, 2013

I have spent a couple of days talking about the situation in Washington, and now it’s time to take another look at the country as a whole. Despite the fun and games in D.C., the real economy continues to improve in multiple ways. Let’s take a look at some.

First, employment. Today’s data shows that, overall, 155,000 jobs were added in December, just matching population growth. This is a reasonable number that should keep the unemployment rate stable, and that is what happened. Unemployment stayed steady at 7.8 percent, and the underemployment rate (which I prefer) remained stable at 14.4 percent. Not great news, but given the fiscal cliff uncertainty, not terrible either.

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1/3/13 – What Comes Next

January 3, 2013

Much of today’s press coverage highlights the points I made yesterday—that is, how the fiscal cliff deal hasn’t really solved any of the problems and just sets the table for the next crisis in a couple of months. All true, but we are where we are.

Now, the question is this: How do we prepare for and resolve the next crisis? I think everyone agrees this is no way to run a railroad. What we’ve learned in the latest debacle, though, is that there is a way around the current dysfunction.

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Market Update for the Quarter Ending December 31, 2012

January 3, 2013

A year that investors can celebrate

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1/2/13 - Hooray

January 2, 2013

The news this morning is that at the last minute, after actually going over the cliff, our government officials have successfully covered their butts and kicked the can down the road for another two months. If that doesn’t sound like a ringing endorsement, it isn’t.

Let’s look at what the legislation actually does. Today, the Washington Post published a good cheat sheet.

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