The idea of this post is to do something a little different. I want to raise a series of questions and remarks based upon two financial brokerage reports published this month. I will compare and contrast the ideas between the two reports, especially when they make opposite predictions. I will also include some of the tips and lessons I have learned from the four-hour seminar yesterday offered by the Online Trading Academy.
What I will not do is say choose one report over another or classify them as “good” or “bad”. As with most things, each report offers partial truths which can only be deciphered after reading comments and “facts” from multiple sources.
These are the two reports:
1) “Objects in the Rear View Mirror May Appear Closer Than They Are: A Look Back to the 1990s“. Liz Ann Sonders. 17 March 2014. Charles Schwab
2) “The RIC Report: Not everything can keep going up”. Research Investment Committee. 11 March 2014. Merrill Lynch. [I cannot post a public link for this report on my blog.]
The Online Trading Academy courses and publications can be found here.
Now I will question certain portions of the Charles Schwab public report and also attach it as a PDF. I will then do the same for the Merrill Lynch report, but instead of including the PDF, I will cite the page or graph number. Last I will cite some of the alarming predictions made by the Online Trading Academy.
Objects in the Rear View Mirror
The public report begins by outlining some major similarities and differences between today’s market environment and the one that existed in the mid-1990s. I want to discuss a few of these similarities and very briefly suggest why I think they are irrelevant or challenge them.
(1) “Slow, ‘jobless’ economic recovery”
Job creation is countercyclical. An economic recovery can imply job creation, but this isn’t necessarily true. The profits that a few have reaped from an inflated stock market can also be a factor. The economy can also grow in the short-term by cutting jobs and replacing workers by more efficient manufacturing or technological processes.
(2) “Freer trade (NAFTA then, WTO pact now)”
In recent history it seems as though “free trade agreements” are implemented in times of economic distress. They are not necessarily implemented during the onset of the economic crisis, but rather trade discussions openly begin a few months or years later. I wonder what the role of diminishing trade barriers has on long-term economic recovery. Does this solution reach natural limitations?
(3) “Rapidly improving federal budget deficit”
This is something I saw throughout both the Charles Schwab and RIC Merrill Lynch reports. There seems to be a large focus on the diminishing federal budget deficit. I cannot do this justice in one paragraph, but I will make my best attempt. This note is relative, and I think the key is not to be aware that the deficit is accumulating less quickly, but rather that it is still increasing and that QE is still being used by the Fed. Maybe one reason for this is because the Fed does not want to be forced into implemented QE for a second time during the third quarter (Q3) of this year?
(4) “Minimum wage hike”
Maybe I missed the boat here, but has legislation been passed nationally to raise the minimum wage? Here I think the government is trying to ensure that interest rates rise. This will happen simultaneously as we reach “full” employment levels and while all workers demand hirer salaries. This will be driven by minimum wage employees demanding “liveable wages” and then others following suit.
Tcherneva discusses Keynes’ targeted demand approach to full employment in her working paper. This is from the abstract of her paper:
“Aggregate demand tends to increase inflation and erode income distribution near full employment, which is why true full employment is not possible via traditional pro-growth, pro-investment aggregate demand stimuli. This was well understood by Keynes, who preferred targeted job creation during expansions.”
(5) “Technology revolution”
This prediction is premature. The technologies to make large portions of the population unemployed already exist. With the advent of 3D printers, self-delivering packages, and automated (self-driving) cars, the economy will again undergo large sectoral shifts. This is not even accounting for things that currently exist that have yet to be largely implemented: self-ordering of food in restaurants, the more efficient use of information technology by the average person, the legitimizing of online universities, etc.
(6) “US market outperforming emerging markets (EM)”
The US market is outperforming the emerging markets simply because the US capital is flowing back home. What we are not considering are the changes not in who attracts the world’s financial assets, but rather another question. Today which countries are producing the real financial assets to invest. Will these financial assets naturally flow to the US or will they be used to foster internal (national) development or used inter-regionally as trade blocs grow and mature. Today countries within the same trade bloc are reinforcing one another. One example of this is how the EU bailed out Greece and other countries in the Eurozone. Another more important example is how Brazil is lending credit to Argentina [“Brazil to sign new credit line with Argentina“. Theirry Ogier. 27 March 2014. Emerging Markets. – See articles tab].
