Friday, 20th of July 2018
Another hot day of summer. Japan is baking under a sweltering heat-wave, it is hot here too… We will start our Newsletter with an interesting and timely quote out of last week’s Economist- ‘Bears sound clever; bulls make money. This piece of financial acumen, imparted by a trader to a colleague, is hard to beat for brevity. It also makes a good point. There is something about market pessimism that endows bears with an aura of wisdom that is not always deserved. The cautious sound clever because they appear to have weighted the odds. Optimists seem heedless by comparison. Yet it is only by taking on risk that investors can hope to make money’.
Perhaps the desire to appear clever drives analysts in consistently underestimating corporate earning? We here on the other hand are naturally optimistic and are willing to pay the price of being considered silly. We are believers in the “Efficient Frontier” theory put forth by Markowitz way back in 1952- An upwards sloping curve traced between Risk (X scale) and Reward (Y scale); The more risk taken, moving to the right of the ‘X’ scale, the higher the expected return found on the ‘Y’ scale. Any investment showing a risk/reward profile placing it on this curve is efficient. You want to be above the curve, where you earn more than the implicit risk taken suggest you should.
Our optimism under this sun rests on some reassuring information- Fed Chairman Powell delivered his semi-annual testimony to Congress this week, starting with an appearance Tuesday before the Senate Committee on Banking, Housing and Urban Affairs. In remarks he provided ahead of a question-and-answer session, Powell painted a largely positive picture of the economy, which he said is expanding at an increasing pace and is being boosted by aggressive fiscal policy on Capitol Hill. “Overall, we see the risk of the economy unexpectedly weakening as roughly balanced with the possibility of the economy growing faster than we currently anticipate,” Powell said. “The unemployment rate is low and expected to fall further. Americans who want jobs have a good chance of finding them,” he added. Powell spoke as the central bank is in the process of gradually raising interest rates. The policymaking Federal Open Market Committee has hiked the Fed’s benchmark rate twice this year in quarter-point increments and is expected to approve two more increases before the end of the year. Inflation is running around the Fed’s 2% target for the first time in several years, while the unemployment rate is at 4% and consistent with a level that most economists consider near to full employment. Powell said wages are growing faster than a year ago but not enough to stoke inflation fears. Powell made brief mention of the ongoing trade war between the U.S. and its global competitors, saying only that it is “difficult to predict” what the ramifications will be on the economy.
However, the “upbeat tone” from the testimony likely means the trade issues won’t keep the Fed from hiking rates, said Andrew Hunter, U.S. economist at Capital Economics.
Don’t you just love statistics? The Fed as other central banks are all trying to bring inflation up to the 2% level. And have failed, so far. In a way this is explainable when one looks at the data- Though total aggregate national income is up somewhat, real wage gains have at best stagnated for most. More than 50% of income gains from 2009 to 2015 went to the wealthiest 1 percent of Americans, according to Emmanuel Saez of the University of California at Berkeley. The New York Times reported in 2016 that the median American family still makes hardly more than in the 1990s. So if revenue stagnates, what can push prices up? And inflation at under 2% believe it if you want to; Since 2000, costs of essentials have increased dramatically, according to the St. Louis Fed. Educational costs are up 132.8%, housing 59.5%, healthcare 53.4%, and food 51.6%. Over the same period, real median wages for full-time employed earners are up only 4.8%. The problem lies with the numbers. The common measures used to explain our economy’s health, from a macroeconomic perspective, paint a misleading picture. At the heart of the problem is the difference between the aggregate and the individual. If Bill Gates, whose net worth is north of $90 billion, moved into a struggling Detroit neighbourhood, we would measure the average wealth in his new ZIP code as being phenomenally higher in the year he moved than in the year prior. But incomes for many – in Detroit, the per capita annual income is $15,562 – wouldn’t have changed. You do remember the Professor of statistics who drowned in a pool with an average depth of 20cm? 😉
This brings us back to last month’s jobs numbers. And GDP. And the stock market. They clearly tell us the economy is strong, but we need real facts that help our policymakers understand how our society is faring in this economy. We need the Fed and other governmental bodies to use new measures that bring the economic reality facing our country into focus. Because if policymakers can’t see there’s a problem, how will they know what to fix? We look at all this through our optimist-goggles and see huge growth potential from the inevitable, eventual increases of purchasing power of the masses… We can only hope that the needed redistribution of wealth will occur gradually and not in the rather brusque Robespierre and Trotsky versions.
Philosophical musings aside, well, one more first- This time is different. We consider those the four most dangerous words in economics. Today, policymakers are paying increased attention to the so-called flattening yield curve — the difference in yields between long-term and short-term Treasury bonds. For the past 50 years, an inverted yield curve, where short rates are higher than long rates, has been an excellent predictor of a U.S. recession. In fact, during this half-century period, each time the yield curve has inverted, a recession has followed. Over the past two-and-a-half years, as the Federal Reserve has raised short-term interest rates, the yield curve has flattened dramatically, with the difference between 10-year and two-year Treasuries down from 134 basis points in December 2016 to 25 basis points today, a 10-year low. Some say, “No. This time is different,” and that the flattening yield curve is not a concern. The truth is we don’t know for sure. But we do know the bond market is telling us that inflation expectations appear well-anchored, the economy is not showing signs of overheating and rates are already close to neutral. This suggests that there is little reason to raise rates much further, invert the yield curve, put the brakes on the economy and risk that it does, in fact, trigger a recession. Well, we succeeded to get this far down our ramblings ‘de la semaine’ without mentioning the “T” word… but here we must- Maybe President Trump was right when he just yesterday criticized the Fed for their rate increases? The primary reason some policymakers argue that this time is different is because the “term premium” is low today, and so they argue that comparisons to past yield curve inversions are misplaced. If the term premium were at its historical average, these policymakers say, the yield curve would be steeper and an inversion would be further off. This is the same argument some policymakers made in late 2006 to explain why they didn’t worry about the then-inverted yield curve. We now know the Great Recession followed that inversion. Deciphering the many signals from financial markets is not an exact science. But declarations that “this time is different” should be a warning that history might be about to repeat itself.
Historian Yuval Harari says the study of the past has taught him an important lesson for the future. “One things that history teaches us is that we should never underestimate human stupidity,” said Harari, a professor at The Hebrew University of Jerusalem.
We break again with our habits, not to say tradition and will conclude with two quotes;
“Patience is the companion of wisdom”, Saint Augustine. Which leads well into J.P. Morgan’s quip “A man always has two reasons for doing anything: a good reason and the real reason”.
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