The Independent Market Observer

5/31/13 – More Good News About the U.S. Economy

May 31, 2013

The good news just keeps coming. This week, we’ve had a seven-year record for home price increases, up over 10 percent from the year before, as well as a rise in the consumer confidence index to a five-year high.

Both show that the improvement in the U.S. economy is wide and sustainable. Representing two-thirds of the economy, consumer spending is the most important part, and higher consumer confidence and wealth suggests that spending will continue—and may well accelerate.

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5/30/13 – Off to Europe

May 30, 2013

I’ll be out of the office for the next week on a trip to Europe, staying in Amsterdam for a week and then a couple of days in Dublin. This is a family vacation, so I’ll certainly be able to report on the five-year-old-boy perspective when I return.

On top of that, though, the trip will offer a valuable eyewitness look at two critical areas in the eurozone. The Netherlands is one of the core northern countries that’s paying the bills—and becoming increasingly conflicted about continuing to do so. I look forward to seeing how that national conversation looks on the ground.

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5/29/13 – U.S. Energy: Beyond Fracking

May 29, 2013

I have written about energy before, but, based on the number of recent news stories on the topic, I think it’s worth taking another look at just how much the energy landscape has changed over the past couple of years.

Last summer, I wrote that, with so many new technologies brewing, it was almost certain that at least some of them would pan out. I wrote about the shift of narrative, recalling a meeting with clients in Massachusetts where I actually sparked an argument about which solar program was better. I wrote about how fracking would be a transition phase.

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5/28/13 – Welcome to Summer

May 28, 2013

My family and I spent the holiday weekend in Maine. Unfortunately, it was in the 40s and 50s on Saturday and Sunday, and, unsurprisingly, there weren’t a lot of people at the pool. Fortunately, Jackson, my now five-year-old son, was happy to spend some quality time snuggled up next to Dad watching movies while Dad read. Sometimes, a quiet weekend is just right.

We did get out a bit, including a drive to the nature lodge on the top of Mount Agamenticus, a local mountain with wonderful views from the summit (on a clear day, which this was not) and miles of trails. Jackson and I have hiked up there before, but this time we just wanted to show it to Mom, who was duly impressed. We’ll be heading back later this summer to do some more hiking.

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5/24/13 – Lower Growth and Stock Market Returns (Part 2)

May 24, 2013

What we were talking about yesterday was the “inside view” of the market. As defined by Daniel Kahneman, the inside view builds up from details and is based on inside knowledge of a situation. Detailed analysis is invaluable, of course, but details can often be used to support our initial biases rather than what’s actually happening.

It is also usually worthwhile to consider the “outside view,” where we simply examine what has happened in the past, without considering the details or why things might be different this time. This bigger-picture view limits the extent to which our biases can influence the conclusions.

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5/23/13 – Lower Growth and Stock Market Returns (Part 1)

May 23, 2013

Yesterday, we talked about why future economic growth may well be at lower levels than it has in the past. Today, I want to look at what that might mean for future stock market returns.

It’s important to note that we’re not talking about the absolute level of growth but the difference from historical levels. This matters because, if the future is different from the past, then metrics that are based on past performance—such as stock market valuation levels—may also be different.

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5/22/13 – More About Future Growth

May 22, 2013

In yesterday’s post, I wrote that higher costs will result in lower growth. We also have other reasons to be concerned that future growth rates won’t match those of the past—with significant impacts on investing.

Here’s the short version: lower future economic growth is very likely to result in lower future stock returns. I’ll get into the details below, but one chart makes the case quite clearly.

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5/21/13 – Higher Costs Equal Slower Growth

May 21, 2013

This is a follow-up of sorts on yesterday’s post, in which I talked about resource constraints. Today, I want to take another look at that topic—specifically, how resource constraints will negatively affect growth going forward.

I’m writing this from Chicago, at the Commonwealth Retirement Symposium. My talk tomorrow, titled “The New New Normal,” will focus on how growth is expected to be lower in the future than it has been historically. I have written about this before—and am in good company with Grantham and Arnott, among others—but there’s a different way to look at the problem that may add to the discussion.

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5/20/13 - Resource Constraints and Breaking Points

May 20, 2013

A point I have been making about the stock market recently is that it makes no sense to bet against it in the short run. The momentum is clearly on the upside, and there are no apparent reasons why that trend can’t continue. We may very well see new records for a while.

I do not, however, expect the trend to go on forever. At some point, the market will top and decline. We are already well into very unusual territory for how long an increase can last without a downturn. At some point, a decline is certain, and the longer it takes, the more certain it becomes.

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5/20/13 — Resource Constraints and Breaking Points

May 20, 2013

A point I have been making about the stock market recently is that it makes no sense to bet against it in the short run. The momentum is clearly on the upside, and there are no apparent reasons why that trend can’t continue. We may very well see new records for a while.

I do not, however, expect the trend to go on forever. At some point, the market will top and decline. We are already well into very unusual territory for how long an increase can last without a downturn. At some point, a decline is certain, and the longer it takes, the more certain it becomes.