U.S. market performance also depends on how other countries value the dollar. Do countries trade in the dollar? Do they horde large quantities of it in their central banks?
(7) Graph #1: Another Jobless Recovery?
I did not know what “nonfarm payrolls” were until I read this report. I am still unsure if entrepreneurs who leave companies during economic downturns to work for themselves are considered in this category. Any answers or thoughts?
(8) Graph #2: Consumption to Pick Up?
This chart shows the personal consumption expenditure (PCE) year/year % change from 1990 to 2013. I think it would have been more beneficial to see a breakdown of the percentage of PCE expenditure for durable goods only. It would nice to have the purchase of durable goods broken down and analyzed by subcategory, similar to what CCSB does on their website.
(9) Graph #3: Very Easy Monetary Policy
The 10-year treasury yield underperformed the federal fund target rate between 2005 and 2007. As of now, the 10-year treasury yield is outperforming the federal funds target rate which is hovering a little above 0% as of 2008. My first question is: why is the federal target rate so low? My second question is: Can this open the door for a possible devaluation of the USD scenario to unfold?
(10) “Related to still-easy monetary policy as well as freer global trade and weaker emerging markets growth; inflation is low with limited risk of a major spike from these levels, even if wage growth picks up from here (like it did in the mid-1990s).”
When a new study is created, it seems as though the basic variables that are held constant from previous studies on which the current study is based are not critically reanalyzed. Even more alarming, sometimes the “basic”/”given”/”fixed”/”constant” variables are not even recognized for what they are, they are simply taken for granted. New studies are made that just replicate or build off of previous studies, without considering that maybe certain variables might have new relevance for the current study. If so, new variables should not be held constant and maybe former “constant” variables should study now should be variable.
(11) “For what it’s worth, in the past three cycles, the 4% level was important both in signaling the finale of the cycle and rising inflation/tighter monetary policy.”
This is in reference to Graph #4: Better Wages, But Still-Low Inflation?.
(12) Graph #5: Deficit Improving
I want to see the fluctuations as percentages of the real GDP. I feel as though the nominal values are just a way to disguise the current reality of the federal budget deficit/surplus.
(13) Graph #7: Midterm Election Years’ Repetitive Patterns
The lesson is simple: invest after midterm elections. Regardless of your political affiliation, many people pull out at that time. Emotions may be playing a role in these stock sales.
(14) Graph #8: US Over EM again
Even when market studies begin to subdivide emerging markets, these attempts are weak at best. Normally, they are too dismissive over the role of emerging markets and see them simply as reactionary. The views are also based upon a time with the U.S. dominated the global financial and economic pie. Also, the perspective is typically uniform, even though there are not many similarities between countries such as Chile and Uzbekistan.
The ranks of emerging countries have changed over time. Now we even see the “developed countries” fall to ranks below those held by “emerging countries”. Just look at the projection for Brazil’s GDP ranking in 2050. This is a good article for basic charts from a PwC projection studying GDP projections until 2050 (however, once again with a lot of factors held constant). At least from face value, even here there is no systematic breakdown of the performance of these emerging markets in relation to one another. We seem to always group them into large or “regional” groups and then make comparisons between X county or region and the “developed” world. Here we are comparing apples and oranges. What is they are using new rules instead of replicating those used in the past?
(15) Graph #9: Market Volatility to Rise in Tandem?
I did not know that in the mid-to-late 1990s stock market and volatility both rose for an extended period of time. This was the first time this happened in history (or at least modern history). What is the important take away is that there is high probability of stagnation when the stock market and volatility rise together.
(16) Graph #10: Margin Debt at Record… Again
This graph has three lines: margin debt, excessive optimism (bearish), and excessive pessimism (bullish). Right now the margin debt is tightly correlated to the level of excessive optimism (bearish). Normally this happens for awhile, and then the margin debt level crashes to below the line for excessive pessimism (bullish). The margin debt can remain almost in-sync with the excessive optimism (bearish) benchmark for eight years or it can do it for three years (using the periods of 1992-2000 and 2004-2007 as the examples).
(17) Graph #11: Equity Funds Flows Picking Up
Are they going out of style? [See Online Trading Academy notes below.]
The RIC Report: Not everything can keep going up
(1) Sunny days
The Merrill Lynch report emphasizes the effect the warmer weather will have on the U.S. economy (p. 1). I also agree that not only does the weather influence buyer/seller emotions, but businesses will also increase productivity
in order to recoup their losses from this past winter. Even outside of the manufacturing sector, other types of businesses lost hours of potential productivity this past winter. I missed at least five days of work myself, since I was unable to commmute to Philadelphia. The RIC report says warmer weather “is likely to be accompanied by rising US Treasury yields and a higher US dollar.”
(2) The report is basing the annual recovery on the S&P 500 index gaining 4.6% (+1 YTD) in February (p. 2).
Even though the report addresses this concern, it needs to be mentioned that extrapolating the projections for the rest of 2014 might not be appropriate. January 2014 was an extremely difficult month economically. We also had bad weather in February, but the economy seems to have recovered. (I am not taking into account what happened in March.) It is important to recognize the February is the shortest month of the year. Economic performance also depends on how many working days are in each month. (Recognizing these two variables also will help you in determining true bargains from your utility company.)
(3) This report introduced me to the MSCI Emerging Markets asset class.
MSCI Emerging Market’s divides some countries into three classes: developed, emerging, and frontier markets. I will be looking into the MSCI global equity indexes which can be found here. I hope that it subdivides bonds for specific countries.
(4) A weaker dollar – down 1.2% in February (p. 2)
This will benefit U.S. exporters, especially if it coincides with the advent of new free trade agreements. It is also good to see that gold prices are correcting themselves.
(5) Household net worth (p.3, Chart 1 on p.4)
This section discusses how household balance sheets have improved due to the growth in the stock market, the continued real estate recovery, and decreasing debt levels. I would like to know how much weight each of these factors have for the increase in household net worth. The percentage of disposal and discretionary income has steadily increased since Q2-2011. I wonder if this is only temporary.
(6) Results from March 18-19 FOMC meeting (p. 4).
Watch the press conference with Janet L. Yellen, projections materials, and the press conference transcript here. The Fed might be able to contain yields without QE.
Based on comments from Fed officials and testimony from Fed Chair Janet Yellen, winding down QE is the clear preference at the Fed. The Fed will probably announce another installment of tapering at the March 18 -19 FOMC meeting. The Fed prefers to shift its focus to its “forward guidance” regarding short term rates. The FOMC has stated that it expects to keep the federal funds rate near zero until “well past the time” that the unemployment rate declines below 6.5%. The unemployment rate stood at 6.7% in February. The advantage of providing suchguidance instead of QE is that the Fed could still contain yields, but without adding further to its balance sheet.
(7) “The GEMs Inquirer: Pig in the Python – the EM carry trade unwind”.
This was an interesting report, and it probably deserves its own blog post. I think the key here is to look for instances where EMs are raising and sharing capital amongst themselves.
(8) US real GDP grows at 2.8% this year; stocks and low quality bonds outperform Treasuries (p.6)
High yield bonds have prices that are less sensitive to rises in interest rates in comparison to other lower yielding bonds. (I need to learn more this myself.)
(9) Pensions (p.7)
Improving pensions is helping to drive flat nominal growth. It would be nice to see more data about the viability of the public and private pensions in this country. All data should be in real terms and the study should include all dates where data is available. Ideally it would stretch back to 1900. All pension systems should be put in proper context, which would include the actual “plan” alongside the developments in the federal governments way to address cracks in the pension system both directly and indirectly.