Two completely non-market-related stories today made me think about trends and changes. The first is about how an aquifer in the American Midwest has started to run dry. Farmers, who for generations had drawn water from it, now have to change crops because the water just isn’t there anymore. This is a trend that has run its course and is not coming back. It will take decades or centuries for the aquifer to recharge, even if left completely alone. Reading the story, the farmers have known what was coming, but they seemingly didn’t make any adjustments until they actually ran out. As a result, some of them are in financial trouble.

The other story is a comparison of the apparent patience of the peripheral European countries with their self-inflicted depressions in the name of preserving the euro. The article compares the situation in Italy and Spain with that in Argentina, where similar economic sacrifices were made to preserve a link between that country’s currency and the U.S. dollar. The commitment was total—right up until Argentina’s economy had shrunk by about 8 percent and subsequently collapsed in short order. It was only then that the country abandoned the dollar link.

The economies of the peripheral eurozone have shrunk about 8 percent right now, suggesting that perhaps the euro is not as certain as it has been assumed to be. The euro has not collapsed, but what happened in Argentina certainly suggests that it is a possibility.

The point here is that trends continue from their own momentum, often beyond what anyone would have thought possible, and then collapse. The housing market is the most recent such example here in the U.S.

Right now, we have many trends moving in the right direction—the deficit and the housing market recovery are two examples. Both are moving the right way for fundamental reasons, and they are not that far along. Moreover, they are still in what can be considered “normal” territory. The gradual recovery of the U.S. economy seems to be just such a trend.

But the primary trend supporting the increase in the stock market is increasing corporate profit margins. This trend has been going on a long time, and it is already at record levels. Even if margins remain at current levels, the idea that they will continue to expand demands that costs, especially employment costs, continue to decline. This is a trend that needs to be watched closely.

There may still be some juice to this. Who knows? But, as the trend gets older and older, and more and more into record territory, the possibility of stabilization or a reversal gets more and more likely. With current market valuations pricing in a great deal of good news, the consequences of that could be bad. Just as with margins, the upward trend of the stock market bears close watching, and plans for a decline need to be made.

As I said above, it makes no sense to bet against the market right now, but it does make sense to think about what to do if and when the market declines. Unless the laws of economics have been repealed, we know that such a decline is coming and that the time to think it through is now.

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5/17/13 – When to Ignore Economic Data

May 17, 2013

I have written before about the difference between precision and accuracy, and the challenge of distinguishing signal from noise. With the constant barrage of economic and stock market data, much of which is taken to ridiculous levels of precision—one part in a thousand, for example, for the unemployment rates—the problem is particularly acute. What makes it even more ridiculous, of course, is that the figures will often be revised substantially. Precision is an illusion in this area.

This isn’t anyone’s fault; it’s just the reality of collecting messy data across a massive economy in a massive country. It is remarkable that the statisticians do as well as they do.

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5/16/13 - Austerity in the Rest of the World

May 16, 2013

I talked yesterday about how the U.S. has been implementing its own austerity plan—by reducing federal and general government spending over the past couple of years—and how that has led to slower growth than would otherwise have been the case. Many would argue that this is nonsense, given the deficits we have been running, but a look at the stats from yesterday demonstrates that the government as a whole has in fact detracted from growth.

What has largely allowed this detraction to occur—while also allowing overall economic growth to continue—has been the Federal Reserve’s support of the financial markets and consumer spending by forcing down interest rates. You can certainly argue about how long the policy should continue or how damaging the exit will be—both questions I have addressed before—but, in my opinion, the idea that lower rates have allowed consumers to de-lever and supported the housing market recovery is beyond question.

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5/15/13 – Austerity and Growth in the U.S.

May 15, 2013

I saw an interesting chart the other day, in a piece by the analyst Jim Paulsen, that showed how the U.S. economy had performed net of the government sector—which, to spare you the suspense, was actually quite well. We’re also seeing increasing debate over federal spending cuts: Are they needed in the short term in the U.S., or are they doing more harm than good?

The austerity debate is also well underway in Europe, and it is starting to be resolved in favor of more spending—at least on a political level. That’s a different discussion, though. Here in the U.S., it is both easier and harder to justify less austerity. Easier, in that we can better afford it; harder in that we need it far less.

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5/14/13 – A More Cheerful Look at Stock Valuations

May 14, 2013

One of the keys to looking at the stock market as a whole is valuations. For a given stream of earnings, how much you pay can make the difference between success and failure. Much like buying a car, getting a great deal goes a long way toward being happy with the results.

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5/13/13 – Thinking About an Exit

May 13, 2013

Last week, I mentioned that just because the Fed wasn’t talking about an exit strategy didn’t mean it wasn’t thinking about one. Sometimes you get lucky—on Saturday, the Wall Street Journal ran with an article on just that.

As the paper reported, Fed decision makers don’t know exactly how they will exit, as it will depend on the circumstances, but they’re now pondering it. To some extent, this puts paid to the notion that we’re doomed to continue on our present path until everything melts down. Yes, the Fed will exit at the appropriate time, even as the economy continues to improve on its own.