(10) The correlation between growth and value (p.7)
As the report states, the correlation between growth and value has strengthened between 2008 and 2013. It would be helpful to know what this correlation was for previous six-year periods. Could more efficient processes and the increased availability of data be drivers for correlations at high statistical significance?
(11) The winter in historical context (p.10-13)
I enjoyed reading about the Extreme Winter Weather (EWW) index used in this section. I also thought it was a good idea to look at the states individually as opposed to comparing national aggregates in a times-series.
However, I thought the question for Chart 9 on page 11 could have been formulated differently. The poll is titled: Number of people who said they were not at work due to weather in December-February (thousands). It would have been more useful if we knew approximately how many times during this two-month period that these individuals did not go to work due to the weather.
(12) There is an approximate 15% drop in ISM manufacturing, new orders between December 2013 and January 2014 (Chart 13, p. 12).
By monitoring the ISM Manufacturing Index, investors are able to better understand national economic conditions. When this index is increasing, investors can assume that the stock markets should increase because of higher corporate profits. The opposite can be thought of the bond markets, which may decrease as the ISM Manufacturing Index increases because of sensitivity to potential inflation.
What happened in January to the bond and stock markets? Where is the new ISM manufacturing, new orders data?
(13) Look across the pond
“European recovery is only just beginning, in our view, and the region is poised for a longer and more sustainable rally in the equity market in 2014” (p.13).
Merrill Charles Schwab says just the opposite. Stagflation can occur in the EU and it can become the next Japan. Germany could also enter into a deflationary spiral. I would prefer to invest in developing countries that have low to moderate inflation rates that in “developed” countries that are undergoing deflationary spirals or encountering stagflation.
(14) The definition of global commodities (p.16)
I think we need to start viewing commodities more broadly, beyond oil, natural gas, gold, and copper. Edible commodities must also be considered especially if we consider future scarcities.
(15) Strengthening of USD against G10 (p. 16)
US energy discoveries can eventually prove the impetus for a revived U.S. recovery if carried out successfully.
(16) Merrill Lynch uses an asset allocation for global investors to reduce the “home country bias” and introduce a currency perspective (p. 20)
BofAML Global Research strategists could do more for aggressive investors. Emerging market allocations make up at most 12% of these portfolios.
(17) Table 12 on p. 22 lists sector weighting in order of preference.
The role of information technology, industrials and energy were accompanied with interesting comments.
(18) Inflation rates in Brazil (p. 27)
CPI inflation is expected to increase 10.6% this year in Brazil, in comparison to 7.4% in 2013F. Inflation will subside to 9.1% in 2015F.
Online Trading Academy Power Workshop
The Online Trading Academy is an institution that teaches individuals how to invest their money. They showed us their preferred platforms and emphasized the need to act instead of react to the market. They also stressed using a minimal amount of the analytical mechanisms to track stocks, since most of these simply distract you and cloud out what is really important – the fundamentals.
The market has been wanted to drop, but the government has not let this occur through QE and other complimentary measures. Mutual funds were designed to support an equally populous new generation. When the baby boomers try to increase their liquidity through the sale of 401Ks and mutual funds, there will not be an equal amount of buyers on the other end. The younger generation has a different take on the market. We have not seen the enormous gains the market can reward individuals, but only the losses that can incur.
When we want to invest, we may also prefer futures, options, and Forex over stocks. I would want the consequences of this will be on the economic and financial system.
From 1985 to 2000 (171-month period), the S&P 500 grew 789.67%. Between 2000 and March 2014 (170-month period), the S&P 500 grew 19.95%. More troubling, the contemporary trend shows a major sell-off after 63-month periods. From 1995 to 2000 (63 months, exact beginning and end months are unknown) the market grew 235.72% before crashing. Over the next 63-month period between 2002 and 2007 grew 102.09%. Currently we are at month 61 and the market had grown 182.46% during this interval.
Why are billionaires dumping stocks? This might be a good article to read.