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5/10/13 – This Is the Way the World Ends

May 10, 2013

Yesterday, two of my colleagues and I were discussing the end of the world, a conversation prompted by some of my recent posts, as well as a call from an advisor seeking help with a client who has a nine-figure net worth and fully expects the world to end. In discussing what to do, we realized we hadn’t actually defined the problem: what does the end of the world mean? The last time we seriously had this discussion, in 2008–2009, we thought we knew what the end of the world looked like, but in talking it over, we realized we didn’t. So, in that vein, here’s my attempt to define various “end of the world” scenarios and what to do about them.

Defcon 1 – The U.S. today: economic uncertainty and looming hazards

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5/9/13 – Book Review: The Signal and the Noise by Nate Silver

May 9, 2013

One of the challenges in anyone’s life, especially in one’s job, is figuring out what’s really going on. For me, and anyone involved in the financial sector, this is especially complicated because there is an infinite amount of data, interpretations, arguments, and conclusions that will tell you up, down, right, left, buy, and sell—all at the same time.

The physical sciences have been dealing with this problem for a long time and refer to it as isolating the signal—the meaningful information you need—from the noise, the random events that can mask the signal.

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5/8/13 – The Most Recent End of the World

May 8, 2013

Yesterday, I was asked to respond to an article on the views of Peter Schiff that appeared on the website I’ve written a couple of these responses, and I think it makes sense to keep addressing questions as they come up, as many of these issues are worth a look on their own merits. The headline of the piece in question reads, “2/3 of America to Lose Everything Because of This Crisis.” If that’s true, it certainly deserves at least one blog post, right?

I’m familiar with Mr. Schiff’s views, as he’s a regular poster on various financial websites that I read. He also shares his opinions on his own website. His views are well known, and he’s not alone in them.

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5/8/13 – First Signs of Obamacare

May 8, 2013

For some time, I’ve been convinced that a sustainable expansion has been going on in the economy, but I do have some concerns. The primary one is employment. While housing continues to recover, business investment is doing relatively well, and consumer spending is growing more strongly than expected, all of this depends on employment growth. For the next several months, the signs are good that it should continue.

What will increasingly matter, however, is whether the job growth continues, as well as the quality of the jobs, and here I have some worries. One of the biggest is how Obamacare will affect both the amount and type of hiring. This isn’t a political argument; the law contains multiple incentives that should—if employers are rational—influence their behavior.

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5/7/13 − Remember When I Said Taxes Were Going Up?

May 7, 2013

As I’ve written several times, taxes have to go up, and when they do, it will be done in a stealth manner, without specifically calling it a tax increase, or by using some other justification.

We’re seeing exactly that right now in the form of Internet sales taxes. Just yesterday, the Senate approved a bill that would allow states to force large online retailers to collect sales tax, even if they have no operation in that jurisdiction.

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5/6/13 - Higher Education as the Next Bubble?

May 6, 2013

One of the things I’ve been keeping an eye on is student debt, widely touted as the next bubble. As you can see in the following chart, student debt is at an all-time high, approaching a trillion dollars.

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5/3/13 - May 2013 Market Thoughts Video

May 3, 2013


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5/3/13 – A Very Funny and Depressing Hour with Simpson and Bowles

May 3, 2013

I’ve been at the Goldman Sachs investor conference yesterday and today, listening to and learning from a group of very smart people. Among the smartest were Alan Simpson and Erskine Bowles, the cochairs of the commission that brought us the Simpson-Bowles (or Bowles-Simpson) budget plan. Unexpectedly, they were also the funniest, which, given their dire message, was a relief.

At Commonwealth’s National Conference last year, I gave a fairly detailed presentation on the budget problems we faced, noting that I believed any solution would eventually converge to something close to the Simpson-Bowles plan.

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5/2/13 – Mean Reversion and “Onshoring”

May 2, 2013

Recently, I’ve noticed some pushback on the notion of onshoring jobs. In particular, some economists I respect have noted that there’s little aggregate evidence of a systemic change so far. Most evidence is anecdotal, they say, and overall manufacturing continues to be relatively weak, despite some signs of strength.

I agree with that, but I don’t necessarily think it disproves the onshoring case. What we’re talking about here is a multi-year process, which will start slowly and then gather momentum—exactly as the offshoring process did. Second, in a time of global economic weakness, it’s hard to discern a nascent strengthening trend against a backdrop of much stronger global weakening. Third, we continue to see signs that manufacturing in the least expensive countries has its own sets of problems, which are becoming increasingly public.

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5/2/13 - Market Update for the Month Ending April 30, 2013

May 2, 2013

Markets strong as real economy slows

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5/1/13 – Why the Dollar Isn’t Likely to Collapse Anytime Soon

May 1, 2013

A question I get periodically is whether the dollar is going to collapse. It comes in several different variants, but the crux is usually that, under the Fed’s policies, the value of the dollar has to decline since there are now so many of them in the system.

The most recent version of the question is whether the dollar will be replaced by the Special Drawing Rights (SDRs) developed by the International Monetary Fund. The answer is an unequivocal no, but the original question remains: Is the dollar going to collapse?

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